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, 2007

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, 2007 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $14,220,379 based upon a total of 1,736,310 shares held as of June 30, 2007 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 20, 2008, there were 11,217,914 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.    12
Item 1B.    Unresolved Staff Comments    17
Item 2.    Properties.    18
Item 3.    Legal Proceedings.    23
Item 4.    Submission of Matters to a Vote of Security Holders.    24
   PART II   
Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.    25
Item 6.    Selected Financial Data.    28
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operation.    29
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk.    41
Item 8.    Financial Statements and Supplementary Data.    42
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.    97
Item 9A(T).    Controls and Procedures.    97
Item 9B.    Other Information.    98
   PART III   
Item 10.    Directors, Executive Officers and Corporate Governance.    99
Item 11.    Executive Compensation.    107
Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    108
Item 13.    Certain Relationships and Related Transactions, and Director Independence.    109
Item 14.    Principal Accountant Fees and Services.    111
   PART IV   
Item 15.    Exhibits and Financial Statement Schedules.    114
Signature Page    116

 

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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”.

PART I

 

ITEM 1. BUSINESS

General

As used herein, the terms “ARI,” “the Company,” “we,” “our” or “us” refer to American Realty Investors, Inc., a Nevada corporation, individually or together with its subsidiaries. The Company’s common stock trades on the New York Stock Exchange under the symbol “ARL”. ARI is a “C” corporation for U.S. federal income tax purposes. ARI was organized in 1999. In August 2000 the Company 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 in 1961. The business trust was merged into ART in 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.

ARI subsidiaries own approximately 80.2 percent of the outstanding shares of common stock of Transcontinental Realty Investors, Inc., a Nevada corporation (“TCI”) whose common stock is traded on the New York Stock Exchange under the symbol “TCI”. TCI owns approximately 24.88% of the outstanding common shares of Income Opportunity Realty Investors, Inc., (“IORI”) whose common stock is traded on the American Stock Exchange under the symbol “IOT”. ARI’s ownership of the TCI shares was achieved through a series of transactions, including a cash tender offer completed in 2003, an exchange by certain ARI subsidiaries of securities with Basic Capital Management, Inc. (“BCM”) and a sale of a participating interest in certain loans made by One Realco Corporation (“One Realco”) to BCM, as well as certain open market purchases of TCI shares in 2003. BCM and One Realco are companies affiliated with ARI. ARI has consolidated TCI’s accounts and operations since March 2003.

ARI’s contractual Advisor is Prime Income Asset Management, LLC (“Prime”), the sole member of which is Prime Income Asset Management, Inc., a Nevada corporation (“PIAMI”). PIAMI is owned by Realty Advisors, Inc. (“RAI”)(80%) and Syntek West, Inc. (“SWI”)(20%), SWI is owned by Gene E. Phillips, Realty Advisors, Inc. is owned by a Trust for the benefit of the children of Gene E. Phillips (the “Trust”). Gene E. Phillips is an officer and director of SWI and serves as a representative of the Trust. While Mr. Phillips is not an officer or director of ARI, he does periodically consult with the executive officers and directors of ARI rendering advice and input with respect to investment decisions affecting ARI. PIAMI also owns approximately 14.9% of the common stock of ARI and approximately 7.4% of the Series A 10% cumulative convertible preferred Stock of ARI.

ARI’s Board of Directors represents the Company’s shareholders and is responsible for directing the overall affairs of ARI and for setting the strategic policies that guide the Company. The Board of Directors has delegated the day-to-day management of the Company to Prime Income Asset Management, LLC (“Prime”) under a written advisory agreement that is reviewed annually by ARI’s Board of Directors.

 

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Prime is a limited liability company whose sole member is a Nevada corporation indirectly owned 80 percent by the Trust and 20 percent by another Nevada corporation wholly-owned by Mr. Phillips. Prime owns approximately 13 percent of the outstanding common stock of ARI. Prime’s duties include but are not limited to locating, evaluating and recommending real estate and real estate-related investment opportunities. Prime also arranges, for ARI’s benefit, debt and equity financing with third party lenders and investors. Prime is compensated by ARI under an advisory agreement that is more fully described in Part III, Item 10, “Directors, Executive Officers and Corporate Governance”.

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. One 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, LP. (“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 Prime Income Asset Management, Inc. (“PIAMI”). The limited partner of Triad is Highland Realty Services, Inc. (“HRS Holdings LLC (“HRSHLLC”). Triad subcontracts the property-level management and leasing our commercial properties (shopping centers, office buildings, and industrial warehouses) to Regis Realty I, LLC (“Regis I”) which is owned by HRSHLLC. 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 our hotels. The sole member of Regis I and Regis Hotel I, LLC is HRSHLLC. 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, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.”

ARI’s primary business is the acquisition, development and ownership of income-producing residential, hotel and commercial real estate properties. In addition, ARI opportunistically acquires land for future development in in-fill or high-growth suburban markets. From time to time and when we believe it appropriate to do so, we will also sell land and income-producing properties. We generate revenues by leasing apartment units to residents; leasing office, industrial and retail space to various for-profit businesses as well as certain local, state and federal agencies; leasing trade show and exhibit space to temporary as well as long-term tenants; and renting hotel rooms to guests. We also generate revenues from gains on sales of income-producing properties and land. At December 31, 2007, our income-producing properties consisted of:

 

   

5.9 million rentable square feet of commercial properties, including 18 office buildings, 7 industrial properties, 5 retail properties and a four-story, 344,975 square-foot trade show and exhibit hall located in Denver, Colorado

 

   

69 residential apartment communities comprising almost 12,788 units

 

   

Nine hotels comprising 1,125 rooms

Subsequent to the year ended, we purchased and sold various properties. See NOTE 22 Subsequent Events.

 

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The following table sets forth the location of our real estate held for investment (income-producing properties only) by asset type as of December 31, 2007:

 

     Apartments    Commercial    Hotels

Location

   No.    Units    No.    SF    No.    Rooms

Greater Dallas-Ft. Worth, TX

   18    3,825    13    2,769,587    —      —  

Greater Houston, TX

   9    2,202    —      —      —      —  

Midland-Odessa, TX

   15    2,457    —      —      —      —  

San Antonio, TX

   4    1,112    1    101,500    —      —  

Other Texas

   6    1,193    —      —      —      —  

Mississippi

   7    450    —      —      —      —  

Arkansas

   3    428    —      —      —      —  

Florida

   3    322    —      —      —      —  

New Orleans, LA

   —      —      6    1,369,388    —      —  

Denver, CO

   —      —      2    419,791    1    161

Fresno, CA

   —      —      —      —      4    647

Chicago, IL

   —      —      —      —      3    152

Other

   4    799    9    1,241,305    1    165

Totals

   69    12,788    31    5,901,571    9    1,125
                             

We finance our acquisitions primarily through operating cash flow, proceeds from the sale of land and income-producing properties and debt financing primarily in the form of property-specific first-lien mortgage loans from commercial banks and institutional lenders. We finance our development projects principally with short-term, variable-rate construction loans that are refinanced with the proceeds of long-term, fixed-rate amortizing mortgages when the development has been completed and occupancy has been stabilized. When we sell properties, we may carry a portion of the sales price generally in the form of a short-term, interest bearing seller-financed note receivable, secured by the property being sold. We may also from time to time enter into partnerships or joint ventures with various investors to acquire land or income-producing properties or to sell interests in certain of our properties.

We partner with various third-party development companies to construct residential apartment communities. The third-party developer typically holds a general partner as well as a limited partner interest in a limited partnership formed for the purpose of building a single property while we generally take a limited partner interest in the limited partnership. We may contribute land to the partnership as part of our equity contribution or we may contribute the necessary funds to the partnership to acquire the land. We are required to fund all required equity contributions while the third-party developer is responsible for obtaining construction financing, hiring and a general contractor and for the overall management, successful completion and delivery of the project. We generally bear all the economic risks and rewards of ownership in these partnerships and therefore include these partnerships in our consolidated financial statements. The third-party developer is paid a developer fee typically equal to a percentage of the construction costs. When the project reaches stabilized occupancy, we acquire the third-party developer’s partnership interests in exchange for any remaining unpaid developer fees.

 

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At December 31, 2007, our projects in development included:

 

Property

  Location   No. of
Units
  Costs to
Date
  Total
Projected
Costs

Bolivar Homes

  Cleveland, MS   65   $ 5,273   $ 8,613

Broadway Estates

  Greenville, MS   104     4,385     8,362

Dorado Ranch

  Odessa, TX   224     2,690     19,137

Huntington Ridge—Desoto

  Desoto, TX   198     13,691     17,873

Lakeview @ Pecan Creek/Preserve

  Denton, TX   192     5,296     18,008

Lincoln Estate I

  Leake County, MS   55     1,536     7,708

Longfellow Arms

  Longview, TX   216     12,684     16,672

Mansions of Mansfield

  Mansfield, TX   208     5,618     18,687

Mason Park

  Houston, TX   312     14,436     23,018

Northside of Travis

  Sherman, TX   200     2,078     16,999

Parc at Rogers

  Rogers, AR   250     22,205     24,192

Parc at Clarksville

  Clarksville, TN   168     14,291     14,291

Parkway Place

  Greenwood, MS   65     1,369     16,999

Pecan Pointe

  Temple, TX   232     17,643     19,526

Portafino—Lago Vista

  Farmer’s Branch, TX   212     20,078     26,450

Sunflower Estates

  Indianola, MS   65     4,266     8,435

Yazoo Estates

  Yazoo City, MS   96     4,101     8,351

Castleglen

  Garland, TX   150     760     11,380

Pioneer Crossing

  Austin, TX   240     814     22,000
                 
    3,252   $ 153,214   $ 306,701
                 

Our Subsidiary, TCI, has formed a number of joint ventures with Icon Partners, LLC (“Icon”) to develop various residential, commercial and mixed-use projects. The subsidiary typically owns 75 percent of these joint ventures, arranges for and guarantees all debt financing and provides all required equity capital. The terms of the joint ventures also allow our subsidiary to receive its cumulative investment plus a preferred return before Icon receives any equity distribution. Icon provides various development and project management services to the joint ventures and is paid monthly developer fees for those services. We include these joint ventures in the Company’s consolidated financial statements and record a minority interest for Icon’s equity in the venture.

We have made substantial investments in a number of large tracts of undeveloped and partially developed land and intend to a) continue to improve these tracts of land for our own development purposes or b) make the improvements necessary to ready the land for sale to other developers.

At December 31, 2007, our investments in undeveloped and partially developed land consisted of the following:

 

Property

  

Location

   Date(s)
Acquired
   Acres    Cost   

Primary

Intended Use

Mercer Crossing

   Dallas, TX    1996-2007    772    108,230    Mixed use

Windmill Farms

   Dallas, TX    2006    3,035    55,881    Single-family residential

Pioneer Crossing

   Austin, TX    1997-2005    760    33,935    Multi-family residential

Circle C Ranch

   Austin, TX    2006    1,092    32,669    Single-family residential

McKinney Ranch

   Dallas, TX    1997-2005    306    26,385    Mixed use

Las Colinas Multi-Tracts

   Dallas, TX    1995-2006    277    23,238    Commercial

Dallas North Tollway

   Dallas, TX    2006    17    15,905    Commercial

Mandhal Bay

   St. Thomas, USVI    2005    91    14,710    Single-family residential

Kaufman County

   Dallas, TX    2000-2005    2,633    13,001    Single-family residential

Waco Multi-Tracts

   Waco, TX    2005-2006    545    5,469    Single-family residential

Meloy Portage

   Kent, OH    2004    53    5,119    Multi-family residential

Jackson Convention Center

   Jackson, MS    2007    2    3,848    Mixed use

Beltine-Geller Road

   Dallas, TX    2007    379    2,888    Commercial
                  

Subtotal

         9,962    341,278   

Other land holdings

   Various    1990-2007    912    48,714    Various
                  

Total land holdings

         10,874    389,992   
                  

 

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In addition, we own 1) a non-controlling 20 percent interest in Milano Restaurants International, which operates and franchises several quick service restaurant concepts in California and 2) various other interests in real estate and real-estate related entities. We generally use the equity method to account for these investments.

Transactions during 2007

Land and income producing properties acquired during 2007 consisted of:

 

Property

  Acres/ SF/
Units
 

Location

 

Property Type/

Intended Use

  Date
Acquired
  Purchase
Price
  Debt
Incurred
  Annual
Interest
Rate
    Fixed/
Variable
  Maturity
Date

Income-Producing Properties:

                 

Parkwest I

  383,000SF   Dallas, TX   Office   Jan-07     40,604     35,000   6.06 %   Fixed   Jan-08

Parkwest II

  708,000SF   Dallas, TX   Office   Jan-07     69,694     62,000   9.32 %     Jan-08

Thornwood(1)

  109Units   Midland, TX   Multi-family residential       1,895     1,638      

Subtotal

            112,193     98,638      

Land:

                 

Keller Springs

  6Acres   Dallas, TX   Multi-family residential   Jan-07     2,646     2,021   8.25 %   Prime + 100 bps   8-Feb

Audubon Terrace(2)

  29Acres   Natchez, MS   Multi-family residential   Mar-07          

Waco 151

  151Acres   Waco, TX   Single-family residential   Apr-07     2,106     1,300   8.25 %   Prime + 100 bps   10-Apr

Senlac Road

  4Acres   Dallas, TX   Commercial   Apr-07     1,005     —     NA     NA   NA

Hines Meridian

  40Acres   Dallas, TX   Commercial   May-07     8,490     5,000   9.25 %   Fixed   10-Jun

William Sprowles

  1Acres   Dallas, TX   Commercial   Jun-07     288     —     NA     NA   NA

Jackson Convention Center

  2Acres   Jackson, MS   Mixed use   Jul-07     3,848     —     NA     NA   NA

Dorado Ranch

  11Acres   Odessa, TX   Multi-family residential   Jul-07     733     467      

Austin Landing

  11Acres   Sherman, TX   Multi-family residential   Oct-07     1,301     950   5.35 %     9-Feb

Denham Springs

  16Acres   Denham Springs, LA   Multi-family residential   Oct-07     1,350     892      

Beltline-Geller Road

  379Acres   Dallas, TX   Commercial   Nov-07     2,782     1,909      

Subtotal

            24,549     12,539      

Total

          $ 136,742   $ 111,177      

 

(1) Acquired from an affiliated company.
(2) Currently undergoing development.

 

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Significant Real Estate Acquisitions / Dispositions and Financings

The highlights of the twelve months ended December 31, 2007 included the following:

On January 1, 2007, we obtained a $7.0 million loan secured by 109 acres of land in Farmers Branch, Texas known as the Manhattan land. We received $6.6 million in cash after paying closing costs.

On January 17, 2007, we refinanced the existing $3.6 million mortgage on City Suites Hotel in Chicago, Illinois for a new note of $7.3 million. We received $3.3 million in cash after paying down the existing debt and closing costs.

On January 19, 2007, we acquired a 383,114 and a 707,599 square foot office building in Farmers Branch, Texas known as Park West I and Park West II, respectively and a 4.7-acre tract of undeveloped land at an aggregate purchase price of $110.2 million. The acquisition was financed with $10.1 million in cash and $97.0 million in new debt. Two separate notes were obtained on this acquisition; a $35.0 million note which accrues interest at 6.06% maturing January 2009 and a $62.0 million note which accrues interest at a variable rate (currently 9.32%) maturing January 2013.

On February 16, 2007, we sold the Bluffs at Vista Ridge a 272-unit apartment complex in Lewisville, Texas for $24.6 million. The proceeds were used to pay down the existing mortgage of $15.5 million receiving $9.1 million in cash. A gain of $3.6 million was recorded on this sale.

On February 23, 2007, we obtained a $5.0 million loan secured by 97 acres of Pioneer Crossing land located in Austin, Texas. The note accrues interest at prime plus 1% and matures February 23, 2008.

On March 5, 2007, we refinanced the existing $3.1 million and $3.4 million mortgage on the Majestic Hotel and Willows Hotels with a new note for $6.0 million and $5.2 million, respectively with a single lender. We received cash in aggregate of $4.4 million after pay off of existing notes and closing costs. The Hotels are located in Chicago, IL, the Majestic is a 55-room hotel and the Willows is a 52 room Hotel. The notes accrue interest at 7.76% and matures March in 2010.

On March 16, 2007, we refinanced with a single lender three existing mortgage totaling $11.6 million on three hotels located in Fresno, California; the Piccadilly Chateau, Piccadilly Shaw, and Piccadilly Airport totaling 457 rooms for new debt totaling $28.7 million. We received $14.7 million in cash, after paying off the existing debt and $ 2.4 million in closing costs and early payment penalties. The new note accrues interest at 8% and matures on February 2012.

On April 30, 2007, we refinanced the existing debt of $7.1 million on the Whispering Pines Apartments, a 320-unit complex in Topeka, Kansas for a new note of $8.3 million, receiving $1.0 million in cash. The new note accrues interest at 7.0% and matures in April 2008.

On May 3, 2007, we obtained a loan for $12.0 million receiving $11.2 million in cash. The loan is secured by 257 acres of land in Austin, Texas known as Pioneer Crossing. The loan accrues interest at 10.25% and matures in May 2008.

On May 8, 2007, we acquired 40.1 acres of land in Las Colinas, Texas known as Hines Meridian for $8.4 million. The purchase was financed with $2.9 million in cash and a note payable of $5.0 million. The note accrues interest at 9.25% and matures in June 2010.

On May 31, 2007, we refinanced the existing debt of $12.2 million on the Hickory IV building, a 221,000 square foot commercial building in Farmers Branch, Texas for a new note of $26.0 million. The note accrues interest at 8.67% and matures in May 2009.

 

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On June 6, 2007, we refinanced $12.4 million in existing mortgages with a single commercial lender. The mortgages relate to eight different apartment complexes; Arbor Pointe, Courtyard, Coventry Point, Fountains at Waterford, Southgate, Sunchase, Thornwood, and Westwood Square Apartments totaling 1,287 units, located throughout Midland and Odessa, Texas. The new loans total $33.2 million. We received $16.0 million in cash after paying down property debt and defeasance costs totaling $4.1 million. The notes accrue interest at 7.03% and mature in July 2037. All eight of these apartments were sold, subsequent to year end.

On June 26, 2007, we sold the Durham office building, a 207,171 square foot commercial building located in Durham North Carolina for $19.2 million, recording a gain of $1.7 million. We received $3.4 million in cash after paying off the existing debt and closing costs.

On June 28, 2007, we refinanced the existing $2.9 million mortgage on Sunset Apartments, a 240-unit complex located in Odessa, Texas with a new note of $5.5 million. We received $1.3 million in cash after paying off the existing debt and closing costs. The new note accrues interest at prime plus 25 basis points and matures on September 2008.

On July 6, 2007, we refinanced the existing $2.9 million mortgage on seven tracts of land located in and around Dallas, Texas with a new note for $8.4 million. We received 5.3 million in cash, after paying down the existing debt and $200,000 in closing costs. The note accrues interest at 8.6% and matures on August 10, 2009.

On July 27, 2007, we sold the Forum Office Building in Richmond, Virginia, a 79,791 square foot commercial building, for $9.4 million, recording a $3.4 million gain on sale. We received $3.1 million in cash after paying off the $5.9 million mortgage and $400,000 in closing costs.

On August 30, 2007, we refinanced the existing $13.3 million mortgage on the Amoco building, a 378,895 square foot commercial building located in New Orleans, LA, with a new note for $19.5 million receiving $4.6 million in cash after paying closing costs, accrued interest and fees. The new note accrues interest at LIBOR plus 400 points, currently 8.1%. The note is payable in monthly payments of interest only through September 1, 2008 at which time all accrued and unpaid interest and outstanding principal or due. The note contains a provision to extend the maturity date to September 1, 2010 with an increase in the interest rate of LIBOR plus 425 points for the first extension and LIBOR plus 450 basis points for the second extension.

On September 27, 2007, we sold 2.2 acres of land in Dallas Texas, known as the West End Land, for $6.5 million, recording a gain of $3.8 million. We received $2.3 million in cash after paying of the existing debt of $3.8 million.

On September 28, 2007, we refinanced three existing mortgages totaling $32.7 million on three apartment complexes; Limestone Ranch, Limestone Canyon, and Tivoli, located through Texas with a single lender for a new note of $38.7 million. We received $3.5 million in cash after paying down the existing debt and $2.5 million in closing costs.

On November 4, 2007, we sold the El Chaparral Apartments, a 190-unit community complex, in San Antonio, Texas for $5.5 million, recording a gain of $3.9 million on the sale. We received $1.0 million in cash after paying off the $3.9 million mortgage and $600,000 in closing costs and commissions.

On November 29, 2007, we sold the Atlantic Sands Hotel, a 110-room hotel located in Virginia Beach, Virginia, for $12.0 million. We provided $2.0 million in seller financing, and recorded a gain on sale of $5.4 million. We received cash proceeds of $7.4 million, after paying down the existing $3.1 million mortgage, closing costs, and commissions.

On November 27, 2007, we sold the Arlington Place Apartments, a 230-unit apartment complex, located in Houston, Texas for $5.8 million, recording a gain on sale of $4.8 million. We received $1.6 million in cash after pay off of the existing $3.9 million mortgage and $300,000 in closing costs and commissions.

 

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On November 28, 2007, we sold the Woodlake Apartments, a 256-unit apartment complex, located in Carrollton, Texas for $10.8 million, recording a gain on sale of $8.4 million. We received $2.5 million in cash after paying off the $7.8 million mortgage and $500,000 in closing costs and commissions.

On December 12, 2007, we refinanced the existing $7.8 million note on 80.6 acres of land in McKinney, Texas known as McKinney Ranch Land with a new note for $8.0 million with a commercial lender. We received approximately $2,600 in cash after paying off the existing debt and closing costs. The new note is payable in monthly installments of interest only. The note accrues interest at prime plus 2.5%, which was 10% at December 31, 2007. The principal and all unpaid and accrued interest are due and payable on maturity, December 1, 2010.

On December 19, 2007, we sold the Harpers Ferry apartments, a 122-unit complex, in Lafayette, Louisiana for $5.5 million, recording a gain on sale of $3.6 million. We received $1.6 million in cash after pay off of the existing $3.0 million mortgage, $500,000 in early payment penalties and $400,000 in closing costs.

Business Plan and Investment Policy

Our business objective is to maximize long-term value for our stockholders by investing in commercial real estate through the acquisition, development and ownership of apartments, commercial properties, hotels, and land. We intend to achieve this objective through acquiring and developing properties in multiple markets and operating as an industry-leading landlord. We believe this objective will provide the benefits of enhanced investment opportunities, economies of scale and risk diversification, both in terms of geographic market and real estate product type. We believe our objective will also result in continuing access to favorably priced debt and equity capital. In pursuing our business objective, we seek to achieve a combination of internal and external growth while maintaining a strong balance sheet and employing a strategy of financial flexibility. We maximize the value of our apartments and commercial properties by maintaining high occupancy levels while charging competitive rental rates, controlling costs and focusing on tenant retention. We also pursue attractive development opportunities either directly or in partnership with other investors.

For our portfolio of commercial properties, we generate increased operating cash flow through annual contractual increases in rental rates under existing leases. We also seek to identify best practices within our industry and across our business units in order to enhance cost savings and gain operating efficiencies. We employ capital improvement and preventive maintenance programs specifically designed to reduce operating costs and increase the long-term value of our real estate investments.

We seek to acquire properties consistent with our business objectives and strategies. We execute our acquisition strategy by purchasing properties which management believes will create stockholder value over the long-term. We 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.

We are 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 of our properties are owned by subsidiary companies, many of which are single-asset entities. This ownership structure permits greater access to financing for individual properties and permits flexibility in negotiating a sale of either the asset or the equity interests in the entity owning the asset. From time-to-time, our subsidiaries have invested in joint ventures with other investors, 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 our objectives, which may in turn require us to make investment decisions different from those if we were the sole owner.

Real estate generally cannot be sold quickly. We 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 our strategy to

 

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maintain an efficient investment portfolio and to provide additional sources of capital. We 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. We may purchase properties by assuming existing loans secured by the acquired property. When properties are acquired in such a manner, we customarily seek to refinance the asset in order to properly leverage the asset in a manner consistent with our investment objectives.

Our businesses are not generally seasonal with regard to real estate investments. Our investment strategy seeks both current income and capital appreciation. Our plan of operation is to continue, to the extent our liquidity permits, to make equity investments in income-producing real estate such as hotels, apartments, and commercial properties. We may also invest in the debt or equity securities of real estate-related entities. We intend to pursue higher risk, higher reward investments, such as improved and unimproved land where we can obtain reasonably-priced financing for substantially all of a property’s purchase price. We intend to continue the development of apartment properties in selected markets in Texas and in other locations where we believe adequate levels of demand exist. We intend to pursue sales opportunities for properties in stabilized real estate markets where we believe our properties’ value has been maximized. We also intend to be an opportunistic seller of properties in markets where demand exceeds current supply. Although we no longer actively seek to fund or purchase mortgage loans, we may, in selected instances, originate mortgage loans or we may provide purchase money financing in conjunction with a property sale.

Our Board of Directors has broad authority under our governing documents to make all types of investments, and we may devote available resources 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 our real estate portfolio owned by ARI directly and through our 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. We intend to maintain a real estate portfolio that is diversified by both location and type of property.

Competition

The real estate business is highly competitive and ARI competes with numerous companies engaged in real estate activities (including certain entities described in ITEM 13. “Certain Relationships and Related Transactions, and Director Independence.”), some of which have greater financial resources than ARI. We believe that success against such competition is dependent upon the geographic location of a property, the performance of property-level managers in areas such as leasing and marketing, collection of rents 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 a 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. We believe 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 owners 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, AND DIRECTOR INDEPENDENCE,” the officers and directors of ARI serve as officers and directors of TCI,

 

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the officers of ARI serve as the officers of IORI and one director of ARI is also a director 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 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, as described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE,” ARI competes with affiliates of Prime having similar investment objectives related to the acquisition, development, disposition, 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.

We have historically engaged in and will continue to engage in certain business transactions with related parties, including but not limited to asset acquisitions and dispositions. Transactions revolving related parties cannot be presumed to be carried out on an arm’s length basis due to the absence of free market forces that naturally exist in business dealings between two or more unrelated entities. Related party transactions may not always be favorable to our business and may include terms, conditions and agreements that are not necessarily beneficial to or in the best interests of our company.

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.

 

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 our Business

Adverse events concerning our existing tenants or negative market conditions affecting our existing tenants could have an adverse impact on our ability to attract new tenants, release 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. We 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 properties are located;

 

   

inability to retain existing tenants and attract new tenants;

 

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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 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, we may not be able to rent the space. Furthermore, leases that are renewed, and some new leases for space that is re-let, may have terms that are less economically favorable than expiring lease terms, or may require us 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 our ability to make distributions to shareholders and service indebtedness. A significant portion of the costs of owning property, such as real estate taxes, insurance, and debt service payments, are not necessarily reduced when circumstances cause a decrease in rental income from the properties.

We may not be able to compete successfully with other entities that operate in our industry.

We experience a great deal of competition in attracting tenants for the properties and in locating land to develop and properties to acquire.

In our effort to lease properties, we compete for tenants with a broad spectrum of other landlords in each of the markets. 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 we are able to offer.

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

We may experience increased operating costs which could adversely affect our financial results and the value of our properties.

Our 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 are obligated by their leases to reimburse us 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 our markets, we 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, our ability to make distributions to shareholders and service indebtedness could be adversely affected.

Our ability to achieve growth in operating income depends in part on its ability to develop additional properties.

We intend to continue to develop properties where warranted by market conditions. We have a number of ongoing development and land projects being readied for commencement.

 

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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;

 

   

we 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 us to abandon our activities entirely with respect to a project;

 

   

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

 

   

we 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.

We face risks associated with property acquisitions.

We acquire individual properties and various portfolios of properties and intend to continue to do so. Acquisition activities are subject to the following risks:

 

   

when we are 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 we face 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;

 

   

we 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.

We 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, we might be required to pay substantial sums to settle it, which could adversely affect cash flow.

Many of our properties are concentrated in our primary markets and the Company may suffer economic harm as a result of adverse conditions in those markets.

Our 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.

 

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We are leveraged and may not be able to meet our debt service obligations.

We had total indebtedness at December 31, 2007 of approximately $1.2 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. Our leveraged position makes us vulnerable to declines in the general economy and may limit the Company’s ability to pursue other business opportunities in the future.

We may not be able to access financial markets to obtain capital on a timely basis, or on acceptable terms.

We rely 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 that we 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;

 

   

our 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 similar properties.

We may suffer adverse effects as a result of terms and covenants relating to the Company’s indebtedness.

Required payments on our 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, we 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.

We anticipate only a small portion of the principal of its debt will be repaid prior to maturity. Therefore, we are likely to refinance a portion of its outstanding debt as it matures. There is a risk that we 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.

Our 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 we must maintain. our 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 we 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.

Our degree of leverage could limit our ability to obtain additional financing or affect the market price of our common stock.

The degree of leverage could affect our ability to obtain additional financing for working capital, capital expenditures, acquisitions, development or other general corporate purposes. The degree of leverage could also make us more vulnerable to a downturn in business or the general economy.

 

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An increase in interest rates would increase interest costs on variable rate debt and could adversely impact the ability to refinance existing debt.

We currently have, and may incur more, indebtedness that bears interest at variable rates. Accordingly, if interest rates increase, so will the interest costs, which could adversely affect cash flow and the ability to pay principal and interest on our debt and the ability to make distributions to shareholders. Further, rising interest rates could limit our 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, we 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.

We may need to sell properties from time to time for cash flow purposes.

Because of the lack of liquidity of real estate investments generally, our ability to respond to changing circumstances may be limited. Real estate investments generally cannot be sold quickly. In the event that we must sell assets to generate cash flow, we cannot predict whether there will be a market for those assets in the time period desired, or whether we will be able to sell the assets at a price that will allow the Company to fully recoup its investment. we 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.

We plan 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:

 

   

we 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;

 

   

we 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;

 

   

we 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.

We are 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:

 

   

our 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;

 

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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;

 

   

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.

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. We 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 our 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 our ability to meet our obligations.

 

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2.     PROPERTIES

On December 31, 2007, our portfolio consisted of 110 properties totaling 5.9 million rentable square feet. Our properties consisted of 69 apartments, 9 hotels, and 32 commercial properties consisting of; 18 office buildings, 7 Industrial warehouses, 5 shopping centers, a Merchandise Mart and a Town home. In addition, we own or control 11,000 acres of improved and unimproved land for future development or sale, 19 apartments under construction totaling approximately 3,252 rentable units upon completion. The table below shows information relating to those properties.

 

Property

  Location   Units   Occupancy
% 2007
 

Apartments

     

Anderson Estates

  Oxford, MS   48   98 %

Blue Lake Villas

  Waxahachie, TX   186   94 %

Blue Lake Villas II

  Waxahachie, TX   70   94 %

Breakwater Bay

  Beaumont, TX   176   96 %

Bridges on Kinsey

  Tyler, TX   232   98 %

Bridgestone

  Friendswood, TX   76   99 %

Capitol Hill

  Little Rock, AR   156   94 %

Château

  Bellevue, NE   115   94 %

Château Bayou

  Ocean Springs, MS   122   99 %

Curtis Moore

  Greenwood, MS   104   98 %

Dakota Arms

  Lubbock, TX   208   98 %

David Johnson Phase II

  Greenwood, MS   32   91 %

David Johnson Phase III

  Greenwood, MS   40   98 %

DeSoto Ranch

  DeSoto, TX   248   96 %

Fairway View Estates

  El Paso, TX   264   93 %

Falcon Lakes

  Arlington, TX   248   94 %

Fountain Lake

  Texas City, TX   166   90 %

Foxwood

  Memphis, TN   220   81 %

Heather Creek

  Mesquite, TX   200   94 %

Kingsland Ranch

  Houston, TX   398   92 %

Laguna Vista

  Dallas, TX   202   92 %

Lake Forest

  Houston, TX   240   93 %

Legends of El Paso

  El Paso, TX   240   87 %

Limestone Canyon

  Austin, TX   260   95 %*

Limestone Ranch

  Lewisville, TX   252   95 %*

Mariposa Villas

  Dallas, TX   216   91 %

Mission Oaks

  San Antonio, TX   228   93 %

Monticello Estates

  Monticello, AR   32   97 %

Mountain Plaza

  El Paso, TX   188   98 %

Paramount Terrace

  Amarillo, TX   181   92 %

Parc at Maumelle

  Little Rock, AR   240   92 %

Parc at Metro

  Nashville, TN   144   98 %

Quail Oaks

  Balch Springs, TX   131   92 %

River Oaks

  Wylie, TX   180   97 %

Riverwalk I

  Greenville, MS   32   91 %

Riverwalk II

  Greenville, MS   72   96 %

Sendero Ridge

  San Antonio, TX   384   92 %*

Spy Glass

  Mansfield, TX   256   93 %

Stonebridge at City Park

  Houston, TX   240   91 %

Tivoli

  Dallas, TX   190   94 %*

Treehouse

  Irving, TX   160   91 %

Verandas at City View

  Fort Worth, TX   314   95 %

Villager

  Ft. Walton, FL   33   94 %

Vistas at Pinnacle Park

  Dallas, TX   332   91 %

Vistas at Vance Jackson

  San Antonio, TX   240   90 %

Westwood

  Mary Ester, FL   120   93 %

Whispering Pines

  Topeka, KS   320   91 %

Wildflower Villas

  Temple, TX   220   91 %

Willow Creek

  El Paso, TX   112   90 %

Windsong

  Ft. Worth, TX   188   93 %
       
  Total Units   9,256  
       

 

* These properties are subject to sale per the deposit method.

 

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Property

  

Location

   Sq. Ft.    Occupancy %
2007
 

Office Buildings

        

1010 Common

   New Orleans, LA    512,593    76 %

217 Rampart

   New Orleans, LA    11,913    0 %

225 Baronne

   New Orleans, LA    422,037    0 %

305 Baronne

   New Orleans, LA    37,081    48 %

600 Las Colinas

   Las Colinas, TX    510,841    67 %

Amoco

   New Orleans, LA    378,895    90 %

Cooley Building

   Farmers Branch, TX    27,000    100 %

Eton Square

   Tulsa, OK    225,566    90 %

Executive Court

   Memphis, TN    41,340    0 %

One Hickory Centre

   Farmers Branch, TX    97,361    97 %

Park West I (Browning Place)

   Farmers Branch, TX    627,312    100 %

Park West (Fenton Centre)

   Farmers Branch, TX    696,638    89 %

Parkway North

   Dallas, TX    69,009    77 %

University Square

   Anchorage, AK    22,260    100 %

Signature Building

   Dallas, TX    58,910    0 %

Two Hickory Centre

   Farmers Branch, TX    97,117    72 %

Westgrove Air Plaza

   Addison, TX    79,713    80 %
          
      3,915,586   
          

Industrial Warehouses

        

5360 Tulane

   Atlanta, GA    30,000    100 %

Addison Hanger

   Addison, TX    25,102    100 %

Addison Hanger II

   Addison, TX    24,000    100 %

Clarke Garage

   New Orleans, LA    6,869    0 %

Encon

   Fort Worth, TX    256,584    0 %

Space Center

   San Antonio, TX    101,500    61 %

GNB

   Farmers Branch, TX    200,000    93 %
          
      644,055   
          

Shopping Centers

        

Bridgeview Plaza

   LaCrosse, WI    122,205    92 %

Cross County Mall

   Mattoon, IL    307,266    87 %

Cullman

   Cullman, AL    92,466    48 %

Dunes Plaza

   Michigan City, IN    220,461    52 %

Willowbrook Village

   Coldwater, MI    179,741    91 %
          
      922,139   
          

Merchandise Mart

        

Denver Mart

   Denver, CO    344,975    83 %
          
   Total Commeral SqFt    5,826,755   
          

Single Family Residence

        

Tavel Circle

   Dallas, TX    2,155    100 %

Property

  

Location

   Rooms    Occupancy %
2007
 

Hotels

        

Akademia

   Wroclaw, Poland    165    78 %

Comfort Inn

   Denver, CO    161    59 %

Picadilly Airport

   Fresno, CA    185    63 %

Château Inn

   Fresno, CA    78    57 %

Picadilly Shaw

   Fresno, CA    194    62 %

Picadilly University

   Fresno, CA    190    58 %
          
   Total Rooms    973   
          

 

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Held For Sale

 

Property

  Location   Rooms   Occupancy %
2007
 

Apartments

     

4400

  Midland, TX   92   98 %

Arbor Point

  Odessa, TX   194   96 %

Ashton Way

  Midland, TX   178   94 %

Autumn Chase

  Midland, TX   64   100 %

Bay Walk

  Galveston, TX   192   91 %

Courtyard

  Midland, TX   133   96 %

Coventry

  Midland, TX   120   93 %

Fairways

  Longview, TX   152   95 %

Fountains of Waterford

  Midland, TX   172   96 %

Governor’s Square

  Tallahassee, FL   169   96 %

Hunters Glen

  Midland, TX   212   96 %

Island Bay

  Galveston, TX   458   89 %

Marina Landing

  Galveston, TX   256   89 %

Southgate

  Odessa, TX   180   98 %

Sunchase

  Odessa, TX   300   95 %

Sunset

  Odessa, TX   240   98 %

Thornwood

  Odessa, TX   109   95 %

Westwood

  Odessa, TX   79   94 %

Woodview

  Odessa, TX   232   96 %
       
  Total Units   3,532  
       

 

Property

 

Location

  Square
feet
  Occupancy
% 2007
 

Office Building

     

Lexington Center

  Colorado Springs, CO   74,816   24 %

Property

 

Location

  Rooms   Occupancy
% 2007
 

Hotels

     

City Suites

  Chicago, IL   45   66 %

The Majestic

  Chicago, IL   55   59 %

Willows

  Chicago, IL   52   58 %
       
  Total Rooms   152  
       

Lease Expiration by Year

 

Year of lease Expiration

  Rentable
Square Feet
Subject to
Expiring
Leases
  Current
Annualized(1)
Contractual
Rent Under
Expiring
Leases
  Current
Annualized(1)
Contractual
Rent Under
Expiring
Leases
(p.s.f.)
  Percentage
of total

Square Feet
 

2008

  620,873   $ 7,098,743   $ 11.43   12.3 %

2009

  560,062     5,681,790     10.14   11.1 %

2010

  685,956     6,295,283     9.18   13.6 %

2011

  369,524     5,942,097     16.08   7.3 %

2012

  302,931     4,709,950     15.55   6.0 %

2013

  242,890     3,140,906     12.93   4.8 %

2014

  140,470     2,598,911     18.50   2.8 %

2015

  45,709     912,721     19.97   0.9 %

2016

  120,417     1,998,490     16.60   2.4 %

2017

  309,817     4,831,251     15.59   6.1 %

Thereafter

  193,251     3,243,001     16.78   3.8 %

 

(1) Represents the monthly contractual base rent and recoveries from tenants under existing leases as of December 31, 2007 multiplied by twelve. This amount reflects total rent before any rent abatements and includes expense reimbursements, which may be estimates as of such date.

 

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Table of Contents

Property

  

Location

   Acres

Land Tracts

     

1013 Common

   New Orleans, LA    0.41

2301 Valley Branch

   Farmers Branch, TX    23.76

Alliance 52

   Tarrant County, TX    51.90

Alliance 8

   Tarrant County, TX    8.00

Alliance Airport

   Tarrant County, TX    12.70

Audubon Terrace

   Adams County, MS    48.20

Backlick

   Springfield, VA    4.00

Betline 378/Geller Rd

   Dallas County, TX    378.83

Bonneau

   Dallas County, TX    8.39

Centura

   Farmers Branch, TX    10.08

Chase Oaks

   Plano, TX    9.93

Circle C Ranch

   Austin, TX    1,092.00

Cooks Lane

   Ft. Worth, TX    21.90

Creekside Land

   Ft Worth, TX    30.00

Croslin

   Dallas, TX    0.80

Crowley Land

   Ft Worth, TX    24.90

Dalho

   Farmers Branch, TX    3.44

Dedeaux Road

   Gulfport, MS    10.00

Denton

   Denton, TX    15.65

Denton-Andrew B

   Denton, TX    22.90

Denton-Andrew C

   Denton, TX    5.20

Desoto

   Desoto, TX    21.90

Diplomat Drive

   Farmers Branch, TX    14.40

Dominion

   Dallas, TX    11.65

Elm Fork

   Denton County, TX    44.03

Ewing 8

   Addison, TX    16.79

Fiesta

   San Angelo, TX    0.70

Folsom

   Dallas, TX    36.38

Forney land

   Kaufman County, TX    34.80

Fort Wayne

   Fort Wayne, IN    18.90

Fruitland

   Fruitland Park, FL    0.15

GNB Land ARI

   Farmers Branch, TX    11.50

GNB Land Edina

   Farmers Branch, TX    34.00

Hines Meridan

   Las Colinas, TX    36.09

Hollywood Casino

   Farmers Branch, TX    28.78

HSM

   Farmers Branch, TX    6.16

Jackson Multi-Tract

   Jackson, MS    1.71

JHL Connell

   Carrollton, TX    3.93

Kaufman Cogen

   Kaufman County, TX    2,567.00

Kaufman Taylor

   Kaufman County, TX    31.00

Keenan Bridge

   Farmers Branch, TX    7.50

Keller Springs Lofts

   Addison, TX    7.40

Kelly Lots

   Collin County, TX    0.75

Kinwest (Hackberry Creek)

   Irving, TX    7.98

Lacy Longhorn

   Farmers Branch, TX    17.12

LaDue

   Farmers Branch, TX    99.00

Lakeshore Villas

   Humble, TX    19.51

 

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Table of Contents

Property

  

Location

   Acres

Land Tracts—(Continued)

     

Lamar/Parmer

   Austin, TX    17.07

Las Colinas

   Las Colinas, TX    1.57

Las Colinas

   Las Colinas, TX    4.70

Las Colinas Apts/Lofts

   Irving, TX    4.77

Las Colinas High Rise Apartments

   Irving, TX    1.65

Las Colinas High Rise Office

   Irving, TX    3.49

Las Colinas Townhomes

   Irving, TX    15.56

LCLLP

   Las Colinas, TX    45.49

Leone

   Irving, TX    8.23

Los Colinas-Walnut Hill

   Irving, TX    1.58

Lubbock

   Lubbock, TX    2.86

Luna

   Farmers Branch, TX    2.60

Mandahl Bay

   US Virgin Island    91.10

Manhattan

   Farmers Branch, TX    108.90

Mansfield

   Mansfield, TX    7.83

Marine Creek

   Ft. Worth, TX    44.17

Mason/Goodrich

   Houston, TX    13.00

McKinney 36

   Collin County, TX    34.48

McKinney Corners II

   Collin County, TX    18.53

McKinney Ranch

   McKinney, TX    252.90

Meloy

   Kent, OH    52.95

Mendoza

   Dallas, TX    0.40

Mira Lago

   Farmers Branch, TX    4.20

Nashville ARI

   Nashville, TN    16.57

Nashville TCI

   Nashville, TN    58.62

Ocean Estates

   Gulfport, MS    12.00

Pac Trust

   Farmers Branch, TX    7.07

Palmer Lane

   Austin, TX    367.43

Pantaze

   Dallas, TX    6.00

Payne I

   Las Colinas, TX    149.70

Pioneer Crossing

   Austin, TX    375.80

Pulaski

   Pulaski County, AR    21.90

Railroad

   Dallas, TX    0.29

Ridgepoint Drive

   Irving, TX    0.60

Ritchie Road

   Waco, TX    350.70

Seminary West

   Ft. Worth, TX    5.36

Senlac

   Farmers Branch, TX    11.94

Senlac 3.976

   Farmers Branch, TX    3.98

Senlac Hutton

   Farmers Branch, TX    5.86

Senlac VHP

   Farmers Branch, TX    3.90

Sheffield Village

   Grand Prairie, TX    13.90

Siskiyou

   Siskiyou County, CA    20.70

Sladek Land

   Travis County, TX    63.28

Southwood Plantation

   Tallahassee, FL    12.90

Southwood Plantation

   Tallahassee, FL    14.52

Texas Land Plaza

   Irving, TX    10.33

Thompson

   Farmers Branch, TX    3.99

Thompson II

   Dallas County, TX    3.32

Tomlin

   Farmers Branch, TX    9.20

Valley Ranch

   Irving, TX    30.00

Valley Ranch 20

   Irving, TX    20.62

Valley View 34 (Mercer Crossing)

   Farmers Branch, TX    33.90

 

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Table of Contents

Property

  

Location

   Acres

Land Tracts—(Continued)

     

Valwood

   Dallas, TX    235.00

Vineyards II

   Grapevine, TX    7.20

Vineyards(Grapevine)

   Grapevine, TX    3.94

Vista Ridge

   Lewisville, TX    5.18

Waco 151

   Waco, TX    151.40

Waco 42

   Waco, TX    42.80

Walker

   Dallas County, TX    41.79

West End

   Dallas, TX    5.50

Whorton

   Benton County, AR    79.70

Willowick Land

   Pensacola, FL    39.78

Wilmer 88

   Dallas, TX    87.60

Windmill Farms

   Kaufman County, TX    3,034.51

Woodmont Fairway

   Dallas, TX    5.87

Woodmont Galleria East

   Dallas, TX    15.00

Woodmont Galleria West

   Farmers Branch, TX    9.15

Woodmont Merit Drive

   Dallas, TX    9.28
       
   Total Acres    11,008.23
     
       

 

ITEM 3.    LEGAL PROCEEDINGS

On October 19, 2007, the Company and Basic Capital Management, Inc. (“BCM”) participated in mediation proceedings which resulted in a Stipulation of Settlement with The Fansler Foundation (“Fansler”) in a case then pending in the United States District Court, Eastern District of California. Pursuant to the Stipulation of Settlement (which is now embodied in a final Settlement Agreement and Mutual Release finally executed on January 7, 2008 by the last party), Fansler surrendered, assigned transferred to BCM 1,600,000 shares of Series A Cumulative Convertible Preferred Stock (the “Series A Stock”) originally issued to Fansler in exchange for a payment commitment by BCM to Fansler of $26,000,000. $4.5 million was paid by BCM on February 6, 2008, $4 million is to be paid in April 2008 with the balance to be paid in ten quarterly payments of $1,750,000 each beginning June 1, 2008 with 8% simple interest per annum with a provison that if the full outstanding balance is paid on or before September 1, 2008, all interest is waived. BCM became the owner of the 1,600,000 of Series A Stock and has the payment obligation to the plaintiff. The Company is relieved of the payment obligation to the plaintiff unless BCM fails to make a payment. In the event BCM defaults in the payment schedule, the plaintiff is to give notice of default to both BCM and the Company which will then have five business days to cure such default. The Settlement Agreement, which has no effect upon any other holder of Series A Stock issued by the Company, brings an end to litigation existing between the parties since February 2004.

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.

 

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Table of Contents
ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Annual Meeting of Stockholders was held on November 16, 2007, 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, 2007. At the Meeting, stockholders elected the following individuals as Directors:

 

     Shares Voting

Director

   For    Withheld
Authority

Henry A. Butler

   10,809,378    65,137

Sharon Hunt

   10,810,017    64,498

Robert A. Jakuszewski

   10,810,126    64,389

Ted R. Munselle

   10,809,998    64,517

Ted P. Stokely

   10,809,296    65,219

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 10,829,578 votes were received in favor of such proposal, 27,977 votes were received against such proposal, and 16,960 votes abstained.

 

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Table of Contents

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, 2008 (through March 20, 2008)

   $ 8.22    $ 8.20

December 29, 2007

     10.50      7.25

September 26, 2007

     8.25      7.00

June 30, 2007

     10.00      8.08

March 31, 2007

     8.59      7.69

December 30, 2006

     9.19      7.50

September 28, 2006

     9.05      8.00

June 30, 2006

     9.71      8.25

March 31, 2006

     10.50      7.51

On March 20, 2008, the closing market price of ARI’s common stock on the New York Stock Exchange was $8.20 per share.

As of March 20, 2008, 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 2007. 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, 2007, 3,390,916 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 20, 2007, no shares of Series C Preferred Stock was outstanding.

 

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Table of Contents

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 20, 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 20, 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 20, 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 2007:

 

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

Balance at September 30

         886,965    113,035

October, 2007

   1,300    $ 7.38    888,265    111,735

November, 2007

   2,200      8.38    890,465    109,535

December, 2007

   2,600      9.41    893,065    106,935
                     

Total

   6,100    $ 8.39    893,065    106,935
                     

 

(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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Table of Contents

Performance Graph

The following graph compares the cumulative total stockholder return on ARI’s shares of common stock with the Dow Jones Equity Market Index (“Dow Jones US Total Market”) and the Dow Jones Real Estate Investment Index (“Dow Jones US Real Estate”). The comparison assumes that $100 was invested on December 31, 2002 in shares of common stock and in each of the indices and further assumes the reinvestment of all dividends. Past performance is not necessarily an indicator of future performance.

LOGO

 

     12/02    12/03    12/04    12/05    12/06    12/07

American Realty Investors, Inc.

   100.00    112.86    119.90    99.13    97.28    121.14

Dow Jones US

   100.00    130.75    146.45    155.72    179.96    190.77

Dow Jones US Real Estate

   100.00    136.90    179.63    196.94    266.84    218.41

 

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Table of Contents
ITEM 6.    SELECTED FINANCIAL DATA

 

    Years Ended December 31,  
    2007     2006     2005     2004     2003  
    (dollars in thousands)  

EARNINGS DATA

         

Total Operating Revenues

  $ 176,930     $ 147,563     $ 123,147     $ 28,909     $ 31,382  

Total Operating Expenses

    (167,748 )     (142,597 )     (123,435 )     (62,324 )     (63,167 )
                                       

Operating (loss)/income

    9,182       4,966       (288 )     (33,415 )     (31,785 )

Other income (expense)

    (45,589 )     (38,859 )     (47,265 )     (27,880 )     (23,417 )
                                       

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

    (36,407 )     (33,893 )     (47,553 )     (61,295 )     (55,202 )

Gain on land sales

    20,468       23,973       39,926       11,781       43,831  

Minority interest

    (2,652 )     672       (3,056 )     (7,270 )     (771 )

Equity in income (loss) of investees

    286       1,540       397       (41 )     (4,441 )

Income Tax benefit

    15,703       7,271       20,196       31,507       9,956  
                                       

Net Income (loss) from continuing operations

    (2,602 )     (437 )     9,910       (25,318 )     (6,627 )

Net Income (loss) from discontinued operations

    29,164       13,503       37,507       58,512       18,490  
                                       

Net Income (loss)

    26,562       13,066       47,417       33,194       11,863  

Preferred dividend requirement

    (2,490 )     (2,491 )     (2,572 )     (2,601 )     (2,351 )
                                       

Income (loss) applicable to common shares

  $ 24,072     $ 10,575     $ 44,845     $ 30,593     $ 9,512  
                                       

PER SHARE DATA

         

Basic earnings per share

         

Net Income (loss) from continuing operations

  $ (0.50 )   $ (0.29 )   $ 0.72     $ (2.63 )   $ (0.83 )

Net Income (loss) from discontinued operations

    2.85       1.33       3.70       5.53       1.71  
                                       

Net Income (loss) applicable to common shares

  $ 2.35     $ 1.04     $ 4.42     $ 2.90     $ 0.88  
                                       

Weighted Average shares outstanding

    10,227,593       10,149,000       10,149,000       10,559,571       10,789,352  

Diluted earnings per share

         

Net Income (loss) from continuing operations

  $ (0.50 )   $ (0.29 )   $ 0.56     $ (2.63 )   $ (0.83 )

Net Income (loss) from discontinued operations

    2.85       1.33       2.86       5.53       1.71  
                                       

Net Income (loss) applicable to common shares

  $ 2.35     $ 1.04     $ 3.42     $ 2.90     $ 0.88  
                                       

Weighted Average shares outstanding

    10,227,593       10,149,000       13,106,000       10,559,571       10,789,352  

BALANCE SHEET DATA

         

Real Estate, net

  $ 1,485,859     $ 1,272,424     $ 1,113,105     $ 983,422     $ 1,054,835  

Notes and interest receivable, net

    83,467       52,631       81,440       72,661       70,595  

Total Assets

    1,777,854       1,493,671       1,345,795       1,190,843       1,240,880  

Notes and interest payable

    1,400,877       1,124,765       1,021,822       939,921       986,769  

Stock-secured notes payable

    17,546       22,452       22,549       18,663       21,194  

Stockholder’s equity

    192,386       160,489       148,397       103,009       76,871  

Book value per share

  $ 18.81     $ 15.81     $ 12.80     $ 8.89     $ 6.75  

 

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Table of Contents
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

 

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Table of Contents

all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to our quarterly reports on Form 10-Q for future periods and 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.

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, 2007, 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. In addition, TCI owns 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 2007 acquired over $145 million and sold over $181 million of land and income-producing properties. As of December 31, 2007, the Company owned approximately 12,788 units in 69 residential apartment communities, 31 commercial properties comprising almost 5.8 million rentable square feet and 9 hotels containing a total of 1,125 rooms. In addition, at December 31, 2007, ARI owned 11,000 acres of land held for development and had over 2,400 apartment units in 19 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

 

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properties are managed by Regis Commercial while the Company’s hotels are managed by Regis Hotel. ARI currently contracts with five third-party 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

 

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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.

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

Management reviews its long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates impairment in value. An impairment loss is recognized if the carrying amount of its assets is not recoverable and exceeds its fair value. If such impairment is present, an impairment loss is recognized based on the excess of the carrying amount of the asset over its fair value. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods.

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 judgment. 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

 

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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.

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.

 

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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.

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

The following discussion is based on our Consolidated Financial Statements for the years ended December 31, 2007, 2006, and 2005.

At December 31, 2007, 2006, and 2005, we owned or had interests in a portfolio (the Total Property Portfolio) of 110, 130, and 116 income producing properties, respectively.

Comparison of the year ended December 31, 2007 to the year ended December 31, 2006.

We define Same Property Portfolio 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 being compared. A stabilized property is defined as a newly developed project whose occupancy has reached greater than approximately 85%. The Same Property Portfolio consists of 51 apartments, 27 commercial properties, and 6 hotels.

We had net income of $24.1 million in 2007, which includes gains of land sales of $20.5 million, and net income from discontinued operations of $29.1 million, compared to net income of $10.5 million in 2006, including gains on land sales totaling $23.9 million and net income from discontinued operations of $13.5 million.

Rents and other property revenues were $176.9 million in 2007 as compared to $147.6 million in 2006 and an increase of $29.3 million. Rents and other property revenues from our same property portfolio was $136.7 million in 2007 as compared to $136.1 million in 2006, an increase of $600.000. This was due to an increase in apartments and hotel revenues of $2.5 million and $400,000, respectively, offset by a decrease in commercial property revenues of $2.3 million. The remaining increase of $28.8 million was due to revenues associated with the acquisition of commercial (ParkWest I & II) and hotel properties of $22.0 million and $2.2 million, respectively, and developed properties of $5.8 million, offset by a decrease in revenues from land and other of $1.2 million.

Property operations expenses were $112.5 million in 2007 as compared to $98.6 million in 2006, an increase of $13.9 million. Property operations expenses from our same property portfolio were $85.0 in 2007 as compared to 86.3 million in 2006, a decrease of $1.3 million. This is attributable to a decrease in the operating costs of our hotels and apartments of $1.8 million and $100,000 respectively, offset by an increase in our commercial portfolio of $600,000. The remaining increase of $15.2 million is from the acquisition of commercial properties of $9.4 million, increased costs in our hotel operations in Poland of $2.2 million, Developed properties of $3.3 million, and land holding and other costs of $300,000.

 

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Depreciation and amortization expenses were $24.4 million in 2007 as compared to $21.9 million in 2006, an increase of $2.5 million. The acquisition of the Park West I & II building increase depreciation by $2.5 million. The completion of Developed Properties not stabilized accounted for another $1.0 million of depreciation expense. This was offset by a decrease of ($1.0 million) from the Same Property Portfolio which consisted of; an increase in apartments of $148,000, a decrease in Commercial of ($1.2 million), and a decrease in Hotels of (77,000).

General and administrative expenses were $15.9 million in 2007 as compared to $9.3 million in 2007, an increase of $6.6 million. The 2007 amount includes 2.0 million in legal settlement fees, and higher cost reimbursements to the advisor. The 2006 amount includes credits for litigation reimbursements of $3.3 million, and overall lower legal and professional fees.

Advisory fees to affiliate were $14.9 million in 2007 as compared to 12.7 million in 2006, an increase of $2.2 million. The increase was due to was due to higher gross assets in 2007 than 2006.

Gain on foreign currency translation was $2.4 million in 2007 as compared to $2,000 in 2006, an increase of $2.4 million. The increase was due to the translation of currency associated with our hotel in Poland. The devaluation of the dollar has increased the gain on our currency translation.

Mortgage loan interest expenses were $89.8 million in 2007, as compared to $67.9 million in 2006, an increase of $21.9 million. The increase is due increase in debt due to refinancings, new loans on acquisitions, and construction draws. Refinancings on the Same Property Portfolio accounted for $4.4 million of the increase, which consists of: Apartments $1.2 million and Hotels $3.2 million. The refinancing of land accounted for $6.3 million. Additional debt incurred in the acquisition of commercial properties accounted for $6.5 million, and Construction draws accounted for $3.3 million.

Gain on involuntary conversion was $34.7 million in 2007 as compared to 20.5 million in 2006, an increase of 14.2 million. The gain of $34.7 million in 2007 relates to the subsequent collection of insurance proceeds from the damages sustained at our new Orleans commercial properties from Hurricane Katrina during 2005. In the prior year, we recorded a gain of 20.5 million from the collection of insurance proceeds related to Hurricane Katrina. The remaining $2.2 million gain on involuntary conversion relates to various individual claims under $500,000 each related to collections of insurance proceeds.

In 2007, we determined that an impairment write down was need for the Executive Court of $206,000 and the Encon Warehouse of $797,000. There were no impairments in 2006.

In 2007, we paid $1.3 million in expense towards the settlement of the Sunset litigation that were not previously accrued. The Sunset litigation was settled September 18, 2007. There were no significant litigation settlement expenses in 2006.

Gain on land sales was $20.5 million in 2007 as compared to $24.0 million in 2006. In 2007, we sold 252 acres of land in 18 separate transactions with an aggregate sales price of $36.0 million, receiving $13.1 million in cash. The average sales price was $142,000 per acre. The sales relate to the land properties known as; Desoto Ranch(easement), 28.9 acres of McKinney Ranch, 3.4 acres Mandahl Bay, 2.3 acres West End, 3.0 acres Miro Lago, 4.0 acres Hines Meridian, 86.0 acres RB, 4.6 acres Grapevine Vineyards, 75.4 acres Metro Center, 1.2 acres Katrina, 39.2 acres Windmill Farm, and 4.0 acres Vista Ridge. In 2006, we sold 317 acres of land in 19 separate transactions for at an average sales price of $195,000 per acre.

Net income from discontinued operations was $29.2 million in 2007 as compared $13.5 in 2006. For 2007 and 2006, income from discontinued operations relates to 59 properties of which 20 were sold in 2006, 18 sold in 2007 and 21 were held for sale and subsequently sold in 2008.

 

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     For the twelve months ending Dec 31,  
     2007     2006  

Revenue

    

Rental

   $ 41,541     $ 52,346  

Restaurant Income

     —         34,199  
                

Total Income

     41,541       86,545  

Cost of Sales

    

Property operations

     29,626       36,427  

Restaurant Expenses

     —         25,503  
                

Total Expenses

     29,626       61,930  
                
     11,915       24,615  
                

Other

    

Interest

     (15,804 )     (15,403 )

G&A

     (82 )     (3,467 )

Depreciation

     (4,537 )     (7,130 )
                

Income (Loss) from Disc Operations

     (8,508 )     (1,385 )

Gain on sale of discontinued operations

     53,375       22,159  
                

Income (Loss) from Disc Operations

     44,867       20,774  

Tax Expense (Benefit)

     (15,703 )     (7,271 )
                

Net Income (loss)

   $ 29,164     $ 13,503  
                

Comparison of the year ended December 31, 2006 to the year ended December 31, 2005.

We define Same Property Portfolio 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 being compared. The Same Property Portfolio consists of 67 apartments, 27 commercial properties, and 11 hotels.

ARI had net income applicable to common shares of $10.5 million in 2006, including gains on land sales totaling $24.0 million and net income from discontinued operations of $13.5 million, compared to net income applicable to common shares of $44.8 million in 2005, including gains on land sales of $39.9 million and income from discontinued operations of $37.5 million.

Rents and other property revenues were $147.6 million in 2006 as compared to $123.1 million in 2005, an increase of $24.5 million. Rents and other property revenues from our same property portfolio was $136.1 in 2006 as compared to $116.8 in 2005, an increase of $19.3 million. This is attributable to an overall increase in rents from apartments, commercial properties and hotels of $10.6 million, $8.0 million, and $700,000, respectively. The remaining $5.2 million is due to the acquisition of commercial properties (ParkWest I & II) and hotel properties of $2.4 and $1.0 million, respectively. In addition, revenues from developed properties and land increased $1.5 million and $300,000, respectively.

Property operations expense were $98.6 million in 2006 as compared to $82.6 million in 2005, an increase of $16.0 million. Property operations expense from the same property portfolio was 85.8 million in 2006 as compared to $72.5 million in 2005, an increase of $13.3 million. This increase is attributable to an overall increase in costs across the board on all of our apartments, commercial and hotel properties of $4.8 million, $7.4 million, and $1.1 million, respectively. The remaining $2.7 million Is due to costs from acquired properties and develop properties of $1.4 million and $1.4 million, respectively.

 

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Depreciation and amortization expenses were $21.9 million in 2006 as compared to $17.4 million in 2005, an increase of $4.5 million. Depreciation for the Same Property Portfolio increased $3.9 million, which consisted of: Apartment Portfolio of $1.9 million, Commercial Portfolio of 1.8 million, and Hotel Portfolio of $300,000. The increases were due to depreciation associated with the purchase new assets. The remaining increase is due the depreciation of $300,000 on land improvements, and $300,000 on the acquisition of properties within the commercial Portfolio in the current year.

General and administrative expenses were $9.3 million in 2006 as compared to $14.0 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 were $12.7 million in 2006 as 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.”

Mortgage and loan interest expenses were $67.9 million in 2006 as compared to $50.7 in 2005, an increase of $17.2 million. Refinancing of existing debt within the Same Property Portfolio accounted for $5.2 million of the increase which consisted of; Apartment Portfolio of $2.4 million and the Commercial Portfolio of $2.7 million. The acquisition of a commercial building accounted for $400,000. The refinancings and increases in variable interest rates on the land Portfolio accounted for $11.6 million.

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.

Gain on land sales were $23.9 million in 2006 as compared to 39.9 million in 2005, a decrease of $16.0 million. 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 $13.5 million in 2006 as compared to $37.5 million in 2005. For 2006 and 2005, income from discontinued operations relates to 71 properties of which 21 were held for sale and sold in 2008, 10 sold in 2007, 20 sold in 2006 and 21 sold in 2005. A summary of the discontinued operations for 2006 and 2005 is listed below:

 

     For the twelve months ending Dec 31,  
           2006                 2005        

Revenue

    

Rental

   $ 52,346     $ 64,152  

Restaurant Income

     34,199       36,818  
                

Total Income

     86,545       100,970  

Cost of Sales

    

Property operations

     36,427       47,439  

Restaurant Expenses

     25,503       27,905  
                

Total Expenses

     61,930       75,344  
                
     24,615       25,626  
                

Other

    

Interest

     (15,403 )     (20,338 )

G&A

     (3,467 )     (3,643 )

Depreciation

     (7,130 )     (6,559 )
                

Income (Loss) from Disc Operations before income tax

     (1,385 )     (4,914 )

Gain on sale of discontinued operations

     22,159       62,617  
                

Income (Loss) from Disc Operations

     20,774       57,703  

Tax Expense (Benefit)

     (7,271 )     (20,196 )
                

Net Income (loss)

   $ 13,503     $ 37,507  
                

Liquidity and Capital Resources

General

Our principal liquidity needs are:

 

   

fund normal recurring expenses;

 

   

meet debt service and principal repayment obligations including balloon payments on maturing debt;

 

   

fund capital expenditures, including tenant improvements and leasing costs;

 

   

fund development costs not covered under construction loans;

 

   

fund possible property acquisitions

Our principal sources of cash have been and will continue to be property operations, proceeds from land and income-producing property sales, collection of mortgage notes receivable, collections of receivables from affiliated companies, refinancing of existing debt and additional borrowings, including mortgage notes payable, lines of credit. We may also issue additional equity securities, including common stock and preferred stock. Management anticipates that our cash at December 31, 2007, along with cash that will be generated in 2008 from property operations, may not be sufficient to meet all of our cash requirements. Management intends to selectively sell land and income producing assets, refinance or extend real estate debt and seek additional borrowings secured by real estate to meet its liquidity requirements. Historically, management has been successful at extending a portion of the Company’s current maturity obligations.

 

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Cash flow summary

The following summary discussion of our cash flows is based on the consolidated statements of cash flows in “item 8”. Consolidated Financial Statements and Supplementary Data and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below.

Cash and cash equivalents were $11.6 million at December 31, 2007 as compared to $7.0 million at December 31, 2006, an increase in cash of $4.6 million. The increase was the results of a decrease in cash from operating activities of ($23.5) million, a decrease in cash from investing activities of ($224.5) million, and an increase in cash from financing activities of $252.5 million.

Our cash from operating activities which consists primarily of income from the operations of our Apartments, Hotels, and Commercial properties was not sufficient to support our current operations. We had a cash shortfall of ($23.5) million in 2007. This was primarily due to our increased costs associated with land holding costs, increased interest rates on existing debt, and the increased interest expense associated with the acquisition of new and refinanced debt. Management anticipates on selling selected land tracts and income producing properties to finance our continuing operations. In the past, management has been successful at meeting our cash flow needs.

Our primary use of cash was for investing activities of ($224.5) million. We currently have 19 apartment communities under construction, which used ($204.7) million in cash for construction and development. We purchased 677 acres of land using ($25.0) million in cash, and two commercial buildings using ($114.3) million in cash. These cash requirements were partially funded from the sale of income producing properties providing $55.3 million in cash, which included the sale of one Hotel, four Commercial buildings, and seven apartments. In addition, we sold 252 acres of land providing $65.5 million in cash proceeds. We also invested $15.1 million in cash on improvements on existing income producing properties.

Our financing activities provided us with $252.5 million in cash. Our primary source of cash was from new and refinanced debt, which provided us with $529.1 million in cash. We refinanced 30 existing mortgage notes payable and obtained 12 new notes associated with the purchase of ten tracts of land and two buildings. This was offset by payments on maturing notes of $240.2 million.

We anticipate that funds from existing cash resources, aggressive sales of land and selected income producing property sales, refinancing of real estate, and borrowings against our real estate will be sufficient to meet the cash requirements associated with our current and anticipated level of operations, maturing debt obligations and existing commitments. To the extent that our liquidity permits or financing sources are available, We will continue to make investments in real estate, primarily in improved and unimproved land, 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 2007, ARI declared dividends to its preferred stockholders totaling $2.5 million, of which approximately $1 million was paid.

 

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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 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, 2007.

 

     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

   $ 1,382,613    $ 434,900    $ 250,074    $ 125,404    $ 572,235

Capital Lease Obligations

     —        —        —        —        —  

Operating Lease Obligations

     —        —        —        —        —  

Purchase Obligations

     —        —        —        —        —  

Other Long-Term Liabilities Reflected on the Registrant’s

     3,067      3,067      —        —        —  

Balance Sheet under GAAP

     —        —        —        —        —  
                                  

Total

   $ 1,385,680    $ 437,967    $ 250,074    $ 125,404    $ 572,235
                                  

 

(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.

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 change 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 2007 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 2008 than they did during 2007, 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, 2007. 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. All Dollars are in thousands.

 

    2008     2009     2010     2011     2012     Thereafter     Total

Assets

             

Marketable securities at fair value

              $ 14,442

Notes Receivable

             

Variable interest rate-fair value

              $ 23,875

Instrument’s maturities

  $ 5,633     $ 13,561     $ 6,553     $ —       $ —       $ —       $ 25,747

Instrument’s amortization

    —         —         —         —         —         —         —  

Interest

    2,712       1,889       331       —         —         —         4,932

Average rate

    9.6 %     9.0 %     8.8 %     0.0 %     0.0 %     0.0 %  

Fixed interest rate-fair value

              $ —  

Instrument’s maturities

  $ 19,449     $ 6,430     $ 9,323     $ 627     $ —       $ 24,981     $ 60,810

Instrument’s amortization

    6       —         —         —         —         —         6

Interest

    4,917       4,053       3,341       3,211       3,157       5,878       24,557

Average rate

    11.0 %     12.1 %     12.8 %     13.8 %     13.8 %     9.4 %  

Liabilities

             

Notes Payable

             

Variable interest rate-fair value

              $ 387,349

Instrument’s maturities

  $ 180,534     $ 80,492     $ 39,187     $ 12,031     $ 4,340     $ 27,736     $ 344,320

Instrument’s amortization

    39,136       2,960       800       729       354       10,889       54,868

Interest

    23,152       8,474       6,000       3,491       2,858       15,738       59,713

Average rate

    8.0 %     7.7 %     7.6 %     7.6 %     12.3 %     —      

Fixed interest rate-fair value

              $ —  

Instrument’s maturities

  $ 197,411     $ 50,420     $ 23,908     $ 19,276     $ 63,493     $ 89,501     $ 444,009

Instrument’s amortization

    38,211       40,023       12,284       12,505       12,675       444,109       559,807

Interest

    68,553       50,911       43,605       37,803       34,290       481,629       716,791

Average rate

    8.1 %     10.3 %     9.5 %     7.2 %     7.9 %     —      

 

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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

   43

Consolidated Balance Sheets—December 31, 2007 and 2006

   44

Consolidated Statements of Operations—Years Ended December 31, 2007, 2006 and 2005

   45

Consolidated Statements of Stockholders’ Equity—Years Ended December 31, 2007, 2006 and 2005

   46

Consolidated Statements of Cash Flows—Years Ended December 31, 2007, 2006 and 2005

   47

Notes to Consolidated Financial Statements

   48

Financial Statement Schedules

  

Schedule III—Real Estate and Accumulated Depreciation

   76

Schedule IV—Mortgage Loans on Real Estate

   91

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

To the Board of Directors of and

Stockholders of American Realty Investors, Inc.

Dallas, Texas

We have audited the accompanying consolidated balance sheets of American Realty Investors, Inc. and Subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows each for each of the years in the three-year period ended December 31, 2007. American Realty Investors, Inc’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated 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 consolidated 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 audits 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 consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 21, American Realty Investors, Inc.’s management intends to 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, 2007 and 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2007, 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 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 consolidated financial statements and, in our opinion, fairly state, 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 31, 2008

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

 

     December 31,
2007
    December 31,
2006
 
     (dollars in thousands)  
Assets             

Real estate held for investment

   $ 1,508,815     $ 1,249,833  

Less—accumulated depreciation

     (148,404 )     (178,029 )
                
     1,360,411       1,071,804  

Real estate held for sale, net of depreciation

     61,128       134,593  

Real estate subject to sales contracts

     64,320       66,027  

Notes and interest receivable

    

Performing ($16,485 in 2007 and 25,578 in 2006 from affiliates)

     69,977       50,668  

Non-performing ($16,246 million in 2007 and $2,963 in 2006 from affiliates)

     16,468       2,963  
                
     86,445       53,631  

Less—allowance for estimated losses

     (2,978 )     (1,000 )
                
     83,467       52,631  

Marketable securities, at market value

     13,157       9,038  

Cash and cash equivalents

     11,560       7,035  

Restricted cash

     2,556       6,000  

Investments in equity investees

     23,867       25,056  

Other assets ($54,439 in 2007 and $52,793 in 2006 from affiliates)

     157,388       121,487  
                
   $ 1,777,854     $ 1,493,671  
                
Liabilities and Stockholders’ Equity             

Liabilities:

    

Notes and interest payable ($8,269 in 2007 and $7,499 in 2006 to affiliates)

   $ 1,221,987     $ 1,022,370  

Liabilities related to assets held-for-sale

     116,377       43,579  

Liabilities subject to sales contracts

     62,513       58,816  

Stock-secured notes payable

     17,546       22,452  

Accounts payable and other liabilities ($1,873 in 2007 and $10,452 in 2006 to affiliates)

     104,884       107,771  
                
     1,523,307       1,254,988  

Commitments and contingencies

    

Minority interest

     62,161       78,194  

Stockholders’ equity

    

Preferred Stock, $2.00 par value, authorized 15,000,000 shares, issued and outstanding Series A, 3,390,316 shares in 2007 and 2006 (liquidation preference $33,909), including 900,000 shares in 2007 and 2006 held by subsidiaries

     4,979       4,979  

Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,592,272 shares in 2007 and 2006

     114       114  

Treasury stock, at cost;1,129,530 and 1,443,272 shares in 2007 and 2006, respectively

     (12,664 )     (15,146 )

Paid-in capital

     100,277       93,378  

Retained earnings

     99,452       75,380  

Accumulated other comprehensive income (loss)

     228       1,784  
                
     192,386       160,489  
                
   $ 1,777,854     $ 1,493,671  
                

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, 2007  
    2007     2006     2005  
    (dollars in thousands)  

Revenues:

     

Rental and other property revenues ($1,197 in 2007, $1,423 in 2006 and $1,091 in 2005 from affiliates)

  $ 176,930     $ 147,563     $ 123,147  

Expenses:

     

Property operating expenses ($9,239 in 2007, $8,212 in 2006 and $5,182 in 2005 from affiliates)

    112,454       98,649       82,638  

Depreciation and amortization

    24,430       21,949       17,421  

General and administrative ($3,657 in 2007, $4,481 in 2006 and $4,407 in 2005 from affiliates)

    15,966       9,321       14,040  

Advisory fee to affiliate

    14,898       12,678       9,336  
                       

Total operating expenses

    167,748       142,597       123,435  
                       

Operating income (loss)

    9,182       4,966       (288 )

Other income (expense):

     

Interest income ($1,196 in 2007, $2,692 in 2006 and $2,379 in 2005 from affiliates)

    6,156       6,000       5,439  

Gain on foreign currency transaction

    2,368       2       292  

Other income

    8,406       6,181       2,652  

Mortgage and loan interest ($603 in 2007, $1,857 in 2006 and $2,510 in 2005 from affiliates)

    (89,848 )     (67,904 )     (50,663 )

Net income fee to affiliate

    514       (972 )     (3,712 )

Incentive fee to affiliate

    (5,599 )     (1,490 )     (1,128 )

Discount on notes receivable

    0       (1,170 )     (15 )

Gain on involuntary conversion

    34,771       20,479       0  

Provision for impairment

    (1,003 )     0       0  

Litigation settlement

    (1,354 )     15       (130 )
                       

Total other income (expense)

    (45,589 )     (38,859 )     (47,265 )
                       

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

    (36,407 )     (33,893 )     (47,553 )

Gain on land sales

    20,468       23,973       39,926  

Minority interest

    (2,652 )     672       (3,056 )

Equity in income (loss) of investees

    286       1,540       397  
                       

Income (loss) from continuing operations before income tax benefit

    (18,305 )     (7,708 )     (10,286 )

Income tax benefit (expense)

    15,703       7,271       20,196  
                       

Net income (loss) from continuing operations

    (2,602 )     (437 )     9,910  
                       

Income from discontinued operations before tax expense

    44,867       20,774       57,703  

Income tax benefit (expense)

    (15,703 )     (7,271 )     (20,196 )
                       

Net income (loss) from discontinuing operations

    29,164       13,503       37,507  
                       

Net income

    26,562       13,066       47,417  

Preferred dividend requirement

    (2,490 )     (2,491 )     (2,572 )
                       

Net income applicable to common shares

  $ 24,072     $ 10,575     $ 44,845  
                       

Earnings per share—basic

     

Income (loss) from continuing operations

  $ (0.50 )   $ (0.29 )   $ 0.72  

Discontinued operations

    2.85       1.33       3.70  
                       

Net income applicable to common shares

  $ 2.35     $ 1.04     $ 4.42  
                       

Earnings per share—diluted

     

Income (loss) from continuing operations

  $ (0.50 )   $ (0.29 )   $ 0.56  

Discontinued operations

    2.85       1.33       2.86  
                       

Net income applicable to common shares

  $ 2.35     $ 1.04     $ 3.42  
                       

Weighted average common share used in computing earnings per share

    10,227,593       10,149,000       10,149,000  

Weighted average common share used in computing diluted earnings per share

    10,227,593       10,149,000       13,106,000  

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, 2005

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

Unrealized gain on foreign currency translation

    —         —         —       —         —         —         935       935  

Unrealized gain on marketable securities

    —         —         —       —         —         —         866       866  

Net income

    —         —         —       —         —         47,417       —         47,417  

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 )     —       —         —         —         —         (100 )

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

    —         —         —       —         —         (2,550 )     —         (2,550 )

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

    —         —         —       —         —         (22 )     —         (22 )
                                                             

Balance, December 31, 2005

  $ 4,982     $ —       $ 114   $ (15,146 )   $ 93,389     $ 64,805     $ 253     $ 148,397  

Unrealized gain on foreign currency translation

    —         —         —       —         —         —         (790 )     (790 )

Unrealized gain on marketable securities

    —         —         —       —         —         —         2,321       2,321  

Net income

    —         —         —       —         —         13,066       —         13,066  

Repurchase of series A preferred stock

    (3 )     —         —       —         (11 )     —         —         (14 )

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

    —         —         —       —         —         (2,491 )     —         (2,491 )
                                                             

Balance, December 31, 2006

  $ 4,979     $ —       $ 114   $ (15,146 )   $ 93,378     $ 75,380     $ 1,784     $ 160,489  

Unrealized gain on foreign currency translation

    —         —         —       —         —         —         (5,983 )     (5,983 )

Unrealized gain on marketable securities

    —         —         —       —         —         —         4,427       4,427  

Unrealized gain

    —           —       —         —         —         —         —    

Net income

    —         —         —       —         —         26,562       —         26,562  

Acquisition of Minority Interest

    —         —         —       —         6,899       —         —         6,899  

Sale of Common Stock

    —         —         —       3,779       —         —         —         3,779  

Cancelled Preferred shares

    —           —       —         —         —         —         —    

Repurchase of Common Stock

    —         —         —       (1,297 )     —         —         —         (1,297 )

Series B preferred stock dividend

    —         —         —       —         —         —         —         —    

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

    —         —         —       —         —         (2,490 )     —         (2,490 )
                                                             

Balance, December 31, 2007

  $ 4,979     $ —       $ 114   $ (12,664 )   $ 100,277     $ 99,452     $ 228     $ 192,386  
                                                             

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

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

    Year Ended December 31, 2007  
    2007     2006     2005  
    (dollars in thousands)  

Cash Flow From Operating Activities:

     

Net income (loss) applicable to common shares

  $ 24,072     $ 10,575     $ 44,845  

Adjustments to reconcile net loss applicable to common shares to net cash (used in)/provided by operating activities:

     

Gain on sale of land

    (20,468 )     (23,973 )     (20,777 )

Depreciation and amortization

    28,967       32,524       28,887  

Discount on sale of notes receivable

    —         1,183       15  

Amortization of deferred borrowing costs

    7,157       3,049       6,671  

Equity in (income) loss of investees

    (286 )     (1,540 )     (397 )

Gain (loss) on foreign currency transaction

    (2,368 )     (2 )     (292 )

Gain on sale of income producing properties

    (53,375 )     (22,159 )     (62,617 )

Provision for asset impairment

    1,003       —         —    

(Increase) decrease in assets:

     

Accrued interest receivable

    (2,347 )     1,022       1,008  

Other assets

    3,935       (2,918 )     (8,322 )

Prepaid expense

    (1,890 )     —         —    

Escrow

    (1,022 )     —         —    

Earnest Money

    6,544       (9,386 )     (2,670 )

Rent receivables

    (7,641 )     —         —    

(Increase) decrease in liabilities:

     

Accrued interest payable

    (5,556 )     2,233       (1,984 )

Minority interest

    2,652       (5,551 )     1,469  

Other liabilities ($14,500 in 2007, $10,542 in 2006, and $2,110 in 2005 from affiliates)

    (2,888 )     (10,503 )     24,006  
                       

Net cash (used in) provided by operating activities

  $ (23,511 )   $ (25,446 )   $ 9,842  
                       

Cash Flow From Investing Activities:

     

Collections on notes receivables($2,248 in 2007, $1,931 in 2006, and $2,490 in 2005 from affiliates)

  $ 8,186     $ 12,368     $ 6,277  

Proceeds from sale of notes receivable

    10,126       6,828       33,265  

Funding of notes receivable

    (1,770 )     (5,060 )     (12,139 )

Acquisition of land held for development

    (24,965 )     —         —    

Proceeds from sales of income producing properties

    55,256       66,722       166,254  

Proceeds from sale of land

    65,516       4,617       —    

Investment in unconsolidated real estate entities

    960       (44,293 )     (4,849 )

Improvement to land held for development

    (3,728 )     —         —    

Improvement of income producing properties

    (15,135 )     (567 )     (59,806 )

Investments in marketable equity securities

    —         —         84  

Construction and development of new properties

    (204,672 )     —         —    

Acquisitions of income producing properties

    (114,258 )     (142,527 )     (170,333 )
                       

Net cash used in investing activities

  $ (224,484 )   $ (101,912 )   $ (41,247 )
                       

Cash Flow From Financing Activities:

     

Proceeds from notes payable

  $ 529,058     $ 245,848     $ 227,877  

Recurring amortization of principal on notes payable

    (12,872 )     —         —    

Increase in due from affiliates

    (11,601 )     (9,927 )     (32,827 )

Payments on maturing notes payable

    (240,209 )     (102,940 )     (170,228 )

Deferred financing costs

    (10,394 )     (6,477 )     (4,417 )

Restricted cash

    3,444       (6,000 )     —    

Secured stock borrowings

    (4,906 )     —         3,878  

Purchase of treasury stock

    —         (15 )     (1,375 )
                       

Net cash provided by financing activities

  $ 252,520     $ 120,489     $ 22,908  
                       

Net increase (decrease) in cash and cash equivalents

    4,525       (6,869 )     (8,497 )

Cash and cash equivalents, beginning of period

    7,035       13,904       22,401  
                       

Cash and cash equivalents, end of period

  $ 11,560     $ 7,035     $ 13,904  
                       

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

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The accompanying Consolidated Financial Statements of American Realty Investors, Inc. and consolidated subsidiaries have been prepared in conformity with accounting principles generally accepted in the United States of America, the most significant of which are described in NOTE 1. “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.” These, along with the remainder of the Notes to Consolidated Financial Statements, are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables and accompanying footnotes are in thousands, except per share amounts.

Certain balances for 2006 and 2005 have been reclassified to conform to the 2007 presentation.

 

NOTE 1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Business.    In November 1999, American Realty Investors, Inc. (“ARI”), a Nevada corporation, was formed, and in August 2000, ARI acquired American Realty Trust, Inc. (“ART”), a Georgia corporation and National Realty, L.P. (“NRLP”), a Delaware partnership. ARI primarily invests in real estate and real estate-related entities and purchases and originates mortgage loans.

Effective July 1, 2003, Prime Asset Management, Inc. (“PAMI”) became the advisor to ARI and TCI. PAMI is owned by Realty Advisors (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.

Basis of consolidation.    The accompanying Consolidated Financial Statements include the accounts of the Company, its subsidiaries, generally all of which are wholly-owned, and all entities in which the Company has a controlling interest, including where the Company has been determined to be a primary beneficiary of a variable interest entity in accordance with the provisions and guidance of Interpretation No. 46(R), Consolidation of Variable Interest Entities (“FIN 46(R)”) or meets certain criteria of a sole general partner or managing member as identified in accordance with Emerging Issues Task Force (“EITF”) Issue 04-5, Investor’s Accounting for an Investment in a Limited Partnership when the Investor is the Sole General Partner and the Limited Partners have Certain Rights (“EITF 04-5”). Controlling interest in an entity is normally determined by the ownership of a majority of the entity’s voting interests; however, other determining factors include, but may not be limited to, whether the Company provides significant financial support and bears a majority of the financial risks, authorizes certain capital transactions such as the purchase, sale or financing of material assets or makes operating decisions that materially affect the entity’s financial results. All intercompany balances and transactions have been eliminated in consolidation.

Accounting estimates.    In the preparation of these Consolidated Financial Statements, in conformity with accounting principles generally accepted in the United States of America, it is necessary for management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expense for the year then ended. Actual results could differ materially from these estimates.

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.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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.

Recent Accounting pronouncements.    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 taken 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 was effective for fiscal years beginning after December 15, 2006. FIN No. 48, which was adopted by the Company effective January 1, 2007, did not have a material impact on the Company’s cash flows, results of operations, financial position or liquidity.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB deferred the effective date of SFAS No. 157 for one year for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The FASB also removed certain leasing transactions from the scope of SFAS No. 157. The Company does not expect the adoption of SFAS No. 157 to have a material impact on the Company’s cash flows, results of operations, financial position or liquidity.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—including an amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 permits entities to choose, at specified election dates, to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses shall be reported on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 159 to have a material impact on the Company’s cash flows, results of operations, financial position or liquidity.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”), which establishes principles and requirements for how the acquirer shall recognize and measure in its financial statements the identifiable assets acquired, liabilities assumed, any noncontrolling interest in the acquiree and goodwill acquired in a business combination. SFAS No. 141(R) is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company is currently assessing the potential impact that the adoption of SFAS No. 141(R) will have on its financial position and results of operations.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements—an Amendment of ARB No. 51” (“SFAS No. 160”), which establishes and expands accounting and reporting standards for minority interests, which will be recharacterized as non-controlling interests, in a subsidiary and the deconsolidation of a subsidiary. SFAS No. 160 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. This statement is effective for fiscal years beginning on or after December 15, 2008. The Company is currently assessing the potential impact that the adoption of SFAS No. 160 will have on its financial position and results of operations.

Real estate held for investment and depreciation.    Real estate held for investment is carried at cost. Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), requires that a property be considered impaired if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property. If impairment exists, an impairment loss is recognized, by a charge against earnings, equal to the amount by which the carrying amount of the property exceeds the fair value less cost to sell the property. If impairment of a property is recognized, the carrying amount of the property is reduced by the amount of the impairment, and a new cost for the property is established. Such new cost is depreciated over the property’s remaining useful life. Depreciation is provided by the straight-line method over estimated useful lives, which range from five to 40 years.

Real estate held-for-sale.    Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated costs of sale. SFAS No. 144 also requires that properties held for sale be reported at the lower of carrying amount or fair value less costs of sale. If a reduction in a held for sale property’s carrying amount to fair value less costs of sale is required, a provision for loss is recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale property’s estimated fair value less costs of sale are recorded as an adjustment to the property’s carrying amount, but not in excess of the property’s carrying amount when originally classified as held for sale. A corresponding charge against or credit to earnings is recognized. Properties held for sale are not depreciated.

Investments in equity investees.    ARI may be considered to have the ability to exercise significant influence over the operating and investment policies of certain of its investees. Those investees are accounted for using the equity method. Under the equity method, an initial investment, recorded at cost, is increased by a proportionate share of the investee’s operating income and any additional investment and decreased by a proportionate share of the investee’s operating losses and distributions received.

Present value premiums/discounts.    Present value premiums and discounts are provided on notes receivable or payable that have interest rates that differ substantially from prevailing market rates and such premiums and discounts are amortized by the interest method over the lives of the related notes. The factors considered in determining a market rate for notes receivable include the borrower’s credit standing, nature of the collateral and payment terms of the note.

Foreign currency translation.    Foreign currency denominated assets and liabilities of subsidiaries with local functional currencies are translated to United States dollars at year-end exchange rates. The effects of translation are recorded in the cumulative translation component of shareholders’ equity. Subsidiaries with a United States dollar functional currency remeasure monetary assets and liabilities at year-end exchange rates and non-monetary assets and liabilities at historical exchange rates. The effects of re-measurement are included in income. Exchange gains and losses arising from transactions denominated in foreign currencies are translated at average exchange rates.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Recognition of rental income.    Rental income for commercial property leases is recognized on a straight-line basis over the respective lease terms. 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.

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 either the deposit, the installment, the cost recovery, or the 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.

Operating segments.    Management has determined reportable operating segments to be those that are used for internal reporting purposes, which disaggregates operations by type of real estate.

Fair value of financial instruments.    The following assumptions were used in estimating the fair value of its 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.

Cash equivalents.    For purposes of the Consolidated Statements of Cash Flows, all highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents.

Earnings (loss) per share.    Income (loss) per share is presented in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Income (loss) per share is computed based upon the weighted average number of shares of common stock outstanding during each year.

Stock-based employee compensation.    The Company previously accounted for its stock-based compensation utilizing the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment”, which revised SFAS 123, “Accounting for Stock-Based Compensation.” SFAS 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements and forfeitures to be estimated at the grant date rather than as they occur. The Company previously based its estimated forfeiture rate on historical forfeitures of all stock option grants. The Company adopted SFAS 123(R) effective January 1, 2006 using the modified-prospective method and applied the provisions of SFAS 123(R) to all share-based compensation. All of ARI’s stock options were fully vested as of January 1, 2006 and ARI had no outstanding stock option grants that were modified or settled after January 1, 2006; therefore, the adoption of SFAS 123(R) had no material effect on the Company’s results of operations for the year ended December 31, 2007. The director’s stock option plan was terminated in December of 2005.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

NOTE 2.    REAL ESTATE

A summary of our real estate transactions for the year ended December 31, 2007 is listed below:

 

    Cost
Beginning of
Year
  Acquisitions   Capital
Improvements
  Development
Costs
  Completed
Development
    Property
Sales
    Impairment
Charges
    Reclassifications
and Other
Adjustments
    Cost
12/31/2007
  Accumulated
Depreciation
12/31/2007

Apartments

  $ 474,481   $ 3,974   $ 59   $ —     $ 89,985     $ (3,560 )   $ (1,003 )   $ (48,404 )   $ 515,532   $ 41,939

Apartments under construction

    61,583     —       —       172,581     (89,985 )     —         —         9,035       153,214     70

Other developments in progress

    78,230     —       —       32,091     —         —         —         —         110,321     —  

Commercial properties

    348,080     110,284     9,789     —       —         (51,696 )     —         30,646       447,103     89,820

Hotels

    85,681     —       5,287     —       —         —         —         (2,430 )     88,538     16,382

Land held for development

    201,778     24,965     3,728     —       —         (18,241 )     —         (18,123 )     194,107     193
                                                                   

Real estate held for investment

  $ 1,249,833   $ 139,223   $ 18,863   $ 204,672   $ —       $ (73,497 )   $ (1,003 )   $ (29,276 )   $ 1,508,815   $ 148,404
                                                                   

Real estate held for sale

  $ 157,546   $ —     $ —     $ —     $ —       $ (70,499 )   $ —       $ (3,663 )   $ 83,384   $ 22,256
                                                                   

Real estate subject to sales contract

  $ 73,033   $ —     $ —     $ —     $ —       $ —       $ —       $ —       $ 73,033   $ 8,713
                                                                   

Park West I & II

On January 19, 2007, we acquired a 383,114 and a 707,599 square foot office building in Farmers Branch, Texas known as Park West I and Park West II, respectively and a 4.7-acre tract of undeveloped land at an aggregate purchase price of $107.1 million. The acquisition was financed with $10.1 million in cash and $97.0 million in new debt. Two separate notes were obtained on this acquisition; a $35.0 million note which accrues interest at 6.06% maturing January 2009 and a $62.0 million note which accrues interest at a variable rate (currently 9.32%) maturing January 2013.

Bluffs at Vista Ridge

On February 16, 2007, we sold the Bluffs at Vista Ridge a 272-unit apartment complex in Lewisville, Texas for $24.6 million. The proceeds were used to pay down the existing mortgage of $15.5 million receiving $9.1 million in cash. A gain of $3.6 million was recorded on this sale.

Hines Meridian

On May 8, 2007, we acquired 40.1 acres of land in Las Colinas, Texas known as Hines Meridian for $7.9 million. The purchase was financed with $2.9 million in cash and a note payable of $5.0 million. The note accrues interest at 9.25% and matures in June 2010.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Durham Center

On June 26, 2007, we sold the Durham office building, a 207,171 square foot commercial building located in Durham North Carolina for $19.2 million, recording a gain of $1.7 million. We received $3.4 million in cash after paying off the existing debt and closing costs.

Forum Office Building

On July 27, 2007, we sold the Forum Office Building in Richmond, Virginia, a 79,791 square foot commercial building, for $9.4 million, recording a $3.4 million gain on sale. We received $3.1 million in cash after paying off the $5.9 million mortgage and $400,000 in closing costs

West End Land

On September 27, 2007, we sold 2.2 acres of land in Dallas Texas, known as the West End Land, for $6.5 million, recording a gain of $3.8 million. We received $2.3 million in cash after paying off the existing debt of $3.8 million.

El Chapparal

On November 4, 2007, we sold the El Chapparal Apartments, a 190-unit community complex, in San Antonio, Texas for $5.5 million, recording a gain of $3.9 million on the sale. We received $1.0 million in cash after paying off the $3.9 million mortgage and $600,000 in closing costs and commissions.

Four Hickory

On November 13, 2007, we sold a 71% interest, retaining a 29% equity interest in the Four Hickory building, a 226,911 square foot commercial building located in Farmers Branch, Texas for $39.7 million, recording a gain on sale of $15.4 million, and deferring $3.7 million of the gain. We received $7.5 million in cash after paying off the existing debt and closing costs.

Atlantic Sands Hotel

On November 29, 2007, we sold the Atlantic Sands Hotel, a 110-room hotel located in Virginia Beach, Virginia, for $12.0 million. We provided $2.0 million in seller financing, and recorded a gain on sale of $5.4 million. We received cash proceeds of $7.4 million, after paying down the existing $3.1 million mortgage, closing costs, and commissions.

Arlington Place apartments

On November 27, 2007, we sold the Arlington Place Apartments, a 230-unit apartment complex, located in Houston, Texas for $5.8 million, recording a gain on sale of $4.8 million. We received $1.6 million in cash after paying off the existing $3.9 million mortgage and $300,000 in closing costs and commissions.

Woodlake apartments

On November 28, 2007, we sold the Woodlake Apartments, a 256-unit apartment complex, located in Carrollton, Texas for $10.8 million, recording a gain on sale of $8.4 million. We received $2.5 million in cash after paying off the $7.8 million mortgage and $500,000 in closing costs and commissions.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Harpers Ferry Apartment

On December 19, 2007, we sold the Harpers Ferry apartments, a 122-unit complex in Lafayette, Louisiana for $5.5 million, recording a gain on sale of $3.6 million. We received $1.6 million in cash after paying off the existing $3.0 million mortgage, $500,000 in early payment penalties and $400,000 in closing costs.

Ewing Land

In December 2006, ARI acquired 16.792 acres in North Dallas known as the Ewing Land, for $3.4 million cash and a seller financing of $10.8 million. The land was acquired for future development and borders the cities of Addison and Farmers Branch. The loan matures in December 2009 and requires interest only payments at 5.5 % until maturity.

Windmill Farms

On November 21, 2006, the Company purchased 3,035 acres of land located in Kaufman County, Texas for $52.0 million, known as Windmill Farms. The purchase price consisted of $39.1 million in new debt, $10.0 million in preferred stock acquired from an affiliated entity and $2.9 million in cash. The financing consisted of two notes of $2.0 million and $37.1 million. The $2.0 million note is payable in quarterly interest only payments through maturity. On November 21, 2007, $1.0 million of principal is due. The remainder of the principal is due on the maturity date, November 21, 2008. The $37.1 million note is payable in monthly installments of interest only. Principal payments of $7.5 million each are due on November 17, 2007 and November 17, 2008. The remaining accrued unpaid interest and principal balances are due on maturity, November 17, 2009. In addition, a portion of the note proceeds, $6.0 million, went to a restricted cash account to pay for future interest payments mentioned above.

Galleria East

In November 2006, ARI acquired approximately 15 acres located at the intersection of the Dallas North Tollway and IH-635 (LBJ Freeway) in Dallas, Texas for a purchase price of $25.2 million. Payment was in the form of $8.8 million cash and a note payable of $18.4 million due in December 2007. Terms of the note require interest only payments at 6.0 % until maturity. ARI intends to hold the land for future development or sale.

Galleria West

In November 2006, ARI purchased two parcels of land in separate transactions totaling approximately 9.2 acres in North Dallas for approximately $7.5 million. Payment was made in the form of notes payable in the amounts of $1.5 million and $5.2 million. The notes require interest payments at 6.0 percent through maturity in December 2007. ARI intends to hold the land for future development or resale.

New Orleans Properties

In August 2006, ARI purchased the Clarke Garage at 913 Gravier in New Orleans, Louisiana for $9.0 million. The property is adjacent to and includes 305 Baronne. 305 Baronne contains approximately 2,000 square feet of retail space and is currently occupied by retail tenants. 225 Baronne consists of approximately 417,000 square feet of office space and was significantly damaged during Hurricane Katrina in September 2005. In 2006, ARI reduced the carrying value of 225 Baronne to $1.2 million, which approximates the value of the underlying land. ARI intends to redevelop 225 Baronne into an urban residential facility, which it considers the best and most profitable use of the property. To facilitate the marketability of the property, ARI acquired the Clarke Garage and 305 Baronne to provide additional parking and retail for the residential development.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

GNB Building

In July 2006, the Company acquired from an affiliated entity, the GNB building that sits on .5 acres of land and an additional 45 acres of undeveloped land adjacent to the building known as GNB located in Farmers Branch, Texas. The Company paid $15 million for the building and land, via $5 million in cash and acquired $10 million of existing debt.

Williamsburg Hospitality House

On November 27, 2006, the Company sold the Williamsburg Hospitality House, a 269-room hotel located in Williamsburg, Virginia, for $27.5 million. The Company received $10.3 million in cash after paying off three notes secured by this property. The notes consisted of a first lien of $10.7 million, a second lien of $5.6 million and an additional lien of $201,000 for an aggregated pay down of $16.5 million. The Company recorded a $10.5 million gain on the sale of this property.

McKinney Ranch Land

In June 2006, ARI sold approximately 168.8 acres of the McKinney Ranch land in McKinney, Texas for $26.9 million. The sale resulted in a gain of $8.8 million and net cash proceeds of $16.0 million after pay down of $10.2 million on notes payable and other costs of sale.

Will-O-Wick

In May 2006, ARI sold the Will-O-Wick apartments in Pensacola, Florida, for $6.5 million. The sale resulted in a gain of $2.9 million and net cash proceeds received of $2.8 million after payment of outstanding mortgages and costs of sale.

NOTE 3.    NOTES AND INTEREST RECEIVABLE

 

     2007    2006
     Estimated
Fair Value
   Book
Value
   Estimated
Fair Value
   Book
Value

Notes receivable

           

Performing

   $ 64,681    $ 64,243    $ 51,723    $ 46,174

Non-performing

     15,872      16,468      4,852      2,963
                           
   $ 80,553    $ 80,711    $ 56,575    $ 49,137
                   

Interest receivable

        5,734         4,494
                   
      $ 86,445       $ 53,631
                   

Interest income is recognized on non-performing notes receivable on a cash basis. If the notes for the years 2007, 2006, and 2005 had been performing, an additional receivable totaling $1.0 million, $765,000 and $172,000, respectively, would have been recognized.

As of December 31, 2007, the obligors on $44.1 million or 84% of the mortgage notes receivable portfolio were affiliates of ARI. Also at that date, $16.5 million or 36% of the mortgage notes receivable portfolio was non-performing.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Notes receivable at December 31, 2007, mature from 2008 to 2017 with interest rates ranging from 7.0% to 18.0% per annum and a weighted average rate of 9.41% per annum. Notes receivable are generally collateralized by real estate or interests in real estate and personal guarantees of the borrower and, unless noted otherwise, are so secured. A majority of the notes receivable provide for principal to be paid at maturity. Scheduled principal maturities of $25.0 million are due in 2008.

NOTE 4.    ALLOWANCE FOR ESTIMATED LOSSES

Activity in the allowance for estimated losses was as follows:

 

     2007    2006    2005  

Balance January 1,

   1,000    1,000    1,865  

(Decrease) Increase in provision

   1,978    —      (865 )
                

Balance December 31,

   2,978    1,000    1,000  
                

The allowance was reduced in 2005 when ARI received title to 13 acres of land in Harris County in settlement of a $1.4 million note from an unrelated party. No changes to the allowance account have been made for 2006. In 2007, the allowance account was reviewed and an additional $2.0 million was accrued.

NOTE 5.    INVESTMENTS IN EQUITY INVESTEES

Investment in equity method entities consisted of the following:

 

     2007    2006

Income Opportunity Realty Investors, Inc. (“IORI”)

   $ 6,162    $ 6,345

Garden Centura, L.P

     1,944      1,944

Gruppa Florentina, LLC (“Gruppa”)

     4,908      4,530

Other

     10,853      12,237
             
   $ 23,867    $ 25,056
             

In November 2006, ARI completed its sale of its 80% interest in Milano restaurants through its investment in Gruppa Florentina, LLC. As of December 2006, ARI’s remaining 20% interest is recorded via the equity method. Gruppa is not publicly traded and has no readily determinable market value.

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, 2007. The carrying value of this investment is approximately $6.1 million at December 31, 2007.

In December 2004, ARI sold a 95% interest in Garden Centura, L.P., a limited partnership that owns the 411,000 sq. ft. Centura Tower office building located in Farmers Branch, Texas. ARI retained a non-controlling one percent general partner and 4 percent limited partner interest in Garden Centura, L.P. ARI accounts for its investment in this partnership on the equity method. ARI advanced approximately $4.1 million to Garden Centura, L.P. during 2005 for rent abatements and tenant improvements. ARI contributed an additional $600,000 and $1.8 million to Garden Centura, L. P. for cash shortfalls in 2005 and 2006. These funds are recorded as an interest-bearing loan due from the partnership.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

A significant portion of ARI’s investment in IORI and TCI is pledged as collateral for borrowings. See NOTE 7. “NOTES AND INTEREST PAYABLE” and NOTE 8. “STOCK-SECURED NOTES PAYABLE.”

Set forth below are summarized financial data for the entities accounted for using the equity method.

 

     2007     2006        

Real estate, net of accumulated depreciation

   $ 138,992     $ 58,621    

Notes receivable

     27,441       27,777    

Other assets

     39,238       22,513    

Notes payable

     (123,120 )     (61,546 )  

Other liabilities

     (5,199 )     (2,526 )  
                  

Shareholders equity/partners’ capital

   $ 77,352     $ 44,839    
                  
     2007     2006     2005  

Revenues

   $ 16,894     $ 11,064     $ 20,149  

Depreciation

     (3,177 )     (750 )     (3,722 )

Operating expenses

     —         —         —    

Gain on land sales

     (6,614 )     (4,764 )     (5,829 )

Interest expense

     (8,287 )     (5,378 )     (8,740 )
                        

Income (loss) from continuing operations

     (1,184 )     172       1,858  

Income (loss) from discontinued operations

     —         —         —    

Gain from sale of discounted operations

     57       —         —    
                        

Net income

   $ (1,127 )   $ 172     $ 1,858  
                        

ARI’s equity share of:

      
     2007     2006     2005  

Income (loss) before gain on sale of real estate

   $ (270 )   $ 41     $ 397  

Gain on sale of real estate

     —         —         —    
                        

Net Income (loss)

   $ (270 )   $ 41     $ 397  
                        

The cash flow from IORI is dependent on the ability of IORI to make distributions. IORI ceased making quarterly distributions in the fourth quarter of 2000.

 

NOTE 6. MARKETABLE EQUITY SECURITIES

In March 2003, TCI acquired equity securities of Realty Korea CR-REIT Co., Ltd. No. 1 for $5.0 million, representing approximately a 9.2% ownership interest. This investment is considered an available-for-sale security. ARI has recognized unrealized gains of $4.1 million and $2.3 million during 2007 and 2006, respectively, due to increases in market price since December 31, 2007.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

NOTE 7.    NOTES AND INTEREST PAYABLE

The summary of notes payable for the year ended December 31, 2007 is listed below;

 

    Balance
Beginning of
Year
  Additional Borrowings   Repayments     Reclassifications
and Other

Adjustments
    Balance
31-Dec
2007
 
    Acquisitions   Developments   Refinancings   Amortization     Property Sales     Refinancings      

Apartments

  $ 406,775   $ 5,828   $ —     $ 48,185   $ (3,975 )   $ (20,711 )   $ (22,984 )   $ (52,081 )   $ 361,037  

Apartments under construction

    30,073     —       102,185     —       (1,559 )     —         —         —         130,699  

Other developments in progress

    66,547     —       104,338     14,298     (279 )     —         (7,970 )     —         176,934  

Commercial properties

    210,476     97,000     —       19,500     (4,021 )     (22,068 )     (18,866 )     (9,954 )     272,067  

Hotels

    56,914     —       —       47,160     (637 )     —         (22,143 )     939       82,233  

Land held for development

    209,630     22,095     3,446     21,946     —         (20,988 )     (14,861 )     (14,777 )     206,491  

Corporate and other

    34,540     —       4,357     —       (247 )     (5,000 )     (500 )     (46,553 )     (13,403 )

Accrued interest

    7,415     —       —       —       —         —         —         (1,486 )     5,929  
                                                               

Real estate held for investment

  $ 1,022,370   $ 124,923   $ 214,326   $ 151,089   $ (10,718 )   $ (68,767 )   $ (87,324 )   $ (123,912 )   $ 1,221,987  
                                                               

Real estate held for sale

  $ 43,579   $ —     $ —     $ —     $ (666 )   $ (51,233 )   $ —       $ 124,697     $ 116,377  
                                                               

Real estate subject to sales contract

  $ 58,816   $ —     $ —     $ 38,720   $ (1,488 )   $ —       $