Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

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

For the fiscal year ended December 31, 2008

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 a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨    Accelerated filer  ¨
Non-accelerated filer  x (Do not check if smaller reporting company)    Smaller reporting company  ¨

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, 2008 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $14,527,019 based upon a total of 1,532,386 shares held as of June 30, 2008 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 5, 2009, there were 11,237,066 shares of common stock outstanding.

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.

   11

Item 1B.

 

Unresolved Staff Comments.

   16

Item 2.

 

Properties.

   16

Item 3.

 

Legal Proceedings.

   22

Item 4.

 

Submission of Matters to a Vote of Security Holders.

   22
PART II

Item 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.    23

Item 6.

 

Selected Financial Data.

   26

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations.    27

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk.

   40

Item 8.

 

Financial Statements and Supplementary Data.

   41

Item 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.    92

Item 9A(T).

 

Controls and Procedures.

   92

Item 9B.

 

Other Information.

   93
PART III

Item 10.

 

Directors, Executive Officers and Corporate Governance.

   94

Item 11.

 

Executive Compensation.

   102

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    103

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence.

   104

Item 14.

 

Principal Accounting Fees and Services.

   106
PART IV

Item 15.

 

Exhibits, Financial Statement Schedules.

   108

Signature Page

   110

 

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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 Part I, Item 1A. “Risk Factors”.

PART I

 

ITEM 1. BUSINESS

General

As used herein, the terms “ARL,” “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”. ARL is a “C” corporation for U.S. federal income tax purposes. ARL 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.

ARL subsidiaries own approximately 82.8% 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 24.9% of the outstanding common shares of Income Opportunity Realty Investors, Inc., (“IOT”) whose common stock is traded on the American Stock Exchange under the symbol “IOT”. ARL has consolidated TCI’s accounts and operations since March 2003.

ARL’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%), which is owned by Gene E. Phillips, Realty Advisors, Inc. which 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 ARL, he does regularly consult with the executive officers and directors of ARL rendering advice and input with respect to investment decisions affecting ARL. PIAMI, together with its subsidiary, One Realco Holdings, Inc., also owns approximately 15.3% of the common stock of ARL and approximately 7.4% of the Series A 10% cumulative convertible preferred Stock of ARL.

ARL’s Board of Directors represents the Company’s shareholders and is responsible for directing the overall affairs of ARL 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 ARL’s Board of Directors. 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 ARL’s benefit, debt and equity financing with third party lenders and investors. Prime is compensated by ARL under the advisory agreement that is more fully described in Part III, Item 10, “Directors, Executive Officers and Corporate Governance”.

 

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Prime also serves as advisor to TCI. The officers of ARL are also officers of IOT, TCI, and Prime. The directors of ARL also serve as directors of TCI. The Chairman of the Board of Directors of ARL also serves as the Chairman of the Board of Directors of TCI. One director of ARL also serves as a director of IOT. Affiliates of Prime have provided property management services to ARL. Currently, Triad Realty Services, LP. (“Triad”), subcontracts 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 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.

Regis I is also entitled to receive real estate brokerage commissions in accordance with the terms of the Advisory Agreement as discussed in Part III, Item 10. “Directors, Executive Officers and Corporate Governance.”

ARL’s primary business is the acquisition, development and ownership of income-producing residential, hotel and commercial real estate properties. In addition, ARL 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, 2008, our income-producing properties consisted of:

 

   

5.9 million rentable square feet of commercial properties, including 20 office buildings, 8 industrial properties, five retail properties, and a 344,975 square foot trade show and exhibit hall,

 

   

60 residential apartment communities comprising 11,437 units, and one single family residence; and

 

   

Five hotels comprising 808 rooms.

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, 2008:

 

     Apartments     Commercial    Hotels

Location

   No.    Units     No.    SF    No.    Rooms

Greater Dallas-Ft Worth, TX

   18    3,681 (1)   16    2,865,715      

Greater Houston, TX

   9    2,348             

Midland-Odessa, TX

   4    845             

San Antonio, TX

   3    852     1    101,500      

Tyler, TX

   6    1,101             

Other Texas

   1    260             

Mississippi

   7    450             

Arkansas

   4    580             

Tennessee

   3    532             

Florida

   2    153     1    6,722      

New Orleans, LA

        6    1,369,388      

Indianapolis

        1    220,461      

Oklahoma

        1    225,566      

Michigan

        1    179,741      

Colorado

        1    344,975    1    161

California

              4    647

Other

   3    635     6    598,652      
                              

Total

   60    11,437     34    5,912,720    5    808
                              

 

(1) includes a single family residence

 

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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 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.

At December 31, 2008, our projects in development included (dollars in thousands):

 

Property

  

Location

   No. of
Units
   Costs to
Date
   Total
Projected
Costs

Savoy of Garland

   Garland, TX    144    $ 2,382    $ 11,380

Dorado Ranch

   Odessa, TX    224      17,081      19,137

Mansions of Mansfield

   Mansfield, TX    208      16,870      18,687

Northside on Travis

   Sherman, TX    200      15,184      16,999

Sugar Mill

   Baton Rouge, LA    160      4,678      13,199
                     

Total

      936    $ 56,195    $ 79,402
                     

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% 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. 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.

 

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At December 31, 2008, our investments in undeveloped and partially developed land consisted of the following (dollars in thousands):

 

Property

 

Location

  Date(s)
Acquired
  Acres   Cost  

Primary

Intended Use

Beltline-Geller Road

  Dallas, TX   2007   379   $ 2,888   Commercial

Circle C Ranch

  Austin, TX   2006   1,092     44,622   Single-family residential

Dallas North Tollway

  Dallas, TX   2006   17     16,005   Commercial

Jackson Convention Center

  Jackson, MS   2007-2008   2     10,826   Mixed use

Kaufman County

  Dallas, TX   2000-2008   2,824     11,620   Single-family residential

Las Colinas Multi-Tracts

  Dallas, TX   1995-2006   280     23,563   Commercial

Mandahl Bay

  St. Thomas, USVI   2005-2008   91     15,845   Single-family residential

McKinney Multi-Tracts

  Dallas, TX   1997-2008   211     24,201   Mixed use

Meloy Portage

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

Mercer Crossing

  Dallas, TX   1996-2008   760     96,654   Mixed use

Pioneer Crossing

  Austin, TX   1997-2008   886     39,503   Multi-family residential

Port Olpenitz

  Germany   2008   420     13,654   Mixed use

Travis Ranch

  Dallas, TX   2008   832     18,661   Multi-family residential

Valley Ranch

  Dallas, TX   2004   27     5,826   Commercial

Waco Multi-Tracts

  Waco, TX   2005-2006   502     4,911   Single-family residential

Windmill Farms

  Dallas, TX   2006-2008   3,290     65,558   Single-family residential

Woodmont Multi-Tracts

  Dallas, TX   2006-2008   71     83,582   Mixed use
               

Subtotal

      11,737     483,038  

Other land holdings

  Various   1990-2008   841     66,001   Various
               

Total land holdings

      12,578   $ 549,039  
               

In addition, we own a non-controlling 20% interest in Milano Restaurants International, which operates and franchises several quick service restaurant concepts in California. We use the equity method to account for these investments.

Significant Real Estate Acquisitions/Dispositions and Financings

A summary of some of the significant transactions for the year ended December 31, 2008 are discussed below:

On January 15, 2008, we purchased 4.0 acres of land in Dallas, Texas known as Woodmont TCI XIV, LP for $6.4 million. We financed the transaction with $1.9 million cash, a new mortgage of $4.1 million with a commercial lender and accrued $400,000 in commissions payable and other closing cost. The mortgage is secured by the property and accrues interest at Prime plus 0.75%.

On January 25, 2008, we sold 15 apartment complexes in a single transaction for an aggregate sales price of $98.3 million and recorded a gain on sale of $72.1 million. We received cash of $28.4 million after paying off existing mortgages of $62.1 million, and $7.8 million in commissions and other closing costs.

The properties consisted of:

 

   

Forty-Four Hundred Apartments, a 92-unit complex in Midland, Texas;

 

   

Arbor Pointe, a 194-unit complex in Odessa, Texas;

 

   

Ashton Way, a 178-unit complex in Midland, Texas;

 

   

Autumn Chase, a 94-unit complex in Midland, Texas;

 

   

Courtyard Apartments, a 133-unit complex in Midland, Texas;

 

   

Coventry Point, a 120-unit complex in Midland, Texas;

 

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Fairway, a 152-unit complex in Longview, Texas;

 

   

Fountains at Waterford, a 172-unit complex in Midland, Texas;

 

   

Hunters Glen, a 260-unit complex in Midland, Texas;

 

   

Southgate, a 180-unit complex in Odessa, Texas;

 

   

Sunchase, a 300-unit complex in Odessa, Texas;

 

   

Sunset, a 240-unit complex in Midland, Texas;

 

   

Thornwood, a 109-unit complex in Odessa, Texas;

 

   

Westwood, a 79-unit complex in Odessa, Texas; and

 

   

Woodview, a 232-unit complex in Odessa, Texas.

On January 31, 2008, we sold the Lexington office building, a 75,000 square foot commercial building located in Colorado Springs, Colorado for $5.4 million. We received cash of $1.6 million after paying off the existing mortgage of $3.5 million and $300,000 in closing costs. We recorded a $700,000 gain on sale.

On February 6, 2008, we sold the Fairway View apartments, a 264-unit complex located in El Paso, Texas for $10.3 million recording a gain on sale of $6.0 million. We received $4.8 million in cash after paying off the existing mortgage of $5.3 million and closing costs.

On February 14, 2008, we sold the Governors Square apartments, a 169-unit complex located in Tallahassee, Florida for $8.5 million, recording a gain on sale of $5.7 million. We received $4.7 million in cash after paying off the existing mortgage of $2.9 million and $900,000 in closing costs.

On February 14, 2008, we sold three hotels located in Chicago, Illinois in a single transaction for $30.0 million recording a gain on sale of $18.4 million. We received cash of $9.8 million after paying off existing mortgages of $18.5 million and closing costs. The properties consisted of:

 

   

City Suites Hotel, a 45-room hotel;

 

   

Majestic Hotel, a 55-room hotel; and

 

   

Willows Hotel, a 52-room hotel.

On March 28, 2008, we sold all of our shares in S.P. Zoo (a Polish Corporation) for $11.8 million. The sale of the shares represented our 66.67% interest in the Radisson-SAS Hotel Akademia, a 161-room hotel located in Wroclaw, Poland. We received cash of $11.8 million upon sale of our shares and recorded a gain on sale of $7.7 million.

On April 2, 2008, we acquired the Bridgewood Ranch apartments, a 106-unit complex located in Kaufman, Texas for $7.6 million. We financed the purchase with a new mortgage (secured by the property) of $5.1 million, cash of $1.3 million, and $1.2 million in liabilities. The mortgage accrues interest at the higher rate of 6.75% or Prime plus 0.25% and matures in March 31, 2019.

On April 16, 2008, we acquired the Quail Hollow apartments, a 200-unit complex located in Holland, Ohio for $14.1 million. We financed the purchase with a new mortgage (secured by the property) of $11.5 million, cash of $77,000, and $2.6 million in liabilities. The mortgage accrues interest at 7.00% and matures in October 2011.

On June 10, 2008, we sold 20.6 acres of undeveloped land located in Irving, Texas for $7.2 million, recording a $1.9 million gain on sale. We received $2.0 million in cash and provided $2.2 million in seller financing, after paying down $2.9 million in existing debt, and incurring $100,000 in closing costs.

 

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On June 26, 2008, we purchased the Stanford Centre, a 274,684 square foot commercial building located in Dallas, Texas including 3.1 acres of land, for $38.8 million. We financed the transaction with $11.5 million in cash and a $26.1 million mortgage from a commercial bank. In addition, we incurred $1.2 million in accruals and credits at closing. The note accrues interest at LIBOR plus 3.75% and matures on July 1, 2011.

On July 23, 2008, we purchased 24.1 acres of land known as Las Colinas land located in Irving, Texas for $6.7 million. We financed the transaction with $2.2 million in cash and a $4.5 million mortgage secured by the property. The note accrues interest at Prime plus 4.00% and matures on July 23, 2010.

On July 23, 2008, we purchased 246.0 acres of land known as Windmill Farms Harlan land located in Kaufman County, Texas for $6.8 million. We financed the transaction with $1.3 million cash and seller financing of $5.5 million. The note accrues interest at 2.00% for the first year, 4.00% for the second year and 6.00% for the third year and each year thereafter and matures on July 23, 2013.

On August 12, 2008, we purchased 833.4 acres of land in Forney, Texas known as Travis Ranch land for $18.7 million. We financed the transaction with $2.2 million cash, a $5.8 million loan with a commercial lender and a $7.5 million loan provided by the seller. In addition, we accrued $3.2 million in commissions and closing costs. The commercial note and seller financing both accrue interest at 5.00% and are due upon demand.

On October 10, 2008, we obtained a new $ 8.5 million loan with a commercial lender which was collateralized by the property known as Travis Ranch land. The proceeds were used to pay off the existing $5.8 million loan on Travis Ranch land and to reduce the seller financed loan by $2.7 million. The new loan accrues interest at 17% and is payable on maturity, April 9, 2009.

On October 15, 2008, we sold the Mountain Plaza apartments, a 188-unit complex, located in El Paso, Texas for $7.9 million. We received $1.1 million in cash, after providing seller financing of $1.9 million. The buyer assumed the existing mortgage of $4.9 million secured by the property.

On December 17, 2008, we refinanced the existing mortgage on 22 acres of land known as Hines Land for a new mortgage of $5.0 million receiving $2.6 million in cash after paying down the existing debt of $2.0 million and $400,000 in closing costs. The note accrues interest at 17.0%, and is payable on maturity, June 17, 2009 at which time all accrued and unpaid interest and principal is due.

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.

 

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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 ARL 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 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 ARL 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.

 

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Competition

The real estate business is highly competitive and we compete with numerous companies engaged in real estate activities (including certain entities described in Part III, Item 13. “Certain Relationships and Related Transactions, and Director Independence”), some of which have greater financial resources than ARL. 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 Part I, Item 1A. “Risk Factors”.

To the extent that ARL 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 ARL’s properties are located, as well as aggressive buyers attempting to dominate or penetrate a particular market.

As described above and in Part III, Item 13. “Certain Relationships and Related Transactions, and Director Independence”, the officers and directors of ARL serve as officers and directors of TCI, the officers of ARL serve as the officers of IOT and one director of ARL is also a director of IOT. TCI and IOT have business objectives similar to ARL. ARL’s officers and directors owe fiduciary duties to both IOT and TCI as well as to ARL under applicable law. In determining whether a particular investment opportunity will be allocated to ARL, IOT, 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 Part III, Item 13. “Certain Relationships and Related Transactions, and Director Independence”, ARL 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 ARL 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

ARL 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, ARL has

posted the charters for the Audit Committee, Compensation Committee, and Governance and Nominating

 

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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. ARL will also provide a copy of these documents free of charge to stockholders upon written request. ARL 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;

 

   

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; and

 

   

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

 

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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.

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; and

 

   

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;

 

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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; and

 

   

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 United States. The Company’s overall performance is largely dependent on economic conditions in those regions.

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

We had total indebtedness at December 31, 2008 of approximately $1.5 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; and

 

   

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.

 

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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.

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.

 

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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; and

 

   

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;

 

   

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.

Our performance and value are subject to risks associated with our real estate assets and with the real estate industry.

Our economic performance and the value of our real estate assets, and consequently the value of our securities, are subject to the risk that if our properties do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures, our cash flow will be adversely affected. The following factors, among others, may adversely affect the income generated by our properties:

 

   

downturns in the national, regional and local economic conditions (particularly increases in unemployment);

 

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competition from other office, hotel and commercial buildings;

 

   

local real estate market conditions, such as oversupply or reduction in demand for office, hotel or other commercial space;

 

   

changes in interest rates and availability of financing;

 

   

vacancies, changes in market rental rates and the need to periodically repair, renovate and re-let space;

 

   

increased operating costs, including insurance expense, utilities, real estate taxes, state and local taxes and heightened security costs;

 

   

civil disturbances, earthquakes and other natural disasters, or terrorist acts or acts of war which may result in uninsured or underinsured losses;

 

   

significant expenditures associated with each investment, such as debt service payments, real estate taxes, insurance and maintenance costs which are generally not reduced when circumstances cause a reduction in revenues from a property;

 

   

declines in the financial condition of our tenants and our ability to collect rents from our tenants; and

 

   

decreases in the underlying value of our real estate.

Adverse economic and geopolitical conditions and dislocations in the credit markets could have a material adverse effect on our results of operations, and financial condition.

Our business may be affected by market and economic challenges experienced by the U.S. economy or real estate industry as a whole or by the local economic conditions in the markets in which our properties are located, including the current dislocations in the credit markets and general global economic recession. These current conditions, or similar conditions existing in the future, may adversely affect our results of operations, and financial condition as a result of the following, among other potential consequences:

 

   

the financial condition of our tenants may be adversely affected which may result in tenant defaults under leases due to bankruptcy, lack of liquidity, operational failures or for other reasons;

 

   

significant job losses within our tenants may occur, which may decrease demand for our office space, causing market rental rates and property values to be negatively impacted;

 

   

our ability to borrow on terms and conditions that we find acceptable, or at all, may be limited, which could reduce our ability to pursue acquisition and development opportunities and refinance existing debt, reduce our returns from our acquisition and development activities and increase our future interest expense;

 

   

reduced values of our properties may limit our ability to dispose of assets at attractive prices or to obtain debt financing secured by our properties and may reduce the availability of unsecured loans; and

 

   

one or more lenders could refuse to fund their financing commitment to us or could fail and we may not be able to replace the financing commitment of any such lenders on favorable terms, or at all.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

On December 31, 2008, our portfolio consisted of 99 income producing properties consisting of 59 apartments, 34 commercial properties, one single family residence, and five hotels. The apartments have a total of 11,436 units. The commercial properties consist of 20 office buildings, 8 industrial warehouses, five shopping centers, and one merchandise mart which is 344,975 square feet. The five hotels have total of 808 rooms. In addition, we own or control 12,578 acres of improved and unimproved land held for future development or sale. The table below shows information relating to those properties.

 

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The GNB building which was included in the property detail in 2007 was razed in 2008. Based on the surrounding land values, management determined that the acquisition price of the GNB land and building was due to the value of the land, and not the building. Thus, the value of the building and the cost to raze the building was reallocated to the cost of the land.

 

Apartments

  

Location

   Units    Occupancy  

Anderson Estates

   Oxford, MS    48    95.94 %

Bay Walk

   Galveston, TX    192    95.95 %

Blue Lake Villas I

   Waxahachie, TX    186    93.65 %

Blue Lake Villas II

   Waxahachie, TX    70    92.95 %

Breakwater Bay

   Beaumont, TX    176    98.98 %

Bridges On Kinsey

   Tyler, TX    232    96.23 %

Bridgestone

   Friendswood, TX    76    79.04 %

Bridgewood Ranch

   Kaufman, TX    106    94.45 %

Capitol Hill

   Little Rock, AR    156    93.04 %

Chateau

   Bellevue, NE    115    92.28 %

Curtis Moore Estates

   Greenwood, MS    104    92.41 %

Dakota Arms

   Lubbock, TX    208    98.16 %

David Jordan Phase II

   Greenwood, MS    32    100.00 %

David Jordan Phase III

   Greenwood, MS    40    100.00 %

Desoto Ranch

   DeSoto, TX    248    90.82 %

Falcon Lakes

   Arlington, TX    248    98.10 %

Foxwood

   Memphis, TN    220    79.17 %

Heather Creek

   Mesquite, TX    200    94.59 %

Huntington Ridge

   DeSoto, TX    198    89.40 %

Island Bay

   Galveston, TX    458    89.85 %

Kingsland Ranch

   Houston, TX    398    93.57 %

Laguna Vista

   Dallas, TX    206    93.66 %

Lake Forest

   Houston, TX    240    92.61 %

Legends of El Paso

   El Paso, TX    240    95.10 %

Longfellow Arms

   Longview, TX    216    97.20 %

Marina Landing

   Galveston, TX    256    88.78 %

Mariposa Villas

   Dallas, TX    216    97.33 %

Mason Park

   Katy, TX    312    80.10 %

Mission Oaks

   San Antonio, TX    228    95.73 %

Monticello Estate

   Monticello, AR    32    93.86 %

Paramount Terrace

   Amarillo. TX    181    94.06 %

Parc at Clarksville

   Clarksville, TN    168    92.90 %

Parc at Maumelle

   Little Rock, AR    240    95.94 %

Parc at Metro Center

   Nashville, TN    144    98.02 %

Parc at Rogers

   Rogers, AR    152    100.00 %

Pecan Pointe

   Temple, TX    232    87.50 %

Portofino

   Farmers Branch, TX    224    79.90 %

Preserve at Pecan Creek

   Denton, TX    192    94.80 %

Quail Hollow

   Holland, OH    200    85.50 %

Quail Oaks

   Balch Springs, TX    131    89.47 %

River Oaks

   Wylie, TX    180    91.21 %

Riverwalk Phase I

   Greenville, MS    32    93.86 %

Riverwalk Phase II

   Greenville, MS    72    94.56 %

Spyglass

   Mansfield, TX    256    90.33 %

Stonebridge at City Park

   Houston, TX    240    97.61 %

Treehouse

   Irving, TX    160    81.96 %

Verandas at City View

   Fort Worth, TX    314    96.60 %

Villager

   Ft Walton, FL    33    84.97 %

Vistas of Pinnacle Park

   Dallas, TX    332    93.48 %

Vistas of Vance Jackson

   San Antonio, TX    240    94.27 %

Westwood

   Mary Ester, FL    120    90.95 %

Whispering Pines

   Topeka, KS    320    94.79 %

Wildflower Villas

   Temple, TX    220    94.61 %

Windsong

   Fort Worth, TX    188    93.72 %
          
   Total Apartment Units    10,228   
          

 

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Office Buildings

  

Location

   SqFt    Occupancy  

1010 Common

   New Orleans, LA    512,593    76.87 %

217 Rampart

   New Orleans, LA    11,913    0.00 %

225 Baronne

   New Orleans, LA    422,037    0.00 %

305 Baronne

   New Orleans, LA    37,081    38.00 %

600 Las Colinas

   Las Colinas, TX    510,841    71.92 %

Amoco Building

   New Orleans, LA    378,895    91.82 %

Browning Place (Park West I)

   Dallas, TX    627,312    100.00 %

Cooley Building

   Farmers Branch, TX    27,000    100.00 %

Ergon Office Building

   Jackson, MS    26,000    0.00 %

Eton Square

   Tulsa, OK    225,566    80.36 %

Fenton Center (Park West II)

   Dallas, TX    696,458    82.19 %

Fruitland Park

   Fruitland,FL    6,722    100.00 %

One Hickory Center

   Dallas, TX    97,361    95.95 %

Parkway North

   Dallas, TX    69,009    67.36 %

Sesame Square

   Anchorage, AK    20,715    99.57 %

Signature Building

   Dallas, TX    58,910    0.00 %

Stanford Center

   Dallas, TX    336,910    99.24 %

Teleport

   Las Colinas, TX    6,833    100.00 %

Two Hickory Center

   Dallas, TX    97,117    96.16 %

Westgrove Air Plaza

   Addison, TX    79,652    89.19 %
          
      4,248,925   
          

Industrial Warehouses

  

Location

   SqFt    Occupancy  

5360 Tulane

   Atlanta, GA    30,000    100.00 %

Addison Hanger I

   Addison, TX    25,102    100.00 %

Addison Hanger II

   Addison, TX    24,000    100.00 %

Alpenloan

   Dallas, TX    28,594    100.00 %

Clark Garage

   New Orleans, LA    6,869    0.00 %

Space Center

   San Antonio, TX    101,500    60.59 %

Senlac (VHP)

   Dallas, TX    2,812    100.00 %

Thermalloy

   Farmers Branch, TX    177,805    100.00 %
          
      396,682   
          

Shopping Centers

  

Location

   SqFt    Occupancy  

Bridgeview Plaza

   LaCrosse, WI    122,205    90.13 %

Cross County Mall

   Matoon, IL    307,266    84.26 %

Cullman Shopping Center

   Cullman, AL    92,466    48.48 %

Dunes Plaza

   Michigan City, IN    220,461    51.56 %

Willowbrook Village

   Coldwater, MI    179,741    85.81 %
          
      922,139   
          

Merchandise Mart

  

Location

   SqFt    Occupancy  

Denver Merchandise Mart

   Denver, CO    344,975    83.16 %
          
   Total Commercial Square Feet    5,912,720   
          

Single Family Residence

  

Location

   Units    Occp  

Tavel Circle

   Dallas, TX    1    100.00 %

 

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Hotels

  

Location

   Units       

Inn at the Mart (Comfort Inn)

   Denver, CO    161   

Piccadilly—Airport

   Fresno, CA    185   

Piccadilly—Chateau

   Fresno, CA    78   

Piccadilly—Shaw

   Fresno, CA    194   

Piccadilly—University

   Fresno, CA    190   
          
   Total Hotel Rooms    808   
          

Apartments Held for Sale

  

Location

   Units    Occp  

Chateau Bayou

   Ocean Springs, MS    122    94.37 %
          
   Total Held for Sale    122   
          

Apartments Subject to Sales Contract

  

Location

   Units    Occp  

Limestone Canyon

   Austin, TX    260    91.65 %

Limestone Ranch

   Lewisville, TX    252    93.36 %

Sendero Ridge

   San Antonio, TX    384    92.28 %

Tivoli

   Dallas, TX    190    90.63 %
          
   Total Subject to Sales Contract    1,086   
          

Lease Expiration by Year

 

Year of Lease Expiration

   Rentable
Square Feet
Subject to
Expiring
Leases
   Current
Anualized(1)
Contractual
Rent Under
Expiring
Leases
   Current
Annualized(1)
Contractual
Rent Under
Expiring
Leases
(P.S.F.)
   Percentage
of Total
Square Feet
 

2009

   772,030    $ 7,752,647    $ 10.04    12.8 %

2010

   517,516    $ 6,363,896    $ 12.30    8.6 %

2011

   631,342    $ 10,642,265    $ 16.86    10.5 %

2012

   500,997    $ 7,939,281    $ 15.85    8.3 %

2013

   812,623    $ 11,561,612    $ 14.23    13.5 %

2014

   318,671    $ 6,644,510    $ 20.85    5.3 %

2015

   201,034    $ 4,611,587    $ 22.94    3.3 %

2016

   170,502    $ 3,104,625    $ 18.21    2.8 %

2017

   409,256    $ 6,916,122    $ 16.90    6.8 %

2018

   102,040    $ 1,843,591    $ 18.07    1.7 %

Thereafter

   97,956    $ 1,527,625    $ 15.60    1.6 %

 

(1) Represents the monthly contractual base rent and recoveries from tenants under existing leases as of December 31, 2008 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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Land

  

Location

   Acres

1013 Common St

   New Orleans, LA    0.41

Ackerley Land

   Dallas, TX    1.31

Alliance Airport

   Tarrant County, TX    12.70

Alliance Centurion

   Tarrant County, TX    51.90

Alliance Hickman Bluestar

   Tarrant County, TX    8.00

Archon Land

   Irving, TX    24.14

Audubon

   Adams County, MS    48.20

Backlick Land

   Springfield, VA    3.41

Beltline 378

   Dallas County, TX    378.83

Bonneau Land

   Dallas County, TX    8.39

Centura Land

   Dallas, TX    10.08

Chase Oaks Land

   Plano, TX    9.93

Circle C Land

   Austin, TX    1,092.00

Cooks Lane Land

   Fort Worth, TX    21.90

Creekside

   Fort Worth, TX    30.00

Nicholson Croslin

   Dallas, TX    0.80

Crowley

   Fort Worth, TX    24.90

Dalho

   Farmers Branch, TX    2.89

Dedeaux

   Gulfport, MS    10.00

Denham Springs

   Denham Springs, LA    15.85

Denton (Andrew B)

   Denton, TX    22.90

Denton (Andrew C)

   Denton, TX    5.20

Denton Land

   Denton, TX    15.65

Desoto Ranch

   Desoto, TX    7.39

Diplomat Drive

   Farmers Branch, TX    11.65

Dominion Tract

   Dallas, TX    10.59

Elm Fork Land

   Denton County, TX    35.84

Ewing 8

   Addison, TX    16.79

Folsom Land

   Dallas, TX    36.38

Fortune Drive

   Irving, TX    14.88

Galleria East Center Retail

   Dallas, TX    15.00

Galleria West Lofts

   Dallas, TX    7.19

GNB Land

   Farmers Branch, TX    45.00

Hines Meridian

   Las Colinas, TX    36.09

Hollywood Casino (Dominion)

   Farmers Branch, TX    19.71

Hollywood Casino Land

   Farmers Branch, TX    13.85

HSM Cummings

   Farmers Branch, TX    6.16

Hunter Equities Land

   Dallas, TX    2.56

Jackson Convention Center

   Jackson, MS    1.71

JHL Connell

   Carrollton, TX    3.93

Kaufman—Adams

   Kaufman County, TX    193.73

Kaufman—Bridgewood

   Kaufman County, TX    5.04

Kaufman—Cogen Land

   Forney, TX    2,567.00

Kaufman—Stagliano

   Forney, TX    34.80

Kaufman—Taylor

   Forney, TX    31.00

Keenan Bridge Land

   Farmers Branch, TX    7.36

Keller Springs Lofts

   Addison, TX    7.40

Kelly Lots

   Collin County, TX    0.75

KinWest

   Irving, TX    7.98

Lacy Longhorn Land

   Farmers Branch, TX    17.12

 

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Land

  

Location

   Acres

LaDue/Walker Land

   Farmers Branch, TX    99.00

Lake Shore Villas

   Humble, TX    19.51

Lamar/Palmer Land

   Austin, TX    17.07

Las Colinas—Walnut Hill

   Las Colinas, TX    1.58

Las Colinas (Cigna)

   Las Colinas, TX    4.70

Las Colinas Apts/Lofts

   Las Colinas, TX    4.77

Las Colinas High Rise Apartments

   Las Colinas, TX    1.65

Las Colinas High Rise Office

   Las Colinas, TX    3.49

Las Colinas Townhomes

   Las Colinas, TX    15.56

LCLLP (Kinwest/Hackberry)

   Las Colinas, TX    45.49

Leone Land

   Irving, TX    8.23

Limestone Canyon II

   Austin, TX    9.96

Lubbock Land

   Lubbock, TX    2.86

Luna (Carr)

   Farmers Branch, TX    2.60

Luna Ventures

   Farmers Branch, TX    26.74

Mandahl Bay Land

   US Virgin Islands    91.10

Manhattan Land

   Farmers Branch, TX    108.90

Mansfield Land

   Mansfield, TX    7.83

Marine Creek

   Fort Worth, TX    44.17

Mason/Goodrich Land

   Houston, TX    13.00

McKinney 36

   Collin County, TX    34.48

McKinney Corners II

   Collin County, TX    6.76

McKinney Ranch Land

   McKinney,TX    169.74

Meloy/Portage Land

   Kent, OH    52.95

Nashville Land

   Nashville, TN    11.87

Nicholson Croslin

   Dallas, TX    0.80

Nicholson Mendoza

   Dallas, TX    0.35

Ocean Estates

   Gulfport, MS    12.00

Pac Trust Land

   Farmers Branch, TX    7.07

Palmer Lane (Las Praderas)

   Austin, TX    367.43

Pantaze Land

   Dallas, TX    6.00

Payne Land

   Las Colinas, TX    149.70

Pioneer Crossing

   Austin, TX    400.60

Pioneer Crossing

   Austin, TX    38.54

Polo Estates At Bent Tree

   Richardson, TX    5.87

Port Olpenitz GmBH

   Kappelin, Germany    420.00

Pulaski Land

   Pulaski County, AR    21.90

Ridgepoint Drive

   Irving, TX    0.60

Seminary West Land

   Fort Worth, TX    3.03

Senlac Land

   Farmers Branch, TX    3.98

Senlac Land

   Farmers Branch, TX    11.94

Sheffield Village

   Grand Prairie, TX    13.90

Sisikiyou County Land

   Siskiyou County, CA    20.70

Sladek Land

   Travis County, TX    63.28

Southwood Plantation

   Tallahassee, FL    12.90

Southwood Plantation 1394

   Tallahassee, FL    14.52

Stanley Tools

   Farmers Branch, TX    23.76

Texas Plaza Land

   Irving, TX    10.33

Thompson Land I

   Farmers Branch, TX    3.99

Thompson Land II

   Farmers Branch, TX    3.32

 

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Land

  

Location

   Acres

Tomlin Land

   Farmers Branch, TX    9.20

Travis Ranch Land

   Kaufman County, TX    833.39

Union Pacific Railroad Land

   Dallas, TX    0.29

Valley Ranch Land

   Irving, TX    30.00

Valley View (Hutton/Senlac)

   Farmers Branch, TX    2.42

Valley View 34 (Mercer Crossing)

   Farmers Branch, TX    2.19

Valley View/Senlac

   Farmers Branch, TX    3.45

Valwood

   Dallas, TX    257.05

Vineyards

   Grapevine, TX    3.56

Vineyards II

   Grapevine, TX    3.94

W Hotel

   Dallas, TX    1.97

Waco 151 Land

   Waco,TX    151.40

Waco Swanson

   Waco, TX    350.70

Walker Land

   Dallas County, TX    48.62

West End Land

   Dallas, TX    5.50

Whorton Land

   Bentonville, AR    79.70

Willowick Land

   Pensacola, TX    39.78

Wilmer 88

   Dallas, TX    87.60

Windmill Farms—Harlan Land

   Kaufman County, TX    245.95

Windmill Farms I

   Kaufman County, TX    3,044.11
       
   Total Land/Development    12,577.63
       

 

ITEM 3. LEGAL PROCEEDINGS

The ownership of property and provision of services to the public as tenants entails an inherent risk of liability. Although the Company and its subsidiaries are involved in various items of litigation incidental to and in the ordinary course of its business, in the opinion of Management, the outcome of such litigation will not have a material adverse impact upon the Company’s financial condition, results of operations or liquidity.

 

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

The Annual Meeting of Stockholders was held on November 20, 2008, 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 ARL for the fiscal year ending December 31, 2009. At the Meeting, stockholders elected the following individuals as Directors:

 

     Shares Voting

Director

   For    Withheld
Authority

Henry A. Butler

   10,216,655    29,720

Sharon Hunt

   10,217,066    29,309

Robert A. Jakuszewski

   10,216,913    29,462

Ted R. Munselle

   10,217,272    29,103

Ted P. Stokely

   10,216,679    29,696

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, 2008, and any interim period, at least 10,227,672 votes were received in favor of such proposal, 7,599 votes were received against such proposal, and 11,104 votes abstained.

 

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PART II

 

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

ARL’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.

 

     High    Low    High    Low
     2008    2007

First Quarter

   $ 8.59    $ 7.69    $ 12.34    $ 8.71

Second Quarter

   $ 10.00    $ 8.08    $ 13.04    $ 8.79

Third Quarter

   $ 8.25    $ 7.00    $ 10.05    $ 7.51

Fourth Quarter

   $ 10.50    $ 7.25    $ 9.85    $ 7.50

On March 5, 2009, the closing market price of ARL’s common stock on the New York Stock Exchange was $10.75 per share, and was held by approximately 2,752 stockholders of record.

During the second quarter of 1999, the Board of Directors established the policy that dividend declarations on ARL’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 on common stock in 2008, 2007 or 2006. Future distributions to common stockholders will be dependent upon ARL’s realized income, financial condition, capital requirements and other factors deemed relevant by the Board.

Under ARL’s Amended Articles of Incorporation, 15,000,000 shares of Series A 10.0% Cumulative Convertible Preferred Stock are authorized 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 ARL’s common stock for the prior 20 trading days. At December 31, 2008, 3,390,913 shares of Series A Preferred Stock were outstanding and 869,808 shares were reserved for issuance as future consideration in various business transactions. Of the outstanding shares, 300,000 shares are owned by ART Edina, Inc., and 600,000 shares are owned by ART Hotel Equities, Inc., a wholly-owned subsidiary of ARL. Dividends are not paid on the shares owned by ARL subsidiaries.

Under ARL’s Amended Articles of Incorporation, 231,750 shares of Series C Cumulative Convertible Preferred Stock are authorized 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, 2008, 6,813,750 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, 2006, all outstanding shares of Series C Preferred Stock may be converted into ARL common stock. All conversions of Series C Preferred Stock into ARL common stock will be at 90.0% of the average daily closing price of ARL’s common stock for the prior 20 trading days. At December 31, 2008, no shares of Series C Preferred Stock were outstanding.

Under ARL’s Amended Articles of Incorporation, 91,000 shares of Series D 9.50% Cumulative Preferred Stock are authorized 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

 

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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. At March 5, 2008, no shares of Series D Preferred Stock were outstanding.

Under ARL’s Amended Articles of Incorporation, 500,000 shares of Series E 6.0% Cumulative Preferred Stock are authorized 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 5, 2009, no Series E Preferred Stock were outstanding.

As an instrument amendatory to ARL’s Amended Articles of Incorporation, 100,000 shares of Series J 8% Cumulative Convertible Preferred Stock have been designated pursuant to a Certificate of Designation filed March 16, 2006, 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 5, 2009.

The following table sets forth information regarding purchases made by ARL of shares of ARL common stock on a monthly basis during the fourth quarter of 2008:

 

Period

   Total Number of
Shares Purchased
   Average Price
Paid per share
   Total Number of
Shares Purchased
as Part of Publicly
Announced Program(1)
   Maximum Number of
Shares that May
Yet be Purchased
Under the Program

Balance at September 30

         931,665    68,335

October, 2008

   —      —      931,665    68,335

November, 2008

   —      —      931,665    68,335

December, 2008

   —      —      931,665    68,335
             

Total

   —           
             

 

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

 

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Performance Graph

The following graph compares the cumulative total stockholder return on ARL’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, 2003 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

     12/03    12/04    12/05    12/06    12/07    12/08

American Realty Investors Inc.

   $ 100.00    $ 106.24    $ 87.84    $ 86.20    $ 107.34    $ 98.03

Dow Jones US

   $ 100.00    $ 103.15    $ 102.52    $ 119.22    $ 126.89    $ 83.95

Dow Jones US Real Estate

   $ 100.00    $ 130.13    $ 141.85    $ 188.88    $ 151.38    $ 90.01

 

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ITEM 6. SELECTED FINANCIAL DATA

 

          For the Years Ended December 31,        
    2008     2007     2006     2005     2004  
    (dollars in thousands, except share and per share amounts)  

EARNINGS DATA

         

Total operating revenues

  $ 181,920     $ 169,394     $ 142,138     $ 119,560     $ 102,131  

Total operating expenses

    178,943       162,886       138,495       123,629       121,844  
                                       

Operating (loss) income

    2,977       6,508       3,643       (4,069 )     (19,713 )

Other expenses

    (91,619 )     (42,746 )     (34,799 )     (43,034 )     (39,392 )
                                       

Loss before gain on land sales, minority interest, and income taxes

    (88,642 )     (36,238 )     (31,156 )     (47,103 )     (59,105 )

Gain on land sales

    5,584       20,468       23,973       39,926       11,781  

Minority interest

    146       (2,652 )     672       (3,056 )     (7,270 )

Income tax benefit

    36,838       15,744       6,852       16,596       31,402  
                                       

Net income (loss) from continuing operations

    (46,074 )     (2,678 )     341       6,363       (23,192 )
                                       

Net income from discontinuing operations , net of minority interest

    68,708       29,240       12,725       41,054       56,386  
                                       

Net income

    22,634       26,562       13,066       47,417       33,194  

Preferred dividend requirement

    (2,487 )     (2,490 )     (2,491 )     (2,572 )     (2,601 )
                                       

Net income applicable to common shares

  $ 20,147     $ 24,072     $ 10,575     $ 44,845     $ 30,593  
                                       

PER SHARE DATA

         

Earnings per share - basic

         

Income (loss) from continuing operations

  $ (4.46 )   $ (0.51 )   $ (0.21 )   $ 0.37     $ (2.44 )

Discontinued operations

    6.31       2.86       1.25       4.05       5.34  
                                       

Net income applicable to common shares

  $ 1.85     $ 2.35     $ 1.04     $ 4.42     $ 2.90  
                                       

Weighted average common share used in computing earnings per share

    10,888,833       10,227,593       10,149,000       10,149,000       10,559,571  

Earnings per share - diluted

         

Income (loss) from continuing operations

  $ (4.46 )   $ (0.51 )   $ (0.16 )   $ 0.29     $ (2.44 )

Discontinued operations

    6.31       2.86       0.97       3.13       5.34  
                                       

Net income applicable to common shares

  $ 1.85     $ 2.35     $ 0.81     $ 3.42     $ 2.90  
                                       

Weighted average common share used in computing diluted earnings per share

    10,888,833       10,227,593       13,106,000       13,106,000       10,559,571  

BALANCE SHEET DATA

         

Real Estate, net

  $ 1,613,402     $ 1,485,859     $ 1,272,424     $ 1,113,105     $ 983,422  

Notes and interest receivable, net

    77,003       83,467       52,631       81,440       72,661  

Total assets

    1,842,153       1,777,854       1,493,671       1,345,795       1,190,843  

Notes and interest payables

    1,382,629       1,400,877       1,124,765       1,021,822       939,921  

Stock-secured noted payable

    14,026       17,546       22,452       22,549       18,663  

Stockholders’ equity

    215,678       192,386       160,489       148,397       103,009  

Book value per share

  $ 19.81     $ 18.81     $ 15.81     $ 12.80     $ 8.89  

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report.

This Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws, principally, but not only, under the captions “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We caution investors that any forward-looking statements in this report, or which management may make orally or in writing from time to time, are based on management’s beliefs and on assumptions made by, and information currently available to, management. When used, the words “anticipate,”, “believe,”, “expect,” “intend,” “may,” “might,” “plan,” “estimate,” “project,” “should,” “will,” “result” and similar expressions which do not relate solely to historical matters are intended to identify forward-looking statements. These statements are subject to risks, uncertainties, and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties, and factors, that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. We caution you that, while forward-looking statements reflect our good faith beliefs when we make them, they are not guarantees of future performance and are impacted by actual events when they occur after we make such statements. We expressly disclaim any responsibility to update our forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:

 

   

general risks affecting the real estate industry (including, without limitation, the inability to enter into or renew leases, dependence on tenants’ financial condition, and competition from other developers, owners and operators of real estate);

 

   

risks associated with the availability and terms of financing and the use of debt to fund acquisitions and developments;

 

   

failure to manage effectively our growth and expansion into new markets or to integrate acquisitions successfully;

 

   

risks and uncertainties affecting property development and construction (including, without limitation, construction delays, cost overruns, inability to obtain necessary permits and public opposition to such activities);

 

   

risks associated with downturns in the national and local economies, increases in interest rates, and volatility in the securities markets;

 

   

costs of compliance with the Americans with Disabilities Act and other similar laws and regulations;

 

   

potential liability for uninsured losses and environmental contamination;

 

   

risks associated with our dependence on key personnel whose continued service is not guaranteed; and

 

   

the other risk factors identified in this Form 10-K, including those described under the caption “Risk Factors.”

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

 

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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

ARL was organized in 1999. In August 2000, ARL 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.

ARL subsidiaries own approximately 82.8% 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”). ARL has consolidated TCI’s accounts and operations since March 31, 2003. At December 31, 2007, TCI owned approximately 24.9% of the outstanding common stock of Income Opportunity Realty Investors, Inc., (“IOT”), a public company whose shares are listed and traded on the American Stock Exchange.

Approximately 76% of ARL’s common stock is owned by Realty Advisors and its subsidiaries( Prime, Inc, and OneRealco Stock Holdings, Inc.). Other affiliated companies own approximately 12% of ARL’s outstanding common shares. ARL is a “C Corporation” for U.S. federal income tax purposes and files an annual consolidated income tax return with TCI. ARL does not qualify as a Real Estate Investment Trust (“REIT”) for federal income tax purposes primarily due to ARL’s majority ownership of the Company. In addition, TCI owns 276,972 shares of common stock of ARL.

ARL 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. ARL’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. ARL acquires land primarily in in-fill locations or high-growth suburban markets. ARL is an active buyer and seller and during 2008 acquired over $119 million and sold over $179 million of land and income-producing properties. As of December 31, 2008, the Company owned approximately 11,437 units in 59 residential apartment communities, one single family residential, 34 commercial properties comprising almost 5.9 million rentable square feet and five hotels containing a total of 808 rooms. In addition, ARL owned 12,578 acres of land held for development and 5 projects under construction. The Company currently owns income-producing properties and land in 20 states as well as in the U.S. Virgin Islands. ARL 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. ARL 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

 

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commercial tenants; and renting hotel rooms to guests. ARL is advised by Prime under a contractual arrangement that is reviewed annually by ARL’s Board of Directors. ARL’s commercial properties are managed by Regis Commercial while the Company’s hotels are managed by Regis Hotel. ARL currently contracts with five third-party companies to manage the Company’s apartment communities.

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, ARL assesses the fair value of acquired tangible and intangible assets, including land, buildings, tenant improvements, “above” and “below-market” leases, origination costs, acquired in-place leases, other identified intangible assets and assumed liabilities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and allocates the purchase price to the acquired assets and assumed liabilities, including land at appraised value and buildings at replacement cost.

We assess and consider fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates, as well as available market information. Estimates of future cash flows are based on a number of factors including the historical operating results, known and anticipated trends, and market and economic conditions. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant. We also consider an allocation of purchase price of other acquired intangibles, including acquired in-place leases that may have a customer relationship intangible value, including (but not limited to) the nature and extent of the existing relationship with the tenants, the tenants’ credit quality and expectations of lease renewals. Based on our acquisitions to date, our allocation to customer relationship intangible assets has been immaterial.

We record acquired “above” and “below market” leases at their fair values (using a discount rate which reflects the risks associated with the leases acquired) equal to the difference between (1) the contractual amounts to be paid pursuant to each in-place lease and (2) management’s estimate of fair market lease rates for each corresponding in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases.

Other intangible assets acquired include amounts for in-place lease values that are based on our evaluation of the specific characteristics of each tenant’s lease. Factors to be considered include estimates of carrying costs during hypothetical expected lease-up periods considering current market conditions, and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, depending on local market conditions. In estimating costs to execute similar leases, we consider leasing commissions, legal and other related expenses.

 

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

Management reviews its long-lived assets used in operations for impairment when there is an event or change in circumstances that indicates 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, ARL 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, ARL’s net equity is reflected within the Consolidated Balance Sheets, and our share of net income or loss from the joint ventures is included within the Consolidated Statements of Operations. The joint venture agreements may designate different percentage allocations among investors for profits and losses; however, ARL’s recognition of joint venture income or loss generally follows the joint venture’s distribution priorities, which may change upon the achievement of certain investment return thresholds. For ownership interests in variable interest entities, the Company consolidates those in which we are the primary beneficiary.

 

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Recognition of Rental Income

Rental income for commercial property leases is recognized on a straight-line basis over the respective lease terms. In accordance with SFAS No. 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 ARL 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 No. 66 guidelines.

Non-performing Notes Receivable

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

Interest Recognition on Notes Receivable

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

Allowance for Estimated Losses

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

 

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Fair Value of Financial Instruments

The following assumptions were used in estimating the fair value of our 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 our 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 discussion of our results of operations is based on management’s review of operations, which is based on our segments. Our segments consist of apartments, commercial buildings, hotels, land and other. For discussion purposes, we break these segments down into the following sub-categories; same property portfolio, acquired properties, and developed properties in the lease-up phase. The same property portfolio consists of properties that were held by us for the entire period for both years being compared. The acquired property portfolio consists of properties that we acquired but have not held for the entire period for both periods being compared. Developed properties in the lease-up phase consist of completed projects that are being leased-up. As we complete each phase of the project, we lease up that phase and include those revenues in our continued operations. Once a developed property becomes leased up (80% or more) and is held the entire period for both years; under comparison it is considered to be included in the same property portfolio. Income producing properties that we have sold during the year are reclassified to discontinuing operations for all periods presented.

The following discussion is based on our Consolidated Statements of Operations for the twelve months ended December 31, 2008, 2007, and 2006 as included in Part II, Item 8. “Financial Statements and Supplementary Data” of this report. The prior year’s property portfolios have been adjusted for subsequent sales. Continue operations relates to income producing properties that were held during those years as adjusted for sales in the subsequent years.

At December 31, 2008, 2007, and 2006, we owned or had interests in a portfolio (the Total Property Portfolio) of 99, 110, and 130 income producing properties, respectively. For discussion purposes, we broke this out between continued operations and discontinued operations. The total property portfolio represents all income producing properties held as of December 31 for the year end presented. Sales subsequent to year end represent properties that were held as of year end for the years presented, but sold in the next year. Continuing operations represents all properties that have not been reclassed to discontinued operations as of December 31, 2008 for the year presented. The table below shows the number of income producing properties held by year.

 

     2008    2007    2006

Continued operations

   98    82    90

Sales subsequent to year end

   1    28    40
              

Total property portfolio

   99    110    130
              

Comparison of the year ended December 31, 2008 to the same period ended December 31, 2007;

Our net income applicable to common shares decreased $3.9 million as compared to the prior year. The current year net income applicable to common shares was $20.1 million, which includes gain on land sales of $5.6 million and net income from discontinued operations, net of minority interest of $67.2 million, as compared to prior year net income applicable to common shares of $24.1 million, which includes gain on land sales of $20.4 million and net income from discontinued operations, net of minority interest of $30.6 million.

 

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Revenues

Rental revenues increased by $12.5 million which by segment is an increase in apartment revenues of $12.9 million and land of $2.3 million, offset by a decrease in our hotels of $1.6 million and a decrease in our land and other segment of $1.1 million. Within our apartment portfolio, the majority of the increase came from our developed properties in the lease up phase which increased $11.5 million. Our acquisition of Bridgewood apartments accounted for $0.7 million of the increase with the remaining increase coming from our same property portfolio. We have increased occupancies within our apartment portfolio and there is an overall increased demand for new apartments. Our land portfolio revenues increased as a result of the temporary increase in oil and gas prices. We receive royalty revenues from some of our land holdings. Revenues from our same hotel portfolio are down due to decreased stays, which we attribute to the current state of the economy.

Expenses

Property operating expenses increased by $10.8 million, which by segment is an increase in our apartments of $9.3 million, an increase in our commercial properties of $1.3 million, an increase in our land and other segments of $0.7 million, offset by a decrease in our hotels of $0.5 million. Within the apartment portfolio, the same apartment properties increase of $2.4 million is due to an increase in overall costs and additional repairs and maintenance. The developed apartments increased expenses by $6.5 million, and the current year acquisition increased expenses by $0.4 million. The increase within the commercial portfolio was due to an increase from acquired properties of $3.1 million, offset by a decrease in our same property portfolio of $1.8. The increase within our land and other portfolios is due to the continued increase in land holding costs. The decrease in our hotel portfolio is due to the decrease in variable costs that are directly associated with stays within the hotel.

Depreciation expense increased by $3.5 million, which by segment is $3.1 million due to our apartments, $0.4 million due to our commercial buildings, and $0.2 million due to our hotels, offset by a decrease in our land holdings of $0.2 million. The increase within our apartment portfolio was due to increases in our same properties of $1.4 million, acquired properties of $0.2 million and developed properties of $1.5 million. The same apartment property portfolio increase due to depreciation on newly capitalized items. Developed apartment properties are depreciated as we complete each phase and lease up the properties.

Other income (expense)

Interest income increased by $2.2 million, the increase is due to receipt of interest income on the Unified Housing Foundation, Inc. notes receivables. These receivables are excess cash flow notes. As such, we do not record interest income on the receivable, unless we receive cash payments.

We had an increase in our interest expense of $3.5 million, which by segment is an increase in our apartment portfolio of $6.8 million, an increase in our commercial portfolio of $0.8 million and an increase in our other portfolio of $0.6 million; which is offset by a decrease in our hotel portfolio of $0.9 million and a decrease in our land portfolio of $3.8 million. The increase within our apartment portfolio is mainly due to the increase within our developed properties in the lease up phase of $6.0 million. During the construction phase the interest expense is capitalized. When the properties are completed and begin lease up, the interest is expensed. The remaining increase is $0.3 million from our acquired properties and $0.5 million in additional expense from our same property portfolio. Within our commercial portfolio we had an increase of $0.9 million from our same properties, offset by a decrease in our acquired properties due to the decrease in variable rates tied to Prime. The decreased interest expense within our hotels was due to the rates being tied to Prime, and the decreased Prime rate. The decrease in our land and other portfolios is primarily due to the sale of properties and the disposition of the debt upon sale.

Earnings from unconsolidated subsidiaries and investees were a loss of $1.9 million. This represents our portion of income (equity pickup) for unconsolidated subsidiaries and joint ventures. These investees posted an aggregate loss for the twelve months ended December 31, 2008.

 

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Involuntary conversion decreased by $34.8 million. There were no involuntary conversions in the current year. The prior year gain on involuntary conversion relates to the collection of insurance proceeds in 2007 for the damage sustained at our New Orleans commercial properties from hurricane Katrina in 2005.

Provision for allowance on notes receivable and impairment was $12.4 million for the twelve months ended December 31, 2008. We recorded a $5.0 million allowance for doubtful receivables and a $7.4 million allowance for doubtful collectability of certain investments within our portfolio. In 2007, we wrote down the Executive Court apartments for $0.2 million and the Encon Warehouse for $0.8 million.

Litigation settlement expense decreased as compared to the prior year. The majority of the decrease was due recording a $1.3 million in expense related to the settlement of the Sunset litigation that was not previously accrued in the prior year. The Sunset litigation was settled September 18, 2007.

Gain on land sales has decreased by $14.9 million. The current state of the banking industry has significantly impacted the banks willingness to originate loans. Land loans seem to be more sensitive to this than most other types of loans. We have found it difficult to complete land transactions with third parties, as the banks willingness and/or ability to fund land transactions seems limited. The current economic conditions have resulted in fewer land transactions in the current year.

Discontinued operations relates to properties that were either sold or held for sale as of the year ended December 31, 2008. Included in discontinued operations are a total of 28 and 41 properties as of 2008 and 2007, respectively. Properties sold in 2008 that were held in 2007 have been reclassified to discontinued operations for 2007. In 2008, we had one property, Chateau Bayou apartments, pending sale, and sold 27 properties which consisted of 20 apartment complexes (Arbor Pointe, Ashton Way, Autumn Chase, Courtyard, Coventry Pointe, Fairways, Forty-Four Hundred, Fountains at Waterford, Hunters Glen, Southgate, Sunchase, Thornwood, Westwood Square, Woodview, Fairway View Estate, Willow Creek, Fountain Lake, Mountain Plaza, Sunset, and Governors Square), three commercial buildings (Lexington Center, Executive Court, and Encon Warehouse), and four hotels (City Suites, Majestic Inn, Willow, and Hotel Akademia). In 2007, we sold 13 income producing properties which consists of nine apartments (Bluff at Vista Ridge, Somerset, El Chapparral, Harper’s Ferry, Oak Park IV, Med Villa, Villa Del Mar, Arlington Place, and Woodlake), three commercial buildings (Forum office building, Durham Center, Four Hickory), and one hotel (Atlantic Sands). The gain on sale of the properties is also included in discontinued operations for those years as shown in the table below (dollars in thousands).

 

     For Years Ended December 31,  
             2008                       2007            

Revenue

    

Rental

   $ 6,431     $ 51,937  

Property operations

     2,971       32,912  
                
     3,460       19,025  

Expenses

    

Interest

     (6,544 )     (16,352 )

General and administration

     (1,552 )     (102 )

Depreciation

     (349 )     (4,803 )
                
     (8,445 )     (21,257 )
                

Net income (loss) from discontinued operations before gains on sale of real estate, taxes, fees and minority interest

     (4,985 )     (2,232 )

Gain on sale of discontinued operations

     119,572       53,375  

Net income/sales fee to affiliate

     (10,994 )     (2,050 )

Minority interest

     (4,480 )     (1,682 )

Equity of investees gain on sale

     6,591       (2,427 )
                

Income from discontinued operations, net of minority interest before tax

     105,704       44,984  

Tax expense

     (36,996 )     (15,744 )
                

Income from discontinued operations, net of minority interest

   $ 68,708     $ 29,240  
                

 

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Comparison of the year ended December 31, 2007 to the same period ended December 31, 2006;

Revenues

We had an increase in our rental and other property revenues of $27.3 million, which by segment is an increase in the apartment portfolio of $7.8 million, an increase in the commercial portfolio of $23.8 million, and increase in the Hotel portfolio of $0.4 million, offset by decreases in the land and other portfolios of $0.7 million in aggregate. Within the apartment portfolio, the same properties increased by $1.3 million and the developed properties in the lease up phase increased by $6.5 million. The occupancy rates in our same properties remains strong and we continue to see a growing demand for new apartments. Within our commercial portfolio, the acquired properties increased by $19.8 million, offset by decreases in the same properties of $4.0 million. The purchase of Browning Place and Fenton Centre (formerly known as Park West One and Two) in 2007 attributed to the increase from the acquired properties, while the majority of the decrease in the same properties was due to a loss of a significant tenant.

Expenses

We had an increase in our property operating expenses of $13.0 million as compared to prior period, which by segment is an increase in the apartments of $3.9 million, an increase in the commercial of $10.1 million, an increase in other of $2.1 million, offset by a decrease in hotel and land of $1.9 million and $1.2 million respectively. Within the apartment portfolio, the vast majority of the increase is due to the developed apartments in the lease up phase. We continue to complete phases and start up operations. Within the commercial portfolio, the vast majority of the increase is due to the acquisition of the purchase of Browning Place and Fenton Centre. We acquired these properties in January 2007. The increase in the hotel properties is from the same property portfolio.

We had an increase in depreciation and amortization expense of $1.9 million, which by segment is an increase in apartments of $0.5 million and an increase in commercial of $1.4 million. The increase within our apartment portfolio is due to the additional depreciation from our developed properties in the lease up phase. Within our commercial portfolio of $2.6 million of the increase is from the acquisition of Browning Place and Fenton Centre, which is offset by a decrease in our same properties of $1.2 million.

General and administrative expenses increased $7.3 million. The majority of the increase is from $2.0 million in legal fees included in 2007, not included in 2006. The 2006 amount also includes credits for litigation reimbursements of $3.3 million. In addition, the reimbursement costs to the advisor were higher in 2007 than in 2006.

Advisory fees to affiliate increased by $2.2 million. The increase in fees was due to higher gross assets in 2007 than in 2006.

Other income (expense)

We had an increase in interest expense of $21.6 million as compared to prior period. The increase is due to new loans on acquisitions, refinancings, and changes in variable rate debt. The breakdown by segment is an increase in apartments of $4.6 million, an increase in commercial of $6.5 million, an increase in hotels of $2.6 million, an increase in land of $3.4 million, and in increase in other of $4.5 million. The increase in the apartment portfolio is due to interest expense on the developed properties in the lease up phase. As phases of the properties are completed and begin lease up the previously capitalized interest is expensed. The increase of $6.5 million in the commercial portfolio is due to the acquisition of the Browning Place and Fenton Centre (formerly known as Park West One and Two buildings). The increase in the hotel portfolio is due to refinancing the existing debt on three of the four Piccadilly hotels; known as the Shaw, Chateau, and Airport. The increase within the land portfolio is due to the acquisition of properties and refinancing of existing debt.

 

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Gain on involuntary conversion increased by $14.3 million. The gain relates to the collection of insurance proceeds of $34.7 million and $20.5 million from the damages sustained at our New Orleans commercial properties from Hurricane Katrina during 2005 during the years ended 2007 and 2006, respectively.

In 2007, we recorded an impairment write down for Executive Court and Encon Warehouse for $0.2 million and $0.8 million, respectively.

In 2006 we sold a note receivable at a loss recording a discount of $1.2 million. There have been no subsequent sales of note receivables.

Litigation settlement was $1.0 million in 2007 due to paying expenses 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 decreased by $3.5 million. 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.

Discontinued operations relates to properties that were either sold or held for sale as of the year ended December 31, 2008. Properties that were sold subsequent to the yearend that were held during those years have been reclassified as discontinued operations for those periods presented. Included in discontinued operations are properties that were sold in 2008 and reclassified to discontinued operations for the years 2007 and 2006, expect for the Thornwood apartments which was purchased in 2007 and sold in 2008. Included in discontinued operations are a total of 41 and 46 properties as of 2007 and 2006, respectively. In 2007, we sold 13 income producing properties which consists of nine apartments (Bluff at Vista Ridge, Somerset, El Chaparral, Harper’s Ferry, Oak Park IV, Med Villa, Villa Del Mar, Arlington Place, and Woodlake), three commercial buildings (Forum OB, Durham Center, Four Hickory), and one hotel (Atlantic Sands). In 2006, we sold six income producing properties which consists of five apartment complexes (Apple Lane, Plantation, Timbers, Will-o-Wick, and Oak Tree), and one hotel (Williamsburg). The gain on sale of the properties is also included in discontinued operations for those years presented as shown in the table below (dollars in thousands).

 

     For Years Ended December 31,  
               2007                     2006          

Revenue

    

Rental

   $ 51,937     $ 92,883  

Property operations

     32,912       65,843  
                
     19,025       27,040  

Expenses

    

Interest

     (16,352 )     (16,134 )

General and administration

     (102 )     (3,441 )

Depreciation

     (4,803 )     (6,832 )
                
     (21,257 )     (26,407 )
                

Net income (loss) from discontinued operations before gains on sale of real estate, taxes, fees and minority interest

     (2,232 )     633  

Gain on sale of discontinued operations

     53,375       22,159  

Net income/sales fee to affiliate

     (2,050 )     (2,462 )

Minority interest

     (1,682 )     (1,403 )

Equity of investees gain on sale

     (2,427 )     650  
                

Income from discontinued operations, net of minority interest before tax

     44,984       19,577  

Tax expense

     (15,744 )     (6,852 )
                

Income from discontinued operations, net of minority interest

   $ 29,240     $ 12,725  
                

 

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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; and

 

   

fund possible property acquisitions.

Our principal sources of cash have been and will continue to be:

 

   

property operations;

 

   

proceeds from land and income-producing property sales;

 

   

collection of mortgage notes receivable;

 

   

collections of receivables from affiliated companies;

 

   

refinancing of existing debt and additional borrowings; and

 

   

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, 2008, along with cash that will be generated in 2009 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. Although the past cannot predict the future, historically, management has been successful at extending a portion of the Company’s current maturity obligations and selling assets as necessary to meet current obligations.

Cash flow summary

The following summary discussion of our cash flows is based on the consolidated statements of cash flows in Part II, 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 (dollars in thousands).

 

     2008     2007     Variance  

Net cash provided by (used in) operating activities

   $ 24,140     $ (34,320 )   $ 58,460  

Net cash used in investing activities

   $ (63,513 )   $ (221,832 )   $ 158,319  

Net cash provided by financing activities

   $ 33,855     $ 260,677     $ (226,822 )

The primary use of cash for operations is daily operating costs, general and administrative expenses, advisory fees, and land holding costs. Our primary source of cash from operating activities is from rental income on properties. In addition, we had a significant receivable due from affiliated entities in 2007. The majority of the change in cash was due to the collections on our affiliated receivables. In 2008, the majority of the affiliated receivable was paid down. We collected approximately $53.0 million of the outstanding receivable balance. This took our cash from operations to positive number. Thus, we had cash provided by operating activities for the year ended December 31, 2008.

 

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Our major investing cash outlays are from construction and development of new properties. We currently have five projects under construction. We used $148.8 million in cash on the construction and development of new properties. We used $64.5 million for our continued investment in new properties. We acquired two apartment complexes and five buildings. We used $54.7 million for the acquisition of land of approximately 1,400 acres of land. Our sources of cash from investing activities are the sales of land and income producing properties. We received $179.7 million from the sale of 19 apartments, three commercial buildings and four hotels. We received $17.0 million for the sale of approximately 103 acres of land.

Our major source of cash from financing activities is $221.4 million from the proceeds of notes payable which includes the cash borrowed for purchases. Our major use of cash is for the payment of recurring debt obligations of $20.3 million and the payment on maturing notes payable of $178.7 million which includes the pay off of mortgages on properties sold.

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.    ARL has from time to time purchased shares of IOT and TCI. The Company may purchase additional equity securities of IOT and TCI through open market and negotiated transactions to the extent ARL’s liquidity permits.

Equity securities of TCI held by ARL (and of IOT held by TCI) may be deemed “restricted securities” under Rule 144 of the Securities Act of 1933 (“Securities Act”). Accordingly, ARL 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 ARL’s ability to realize the full fair value of such investments if ARL attempted to dispose of such securities in a short period of time.

Management reviews the carrying values of ARL’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.

 

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Contractual Obligations

We have contractual obligations and commitments primarily with regards to the payment of mortgages. The following table aggregates our expected contractual obligations and commitments and includes items not accrued, per Generally Accepted Accounting Principles, through the term of the obligation such as interest expense and operating leases. Our aggregate obligations subsequent to December 31, 2008 are shown in the table below (dollars in thousands);

 

    Total   Less than
1 Year
  1-3 Years   4-5 Years   More than
5 years

Long-term debt obligation(1)

  $ 2,432,665   $ 489,353   $ 379,939   $ 249,550   $ 1,313,823

Capital lease obligation

    —       —       —       —       —  

Operating lease obligation

    65,112     1,484     2,451     2,314     58,863

Purchase obligation

    —       —       —       —       —  

Other long-term debt liabilities reflected on the Registrant’s

    147,920     147,920     —       —       —  

Balance sheet under GAAP

         
                             

Total

  $ 2,645,697   $ 638,757   $ 382,390   $ 251,864   $ 1,372,686
                             

 

(1) ARL’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.

Environmental Matters

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

Inflation

The effects of inflation on ARL’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.

ARL’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.

ARL is exposed to interest rate risk associated with variable rate notes payable and maturing debt that has to be refinanced. ARL 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. ARL’s interest rate sensitivity position is managed by ARL’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. ARL’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 ARL’s market risk is exposure to short-term interest rates from variable rate borrowings. The impact on ARL’s financial statements of refinancing fixed debt that matured during 2008 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 2009 than they did during 2008, ARL’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 ARL’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 ARL’s financial structure.

The following table contains only those exposures that existed at December 31, 2008. Anticipation of exposures of risk on positions that could possibly arise was not considered. ARL’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.

 

    2009     2010     2011     2012     2013     Thereafter     Total

Assets

             

Market securities at fair value

              $ 2,775

Note Receivable

             

Variable interest rate-fair value

                16,067

Instrument’s maturities

  $ 6,159     $ 7,133     $ 2,775     $ —       $ —       $ —         16,067

Instrument’s amortization

    —         —         —         —         —         —         —  

Interest

    488       348       109       —         —         —         945

Average Rate

    5.0 %     4.5 %     5.3 %     0.0 %     0.0 %     0.0 %  

Fixed interest rate-fair value

                57,282

Instrument’s maturities

    27,045       639       —         1,875       16,224       11,499       57,282

Instrument’s amortization

    —         —         —         —         —         —         —  

Interest

    3,633       3,241       3,190       3,099       2,422       2,426       18,011

Average Rate

    9.9 %     10.6 %     10.7 %     10.7 %     10.7 %     10.2 %  
    2009     2010     2011     2012     2013     Thereafter     Total

Notes Payable

             

Variable interest rate-fair value

              $ 437,114

Instrument’s maturities

  $ 243,250     $ 121,835     $ 28,750     $ 4,840     $ 3,197     $ 4,209       406,081

Instrument’s amortization

    8,834       4,929       3,176       1,416       912       11,766       31,033

Interest

    25,147       13,818       3,411       1,823       1,216       6,353       51,768

Average Rate

    5.63 %     5.71 %     4.93 %     4.77 %     5.52 %    

Fixed interest rate-fair value

                951,615

Instrument’s maturities

    133,356       28,493       48,751       58,722       76,888       118,914       465,124

Instrument’s amortization

    15,497       11,990       10,025       8,858       7,163       432,958       486,491

Interest

    63,270       54,337       50,423       44,937       39,578       739,623       992,168

Average Rate

    7.52 %     6.91 %     6.66 %     6.55 %     6.23 %    

 

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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

     Page

Financial Statements

  

Report of Independent Registered Public Accounting Firm

   42

Consolidated Balance Sheets—December 31, 2008 and 2007

   43

Consolidated Statements of Operations—Years Ended December 31, 2008, 2007 and 2006

   44

Consolidated Statements of Shareholders’ Equity—Years Ended December 31, 2008, 2007 and 2006

   45

Consolidated Statements of Cash Flows—Years Ended December 31, 2008, 2007 and 2006

   46

Notes to Consolidated Financial Statements

   47

Financial Statement Schedules

  

Schedule III—Real Estate and Accumulated Depreciation

   74

Schedule IV—Mortgage Loan Receivables on Real Estate

   86

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, 2008 and 2007, 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, 2008. 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 audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2008, 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 27, 2009

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

 

    

December 31,
2008

    December 31,
2007
 
    (dollars in thousands, except
share and par value amounts)
 
Assets    

Real estate, at cost

  $ 1,712,506     $ 1,508,815  

Real estate held for sale at cost, net of depreciation ($640 for 2008 and $22,256 for 2007)

    10,333       61,128  

Real estate subject to sales contracts at cost, net of depreciation ($12,226 for 2008 and $8,713 for 2007)

    55,100       64,320  

Less accumulated depreciation

    (164,537 )     (148,404 )
               

Total real estate

    1,613,402       1,485,859  

Notes and interest receivable

   

Performing (including $38,384 in 2008 and $16,485 in 2007 from affiliates and related parties)

    68,845       69,977  

Non-performing (including $12,837 in 2008 and $16,246 in 2007 from affiliates and related parties)

    20,032       16,468  

Less allowance for estimated losses

    (11,874 )     (2,978 )
               

Total notes and interest receivable

    77,003       83,467  

Cash and cash equivalents

    6,042       11,560  

Restricted cash

    271       2,556  

Investments in securities

    2,775       13,157  

Investments in unconsolidated subsidiaries and investees

    27,113       23,867  

Other assets (including $526 in 2008 and $54,439 in 2007 from affiliates and related parties)

    115,547       157,388  
               

Total assets

  $ 1,842,153     $ 1,777,854  
               
Liabilities and Shareholders’ Equity    

Liabilities:

   

Notes and interest payable (including $9,103 in 2008 and $8,269 in 2007 to affiliates and related parties)

  $ 1,311,935     $ 1,221,987  

Notes related to assets held-for-sale

    7,722       116,377  

Notes related to subject to sales contracts

    62,972       62,513  

Stock-secured notes payable

    14,026       17,546  

Accounts payable and other liabilities (including $23,018 in 2008 and $1,873 in 2007 to affiliates and related parties)

    147,920       104,884  
               
    1,544,575       1,523,307  

Commitments and contingencies:

   

Minority interest

    81,900       62,161  

Shareholders’ equity:

   

Preferred Stock, $2.00 par value, authorized 15,000,000 shares, issued and outstanding Series A, 3,087,418 share in 2008 and 3,390,316 shares in 2007 (liquidation preference $33,909), including 600,000 shares in 2008 and 2007 held by subsidiaries

    4,979       4,979  

Common Stock, $.01 par value, authorized 100,000,000 shares; issued 11,874,138 shares in 2008 and 11,592,272 shares in 2007

    114       114  

Treasury stock at cost; 637,072 and 1,129,530 shares in 2008 and 2007, respectively, which includes 276,972 and 746,972 shares held by TCI (consolidated) as of 2008 and 2007, respectively.

    (5,954 )     (12,664 )

Paid-in capital

    92,609       100,277  

Retained earnings

    119,599       99,452  

Accumulated other comprehensive income (loss)

    4,331       228  
               

Total shareholders’ equity

    215,678       192,386  
               

Total liabilities and shareholders’ equity

  $ 1,842,153     $ 1,777,854  
               

The accompanying notes are an integral part of these consolidated financial statements.

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

    For the Years Ended December 31,  
    2008     2007     2006  
   

(dollars in thousands, except

share and per share amounts)

 

Revenues:

     

Rental and other property revenues (including $3,805 and $1,197 and $1,423 for 2008 and 2007 and 2006 respectively from affiliates and related parties)

  $ 181,920     $ 169,394     $ 142,138  

Expenses:

     

Property operating expenses (including $8,659 and $9,239 and $8,212 for 2008 and 2007 and 2006 respectively from affiliates and related parties)

    117,973       107,200       94,233  

Depreciation and amortization

    27,646       24,164       22,248  

General and administrative (including $6,741 and $3,657 and $4,481 for 2008 and 2007 and 2006 respectively from affiliates and related parties)

    17,384       16,624       9,336  

Advisory fee to affiliate

    15,940       14,898       12,678  
                       

Total operating expenses

    178,943       162,886       138,495  
                       

Operating income

    2,977       6,508       3,643  

Other income (expense):

     

Interest income (including $4,692 and $1,196 and $2,692 for 2008 and 2007 and 2006 respectively from affiliates and related parties)

    7,390       5,236       6,000  

Other income (including $3,485 and $0 and $0 for 2008 and 2007 and 2006 respectively from affiliates and related parties)

    8,699       8,406       5,821  

Mortgage and loan interest including $2,729 and $603 and $1,857 for 2008 and 2007 and 2006 respectively from affiliates and related parties)

    (92,610 )     (89,088 )     (67,484 )

Earnings from unconsolidated subsidiaries and investees

    (1,878 )     286       1,540  

Gain on foreign currency translation

    (517 )     0       0  

Involuntary conversion

    0       34,771       20,479  

Provision for allowance on notes receivable and impairment

    (12,417 )     (1,003 )     0  

Discount on note receivable

    0       0       (1,170 )

Litigation settlement

    (286 )     (1,354 )     15  
                       

Total other expenses

    (91,619 )     (42,746 )     (34,799 )
                       

Loss before gain on land sales, minority interest, and income taxes

    (88,642 )     (36,238 )     (31,156 )

Gain on land sales

    5,584       20,468       23,973  

Minority interest

    146       (2,652 )     672  
                       

Loss from continuing operations before income tax benefit

    (82,912 )     (18,422 )     (6,511 )

Income tax benefit

    36,838       15,744       6,852  
                       

Net loss from continuing operations

    (46,074 )     (2,678 )     341  
                       

Income from discontinued operations, net of minority interest before income tax expense

    105,704       44,984       19,577  

Income tax expense

    (36,996 )     (15,744 )     (6,852 )
                       

Net income from discontinuing operations , net of minority interest

    68,708       29,240       12,725  
                       

Net income

    22,634       26,562       13,066  

Preferred dividend requirement

    (2,487 )     (2,490 )     (2,491 )
                       

Net income applicable to common shares

  $ 20,147     $ 24,072     $ 10,575  
                       

Earnings per share—basic

     

Loss from continuing operations

  $ (4.46 )   $ (0.51 )   $ (0.21 )

Discontinued operations

    6.31       2.86       1.25  
                       

Net income applicable to common shares

  $ 1.85     $ 2.35     $ 1.04  
                       

Earnings per share—diluted

     

Loss from continuing operations

  $ (4.46 )   $ (0.51 )   $ (0.16 )

Discontinued operations

    6.31       2.86       0.97  
                       

Net income applicable to common shares

  $ 1.85     $ 2.35     $ 0.81  
                       

Weighted average common share used in computing earnings per share

    10,888,833       10,227,593       10,149,000  

Weighted average common share used in computing diluted earnings per share

    10,888,833       10,227,593       13,106,000  

The accompanying notes are an integral part of these consolidated financial statements.

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(dollars in thousands)

 

    Series A
Preferred
Stock
    Common Stock   Treasury
Stock
    Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Capital
 
             
             
    Shares   Amount          

Balance, December 31, 2005

  $ 4,982     11,592,272   $ 114   $ (15,146 )   $ 93,389     $ 64,805     $ 253     $ 148,397  

Unrealized loss on foreign currency translation

                (790 )     (790 )

Unrealized gain on investment securities

                2,321       2,321  

Net income

              13,066         13,066  

Repurchase/sale of treasury shares, net

    (3 )           (11 )         (14 )

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

              (2,491 )       (2,491 )
                                                         

Balance, December 31, 2006

    4,979     11,592,272     114     (15,146 )     93,378       75,380       1,784       160,489  

Unrealized gain on foreign currency translation

                4,427       4,427  

Unrealized loss on investment securities

                (5,983 )     (5,983 )

Net income

              26,562       —         26,562  

Acquisition of minority interest

            6,899           6,899  

Repurchase/sale of treasury shares, net

          2,482             2,482  

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

              (2,490 )       (2,490 )
                                                         

Balance, December 31, 2007

    4,979     11,592,272     114     (12,664 )     100,277       99,452       228       192,386  

Unrealized gain on foreign currency translation

              —         9,685       9,685  

Unrealized loss on investment securities

                (5,582 )     (5,582 )

Net income

              22,634         22,634  

Acquisition of minority interest

            (7,668 )         (7,668 )

Stock reconcilation

    281,866               —    

Repurchase/sale of treasury shares, net

          6,710       —             6,710  

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

              (2,487 )       (2,487 )
                                                         

Balance, December 31, 2008

  $ 4,979     11,874,138   $ 114   $ (5,954 )   $ 92,609     $ 119,599     $ 4,331     $ 215,678  
                                                         

 

* Stock reconciliation was to adjust shares to agree to records per transfer agent, American Stock Transfer & Trust Company, effective January 1, 2008.

 

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AMERICAN REALTY INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

    For the Years Ended December 31,  
         2008              2007             2006      
    (dollars in thousands)  

Cash Flow From Operating Activities:

     

Net income applicable to common shares

  $ 20,147     $ 24,072     $ 10,575  

Adjustments to reconcile net loss applicable to common shares to net cash used in operating activities:

     

Gain on sale of land

    (5,584 )     (20,468 )     (23,973 )

Depreciation and amortization

    27,995       28,967       32,524  

Provision for allowance of notes receivable and impairment

    12,417       1,003       1,183  

Amortization of deferred borrowing costs

    9,481       7,157       3,049  

Earnings from unconsolidated subsidiaries and investees

    (4,713 )     (286 )     (1,540 )

Change in minority interest

    4,334       —         —    

Gain (loss) on foreign currency translation

    517       (2,368 )     (2 )

Gain on sale of income producing properties

    (119,572 )     (53,375 )     (22,159 )

(Increase) decrease in assets:

     

Accrued interest receivable

    2,081       (2,347 )     1,022  

Restricted cash

    2,285       3,444       (6,000 )

Other assets

    58,529       3,935       (2,918 )

Prepaid expense

    (1,187 )     (1,890 )     —    

Escrow

    (21,227 )     (1,022 )     —    

Earnest money

    4,128       6,544       (9,386 )

Rent receivables

    (6,530 )     (7,641 )     —    

Increase (decrease) in liabilities:

     

Accrued interest payable

    (1,997 )     (5,556 )     2,233  

Intercompany change

    23,018       (11,601 )     (9,927 )

Other liabilities ($24,433 in 2008, $14,500 in 2007 and $10,542 in 2006 from affiliates)

    20,018       (2,888 )     (10,503 )
                       

Net cash provided by (used in) operating activities

    24,140       (34,320 )     (35,822 )

Cash Flow From Investing Activities:

     

Proceeds from notes receivables (($4,017) in 2008, $2,248 in 2007 and $1,931 in 2006 from affiliates)

    (351 )     16,542       14,136  

Acquisition of land held for development

    (54,744 )     (24,965 )     —    

Proceeds from sales of income producing properties

    179,669       55,256       66,722  

Proceeds from sale of land

    16,988       65,516       4,617  

Investment in unconsolidated real estate entities

    (3,246 )     960       (44,293 )

Improvement of land held for development

    (1,789 )     (3,728 )     —    

Improvement of income producing properties

    (16,873 )     (15,135 )     (567 )

Acquisition of minority interest

    19,739       2,652       (5,551 )

Investment in marketable equity securities

    10,382       —         —    

Acquisition of income producing properties

    (64,466 )     (114,258 )     (142,527 )

Construction and development of new properties

    (148,822 )     (204,672 )     —    
                       

Net cash used in investing activities

    (63,513 )     (221,832 )     (107,463 )

Cash Flow From Financing Activities:

     

Proceeds from notes payable ($10,850 in 2008, $8,669 in 2007 and $0 in 2006 from affiliates)

    221,354       529,058       245,848  

Recurring amortization of principal on notes payable

    (20,323 )     (12,872 )     —    

Payments on maturing notes payable

    (178,746 )     (240,209 )     (102,940 )

Deferred financing costs

    8,380       (10,394 )     (6,477 )

Stock-secured borrowings

    (3,520 )     (4,906 )     —    

Repurchase/sale of treasury stock

    6,710       —         (15 )
                       

Net cash provided by financing activities

    33,855       260,677       136,416  
                       

Net increase (decrease) in cash and cash equivalents

    (5,518 )     4,525       (6,869 )

Cash and cash equivalents, beginning of period

    11,560       7,035       13,904  
                       

Cash and cash equivalents, end of period

  $ 6,042     $ 11,560     $ 7,035  
                       

Supplemental disclosures of cash flow information:

     

Cash paid for interest

  $ 97,158     $ 110,997     $ 82,681  

Cash paid for income taxes, net of refunds

    —         —         —    

Schedule of noncash investing and financing activities:

     

Unrealized foreign currency translation gain (loss)

  $ 9,685     $ 4,427     $ (790 )

Unrealized gain (loss) on marketable securities

    (5,582 )     (5,983 )     2,321  

Note receivable allowance

    (1,500 )     —         —    

Note receivable for treasury stock

    —         3,779       —    

Land exchanged with affiliated party

    —         900       1,500  

Note receivable received from affiliate

      16,132       —    

Note receivable from sale of real estate

    —         —         3,821  

Subsidiary purchased from affiliate decreasing affiliate receivable

    —         —         5,150  

Issuance of affiliated preferred stock and reduction in affiliated receivables

    —         —         10,000  

Real Estate received from related party to satisfy debt

    —         —         12,214  

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 2007 and 2006 have been reclassified to conform to the 2008 presentation.

 

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Business.    In November 1999, American Realty Investors, Inc. (“ARL”), a Nevada corporation, was formed, and in August 2000, ARL acquired American Realty Trust, Inc. (“ART”), a Georgia corporation and National Realty, L.P. (“NRLP”), a Delaware partnership. ARL 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 ARL 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 ARL 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 No. 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.    ARL 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 September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” (“SFAS No. 157”). SFAS No. 157 defines fair value and establishes a framework for measuring fair value, which includes a hierarchy based on the quality of inputs used to measure fair value. SFAS No. 157 also expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 requires the categorization of financial assets and liabilities, based on the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to the quoted prices in active markets for identical assets and liabilities and lowest priority to unobservable inputs. SFAS No. 157 requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement. The levels of the SFAS No. 157 fair value hierarchy are described as follows:

 

   

Level 1—Financial assets and liabilities whose values are based on unadjusted quoted market prices for identical assets and liabilities in an active market that the Company has the ability to access.

 

   

Level 2—Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable for substantially the full term of the asset or liability.

 

   

Level 3—Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.

SFAS No. 157 became 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. On January 1, 2008, the Company adopted SFAS No. 157. The Company currently does not have any non-financial assets or non-financial liabilities that are required to be measured under SFAS No. 157.

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 became effective for fiscal years beginning after November 15, 2007. On January 1, 2008, the Company adopted SFAS No. 159 and has currently not elected to measure any financial instruments or other items (not currently required to be measured at fair value) at fair value.

In December 2007, the FASB issued SFAS No. 141 (revised in 2007) (“SFAS No. 141R”), “Business Combinations.” SFAS No. 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combinations. SFAS No. 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations the Company engages in will be recorded and disclosed following existing accounting principles until January 1, 2009. The Company expects SFAS No. 141R will affect the Company’s consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, term and size of the acquisitions, if any, the Company consummates after the effective date.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” effective for financial statements issued for fiscal years beginning after December 15, 2008. SFAS No. 160 states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, and will impact the recording of minority interest. The Company is currently evaluating the effects 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.    ARL 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.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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.

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 ARL 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 No. 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 ARL’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 No. 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 No. 123(R) effective January 1, 2006 using the modified-prospective method and applied the provisions of SFAS No. 123(R) to all share-based compensation. All of ARL’s stock options were

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

fully vested as of January 1, 2006 and ARL had no outstanding stock option grants that were modified or settled after January 1, 2006; therefore, the adoption of SFAS No. 123(R) had no material effect on the Company’s results of operations for the year ended December 31, 2008. The Director’s stock option plan was terminated in December of 2005.

NOTE  2.     REAL ESTATE

A summary of our real estate transactions for the year ended December 31, 2008 is listed below (dollars in thousands):

 

     2008     2007  

Apartments

   $ 656,578     $ 515,532  

Apartments under construction

     56,195       153,214  

Other developments in progress

     304,095       110,321  

Commercial properties

     441,318       447,103  

Hotels

     41,046       88,538  

Land held for development

     213,274       194,107  

Real estate held for sale

     10,973       83,384  

Real estate subject to sales contract

     67,326       73,033  
                

Total Real Estate

     1,790,805       1,665,232  

Less accumulated deprecation

     (177,403 )     (179,373 )
                
   $ 1,613,402     $ 1,485,859  
                

Expenditures for repairs and maintenance are charged to operations as incurred. Significant betterments are capitalized. When assets are sold or retired, their costs and related accumulated depreciation are removed from the accounts with the resulting gains or losses reflected in net income or loss for the period.

Depreciation is computed on a straight line basis over the estimated useful lives of the assets as follows:

 

Land improvements

   25 to 40 years

Buildings and improvements

   10 to 40 years

Tenant improvements

   Shorter of useful life or terms of related lease

Furniture, fixtures and equipment

   3 to 7 years

Provision for Asset Impairments. In 2008, the provision for allowance and impairments was related to our receivables and our investments in unconsolidated entities and other investees. In 2007, we recorded a $1.0 million provision for impairment. We wrote down the Executive Court apartments for $0.2 million and the Encon warehouse for $0.8 million.

The following is a brief description of the more significant property acquisitions and sales in 2008:

Woodmont TCI XIV, LP

On January 15, 2008, we purchased 4.0 acres of land in Dallas, Texas known as Woodmont TCI XIV, LP for $6.4 million. We financed the transaction with $1.9 million cash, a new mortgage of $4.1 million with a commercial lender and accrued $400,000 in commissions payable. The mortgage is secured by the property and accrues interest at Prime plus 0.75%.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Midland/Odessa

On January 25, 2008, we sold 15 apartment complexes known as the Midland/Odessa properties in a single transaction for an aggregate sales price of $98.3 million. We recorded a gain on sale of $72.1 million. We received cash of $28.4 million after paying off existing mortgages of $62.1 million, and $7.8 million in commissions and other closing costs. The properties consisted of:

 

   

Forty-Four Hundred Apartments, a 92-unit complex located in Midland, Texas;

 

   

Arbor Pointe, a 194-unit complex located in Odessa, Texas;

 

   

Ashton Way, a 178-unit complex located in Midland, Texas;

 

   

Autumn Chase, a 94-unit complex located in Midland, Texas;

 

   

Courtyard Apartments, a 133-unit complex located in Midland, Texas;

 

   

Coventry Point, a 120-unit complex located in Midland, Texas

 

   

Fairway, a 152-unit complex located in Longview, Texas;

 

   

Fountains at Waterford, a 172-unit complex located in Midland, Texas;

 

   

Hunters Glen, a 260-unit complex located in Midland, Texas;

 

   

Southgate, a 180-unit complex located in Odessa, Texas;

 

   

Sunchase, a 300-unit complex located in Odessa, Texas;

 

   

Sunset, a 240-unit complex located in Odessa, Texas;

 

   

Thornwood, a 109-unit complex located in Midland, Texas;

 

   

Westwood, a 79-unit complex located in Odessa, Texas; and

 

   

Woodview, a 232-unit complex located in Odessa, Texas.

Lexington

On January 31, 2008, we sold the Lexington office building, a 75,000 square foot commercial building located in Colorado Springs, Colorado for $5.4 million, receiving cash of $1.6 million after paying off the existing mortgage of $3.5 million and $300,000 in closing costs. We recorded a $700,000 gain on sale.

Fairway View

On February 6, 2008, we sold the Fairway View Apartments, a 264-unit complex located in El Paso, Texas for $10.3 million recording a gain on sale of $6.0 million. We received $4.8 million in cash after paying off the existing mortgage of $5.3 million and closing costs.

Governors Square

On February 14, 2008, we sold the Governors Square apartments, a 169-unit complex located in Tallahassee, Florida for $8.5 million, recording a gain on sale of $5.7 million. We received $4.7 million in cash after paying off the existing mortgage of $2.9 million and $900,000 in closing costs.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Chicago Hotels

On February 14, 2008, we sold three hotels located in Chicago, Illinois in a single transaction for $30.0 million recording a gain on sale of $18.4 million. We received cash of $9.8 million after paying off existing mortgages of $18.5 million and closing costs. The properties consisted of:

 

   

City Suites Hotel, a 45-room hotel;

 

   

Majestic Hotel, a 55-room hotel; and

 

   

Willows Hotel, a 52-room hotel.

Hotel Akademia

On March 28, 2008, we sold all of our shares in S.P. Zoo (a Polish Corporation) for $11.8 million. The sale of the shares represented our 66.67% interest in the Radisson-SAS Hotel Akademia, a 161-room hotel located in Wroclaw, Poland. We received cash of $11.8 million upon sale of our shares and recorded a gain on sale of $7.7 million.

Bridgewood Ranch

On April 2, 2008, we acquired the Bridgewood Ranch apartments, a 106-unit complex located in Kaufman, Texas for $7.6 million. We financed the purchase with a new mortgage (secured by the property) of $5.1 million, cash of $1.3 million, and $1.2 million in liabilities. The mortgage accrues interest at the higher of 6.75% or Prime plus 0.25% and matures on March 31, 2019.

Quail Hollow

On April 16, 2008, we acquired the Quail Hollow apartments, a 200-unit complex located in Holland, Ohio for $14.1 million. We financed the purchase with a new mortgage (secured by the property) of $11.5 million, cash of $77,000, and $2.6 million in liabilities. The mortgage accrues interest at 7.00% and matures in October 2011.

Valley Ranch Land

On June 10, 2008, we sold 20.6 acres of undeveloped land located in Irving, Texas for $7.2 million, recording a $1.9 million gain on sale. We received $2.0 million in cash and provided $2.2 million in seller financing, after paying down $2.9 million in existing debt, and incurring $100,000 in closing costs.

Stanford Centre

On June 26, 2008, we purchased Stanford Centre, a 274,684 square foot commercial building located in Dallas, Texas, including 3.1 acres of land, for $38.8 million. We financed the transaction with $11.5 million in cash and a $26.1 million mortgage from a commercial bank. In addition, we incurred $1.2 million in accruals and credits at closing. The mortgage accrues interest at LIBOR plus 3.75%, and matures July 1, 2011.

Las Colinas Land

On July 23, 2008, we purchased 24.1 acres of land known as Las Colinas land in Irving, Texas for $6.7 million. We financed the transaction with $2.2 million in cash and a $4.5 million mortgage. The note accrues interest at Prime plus 4.00% and matures on July 23, 2010.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Windmill Farms Harlan Land

On July 23, 2008, we purchased 246.0 acres of land known as Windmill Farms Harlan land located in Kaufman County, Texas for $6.8 million. We financed the transaction with $1.3 million cash and seller financing of $5.5 million. The note accrues interest at 2.00% for the first year, 4.00% for the second year and 6.00% for the third year and each year thereafter and matures on July 23, 2013.

Travis Ranch

On August 12, 2008, we purchased 833.4 acres of land in Forney, Texas known as Travis Ranch land for $18.7 million. We financed the transaction with $2.2 million cash, a $5.8 million loan with a commercial lender and a $7.5 million loan provided by the seller. In addition, we accrued $3.2 million in commissions and closing costs. The commercial note and seller financing both accrue interest at 5.00% and are due upon demand.

Mountain Plaza

On October 15, 2008, we sold the Mountain Plaza apartments, a 188-unit complex, located in El Paso, Texas for $7.9 million. We received $1.1 million in cash, after providing seller financing of $1.9 million. The buyer assumed the existing mortgage of $4.9 million secured by the property.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

NOTE 3. NOTES AND INTEREST RECEIVABLE

A portion of our assets are invested in mortgage notes receivable, principally secured by real estate. We may originate mortgage loans in conjunction with providing purchase money financing of property sales. Notes receivable are generally collateralized by real estate or interests in real estate and personal guarantees of the borrower and, unless noted otherwise, are so secured Management intends to service and hold for investment the mortgage notes in our portfolio. A majority of the notes receivable provide for principal to be paid at maturity. Our mortgage notes receivable consist of first, wraparound and junior mortgage loans (dollars in thousands).

 

Borrower

  Maturity
Date
  Interest
Rate
    Amount    

Security

Performing loans:

       

3334Z Apts, LP

  04/12   6.50 %   $ 1,875     100% Interest in 3334Z Apts

400 St. Paul

  01/09   9.25 %     3,612     Office building, Dallas, TX

Basic Capital Management(1)

  10/11   7.00 %     1,253     Industrial building, Arlington, TX

Basic Capital Management(1)

  10/11   7.00 %     1,523     Retail building, Cary, NC

CTMGT Travis Ranch, LLC

  08/14   6.00 %     2,404     Unsecured

CTMGT Travis Ranch, LLC

  Demand   5.00 %     4,866     Unsecured

Dallas Fund XVII LP

  10/09   9.00 %     5,499     Assignment of partnership interests

Garden Centura LP(1)

  N/A   7.00 %     4,026     Excess cash flow from partnership

International Health Product(1)

  08/10   Prime + 1.00 %     3,779     335900 Shares of Stock (11.25 per share)

Miscellaneous non-related party notes

  Various   Various       3,743     Various security interests

Miscellaneous related party notes(1)

  Various   Various       1,431     Various security interests

Ocean Beach Partners(1)

  12/09   7.00 %     2,000     Vendors Lien

Pioneer Austin Development

  10/13   10.00 %     2,407     33 acres undeveloped land, Austin, TX

Realty Advisors(1)

  11/11   7.00 %     12,999     850 shares of ARI stock owned by BCM

Syntek Acquisition Corp(1)

  08/10   Prime + 1.00 %     3,354     Unsecured

Thornwood Wrap Note, ICC Surfwood

  07/09   7.50 %     1,638     Unsecured

Unified Housing of Harvest Hill(1)

  10/13   12.00 %     8,783     100% Interest in UHF Harvest Hill
             

Total Performing

      $ 65,192    

Non-Performing loans:

       

Blue Lake at Marine Creek(1)

  12/13   12.00 %   $ 125     100% Interest in Marine Creek

HFS of Humble LLC(1)

  12/17   12.00 %     2,630     100% Interest in HFS Humble

Tracy Suttles

  01/09   12.00 %     1,077     Unsecured

UHF Burleson(1)

  08/13   12.00 %     762     100% Interest in UHF Burleson

UHF Chase Oaks(1)

  12/13   12.00 %     127     100% Interest in UHF Chase Oaks

UHF Inwood(1)

  12/13   12.00 %     4,974     100% Interest in UHF Inwood

UHF Kensington(1)

  03/14   12.00 %     5,099     100% Interest in UHF Kensington

UHF McKinney(1)

  12/13   12.00 %     2,375     100% Interest in UHF McKinney

UHF Parkside Advances(1)

  12/13   12.00 %     323     100% Interest in UHF Parkside Advances

UHF Walnut Park Crossing(1)

  12/13   12.00 %     355     100% Interest in UHF Walnut Park Crossing

Windmill Farms

  07/09   7.00 %     2,185     Unsecured
             

Total Non-Performing

      $ 20,032    

Total

        85,224    

Accrued interest

        3,653    

Allowance for estimated losses

        (11,874 )  
             

Total

      $ 77,003    
             

 

(1) Related party notes

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Junior Mortgage Loans.    We may invest in junior mortgage loans, secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on such loans ordinarily includes the real estate on which the loan is made, other collateral and personal guarantees by the borrower. The Board of Directors restricts investment in junior mortgage loans, excluding wraparound mortgage loans, to not more than 10.0% of our assets. At December 31, 2008, 2.0% of our assets were invested in junior and wraparound mortgage loans.

Interest income is recognized on non-performing notes receivable and cash flow notes receivables. Effective 2008, interest income is recorded when cash is received, and no accrued interest income is recorded on non-performing notes receivables. If the notes for the years 2008 and 2007 had been performing, an additional interest income totaling $84.8 million and $1.0 million, respectively, would have been recognized.

As of December 31, 2008, the obligors on $56.0 million or 73% of the mortgage notes receivable portfolio were due from affiliated entities. Also at that date, $20.0 million or 26% of the mortgage notes receivable portfolio was non-performing. At December 31, 2008, approximately 4.00% of our assets were invested in notes and interest receivable.

NOTE 4.    ALLOWANCE FOR ESTIMATED LOSSES

The table below shows our allowance for estimated losses (dollars in thousands).

 

     2008    2007    2006

Balance January 1,

   $ 2,978    $ 1,000    $ 1,000

(Decrease) Increase in provision

     8,896      1,978      —  
                    

Balance December 31,

   $ 11,874    $ 2,978    $ 1,000
                    

NOTE 5.    INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES AND INVESTEES

Investments in unconsolidated subsidiaries, jointly owned companies and other investees in which we have a 20% to 50% interest or otherwise exercise significant influence are carried at cost, adjusted for the Company’s proportionate share of their undistributed earnings or losses, via the equity method of accounting. Income Opportunity Investors, Inc. (“IOT”) is a related entity and an unconsolidated subsidiary.

Investment accounted for via the equity method consists of the following:

 

      Percent ownership  

Investee

   2008     2007  

Gruppa Florentina, LLC (“Gruppa”)

   20 %   20 %

Income Opportunity Investors, Inc.(1)

   25 %   25 %

Garden Centura

   5 %   5 %

LK Four Hickory

   29 %   29 %

 

(1) Unconsolidated subsidiary

Our partnership interest in Garden Centura LP in the amount of 5% is accounted for under the equity method, because we exercise significant influence over the operations and financial activities. We have guaranteed the notes payable and control the day to day activities. Accordingly, the investment is carried at cost, adjusted for the companies’ proportionate share of earnings or losses.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The market values, other than the unconsolidated subsidiaries, as of the year ended December 31, 2008 and 2007 were not determinable as there were no readily traded markets for this entity.

The following is a summary of the financial position and results of operations from our unconsolidated subsidiaries and investees (dollars in thousands);

 

     Unconsolidated
Subsidiaries
    Other
Investees
    Total  

2008

      

Real estate, net of accumulated depreciation

   $ 36,942     $ 130,538     $ 167,480  

Notes Receivable

     39,606       3,367       42,973  

Other assets

     39,005       43,929       82,934  

Notes payable

     (42,319 )     (97,543 )     (139,862 )

Other liabilities

     (2,459 )     (9,093 )     (11,552 )

Shareholders equity/partners capital

   $ (70,775 )   $ (71,198 )     (141,973 )
                        

Revenue

   $ 3,827     $ 58,706       62,533  

Depreciation

     (206 )     (6,244 )     (6,450 )

Operating expenses

     (3,475 )     (44,914 )     (48,389 )

Gain on land sales

      

Interest expense

     (2,410 )     (6,382 )     (8,792 )
                        

Income from continuing operations

     (2,264 )     1,166       (1,098 )

Income from discontinued operations

     28,973         28,973  
                        

Net income

   $ 26,709     $ 1,166       27,875  
                        

Companys proportionate share of earnings

   $ 6,656     $ 146       6,802  
                        
     Unconsolidated
Subsidiaries
    Other
Investees
    Total  

2007

      

Real estate, net of accumulated depreciation

   $ 57,603     $ 132,450     $ 190,053  

Notes Receivable

     27,441     $ 2,724       30,165  

Other assets

     31,936     $ 43,262       75,198  

Notes payable

     (69,506 )   $ (99,454 )     (168,960 )

Other liabilities

     (2,730 )   $ (8,952 )     (11,682 )

Shareholders equity/partners capital

   $ (44,744 )   $ (70,030 )   $ (114,774 )
                        

Revenue

   $ 7,050       49,432     $ 56,482  

Depreciation

     (348 )     (4,188 )     (4,536 )

Operating expenses

     (3,726 )     (40,191 )     (43,917 )

Gain on land sales

      

Interest expense

     (3,768 )     (4,412 )     (8,180 )
                        

Income from continuing operations

     (792 )     641       (151 )

Income from discontinued operations

     57         57  
                        

Net income

   $ (735 )     641     $ (94 )
                        

Companys proportionate share of earnings

   $ (183 )     182     $ (1 )
                        

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

     Unconsolidated
Subsidiaries
    Other
Investees
    Total  

2006

      

Real estate, net of accumulated depreciation

   $ 58,621     $ 6,285     $ 64,906  

Notes Receivable

     27,777       2,082       29,859  

Other assets

     22,513       33,850       56,363  

Notes payable

     (61,546 )     (12,826 )     (74,372 )

Other liabilities

     (2,526 )     (6,744 )     (9,270 )

Shareholders equity/partners capital

   $ (44,839 )   $ (22,647 )     (67,486 )
                        

Revenue

   $ 11,064     $ 38,280     $ 49,344  

Depreciation

     (750 )     (1,125 )     (1,875 )

Operating expenses

       (31,744 )     (31,744 )

Gain on land sales

     (4,764 )       (4,764 )

Interest expense

     (5,378 )     (1,367 )     (6,745 )
                        

Income from continuing operations

     172       4,044       4,216  

Income from discontinued operations

      
                        

Net income

   $ 172     $ 4,044     $ 4,216  
                        

Companys proportionate share of earnings

   $ 41     $ 120     $ 161  
                        

NOTE 6.    INVESTMENTS IN SECURITIES

Our investments include equity investments via stock ownership in Storm Cat Energy (“SCU”) and Realty Korea CR-REIT, Ltd. We account for these investments in accordance with FAS No. 115, as amended by FAS No.157. We consider our investment in SCU as “trading” and our investment in Realty Korea CR-REIT, Ltd. as “available for sale” as defined by FAS No. 115. The methodology that we used to determine the fair value of these investments is discussed below:

The fair value of SCU is based on combination of level 2 and level 3 fair value adjustments. SCU is trading Over the Counter (OTC) as “SCUEF.PK”. The stock was delisted from the New York Stock Exchange (NYSE) and the Toronto Stock Exchange (TSE) on November 17, 2008 and November 18, 2008, respectively. The level 2 fair value input of this stock was based on the most recent OTC trade closest to year end. In addition, we included an adjustment for risk which is included in our level 3 fair value measurement.

The fair value of our investment in Realty Korea CR-REIT, Ltd. (“CR-REIT”) is based on the sale and distribution of the assets. The CR-REIT was dissolved in 2008 and delisted from the Korean stock exchange, but a portion of the proceeds have yet to be distributed. Thus, we have performed a level 3 fair value analysis which is based on anticipated proceeds which were received subsequent to year end.

 

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AMERICAN REALTY INVESTORS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The fair value measurements of SCU and Realty Korea CR-REIT, Ltd are shown below (dollars in thousands):

 

          Fair Value Measurements at Reporting Date Using  

Description

   12/31/2008    Quoted
prices in
Active
Markets
(Level 1)
   Significant
other
observable
inputs

(Level 2)
    Significant
Unobservable
inputs

(level 3)
 

Trading securities

   $ —      $ —      $ 10     $ (10 )

Available for sale securities

     2,775      —        —         2,775  
                              

Total

   $ 2,775    $ —      $ 10     $ 2,765  
                              
               Investments     Total  

Beginning Balance

         $ —       $ —    

Total gains or losses(realized/unrealized)

          

Included in earnings

           (10 )     (10 )

Included in other comprehensive income

           2,775       2,775  

Purchases, issuances, and settlements

           —         —    

Transfers in/or out of level 3

           —         —    
                      

Ending balance

         $ 2,765     $ 2,765  
                      

The amount of total gains or (losses) for the period included in earnings attributable to the change in unrealized gains or losses realating to assets still held at reporting date

         $ —       $ —    
                      

Gain and losses(realized and unrealized) included in earnings for the year ended December 31, 2008 are reported in trading revenues and in other revenues as follows:

 

     Other
Income

Total gains or losses included in earnings for the year ended December 31, 2008

   $ 832
      

Change in unrealized gains or losses relating to assets held at reporting date

   $ —