UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period to
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Commission File number 001-31659
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Berkshire Income Realty, Inc.
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Maryland 32-0024337
------------------------------------------------ ------------------
(State or other jurisdiction of incorporation or (IRS employer
organization) identification no.)
One Beacon Street, Boston, Massachusetts 02108
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(Address of principal executive offices) (Zip code)
(Registrant's telephone number, including area code) (617) 523-7722
---------------------------
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 whether the registrant is an accelerated filer (as
defined in rule 12 (b-2) of the Exchange Act)
Yes [ ] No [X]
As of November 14, 2003, 1,283,313 shares of Class B common stock outstanding.
BERKSHIRE INCOME REALTY, INC.
TABLE OF CONTENTS
Page
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements:
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
Balance Sheets (Unaudited) at September 30, 2003 and
December 31, 2002 ------------------------------------------------- 2
Statements of Operations (Unaudited) for the three and
nine months ended September 30, 2003 and 2002 --------------------- 3
Statements of Changes in Stockholders' Equity / Owners'
Deficit (Unaudited) for the nine months ended
September 30, 2003 and December 31, 2002 -------------------------- 4
Statements of Cash Flows (Unaudited) for the nine months
ended September 30, 2003 and 2002 --------------------------------- 5
Notes to Financial Statements (Unaudited) -------------------------- 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ------------------------------- 19
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ------------------------------------------------------- 34
Item 4. Controls and Procedures ----------------------------------- 34
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K -------------------------- 35
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
BALANCE SHEETS
(unaudited, in thousands, except share and per share amounts)
December 31,
September 30, 2002
2003 (Note 1)
Consolidated Combined
---------- ----------
ASSETS
Multi-family apartment communities, net of
accumulated depreciation of $100,166 and
$94,712, respectively $ 99,896 $ 94,343
Cash and cash equivalents 41,819 4,852
Cash restricted for tenant security deposits 855 850
Replacement reserve escrow 250 407
Prepaid expenses and other assets 3,601 3,733
Investment in Mortgage Funds 40,197 -
Deferred expenses, net of accumulated
amortization of $281 and $246, respectively 1,262 1,288
---------- ----------
Total assets $ 187,880 $ 105,473
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY/OWNERS' DEFICIT
Liabilities:
Mortgage notes payable $ 131,901 $ 119,162
Notes payable - 3,155
Due to affiliates 1,456 2,879
Dividend and distributions payable 1,338 -
Accrued expenses and other liabilities 3,317 1,891
Tenant security deposits 940 912
---------- ----------
Total liabilities 138,952 127,999
Minority interest - -
Commitments and Contingencies - -
Stockholders' equity / owners' deficit:
Series A 9% Cumulative Redeemable
Preferred Stock, no par value, $25 stated
value, 5,000,000 shares authorized,
2,978,110 and 0 shares issued and
outstanding at September 30, 2003 and
December 31, 2002, respectively 70,212 -
Class A common stock, $.01 par, 5,000,000
shares authorized; 0 shares issued and
outstanding at September 30, 2003 and
December 31, 2002, respectively - -
Class B common stock, $.01 par, 5,000,000
shares authorized; 1,283,313 and 100
shares issued and outstanding at September
30, 2003 and December 31, 2002, respectively 12 -
Excess stock, $.01 par value, 15,000,000
shares authorized, 0 shares issued and
outstanding at September 30, 2003 and
December 31, 2002, respectively - -
Accumulated deficit (21,296) -
Owners' deficit - (22,526)
---------- ----------
Total stockholders' equity / owners'
deficit 48,928 (22,526)
Total liabilities and stockholders'
equity / owners' deficit $ 187,880 $ 105,473
========== ==========
The accompanying notes are an integral
part of these financial statements.
2
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
STATEMENTS OF OPERATIONS
(unaudited, in thousands, except share and per share amounts)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
2003 2002 2003 2002
Consolidated Combined Consolidated Combined
---------- ---------- ---------- ----------
Revenue:
Rental $ 6,909 $ 6,738 $ 20,598 $ 19,739
Interest 11 86 78 158
Utility reimbursement 133 133 340 448
Other 372 276 925 737
---------- ---------- ---------- ----------
Total revenue 7,425 7,233 21,941 21,082
Expenses:
Operating 1,909 1,524 5,184 4,469
Maintenance 715 577 1,784 1,551
Real estate taxes 644 553 1,819 1,633
General and administrative 476 343 1,149 694
Organizational costs - - 213 -
Management fees 465 451 1,573 1,351
Depreciation 1,819 1,482 5,454 4,386
Interest 1,830 2,189 5,580 4,509
Loss on extinguishment of debt 87 285 339 1,168
Participation interest - 44 - 132
---------- ---------- ---------- ----------
Total expenses 7,945 7,448 23,095 19,893
---------- ---------- ---------- ----------
Income (loss) before minority
interest in properties, equity
in income of Mortgage Funds
and minority common interest
in Operating Partnership (520) (215) (1,154) 1,189
Minority interest in properties (31) - (125) (1,436)
Equity in income of Mortgage
Funds 3,153 - 4,883 -
---------- ---------- ---------- ---------
Income (loss) before
minority common interest in
Operating Partnership 2,602 (215) 3,604 (247)
Minority common interest
in Operating Partnership (488) - (488) -
---------- ---------- ---------- ----------
Net income (loss) $ 2,114 $ (215) $ 3,116 $ (247)
========== ========== ========== ==========
Preferred dividend (1,675) - (3,276) -
---------- ---------- ---------- ----------
Net income (loss)available
to common shareholders $ 439 $ (215) $ (160) $ (247)
========== ========== ========== ==========
Earnings per common
share, basic $ 0.34 $ (0.19)
========== ==========
Weighted average number of
common shares outstanding 1,283,313 837,207
========== ==========
The accompanying notes are an integral part of these
financial statements.
3
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY / OWNERS' DEFICIT
(Unaudited, in thousands)
Total
Stockholders'
equity/
Common Preferred Accumulated owners'
Stock A Deficit deficit
---------- ---------- ---------- ----------
Balance at
December 31, 2002 $ - $ - $ (22,526) $ (22,526)
Net income - - 3,116 3,116
Issuance of preferred shares,
net of issuance costs of $4,241 - 70,212 - 70,212
Issuance of Common Operating
Partnership Units 12 - - 12
Distributions - - (3,391) (3,391)
Contributions - - 1,505 1,505
---------- ---------- ---------- ----------
Balance at
September 30, 2003 $ 12 $ 70,212 $ (21,296) $ 48,928
========== ========== ========== ==========
The accompanying notes are an integral part of these
financial statements.
4
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERSHIRE INCOME REALTY PREDECESSOR GROUP)
STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
For the Nine Months
Ended September 30,
----------------------
2003 2002
---------- ----------
Cash flows from operating activities:
Net income (loss) $ 3,116 $ (247)
Adjustments to reconcile net income (loss) to
net cash provided by operating
activities:
Amortization of deferred financing costs 141 113
Depreciation 5,454 4,386
Loss on extinguishment of debt 338 392
Minority interest in properties 125 1,438
Minority interest in Operating Partnership 488 -
Increase (decrease) in cash attributable to
changes in assets and liabilities:
Tenant security deposits, net 22 98
Due to affiliates (1,423) 1,829
Prepaid expenses and other assets 133 (1,840)
Accrued expenses and other liabilities 1,425 2,072
---------- ----------
Net cash provided by operating
activities 9,819 8,241
---------- ----------
Cash flows from investing activities:
Capital improvements (3,939) (2,547)
Acquisition of property (7,068) -
Distributions from investment in
Mortgage Funds 34,469 -
Investment in Mortgage Funds (213) -
Deposits to replacement reserve (305) (230)
Withdrawals from replacement reserve 462 150
---------- ----------
Net cash provided by (used in)
investing activities 23,406 (2,627)
---------- ----------
Cash flows from financing activities:
Principal payments on mortgage notes payable (1,073) (897)
Prepayments on mortgage notes payable (20,810) (71,858)
Borrowings on mortgage notes payable 31,467 102,080
Deferred financing costs (452) (884)
Syndication costs (4,241) -
Distributions to owners (104) -
Distributions to minority interest in
properties (125) (2,057)
Distributions to preferred shareholders (2,438) (12,858)
Contributions from owners 1,518 325
---------- ----------
Net cash provided by financing activities 3,742 13,851
---------- ----------
Net increase in cash and cash equivalents 36,967 19,465
Cash and cash equivalents at beginning of period 4,852 4,395
---------- ----------
Cash and cash equivalents at end of period $ 41,819 $ 23,860
========== ==========
Supplemental disclosure:
Cash paid for interest $ 6,807 $ 4,888
Supplemental disclosure of non-cash investing and
financing activities:
Issuance of preferred shares in exchange for
interests in the Mortgage Funds $ 74,453 $ -
Capital improvements included in accrued
expenses and other liabilities $ - $ 144
Dividend declared and payable to preferred
shareholders $ 837 $ -
Distribution declared and payable on common
operating partnership units $ 500 $ -
The accompanying notes are an integral part of these
financial statements.
5
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
1. ORGANIZATION AND BASIS OF PRESENTATION
Berkshire Income Realty, Inc., (the "Company"), a Maryland corporation, was
organized on July 19, 2002 and 100 Class B common shares were issued. The
Company is in the business of acquiring, owning and operating multi-family
apartment communities.
The Company filed a registration statement on Form S-11 with the Securities
and Exchange Commission with respect to its offers (the "Offering") to exchange
its 9% Series A Cumulative Redeemable Preferred Stock ("Preferred Shares") for
interests ("Interests") in the following six mortgage funds: Krupp Government
Income Trust ("GIT"), Krupp Government Income Trust II ("GIT II"), Krupp Insured
Mortgage Limited Partnership ("KIM"), Krupp Insured Plus Limited Partnership,
("KIP"), Krupp Insured Plus II Limited Partnership ("KIP II"), and Krupp Insured
Plus III Limited Partnership ("KIP III") (collectively, the "Mortgage Funds").
For each Interest in the Mortgage Funds validly tendered and not withdrawn in
the Offering, the Company offered to exchange its Preferred Shares based on an
exchange ratio applicable to each Mortgage Fund. The registration statement was
declared effective on January 9, 2003. Offering costs incurred in connection
with the Offering have been reflected as a reduction of preferred shares.
On April 4, 2003 and April 18, 2003, the Company issued 2,667,717 and
310,393 shares, respectively, of its Preferred Shares, with a $25.00 liquidation
preference per share. The Preferred Shares were issued in exchange for Interests
in the six Mortgage Funds referred to above. For each Interest in the Mortgage
Funds that was validly tendered and not withdrawn in the Offering, the Company
issued its Preferred Shares based on an exchange ratio applicable to each
Mortgage Fund.
Simultaneously with the completion of the Offering on April 4, 2003, KRF
Company, L.L.C. ("KRF Company"), an affiliate of the Company, contributed its
ownership interests in five multi-family apartment communities (the
"Properties"), to our operating partnership, Berkshire Income Realty - OP, L.P.
(the "Operating Partnership") in exchange for common limited partner interests
in the Operating Partnership. KRF Company then contributed an aggregate of
$1,283 to the Company in exchange for common stock of the Company in an amount,
which together with the one hundred dollars contributed prior to the offering,
totaling 1,283,313 shares of common stock of the Company and equal 1% of the
fair value of the total net assets of the Operating Partnership. This amount was
contributed by the Company to its wholly owned subsidiary, BIR GP, L.L.C., who
then contributed the cash to the Operating Partnership in exchange for the sole
general partner interest in the Operating Partnership.
The Operating Partnership is the successor to the Berkshire Income Realty
Predecessor Group ("the Predecessor"). The combination of the separate business
into the Company and the Operating Partnership was considered a purchase
business combination with the Predecessor being the accounting acquirer.
Accordingly, the acquisition or contribution of the various Predecessor
interests was accounted for at their historical cost. The acquisition of the
Interests was accounted for using purchase accounting based upon the fair value
of the Preferred Shares issued.
Certain minority ownership interests in three of the contributed
multi-family properties are owned by an unaffiliated third party. As the
minority interests have not changed in connection with the completion of the
Offering, the accounting for these interests is based on existing carrying
amounts.
6
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
As a result of the common control of ownership between the Predecessor and
the Company, the Company has not been deemed a new reporting entity pursuant to
the provisions of Accounting Principles Board Opinion #20 Accounting Changes.
Accordingly, the financial statements of the Company do not start "fresh" upon
completion of the Offering in April 2003. Rather, the Company's financial
statements are a continuation of the Predecessor's financial statements and have
been re-titled to those of the Company effective in April 2003.
The Company's financial statements include the accounts of the Company, its
subsidiary, the Operating Partnership, as well as the various subsidiaries of
the Operating Partnership. The Company owns preferred and general partner
interests in the Operating Partnership. The remaining common limited partnership
interests in the Operating Partnership owned by KRF Company and affiliates are
reflected as Minority Interest in Operating Partnership in the financial
statements of the Company.
On March 20, 2003, KRF Company, through a newly formed affiliate, Gables of
Texas Limited Partnership ("Gables"), acquired the Gables Apartments, a 140-unit
multi-family apartment community, located in Houston, Texas, from an unrelated
third party for a purchase price of approximately $6,925. On April 24, 2003, the
Operating Partnership acquired the interests in Gables, its general partner, and
Gables of Texas, L.L.C. from KRF Company for approximately $6,925 plus closing
costs of approximately $143. The purchase price for Gables and Gables of Texas
L.L.C. was equal to the purchase price KRF Company paid the original seller of
the Gables Apartments (including equity payments, transfer taxes, financing and
closing costs as applicable).
Due to the affiliation of the ownership of the Company and KRF Company, the
acquisition of interests in the Gables property has been accounted for as a
reorganization of entities under common control, requiring the Company to
retroactively restate the financial statements from March 20, 2003, the
acquisition date of the property by KRF Company, through the period presented.
On April 29, 2003, the Preferred Shares began trading on the American Stock
Exchange, under the symbol "BIR.PR.A.".
On May 30, 2003, the Operating Partnership and its wholly owned subsidiary
BIR McNab Sub, L.L.C., a newly formed Delaware limited liability company,
acquired all of the outstanding limited and general partner units of McNab KC3
Limited Partnership ("McNab") from affiliates of the Company. The acquisition
was structured as a contribution of units from an affiliate of the Company in
exchange for the issuance by the Operating Partnership of 5,000 common limited
partner units valued at $10.00 per unit. McNab is the fee simple owner of a
276-unit multi-family apartment community located in Pompano Beach, Florida that
is referred to as Windward Lakes Apartments. The former general and limited
partners of McNab are affiliates of the Company, namely George and Douglas
Krupp. At the time of the contribution, control of both the Company and McNab
rested with George and Douglas Krupp via their 100% ownership interest in the
common stock of the Company and their 100% indirect ownership interest in the
general and limited partnership units of McNab. Therefore, the acquisition or
contribution of the general and limited partnership units of McNab by the
Operating Partnership in exchange for the issuance by the Operating Partnership
of common limited partner units is considered a transfer of net assets between
entities under common control.
Due to the affiliation of the ownership of the Company and McNab, the
acquisition of the interests in McNab has been accounted for as a reorganization
of entities under common control, requiring the Company to retroactively restate
the financial statements for the periods presented, which is similar to the
accounting for a pooling of interests.
7
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
Properties
A summary of the multi-family apartment communities owned by the Company at
September 30, 2003 is presented below.
Year Total Controlling
Description Location Acquired Units Interest
----------- ------------- ----------- -------- ------------
Century Cockeysville,
Maryland 1984 468 75.82%
Dorsey's Forge Columbia,
Maryland 1983 251 91.38%
Hannibal Grove Columbia,
Maryland 1983 316 91.38%
Seasons of Laurel Laurel,
Maryland 1985 1,088 100.00%
Walden Pond Houston,
Texas 1983 416 100.00%
Windward Lakes Pompano,
Florida 1992 276 100.00%
Gables of Texas Houston,
Texas 2003 140 100.00%
------
Total 2,955
======
Accounting Policies
Purchase Accounting for Acquisition of Real Estate
Acquired Real Estate Assets - The Company accounts for its acquisitions of
investments in real estate in accordance with Statement of Financial Accounting
Standards (SFAS) No. 141, Business Combinations, which requires the fair value
of the real estate acquired to be allocated to the acquired tangible assets,
consisting of land, building, furniture, fixtures and equipment and identified
intangible assets and liabilities, consisting of the value of above-market and
below-market leases, other value of in-place leases and value of other tenant
relationships, based in each case on their fair values. The Company considers
acquisitions of operating real estate assets to be businesses as that term is
contemplated in Emerging Issues Task Force Issue No. 98-3, Determining Whether a
Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business.
The Company allocates purchase price to the fair value of the tangible
assets of an acquired property (which includes the land, building, furniture,
fixtures and equipment) determined by valuing the property as if it were vacant.
The as-if-vacant value is allocated to land and buildings, furniture, fixtures
and equipment based on management's determination of the relative fair values of
these assets.
8
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
Accounting Policies, continued
Purchase Accounting for Acquisition of Real Estate, continued
Above-market and below market in-place lease values for acquired properties
are recorded based on the present value (using an interest rate which reflects
the risks associated with the leases acquired) of the difference between (i) the
contractual amounts to be paid pursuant to the in-place leases and (ii)
management's estimate of fair market lease rates for the corresponding in-place
leases, measured over a period equal to the remaining non-cancelable term of the
lease. The capitalized above-market lease values are amortized as a reduction of
rental income over the remaining non-cancelable terms of the respective leases.
The capitalized below-market lease values are amortized as an increase to rental
income over the initial term and any fixed-rate renewal periods in the
respective leases.
Management may engage independent third-party appraisers to perform these
valuations and those appraisals use commonly employed valuation techniques, such
as discounted cash flow analyses. Factors considered in these analyses include
an estimate of carrying costs during hypothetical expected lease-up periods
considering current market conditions, and costs to execute similar leases. The
Company also considers information obtained about each property as a result of
its pre-acquisition due diligence, marketing and leasing activities in
estimating the fair value of the tangible and intangible assets acquired. In
estimating carrying costs, management also includes real estate taxes, insurance
and other operating expenses and estimates of lost rentals at market rates
during the expected lease-up periods depending on specific local market
conditions and depending on the type of property acquired.
The total amount of other intangible assets acquired is further allocated
to in-place leases, which includes other tenant relationship intangible values
based on management's evaluation of the specific characteristics of the
residential leases and the Company's tenant retention history.
The value of in-place leases and tenant relationships are amortized as a
leasing cost expense over the initial term of the respective leases and any
expected renewal period. The intangible assets associated with the Gables
acquisition were nominal.
Investments in Mortgage Funds
The acquisition of the Interests in the Mortgage Funds by the Company has
been accounted for using purchase accounting based upon the fair value of the
Preferred Shares issued for the Interests acquired. The market value was
determined to be the $25.00 liquidation preference for the Preferred Shares
since this is the most readily available market value.
This transaction generated a basis difference between the Company's
investment in the Mortgage Funds (fair value) and its underlying equity in the
net assets of the Mortgage Funds (book value). The excess of the book value over
the carrying value for each Mortgage Fund has been allocated to such fund's
mortgage loan investments based upon their relative value. Such allocated
amounts are being amortized into income over the contractual life of the
respective mortgage loans on a basis which approximates the effective interest
method.
9
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
Accounting Policies, continued
Investments in Mortgage Funds, continued
The Company is accounting for its investments in the Mortgage Funds, which
it does not control, using the equity method of accounting. Under the equity
method of accounting, the net equity investment of the Company is reflected on
the balance sheet, and the Company's share of net income or loss from the
Mortgage Funds is included on the Statement of Operations.
Debt Extinguishment Costs
Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 145, Rescission of FAS Nos. 4, 44, and 64, Amendment of
FAS 13, and Technical Corrections. Prior periods that included such debt
extinguishment costs will be reclassified to conform to this standard. Prior to
the adoption of FAS 145, the Company classified costs associated with the early
extinguishment of debt as extraordinary items. In accordance with FAS 145, the
Company has determined that such costs do not meet the criteria for
classification as extraordinary pursuant to APB Opinion No. 30. Accordingly,
costs associated with the early extinguishment of debt are included in the
caption "loss on extinguishment of debt" in the Statements of Operations for the
three and nine months ended September 30, 2003 and 2002. There is no impact on
our financial statements.
Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", an interpretation of ARB No. 51 -
"Consolidated Financial Statements." The interpretation addresses consolidation
by businesses of special purpose entities (variable interest entities, "VIE").
This interpretation addresses consolidation by business enterprises of variable
interest entities in which the equity investment at risk is not sufficient to
permit the entity to finance its activities without additional subordinated
financial support from other parties or in which the equity investors do not
have the characteristics of a controlling financial interest. This
interpretation requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The interpretation also requires disclosures
about variable interest entities that the company is not required to consolidate
but in which it has a significant variable interest. The consolidation
requirements of this interpretation apply immediately to variable interest
entities created after January 31, 2003 but a deferral has been granted until
the end of the first fiscal year or interim period ending after December 15,
2003 for VIE's existing before February 1, 2003. Therefore, it is effective on
December 31, 2003 for the Company. Management is uncertain but is assuming that
it is reasonably possible that each of the Mortgage Funds in which it has an
investment would be considered a VIE. The Company is determining where it is the
primary beneficiary and as a result the Company may consolidate all or a certain
number of the mortgage funds' assets and liabilities.
10
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
Recent Accounting Pronouncements, continued
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
Statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. On October 29, 2003 the FASB indefinitely
deferred the provisions of paragraphs 9 and 10 of SFAS 150 as they apply to
mandatorily redeemable noncontrolling interests. Such interests exist within the
Company. Barring the outcome of the FASB relating to this deferral, the Company
is still in the process of evaluating the potential impact of this standard on
its financial statements.
Income taxes
The Company has elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code upon the filing of its first income tax
return. As of that date, the Company is required to distribute at least 90% of
its REIT taxable income to its shareholders to maintain its REIT status. REITs
are subject to a number of organizational and operational requirements. If the
Company fails to qualify as a REIT in any taxable year, the Company will be
subject to federal income tax on its taxable income at regular corporate tax
rates. Even if the Company qualifies for taxation as a REIT, the Company may be
subject to state and local taxes on its income and property and to federal
income and excise taxes on its undistributed income.
Reclassification
Certain prior period balances have been reclassified in order to conform to
the current period presentation.
Unaudited interim financial statements
The accompanying interim financial statements of the Company are unaudited;
however, the financial statements have been prepared in accordance with the
accounting principles generally accepted in the United States of America
("GAAP") for interim financial information and in conjunction with the rules and
regulations of the Securities and Exchange Commission. Accordingly, certain
disclosures accompanying annual financial statements prepared in accordance with
GAAP are omitted. The year-end balance sheet data was derived from the audited
financial statements of the Predecessor adjusted for the acquisition of the
interests in McNab as a reorganization of entities under common control, thereby
retroactively restating the combined financial statements for all periods
presented which is similar to the accounting for a pooling of interests, but
does not include all disclosures required by GAAP. In the opinion of management,
all adjustments (consisting solely of normal recurring matters) necessary for a
fair presentation of the financial statements for the interim periods have been
included. The results of operations for the interim periods are not necessarily
indicative of the results to be obtained for other interim periods or for the
full fiscal year. The interim financial statements and notes thereto should be
read in conjunction with the Predecessor's financial statements and notes
thereto included in the Company's Form 10-K for the year ended December 31, 2002
and Form 8-K/A filed on August 13, 2003 for the significant acquisition of
McNab.
11
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
2. INVESTMENT IN MORTGAGE FUNDS
The investments in Mortgage Funds consist of the following:
Mortgage Fund Nominal Ownership
---------------- -------------------------
GIT I 30.76%
GIT II 28.81%
KIP 29.66%
KIP II* 25.00%
KIP III 28.63%
KIM 27.81%
*KIP II liquidated on July 29, 2003, thus the Company's nominal ownership is 0%
at September 30, 2003.
The summarized balance sheets of the individually significant investments
in Mortgage Funds and the combined investment in Mortgage Funds are as follows:
September 30, 2003
-----------------------------------------------
Total
Other
Investments
in Mortgage
GIT GIT II Funds Combined
---------- ---------- ---------- ----------
ASSETS
Mortgage investments $ 11,474 $ 67,202 $ 45,354 $ 124,030
Cash and cash equivalents 1,538 23,043 5,767 30,348
Other assets 76 1,299 251 1,626
---------- ---------- ---------- ----------
Total assets $ 13,088 $ 91,544 $ 51,372 $ 156,004
========== ========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities $ 407 $ 38 $ 370 $ 815
Shareholders' equity 12,681 91,506 51,002 155,189
---------- ---------- ---------- ----------
Total liabilities and
shareholders' equity $ 13,088 $ 91,544 $ 51,372 $ 156,004
========== ========== ========== ==========
Company's share of equity $ 3,901 $ 26,363 $ 14,582 $ 44,846
Basis differential (1) (943) (3,350) (356) (4,649)
---------- ---------- ---------- ----------
Carrying value of the Company's
investment in Mortgage Funds $ 2,958 $ 23,013 $ 14,226 $ 40,197
========== ========== ========== ==========
(1) This amount represents the difference between the Company's investment in
the Mortgage Funds (fair value) and its underlying equity in the net assets
of the Mortgage Funds (book value). Basis differentials occurred upon the
acquisition of the Mortgage Fund Interests for which the acquisition price
was less than the underlying equity in the net assets of the Mortgage
Funds.
12
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
2. INVESTMENT IN MORTGAGE FUNDS, continued
The summarized statements of operations of each individually significant
investment in Mortgage Funds and the combined investment in Mortgage Funds are
as follows:
Nine Months Ended
September 30, 2003
-----------------------------------------------
Total
Other
Investments
in
Mortgage
GIT GIT II Funds Combined
---------- ---------- ---------- ----------
Revenue* $ 3,728 $ 5,983 $ 3,520 $ 13,231
Expenses* 412 1,208 996 2,616
---------- ---------- ---------- ----------
Net income $ 3,316 $ 4,775 $ 2,524 $ 10,615
========== ========== ========== ==========
Company's share of net income 1,012 1,361 700 3,073
Amortization of basis
differential 711 1,166 (67) 1,810
---------- ---------- ---------- ----------
Equity in income of Mortgage
Funds $ 1,723 $ 2,527 $ 633 $ 4,883
========== ========== ========== ==========
*Represents the revenues and expenses for the period commencing April 4 and
April 18, 2003, which is the period during which the Company had an investment
in the respective mortgage funds.
3. DEBT
The McNab partnership interests contributed to the Operating Partnership by
George and Douglas Krupp, were subject to certain obligations of McNab and its
partners including the assumption of $13,398 of first mortgage debt, including
accrued interest, $4,162 of principal, accrued interest, participation interest
and interest rebates collateralized by the partnership interests (the
"Additional Loan") and the assumption of approximately $1,266 of liabilities
payable to other affiliates of the Company. Upon completion of the acquisition,
the Operating Partnership immediately paid off the first mortgage and Additional
Loan debt totaling $18,244 using available cash. The Company recognized a loss
of approximately $252 resulting from the write-off of unamortized deferred
financing costs. In accordance with FAS 145, the Company has determined that
such costs do not meet the criteria for classification as extraordinary pursuant
to APB Opinion No. 30. Accordingly, costs associated with the early
extinguishment of debt are included in the caption "loss on extinguishment of
debt" in the consolidated statement of operations for the nine months ended
September 30, 2003. Furthermore, costs previously classified as extraordinary in
prior periods have been reclassified to conform with the adoption of this
pronouncement.
13
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
3. DEBT, continued
In accordance with SOP 97-1, Accounting by Participating Mortgage Loan
Borrowers, the Company estimated the fair value of the participation feature in
the first mortgage debt of McNab noted above to be approximately $720 at
December 31, 2002 and $545 at December 31, 2001, and was recorded as due to
affiliates in the balance sheet at December 31, 2002. The fair value of the
participating interest was deferred and amortized into the statement of
operations over the first mortgage debt's estimated life using the effective
interest rate method.
The lender on both the Additional Loan and the first mortgage for McNab is
GIT. As of the completion of the Offering, the Operating Partnership owns
approximately 31%. The Operating Partnership received $5,650 as a special
distribution from GIT after the payoff of this indebtedness on July 24, 2003.
On August 21, 2003, the Company refinanced its mortgage on Walden Pond. The
original variable mortgage of $4,353 was paid in full and the related deferred
financing costs incurred in the original financing was recorded in "loss on
extinguishment of debt" in the consolidated financial statement of operations
for the three months ended September 30, 2003. The new financing of $12,675,
with a fixed interest rate of 4.86% for a term of 10 years and related deferred
financing costs are included on the consolidated balance sheet at September 30,
2003.
The Company also obtained new mortgages on two additional properties,
Windward Lakes and Gables. The balances and terms are $13,467 at 5.10% for 9
years and $5,325 at 4.86% for 10 years, respectively. Both are fixed interest
rate mortgages.
4. MINORITY INTERESTS
Minority Interest in Properties
An unaffiliated third party has ownership interests in three of the
Company's multi-family apartment communities. Such interests are accounted for
as "minority interest in properties" in the accompanying financial statements.
Allocations of earnings and distributions are made to minority holders based
upon their respective share allocations. Losses in excess of minority holders
investment basis are allocated to the Company. Distributions to the minority
holders in excess of their investment basis are recorded in the Company's
statement of operations as minority interest in properties.
Minority Interest in Operating Partnership
In accordance with Emerging Issues Task Force Issue (EITF) No, 94-2,
Treatment of Minority Interest in Certain Real Estate Investment Trusts, KRF
Company and affiliates' common limited partnership interest in the Operating
Partnership are being reflected as Minority Interest in the financial statements
of the Company. Upon completion of the Offering, the net equity to the common
and general partner interests in the Operating Partnership was less than zero
after an allocation to the Company and affiliates' preferred interest in the
Operating Partnership. Further, KRF Company and affiliates have no obligation to
fund such deficit. Accordingly, for financial reporting purposes, KRF Company
and affiliates' minority interest in the Operating Partnership has been
reflected as zero with common stockholders' equity being reduced for the deficit
amount.
14
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
4. MINORITY INTERESTS, continued
Minority Interest in Operating Partnership, continued
In accordance with the guidance in EITF No. 95-7, Implementation Issues
Related to the Treatment of Minority Interests in Certain Real Estate Investment
Trusts, earnings of the Operating Partnership are first being allocated to the
preferred interests held by the Company. The remainder of earnings, if any, are
allocated to the Company's general partner and KRF Company and affiliates'
common limited partnership interests in accordance with their relative ownership
percentages. The excess of the allocation of income to KRF Company and
affiliates over cash distributed to them will be credited directly to the
Company's equity (with a corresponding debit to minority interest) until the
minority interest deficit that existed upon the completion of the Offering is
eliminated.
The following table sets forth the calculation of minority interest in
Operating Partnership:
Nine Months Ended
September 30, 2003
------------------
Income before minority common interest in Operating
Partnership $ 3,604
Preferred dividend (3,276)
------------------
Income available for common equity 328
Common Operating Partnership units of minority interest 97.61%
------------------
Minority common interest in Operating Partnership 320
Accrued distributions to minority interest in Operating
Partnership in excess of minority common interest in
Operating Partnership 168
------------------
Minority common interest in Operating Partnership $ 488
==================
The following table sets forth a summary of the items affecting the
minority interest in the Operating Partnership for the nine months ended
September 30, 2003:
Minority
Common Company's
Interest Interest Total
in in Common
Operating Operating Owners'
Partnership Partnership Deficit
---------- ---------- ----------
Balance at December 31, 2002 $ (22,526) $ - $ (22,526)
Capital Contributions 228 1,289 1,517
Minority common interest in Operating
Partnership 320 8 328
Accrued distributions to common interest in
Operating Partnership (488) (12) (500)
Other distributions effecting common
interest in Operating Partnership (101) (2) (103)
---------- ---------- ----------
Balance at September 30, 2003 (1) $ (22,567) $ 1,283 $ (21,284)
========== ========== ==========
(1) Minority common interest in Operating Partnership is carried at zero on the
balance sheet due to the minority interest having no obligation to fund
losses/deficits.
As of September 30, 2003, the minority interest in the Operating
Partnership consisted of 5,242,223 Operating Partnership units held by parties
other than the Company.
15
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
4. MINORITY INTERESTS, continued
Minority Interest in Operating Partnership, continued
On August 12, 2003, the Board authorized the general partner of the
Operating Partnership to distribute $250 from its operating cash flows to common
general and common limited partners. The distribution is payable on August 15,
2003, November 15, 2003 and February 15, 2004. The distribution payable on
August 15, 2003 was disbursed on October 24, 2003.
5. COMMITMENTS AND CONTINGENCIES
The Company entered into Indemnification Agreements with each of the
independent members of the Board of Directors and its president on August 12,
2003. The agreements indemnify the independent board members and the president
with respect to claims arising from or related to their service to the company
to the extent allowable under Maryland law.
6. PROFORMA CONDENSED FINANCIAL INFORMATION
The accompanying unaudited pro forma information for the three and nine
months ended September 30, 2003 and 2002 is presented as if the Offering for the
Interests in the Mortgage Funds on April 4, 2003 and April 18, 2003 had occurred
on January 1, 2002. The unaudited pro forma information does not purport to
represent what the actual results of operations of the Company would have been
had the above occurred, nor do they purport to predict the results of operations
of future periods.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Equity in income of Mortgage
Funds $ 6,840 $ 5,781 $ 18,820 $ 22,482
========== ========== ========== ==========
Net income $ 5,801 $ 5,566 $ 17,053 $ 22,235
========== ========== ========== ==========
Preferred dividend $ (1,675) $ (1,675) $ 5,025 $ 5,025
========== ========== ========== ==========
Net income available to common
shareholders $ 4,126 $ 3,891 $ 12,028 $ 17,210
========== ========== ========== ==========
Basic earnings per share:
Net income available to common
shareholders $ 3.22 $ 3.03 $ 9.37 $ 13.41
========== ========== ========== ==========
Weighted average number of
common shares outstanding 1,283,313 1,283,313 1,283,313 1,283,313
========== ========== ========== ==========
16
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
7. DECLARATION OF DIVIDEND AND DISTRIBUTIONS
On March 25, 2003, the Company's Board of Directors (the "Board") declared
a dividend at an annual rate of 9% the stated liquidation preference of $25 per
share of the outstanding Series A Cumulative Redeemable Preferred Stock (the
"Preferred Stock") of the Company which will be payable quarterly in arrears, on
February 15, May 15, August 15 and November 15 of each year to shareholders of
record in the amount of $.5625 per share per quarter. The dividend paid on May
15, 2003 was prorated to reflect the issue date of the Preferred Shares. For the
nine months ended September 30, 2003, the Company has declared $3,276 of which
$837 is payable and included on the balance sheet in Dividends and Distributions
Payable.
On August 12, 2003, the Board authorized the general partner of the
Operating Partnership to distribute $250 from its operating cash flows to common
general and common limited partners. On the same day the Board also declared a
common dividend of $0.004656 per share on the Company's Class B common stock.
Both the distribution and the dividend are payable on August 15, 2003, November
15, 2003 and February 15, 2004. At September 30, 2003, neither the distribution
nor the dividend payable on August 15, 2003 had been disbursed and as such are
included on the balance sheet in Dividends and Distributions Payable. Both the
distribution and the dividend payable on August 15, 2003 were disbursed on
October 24, 2003.
8. RELATED PARTY TRANSACTIONS
The Company pays property management fees to an affiliate for property
management services. The fees are payable for the properties under management.
On May 6, 2003, the Company's property manager agreed to reduce the property
management fee payable by the Company from 5% of gross income to 4% of gross
income. This change in the management fee has been applied prospectively
effective April 1, 2003. Upon payoff of the McNab debt (See Note 1), the
property management fee for the Windward Lakes property was increased from 3% to
4% of gross income.
The Company pays asset management fees to an affiliate for asset management
services. These fees are payable quarterly, in arrears, and may be paid only
after all distributions currently payable on the Company's Preferred Shares have
been paid. Effective April 4, 2003, the affiliate is entitled to receive annual
asset management fees equal to 0.40% of the purchase price of real estate
properties owned by the Company, as adjusted from time to time to reflect the
then current fair market value of the properties. The purchase price is defined
as the capitalized basis of an asset under GAAP, including renovation or new
construction costs, costs of acquisition or other items paid or received that
would be considered an adjustment to basis. Prior to April 4, 2003, asset
management fees paid by the Predecessor were based on fees specified under the
terms of the agreements governing the various Predecessor entities.
The Company also reimburses affiliates for certain expenses incurred in
connection with the operation of the properties, including administrative
expenses and salary reimbursements.
The Company pays acquisition fees to an affiliate for acquisition services.
These fees are payable upon the closing of an acquisition of real property. The
fee is equal to 1% of the purchase price of any new property acquired directly
and indirectly by the Company. The purchase price is defined as the capitalized
basis of an asset under GAAP, including renovations or new construction costs,
cost of acquisition or other items paid or received that would be considered an
adjustment to basis. The purchase price does not include acquisition fees and
capital costs of a recurring nature. During the nine months ended September 30,
2003, the Company paid fees on the following acquisitions:
Acquisition Acquisition Fee
-------------------------------------------- ---------------
Gables $ 69
Windward Lakes 190
---------------
$ 259
===============
17
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share amounts)
8. RELATED PARTY TRANSACTIONS, continued
The Gables acquisition fee has been capitalized and is included in
multi-family apartments in the accompanying balance sheet. The Windward Lakes
acquisition fee has been expensed and included in management fees on the
statement of operations because Windward Lakes is included in the financial
statements in a method similar to a pooling of interests. Accordingly, all
expenses associated with the Company's acquisition of Windward Lakes have been
expensed.
During the three months ended September 30, 2002, the Company also paid an
affiliate advisory fees of $131 related to the refinancings of the Seasons of
Laurel mortgage notes payable and is included in deferred expenses at September
30, 2002 in the accompanying balance sheet. Such fees are no longer payable
under the terms of the advisory agreement, which became effective on April 4,
2003. Amounts accrued or paid to the Company's affiliates for the nine months
ended September 30, 2003 and 2002 were as follows:
For the Nine Months
Ended September 30,
-----------------------
2003 2002
-----------------------
(Unaudited)
Property management fees $ 942 $ 1,044
Expense reimbursements 73 168
Salary reimbursements 1,978 1,797
Acquisition fees 259 -
Asset management fees 441 224
---------- ----------
Total $ 3,693 $ 3,233
========== ==========
Due to affiliates of $1,456 at September 30, 2003 represents development
fees and shared services. Due to affiliates of $2,879 at December 31, 2002,
represents accrued interest related to the McNab debt, development fees and
shared services.
9. SUBSEQUENT EVENTS
On October 7, 2003, the Company received a special distribution from its
investment in GIT II in the amount of $3,228,926, and on October 29, 2003, the
Company received a special distribution from its investment in KIM in the amount
of $4,450,120. All five remaining funds will make regular quarterly
distributions on November 14, 2003.
On October 29, 2003, the Company closed on additional financing on Seasons
of Laurel in the amount of $20,378. The rate is fixed at 5.07% and matures in
July 2009, coterminous with the existing first mortgage.
On October 30, 2003, the Operating Partnership of the Company, through its
newly formed and wholly owned subsidiary, St. Marin/Karrington Limited
Partnership, acquired St. Marin Apartments ("St. Marin") and Karrington
Apartments ("Karrington") from an unaffiliated third party. St. Marin and
Karrington are 350 unit and 250 unit multi-family apartment communities,
respectively, located in Coppell, Texas. The purchase price of $26,125 and
$20,000, respectively was funded with available cash. St. Marin was constructed
in 1999 and Karrington was constructed in 2001.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF BERKSHIRE INCOME REALTY, INC. (FORMERLY BERKSHIRE
INCOME REALTY PREDECESSOR GROUP)
(In Thousands, except share and per share amounts)
You should read the following discussion in conjunction with the Berkshire
Income Realty Inc.'s financial statements and their related notes and other
financial information included in this report. For further information please
refer to the Predecessor's financial statements and footnotes thereto included
in the Company's annual report on Form 10-K for the year ended December 31, 2002
and Form 8 K/A filed on August 13, 2003 for the significant acquisition of McNab
KC3 Limited Partnership.
Overview
Berkshire Income REalty - OP, L.P.
Berkshire Income Realty - OP, L.P. (Operating Partnership), a Delaware
limited partnership, is the entity through which we conduct substantially all of
our business and own, either directly or through subsidiaries, substantially all
of our assets. Our wholly owned subsidiary, BIR GP, LLC, a Delaware limited
liability company, is the sole general partner of the Operating Partnership. As
of November 14, 2003, the Company is the owner of 100% of the preferred limited
partner units of the Operating Partnership, whose terms mirror the terms of the
Company's Preferred Shares and, through BIR GP, LLC, owns 100% of the general
partner interest, which represents approximately 2.39% of the common economic
interest of the Operating Partnership.
Our general and limited partner interests in the Operating Partnership
entitle us to share in cash distributions from, and in the profits and losses of
the Operating Partnership in proportion to our percentage interest therein. The
other partners of the Operating Partnership are affiliates who contributed their
direct or indirect interests in certain properties to the Operating Partnership
in exchange for common units of limited partnership interest in the Operating
Partnership.
Preferred units of the Operating Partnership have the rights, preference
and other privileges as set forth in amendments to the limited partnership
agreement of the Operating Partnership. As of November 14, 2003, the Operating
Partnership had one series of its preferred units outstanding. The Series A
preferred units have an aggregate liquidation preference of approximately
$74,453 and are entitled to a preferred distribution at a rate of 9% per annum,
payable quarterly. The Company is the sole owner of the Series A preferred
units.
General
The Company detailed a number of significant trends and specific factors
affecting the real estate industry in general and the Company's business in
particular in "Management's Discussion and Analysis of Financial Condition and
Results of Operations", Item 7 of our Annual Report on Form 10-K for the year
ending December 31, 2002 under several headings, including "Liquidity and
Capital Resources", "Inflation and Economic Conditions" and "Property
Renovations". The Company believes those trends and factors continue to be very
relevant to the Company's performance and financial condition.
19
Forward Looking Statements
Certain statements contained in this report, including information with
respect to our future business plans, constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933 and 21E of the
Securities Exchange Act of 1934. For this purpose, any statements contained
herein that are not statements of historical fact may be deemed to be
forward-looking statements, subject to a number of risks and uncertainties that
could cause actual results to differ significantly from those described in this
report. These forward-looking statements include statements regarding, among
other things, our business strategy and operations, future expansion plans,
future prospects, financial position, anticipated revenues or losses and
projected costs and objectives of management. Without limiting the foregoing,
the words "may", "will", "should", "could", "expects", "plans", "anticipates",
"believes", "estimates", "predicts", "potential" or "continue" or the negative
of such terms and other comparable terminology are intended to identify
forward-looking statements. There are a number of important factors that could
cause our results to differ materially from those indicated by such
forward-looking statements. These factors include, but are not limited to,
changes in economic conditions generally and the real estate and bond markets
specifically, legislative/regulatory changes (including changes to laws
governing the taxation of real estate investment trusts ("REITs"), availability
of capital, interest rates and interest rate spreads, changes in GAAP and
policies and guidelines applicable to REITs, those set forth in Part I, Item 1A.
"Risk Factors" of the Company's Form 10-K for the year ended December 31, 2002
and other risks and uncertainties as may be detailed from time to time in our
public announcements and SEC filings.
The risks here are not exhaustive. Other sections of this report may
include additional factors that could adversely affect our business and
financial performance. Moreover, we operate in a 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 it assess the
impact of all such risk factors on our business or the extent to which any
factor, or combination of factors, may cause actual 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.
Critical Accounting Policies
The discussion below describes what we believe are the critical accounting
policies that affect the Company's more significant judgments and the estimates
used in the preparation of its financial statements. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America ("GAAP") requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities, revenues
and expenses, and related disclosures of contingent assets and liabilities in
the Company's financial statements and related notes. We believe that the
following critical accounting policies affect significant judgments and
estimates used in the preparation of the Company's financial statements:
Purchase Accounting for Acquisition of Real Estate
Acquired Real Estate Assets - The Company accounts for its acquisitions of
investments in real estate in accordance with Statement of Financial Accounting
Standards (SFAS) No. 141, Business Combinations, which requires the fair value
of the real estate acquired to be allocated to the acquired tangible assets,
consisting of land, building, furniture, fixtures and equipment and identified
intangible assets and liabilities, consisting of the value of above-market and
below-market leases, other value of in-place leases and value of other tenant
relationships, based in each case on their fair values. The Company considers
acquisitions of operating real estate assets to be businesses as that term is
contemplated in Emerging Issues Task Force Issue No. 98-3, Determining Whether a
Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business.
The Company allocates purchase price to the fair value of the tangible
assets of an acquired property (which includes land, building, furniture,
fixtures and equipment) determined by valuing the property as if it were vacant.
The as-if-vacant value is allocated to land and buildings, furniture, fixtures
and equipment based on management's determination of the relative fair values of
these assets.
20
Above-market and below market in-place lease values for acquired properties
are recorded based on the present value (using an interest rate which reflects
the risks associated with the leases acquired) of the difference between (i) the
contractual amounts to be paid pursuant to the in-place leases and (ii)
management's estimate of fair market lease rates for the corresponding in-place
leases, measured over a period equal to the remaining non-cancelable term of the
lease. The capitalized above-market lease values are amortized as a reduction of
rental income over the remaining non-cancelable terms of the respective leases.
The capitalized below-market lease values are amortized as an increase to rental
income over the initial term and any fixed-rate renewal periods in the
respective leases.
Management may engage independent third-party appraisers to perform these
valuations and those appraisals use commonly employed valuation techniques, such
as discounted cash flow analyses. Factors considered in these analyses include
an estimate of carrying costs during hypothetical expected lease-up periods
considering current market conditions, and costs to execute similar leases. The
Company also considers information obtained about each property as a result of
its pre-acquisition due diligence, marketing and leasing activities in
estimating the fair value of the tangible and intangible assets acquired. In
estimating carrying costs, management also includes real estate taxes, insurance
and other operating expenses and estimates of lost rentals at market rates
during the expected lease-up periods depending on specific local market
conditions and depending on the type of property acquired.
The total amount of other intangible assets acquired is further allocated
to in-place leases, which includes other tenant relationship intangible values
based on management's evaluation of the specific characteristics of the
residential leases and the Company's tenant retention history.
The value of in-place leases and tenant relationships are amortized as a
leasing cost expense over the initial term of the respective leases and any
expected renewal period. The intangible assets associated with the Gables
acquisition were nominal.
Unconsolidated Investments in Mortgage Funds
The acquisition of the Interests in the Mortgage Funds by the Company has
been accounted for using purchase accounting based upon the fair value of the
Preferred Shares for the Interests acquired. The fair value was determined to be
the $25.00 liquidation preference for the Preferred Shares since this was most
readily available market value at the date of the closing of the exchange offer.
This transaction generated a basis difference between the Company's
investment in the Mortgage Funds (fair value) and its underlying equity in the
net assets of the Mortgage Funds (book value). The excess of the book value over
the carrying value for each Mortgage Fund has been allocated to such fund's
mortgage loan investments based upon their relative value. Such allocated
amounts are being amortized into income over the contractual life of the
respective mortgage loans on a basis which approximates the effective interest
method.
The Company is accounting for its investments in the Mortgage Funds, which
it does not control, using the equity method of accounting. Under the equity
method of accounting, the net equity investment of the Company is reflected on
the balance sheet, and the Company's share of net income or loss from the
Mortgage Funds is included on the statement of operations.
Debt Extinguishment Costs
Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 145, Rescission of FAS Nos. 4, 44, and 64, Amendment of
FAS 13, and Technical Corrections. Prior periods that included such debt
extinguishment costs will be reclassified to conform to this standard. Prior to
the adoption of FAS 145, the Company classified costs associated with the early
extinguishment of debt as extraordinary items. In accordance with FAS 145, the
Company has determined that such costs do not meet the criteria for
classification as extraordinary pursuant to APB Opinion No. 30. Accordingly,
costs associated with the early extinguishment of debt are included in the
caption "loss on extinguishment of debt" in the Statements of Operations for the
three and nine months ended September 30, 2003 and 2002. There is no impact on
our financial statements.
21
Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", an interpretation of ARB No. 51 -
"Consolidated Financial Statements." The interpretation addresses consolidation
by businesses of special purpose entities (variable interest entities, "VIE").
This interpretation addresses consolidation by business enterprises of variable
interest entities in which the equity investment at risk is not sufficient to
permit the entity to finance its activities without additional subordinated
financial support from other parties or in which the equity investors do not
have the characteristics of a controlling financial interest. This
interpretation requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The interpretation also requires disclosures
about variable interest entities that the company is not required to consolidate
but in which it has a significant variable interest. The consolidation
requirements of this interpretation apply immediately to variable interest
entities created after January 31, 2003 but a deferral has been granted until
the end of the first fiscal year or interim period ending after December 15,
2003 for VIE's existing before February 1, 2003. Therefore, it is effective on
December 31, 2003 for the Company. Management is uncertain but is assuming that
it is reasonably possible that each of the Mortgage Funds in which it has an
investment would be considered a VIE. The Company is determining where it is the
primary beneficiary and as a result the Company may consolidate all or a certain
number of the mortgage funds' assets and liabilities.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
Statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. On October 29, 2003 the FASB indefinitely
deferred the provisions of paragraphs 9 and 10 of SFAS 150 as they apply to
mandatorily redeemable noncontrolling interests. Such interests exist within the
Company. Barring the outcome of the FASB relating to this deferral, the Company
is still in the process of evaluating the potential impact of this standard on
its financial statements.
Liquidity and Capital Resources
Cash and Cash Flows
As of September 30, 2003 and 2002, the Company had approximately $41,819
and $23,860 of cash and cash equivalents, respectively.
Nine months ended
September 30,
----------------------
2003 2002
---------- ----------
Cash Provided by Operating Activities $ 9,819 $ 8,241
Cash Provided by (Used in) Investing Activities 23,406 (2,627)
Cash Provided by Financing Activities 3,742 13,851
The Company expects its principal liquidity demands to be capital
improvements, including select property renovations, repairs and maintenance for
our properties, acquisition of additional properties, repayment of indebtedness
and distributions to the Company's common and preferred stockholders and
Operating Partnership unitholders. In order to qualify as a REIT, the Company is
required to make dividend distributions, other than capital gain dividends, to
its shareholders each year in the amount of at least 90% of the Company's REIT
taxable income (computed without regard to dividends paid deductions and our net
capital gain and subject to certain other potential adjustments) for all tax
years.
The Company intends to meet its short-term liquidity requirement through
net cash flows provided by operating activities and through distributions of
income on the Interest acquired in the Offering.
22
In addition to distributions of income on the Interests acquired in the
Offering, the Company also receives special distributions representing return of
principal on the payment or prepayment of the underlying mortgages held by the
Mortgage Funds. As opportunities occur the Company intends to utilize these
special distributions for the acquisition of additional real estate.
During the three months ended September 30, 2003, the Company received
proceeds from refinancing its mortgage debt on its Walden Pond property, which
originally had a variable interest rate. In addition to obtaining a fixed
interest rate, the Company paid off the outstanding $4,353 of existing debt and
obtained $12,675 in mortgage debt at 4.86% over a 10-year period. The Company
also financed mortgage debt on its Windward and Gables properties, at $13,467
and $5,325, respectively. Please refer to Indebtedness table below for terms. On
October 29, 2003, the Company closed on an additional $20,378 of mortgage
obligations on its Seasons of Laurel property, at a 5.07% interest rate, which
is coterminous with Seasons of Laurel's original outstanding mortgage debt. The
Company expects to utilize the proceeds on these mortgages for the acquisition
of additional real estate, such as the Company's recent purchase of St.
Marin/Karrington as discussed in Footnote 9 within the financial statement
footnotes.
In previous filings the Company discussed the commitment of $20,000 to a
joint venture (the "Venture") sponsored by an affiliate of the Company's
advisor. At this time, the Company is still interested in participating in the
Venture, however, due to structural issues, which must be resolved before the
Company can participate, the Company is uncertain as to the timing of its
investment and the total capital investment required, which will be no more than
$20,000 but may be less. As of September 30, 2003, the Company had not incurred
any significant costs associated with the Venture.
Indebtedness
The following table provides summary information with respect to the
mortgage debt incurred by the Company during the three months ended September
30, 2003:
Mortgage Amount
-----------------------
Fixed
Previous Closing Interest
Property Name Balance New Balance Date Rate Term
--------------- -------- ---------- ---------- ---------- ----------
Windward Lakes - $ 13,467 Aug. 15, 2003 5.10% 9 Years
Walden Pond $ 4,353 12,675 Aug. 21, 2003 4.86% 10 Years
Gables - 5,325 Aug. 21, 2003 4.86% 10 Years
-------- ----------
$ 4,353 $ 31,467
======== ==========
As of September 30, 2003, 100% of the Company's mortgage obligations are
under fixed interest rates and the weighted average rate of interest on all
mortgage debt is 5.49%
On October 2, 2003, the Company signed commitments and fixed interest
rates on an additional $20,378 of mortgage obligations. The interest rate
on this new obligation is fixed at 5.07%. The Company closed this financing
on October 29, 2003.
Capital Expenditures
The Company paid $2,560 and $2,547 in recurring capital expenditures during
the nine months ended September 30, 2003 and 2002, respectively.
The Company paid $1,379 and $0 in renovation related capital expenditures
during the nine months ended September 30, 2003 and 2002.
23
In April 2003, the Company began a significant renovation project at Season
of Laurel. This project was based on the results of a limited renovation and
capital improvement project conducted at the property in an initial group of 31
test units to determine the feasibility and benefits of a broader renovation and
improvement plan. The project was originally expected to take 36 months to
complete and cost approximately $7,000, or $7 per apartment unit. As of
September 30, 2003, the Company had completed renovations on approximately 12%
of the 1,088 units. The Company continues to evaluate the scope of the
renovations approved for the Seasons of Laurel project in an effort to provide
desired apartment amenities to tenants. As of September 30, 2003, the Company
has approved several changes to the scope, which is expected to increase the
total cost of the project to approximately $8,100, or $7.4 per apartment unit,
without adversely changing the economic benefit the Company expects to realize
from the project. Included in the change in scope is the increase in units under
renovation at one time, from 31 units to 45 units. The response to the renovated
units has been better than anticipated and the Company believes it may be
beneficial to complete the project in a shorter period of time than originally
projected. Increasing the pace would increase the short-term liquidity needs of
the Company, however, the Company believes the capital provided by the
additional mortgage debt and other sources will be sufficient to meet these
needs.
The Company is currently evaluating renovation strategies at other
properties in its portfolio, including the renovation of test units. As of
September 30, 2003, the Company has not made any material commitments with
respect to these additional projects. However, if after the appropriate level of
evaluation is complete, the Company believes there are sufficient economic
benefits to implementing additional renovation programs it is prepared to do so.
Acquisitions
On March 20, 2003, KRF Company, through a newly formed affiliate, Gables of
Texas Limited Partnership ("Gables"), whose general partner, Gables of Texas,
L.L.C., also a newly formed affiliate, acquired The Gables Apartments, a 140
unit multi-family apartment community located in Houston, Texas, from an
unrelated third party for a purchase price of approximately $6,925. On April 24,
2003, the Operating Partnership acquired Gables and Gables of Texas L.L.C. from
KRF Company for approximately $6,925 plus closing costs of approximately $143.
The purchase price for Gables and Gables of Texas, L.L.C. was equal to the
purchase price KRF Company paid the original seller of The Gables Apartments
(including equity payments, transfer taxes, financing and closing costs as
applicable).
Due to the affiliation of the ownership of the Company and KRF Company, the
acquisition of interests in the Gables property has been accounted for as a
reorganization of entities under common control, requiring the Company to
retroactively restate the financial statements from March 20, 2003, the
acquisition date of the property by KRF Company, through the period presented.
On April 29, 2003, the Preferred Shares began trading on the American Stock
Exchange, under the symbol "BIR.PR.A."
On May 30, 2003, the Operating Partnership and its wholly owned subsidiary
BIR McNab Sub L.L.C., a newly formed Delaware limited liability company,
acquired all of the outstanding limited and general partner units of McNab KC3
Limited Partnership ("McNab") from affiliates of the Company. The acquisition
was structured as a contribution of units from an affiliate of the Company in
exchange for the issuance by the Operating Partnership of 5,000 common limited
partner units valued at $10.00 per unit. McNab is the fee simple owner of a 276
unit multi-family apartment community located in Pompano Beach, Florida that is
referred to as Windward Lakes Apartments. The general and limited partners of
McNab are affiliates of the Company, namely George and Douglas Krupp. Control of
both the Company and McNab rests with George and Douglas Krupp via their 100%
ownership interest in the common stock of the Company and their 100% ownership
interest in the general and limited partnership units of McNab. Therefore, the
acquisition or contribution of the general and limited partnership units of
McNab by the Operating Partnership in exchange for the issuance by the Operating
Partnership of common limited partner units is considered a transfer of net
assets between entities under common control.
24
Declaration of Dividends and Distributions
On March 25, 2003, the Company's Board of Directors (the "Board") declared
a dividend at an annual rate of 9% the stated liquidation preference of $25 per
share of the outstanding Series A Cumulative Redeemable Preferred Stock (the
"Preferred Stock") of the Company which will be payable quarterly in arrears, on
February 15, May 15, August 15 and November 15 of each year to shareholders of
record in the amount of $.5625 per share per quarter. The dividend paid on May
15, 2003 was prorated to reflect the issue date of the Preferred Shares. For the
nine months ended September 30, 2003, the Company has declared $3,276 of which
$837 is payable and included on the balance sheet in Dividends and Distributions
Payable.
On August 12, 2003, the Board authorized the general partner of the
Operating Partnership to distribute $250 from its operating cash flows to common
general and common limited partners. On the same day the Board also declared a
common dividend of $0.004656 per share on the Company's Class B common stock.
Both the distribution and the dividend are payable on August 15, 2003, November
15, 2003 and February 15, 2004. At September 30, 2003, neither the distribution
nor the dividend payable on August 15, 2003 had been disbursed and as such are
included on the balance sheet in Dividends and Distributions Payable. Both the
distribution and the dividend payable on August 15, 2003 were disbursed on
October 24, 2003.
Results of Operations and Financial Condition
On April 24, 2003, the Company's portfolio increased from 6 to 7 properties
(the "Total Portfolio"). As a result of changes in the Company's Total
Portfolio, the financial statements show significant changes in revenue and
expenses from period to period. The Company does not believe that its period to
period financial data are comparable. Therefore, the comparison of operating
results for the three and nine months ended September 30, 2003 and 2002 show
changes attributable to the properties that were owned by the Company throughout
each period compared (the "Same Property Portfolio").
The entities comprising the Berkshire Income Realty Predecessor Group are
deemed to be our predecessors for accounting purposes. Because we did not have
any operations until the second quarter of 2003, the following discussion
relates to our operations for the three and nine months ended September 30, 2003
and the operations of the Berkshire Income Realty Predecessor Group for the
three and nine months ended September 30, 2002.
25
Comparison of the nine months ended September 30, 2003 to the nine months ended
September 30, 2002 (same property).
The table below reflects selected operating information for the Same
Property Portfolio and the Total Property Portfolio. The Same Property Portfolio
consists of the 6 properties acquired or placed in service on or prior to
January 1, 2002 and owned through September 30, 2003. The Total Property
Portfolio includes the effect of the additional rental property acquired after
January 1, 2002.
Same Property Portfolio Total Property Portfolio
----------------------------------------------- -----------------------------------------------
Increase/ % Increase/ %
2003 2002 Decrease Change 2003 2002 Decrease Change
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Revenue:
Rental $ 20,058 $ 19,739 319 1.62% $ 20,598 $ 19,739 859 4.35%
Interest, Utility Reimb and
Other 1,175 1,343 (168) (12.51)% 1,343 1,343 - 0%
---------- ---------- ---------- ----------
Total Revenue 21,233 21,082 21,941 21,082
Operating Expenses:
Operating 4,651 4,469 182 4.07% 5,184 4,469 715 16.00%
Maintenance 1,769 1,551 218 14.06% 1,784 1,551 233 15.02%
Real estate taxes 1,722 1,633 89 5.45% 1,819 1,633 186 11.39%
General and Administrative 514 694 (180) (25.94)% 1,149 694 455 65.56%
Management fees 1,312 1,351 (39) (2.89)% 1,573 1,351 222 16.43%
---------- ---------- ---------- ---------- ----------
Net Operating Income 11,265 11,384 10,432 11,384
Non Operating Expenses:
Organizational costs - - - - 213 - 213 100%
Depreciation 5,261 4,386 875 19.95% 5,454 4,386 1,068 24.35%
Interest 5,549 4,509 1,040 23.06% 5,580 4,509 1,071 23.75%
Loss on early extinguishment
of debt 339 1,168 (829) (70.98)% 339 1,168 (829) (70.98)%
Participation interest - 132 (132) (100.00)% - 132 (132) (100)%
---------- ---------- ---------- ---------- ----------
Total Non Operating Expenses 11,149 10,195 11,586 10,195
---------- ---------- ---------- ----------
Income (loss) $ 116 $ 1,189 $ (1,154) $ 1,189
========== ========== ========== ==========
26
Comparison on the nine months ended September 30, 2003 to nine months ended
September 30, 2002 (same property).
Rental income increased $319 or 1.62% for the nine months ended September
30, 2003 as compared to the same period in 2002. This increase was a result of
an increase in weighted average rental rates of 3.87% for the nine months ended
September 30, 2003 offset by a decrease in occupancy rates to 93.10% from
96.34%.
Interest income decreased $103 or 65.19% for the nine months ended
September 30, 2003 as compared to the same period in 2002 due to a decrease in
the average interest rates on short-term cash investments during the period. The
Company's Seasons of Laurel property experienced a decrease in its cash
equivalents' interest income which significantly decreased the Company's overall
interest income for the period.
Utility reimbursement decreased $108 or 24.10% for the nine months ended
September 30, 2003 as compared to the same period in 2002. The decrease is
primarily due to the collection of amounts deemed uncollectible as of December
31, 2001 in 2002, which resulted in the 2002 amounts being higher than normal.
Other income increased $43 or 5.83% for the nine months ended September 30,
2003 as compared to the same period in 2002. This increase was related to
increases in the various fees collected from tenants and recorded as other
income.
Operating expenses increased $182 or 4.07% for the nine months ended
September 30, 2003 as compared to the same period in 2002. The increase is
attributed to an increased savings in onsite personnel costs during the current
period offset with increases insurance costs for the properties.
Maintenance expenses increased $218 or 14.06% for the nine months ended
September 30, 2003 as compared to the same period in 2002. This increase is due
to an increase in painting, decorating and janitorial contracts during the
period as compared to the prior period. The Company is proactively up keeping
its properties to increase occupancy rates and lower its vacancies and
concessions. This increase in painting and decorating has lowered vacancy rates
at certain properties and increased related rental revenues. Certain properties
experienced higher maintenance expenses due to increased snow removal costs in
February 2003 as compared to the previous period.
Real estate taxes increased $89 or 5.45% for the nine months ended
September 30, 2003 as compared to the same period in 2002. The increase was
primarily related to increases in tax rates on real property in the various
jurisdictions where the initial properties are located. All of the Company's
properties are subject to reassessment on a regular basis. Future increase in
assessments could be significant and would result in increases to real estate
tax expense even if tax rates remained stable. The Company cannot predict future
assessment values, but aggressively arbitrates any increases in value that it
considers to be unreasonable in light of comparable properties or other economic
factors relating to particular properties.
General and administrative expenses decreased $180 or 24.94% for the nine
months ended September 30, 2003 as compared to the same period in 2002. The
decrease is due to an increase in expenses in 2002 at our Seasons of Laurel
property for one time charges for centralized services, thus increasing general
and administrative expenses for the period ended September 30, 2002. The
increase in 2002 was offset by increases in general and administrative expenses
in 2003, particularly in our Seasons of Laurel property.
Management fees decreased $39 or 2.89% for the nine months ended September
30, 2003 as compared to the same period in 2002. The decrease is due to
renegotiation of the Company's property management services from 5% to 4% effect
on April 1, 2003. The savings was offset by an increase in property management
fees for the Company's Windward Lakes property from 3% to 4%.
27
Depreciation expense increased $875 or 19.95% for the nine months ended
September 30, 2003 as compared to the same period in 2002. This decrease is due
to normal straight lining of fixed assets and an increase in capitalized assets
during the year.
Interest expense increased $1,040 or 23.06% for the nine months ended
September 30, 2003 as compared to the same period in 2002. In April and July of
2002, the Company refinanced four of the five initial properties from variable
to fixed interest rates, which increased the interest rates of these mortgages.
In addition to the refinancings, the weighted average interest rate increased
from during the nine months ended September 30, 2003 compared to the same period
in 2002.
Loss on extinguishment of debt is related to the write-off of deferred
mortgage costs and related accumulated amortization for mortgage costs initially
amortized over the life of the related mortgage note. The Company paid off its
mortgage debt on Windward Lakes on May 30, 2003, and as a result recognized a
loss for the remaining deferred financing costs relating to the debt. The
Company also refinanced its Walden Pond property's variable mortgage to a fixed
rate mortgage and paid off the first mortgage in full on August 21, 2003,
resulting in an additional loss in the third quarter.
Participation interest expense decreased $132 or 100% for the nine months
ended September 30, 2003 as compared to the same period in 2002. Participation
interest payable was fully accrued as of December 31, 2002, therefore no expense
was recognized during 2003.
28
Comparison of the three months ended September 30, 2003 to the three months
ended September 30, 2002 (same property).
The table below reflects selected operating information for the Same
Property Portfolio and the Total Property Portfolio. The Same Property Portfolio
consists of the 6 properties acquired or placed in service on or prior to
January 1, 2002 and owned through September 30, 2003. The Total Property
Portfolio includes the effect of the additional rental property acquired after
January 1, 2002.
Same Property Portfolio Total Property Portfolio
----------------------------------------------- -----------------------------------------------
Increase/ % Increase/ %
2003 2002 Decrease Change 2003 2002 Decrease Change
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Revenue:
Rental $ 6,660 $ 6,738 (78) (1.16)% $ 6,909 $ 6,738 171 2.54%
Interest and Other 376 495 (119) (24.04)% 516 495 21 4.24%
---------- ---------- ---------- ----------
Total Revenue 7,036 7,233 7,425 7,233
Operating Expenses:
Operating 1,444 1,524 (80) (5.25)% 1,909 1,524 385 25.26%
Maintenance 707 577 130 22.53% 715 577 138 23.92%
Real estate taxes 597 553 44 7.96% 644 553 91 16.46%
General and Administrative 245 343 (98) (28.57)% 476 343 133 38.78%
Management fees 329 451 (122) (27.05)% 465 451 14 3.10%
---------- ---------- ---------- ----------
Net Operating Income 3,714 3,785 3,216 3,785
Non Operating Expenses:
Depreciation 1,719 1,482 237 15.99% 1,819 1,482 337 22.74%
Interest 1,799 2,189 (390) (17.82)% 1,830 2,189 (359) (16.40)%
Loss on early extinguishment of
debt 87 285 (198) (69.47)% 87 285 (198) (69.47%)
Participation interest - 44 (44) (100)% - 44 (44) (100.00)%
---------- ---------- ---------- ---------
Total Non Operating Expenses 3,605 4,000 3,736 4,000
--------- ---------- ---------- ----------
Net income (loss) $ 109 $ (215) $ (520) $ (215)
========== ========== ========== ==========
29
Comparison on the three months ended September 30, 2003 to three months
ended September 30, 2002 (same property).
Rental income decreased $78 or 1.16% for the three months ended September
30, 2003 as compared to the same periods in 2002. At September 30, 2003, the
occupancy decreased from 96.34% to 93.10% for the quarter, resulting in the
overall decrease, which was offset by an increase in effective rental income of
approximately 3.71% for the quarter. The decrease is also due to higher
concessions for the quarter for some of the Company's properties. The increase
in concessions is primarily due to the soft market in some of the locations of
our properties. The Company's Century, Walden and Windward properties have
experienced decreases in its occupancy and related rental income for the three
month period.
Interest income decreased $79 or 91.86% for the three months ended
September 30, 2003 as compared to the same period in 2002 due to a decrease in
average interest rates on short-term cash investments during the period. The
Company's Seasons of Laurel property experienced a decrease in its cash
equivalents' interest income which significantly decreased the Company's overall
interest income for the period.
Other income decreased $40 or 14.49% for the three months ended September
30, 2003 as compared to the same period in 2002. The decrease is due to
decreases in income earned from the properties' tenants for miscellaneous fees
such as pet, parking, keys and locks, clubhouse fees and late fees.
Operating expenses decreased $80 or 5.25% for the three months ended
September 30, 2003 as compared to the same period in 2002. The decrease is
attributed to an increased savings in onsite personnel costs offset with
increasing insurance costs for the properties.
Maintenance expenses increased $130 or 22.53% for the three months ended
September 30, 2003 as compared to the same period in 2002. This increase is due
to an increase in painting, decorating and janitorial contracts during the
period as compared to the prior period. The Company is proactively up keeping
its properties to increase occupancy rates and lower its vacancies and
concessions. This increase in painting and decorating has lowered vacancy rates
at certain properties and increased related rental revenues.
Real estate taxes increased $44 or 7.96% for the three months ended
September 30, 2003 as compared to the same period in 2002. The increase was
primarily related to increases in tax rates on four of the Company's properties.
On April 30, 2003, the state of Maryland increased its property tax assessment
from 8.4 cents to 13.2 cents effective July 1, 2003. In addition, all of the
Company's properties are subject to reassessment on a regular basis. Future
increase in assessments could be significant and would result in increases to
real estate tax expense even if tax rates remained stable. The Company cannot
predict future assessment values, but aggressively arbitrates any increases in
value that it considers to be unreasonable in light of comparable properties or
other economic factors relating to particular properties.
General and administrative expenses decreased $98 or 28.57% for the three
months ended September 30, 2003 as compared to the same period in 2002. The
decrease is due to increased expenses in 2002 at our Seasons of Laurel property
for one-time charges for centralized services, thus increasing general and
administrative expenses for the quarter ended September 30, 2002. The increase
in 2002 was offset by increases in general and administrative expenses in 2003.
Management fees decreased $122 or 27.05% for the three months ended
September 30, 2003 as compared to the same periods in 2002. The decrease is due
to renegotiation of the Company's property management services from 5% to 4%
effective on April 1, 2003. The savings was offset by an increase in property
management fees for the Company's Windward Lakes property from 3% to 4%.
Depreciation expense increased $237 or 15.99% for the three months ended
September 30, 2003 as compared to the same period in 2002. This decrease is due
to normal straight lining of fixed assets and an increase in capitalized assets
during the year.
Interest expense decreased $390 or 17.82% three months ended as compared to
the same period in 2002. In 2002, the Company refinanced its mortgages in 2
properties which resulted in decreases in the related interest expense. Also in
2002, the Company refinanced its mortgages in 3 additional properties which
resulted
30
in increases in related interest expense, which offset the savings from the
initial refinancings. In May 2003, the Company paid of its Windward Lakes
mortgage and note debt and subsequently refinanced the property on August 21,
2003, which reduced interest expense for the period.
Loss on extinguishment of debt is related to the write-off of deferred
mortgage costs and related accumulated amortization for mortgage costs initially
amortized over the life of the related mortgage note. The Company refinanced its
Walden Pond property's variable mortgage to a fixed rate mortgage and paid off
the first mortgage in full on August 21, 2003.
Participation interest expense decreased $44 or 100% for the three months
ended September 30, 2003 as compared to the same period in 2002. Participation
interest payable was fully accrued as of December 31, 2002, therefore no expense
was recognized during 2003.
Mortgage Debt to Fair Market Value of Real Estate Assets
The Company's total mortgage debt summary and debt maturity schedule, as of
September 30, 2003, is as follows:
Mortgage Debt Summary as of September 30, 2003
Weighted Average
$ Thousands Rate
------------ ----------------------
Collateralized - Fixed Rate $ 131,901 5.49%
Debt Maturity Schedule as of September 30,
2003
Year $ Thousands % of Total
---- ------------ ----------------------
2003 $ 421 .32%
2004 1,798 1.36%
2005 1,903 1.44%
2006 2,013 1.53%
2007 47,914 36.33%
Thereafter 77,852 59.02%
------------ ----------------------
Total $ 131,901 100.00%
============ ======================
The Company's "Mortgage Debt-to-Fair Market Value of Real Estate Assets"
as of September 30, 2003 is presented in the following table. The Company
calculates the fair market value of real estate assets based on the most
recently available third party appraisal. The following information is presented
in lieu of information regarding the Company's "Debt-to-Total Market
Capitalization Ratio", which is a commonly used measure in our industry, because
the Company's market capitalization is not readily determinable since there was
no public market for its common equity during the periods presented in these
financial statements.
The information regarding "Mortgage Debt-to-Fair Market Value of Real
Estate Assets" is presented to allow investors to calculate our loan-to-value
ratios in a manner consistent with those used by management and others in our
industry including those used by our current and potential lenders. Management
uses this information when making decisions about financing or refinancing
properties. Management also uses fair market value information when making
decisions about selling assets as well as evaluating acquisition opportunities
within markets where we have assets. The most directly comparable financial
measure of our property value, calculated and presented in accordance with GAAP,
is net book value, shown on the balance sheet as multi-family apartment
communities, net of accumulated depreciation. At September 30, 2003, the
aggregate net book value of our real estate assets was $99,896.
Fair Market Value of Real Estate as of September 30, 2003
($ in Thousands)
----------------------------------------------------------------------------
Fair Market Value Mortgage Debt Loan-to-Value
------------------------- --------------------- ----------------------
$ 202,470 $ 131,901 65.15%
31
The fair market values are based on third party appraisals obtained between
June 2002 and June 2003 for all of the properties within the portfolio. The
individual appraisals range from $7,100 to $90,500.
Funds From Operations
The Company has adopted the revised definition of Funds from Operations
adopted by the Board of Governors of the National Association of Real Estate
Investment Trusts ("NAREIT"). Management considers Funds from Operations ("FFO")
to be an appropriate measure of performance of an equity REIT. We calculate FFO
by adjusting net income (loss) (computed in accordance with GAAP, including
non-recurring items), for gains (or losses) from sales of properties and real
estate related depreciation and amortization. Management believes that in order
to facilitate a clear understanding of the historical operating results of the
Company, FFO should be considered in conjunction with net income as presented in
the financial statements included elsewhere herein. Management considers FFO to
be a useful measure for reviewing the comparative operating and financial
performance of the Company because, by excluding gains and losses related to
sales of previously depreciated operating real estate assets and excluding real
estate asset depreciation and amortization (which can vary among owners of
identical assets in similar condition based on historical cost accounting and
useful life estimates), FFO can help one compare the operating performance of a
company's real estate between periods or as compared to different companies.
The Company's calculation of FFO may not be directly comparable to FFO
reported by other REITs or similar real estate companies that have not adopted
the term in accordance with the current NAREIT definition or that interpret the
current NAREIT definition differently. In addition to presenting FFO in
accordance with the NAREIT definition, we also disclose FFO before distributions
to preferred stockholders, which we feel provides information that may be useful
to the minority interest holders of our Operating Partnership. Although our
adjusted FFO differs from NAREIT's definition of FFO, as well as that of other
REITs and similar real estate companies, we believe it provides a meaningful
supplemental measure of our operating performance because of the Company's
somewhat unique capital structure. FFO should not be considered as an
alternative to net income (determined in accordance with GAAP) as an indication
of our performance. FFO does not represent cash generated from operating
activities determined in accordance with GAAP and is not a measure of liquidity
or an indicator of our ability to make cash distributions. We believe that to
further understand our performance, FFO and adjusted FFO should be compared with
our reported net income and considered in addition to cash flows in accordance
with GAAP, as presented in our financial statements.
The following table presents a reconciliation of Net Income to Funds from
Operations for the three months ended September 30, 2003:
Three Months Ended
September 30, 2003
----------------------
Net Income $ 2,114
Add:
Minority interest in Operating Partnership 488
Depreciation of real property 1,782
----------------------
Fund from Operations $ 4,384
======================
Environmental Issues
There are no recorded amounts resulting from environmental liabilities,
because there are no known contingencies with respect to environmental
liabilities. The Company obtains environmental audits, through various sources
including lender evaluations and acquisition due diligence, for each of its
properties at various intervals throughout a property's life. The Company has
not been advised by any third party as to the existence
32
of, nor has it identified on its own, any material liability for site
restoration or other costs that may be incurred with respect to any of its
properties.
Inflation and Economic Conditions
Substantially all of the leases at the initial properties are for a term of
one year or less, which enables the Company to seek increased rents for new
leases or upon renewal of existing leases. These short-term leases minimize the
potential adverse effect of inflation on rental income, although residents may
leave without a penalty at the end of their lease terms and may do so if rents
are increased significantly.
Historically, real estate has been subject to a wide range of cyclical
economic conditions, which affect various real estate sectors and geographic
regions with differing intensities and at different times. In 2002 and
continuing into 2003, many regions of the United States experienced varying
degrees of economic recession and certain recessionary trends, such as increased
cost of obtaining sufficient property and liability insurance coverage,
reductions in short-term interest rates, and a temporary reduction in occupancy.
In light of this, we will continue to review our business strategy, however, we
believe that given our property type, garden style residential apartment
communities, and the geographic regions in which our properties are located,
these recessionary trends have not had a material effect on our financial
performance and we do not anticipate any changes in our strategy.
Other Matters
The Company at all times intends to conduct its business so as to not
become regulated as an investment company under the Investment Company Act of
1940, as amended (the "Investment Company Act"). If the Company were to become
regulated as an investment company, then, among other things, the Company's
ability to use leverage would be substantially reduced and there would be
restrictions on certain types of fees paid. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interest in real estate" (i.e.,
"Qualifying Interest"). Under the current interpretation of the staff of the
Securities and Exchange Commission, in order to qualify for this exemption, the
Company must maintain at least 55% of its assets directly in Qualifying
Interests. Accordingly, the Company monitors its compliance with this
requirement in order to maintain its exempt status. As of September 30, 2003,
the Company determined that it is in and has maintained compliance with this
requirement.
33
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Approximately $131,901 of our borrowings bears interest at fixed rates, and
therefore the fair value of these instruments are affected by changes in the
market interest rates. At September 30, 2003 and December 31, 2002, 100% and
96%, respectively of the Company's mortgage obligations were under fixed
interest rates. The weighted average rate of interest on mortgage debt was 5.49%
and 5.8% at September 30, 2003 and December 31, 2002, respectively. The Company
has taken advantage of the low interest rate market to fix rates on the vast
majority of its mortgage debt. We believe that this limits the exposure to
changes in interest rates, minimizing the effect on our financial condition,
results of operations and cash flows. However, please see the discussion in
Capital Expenditures, Distributions, Cash Flows and Indebtedness with respect to
the potential short to medium term impact of these borrowings.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of the date of this report, we carried out an evaluation under the
supervision and with the participation of our management, including the
principal executive officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a- 14(c) and 15d - 14 (c) of the
Securities Exchange Act). Based upon that evaluation, the principal
executive officer and principal financial officer concluded that our
disclosure controls and procedures are effective to ensure that information
required to be disclosed by us in the reports we file or submit under the
Exchange Act is recorded, processed, summarized and reported, within the
time periods specified in the Securities and Exchange Commission's rules
and forms.
(b) Changes in Internal Controls
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect those controls during its
quarter ended September 30, 2003.
34
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS OF FORM 8-K.
(a) Exhibits:
31.1 Certification of Principal Executive Officer and Principal Financial
Officer of Berkshire Income Realty, Inc. Pursuant to Securities
Exchange Act Rules 13a -14 and 15d -14
32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K:
Form 8-K /A was filed on August 13, 2002, with respect to Item 7,
financial statements for the acquisition of McNab KC 3 Limited Partnership
on May 30, 2003.
Form 8-K was filed on August 18, 2003, with respect to Item 12 and
Item 7 Press Release, dated August 14, 2003, announcing the results of
operations and financial condition of Berkshire Income Realty Predecessor
Group for the three months ended and as of June 30, 2003.
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated: November 14, 2003
BERKSHIRE INCOME REALTY, INC.
BY:/s/ David C. Quade
--------------------------------------------
NAME: David C. Quade
TITLE: President and Chief Financial Officer
36
EXHIBIT INDEX
31.1 Certification of Principal Executive Officer and Principal Financial
Officer of Berkshire Income Realty, Inc. Pursuant to Securities Exchange
Act Rules 13a -14 and 15d-14.
32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.