INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2010 and 2009
(Unaudited)
(in thousands, except per share amounts)
| | | | | | |
| | | | Nine Months Ended |
| | | | September 30, |
| | | | 2010 | | 2009 |
Cash flows from operating activities: | | | | |
Net loss | $ | (91,776) | $ | (70,688) |
Adjustments to reconcile net loss to net cash provided by | | | | |
| | operating activities (including discontinued operations): | | | | |
| Depreciation and amortization | | 186,212 | | 192,768 |
| Provision for impairment of investment properties | | 19,657 | | 54,800 |
| Impairment of marketable securities | | - | | 24,831 |
| Impairment of note receivable | | - | | 17,322 |
| Gain on partial sale of investment properties | | (1,464) | | - |
| Gain on sales of investment properties | | (2,057) | | (21,570) |
| Loss on lease terminations | | 8,869 | | 11,556 |
| Gain on interest rate locks | | - | | (3,989) |
| Loss on redemption of noncontrolling interests | | - | | 3,447 |
| Non-cash co-venture obligation expense | | 833 | | - |
| Amortization of loan fees | | 9,886 | | 8,991 |
| Amortization of acquired above and below market lease intangibles | | (1,523) | | (1,786) |
| Amortization of mortgage debt premium | | (937) | | - |
| Amortization of discount on debt assumed | | 382 | | 382 |
| Amortization of lease inducements | | 45 | | 289 |
| Straight-line rental income | | (8,798) | | (6,258) |
| Straight-line ground rent expense | | 3,121 | | 2,996 |
| Stock based compensation expense | | 33 | | 13 |
| Equity in (income) loss of unconsolidated joint ventures | | (1,609) | | 5,262 |
| Distributions from unconsolidated joint ventures | | 3,703 | | 3,609 |
| Recognized gain on sale of marketable securities | | (536) | | (42,629) |
| Provision for bad debt | | 3,627 | | 8,914 |
| Payment of leasing fees | | (4,202) | | (4,846) |
| Costs associated with refinancings | | 1,162 | | - |
Changes in assets and liabilities: | | | | |
| Accounts receivable, net | | 14,623 | | 4,369 |
| Other assets | | 2,003 | | 600 |
| Accounts payable and accrued expenses | | 16,189 | | 13,761 |
| Other liabilities | | (3,771) | | 1,819 |
Net cash provided by operating activities | | 153,672 | | 203,963 |
| | | | | | |
Cash flows from investing activities: | | | | |
| Purchase of marketable securities | | - | | (190) |
| Proceeds from sale of marketable securities | | 3,900 | | 124,340 |
| Changes in restricted escrows | | (47,416) | | (25,101) |
| Purchase of investment properties | | (651) | | (20,031) |
| Capital expenditures and tenant improvements | | (22,670) | | (12,630) |
| Proceeds from partial sale of investment properties to unconsolidated joint venture | | 13,367 | | - |
| Proceeds from sale of investment properties | | 78,851 | | 117,316 |
| Investment in developments in progress | | (2,705) | | (14,491) |
| Acquired lease intangible assets | | - | | (6,972) |
| Acquired above market lease intangibles | | - | | (38) |
| Acquired below market lease intangibles | | - | | 152 |
| Investment in unconsolidated joint ventures | | (3,307) | | (2,273) |
| Payments received under master lease agreements | | 456 | | 1,068 |
| Payoff of notes receivable | | 20 | | 50 |
Net cash provided by investing activities | $ | 19,845 | $ | 161,200 |
See accompanying notes to consolidated financial statements
4
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Consolidated Statements of Cash Flows
(Continued)
For the Nine Months Ended September 30, 2010 and 2009
(Unaudited)
(in thousands, except per share amounts)
| | | | | | |
| | | | Nine Months Ended |
| | | | September 30, |
| | | | 2010 | | 2009 |
Cash flows from financing activities: | | | | |
| Proceeds from margin debt related to marketable securities | $ | 22,860 | $ | 29,750 |
| Payoff of margin debt related to marketable securities | | (4,706) | | (86,090) |
| Proceeds from mortgages and notes payable | | 604,468 | | 220,365 |
| Principal payments on mortgages and notes payable | | (22,651) | | (2,678) |
| Repayments of mortgages and notes payable | | (771,872) | | (323,980) |
| Proceeds from line of credit | | 75,000 | | 30,000 |
| Payoff of line of credit | | (33,758) | | (68,000) |
| Payment of rate lock deposits | | (12,290) | | - |
| Refund of rate lock deposits | | 10,070 | | 5,209 |
| Payment of loan fees and deposits | | (11,434) | | (7,562) |
| Proceeds from issuance of common stock related to option exercises | | 13 | | - |
| Distributions paid, net of DRP | | (35,783) | | (40,548) |
| Distributions to redeemable noncontrolling interests | | (24) | | (23) |
| Redemption of redeemable noncontrolling interests | | - | | (1,048) |
| Contributions from noncontrolling interests | | 112 | | - |
| Repayment of other financings | | (3,410) | | (55,999) |
Net cash used in financing activities | | (183,405) | | (300,604) |
Net (decrease) increase in cash and cash equivalents | | (9,888) | | 64,559 |
Cash and cash equivalents, at beginning of period | | 125,904 | | 121,167 |
Cash and cash equivalents, at end of period | $ | 116,016 | $ | 185,726 |
Supplemental cash flow disclosure, including non-cash activities: | | | | |
| Cash paid for interest, net of interest capitalized | $ | 181,473 | $ | 157,588 |
| Distributions payable | $ | 24,248 | $ | 12,029 |
| Distributions reinvested | $ | 23,353 | $ | 32,376 |
| Proceeds from sales of investment properties | | | | |
| | Land | $ | 20,711 | $ | 40,300 |
| | Building and other improvements, net of accumulated depreciation | | 53,095 | | 150,041 |
| | Accounts and notes receivable | | 474 | | 1,502 |
| | Acquired lease intangibles and other assets | | 3,073 | | 16,805 |
| | Assumption of mortgage debt | | - | | (107,689) |
| | Forgiveness of mortgage debt | | (486) | | - |
| | Acquired below market lease intangibles and other liabilities | | (73) | | (5,213) |
| | Gain on sales of investment properties | | 2,057 | | 21,570 |
| | | $ | 78,851 | $ | 117,316 |
| Proceeds from partial sale of investment properties to unconsolidated joint venture | | | | |
| | Land | $ | 10,400 | $ | - |
| | Building and other improvements, net of accumulated depreciation | | 32,085 | | - |
| | Accounts and notes receivable | | 829 | | - |
| | Acquired lease intangibles and other assets | | (1,246) | | - |
| | Assumption of mortgage debt | | (29,327) | | - |
| | Acquired below market lease intangibles and other liabilities | | (838) | | - |
| | Gain on partial sale of investment properties | | 1,464 | | - |
| | | $ | 13,367 | $ | - |
| Redemption of redeemable noncontrolling interests: | | | | |
| | Redeemable noncontrolling interests | $ | - | $ | 14,906 |
| | Land | | - | | (11,468) |
| | Restricted cash | | - | | (2,390) |
| Cash paid for redemption of redeemable noncontrolling interests | $ | - | $ | 1,048 |
| | | | | | |
| Developments in progress placed in service | $ | - | $ | 35,126 |
| Developments payable | $ | 523 | $ | 1,533 |
| Forgiveness of mortgage debt | $ | 19,561 | $ | - |
See accompanying notes to consolidated financial statements
5
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Readers of this Quarterly Report should refer to the audited financial statements of Inland Western Retail Real Estate Trust, Inc. for the fiscal year ended December 31, 2009, which are included in the Company’s 2009 Annual Report on Form 10-K, as amended, as certain footnote disclosures which would substantially duplicate those contained in the Annual Report have been omitted from this Quarterly Report. In the opinion of management, all adjustments necessary, all of which were of normal nature, for a fair presentation have been included in this Quarterly Report.
(1) Organization and Basis of Presentation
Inland Western Retail Real Estate Trust, Inc. (the “Company”) was formed on March 5, 2003 to acquire and manage a diversified portfolio of real estate, primarily multi-tenant shopping centers and single-user net lease properties.
All amounts in this Form 10-Q are stated in thousands with the exception of per share amounts, square foot amounts, number of properties, number of states, number of leases and number of employees.
The Company issued a total of 459,484 shares of its common stock at $10.00 per share, resulting in gross proceeds of $4,595,193. In addition, as of September 30, 2010, the Company had issued 69,314 shares through its DRP at prices ranging from $6.85 to $10.00 per share for gross proceeds of $666,125 and had repurchased a total of 43,823 shares through its share repurchase program (SRP) (suspended as of November 19, 2008) at prices ranging from $9.25 to $10.00 per share for an aggregate cost of $432,487. During September 2010, one thousand five hundred shares were issued through the exercise of stock options at a price of $8.95 per share for gross proceeds of $13. As a result, the Company had total shares outstanding of 484,976 and had realized total net offering proceeds of $4,828,844 as of September 30, 2010.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. For example, significant estimates and assumptions have been made with respect to useful lives of assets; capitalization of development and leasing costs; fair value measurements; provision for impairment, including estimates of holding periods, capitalization rates and discount rates (where applicable); provision for income taxes; recoverable amounts of receivables; deferred taxes and initial valuations and related amortization periods of deferred costs and intangibles, particularly with resp ect to property acquisitions. Actual results could differ from those estimates.
Certain reclassifications, as a result of discontinued operations and the error noted below, have been made to the 2009 consolidated financial statements to conform to the 2010 presentation.
Subsequent to the issuance of the consolidated financial statements for the three and nine months ended September 30, 2009, the Company identified an error in the presentation of its comprehensive loss in the consolidated statements of operations and other comprehensive loss. Consistent with the accounting guidance for noncontrolling interests, consolidated comprehensive loss and the related amounts attributable to the Company and to noncontrolling interests should be disclosed. As such, the Company’s consolidated statement of operations and other comprehensive loss for the three and nine months ended September 30, 2009 has been corrected to reflect such presentation. This correction resulted in an $81 increase to total comprehensive loss from $12,498 to $12,579 for the three months ended September 30, 2009 and a $3,202 increase to total comprehensive loss from $47,832 to $51,034 for the nine months ended S eptember 30, 2009. In addition, comprehensive loss attributable to noncontrolling interests of $81 and $3,202 and comprehensive loss attributable to Company shareholders of $12,498 and $47,832 have been properly presented for the three and nine months ended September 30, 2009, respectively. Although the Company believes the effects are not material to the previously issued consolidated statements of operations and other comprehensive loss, the Company has corrected the presentation of
6
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
these amounts for comparability purposes. This correction has no effect on the previously reported financial position, results of operations or cash flows.
It is the Company’s current strategy to have access to the capital resources necessary to manage its balance sheet, to repay upcoming maturities and, to a lesser extent, to consider making prudent real estate investments should such opportunities arise. Accordingly, the Company is executing a plan to seek to obtain funds through additional debt or equity financings and/or joint venture capital in a manner consistent with the Company’s intention to operate with what it believes to be a conservative debt capitalization policy. The Company’s other sources of capital include proceeds from sales of developed and non-core assets, proceeds from the sales of securities in the Company’s marketable securities portfolio, and existing unrestricted cash balances. In addition, the Company is focused on controlling operating expenses and deferring certain discretionary capital expenditures and has reduced d istributions to shareholders to preserve cash for upcoming debt maturities and principal paydowns. The Company will also seek loan extensions, generally six months to three years, on certain maturing mortgage debt.
During the nine months ended September 30, 2010, the Company obtained mortgage payable proceeds of $604,468, made mortgage payable repayments of $771,872 and received forgiveness of debt of $19,561. The Company also entered into modifications of existing loan agreements which extended the maturities of $185,659 of mortgages payable up to December 2012. In addition, RC Inland assumed $29,327 of mortgages payable from the Company (see Note 10 for discussion of this joint venture) on September 30, 2010. As the Company addresses its maturing mortgages payable, it has reduced its overall debt and staggered future mortgage maturity dates so that no more than $580,000 will come due in any one year. As of September 30, 2010, the Company had $125,756 of mortgages payable that had matured. During the second quarter of 2010, in order to prompt discussions with the lenders, the Company ceased making monthly debt service payments on two mortgage loans totaling $61,235 as of September 30, 2010, $29,965 of which has matured and is included in the $125,756 of total matured debt. The non-payment of these monthly debt service payments amounts to $3,000 annualized and does not result in noncompliance under any of the Company’s other mortgages payable and line of credit agreements. The Company is currently in active negotiations with the lenders to determine an appropriate course of action under the non-recourse loan agreements. No assurance can be provided that these negotiations will result in favorable outcomes for the Company. One of those lenders has asserted that certain events have occurred that trigger recourse to the Company. However, the Company believes that it has substantive defenses with respect to those claims.
As of September 30, 2010, in addition to the $125,756 that had matured, the Company had $114,332 of mortgages payable, excluding principal amortization and liabilities associated with the investment properties held for sale, maturing in the remainder of 2010. Of this amount, the Company has since refinanced $21,366. On January 8, 2010, the Company entered into a $300,000 forward loan commitment with JP Morgan Chase, subject to customary lender due diligence, to be used to refinance 2010 debt maturities, of which $244,500 has been utilized as of September 30, 2010. In addition to allocating the remaining proceeds of $55,500 ($20,300 as of the date of this filing), the Company is in the process of marketing, planning to seek extensions or planning to sell properties relating to the remaining 2010 maturities. The Company’s current business plan indicates that it will be able to operate in compliance with its loan covenants under its secured line of credit agreement (see Note 9) in 2010 and beyond as the Company extended the credit agreement to October 14, 2011. The balance outstanding on the line of credit at September 30, 2010 was $148,242. In light of current economic conditions, the Company may not be able to obtain loan extensions or financing on favorable terms, or at all, in order to meet principal maturity obligations of the remaining 2010 and 2011 debt maturities, which may cause an acceleration of its secured line of credit and trigger remedies available to lenders on assets securing matured mortgage debt, each of which could significantly impact future operations, liquidity and cash flows available for distribution.
The accompanying consolidated financial statements include the accounts of the Company, as well as all wholly-owned subsidiaries and consolidated joint venture investments. Wholly-owned subsidiaries generally consist of limited liability companies (LLCs) and limited partnerships (LPs).
7
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
The Company’s property ownership is summarized below:
| | | | | | | | | | |
| | Wholly-owned | | Consolidated Joint Venture (a) | | Total Consolidated | | Unconsolidated Joint Venture (b) | | Total Under Management |
Operating properties | 236 | | 55 | | 291 | | 14 | | 305 |
Development properties | 1 | | 5 | | 6 | | 2 | | 8 |
| | | | | | | | | | |
(a) | The Company has ownership interests ranging from 25% to 77% in six LLCs or LPs | | |
(b) | The Company has ownership interests ranging from 20% to 96% in three LLCs or LPs | | |
The Company consolidates certain property holding entities and other subsidiaries in which it owns less than a 100% equity interest if it is deemed to be the primary beneficiary in a variable interest entity (VIE), (an entity in which the contractual, ownership, or pecuniary interests change with changes in the fair value of the entity’s net assets, as defined by the Financial Accounting Standards Board (FASB)), as amended. The Company also consolidates entities that are not VIEs in which it has financial and operating control in accordance with GAAP. All significant intercompany balances and transactions have been eliminated in consolidation. Investments in real estate joint ventures in which the Company has the ability to exercise significant influence, but does not have financial or operating control, are accounted for using the equity method of accounting. Accordingly, the Company’s share of the income (or loss) of these unconsolidated joint ventures is included in consolidated net loss.
The Company is the controlling member in various consolidated entities. The organizational documents of these entities contain provisions that require the entities to be liquidated through the sale of their assets upon reaching a future date as specified in each respective organizational document or through put/call arrangements. As controlling member, the Company has an obligation to cause these property-owning entities to distribute proceeds of liquidation to the noncontrolling interest partners in these partially-owned entities only if the net proceeds received by each of the entities from the sale of assets warrant a distribution based on the agreements. Some of the LLC or LP agreements for these entities contain put/call provisions which grant the right to the outside owners and the Company to require each LLC or LP to redeem the ownership interest of the outside owners during future periods. In insta nces where outside ownership interests are subject to put/call arrangements requiring settlement for fixed amounts, the LLC or LP is treated as a 100% owned subsidiary by the Company with the amount due to the outside owner reflected as a financing arrangement and included in “Other financings” in the accompanying consolidated balance sheets. Interest expense is recorded on such liabilities in amounts equal to the preferential returns due to the outside owners as provided in the LLC or LP agreements. In instances where outside ownership interests are subject to call arrangements without fixed settlement amounts, the LLC is treated as a 100% owned subsidiary by the Company with the amount due to the outside owner reflected as a financing and included in “Co-venture obligation” in the accompanying consolidated balance sheets. Expense is recorded on such liabilities in amounts equal to the preferential returns due to the outside owners as provided in the LLC agreemen t.
On the consolidated statements of operations and other comprehensive loss, revenues, expenses and net income or loss from less-than-wholly-owned subsidiaries are reported at the consolidated amounts, including both the amounts attributable to Company shareholders and noncontrolling interests. Consolidated statements of equity are included in the quarterly financial statements, including beginning balances, activity for the period and ending balances for shareholders’ equity, noncontrolling interests and total equity.
8
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
Below is a table reflecting the activity of the redeemable noncontrolling interests for the nine months ended September 30, 2010 and 2009:
| | | | | |
| | | 2010 | | 2009 |
Balance at January 1, | $ | 527 | $ | 19,317 |
Redeemable noncontrolling interest income (expense) | | 24 | | (3,341) |
Distributions | | (24) | | (23) |
Redemptions | | - | (a) | (14,926) |
Balance at September 30, | $ | 527 | $ | 1,027 |
| | | | | |
(a) | On March 30, 2010, the Company fully redeemed the interest of its partner in a consolidated operating joint venture in which the partner had no equity. |
During the nine months ended September 30, 2010 and 2009, the Company paid certain joint venture partners for the redemption of their interests in certain consolidated joint ventures as summarized below:
| | | | | | | | |
Redemption Date | | Full or Partial Redemption | | Accrued Preferred Return | | Amount included in Other financings | | Total Payment Amount |
January 5, 2010 | | Full | $ | 20 | $ | 3,410 | $ | 3,430 |
Redemption Date | | Full or Partial Redemption | | Accrued Preferred Return | | Amount included in Other financings | | Total Payment Amount |
January 16, 2009 | | Full | $ | - | $ | 3,410 | $ | 3,410 |
April 28, 2009 | | Full | | 114 | | 5,698 | | 5,812 |
June 4, 2009 | | Partial | | - | | 40,539 | | 40,539 |
June 29, 2009 | | Full | | - | | 6,352 | | 6,352 |
Total for the nine months ended September 30, 2009 | | | $ | 114 | $ | 55,999 | $ | 56,113 |
The Company is party to an agreement with an LLC formed as an insurance association captive (the “Captive”), which is wholly-owned by the Company and three related parties, Inland Real Estate Corporation (IREC), Inland American Real Estate Trust, Inc. (IARETI) and Inland Diversified Real Estate Trust, Inc. (IDRETI). The Captive is serviced by a related party, Inland Risk and Management Services, Inc. for a fee of $25 per quarter. The Company entered into the agreement with the Captive to stabilize its insurance costs, manage its exposures and recoup expenses through the functions of the Captive program. The Captive was initially capitalized in 2006 with $750 in cash from the original members IREC, IARETI, a non-affiliated entity which withdrew from the Captive in October 2007, and the Company, of which the Company’s initial contribution was $188. In August 2009, IDRETI was admitted as a memb er to the Captive with an initial contribution of $188, at the approval of the members. Additional contributions were made in the form of premium payments to the Captive determined for each member based upon its respective loss experiences. The Captive insures a portion of the members’ property and general liability losses, a majority of which is attributable to the Company. These losses will be paid by the Captive up to and including a certain dollar limit, which varies based on the type of loss, after which the losses are covered by a third-party insurer. It has been determined that the Captive is a VIE and, as the Company receives the most benefit of all members, the Company is the primary beneficiary. Therefore, the Captive has been consolidated by the Company. The Company re-affirmed its conclusion on consolidating the Captive as of September 30, 2010. The other members’ interests are reflected as “Noncontrolling interests” in the accompanyin g consolidated financial statements.
9
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
The assets of the Captive are restricted to the settlement of liabilities of the Captive. Similarly, creditors of the Captive do not have recourse to the Company. Below is a summary of the assets and liabilities of the Captive:
| | | | |
| | September 30,
2010 | | December 31, 2009 |
Cash and cash equivalents | $ | 13,206 | $ | 10,000 |
Other assets, net | | 483 | | 5,256 |
Accounts payable and accrued expenses | | (395) | | (34) |
Other liabilities | | (5,008) | | (8,320) |
On November 29, 2009, the Company formed IW JV 2009, LLC (IW JV), a wholly-owned subsidiary, and transferred a portfolio of 55 investment properties and the entities which owned them into it. Subsequently, in connection with a $625,000 debt refinancing transaction, which consisted of $500,000 of mortgages payable and $125,000 of notes payable, on December 1, 2009, the Company raised additional capital of $50,000 from a related party, Inland Equity Investors, LLC (Inland Equity) in exchange for a 23% noncontrolling interest in IW JV. IW JV, which is controlled by the Company, and therefore consolidated, will continue to be managed and operated by the Company. Inland Equity is owned by certain individuals, including Daniel L. Goodwin, who controls more than 5% of the common stock of the Company, and Robert D. Parks, who was the Chairman of the Board of the Company until October 12, 2010, and affiliates of The Inla nd Real Estate Group, Inc. The independent directors committee reviewed and recommended approval of this transaction to the Company’s board of directors.
Noncontrolling interests are adjusted for additional contributions by noncontrolling interest holders and distributions to noncontrolling interest holders, as well as the noncontrolling interest holders’ share of the net income or losses of each respective entity.
(2)
Summary of Significant Accounting Policies
There have been no changes to the Company’s significant accounting policies in the nine months ended September 30, 2010. Refer to the Company’s 2009 Form 10-K, as amended, for a summary of significant accounting policies.
New Accounting Pronouncements
In June 2009, the FASB issued guidance that amends the consolidation guidance applicable to VIEs. The amendment requires an enterprise to perform a qualitative analysis when determining whether or not it must consolidate a VIE. It also requires an enterprise to continuously reassess whether it must consolidate a VIE. Additionally, the amendment requires enhanced disclosures about an enterprise's involvement with VIEs and any significant change in risk exposure due to that involvement, as well as how its involvement with VIEs impacts the enterprise's financial statements. Although the amendment significantly affects the overall consolidation analysis under previously issued guidance, the adoption on January 1, 2010 did not have a material impact on the consolidated financial statements.
In January 2010, the FASB issued guidance which provides additional requirements and clarifies existing disclosures about fair value measurements. The guidance requires entities to provide fair value measurement disclosures for each “class” of assets and liabilities, opposed to the old guidance which required disclosures by “major category” of assets and liabilities. The term “major category” was often interpreted to be a line item on the statement of financial position, whereas the term “class” represents a subset of assets or liabilities within a line item in the statement of financial position, thus expanding on the level of disaggregation. The guidance also requires an entity to disclose the amounts of significant transfers between Levels 1 and 2, and all significant transfers into and out of Level 3, of the fair value hierarchy. Furthermore, entities are require d to disclose the reasons for those transfers, and the entity’s policy for determining when transfers between levels are recognized. A description of the valuation techniques and inputs used to determine the fair value of each class of assets or liabilities for Levels 2 and 3 must also be disclosed, including any valuation technique changes and the reason for those changes. This update further amends the reconciliation of the beginning and ending balances of Level 3 recurring fair value measurements, requiring a separate disclosure of total gains and losses recognized
10
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
in other comprehensive income and disclosing separately purchases, sales, issuances, and settlements, as opposed to net presentation as previously allowed. The guidance was effective for the Company on January 1, 2010. The adoption of the guidance did not have a material impact on the consolidated financial statements.
In January 2010, the FASB issued guidance clarifying the accounting for distributions to shareholders with components of stock and cash. Prior to this amendment, it was unclear as to whether the stock portion of a distribution should be accounted for as a new share issuance that is reflected in earnings per share (EPS) prospectively or as a stock dividend by retroactively restating shares outstanding and earnings per share for all periods presented. The amendment clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or shares with potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance and is reflected in EPS prospectively and is not a stock dividend. The guidance was effective for the Company on January 1, 2010. The adoption of the guidance did not have any impact on t he consolidated financial statements.
In January 2010, the FASB issued guidance related to decreases in the ownership of a subsidiary. The guidance clarified that any transaction that involves in-substance real estate should be considered under guidance for sales of real estate and is retroactively effective for periods beginning on or after December 15, 2008. The Company followed this guidance when accounting for the transfer of the 23% interest in IW JV to Inland Equity for $50,000. This transaction was accounted for as a financing arrangement and is reflected in “Co-venture obligation” on the consolidated balance sheets.
(3) Discontinued Operations and Investment Properties Held for Sale
The Company employs a business model, which utilizes asset management as a key component of monitoring its investment properties, to ensure that each property continues to meet expected investment returns and standards. This strategy incorporates the sale of non-core assets that no longer meet the Company’s criteria.
The Company sold five properties during the nine months ended September 30, 2010, as summarized below:
(12) Provision for Impairment of Investment Properties
The Company identified certain indicators of impairment for certain of its properties, such as the property’s low occupancy rate, difficulty in leasing space, and financially troubled tenants. The Company performed a cash flow analysis and determined that the carrying values of certain of its properties exceeded the respective undiscounted cash flows based upon the estimated holding period for the asset. Therefore, the Company has recorded impairment losses related to these properties consisting of the excess carrying value of the assets over their estimated fair values within the accompanying consolidated statements of operations and other comprehensive loss.
24
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
During the nine months ended September 30, 2010, the Company recorded asset impairment charges as summarized below:
| | | | | | | | |
Location | | Property Type | | Impairment Date | | Approximate
Square
Footage | | Provision for
Asset
Impairment |
Richmond, Virginia | | Single-user retail property | | June 30, 2010 | | 383,000 | $ | 7,806 |
Sugarland, Texas (a) | | Multi-tenant retail property | | June 30, 2010 | | 61,000 | | 1,576 |
University Heights, Ohio | | Multi-tenant retail property | | June 30, 2010 | | 287,000 | | 6,281 |
Coppell, Texas (a) | | Multi-tenant retail property | | September 30, 2010 | | 91,000 | | 1,851 |
Southlake, Texas (a) | | Multi-tenant retail property | | September 30, 2010 | | 96,000 | | 1,322 |
| | | | | | | | 18,836 |
Discontinued Operations: | | | | | | | | |
Hinsdale, Illinois | | Single-user retail property | | May 28, 2010 | | 49,000 | | 821 |
| | Nine months ended September 30, 2010 | $ | 19,657 |
| | Estimated fair value of impaired properties | $ | 68,351 |
| | | | | | | | |
(a) Property acquired by RC Inland subsequent to September 30, 2010. Impairment based on estimated net realizable value inclusive of projected contingent earnout proceeds. |
During the nine months ended September 30, 2009, the Company recorded asset impairment charges as summarized below:
| | | | | | | | |
Location | | Property Type | | Impairment Date | | Approximate
Square
Footage | | Provision for
Asset
Impairment |
Mesa, Arizona | | Multi-tenant retail property | | March 31, 2009 | | 195,000 | $ | 20,400 |
Largo, Maryland | | Multi-tenant retail property | | June 30, 2009 | | 482,000 | | 13,100 |
Hanford, California | | Single-user retail property | | June 30, 2009 | | 78,000 | | 3,800 |
Thousand Oaks, California | | Multi-tenant retail property | | September 30, 2009 | | 63,000 | | 2,700 |
Vacaville, California | | Single-user retail property | | September 30, 2009 | | 78,000 | | 4,000 |
| | | | | | | | 44,000 |
Discontinued Operations: | | | | | | | | |
Mountain Brook, Alabama | | Single-user retail property | | September 30, 2009 | | 44,000 | | 1,100 |
Cupertino, California | | Single-user office property | | September 30, 2009 | | 100,000 | | 8,400 |
Kansas City, Missouri | | Single-user retail property | | September 30, 2009 | | 88,000 | | 500 |
Wilmington, North Carolina | | Single-user retail property | | September 30, 2009 | | 57,000 | | 800 |
| | | | | | | | 10,800 |
| | Nine months ended September 30, 2009 | $ | 54,800 |
| | Estimated fair value of impaired properties | $ | 180,135 |
Certain investment properties impaired during the nine months ended September 30, 2010 were also impaired in previous periods and the current carrying value is below the amount of mortgages payable secured by each of those properties. In aggregate, the difference between the current carrying value and the amount of mortgages payable, including accrued interest, was $44,817 as of September 30, 2010. As discussed in Note 1, the Company has ceased making monthly debt service payments on two mortgage loans related to such investment properties and is currently in active negotiations with lenders to determine an appropriate course of action under the non-recourse loan agreements.
25
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
(13) Fair Value Measurements
Fair Value of Financial Instruments
The following table presents the carrying value and estimated fair value of the Company’s financial instruments at September 30, 2010 and December 31, 2009. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date.
| | | | | | | | | | |
| | September 30, 2010 | | December 31, 2009 |
| | | Carrying Value | | Fair Value | | | Carrying Value | | Fair Value |
Financial assets: | | | | | | | | | |
| Investment in marketable securities | $ | 33,282 | $ | 33,282 | | $ | 29,117 | $ | 29,117 |
| Notes receivable | | 8,310 | | 8,244 | | | 8,330 | | 8,287 |
Financial liabilities: | | | | | | | | | |
| Mortgages and notes payable | $ | 3,765,692 | $ | 3,769,762 | | $ | 4,003,985 | $ | 3,822,695 |
| Line of credit | | 148,242 | | 148,242 | | | 107,000 | | 107,000 |
| Other financings | | 8,477 | | 8,477 | | | 11,887 | | 11,887 |
| Co-venture obligation | | 50,972 | | 55,000 | | | 50,139 | | 55,000 |
| Interest rate swaps | | 2,583 | | 2,583 | | | 3,819 | | 3,819 |
The carrying values shown in the table are included in the consolidated balance sheets under the indicated captions, except for notes receivable and interest rate swaps, which are included in “Accounts and notes receivable” and “Other liabilities,” respectively.
The fair value of the financial instruments shown in the above table as of September 30, 2010 and December 31, 2009 represent the Company’s best estimates of the amounts that would be received to sell those assets or that would be paid to transfer those liabilities in a transaction between market participants at that date. Those fair value measurements maximize the use of observable inputs. However, in situations where there is little, if any, market activity for the asset or liability at the measurement date, the fair value measurement reflects the Company’s own judgments about the assumptions that market participants would use in pricing the asset or liability. Those judgments are developed by the Company based on the best information available in those circumstances.
The following methods and assumptions were used to estimate the fair value of each financial instrument:
·
Investment in marketable securities: Marketable securities classified as available-for-sale are measured using quoted market prices at the reporting date multiplied by the quantity held.
·
Notes receivable: The Company estimates the fair value of its notes receivable by discounting the future cash flows of each instrument at rates that approximate those offered by lending institutions for loans with similar terms to companies with comparable risk.
·
Mortgages payable: The Company estimates the fair value of its mortgages payable by discounting the future cash flows of each instrument at rates currently offered to the Company for similar debt instruments of comparable maturities by the Company’s lenders.
·
Line of credit: The carrying value of the Company’s line of credit approximates fair value because of the relatively short maturity of the instrument.
·
Other financings: Other financings on the consolidated balance sheets represent the equity interest of the noncontrolling member in certain consolidated entities where the LLC or LP agreement contains put/call arrangements, which grant the right to the outside owners and the Company to require each LLC or LP to redeem the ownership interest in future periods for fixed amounts. The Company believes the fair value of other financings is that amount which is the fixed amount at which it would settle, which approximates its carrying value.
26
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
·
Co-venture obligation: The Company estimates the fair value of co-venture obligation based on the amount at which it believes the obligation will settle and the timing of such payment. The fair value of the co-venture obligation includes the estimated additional amount the Company would be required to pay upon exercise of the call option. The carrying value of the co-venture obligation includes $972 of cumulative co-venture obligation expense accretion relating to the estimated additional distribution.
·
Interest rate swaps: The fair value of the interest rate swaps is determined using pricing models developed based on the LIBOR swap rate and other observable market data. The Company also incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered any applicable credit enhancements.
Fair Value Hierarchy
GAAP specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs). The following summarizes the fair value hierarchy:
| | |
· | | Level 1 Inputs – Unadjusted quoted market prices for identical assets and liabilities in an active market that the Company has the ability to access. |
· | | Level 2 Inputs – Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly. |
· | | Level 3 Inputs – Inputs based on prices or valuation techniques that are both unobservable and significant to the overall fair value measurements. |
The guidancerequires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2010 and December 31, 2009, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
The following table presents the Company’s assets and liabilities, measured on a recurring basis, and related valuation inputs within the fair value hierarchy utilized to measure fair value as of September 30, 2010 and December 31, 2009:
| | | | | | | | |
| | Level 1 | | Level 2 | | Level 3 | | Total |
September 30, 2010 | | | | | | | | |
Investment in marketable securities | $ | 33,282 | $ | - | $ | - | $ | 33,282 |
Interest rate swaps | $ | | $ | 2,583 | $ | - | $ | 2,583 |
| | | | | | | | |
December 31, 2009 | | | | | | | | |
Investment in marketable securities | $ | 29,117 | $ | - | $ | - | $ | 29,117 |
Interest rate swaps | $ | - | $ | 3,819 | $ | - | $ | 3,819 |
During the nine months ended September 30, 2010, the Company recorded asset impairment charges of $19,657 related to two of its consolidated operating properties, three consolidated operating properties to be contributed to RC Inland
27
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
subsequent to September 30, 2010 and one property that was sold. The combined estimated fair value of these properties was $68,351. During the three months ended September 30, 2010, the Company recorded asset impairment charges of $3,173 related to two of its consolidated operating properties to be contributed to RC Inland subsequent to September 30, 2010. During the nine months ended September 30, 2009, the Company recorded an asset impairment charge of $54,800 related to nine of its consolidated operating properties with a combined fair value of $180,135. The Company’s estimated fair value, measured on a non-recurring basis, relating to this impairment assessment was based upon a discounted cash flow model that included all estimated cash inflows and outflows over a specific holding period or the estimated contract price, if applicable. These cash flows are comprised of unobservable inputs whi ch include contractual rental revenues and forecasted rental revenues and expenses based upon market conditions and expectation for growth. Capitalization rates and discount rates utilized in this model were based upon observable rates that the Company believed to be within a reasonable range of current market rates for the property. Based on these inputs, the Company had determined that its valuation of its consolidated operating properties were classified within Level 3 of the fair value hierarchy, except for when the estimated contract price is used, which results in Level 2 classification.
(14) Commitments and Contingencies
The Company has acquired several properties which have earnout components, meaning the Company did not pay for portions of these properties that were not rent producing at the time of acquisition. The Company is obligated, under these agreements, to pay for those portions when a tenant moves into its space and begins to pay rent. The earnout payments are based on a predetermined formula. Each earnout agreement has a time limit regarding the obligation to pay any additional monies. The time limits generally range from one to three years. If, at the end of the time period allowed, certain space has not been leased and occupied, the Company will generally not have any further payment obligation to the seller. As of September 30, 2010, based on pro-forma leasing rates, the Company may pay as much as $1,400 in the future as retail space covered by earnout agreements is occupied and becomes rent prod ucing.
The Company has previously entered into one construction loan agreement, one secured installment note and one other installment note agreement, one of which was impaired as of December 31, 2009 and written off on March 31, 2010. In conjunction with the two remaining agreements, the Company has committed to fund up to a total of $8,680. One of the two remaining loans requires monthly interest payments with the entire principal balance due at maturity. The combined receivable balance at September 30, 2010 and December 31, 2009 was $8,310 and $8,330, respectively, net of allowances of $300 and $17,209, respectively. The Company is not required to fund any additional amounts on these loans as all of the agreements are non-revolving and all fundings have occurred. In May 2010, the Company entered into an agreement related to the secured installment note that extended the maturity date from May 31, 2010 to February 29, 2012.
Although the loans obtained by the Company are generally non-recourse, occasionally, when it is deemed to be necessary, the Company may guarantee all or a portion of the debt on a full-recourse basis. As of September 30, 2010, the Company has guaranteed $148,242 and $28,349 of the outstanding secured line of credit and mortgage loans, respectively, with maturity dates up to August 1, 2014. As of September 30, 2010, the Company also guaranteed $28,523 representing a portion of the construction debt associated with certain of its consolidated development joint ventures. The guarantees are released as certain leasing parameters are met. The following table summarizes these guarantees:
| | | | | | | | | | |
Location | | Joint Venture | | Construction Loan
Balance at
September 30, 2010 | | Percentage/Amount Guaranteed by the Company | | Guarantee Amount |
| | | | | | | | | | |
Frisco, Texas | | Parkway Towne Crossing | | $ | 20,695 | | | 35% | $ | 7,244 |
Dallas, Texas | | Wheatland Towne Crossing | | | 5,548 | | | 50% | | 2,774 |
Henderson, Nevada | | Lake Mead Crossing | | | 48,990 | | | 15% | | 7,348 |
Henderson, Nevada | | Green Valley Crossing | | | 11,157 | | | $ 11,157 | | 11,157 |
| | | | | | | | | $ | 28,523 |
28
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
As of September 30, 2010, the Company had two letters of credit outstanding for the benefit of the Captive (See Note 1). These letters of credit serve as collateral for payment of potential claims within the limits of self-insurance and will remain outstanding until all claims are closed. There was also one letter of credit outstanding as security for utilities and completion of one development project. The balance of the outstanding letters of credit at September 30, 2010 was $4,400.
On January 8, 2010, the Company entered into a $300,000 forward loan commitment with JP Morgan Chase, subject to customary lender due diligence, to be used to refinance 2010 debt maturities. In conjunction with this commitment, the Company also entered into a rate lock agreement to lock the interest rate at 6.39%. The Company made deposits of $8,500 related to both of these agreements. Subsequent to entering into these agreements, the Company made additional rate lock deposits of $4,067. The loan commitment agreement originally expired on March 31, 2010, but was extended to December 31, 2010. The rate lock agreement originally expired on February 10, 2010, but was extended to November 30,2010. As of September 30, 2010, the Company had used $244,500 of the total commitment proceeds and received refunds of commitment and rate lock deposits of $9,885. The Company is in the process of allocating the remaining commitments of $55,500 ($20,300 as of the date of this filing) and, if successful, will receive a full refund of the remaining deposits upon loan closings. The carrying value of the commitment deposits and rate lock deposits outstanding as of September 30, 2010 was $2,682.
(15) Litigation
The Company previously disclosed in its Form 10-K, as amended, for the fiscal years ended December 31, 2009, 2008 and 2007, the lawsuit filed against the Company and nineteen other defendants by City of St. Clair Shores General Employees Retirement System and Madison Investment Trust in the United States District Court for the Northern District of Illinois (the “Court”). In the lawsuit, plaintiffs alleged that all the defendants violated the federal securities laws, and certain defendants breached fiduciary duties owed to the Company and its shareholders, in connection with the Company’s merger with its business manager/advisor and property managers as reflected in its Proxy Statement dated September 12, 2007.
On July 14, 2010, the lawsuit was settled by the Company and the other defendants (the “Settlement”). On November 8, 2010, the Court granted final approval of the Settlement. Pursuant to the terms of the Settlement, 9,000 shares of common stock of the Company will be transferred back to the Company from shares of common stock issued to the owners (the “Owners”) of certain entities that were acquired by the Company in its internalization transaction. This share transfer will be accounted for as a capital transaction when it occurs. Pursuant to the Settlement, the Company will pay the fees and expenses of counsel for class plaintiffs in the amount of $10,000, as awarded by the Court on November 8, 2010. The Company expects that it will be reimbursed by its insurance carrier for a portion of such fees and expenses. The Company has accrued $10,000 related to the Settle ment. The Owners (who include Daniel L. Goodwin (“Goodwin”), who beneficially owned more than 5% of the stock of the Company as of December 31, 2009, and certain directors and executive officers of the Company) also agreed to provide a limited indemnification to certain defendants who are directors and an officer of the Company if any class members opted out of the Settlement and brought claims against them. Seven class members have opted out of the Settlement; to the Company’s knowledge, none of these seven class members have filed claims against the Company or its directors and officers.
29
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
Notes to Consolidated Financial Statements
(16) Subsequent Events
During the period from October 1, 2010 through the date of this 10-Q filing, the Company:
·
closed on partial sales of four additional properties to RC Inland, consisting of approximately 515,000 square feet, with sales prices totaling $56,441, which resulted in net losses of $3,670, net proceeds of $19,410 and in RC Inland assuming $31,688 of mortgage debt;
·
sold 328 shares of two different securities for net proceeds of $4,729 (resulting in estimated realized net gains of $3,481), which were used to pay down margin debt;
·
paid down $8,895 on the line of credit using proceeds from one property acquired by RC Inland;
·
extended the rate lock agreement from October 31, 2010 to November 30, 2010 and the loan commitment agreement from October 29, 2010 to December 31, 2010, and
·
obtained mortgage payable proceeds of $35,200 and made mortgage payable repayments of $46,351. The new mortgages payable have interest rates of 6.39% and mature in five years. The stated interest rates of the loans repaid ranged from 4.79% to 5.13%
On October 12, 2010, under the Company’s Independent Director Stock Option Plan, each non-employee, non-related party, director was granted options to purchase an additional five thousand shares of common stock.
Robert D. Parks, Chairman of the Company, did not stand for re-election at the Annual Meeting of Shareholders held on October 12, 2010. Gerald M. Gorski, a Director of the Company since July 1, 2003, was elected to the position of Chairman at the board of directors meeting held immediately following the Shareholders’ meeting on October 12, 2010.
30
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Certain statements in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report on Form 10-Q may constitute “forward-looking statements.” Forward-looking statements are statements that are not historical, including statements regarding management’s intentions, beliefs, expectations, representations, plans or predictions of the future and are typically identified by such words as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “plan,” “attempt,” “seek,” “may,” “should” and “could.” We intend that such forward-looking statements be subject to the safe harbor provisions created by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and the Federal Private Securities Litigation Reform Act of 1995 and we include this statement for the purpose of complying with such safe harbor provisions. Future events and actual results, performance, transactions or achievements, financial or otherwise, may differ materially from the results, performance, transactions or achievements expressed or implied by the forward-looking statements. Risks, uncertainties and other factors might cause such differences, some of which could be material. For additional information, see “Risk Factors” under Part II Item 1A of this quarterly report on Form 10-Q and in our annual report on Form 10-K, as amended, for the year ended December 31, 2009.
We disclaim any intention or obligation to update or revise any forward-looking statement whether as a result of new information, future events or otherwise. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of September 30, 2010. The following discussion and analysis compares the three months ended September 30, 2010 to the three months ended September 30, 2009 and the nine months ended September 30, 2010 to the nine months ended September 30, 2009, and should be read in conjunction with our consolidated financial statements and the related notes included in this report.
Executive Summary
We are a self-managed real estate investment trust (REIT) that acquires, manages, and develops a diversified portfolio of real estate, primarily multi-tenant shopping centers. As of September 30, 2010, our portfolio consisted of 291 consolidated operating properties, of which 236 were properties wholly-owned by us, including five properties classified as held for sale on the accompanying consolidated balance sheets (the wholly-owned properties) and 55 were properties in one joint venture (the consolidated joint venture operating properties); and 14 other operating properties in three joint ventures that we do not consolidate. We have also invested in six consolidated development properties, one property wholly-owned by us and five properties in five joint ventures; and two other development properties in one joint venture referred to above that we do not consolidate.
In this report, all references to “we,” “our,” and “us” refer collectively to Inland Western Retail Real Estate Trust, Inc. and its subsidiaries, including joint ventures.
Our goal is to maximize the possible return to our shareholders through a combination of acquisition, development and redevelopment, utilizing joint ventures and the effective asset management of our portfolio, including disposition of non-core assets. We attempt to manage our assets by leasing and re-leasing space at favorable rates, controlling costs, maintaining our strong tenant relationships and creating additional value through asset management. We distribute funds generated from operations to our shareholders and intend to continue to make distributions in order to maintain our REIT status.
The properties in our portfolio are located in 38 states. As of September 30, 2010, our wholly-owned and consolidated joint venture operating properties consisted of 180 multi-tenant shopping centers and 111 free-standing, single-user properties of which 98 are net lease properties. The wholly-owned and consolidated operating property portfolio contains an aggregate of approximately 43,821,000 square feet of gross leasable area (GLA), and we have an aggregate of approximately 46,480,000 square feet of GLA under management. At September 30, 2010, the aggregate leased rate of our wholly-owned and consolidated portfolio was 90.6%, including 1.7% related to temporary short-term leases, as compared to the aggregate leased rate at September 30, 2009 of 89.4%, including 1.8% related to temporary short-term leases. Leased rate includes all signed leases, including those where the tenant has yet to occupy the space or commence paying rent. Our anchor tenants include nationally and regionally recognized grocers, discount retailers and other tenants who provide basic household goods and services. Of our total annualized base rental income as of September 30, 2010, approximately 65% is generated by anchor or credit tenants, including PetSmart, Bed Bath & Beyond, Ross Dress for
31
Less, Wal-Mart, Home Depot, Kohl’s, Best Buy and several others. The term “credit tenant” is subjective and we apply the term to tenants whom we believe have a substantial net worth.
During the nine months ended September 30, 2010, we invested approximately $501 for the funding of one earnout at one existing property, containing a GLA of approximately 5,000 square feet. We also contributed $10,488 and $3,307 for real estate development on our consolidated and unconsolidated joint ventures, respectively. We received $23,353 in investor proceeds through our distribution reinvestment program (DRP), $78,851 in proceeds from the sale of five operating properties, $13,367 in proceeds from the partial sale of investment properties to an unconsolidated joint venture and obtained $604,468 in proceeds from mortgages and notes payable, all of which were used primarily to repay mortgages and notes payable of $771,872.
As part of our ongoing business plan, we monitor the potential credit issues of our tenants, analyzing the possible impact any change would have on our consolidated financial statements and liquidity. We look to enhance the portfolio through our lease-up efforts and maintain strong relationships with national credit tenants. This proactive focus on the financial health of our tenants was a critical element of our strategy during the economic downturn and will continue to be at the forefront over the course of the recovery. We evaluate our real estate for recoverability of our current carrying value, as well as the collectability of the related outstanding accounts receivable, including any tenant related deferred charges, which may include straight-line rents, deferred lease costs, tenant improvements, tenant inducements and intangible assets and liabilities (Tenant Related De ferred Charges). We routinely evaluate our exposure relating to tenants in financial distress. Where appropriate, we have either written off the unamortized balance or accelerated depreciation and amortization expense associated with the Tenant Related Deferred Charges for such tenants.
We believe retailers with strong balance sheets, low debt and experienced management teams will continue to capitalize on the current conditions to increase their market share and upgrade existing locations. The weak performers may continue to close their doors as a result of the challenging economic times. We have experienced stress in our portfolio in the form of tenant evictions, collection issues and requests for rent relief, but the level has been stabilizing. We continue to be pleased with our success in re-leasing our vacant spaces, and continue to see re-leasing opportunities to upgrade our tenant profile. We have interest from some of the strongest retailers for expansion in our centers. We believe that our well-located, high-demographic and newer properties will continue to be vie wed by these retailers as prime locations for expansion.
Leasing
We are encouraged by the solid leasing activity we have achieved during the first nine months of 2010. We remain focused on strengthening our portfolio, and believe that our leased rate will continue to move back towards historical levels over time. More importantly, our consistently high quality property revenue stream is primarily derived from long-term leases with credit retail tenants and we have little reliance on percentage rents generated by tenant sales performance. The dramatic reduction in retail development throughout the downturn in the economy has created a limited supply of new retail space as we move forward in the recovery. We believe that the quality of our shopping center portfolio is strong, as it is generally comprised of newer, well-located assets in areas of high demographics and solid consumer traffic. As national credit tenants revive expansion plans, we believe that our tenur ed relationships with these tenants, along with the quality of our assets puts us in an advantageous position to maintain our leasing velocity. As we continue to sign a record number of new leases, rental rates have generally been below the previous rates; however such rental spreads are stabilizing. In the current retail environment, we have seen an increase in capital investment, in the form of tenant improvements and leasing commissions, required from landlords when significant new leases are signed. We remain focused on renewals in an effort to retain our current high quality tenants. Tenant rotation is inevitable; however shopping centers that are well-located and actively managed perform well. We are very conscious of the risks posed by the economy, but we believe that the position of our portfolio and the general diversity and credit quality of our tenant base should enable us to continue to successfully navigate through the slow moving recovery.
Due in large part to the downturn in the economy and resulting retailer bankruptcies, we had approximately 4,058,000 square feet of retail space become available due to large tenant vacancies. As of September 30, 2010, approximately 1,698,000 square feet of this space has been re-leased, with an additional 1,200,000 square feet of this space with active letters of intent or that are in various stages of lease negotiations, for a total of approximately 71% of the space being addressed. We anticipate the economic impact of the executed leases will be realized as rents commence during the last
32
quarter of 2010 and into 2011. These executed leases represent approximately 4% of total portfolio GLA, and $15,125 in annualized base rental income. In addition, we are focused on retaining our strong tenants, as renewals are the most cost-efficient means of maintaining and increasing occupancy and rental revenues. In the first nine months of 2010, we signed nearly 430 new and renewal leases for a total of approximately 2,849,000 square feet. Given the success we have had re-leasing vacant retail space, we have also been able to focus on anticipating vacancies and proactively re-leasing space before it may become available.
Asset Dispositions
As part of our asset management strategy, we market non-core assets for sale. This also became an integral factor in our deleveraging and recapitalization efforts. We evaluate all potential sale opportunities taking into account the long-term growth prospects of assets being sold, the use of proceeds and the impact on our balance sheet including financial covenants, in addition to the impact on operating results. The following table highlights the results of our asset disposition strategy through September 30, 2010:
| | | | | | | | | | | | | |
| | Number of Assets Sold | | Square Footage | | Combined Sales Price | Total Debt Extinguished | | Net Sales Proceeds |
2010 Dispositions (through September 30, 2010) | | 5 | | 358,000 | | $ | 80,185 | | $ | 60,921 | | $ | 18,416 |
2009 Dispositions | | 8 | | 1,579,000 | | | 338,057 | | | 208,552 | | | 123,944 |
Operating Joint Ventures
We are focused on minimizing dilution to our shareholders; however, we may seek to obtain additional capital through the strategic formation of joint ventures in a manner consistent with our intention to operate with a conservative debt capitalization policy.
Effective April 27, 2007, we formed a strategic joint venture with a large state pension fund. Under the joint venture agreement we are to contribute 20% of the equity and our joint venture partner is to contribute 80% of the equity, up to a total of $500,000. As of September 30, 2010, the joint venture had acquired seven properties (which we contributed) with a purchase price of approximately $336,000 and had assumed from us mortgages on these properties totaling approximately $188,000.
On November 29, 2009, we formed IW JV 2009, LLC (IW JV), a wholly-owned subsidiary, and transferred a portfolio of 55 investment properties and the owner entities into the this entity. Subsequently, in connection with a $625,000 debt refinancing transaction, which consisted of $500,000 of mortgages payable and $125,000 of notes payable, on December 1, 2009, we raised additional capital of $50,000 from a related party, Inland Equity, in exchange for a 23% noncontrolling interest in IW JV. IW JV, which is controlled by us, and therefore consolidated, will continue to be managed and operated by us. Inland Equity is owned by certain individuals, including Daniel L. Goodwin, who controls more than 5% of our common stock, and Robert D. Parks, who was the Chairman of our board of directors until October 12, 2010, and affiliates of The Inland Real Estate Group, Inc.
On May 20, 2010, we entered into definitive agreements to form a joint venture (RC Inland) with RioCan Real Estate Investment Trust (RioCan), a real estate investment trust (REIT) based in Canada. The initial RC Inland investment includes up to eight grocery and necessity-based-anchored shopping centers located in Texas. Under the terms of the agreements, RioCan will contribute cash for an 80% interest in the venture and we will contribute a 20% interest in the properties. RC Inland will acquire an 80% interest in the properties from us in exchange for cash, each of which will be accounted for as a partial sale of real estate. Each property closing will occur individually over time based on timing of lender consent or refinance of the related mortgages payable. We will earn property management, asset management and other customary fees on the joint venture. Certain of the properties contain earn-out provisions which, if met, woul d result in additional sales proceeds to us. On September 30, 2010, three of the initial eight properties were acquired by the joint venture. As discussed in Note 3 to the Consolidated Financial Statements, the remaining five properties meet the held for sale criteria as of September 30, 2010. These transactions do not qualify as discontinued operations in the consolidated statements of operations and other comprehensive loss as a result of our 20% ownership in RC Inland.
33
Development Joint Ventures
Our development joint venture program involves partnering with regional developers. We believe that a national platform of retail development requires strength and expertise in strategic local markets. Upon completion, we will seek to get the best return and we will either buy or sell the completed development. If we sell the developed property, we will share, where applicable, in the proceeds realized upon the consummation of a sale.
Given the current economic conditions, we have made the decision to put any ongoing pursuit of additional development projects on hold and focus on the completion of our current development properties and improvement of our existing portfolio.
Our consolidated joint ventures have the following projects under development:
| | | | | | | | | | |
Location | | Description | | Our OwnershipPercentage | | | Our Equity Investment at September 30, 2010 | | | Construction
Loan Balance at
September 30, 2010 |
Frisco, Texas | | Parkway Towne Crossing | | 75.0% | | $ | 8,717 | | $ | 20,695 |
Dallas, Texas | | Wheatland Towne Crossing | | 75.0% | | | 8,575 | | | 5,548 |
Henderson, Nevada | | Lake Mead Crossing | | 25.0% | | | 35,401 | | | 48,990 |
Henderson, Nevada | | Green Valley Crossing | | 50.0% | | | 11,021 | | | 11,157 |
Billings, Montana | | South Billings Center | | 35.5% | | | 4,956 | | | - |
| | | | | | $ | 68,670 | | $ | 86,390 |
On December 1, 2009, we were notified by the lender for Green Valley Crossing that they had ceased funding and made a demand for payment. On January 15, 2010, the joint venture filed suit against the lender (as well as the financial institution that acquired it) seeking, among other things, a declaratory judgment that the lender acted improperly. On September 28, 2010, a settlement agreement was reached and we entered into a modification and extension agreement on the construction loan. As a result of this modification, the maturity date of the loan was extended to December 2012. The remaining development of the project will be funded by equity contributions.
Our unconsolidated development joint venture has the following project under development:
| | | | | | | | | | | | |
Location | | Description | | Our
Ownership
Percentage | | Our Equity
Investment at
September 30, 2010 | | Construction
Loan Balance at
September 30, 2010 |
Denver, Colorado | | Hampton Retail Colorado | | 96.3% | | $ | 22,664 | | | $ | 20,398 | |
Critical Accounting Policies and Estimates
Our 2009 Annual Report on Form 10-K, as amended, contains a description of our critical accounting policies, including acquisition of investment property, impairment of long-lived assets, cost capitalization, depreciation and amortization, assets held for sale, revenue recognition, marketable securities, partially-owned entities, derivatives and hedging and allowance for doubtful accounts. For the nine months ended September 30, 2010, there were no significant changes to these policies.
Results of Operations
We believe that property net operating income (NOI) is a useful measure of our operating performance. We define NOI as operating revenues (rental income, tenant recovery income, other property income, excluding straight-line rental income and amortization of acquired above and below market lease intangibles) less property operating expenses (real estate tax expense and property operating expense, excluding straight-line ground rent expense and straight-line bad debt expense). Other REITs may use different methodologies for calculating NOI, and accordingly, our NOI may not be comparable to other REITs.
This measure provides an operating perspective not immediately apparent from generally accepted accounting principles (GAAP) operating income or net loss. We use NOI to evaluate our performance on a property-by-property basis because NOI allows us to evaluate the impact that factors such as lease structure, lease rates and tenant base, which vary by
34
property, have on our operating results. However, NOI should only be used as an alternative measure of our financial performance. For reference and as an aid in understanding our computation of NOI, a reconciliation of NOI to net loss as computed in accordance with GAAP has been presented.
Previously, we presented operating information for our same store portfolio separately from our other investment properties. As of January 1, 2010, all of our properties are considered same store since we owned them for the nine months ended September 30, 2010 and 2009. As a result, we have chosen to present operating information in the following table on a consolidated basis.
Comparison of the three months ended September 30, 2010 and 2009
| | | | | | | | | | |
| | | | Three Months Ended
September 30, | | Increase | | % |
| | | | 2010 | | 2009 | | (Decrease) | | Change |
Revenues: | | | | | | | | |
| Rental income | $ | 125,876 | $ | 126,327 | $ | (451) | | (0.4) |
| Tenant recovery income | | 30,240 | | 31,877 | | (1,637) | | (5.1) |
| Other property income | | 3,684 | | 3,361 | | 323 | | 9.6 |
Expenses: | | | | | | | | |
| Property operating expenses | | (23,989) | | (28,894) | | (4,905) | | (17.0) |
| Real estate taxes | | (23,835) | | (23,547) | | 288 | | 1.2 |
Total net operating income | | 111,976 | | 109,124 | | 2,852 | | 2.6 |
Other income (expense): | | | | | | | | |
| Straight-line rental income | | 3,471 | | 1,757 | | 1,714 | | |
| Amortization of acquired above and below market lease intangibles | | 479 | | 590 | | (111) | | |
| Insurance captive income | | 847 | | 534 | | 313 | | |
| Dividend income | | 670 | | 1,689 | | (1,019) | | |
| Interest income | | 188 | | 174 | | 14 | | |
| Gain on contribution of investment properties | | 1,464 | | - | | 1,464 | | |
| Gain on interest rate locks | | - | | 3,989 | | (3,989) | | |
| Equity in income (loss) of unconsolidated joint ventures | | 875 | | (629) | | (1,504) | | |
| Straight-line ground rent expense | | (996) | | (992) | | 4 | | |
| Straight-line bad debt expense | | (190) | | (529) | | (339) | | |
| Depreciation and amortization | | (61,889) | | (62,401) | | (512) | | |
| Provision for impairment of investment properties | | (3,173) | | (6,700) | | (3,527) | | |
| Loss on lease terminations | | (4,465) | | (2,301) | | 2,164 | | |
| Insurance captive expenses | | (911) | | (960) | | (49) | | |
| General and administrative expenses | | (4,169) | | (4,691) | | (522) | | |
| Interest expense | | (67,090) | | (60,121) | | 6,969 | | |
| Co-venture obligation expense | | (1,791) | | - | | 1,791 | | |
| Recognized (loss) gain on marketable securities, net | | (235) | | 43,992 | | (44,227) | | |
| Impairment of note receivable | | - | | (413) | | (413) | | |
| Other expense | | (228) | | (64) | | 164 | | |
(Loss) income from continuing operations | | (25,167) | | 22,048 | | (47,215) | | (214.1) |
Discontinued operations: | | | | | | | | |
| Operating loss | | (39) | | (9,544) | | (9,505) | | |
Loss from discontinued operations | | (39) | | (9,544) | | (9,505) | | (99.6) |
| Net (loss) income | | (25,206) | | 12,504 | | (37,710) | | (301.6) |
| Net (income) loss attributable to noncontrolling interests | | (321) | | 81 | | (402) | | (496.3) |
Net (loss) income attributable to Company shareholders | $ | (25,527) | $ | 12,585 | $ | (38,112) | | (302.8) |
Net operating income increased by $2,852, or 2.6%. Total rental income, tenant recovery and other property income decreased by $1,765, or 1.1%, and total property operating expenses (inclusive of real estate taxes) decreased by $4,617, or 8.8%, for the three months ended September 30, 2010, as compared to September 30, 2009.
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Rental income. Rental income decreased $451, or 0.4%, from $126,327 to $125,876. The decrease is primarily due to:
·
a decrease of $944, composed of $4,991 as a result of expirations or early termination of certain tenant leases, partially offset by $4,047 from new tenant leases replacing former tenants; partially offset by
·
an increase of $229 in rental income due to a decline in rent reductions.
Tenant recovery income. Tenant recovery income decreased $1,637, or 5.1%, from $31,877 to $30,240. The decrease is primarily due to a decrease in recoverable property operating expenses described below.
Other property income. Other property income increased $323, or 9.6%, primarily due to a slight increase in termination fee income.
Property operating expenses. Property operating expenses decreased $4,905, or 17.0%, from $28,894 to $23,989. The decrease is primarily due to:
·
a decrease in bad debt expense of $2,705 and
·
a decrease in overall non-recoverable and recoverable property operating expenses of $825 and $1,381, respectively, due primarily to cost reduction efforts.
Real estate taxes. Real estate taxes increased $288 or 1.2%, from $23,547 to $23,835. This increase is primarily due to:
·
a net increase of $288 from 2009 real estate tax expense primarily due to normal changes in assessed values and tax rates;
·
an increase in tax consulting fees of $286 as a result of successful reductions to proposed increases to assessed valuations or tax rates at certain properties, and
·
an increase of $154 in prior year estimates adjusted during the three months ended September 30, 2010, based on actual real estate taxes paid; partially offset by
·
an increase of $419 in real estate tax refunds received during the three months ended September 30, 2010, for prior year tax assessment adjustments.
Other income (expense). Other income (expense) changed from net expense of $87,076 to net expense of $137,143. The increase in net expense of $50,067, or 57.5%, is primarily due to:
·
a $44,227 decrease in recognized gain on marketable securities due to a significant liquidation of the marketable securities portfolio in 2009 and
·
a $6,969 increase in interest expense primarily due to:
-
higher interest rates on refinanced debt resulting in an increase of $4,546, partially offset by a decrease in loan fee amortization interest expense of $620;
-
an increase of $4,091 related to the senior and junior mezzanine notes of IW JV;
-
prepayment penalties and other costs associated with refinancings of $110, partially offset by
-
a decrease in interest on our line of credit of $632 due primarily to a decrease in the amount outstanding on the line of credit;
-
a decrease in margin payable interest of $26 due to a decrease in the margin payable balance, partially offset by
·
a $3,527 decrease in provision of investment properties. Based on the results of our evaluations for impairment (see Notes 12 and 13 to the consolidated financial statements), we recognized impairment charges of $3,173 and $6,700 for the three months ended September 30, 2010 and 2009, respectively. Although 38 of our properties had impairment indicators at September 30, 2010, undiscounted cash flows for those properties exceeded their respective carrying values by a weighted average of 53%. Accordingly, no additional impairment provisions were warranted for these properties.
Discontinued operations. Discontinued operations consist of amounts related to eight properties that were sold during 2009 and five properties that were sold during the nine months ended September 30, 2010. We closed on the sale of eight
36
properties during the year ended December 31, 2009 aggregating 1,579,000 square feet, for a combined sales price of $338,057. The aggregated sales resulted in the extinguishment or repayment of $208,552 of debt, net sales proceeds totaling $123,944 and total gains on sale of $26,383. The properties sold included three office buildings, three single-user retail properties and two multi-tenant properties.
We did not sell any properties during the three months ended September 30, 2010 that qualified for discounted operations accounting treatment.
Comparison of the nine months ended September 2010 and 2009.
| | | | | | | | | | |
| | | | Nine Months Ended
September 30, | | Increase | | % |
| | | | 2010 | | 2009 | | (Decrease) | | Change |
Revenues: | | | | | | | | |
| Rental income | $ | 376,933 | $ | 384,062 | $ | (7,129) | | (1.9) |
| Tenant recovery income | | 91,055 | | 94,054 | | (2,999) | | (3.2) |
| Other property income | | 11,274 | | 15,547 | | (4,273) | | (27.5) |
Expenses: | | | | | | | | |
| Property operating expenses | | (76,988) | | (86,366) | | (9,378) | | (10.9) |
| Real estate taxes | | (69,498) | | (71,090) | | (1,592) | | (2.2) |
Total net operating income | | 332,776 | | 336,207 | | (3,431) | | (1.0) |
Other income (expense): | | | | | | | | |
| Straight-line rental income | | 8,750 | | 6,025 | | 2,725 | | |
| Amortization of acquired above and below market lease intangibles | | 1,523 | | 1,786 | | (263) | | |
| Insurance captive income | | 2,253 | | 1,671 | | 582 | | |
| Dividend income | | 3,034 | | 9,476 | | (6,442) | | |
| Interest income | | 548 | | 1,318 | | (770) | | |
| Gain on contribution of investment properties | | 1,464 | | - | | 1,464 | | |
| Gain on interest rate locks | | - | | 3,989 | | (3,989) | | |
| Equity in income (loss) of unconsolidated joint ventures | | 1,609 | | (5,262) | | (6,871) | | |
| Straight-line ground rent expense | | (3,121) | | (2,996) | | 125 | | |
| Straight-line bad debt expense | | (554) | | (2,894) | | (2,340) | | |
| Depreciation and amortization | | (185,845) | | (187,565) | | (1,720) | | |
| Provision for impairment of investment properties | | (18,836) | | (44,000) | | (25,164) | | |
| Loss on lease terminations | | (8,869) | | (11,556) | | (2,687) | | |
| Insurance captive expenses | | (3,034) | | (2,648) | | 386 | | |
| General and administrative expenses | | (13,412) | | (14,146) | | (734) | | |
| Interest expense | | (199,932) | | (170,752) | | 29,180 | | |
| Co-venture obligation expense | | (5,375) | | - | | 5,375 | | |
| Recognized gain on marketable securities, net | | 536 | | 17,798 | | (17,262) | | |
| Impairment of note receivable | | - | | (17,322) | | (17,322) | | |
| Other expense | | (5,518) | | (3,884) | | 1,634 | | |
Loss from continuing operations | | (92,003) | | (84,755) | | 7,248 | | 8.6 |
Discontinued operations: | | | | | | | | |
| Operating loss | | (1,830) | | (7,503) | | (5,673) | | |
| Gain on sales of investment properties | | 2,057 | | 21,570 | | (19,513) | | |
Income from discontinued operations | | 227 | | 14,067 | | (13,840) | | (98.4) |
| Net loss | | (91,776) | | (70,688) | | 21,088 | | 29.8 |
| Net (income) loss attributable to noncontrolling interests | | (656) | | 3,202 | | (3,858) | | (120.5) |
Net loss attributable to Company shareholders | $ | (92,432) | $ | (67,486) | $ | 24,946 | | 37.0 |
Net operating income decreased by $3,431, or 1.0%. Total rental income, tenant recovery and other property income decreased by $14,401, or 2.9%, and total property operating expenses (inclusive of real estate taxes) decreased by $10,970, or 7.0%, for the nine months ended September 30, 2010, as compared to September 30, 2009.
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Rental income. Rental income decreased $7,129, or 1.9%, from $384,062 to $376,933. The decrease is primarily due to:
·
a decrease of $3,255 in rental income due to tenant bankruptcies,
·
a decrease of $1,974 in rental income due to rent reductions, and
·
a decrease of $2,489, composed of $11,038 as a result of expirations or early termination of certain tenant leases, partially offset by $8,549 from new tenant leases replacing former tenants; partially offset by an increase of $298 due to earnouts completed subsequent to December 31, 2008.
Tenant recovery income. Tenant recovery income decreased $2,999, or 3.2%, from $94,054 to $91,055. The decrease is primarily due to a decrease in recoverable property operating expenses and real estate tax expenses described below, partially offset by an increase in the 2009 tenant recovery income estimates as a result of the common area maintenance reconciliation process completed during the nine months ended September 30, 2010.
Other property income. Other property income decreased $4,273, or 27.5%, primarily due to $5,000 recognized during the nine months ended September 30, 2009, related to the forfeiture of security deposits due to the bankruptcy of a major tenant.
Property operating expenses. Property operating expenses decreased $9,378, or 10.9%, from $86,366 to $76,988. The decrease is primarily due to:
·
a decrease in bad debt expense of $4,021, and
·
a decrease in overall non-recoverable and recoverable property operating expenses of $2,271 and $3,146, respectively, due primarily to cost reduction efforts.
Real estate taxes. Real estate taxes decreased $1,592, or 2.2%, from $71,090 to $69,498. This decrease is primarily due to:
·
an increase of $2,033 in real estate tax refunds received during the nine months ended September 30, 2010, for prior year tax assessment adjustments;
·
a net decrease of $156 from 2009 real estate tax expense primarily due to decreases in assessed values at certain vacant properties; and
·
a decrease of $119 in prior year estimates adjusted during the nine months ended September 30, 2010, based on actual real estate taxes paid, partially offset by
·
an increase in tax consulting fees of $784 as a result of successful reductions to proposed increases to assessed valuations or tax rates at certain properties.
Other income (expense). Other income (expense) changed from net expense of $420,962 to net expense of $424,779. The increase in net expense of $3,817, or 0.9%, is primarily due to a $29,180 increase in interest expense resulting from:
·
higher interest rates on refinanced debt resulting in an increase of $15,306 and additional loan fee amortization interest expense of $1,152;
·
an increase of $12,127 related to the senior and junior mezzanine notes of IW JV;
·
a decrease in capitalized interest of $899 due to certain phases of our developments being placed into service;
·
prepayment penalties and other costs associated with refinancings of $2,351, partially offset by
·
a decrease in interest on our line of credit of $292 due primarily to a decrease in the amount outstanding on the line of credit, and
·
a decrease of $176 in margin payable interest due to decreases in the margin payable balance.
Additionally, there was:
·
a $17,262 decrease in recognized gain on marketable securities primarily as a result of a significant liquidation of the marketable securities portfolio in 2009 and no other-than-temporary impairment recorded in 2010 as compared to other-than-temporary impairment of $24,831 recorded in 2009, partially offset by
·
a $17,322 decrease in impairment of a note receivable, and
38
·
a $25,164 decrease in provision for impairment of investment properties. Based on the results of our evaluations for impairment (see Notes 12 and 13 to the consolidated financial statements), we recognized impairment charges of $18,836 and $44,000 for the nine months ended September 30, 2010 and 2009, respectively. Although 38 of our properties had impairment indicators at September 30, 2010, undiscounted cash flows for those properties exceeded their respective carrying values by a weighted average of 53%. Accordingly, no additional impairment provisions were warranted for these properties.
Discontinued operations. During the nine months ended September 30, 2010, we completed the sale of five properties that qualified for discontinued operations accounting treatment aggregating 358,000 square feet, for a combined sale price of $80,185. The aggregated sales resulted in the extinguishment or repayment of $60,435 of debt, forgiveness of debt of $486, net sales proceeds totaling $18,416 and total gains on sale of $2,057. Discontinued operations also includes amounts related to eight properties that were sold during 2009.
Funds From Operations
One of our objectives is to provide cash distributions to our shareholders from cash generated by our operations. Cash generated from operations is not equivalent to our loss from continuing operations as determined under GAAP. Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts (NAREIT), an industry trade group, has promulgated a standard known as funds from operations, or FFO. We believe that FFO, which is a non-GAAP performance measure, provides an additional and useful means to assess the operating performance of REITs. As defined by NAREIT, FFO means net loss computed in accordance with GAAP, excluding gains (or losses) from sales of investment properties, plus depreciation and amortization on investment properties including adjustments for unconsolidated joint ventures in which the REIT holds an interest. We have adopted the NAREIT d efinition for computing FFO because management believes that, subject to the following limitations, FFO provides a basis for comparing our performance and operations to those of other REITs. FFO is not intended to be an alternative to “Net Income” as an indicator of our performance nor to “Cash Flows from Operating Activities” as determined by GAAP as a measure of our capacity to pay distributions.
FFO is calculated as follows:
| | | | | | | | |
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, |
| | 2010 | | 2009 | | 2010 | | 2009 |
Net (loss) income attributable to Company shareholders | $ | (25,527) | $ | 12,585 | $ | (92,432) | $ | (67,486) |
Add: | | | | | | | | |
Depreciation and amortization | | 67,171 | | 67,189 | | 198,806 | | 211,987 |
Less: | | | | | | | | |
Gain on sales/contributions of investment properties* | | (2,248) | | - | | (3,778) | | (19,574) |
Noncontrolling interests' share of depreciation | | | | | | | | |
related to consolidated joint ventures | | (2,837) | | (648) | | (8,439) | | (2,231) |
Funds from operations | $ | 36,559 | $ | 79,126 | $ | 94,157 | $ | 122,696 |
| | | | | | | | |
*excludes gain or loss on extinguishment of debt | | | | | | | | |
Depreciation and amortization related to investment properties for purposes of calculating FFO includes loss on lease terminations which encompasses the write-off of tenant related assets, including tenant improvements and in-place lease values, as a result of early lease terminations. Total loss on lease terminations for the three months ended September 30, 2010 and 2009 were $4,465 and $2,301, respectively. Total loss on lease terminations for the nine months ended September 30, 2010 and 2009 were $8,869 and $11,556, respectively.
The decrease in FFO for three months ended September 30, 2010 compared to the same period in 2009 is primarily due to a change in recognized (loss) gain on marketable securities of $44,227 and an increase in interest expense of $6,969, partially offset by a decrease in property operating expenses of $5,240 and a decrease in impairment on investment properties of $3,527.
The decrease in FFO for nine months ended September 30, 2010 compared to the same period in 2009 is primarily due to an increase in interest expense of $29,180, a change in recognized gains (losses) on marketable securities of $17,262, a
39
decrease in income from discontinued operations of $13,840, a decrease in revenues of $11,357, a decrease in dividend income of $6,442, an increase in co-venture obligation expense of $5,375, and a decrease in gain on interest rate locks of $3,989, partially offset by a decrease in impairment on investment properties of $25,164, a decrease in impairment of a note receivable of $17,322, a decrease in property operating expenses of $11,593, and a change in equity in income (loss) of unconsolidated joint ventures of $6,871.
The following table compares cash flows provided by operating activities to distributions declared:
| | | | | | | | | |
| | Three Months Ended
September 30, | | | Nine Months Ended
September 30, |
| | 2010 | | 2009 | | | 2010 | | 2009 |
Cash flows provided by operating activities | $ | 59,661 | $ | 78,785 | | $ | 153,672 | $ | 203,963 |
Distributions declared | | 24,248 | | 12,029 | | | 67,728 | | 59,383 |
Excess | $ | 35,413 | $ | 66,756 | | $ | 85,944 | $ | 144,580 |
Distributions declared per common share are based upon the weighted average number of common shares outstanding. The distribution of $0.14 per share declared for the nine months ended September 30, 2010, represented 71.9% of our FFO for the period. The $0.12 per share distribution declared for the nine months ended September 30, 2009, represented 48.4% of our FFO for the period. Our distribution of current and accumulated earnings and profits for federal income tax purposes are taxable to shareholders as ordinary income. Distributions in excess of these earnings and profits generally are treated as a non-taxable reduction of the shareholders’ basis in the shares to the extent thereof (a return of capital) and thereafter as taxable gain. The distributions in excess of earnings and profits will have the effect of deferring taxation on the amount of the distribution until the sale of the shareholde rs’ shares. The balance of the distribution constitutes ordinary income. In order to maintain our qualification as a REIT, we must make annual distributions to shareholders of at least 90% of our REIT taxable income. REIT taxable income does not include capital gains. Under certain circumstances, we may be required to make distributions in excess of cash available for distribution in order to meet the REIT distribution requirements. Distributions declared and paid are determined by our board of directors and are dependent on a number of factors, including the amount of funds available for distribution, flow of funds, our financial condition, any decision by our board of directors to reinvest funds rather than to distribute the funds, our capital expenditures, the annual distribution required to maintain REIT status under the Code, credit agreement limitations and other factors the board of directors may deem relevant.
Liquidity and Capital Resources
Current Environment
Real estate is a capital intensive business. The recession and credit crisis had a major impact on the credit markets, including the failure of several large financial service companies. Our main focus over the last few years has been evaluating our capital resources and our refinancing opportunities.
The debt capital markets have been volatile and challenging and numerous financial institutions have experienced unprecedented write-offs and liquidity issues. The cost of capital is higher, loan-to-values are lower and the availability of funds from commercial and investment banks can be limited. Life insurance companies are more selective in relation to new lending opportunities, with the overall trend in lending emphasizing quality of sponsorship and strength of relationship as critical factors in the decision making process. Deposits from borrowers may now also be required in order to extend credit.
Part of our overall strategy includes actively addressing debt that has matured or is maturing, and evaluating alternative courses of action given the uncertainty in the capital markets. We intend to maintain a balance in the amount and timing of our debt maturities upon refinance. Based on our current assessment, we believe we have viable refinancing alternatives, but such alternatives may materially impact our expected consolidated financial results due to higher interest rates. Higher interest rates may be offset by lower debt levels as we continue to pay down principal upon refinance in our attempt to reduce outstanding debt on our consolidated balance sheets. Although the credit environment continues to be challenging, we believe that the credit markets have opened up considerably when compared to the last few years. As such, we continue to pursue opportunities with the nation’s largest ban ks, life insurance companies, regional and local banks and believe we have demonstrated success in addressing our maturing debt.
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We continued to dispose of non-core assets as a means of recycling capital, despite a challenging transaction market. In addition, as part of our overall liquidity strategy, we continue to enter into joint ventures such as RC Inland where we retain a 20% interest. For the nine months ended September 30, 2010, we completed the sale of one single-user office building, one medical center and three single-user retail properties aggregating 358,000 square feet, for a combined sale price of $80,185. The aggregated sales resulted in net sales proceeds totaling $18,416, and total gain on sale of $2,057 relating to the carrying costs of these assets. For the three and nine months ended September 30, 2010, we completed partial sales of three multi-tenant retail properties to RC Inland aggregating 352,400 square feet for a combined sales price of $47,137. The aggregated sales resulted in net sales proceeds tota ling $13,367 and total gain on partial sale of $1,464. During 2009, we sold eight properties, of which four were sold during the nine months ended September 30, 2009, aggregating 1,142,800 square feet, for a combined sales price of $226,632. The aggregated sales resulted in net sales proceeds totaling $83,686 and total gains on sale of $21,570. No properties were sold during the three months ended September 30, 2009.
At the current operating levels, we anticipate that cash flows from operating activities will continue to provide adequate capital for all scheduled interest and monthly principal payments on outstanding indebtedness and distribution payments in order to maintain REIT status. We are committed to managing and minimizing discretionary operating and capital expenditures, obtaining the necessary equity and/or debt to repay outstanding borrowings as they mature and complying with financial covenants in 2010 and beyond. In light of current economic conditions, we may not be able to obtain loan extensions or financing on favorable terms, or at all, in order to meet principal maturity obligations on certain of our indebtedness, which may cause an acceleration of our secured line of credit and remedies available to lenders on assets securing matured mortgage debt, each of which could significantly impact future operations, liq uidity and cash flows available for distribution.
General
We remain focused on our balance sheet, identifying future financings at reasonable pricing and selectively evaluating acquisition opportunities created by the distress in the financial markets. Our strategy has been and continues to be to procure financing on an individual asset, non-recourse basis to preserve our corporate credit. This strategy reflects our primary interest in maintaining a strong balance sheet, while attempting to capitalize on attractive investment opportunities that have been created by current market conditions. We continue to review prospective investments based upon risk and return attributes, although there currently appear to be few such opportunities.
As of September 30, 2010, we had cash and cash equivalents of $116,016. As we execute our stated business strategy, we remain a net seller of assets, evidenced by the divestiture of certain recently developed assets and non-core assets. These asset sales are primarily designed to assist in the pay down of 2010 debt maturities. However, there can be no assurance that future sales will occur, or if they do occur, that they will materially assist in reducing our indebtedness.
As of December 31, 2009, we had $1,156,384 of mortgages payable, excluding amortization and liabilities associated with assets held for sale, which had matured or were maturing in 2010. The table below presents the remaining mortgages payable to be addressed as of September 30, 2010, excluding liabilities associated with the investment properties held for sale. The 2010 column includes $125,756 of mortgages payable that had matured as of September 30, 2010 and $114,332 of mortgages payable maturing in the remainder of 2010.
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During the nine months ended September 30, 2010, we obtained mortgage payable proceeds of $604,468, made mortgage payable repayments of $771,872 and received debt forgiveness of $19,561. In addition, RC Inland assumed $29,327 of mortgages payable from us on September 30, 2010. The new mortgages payable that we entered into during the nine months ended September 30, 2010 have interest rates ranging from 2.48% to 8.00% and maturities up to ten years. The stated interest rates of the loans repaid during the nine months ended September 30, 2010 ranged from 1.65% to 6.75%. We also entered into modifications of existing loan agreements which extended the maturities of $185,659 of mortgages payable up to December 2012. As we address our maturing mortgages payable, we have reduced our overall debt and staggered future mortgage maturity dates so that no more than $580,000 will come due in any one year.
In evaluating our maturing mortgage debt, based on management’s current assessment, to the extent we obtain viable financing and refinancing alternatives, available alternatives may have a material adverse impact on our expected financial results as lenders have increased the cost of debt financing and tightened their underwriting standards. As of September 30, 2010, we had $125,756 of mortgages payable that had matured. During the second quarter of 2010, in order to prompt discussions with the lenders, we ceased making monthly debt service payments on two mortgage loans totaling $61,235 as of September 30, 2010, $29,965 of which has matured and is included in the $125,756 of total matured debt. Our non-payment of these monthly debt service payments amounts to $3,000 annualized and does not result in our noncompliance under any of our other mortgages payable and line of credit agreements. We are curre ntly in active negotiations with the lenders to determine an appropriate course of action under the non-recourse loan agreements, but there has been no change in the status of these two loans since we ceased making payments. No assurance can be provided that these negotiations will result in favorable outcomes for us. One of the lenders has asserted that certain events have occurred that trigger recourse to us. However, we believe that we have substantive defenses with respect to those claims.
As of September 30, 2010, in addition to the $125,756 that had matured, we had $114,332 of mortgages payable, excluding principal amortization and liabilities associated with the investment properties held for sale, maturing in the remainder of 2010. Of this amount, we have since refinanced $21,366. On January 8, 2010, we entered into a $300,000 forward loan commitment with JP Morgan Chase, subject to customary lender due diligence, to be used to refinance 2010 debt maturities, of which $244,500 has been utilized as of September 30, 2010. In addition to allocating the remaining proceeds of $55,500 ($20,300 as of the date of this filing), we are in the process of marketing, planning to seek extensions or planning to sell properties relating to the remaining 2010 maturities. As we continue our efforts to refinance our maturing mortgage debt, certain of our non-recourse loans may mature due to lack of replace ment financings, timing issues related to loan closings and protracted extension negotiations. Subject to limitations, such maturities are not prohibited under our credit agreement (see Note 9 to the consolidated financial statements). The balance outstanding on the line of credit, which matures on October 14, 2011, was $148,242 at September 30, 2010. No assurance can be provided that the aforementioned obligations will be refinanced, extended or repaid as currently anticipated.
Our leases typically provide that the tenant bears responsibility for their pro-rata share of a majority of all property costs and expenses associated with ongoing maintenance and operation, including, but not limited to, utilities, property taxes and insurance. In addition, in some instances our leases provide that the tenant is responsible for their pro-rata share of roof and structural repairs. Certain of our properties are subject to leases under which we retain responsibility for certain costs and expenses associated with the property. We anticipate that capital demands to meet obligations related to capital improvements with respect to properties will be minimal for the foreseeable future (as many of our properties have recently been constructed or rehabbed) and can be met with funds from operations and working capital.
We believe that our current capital resources (including cash on hand and marketable securities, net of margin debt) and anticipated refinancings are sufficient to meet our liquidity needs for the remainder of 2010 (except as it relates to the mortgage loans where we have ceased making monthly debt service payments, as described above). We further believe that our individually procured, non-recourse indebtedness positions us well for our refinancing efforts for the rest of 2010 and beyond. We intend to seek refinancing on all of our remaining indebtedness coming due in 2010 (except as it relates to the mortgage loans where we have ceased making monthly debt service payments, as described above). However, when we deem appropriate, we will seek extensions of the existing indebtedness. We cannot provide assurance that the lenders will agree to such extension requests; however, given the non-recourse nature of our indebtedness, we believe lenders will have few viable options other than to agree to our extension requests. We also believe that being a net seller of real estate assets in 2010 continues to benefit our cash position and assist us in our ongoing refinancing efforts.
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Liquidity
We anticipate that cash flows from operating activities will continue to provide adequate capital for all scheduled interest and monthly principal payments on outstanding indebtedness, current and anticipated tenant improvement or other capital obligations, the shareholder distribution required to maintain REIT status and compliance with financial covenants of our credit agreement in 2010 and beyond. To assist in the refinancing needs, we intend to utilize a combination of: proceeds from expected asset sales; and retained capital as a result of the suspension of the share repurchase program and the change in the distribution policy. Distributions declared and paid are determined by our board of directors and are dependent on a number of factors, including the amount of funds available for distribution, flow of funds, our financial condition, any decision by our board of directors to reinvest funds rather than to distr ibute the funds, our capital expenditures, the annual distribution required to maintain REIT status under the Code, credit agreement limitations and other factors the board of directors may deem relevant.
In addition, we are pursuing refinancings and extensions in order to fund our debt repayments and, to the extent deemed appropriate, minimizing further capital expenditures. While we review numerous investment opportunities, we do not expect to invest significant capital in these investment opportunities until debt maturities are appropriately addressed.
Our primary uses and sources of our consolidated cash are as follows:
| | |
Uses | | Sources |
Short-Term: | | |
· Tenant improvement allowances · Improvements made to individual properties that are not recoverable through common area maintenance charges to tenants · Distribution payments · Debt repayment requirements, including principal, interest and costs to refinance · Corporate and administrative expenses | | · Operating cash flow · Available borrowings under revolving credit facilities · Distribution reinvestment plan · Secured loans collateralized by individual properties · Asset sales |
Long-Term: | | |
· Acquisitions · New development · Major redevelopment, renovation or expansion programs at individual properties · Debt repayment requirements, including both principal and interest | | · Secured loans collateralized by individual properties · Long-term project financing · Joint venture financing with institutional partners · Marketable securities · Asset sales |
Mortgages and Notes Payable. Mortgages payable outstanding as of September 30, 2010, excluding liabilities associated with the investment properties held for sale, were $3,572,538 (of which $56,872, or 2%, is recourse to us up to August 1, 2014) and had a weighted average interest rate of 6.08% at September 30, 2010. Of this amount, $3,468,730 had fixed rates ranging from 3.81% to 10.11% and a weighted average fixed rate of 6.12% at September 30, 2010. The remaining $103,808 of outstanding indebtedness represented variable rate loans with a weighted average interest rate of 4.47% at September 30, 2010. Properties with a net carrying value of $5,268,158 at September 30, 2010 and related tenant leases are pledged as collateral for the mortgage loans. Development properties with a net carrying value of $90,709 at September 30, 2010 and related tenant leases are pledged as collateral for the const ruction loans. As of September 30, 2010, scheduled maturities for our outstanding mortgage indebtedness had various due dates through March 1, 2037.
Notes payable outstanding as of September 30, 2010 were $175,000. These notes payable had fixed interest rates ranging from 4.80% to 14.0% and a weighted average fixed interest rate of 10.51% at September 30, 2010.
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Shareholder Liquidity. Effective November 19, 2008, the board of directors voted to suspend the SRP until further notice.
We maintain a DRP, subject to certain share ownership restrictions, which allows our shareholders who have purchased shares in our offerings to automatically reinvest distributions by purchasing additional shares from us. Such purchases under the DRP are not subject to selling commissions or the marketing contribution and due diligence expense allowance. In conjunction with our estimate of the value of a share of our stock for annual statement of value purposes, the board of directors amended our DRP, effective March 1, 2010, solely to modify the purchase price. Thus, on or after March 1, 2010, additional shares of our stock purchased under the DRP have been and will continue to be purchased at a price of $6.85 per share. In the event (if ever) of a listing on a national securities exchange, shares purchased by us for the DRP will be purchased on such exchange or market at the then prevailing market price a nd will be sold to participants at that price. As of September 30, 2010, we had issued 69,314 shares pursuant to the DRP for an aggregate amount of $666,125.
Capital Resources
The following table summarizes our capital structure as of January 1, 2009 and September 30, 2010:
![[iwest10q0930004.gif]](https://capedge.com/proxy/10-Q/0001222840-10-000017/iwest10q0930004.gif)
(a) “Other” includes other financings, co-venture obligation, redeemable noncontrolling interests and noncontrolling interests
We have a credit agreement with KeyBank National Association and other financial institutions for borrowings up to $200,000, subject to the collateral pool requirement described below. Based on the appraised value of the collateral pool, our ability to borrow was limited to $153,051 as of September 30, 2010. The credit agreement has a maturity date of October 14, 2011. The credit agreement requires compliance with certain covenants, such as, among other things, a leverage ratio, fixed charge coverage, minimum net worth requirements, distribution limitations and investment restrictions, as well as limitations on our ability to incur recourse indebtedness. The credit agreement also contains customary default provisions including the failure to timely pay debt service payable thereunder, the failure to comply with our financial and operating covenants, and the failure to pay when our con solidated indebtedness becomes due. In the event our lenders under the credit agreement declare a default, as defined in the credit agreement, this could result in an acceleration of any outstanding borrowings on the line of credit.
The terms of the credit agreement stipulate, as of September 30, 2010:
| | |
· | | monthly interest-only payments on the outstanding balance at the rate equal to LIBOR (3% floor) plus 3.50%; |
· | | quarterly fees ranging from 0.35% to 0.50%, per annum, on the average daily undrawn funds; |
· | | pay down of the line from net proceeds of asset sales; |
· | | an assignment of corporate cash flow in the event of default; |
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| | |
· | | the requirement for a comprehensive collateral pool (secured by mortgage interests in each asset) subject to certain covenants, including a maximum advance rate on the appraised value of the collateral pool of 60%, minimum requirements related to the value of the collateral pool and the number of properties included in the collateral pool, and debt service coverage, and |
· | | permissions for non-recourse cross-default up to $250,000 and permissions for maturity defaults under non-recourse indebtedness for up to 90 days subject to extension at discretion of the lenders. |
As of September 30, 2010, management believes we were in compliance with all of the financial covenants under our credit agreement. The outstanding balance on the line of credit at September 30, 2010 and December 31, 2009 was $148,242 and $107,000, respectively.
Our current business plans indicate that we will be able to operate in compliance with these covenants, in 2010 and beyond; however, the recession and tepid recovery have significantly impacted our expected cash flows, access to non-recourse mortgage capital, our financial position and effective leverage. If the global credit market conditions were to weaken again, or if there is further softening in the retail and real estate industries and a further weakening in consumer confidence leading to a decline in consumer spending such that we are unable to successfully execute plans as further described below, we could violate these covenants, and as a result may be subject to higher finance costs and fees and/or an acceleration of the maturity date of advances under the credit agreement. These risk factors and an inability to predict future economic conditions have encouraged us to adopt a strict focus on lowering leverage and increasing financial flexibility.
It is management’s current strategy to have access to the capital resources necessary to repay upcoming maturities and, to a lesser extent, to consider making prudent investments should such opportunities arise. Accordingly, we may seek to obtain funds through additional debt or equity financings and/or joint venture capital in a manner consistent with our intention to operate with a conservative debt capitalization policy. In light of the current economic conditions, we may not be able to obtain financing on favorable terms, or at all, which may negatively impact future cash flows available for distribution. Foreclosure on mortgaged properties as a result of an inability to refinance existing indebtedness would have a negative impact on our consolidated financial condition and results of operations.
On January 8, 2010, we entered into a $300,000 forward loan commitment with JP Morgan Chase, subject to customary lender due diligence, to be used to refinance 2010 debt maturities. In conjunction with this commitment, we also entered into a rate lock agreement to lock the interest rate at 6.39%. We made deposits of $8,500 related to both of these agreements. Subsequent to entering into these agreements, we made additional rate lock deposits of $4,067. The loan commitment agreement originally expired on March 31, 2010, but was extended to December 31, 2010. The rate lock agreement originally expired on February 10, 2010, but was extended to November 30, 2010. As of September 30, 2010, we had used $244,500 of the total commitment proceeds and received refunds of commitment and rate lock deposits of $9,885. We are in the process of allocating the remaining commitments of $55,500 ($20,300 as of the date of this filing) and, if successful, will receive a full refund of the remaining deposits upon loan closings. The carrying value of the commitment and rate lock deposits outstanding as of September 30, 2010 was $2,682.
The majority of our loans require monthly payments of interest only, although it has become more common for lenders to require principal and interest payments, as well as reserves for real estate taxes, insurance and certain other costs. Although the loans we obtain are generally non-recourse, occasionally, when it is deemed to be necessary, we may guarantee all or a portion of the debt on a full-recourse basis. As of September 30, 2010, we had guaranteed $148,242 of the outstanding secured line of credit and $56,872 of the outstanding mortgages payable with maturity dates up to August 1, 2014 (see Note 14 to the consolidated financial statements), respectively. At times, we have borrowed funds financed as part of a cross-collateralized package, with cross-default provisions, in order to enhance the financial benefits. In those circumstances, one or more of the properties may secure the debt of another of o ur properties. Individual decisions regarding interest rates, loan-to-value, debt yield, fixed versus variable-rate financing, term and related matters are often based on the condition of the financial markets at the time the debt is issued, which may vary from time to time.
Distributions declared and paid are determined by our board of directors and are dependent on a number of factors, including the amount of funds available for distribution, flow of funds, our financial condition, any decision by our board of directors to reinvest funds rather than to distribute the funds, our capital expenditures, the annual distribution required to maintain REIT status under the Code, credit agreement limitations and other factors the board of directors may deem relevant.
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Statements of Cash Flows Comparison for the Nine Months Ended September 30, 2010 and 2009
Cash Flows from Operating Activities
Cash flows provided by operating activities were $153,672 and $203,963 for the nine months ended September 30, 2010 and 2009, respectively, which consists primarily of net income from property operations, adjusted for non-cash charges for depreciation and amortization, provision for impairment of investment properties and marketable securities and gain on extinguishment of debt. The $50,291 decrease is primarily attributable to an increase in interest paid of $23,885 which resulted, in part, from our refinancing efforts, a decrease in dividends received of $7,527, an increase in the cash portion of co-venture obligation expense of $4,542 and a decrease in NOI of $3,431.
Cash Flows from Investing Activities
Cash flows provided by investing activities were $19,845 and $161,200, respectively, for the nine months ended September 30, 2010 and 2009. Of these amounts, $47,416 and $25,101, respectively, were used to fund restricted escrow accounts, some of which are required under certain new mortgage debt arrangements. In addition, $23,321 and $32,661, respectively, were used for acquisition of new properties, earnouts at existing properties, capital expenditures and tenant improvements and $2,705 and $14,491, respectively, were used for existing developments projects during the nine months ended September 30, 2010 and 2009. During the nine months ended September 30, 2010 and 2009, we sold five and four properties, respectively, which resulted in sales proceeds of $78,851 and $117,316, respectively. During the nine months ended September 30, 2010, we contributed three properties to an unconsolidated joint venture, which resulted in proceeds of $13,367. In addition, during the nine months ended September 30, 2010 and 2009, we purchased marketable securities of none and $190, respectively, and sold marketable securities of $3,900 and $124,340, respectively.
We will continue to execute our strategy to dispose of select non-core assets, however it is uncertain given current market conditions when and whether we will be successful in disposing of these assets and whether such sales could recover our original cost. Additionally, tenant improvement costs associated with re-leasing vacant space could continue to be significant.
Cash Flows from Financing Activities
Cash flows used in financing activities were $183,405 and $300,604, respectively, for the nine months ended September 30, 2010 and 2009. We used $165,877 and $202,645, respectively, for the nine months ended September 30, 2010 and 2009, related to the net activity from proceeds from new mortgages secured by our properties, the secured line of credit, other financings, the co-venture arrangement, principal payments, payoffs and the payment and refund of fees and deposits. During the nine months ended September 30, 2010 and 2009, we also generated/(used) $18,154 and $(56,340), respectively, through the net borrowing of margin debt. We paid $35,783 and $40,548, respectively, in distributions, net of distributions reinvested through DRP, to our shareholders for the nine months ended September 30, 2010 and 2009.
Effects of Transactions with Related and Certain Other Parties
See Note 4 – Transactions with Related Parties in our consolidated financial statements, and our Form 10-K for the year ended December 31, 2009, as amended.
Off-Balance Sheet Arrangements, Contractual Obligations, Liabilities and Contracts and Commitments
Contracts and Commitments
We have acquired several properties which have earnout components, meaning that we did not pay for portions of these properties that were not rent producing at the time of acquisition. We are obligated, under these agreements, to pay for those portions, as additional purchase price, when a tenant moves into its space and begins to pay rent. The earnout payments are based on a predetermined formula. Each earnout agreement has a time limit regarding the obligation to pay any additional monies. The time limits generally range from one to three years. If, at the end of the time period allowed, certain space has not been leased and occupied, generally, we will generally not have any further payment obligation. As of September 30, 2010, based on pro-forma leasing rates, we may pay as much as $1,400 in the future as retail space covered by earnout agreements is occupied and becomes rent producing.
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We have previously entered into one construction loan agreement, one secured installment note and one other installment note agreement, one of which was impaired as of December 31, 2009 and written off on March 31, 2010. In conjunction with the two remaining note agreements, we have committed to fund up to a total of $8,680. One of the two remaining loans September 30, 2010 and December 31, 2009 was $8,310 and $8,330, respectively, net of allowances of $300 and $17,209, respectively. We are not required to fund any additional amounts on these loans as all of the agreements are non-revolving and all fundings have occurred. In May 2010, we entered into an agreement related to the secured installment note that extended the maturity date from May 31, 2010 to February 29, 2012.
Although the loans we obtain are generally non-recourse, occasionally, when it is deemed to be necessary, we may guarantee all or a portion of the debt on a full-recourse basis. As of September 30, 2010, we had guaranteed $148,242 and $28,349 of the outstanding secured line of credit and mortgage loans, respectively, with maturity dates up to August 1, 2014. We also guaranteed $28,523 representing a portion of the construction debt associated with certain of the consolidated development joint ventures. The guarantees are released as certain leasing parameters are met.
As of September 30, 2010, we had two letters of credit outstanding for the benefit of the Captive. These letters of credit serve as collateral for payment of potential claims within the limits of self-insurance and will remain outstanding until all claims are closed. There was also one letter of credit outstanding as security for utilities and completion of one development project. The balance of the outstanding letters of credit at September 30, 2010 was $4,400.
On January 8, 2010, we entered into a $300,000 forward loan commitment with JP Morgan Chase, subject to customary lender due diligence, to be used to refinance 2010 debt maturities. In conjunction with this commitment, we also entered into a rate lock agreement to lock the interest rate at 6.39%. We made deposits of $8,500 related to both of these agreements. Subsequent to entering into these agreements, we made additional rate lock deposits of $4,067. The loan commitment agreement originally expired on March 31, 2010, but was extended to December 31, 2010. The rate lock agreement originally expired on February 10, 2010, but was extended to November 30, 2010. As of September 30, 2010, we had used $244,500 of the total commitment proceeds and received refunds of commitment and rate lock deposits of $9,885. We are in the process of allocating the remaining commitments of $55,500 ($20,300 as of th e date of this filing) and, if successful, will receive a full refund of the remaining deposits upon loan closings. The carrying value of the commitment and rate lock deposits outstanding as of September 30, 2010 was $2,682.
Subsequent Events
During the period from October 1, 2010 through the date of this 10-Q filing, we:
·
closed on partial sales of four additional properties to RC Inland, consisting of approximately 515,000 square feet, with sales prices totaling $56,441, which resulted in net losses of $3,670, net proceeds of $19,410 and in RC Inland assuming $31,688 of mortgage debt;
·
sold 328 shares of two different securities for net proceeds of $4,729 (resulting in estimated realized net gains of $3,481), which were used to pay down margin debt;
·
paid down $8,895 on the line of credit using proceeds from one property acquired by RC Inland;
·
extended the rate lock agreement from October 31, 2010 to November 30, 2010 and the loan commitment agreement from October 29, 2010 to December 31, 2010, and
·
obtained mortgage payable proceeds of $35,200 and made mortgage payable repayments of $46,351. The new mortgages payable have interest rates of 6.39% and mature in five years. The stated interest rates of the loans repaid ranged from 4.79% to 5.13%.
On October 12, 2010, under our Independent Director Stock Option Plan, each non-employee, non-related party, director was granted options to purchase an additional five thousand shares of common stock.
Robert D. Parks, our Chairman, did not stand for re-election at the Annual Meeting of Shareholders held on October 12, 2010. Gerald M. Gorski, a Director of ours since July 1, 2003, was elected to the position of Chairman at the board of directors meeting held immediately following the Shareholders’ meeting on October 12, 2010.
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New Accounting Pronouncements
See Note 2 – Summary of Significant Accounting Policies to our consolidated financial statements regarding certain new accounting pronouncements that we have recently adopted and that we expect to adopt in 2010.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We may be exposed to interest rate changes primarily as a result of long-term debt used to maintain liquidity and fund capital expenditures and expansion of our real estate investment portfolio and operations. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve our objectives we borrow primarily at fixed rates or variable rates with the lowest margins available and in some cases, with the ability to convert variable rates to fixed rates.
On January 8, 2010, we entered into a $300,000 forward loan commitment with JP Morgan Chase, subject to customary lender due diligence, to be used to refinance 2010 debt maturities. In conjunction with this commitment, we also entered into a rate lock agreement to lock the interest rate at 6.39%. We made deposits of $8,500 related to both of these agreements. Subsequent to entering into these agreements, we made additional rate lock deposits of $4,067. The loan commitment agreement originally expired on March 31, 2010, but was extended to December 31, 2010. The rate lock agreement originally expired on February 10, 2010, but was extended to November 30, 2010. As of September 30, 2010, we had used $244,500 of the total commitment proceeds and received refunds of commitment and rate lock deposits of $9,885. We are in the process of allocating the remaining commitments of $55,500 ($20,300 as of th e date of this filing) and, if successful, will receive a full refund of the remaining deposits upon loan closings. The carrying value of the commitment and rate lock deposits outstanding as of September 30, 2010 was $2,682.
With regard to variable-rate financing, we assess interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. We maintain risk management control systems to monitor interest rate cash flow risk attributable to both of our outstanding or forecasted debt obligations as well as our potential offsetting hedge positions. The risk management control systems involve the use of analytical techniques, including cash flow sensitivity analysis, to estimate the expected impact of changes in interest rates on our future cash flows.
We may use additional derivative financial instruments to hedge exposures to changes in interest rates on loans secured by our properties. To the extent we do, we are exposed to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes us, which creates credit risk for us. When the fair value of a derivative contract is negative, we owe the counterparty and, therefore, we generally are not exposed to the credit risk of the counterparty. It is our policy to enter into these transactions with the same party providing the financing, with the right of offset. Alternatively, we will minimize the credit risk in derivative instruments by entering into transactions with high-quality counterparties. Market risk is the adverse effect on the value o f a financial instrument that results from a change in interest rates. The market risk associated with interest-rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.
The carrying amount of our mortgages payable, notes payable, line of credit and co-venture obligation is approximately $8,098 lower than fair value as of September 30, 2010.
We had $270,204 of variable-rate debt with a weighted average interest rate of 4.64% at September 30, 2010. An increase in the variable interest rate on this debt constitutes a market risk. If interest rates increase by 1% based on debt outstanding as of September 30, 2010, interest expense would increase by approximately $2,702 on an annualized basis.
We are exposed to equity price risk as a result of our investments in marketable securities. Equity price risk changes as the volatility of equity prices changes or the values of corresponding equity indices change.
Other-than-temporary impairments were none and $24,831 for the nine months ended September 30, 2010 and 2009, respectively. The overall stock market and REIT stocks have been stable since late 2007, which in 2009 resulted in our recognizing other-than-temporary impairments in our REIT stock investments. At this point in time, certain of our investments continue to generate dividend income, while other investments of ours have ceased generating dividend
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income or are doing so at reduced rates. As the equity market recovers, we have been able to sell some marketable securities at prices in excess of our current book values.
The information presented herein is merely an estimate and has limited predictive value. As a result, the ultimate realized gain or loss with respect to interest rate fluctuations will depend on the interest rate exposures that arise during the period, our hedging strategies at that time and future changes in the level of interest rates.
Item 4. Controls and Procedures
We have established disclosure controls and procedures to ensure that material information relating to us, including our consolidated subsidiaries, is made known to the officers who certify our financial reports and to the members of senior management and the board of directors.
Based on management’s evaluation as of September 30, 2010, our chief executive officer, president, chief financial officer and treasurer and chief accounting officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective to ensure that the information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to our management, including our chief executive officer, president, chief financial officer and treasurer and our chief accounting officer to allow timely decisions regarding required disclosure.
There were no changes to our internal controls over financial reporting during the fiscal quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
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Part II – Other Information
Item 1. Legal Proceedings
We previously disclosed in our Form 10-K, as amended, for the fiscal years ended December 31, 2009, December 31, 2008 and December 31, 2007, respectively, the lawsuit filed against us and nineteen other defendants by City of St. Clair Shores General Employees Retirement System and Madison Investment Trust in the United States District Court for the Northern District of Illinois. We previously disclosed in our Form 8-K filed on July 20, 2010, that on July 14, 2010, the lawsuit was settled by us and all other defendants (the “Settlement”), subject to preliminary and final approval by the Court and neither we nor Daniel L. Goodwin (who beneficially owned more than 5% of our stock as of December 31, 2009) exercising a right to terminate the Settlement if class members holding more than an agreed-upon percentage of shares elected to opt out of the Settlement. Following notice of the Settlement to the class members, seven class members elected to opt out of the Settlement. The right to terminate the Settlement was not triggered based on the number of shares held by these seven class members. On November 8, 2010, the Court granted final approval of the Settlement.
Item 1A. Risk Factors
There have been no material changes to our risk factors during the nine months ended September 30, 2010 compared to those risk factors presented in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2009.
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Item 6. Exhibits
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Exhibit No. | Description |
31.1 | Certification of Chief Executive Officer, President, Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934 (filed herewith). |
31.2 | Certification of Chief Accounting Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934 (filed herewith). |
32.1 | Certification of Chief Executive Officer, President, Chief Financial Officer and Treasurer and Chief Accounting Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 (filed herewith). |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
INLAND WESTERN RETAIL REAL ESTATE TRUST, INC.
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By: | /s/ Steven P. Grimes | |
| |
| Steven P. Grimes |
| Chief Executive Officer, President, Chief Financial Officer and Treasurer |
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Date: | November 10, 2010 |
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By: | /s/ James W. Kleifges | |
| |
| James W. Kleifges |
| Chief Accounting Officer |
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Date: | November 10, 2010 |
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