On June 22, 2004, S And A closed on its contract for the sale of the Olney Town Center (“OTC”) in Olney, Maryland. The sale price for the property was $28.2 million. The property was acquired in April 2000 for approximately $15.5 million. S And A utilized part of the selling price to repay the approximate $11 million first mortgage on the property. The operations of OTC are being classified as Discontinued Operations. For financial statement proposes, S And A recognized a gain of approximately $12.8 million from the sale.
On April 16, 2004, S And A closed on the purchase of The Pierre apartments. The Pierre is a 269-unit luxury high-rise apartment building located in Hackensack, N.J. The contract purchase price for The Pierre was approximately $44 million. This amount, together with estimated transaction costs of approximately $2 million, resulted in total acquisition costs of approximately $46 million. The acquisition costs were financed in part by a mortgage loan in the approximate amount of $30 million and the balance of approximately $16 million in cash. FREIT provided 75% of the cash required with the balance of approximately $4 million provided by the 25% minority owners of S And A.
The net proceeds from the OTC sale after the repayment of the first mortgage repaid FREIT and the 25% minority owners for their advances made to acquire The Pierre.
S And A has structured the sale of OTC and the purchase of The Pierre in a manor that would qualify as a like kind exchange of real estate pursuant to Section 1031 of the Internal Revenue Code, and resulted in a deferral for income tax purposes of the realization of gain on the sale of OTC. Since it is the intention of FREIT to continue to qualify as a real estate investment trust, deferred tax would be minimal.
The following unaudited pro forma information shows the results of operations for the three months ended January 31, 2004 for FREIT and its Subsidiaries as though The Pierre had been acquired at the beginning of fiscal 2004:
Page 10
The unaudited pro forma results include adjustments for depreciation based on the purchase price and increased interest expense based on the mortgage placed on the property at the acquisition date.
The unaudited pro forma results of operations set forth above are not necessarily indicative of the results that would have occurred had the acquisition been made at the beginning of fiscal 2004 or of future results of operations of FREIT’s combined properties.
The acquisition price for the building, including closing costs, was approximately $46 million. Based on a detailed appraisal of the property, the purchase price was allocated as follows: approximately $38 million (82.2%) was allocated to the building and other improvements and approximately $8 million (17.8%) was allocated towards land. Value attributable to leases was considered immaterial due to their short-term nature.
Note 6 – Credit line:
On February 4, 2005, FREIT replaced its expired $14 million line of credit with an $18 million line of credit. The line of credit is for three years but can be cancelled by the bank, at its will, at each anniversary date. Draws against the credit line can be used for general corporate purposes, for property acquisitions, construction activities, and letters of credit. Draws against the credit line are secured by mortgages on FREIT’s Franklin Crossing Shopping Center, Franklin Lakes, NJ, retail space in Glen Rock, NJ, Lakewood Apartments, Lakewood, NJ, and Grandview Apartments, Hasbrouck Heights, NJ. Interest rates on draws will be set at the time of each draw for 30, 60, or 90-day periods, based on our choice of the prime rate or at 175 basis points over the 30, 60, or 90-day LIBOR rates at the time of the draws.
FREIT has utilized the credit line for the issuance of a $2 million Letter of Credit in connection with its construction activities.
* *
Back To Index
Page 11
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Cautionary Statement Identifying Important Factors That Could Cause FREIT’s Actual Results to Differ From Those Projected in Forward Looking Statements.
Readers of this discussion are advised that the discussion should be read in conjunction with the unaudited condensed consolidated financial statements of FREIT (including related notes thereto) appearing elsewhere in this Form 10-Q, and the consolidated financial statements included in FREIT’s most recently filed Form 10-K. Certain statements in this discussion may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements reflect FREIT’s current expectations regarding future results of operations, economic performance, financial condition and achievements of FREIT, and do not relate strictly to historical or current facts. FREIT has tried, wherever possible, to identify these forward-looking statements by using words such as “believe,” “expect,” “anticipate,” “intend, “ “plan,” “ estimate,” or words of similar meaning.
Although FREIT believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties, which may cause the actual results to differ materially from those projected. Such factors include, but are not limited to, the following: general economic and business conditions, which will, among other things, affect demand for rental space, the availability of prospective tenants, lease rents and the availability of financing; adverse changes in FREIT’s real estate markets, including, among other things, competition with other real estate owners, risks of real estate development and acquisitions; governmental actions and initiatives; and environmental/safety requirements.
Overview
FREIT is an equity real estate investment trust (“REIT”) that owns a portfolio of residential apartment and retail properties. Our revenues consist primarily of fixed rental income from our residential and retail properties and additional rent in the form of expense reimbursements derived from our income producing retail properties. We also receive income from our 40% owned Affiliate, Westwood Hills, LLC which owns a residential apartment property and from our 40% owned affiliate Wayne PSC, LLC that owns the Preakness Shopping Center. Our policy has been to acquire real property for long-term investment.
Effects of recent accounting pronouncements:
In December 2003, the FASB issued revised FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51.” (“FIN 46R”). FIN 46R requires the consolidation of an entity in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity (variable interest entities, or “VIEs”). Currently, entities are generally consolidated by an enterprise when it has a controlling financial interest through ownership or a majority voting interest in the entity. FIN 46R is applicable for financial statements of public entities that have interests in VIEs or potential VIEs referred to as special-purpose entities for periods ending after December 31, 2003. Applications by public entities for all other types of entities are required in financial statements for periods ending after March 15, 2004.
In accordance with the definition of related parties as defined in paragraph 16 of FIN 46R and the guidance in paragraph 4h, it is the belief of the management of FREIT that FIN 46R is applicable to Westwood Hills, LLC and Wayne PSC, LLC, both 40% owned by FREIT. Because of this determination, FREIT has consolidated these two entities in addition to its 75% owned subsidiary, S And A and its wholly-owned subsidiary, Damascus Centre, LLC, commencing with the quarter ended April 30, 2004, and has restated the prior periods reported in this Form 10-Q. The consolidation of these two entities did not have any impact on FREIT’s equity, net income, or earnings per share.
In December 2004, the FASB issued SFAS No.123 (R) “Accounting for Stock-Based Compensation.” SFAS 123 (R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123 (R) requires that the fair value of such equity instruments be recognized as an expense in the historical financial statements as services are performed. Prior to SFAS 123 (R), only certain pro forma disclosures of fair value were required. SFAS 123 (R) shall be
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effective for FREIT as of the beginning of the first interim or annual reporting period that begins after December 15, 2005. The adoption of this new accounting pronouncement is not expected to have a material impact on FREIT’s consolidated financial statements.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Pursuant to the SEC disclosure guidance for “Critical Accounting Policies,” the SEC defines Critical Accounting Policies as those that require the application of Management’s most difficult, subjective, or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, the preparation of which takes into account estimates based on judgments and assumptions that affect certain amounts and disclosures. Accordingly, actual results could differ from these estimates. The accounting policies and estimates used, which are outlined in Note 1 to our Consolidated Financial Statements included in our annual report on Form 10-K for the year ended October 31, 2004, have been applied consistently as at January 31, 2005 and October 31, 2004, and for the three months ended January 31, 2005 and 2004. We believe that the following accounting policies or estimates require the application of Management’s most difficult, subjective, or complex judgments:
Revenue Recognition: Base rents, additional rents based on tenants’ sales volume and reimbursement of the tenants’ share of certain operating expenses are generally recognized when due from tenants. The straight-line basis is used to recognize base rents under leases if they provide for varying rents over the lease terms. Straight-line rents represent unbilled rents receivable to the extent straight-line rents exceed current rents billed in accordance with lease agreements. Before FREIT can recognize revenue, it is required to assess, among other things, its collectibility. If we incorrectly determine the collectibility of revenue, our net income and assets could be overstated.
Valuation of Long-Lived Assets: We periodically assess the carrying value of long-lived assets whenever we determine that events or changes in circumstances indicate that their carrying amount may not be recoverable. When FREIT determines that the carrying value of long-lived assets may be impaired, the measurement of any impairment is based on a projected discounted cash flow method determined
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by FREIT’s management. While we believe that our discounted cash flow methods are reasonable, different assumptions regarding such cash flows may significantly affect the measurement of impairment.
In October 2001, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires the reporting of discontinued operations ("OTC") to include components of an entity that have either been disposed of or are classified as held for sale. FREIT has adopted SFAS No. 144. During 2004 FREIT sold its Only, MD property. FREIT has reclassified the operations of this property as Discontinued Operations for fiscal year 2004. The adoption of SFAS No. 144 did not have an impact on net income, but only impacted the presentation of this property within the consolidated statements of income.
Overview
We believe that income from continuing operations (which excludes the operations of OTC) is the most significant element of net income. Accordingly, all references and comparisons refer to income from continuing operations unless otherwise stated.
All references to per share amounts are on a diluted basis unless otherwise indicated and have been restated for the March 31, 2004 two-for-one stock split.
Results of Operations:
Three Months Ended January 31, 2005 and 2004
| Three Months Ended
January 31, | | Increase
(Decrease) | |
|---|
| |
| | |
|---|
| | 2005 | | 2004 | | |
|---|
| |
| |
| |
| |
|---|
| (in thousands of dollars) | |
|---|
| Retail revenues: | | | | | | | | | | |
| Same properties (1) | | $ | 4,485 | | $ | 4,386 | | $ | 99 | |
| |
| |
| |
| |
| | | |
| Total Retail | | | 4,485 | | | 4,386 | | | 99 | |
| |
| |
| |
| |
| | | |
| Residential revenues: | | | | | | | | | | |
| Same properties (1) | | | 2,491 | | | 2,489 | | | 2 | |
| New Properties (The Pierre) | | | 1,352 | | | | | | 1,352 | |
| |
| |
| |
| |
| Total Residential | | | 3,843 | | | 2,489 | | | 1,354 | |
| |
| |
| |
| |
| | | | | | | | | | | |
| Total real estate revenues | | | 8,328 | | | 6,875 | | | 1,453 | |
| | | |
| | | | | | | | | | | |
| Investment income | | | | | | | | | | |
| and other | | | 65 | | | 48 | | | 17 | |
| |
| |
| |
| |
| | | | | | | | | | | |
| Total Revenues | | $ | 8,393 | | $ | 6,923 | | $ | 1,470 | |
| |
| |
| |
| |
| | |
| (1) Properties operated since the beginning of fiscal 2004. | |
Revenue for the three months ended January 31, 2005 (“Current Quarter”) increased 21.2%% to $8,393,000 compared to $6,923,000 for the three months ended January 31, 2004 (“Prior Year’s Quarter”).
Income from continuing operations increased 16.6% to $1,560,000 during the Current Quarter compared to $1,338,000 for the Prior Year’s Quarter. The Prior Year’s Quarter’s revenue and net income include a one-time item of $308,000 representing a gain from a lease termination payment made by a former tenant of FREIT (see discussion below).
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In June 2004 FREIT’s 75% owned subsidiary, S And A, sold the OTC. This sale resulted in a gain for financial statement purposes of approximately $12.8 million, which was reported during the third quarter of fiscal 2004. The operations of OTC, less the 25% interest attributable to the minority interest, have been classified as income from Discontinued Operations for the Prior Year’s Quarter ended January 31, 2004.
The consolidated results of operations for the three months ended January 31, 2005 are not necessarily indicative of the results to be expected for the full year.
SEGMENT INFORMATION
The following table sets forth comparative operating data for FREIT’s real estate segments from continuing operations:
| Retail | | Residential | | Combined | |
|---|
| |
| |
| |
| |
|---|
| Three Months Ended
January 31, | | Increase (Decrease) | | Three Months Ended
January 31, | | Increase (Decrease) | | Three Months Ended
January 31, | |
|---|
| |
| |
| |
| |
| |
| |
|---|
| | 2005 | | 2004 | | $ | | % | | 2005 | | 2004 | | $ | | % | | 2005 | | 2004 | |
|---|
| (in thousands) | | | | (in thousands) | | | | (in thousands) | |
|---|
| |
| | | |
| | | |
| |
|---|
| Rental income | | $ | 3,174 | | $ | 3,375 | | $ | (201 | ) | -6.0 | % | $ | 3,808 | | $ | 2,472 | | $ | 1,336 | | 54.0 | % | $ | 6,982 | | $ | 5,847 | |
| Percentage rent | | | 40 | | | 22 | | | 18 | | 81.8 | % | | | | | | | | — | | | | | 40 | | | 22 | |
| Reimbursements | | | 1,191 | | | 891 | | | 300 | | 33.7 | % | | | | | | | | — | | | | | 1,191 | | | 891 | |
| Other | | | 5 | | | 23 | | | (18 | ) | -78.3 | % | | 35 | | | 17 | | | 18 | | 105.9 | % | | 40 | | | 40 | |
| |
| |
| |
| |
| Total Revenue | | | 4,410 | | | 4,311 | | | 99 | | 2.3 | % | | 3,843 | | | 2,489 | | | 1,354 | | 54.4 | % | | 8,253 | | | 6,800 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating expenses | | | 1,288 | | | 1,452 | | | (164 | ) | -11.3 | % | | 1,415 | | | 1,070 | | | 345 | | 32.2 | % | | 2,703 | | | 2,522 | |
| |
| |
| |
| |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net operating income | | $ | 3,122 | | $ | 2,859 | | $ | 263 | | 9.2 | % | $ | 2,428 | | $ | 1,419 | | $ | 1,009 | | 71.1 | % | | 5,550 | | | 4,278 | |
| |
| |
| | | |
| Average | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Occupancy % | | | 92.6 | % | | 88.2 | % | | | | 4.4 | % | | 94.3 | % | | 94.6 | % | | | | -0.3 | % | | | | | | |
| | |
| |
| | | | |
| |
| |
| | | | |
| | | | | | | |
| | Reconciliation to consolidated net income: | | | | | | | |
| | Deferred rents - straight lining | | | 75 | | | 75 | |
| | Net investment income | | | 65 | | | 48 | |
| | General and administrative expenses | | | (227 | ) | | (182 | ) |
| | Depreciation | | | (1,075 | ) | | (766 | ) |
| | Financing costs | | | (2,518 | ) | | (2,025 | ) |
| | Minority interest | | | (310 | ) | | (90 | ) |
| | | |
| |
| | Net income from continuing operations | | | 1,560 | | | 1,338 | |
| | Discontinued operations | | | | | | 165 | |
| | | |
| |
| | Net income | | $ | 1,560 | | $ | 1,503 | |
| | | |
| |
The above table details the comparative NOI for FREIT’s Retail and Residential Segments, and reconciles the combined NOI to consolidated net income. NOI is based on operating revenue and expenses directly associated with the operations of the real estate properties, but excludes deferred rents (straight lining), depreciation, and financing costs. FREIT assesses and measures segment operating results based on NOI. NOI is not a measure of operating results or cash flow as measured by generally accepted accounting principles, and is not necessarily indicative of cash available to fund cash needs and should not be considered an alternative to cash flows as a measure of liquidity.
RETAIL SEGMENT
FREIT’s retail properties for continuing operations consist of seven (7) properties totaling approximately 1,050,000 sq. ft. Six are multi-tenanted retail centers and one is a single tenanted store. In addition, FREIT has
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leased land and receives rental income from a tenant who has built and operates a bank branch on land FREIT owns in Rockaway, NJ
As indicated in the above table, revenues from our retail segment for the Current Quarter are up 2.3% and NOI is up 9.2% to $3,122,000. The NOI for the Current Quarter was bolstered by lower operating costs resulting from a mild winter up until the end of January 2005. Prior Year’s Quarter’ reimbursement income and operating expenses include credits taken for reduced expense charges. Higher operating costs are expected during the next quarter. Revenue and net operating income for the Prior Year’s Quarter includes a one-time item of $308,000 representing the gain from a lease termination payment made by a former tenant located at FREIT’s Westridge Square shopping center. FREIT and the tenant entered into a lease termination agreement whereby Tenant paid FREIT a lump sum payment of approximately $1.8 million ($750,000 as a rent termination payment for past and future rent payments and $1,035,000 for repairing and refurbishing space vacated by Tenant). The tenant made the payment in February 2004. The mortgage lender has agreed to the termination agreement and has entered into an escrow agreement with FREIT whereby the entire lump sum payment made by the Tenant has been deposited in an interest bearing escrow account held for the benefit of the mortgage lender. Up to $750,000 will be disbursed to FREIT in monthly installments of $31,595 over approximately twenty four (24) months, or the balance of the un-disbursed $750,000 will be disbursed to FREIT once the mortgage lender is provided with a C of O covering all of the space vacated by the Tenant. The balance of the lease termination payment of approximately $1 million representing a Tenant Improvement (“TI”) Reserve, will be disbursed to FREIT in $250,000 increments as comparable amounts of TI’s are incurred, or in full at the earlier of when a C of O is obtained and the space vacated by the Tenant is leased and re-occupied, when the mortgage loan has been re-paid. The former tenant’s total rent and expense reimbursements aggregated approximately $488,000 per year.
ASSET SALE
On June 22, 2004, S And A closed on its contract for the sale of the OTC in Olney, Maryland. The sale price for the property was $28.2 million. The property was acquired in April 2000 for approximately $15.5 million. During the third quarter of fiscal 2004 FREIT recognized a gain of approximately $12.8 million from the sale. The operations of OTC have been classified as Discontinued Operations.
RESIDENTIAL SEGMENT
FREIT operates nine (9) multi-family apartment communities totaling 986 apartment units. The NOI of our residential properties is summarized in the above table.
On April 16, 2004, S And A closed on the purchase of The Pierre apartments. The Pierre is a 269-unit high-rise apartment building located in Hackensack, N.J. The contract purchase price for The Pierre was approximately $44 million. This amount, together with estimated transaction costs of approximately $2 million, resulted in total acquisition costs of approximately $46.0 million. The acquisition costs were financed in part by a mortgage loan in the approximate amount of $30 million and the balance of approximately $16 million in cash.
The following table summarized the Net Operating Income of our portfolio of residential properties:
Page 16
| Three Months Ended | |
|---|
| |
| |
|---|
| | January 31, | |
|---|
| | 2005 | | 2004 | |
|---|
| ($Thousands) | |
|---|
| Revenues: | | | | | | | |
| Same properties (1) | | $ | 2,491 | | $ | 2,489 | |
| | |
| New properties (Pierre) | | | 1,352 | | | — | |
| |
| |
| |
| Total revenues | | | 3,843 | | | 2,489 | |
| |
| |
| |
| | | | | | | | |
| Expenses: | | | | | | | |
| Same properties (1) | | | 973 | | | 1,070 | |
| | |
| New properties (Pierre) | | | 442 | | | — | |
| |
| |
| |
| Total expenses | | | 1,415 | | | 1,070 | |
| |
| |
| |
| | | | | | | | |
| Net Operating Income: | | | | | | | |
| Same properties (1) | | | 1,518 | | | 1,419 | |
| | |
| New properties (Pierre) | | | 910 | | | — | |
| |
| |
| |
| Total NOI | | $ | 2,428 | | $ | 1,419 | |
| |
| |
| |
| | | | | |
| (1) Properties operated since the beginning of fiscal 2004. | |
During the Current Quarter NOI from Same Properties increased $99,000 (7%). This increase resulted from a modest increase in revenues and a 9% decrease in operating expenses, resulting from the mild winter up to January 31, 2005. Average occupancy for Same Properties increased modestly to 95% for the Current Quarter from 94.6% for the Prior Year’s Quarter, although average collected monthly rent fell slightly. Occupancy at The Pierre, the 269 high-rise apartment house in Hackensack, NJ, remains steady at 92.5%. As apartments at The Pierre turnover, they are being refurbished. We continue to be optimistic that the rental housing demand will continue to improve and that residential operating results will improve over fiscal year 2004 levels.
Our residential revenue is principally composed of monthly apartment rental income. Total rental income is a factor of occupancy and monthly apartment rents. A 1% decline in annual average occupancy, or a 1% decline in average rents, results in an annual revenue decline of approximately $159,000 and $149,000 respectively.
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FINANCING COSTS
| Three Months Ended
January 31, | |
|---|
| |
| |
|---|
| | 2005 | | 2004 | |
|---|
| |
| |
| |
|---|
| ($000) | |
|---|
| Fixed rate Mortgages | | | | | | | |
| 1st Mortgages | | | | | | | |
| Existing | | $ | 1,741 | | $ | 1,765 | |
| Prepaid | | | 46 | | | 58 | |
| New (1) | | | 459 | | | | |
| 2nd Mortgages | | | | | | | |
| Existing | | | 139 | | | 142 | |
| Other | | | 21 | | | 13 | |
| |
| |
| |
| | | | 2,406 | | | 1,978 | |
| Amortization of | | | | | | | |
| Mortgage Costs | | | 45 | | | 47 | |
| Prepayment Fee | | | 67 | | | — | |
| |
| |
| |
| | | | | | | | |
| Total Financing Costs From | | | | | | | |
| Continuing Operations | | $ | 2,518 | | $ | 2,025 | |
| |
| |
| |
| | |
| (1) Mortgages not in place at beginning of fiscal 2004. | |
Financing Costs for the Current Quarter increased $493,000 (24.3%) to $2,518,000 from $2,025,000 for the Prior Year’s Quarter. The increase is principally attributable to the mortgage on The Pierre property, which was acquired in April 2004, and the pre-payment fee paid the mortgage holder on the Damascus property when the $2.3 million mortgage on the property was prepaid.
LIQUIDITY AND CAPITAL RESOURCES
Our financial condition remains strong. Net Cash Provided By Operating Activities was $2.3 million for the Current Quarter compared to $1.7 million for the Prior Year’s Quarter. We expect that cash provided by operating activities will be adequate to cover mandatory debt service payments, recurring capital improvements and dividends necessary to retain qualification as a REIT (90% of taxable income).
As at January 31, 2005, we had cash and cash equivalents totaling $14.3 million compared to $18.8 million at October 31, 2004, and $12.6 million at January 31, 2004. During the Current Quarter we used approximately $2.4 million of our cash reserves to prepay the 9.25% mortgage on the Damascus property (see below). This mortgage was to be fully amortized in 2011.
Credit Line:
On February 4, 2005, FREIT replaced its expired $14 million line of credit with an $18 million line of credit. The line of credit is for three years but can be cancelled by the bank, at its will, at each anniversary date. Draws against the credit line can be used for general corporate purposes, for property acquisitions, construction activities, and letters of credit (See below). Draws against the credit line are secured by mortgages on FREIT’s Franklin Crossing Shopping Center, Franklin Lakes, NJ, retail space in Glen Rock, NJ, Lakewood Apartments, Lakewood, NJ, and Grandview Apartments, Hasbrouck Heights, NJ. Interest rates on draws will be set at the time of each draw for 30, 60, or 90-day periods, based on our choice of the prime rate or at 175 basis points over the 30, 60, or 90-day LIBOR rates at the time of the draws.
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We are planning the construction of 129 apartment rental units in Rockaway, NJ. The total capital required for this project is estimated at $13.8 million. We expect to finance these costs, in part, from construction and mortgage financing and, in part, from funds available in our institutional money market investment. During January 2005 we utilized our credit line for the issuance of a $2 million Letter of Credit for the benefit of the Township of Rockaway in connection with this construction project. The Letter of Credit guarantees FREIT’s completion of off-site improvements.
It is FREIT’s intention to redevelop and expand its Damascus Shopping Center. The total capital requirement for this project is estimated at $13 million, which will be financed, in part, from construction and mortgage financing and, in part, from funds available in our institutional money market investments.
At January 31, 2005 FREIT’s aggregate outstanding mortgage debt was $145.6 million and bears a fixed weighted average interest rate of 6.4%, and an average life of approximately 7.9 years. These fixed rate mortgages are subject to amortization schedules that are longer than the term of the mortgages. As such, balloon payments (unpaid principal amounts at mortgage due date) for all mortgage debt will be required as follows:
| Fiscal Year | | $ Millions |
|---|
| |
|
| 2007 | | | $ | 15.7 | |
| 2008 | | | $ | 5.9 | |
| 2010 | | | $ | 12.3 | |
| 2013 | | | $ | 8.0 | |
| 2014 | | | $ | 26.1 | |
| 2016 | | | $ | 24.6 | |
| 2019 | | | $ | 28.3 | |
The following table shows the estimated fair value and carrying value of our long-term debt at January 31, 2005 and October 31, 2004:
| (In Millions) | | January 31,
2005 | | October 31,
2004 | |
|---|
| |
| |
| |
| | |
| Fair Value | | $ | 152.7 | | $ | 158.1 | |
| Carrying Value | | $ | 145.6 | | $ | 148.2 | |
Fair values are estimated based on market interest rates at January 31, 2005 and October 31, 2004 and on discounted cash flow analysis. Changes in assumptions or estimation methods may significantly affect these fair value estimates.
FREIT expects to re-finance the individual mortgages with new mortgages when their terms expire. To this extent we have exposure to interest rate risk on our fixed rate debt obligations. If interest rates, at the time any individual mortgage note is due, are higher than the current fixed interest rate, higher debt service may be required, and/or re-financing proceeds may be less than the amount of mortgage debt being retired. For example, at January 31, 2005 a 1% interest rate increase would reduce the fair value of our debt by $6.2 million, and a 1% decrease would increase the fair value by $6.8 million.
We believe that the values of our properties will be adequate to command re-financing proceeds equal to, or higher, than the mortgage debt to be re-financed. We continually review our debt levels to determine if additional debt can prudently be utilized for property acquisition additions to our real estate portfolio that will increase income and cash flow to shareholders.
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Interest rate swap contract: To reduce interest rate volatility, FREIT uses “pay fixed, receive floating” interest rate swaps to convert floating interest rates to fixed interest rates over the terms of certain loans. We enter into these swap contracts with a Counterparty that is usually a high-quality commercial bank.
In essence, we agree to pay our Counterparty a fixed rate of interest on a dollar amount of notional principal (which corresponds to our mortgage debt) over a term equal to the terms of the mortgage note. Our Counterparty, in return, agrees to pay us a short-term rate of interest – generally LIBOR – on that same notional amount over the same term as our mortgage note.
FASB 133 requires us to mark-to-market fixed pay interest rate swaps. As the floating interest rate varies from time-to-time over the term of the contract, the value of the contract will change upward or downward. If the floating rate is higher than the fixed rate, the value of the contract goes up and there is a gain and an asset. If the floating rate is less than the fixed rate, there is a loss and a liability. These gains or losses will not affect our income statement. Changes in the fair value of these swap contracts will be reported in earnings of other comprehensive income and appear in the equity section of our balance sheet.
This gain or loss represents the economic consequence of liquidating our fixed rate swap contracts and replacing them with like-duration funding at current market rates, something we would likely never do.
FREIT had a variable interest rate mortgage securing its Patchogue, NY property. To reduce interest rate fluctuations FREIT entered into an interest rate swap contract. This rate swap contract effectively converted variable interest rate payments to fixed interest rate payments. The contract was initially based on a notional amount of approximately $6,769,000 ($6,499,000 at January 31, 2005). FREIT has the following derivative-related risks with its swap contract: 1) early termination risk, and 2) Counterparty credit risk.
Early Termination Risk: If FREIT wants to terminate its swap contract before maturity, it has to be bought out or terminated at market value; i.e., the difference in the present value of the anticipated net cash flows from each of the swap’s parties. If current variable interest rates are below FREIT’s fixed interest rate payments, this could be costly. At January 31, 2005, FREIT’s liability for early termination would be $51,000. This amount has been included in comprehensive income. Conversely, if interest rates rise above FREIT’s fixed interest payments and FREIT wished early termination, FREIT would realize a gain on termination.
Counterparty Credit Risk: Each party to a swap contract bears the risk that its Counterparty will default on its obligation to make a periodic payment. FREIT reduces this risk by entering swap contracts only with major financial institutions that are experienced market makers in the derivatives market.
INFLATION
Inflation can impact the financial performance of FREIT in various ways. Our retail tenant leases normally provide that the tenants bear all or a portion of most operating expenses, which can reduce the impact of inflationary increases on FREIT. Apartment leases are normally for a one-year term, which may allow us to seek increased rents as leases renew or when new tenants are obtained.
Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See “Liquidity and Capital Resources” above.
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Item 4: Controls and Procedures
As at the end of the period covered by this quarterly report on Form 10-Q, we carried out an evaluation of the effectiveness of the design and operation of FREIT’s disclosure controls and procedures. This evaluation was carried out under the supervision and with participation of FREIT’s management, including FREIT’s Chairman and Chief Executive Officer and Chief Financial Officer, who concluded that FREIT’s disclosure controls and procedures are effective. There has been no change in FREIT’s internal control over financial reporting that occurred during FREIT’s last fiscal quarter that has materially affected, or is reasonably likely to material affect, FREIT’s internal control over financial reporting.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in FREIT’s reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in FREIT’s reports filed under the Exchange Act is accumulated and communicated to management, including FREIT’s Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure.
Part II Other Information
Item 6. Exhibits and Reports on Form 8-K
Exhibit Index
| | Exhibit 31.1 Section 302 Certification of Chief Executive Officer |
| |
| | Exhibit 31.2 Section 302 Certification of Chief Financial Officer |
| |
| | Exhibit 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 |
| |
| | Exhibit 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 |
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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.
| | FIRST REAL ESTATE INVESTMENT |
| | TRUST OF NEW JERSEY |
| | (Registrant) |
| | |
| Date: March 14, 2005 | |
| | |
| | /s/ Robert S. Hekemian |
| | ————————————— |
| | (Signature) |
| | Robert S. Hekemian |
| | Chairman of the Board and Chief Executive |
| | Officer |
| | |
| | |
| | /s/ Donald W. Barney |
| | ————————————— |
| | (Signature) |
| | Donald W. Barney |
| | President, Treasurer and Chief Financial Officer |
| | (Principal Financial/Accounting Officer) |
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