UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended October 31, 1996 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from _____ to _____ Commission File No. 1-6309 HRE PROPERTIES (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2458042 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 321 RAILROAD AVENUE GREENWICH, CONNECTICUT 06830 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (203) 863-8200 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered Common Shares, without par value New York Stock Exchange Preferred Share Purchase Rights New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x The aggregate market value of the voting stock held by non-affiliates of the Registrant as of January 6, 1997: Common Shares, without par value - $67,606,000. Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date: 5,346,081 Common Shares, without par value, as of January 6, 1997. DOCUMENTS INCORPORATED BY REFERENCE Proxy Statement for Annual Meeting of Shareholders to be held on March 12, 1997 (certain parts as indicated herein) (PartIII). TABLE OF CONTENTS Form 10-K Item No. Report Page PART I 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . .. . . . .3 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . .. . . . .8 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . .. . . . 10 4. Submission of Matters to a Vote of Security Holders . . . .. . . . 10 PART II 5. Market for the Registrant's Common Equity and Related Shareholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . 10 6. Selected Financial Data . . . . . . . . . . . . . . . . . .. . . . 12 7. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . .. . . . 13 8. Financial Statements and Supplementary Data . . . . . . . .. . . . 18 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. . . . . . . . . .. . . . 18 PART III 10. Directors and Executive Officers of the Registrant. . . . .. . . . 18 11. Executive Compensation. . . . . . . . . . . . . . . . . . .. . . . 19 12. Security Ownership of Certain Beneficial Owners and Management.. . 19 13. Certain Relationships and Related Transactions. . . . . . .. . . . 19 PART IV 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K . 20 Item I. Business. HRE Properties (the "Trust") was organized on July 7, 1969 as an unincorporated business trust under the laws of the Commonwealth of Massachusetts pursuant to a Declaration of Trust dated July 7, 1969, as amended. The Trust has qualified and has elected to be taxed as a real estate investment trust under Sections 856-860 of the Internal Revenue Code of 1986, as amended (the "Code"). Pursuant to such provisions of the Code, a trust which distributes at least 95% of its real estate investment trust taxable income to its shareholders each year and which meets certain other conditions will not be taxed on that portion of its taxable income which is distributed to its shareholders. The Trust intends to continue to qualify as a real estate investment trust for federal income tax purposes. Description of Business The Trust's sole business is the ownership of real estate investments which consist principally of equity investments in income-producing properties, with primary emphasis on properties in the northeastern part of the United States. The Trust's core properties consist of community shopping centers in the northeastern part of the United States. The remaining properties include office and retail buildings and industrial properties. The Trust also seeks to identify desirable properties for acquisitions which it acquires in the normal course of business. In addition, the Trust regularly reviews its portfolio and from time to time considers and effects the sale of certain properties. At October 31, 1996, the Trust owned or had an equity interest in e ighteen properties comprised of shopping centers, single tenant retail stores, office buildings and service and distribution facilities located in twelve states throughout the United States, containing a total of 2,798,000 square feet of gross leasable area. For a description of the Trust's individual investments, see Item 2. The Trust intends to continue to invest substantially all of its assets in income producing real estate, with a primary emphasis on shopping centers, although the Trust will retain the flexibility to invest in other types of real property. While the Trust is not limited to any geographical location, the Trust's current strategy is to invest primarily in properties located in the Northeastern United States. Investment and Operating Strategy The Trust's investment objective is to increase cash flow, current income and consequently the value of its existing portfolio of properties, and to seek continued growth through (i) the strategic re-tenanting, renovation and expansion of its existing properties, and (ii) the selective acquisitions of income-producing real estate properties, primarily neighborhood and community shopping centers, in the geographic region, where the Trust presently operates. These neighborhood and community shopping center properties are designed to attract local area customers and would typically be anchored by a supermarket, discount department store or drugstore tenant offering day-to-day necessities rather than high-priced luxury items. Core Properties The Trust considers those properties which are directly managed by the Trust, located close to the Trust's headquarters and concentrated in the community shopping center sector to be core properties. Of the eighteen properties in the Trust's portfolio, ten properties are considered core properties consisting of seven community shopping centers, one mixed-use (retail/office) property and two office buildings (including the Trust's executive headquarters). The properties contain in the aggregate 1,225,000 square feet of gross leasable area. The Trust's core retail properties collectively had 158 tenants providing a wide range of retail products and services. Tenants include national supermarkets, discount department stores, a regional electronic store and local retailers. At October 31, 1996, the core properties were 91% leased. A substantial portion of the Trust's operating lease income from retail tenants consists of rent received under short- and intermediate-term leases. Most of the leases provide for the payment of fixed base rentals monthly in advance and for the payment by tenants of a pro-rata share of the real estate taxes, insurance, utilities and common area maintenance expenses incurred in operating the shopping centers. Non-Core Properties In fiscal 1995, the Board of Trustees expanded and refined the strategic objectives of the Trust to refocus the real estate portfolio into one of self-managed retail properties located in the Northeast and authorized a plan to sell the non-core properties of the Trust in the normal course of business over the next several years. The Trust believes that economic conditions in the real estate markets where the Trust's non-core properties are located have improved and that opportunities to sell those properties over the next several years have also improved. At October 31, 1996, the non-core properties total eight properties, having an aggregate net book value of $32,986,000 ($46,212,000 at October 31, 1995) and comprise the Trust's office (with the exception of the Trust's headquarters), distribution and service facilities, and certain retail properties located outside of the northeast region of the United States. As a result of this change in investment strategy, the Trust recorded a non-cash charge of $7,000,000 in fiscal 1995, to writedown the carrying value of two of the non-core properties to their respective estimated net realizable values. The Trust expects that the ultimate sales of the non-core properties over the next several years will result in net gains to the Trust. At October 31, 1996, the Trust's non-core properties consisted of one office building, containing 212,000 square feet of gross leasable area (GLA), three retail properties totaling 440,000 square feet and four industrial properties with a total of 921,000 square feet of GLA. The non-core properties were 98% leased at October 31, 1996. The office property has four tenants which offer a range of services, including insurance, engineering and management. The four service and distribution facilities are 100% occupied and consist of two automobile and truck parts distribution warehouses, one truck sales and service center and one automobile tire distribution facility. The service and distribution facilities are net leased under long-term lease arrangements whereby the tenants pay all taxes,insurance, maintenance and other operating costs of the property during the term of the lease. The three retail properties consist of a 231,000 square foot shopping center located in Clearwater, Florida containing 44 tenants and two single tenant properties located in Tempe and Mesa, Arizona totaling 209,000 square feet of GLA. On November 22, 1996, the Trust formed a limited partnership with certain shareholders of the Trust to own, manage and redevelop the Trust's shopping center in Clearwater, Florida. The Trust, as the general partner, contributed the shopping center at its net carrying amount (which amount approximates its fair value of $13 million), and the limited partners, including Kimco Realty Corp. which will manage the property, contributed 600,000 common shares of the Trust to the limited partnership. At October 31, 1996, the Trust also owned a portfolio of mortgage notes receivable consisting of fixed rate mortgages aggregating $3,706,000. The fixed rate mortgages are secured by retail properties sold by the Trust in prior years. During the five year period ended October 31, 1996, the Trust acquired eight properties totalling 834,000 square feet of gross leasable space at an aggregate cost of $71.7 million. The properties were acquired with cash and $36 million of non-recourse first mortgage loans. In the same period, the Trust spent nearly $9.1 million to expand, renovate, improve and lease its existing properties. Such activities were funded from available cash. During the five year period ended October 31, 1996, the Trust has sold or disposed of twelve properties totalling 1,566,000 square feet of gross leasable area which the Trust determined no longer fit into its strategic plans. Recent Developments In November 1996, the Trust negotiated a settlement proposal with one of its tenants to recover, among other things, unpaid additional percentage rents including interest totalling $3.25 million. In accordance with the terms of its lease, the tenant was required to aggregate the sales of all its stores in a specified radius when computing percentage rent due the Trust. The settlement proposal, including certain other modifications to the lease, is expected to be completed and recorded as income in the Trust's first quarter of fiscal 1997. During fiscal 1996, the Trust acquired one property comprising 30,700 square feet of gross leasable area at a purchase price of $880,000 and sold three non-core properties totalling 324,000 square feet of gross leasable space for net proceeds of $18 million. In addition, the Trust spent $5.6 million for leasing costs and capital improvements to properties it already owns. Substantially all such capital improvements were incurred in connection with the Trust's retail leasing activities. The Trust also leased or renewed 75,000 square feet of gross leasable area in fiscal 1996, compared to 153,000 square feet of GLA in the prior year. The square footage leased or renewed in fiscal 1996 comprised 7% of the total gross leasable area of the Trust's core properties. Matters Relating to the Real Estate Business The Trust is subject to certain business risks arising in connection with owning real estate which include, among others, (1) the bankruptcy or insolvency of, or a downturn in the business of, any of its major tenants, (2) the possibility that such tenants will not renew their leases as they expire, (3) vacated anchor space affecting the entire shopping center because of the loss of the departed anchor tenant 's customer drawing power, (4) risks relating to leverage, including uncertainty that the Trust will be able to refinance its indebtedness, and the risk of higher interest rates, (5) potential liability for unknown or future environmental matters, and (6) the risk of uninsured losses. Unfavorable economic conditions could also result in the inability of tenants in certain retail sectors to meet their lease obligations and otherwise could adversely affect the Trust's ability to attract and retain desirable tenants. The Trust believes that its shopping centers are relatively well positioned to withstand adverse economic conditions since they typically are anchored by grocery stores, drug stores and discount department stores that offer day-to-day necessities rather than luxury goods. Compliance with Governmental Regulations The Trust, like others in the commercial real estate industry, is subject to numerous environmental laws and regulations. Although potential liability could exist for unknown or future environmental matters, the Trust believes that its tenants are operating in accordance with current laws and regulations and has established procedures to monitor these operations. Competition The real estate investment business is highly competitive. The Trust competes for real estate investments with investors of all types, including domestic and foreign corporations, financial institutions, other real estate investment trusts and individuals. In addition, the Trust's properties are subject to local competitors from the surrounding areas. The Trust does not consider its real estate business to be seasonal in nature. The Trust's shopping centers compete for tenants with other regional, community or neighborhood shopping centers in the respective areas where Trust retail properties are located. The Trust's office buildings compete for tenants principally with office buildings throughout the respective areas in which they are located. In most areas where the Trust's office buildings are located, competition for tenants is intense. Leasing space to prospective tenants is generally determined on the basis of, among other things, rental rates, location, physical quality of the property and availability of space. Since the Trust's industrial properties are all net leased under long-term lease arrangements which are not due to expire in the near future, the Trust does not currently face any competitive pressures with respect to such properties. Property Management The Trust actively manages and supervises the operations and leasing at all of its core properties. Six of the Trust's non-core properties are net leased to single tenants under long-term lease arrangements, in which case, management is provided by the tenants. The Trust's two remaining non-core properties are managed by independent property management firms retained by the Trust. The Trust closely supervises the property management firms it engages to manage its properties. Employees The Trust's executive offices are located at 321 Railroad Avenue, Greenwich, Connecticut. It occupies approximately 5,000 square feet in a two story office building owned by the Trust. The Trust has 15 employees, eight of whom oversee the management of the Trust's real estate portfolio, or analyze potential acquisition properties and determine which properties, if any, to sell. The Trust's remaining employees serve in various professional, executive and administrative capacities. Item II. Properties. Core Properties The following table sets forth information concerning each core property at October 31, 1996. All core properties are 100% owned by the Trust. Gross Leasable Year Year Square Number Location Completed Acquired Feet Acres of Tenants Leased Principal Tenant Meriden, Connecticut 1989 1993 300,000 29.2 20 94% ShopRite Supermarket Springfield, Massachusetts 1970 1970 293,000 26.0 18 88% Great Atlantic &Pacific Tea Co. Danbury, Connecticut 1989 1995 193,000 19.3 24 100% Barnes & Noble Carmel, New York 1983 1995 126,000 19.0 11 58% ShopRite Supermarket Newington, New Hampshire 1975 1979 102,000 14.3 10 100% Sears Roebuck Wayne, New Jersey 1959 1992 102,000 9.0 44 98% Great Atlantic &Pacific Tea Co. Farmingdale, New York 1981 1993 70,000 5.6 12 95% King Kullen Supermarket Somers, New York 1989 1992 19,000 4.9 12 100% Putnam County Savings Bank Greenwich, Connecticut 1983 1993 10,000 .2 3 100% HRE Properties Greenwich, Connecticut 1983 1994 9,700 .2 4 100% Rogers &Goffigon Non-Core Properties The following table sets forth information concerning each non-core property in which the Trust owned an equity interest at October 31, 1996. Except as otherwise noted, non- core properties are 100% owned by the Trust. Rentable Year Year Square Number Location Completed Acquired Feet Acres of Tenants Leased Principal Tenant Southfield, Michigan(1) 1973 1983 212,000 7.8 4 100% Giffels Associates Clearwater, Florida(2) 1983 1985 231,000 21.5 44 89% Albertson's Supermarket Mesa, Arizona 1971 1971 92,000 7.6 1 100% Mervyn's Tempe, Arizona 1970 1970 117,000 8.6 2 100% Mervyn's Albany, Georgia 1972 1972 476,000 51.3 1 100% Firestone Dallas, Texas 1970 1970 253,000 14.5 1 100% Chrysler Corporation St. Louis, Missouri 1970 1970 163,000 16.0 1 100% Chrysler Corporation Syracuse, New York 1973 1973 29,000 10.0 1 100% Navistar International (1) The Trust owns an 85% partnership interest in this property. (2) The Trust has a general partner interest in this property, effective November 22,1996. Item III. Legal Proceedings. No legal proceedings are required to be reported under this Item. Item IV. Submission of Matters to a Vote of Security Holders. No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended October 31,1996. Item Pursuant to Instruction 3 of Item 401 (b) of Regulation S-K: Executive Officers of the Trust. For information regarding Executive Officers of the Trust--See Item X. PART II Item V. Market for the Registrant's Common Equity and Related Shareholder Matters. (a) Price Range of Common Shares The Common Shares of the Trust are traded on the New York Stock Exchange under the symbol "HRE". The following table sets forth the high and low closing sales prices for the Trust's Common Shares during the fiscal years ended October 31, 1996 and October 31, 1995 as reported on the New York Stock Exchange: Fiscal Year Fiscal Year Ended Ended October 31, 1996 October 31, 1995 High Low High Low Fourth Quarter $16 - $14-1/4 $14-3/8 - $13-3/8 Third Quarter 16 - 14 14-3/8 - 13-3/8 Second Quarter 15-5/8 - 13-1/2 13-7/8 - 13 First Quarter 14-1/8 - 13-1/8 14-1/4 - 13-1/4 (b) Approximate Number of Equity Security Holders At December 31, 1996 (latest date available), there were 2,568 shareholders of record of the Trust's Common Shares. (c) Dividends Declared on Common Shares and Tax Status The following table sets forth the dividends declared per Common Share and tax status for Federal income tax purposes of the dividends paid during the fiscal years ended October 31, 1996 and 1995: Portion of Dividend Designated as: Fiscal Year Ended Gross Dividend Income Capital Gain October 31, 1996: Paid Per Share Distribution Distribution Fourth Quarter $ .31 $ .26 $ .05 Third Quarter $ .31 $ .26 $ .05 Second Quarter $ .31 $ .26 $ .05 First Quarter $ .29 $ .24 $ .05 $1.22 $1.02 $ .20 Portion of Dividend Designated as: Fiscal Year Ended Gross Dividend Income October 31, 1995: Paid Per Share Distribution Fourth Quarter $ .29 $ .29 Third Quarter $ .29 $ .29 Second Quarter $ .28 $ .28 First Quarter $ .28 $ .28 $1.14 $1.14 The Trust made distributions to shareholders aggregating $1.22 per Common Share during the fiscal year ended October 31, 1996. The Trust has paid quarterly dividends on its Common Shares since it commenced operations as a real estate investment trust in 1969. Although the Trust intends to continue to declare quarterly dividends on its Common Shares, no assurances can be made as to the amounts of any future dividends. The declaration of any future dividends by the Trust is within the discretion of the Board of Trustees, and will be dependent upon, among other things, the earnings, financial condition and capital requirements of the Trust, as well as any other factors deemed relevant by the Board of Trustees. Two principal factors in determining the amounts of dividends are (i) the requirement of the Code that a real estate investment trust distribute to shareholders at least 95% of its real estate investment trust taxable income, and (ii) the amount of the Trust's funds from operations. The Trust has a Dividend Reinvestment and Share Purchase Plan which allows shareholders to acquire additional shares by automatically reinvesting dividends. Shares are acquired pursuant to the Plan at a price equal to the higher of 95% of the market price of such shares on the dividend payment date or 100% of the average of the daily high and low sales prices for the five trading days ending on the day of purchase without payment of any brokerage commission or service charge. Approximately 14% of the Trust's eligible shareholders currently participate in the Plan. Item VI. Selected Financial Data. (In thousands, except per share data) Year Ended October 31, 1996 1995 1994 1993 1992 Total Assets $132,160 $149,099 $142,559 $119,330 $137,855 Mortgage Notes Payable $ 39,798 $ 57,212 $ 46,386 $ 24,227 $ 31,226 Revenues $ 24,432 $ 22,853 $ 18,969 $ 16,162 $ 16,942 Operating Income (Loss) $ 3,930 $( 3,703) $ 1,262 $( 7,293) $ 1,588 Gains on Sales of Properties $ 6,341 $ 7,567 $ 82 $ 2,330 $ -- Net Income (Loss) $ 10,271 $ 3,864 $ 1,344 $ (4,963) $ 1,588 Funds from Operations* $ 9,525 $ 8,510 $ 7,653 $ 6,748 $ 6,631 Per Share Data: Net Income (Loss) $1.91 $ .72 $ .26 $ (.94) $.30 Cash Dividends $1.22 $ 1.14 $ 1.10 $ 1.08 $ 1.16 *Defined as net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from debt restructuring and sales of properties, plus depreciation, amortization, and the elimination of significant non-recurring charges and credits. In 1996, the Trust adopted the revised definition of Funds from Operations suggested by the National Association of Real Estate Investment Trusts (NAREIT). 1995 and prior year amounts have been restated to conform to the new NAREIT definition. ITEM VII. Management's Discussion and Analysis of Financial Condition and Results of Operations. Liquidity and Capital Resources The Trust's liquidity and capital resources include its cash and cash equivalents, funds available from bank borrowings and long-term mortgage debt and sales of real estate investments. The Trust meets its liquidity requirements primarily by generating cash from the operations of its properties and collection of principal and interest on its mortgage notes receivable. Payments of expenses related to real estate operations, capital improvement programs, debt service, management and professional fees, and dividend requirements place demands on the Trust's liquidity. The Trust believes that the financial resources currently available to it are sufficient to meet all of its known obligations and commitments and to make additional real estate investments when appropriate opportunities arise. At October 31, 1996, the Trust had cash and cash equivalents of $1.8 million compared to $7.1 million in 1995 and $8.7 million in 1994. The Trust also expects to receive a cash settlement of $3.25 million in the first quarter of fiscal 1997 for unpaid percentage rent from one of its tenants. The Trust also has available $15 million in unsecured lines of credit with two major commercial banks. The credit lines are available to finance the acquisition, management or development of commercial real estate and for working capital purposes. The credit lines expire at various periods in 1997 and outstanding borrowings, if any, may be repaid from proceeds of debt financings or sales of properties. At October 31, 1996, there were no outstanding borrowings under existing lines of credit. It is the Trust's intent to renew these credit lines as they expire in 1997. Long-term debt consists of mortgage notes payable totalling $39.8 million, of which $3.1 million in principal payments are due in fiscal 1997 (including a mortgage note of $2.4 million, which matures in February, 1997). The mortgage loans bear interest at fixed rates that range from 7.5% to 9.75%. The Trust has received a commitment for $2 million to refinance the $2.4 million mortgage note and expects to use available cash for the difference between the current mortgage and the commitment amount. Since 1992, the Trust has selectively sold or disposed of properties which were determined to no longer fit into its strategic plan and employed the proceeds of sales, available cash and long-term mortgage debt to acquire nearly $75 million of properties during this same period. In fiscal 1995, the Board of Trustees expanded and refined the strategic objectives of the Trust to refocus the real estate portfolio into one of self-managed retail properties located in the Northeast and authorized a plan to sell the non-core properties of the Trust in the normal course of business over the next several years. The non-core properties comprise all of the Trust's offices (except its headquarters), distribution and service facilities, and certain retail properties located outside of the Northeast region of the United States. As a result of this change in investment strategy, the Trust recorded a charge of $7,000,000 in fiscal 1995, to writedown the carrying value of two of the non-core properties to their estimated net realizable values. The Trust believes that economic conditions in the real estate markets where the Trust's non-core properties are located have improved and that opportunities to sell those properties over the next several years have also improved. The Trust expects the ultimate sales of the non-core properties over the next several years to result in net gains to the Trust. During fiscal 1996, the Trust sold three non-core properties for aggregate sales proceeds of $20 million and realized net gains on the sales of the properties of $6,341,000. The proceeds from these sales were used principally to reduce outstanding mortgage indebtedness by approximately $19 million. At October 31, 1996, the non-core properties total eight properties having an aggregate net book value of $32,986,000. The Trust expects to make additional real estate investments periodically. The funds for such investments may come from existing liquid assets, line of credit arrangements, proceeds from property sales, financing of acquired or existing properties or the sale of mortgage notes receivable. In 1996, the Trust acquired Southern Plaza, a 30,700 square foot shopping center in Tempe, Arizona for a purchase price of $880,000. The Trust also invests in its existing properties and, during fiscal 1996, spent approximately $5.6 million on its properties for capital improvement and leasing costs. In fiscal 1996, the Trust's Board of Trustees authorized a program to purchase up to one million of the Trust's common shares over the next two to three years. The Trust expects to finance the purchase of such common shares from available cash or proceeds from the sales of its non-core assets. The repurchase program is subject to postponement or termination at any time in light of prevailing market conditions and other factors. In fiscal 1996, the Trust repurchased 40,700 shares at an aggregate cost of $631,000. Funds from Operations Funds from Operations is defined as net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from debt restructuring and sales of properties, plus depreciation and amortization, and the elimination of significant non-recurring charges and credits. In fiscal 1996, the Trust adopted the revised definition of Funds from Operations suggested by the National Association of Real Estate Investment Trusts (NAREIT), which eliminated the adjustment for amortization of non-real estate assets. The Trust believes the level of Funds from Operations to be an appropriate supplemental financial measure of its operating performance. Funds from Operations does not represent cash flows from operations as defined by generally accepted accounting principles, is not indicative that cash flows are adequate to fund all cash needs and is not considered to be an alternative to net income. The Trust considers recoveries of investment in properties which are subject to financing leases to be analogous to amortization for purposes of calculating Funds from Operations. In fiscal 1996, Funds from Operations increased 12% to $9,525,000 from $8,510,000 in 1995, and $7,653,000 in 1994. The improvement in fiscal 1996 is primarily the result of the positive effect of the Trust's recent property acquisitions and new leasing at certain of the Trust's core retail properties. Results of Operations Fiscal 1996 vs. Fiscal 1995 Revenues Total revenues increased 6.9% to $24,432,000 in fiscal 1996 compared to $22,853,000 in fiscal 1995. Operating lease revenues, which comprise more than 90% of the Trust's total revenues, increased by $2,767,000 or 14% resulting from the additional rents of two retail properties acquired in fiscal 1995 and new leasing at certain of the Trust's core properties. The Trust also sold two office properties and one retail property during fiscal 1996. In fiscal 1996, the Trust leased or renewed 75,000 square feet of retail space. Overall, the Trust's portfolio was 94% leased at year end. When adjusted to exclude properties acquired and sold in 1995 and 1996, rental income increased by 9% in fiscal 1996 from additional leasing of vacant space. At the end of fiscal 1996, more than 85% of the Trust's real estate portfolio consisted of retail properties. Other income in fiscal 1995 included $600,000 of non- recurring contract extension and other fees earned in connection with the sale of a property. Finance lease income decreased in fiscal 1996 as a result of the sale of four distribution properties in fiscal 1995 which were accounted for as direct finance leases. During 1996, the outlook for the retail industry improved. However, certain retailers continued to report sluggish sales, intense competition for consumer dollars and lower profit margins. Recently, there have been a number of retailer bankruptcies and others are anticipated. As of October 31, 1996, two discount retailers occupying space at two of the Trust's retail properties are in various stages of bankruptcy. In one instance, the lease has been reassigned to a credit worthy tenant who continues on the lease and has met all of its obligations under the lease. In the second instance, the tenant has historically reported good store sales and currently pays a modest rent. A third tenant closed its store and rejected its lease in bankruptcy. The Trust has obtained control of the lease and is actively seeking to re-tenant the space. While the Trust cannot predict the ultimate outcomes, it is optimistic and will monitor events in fiscal 1997. The gains on sales of properties in 1996 resulted from the sales of two office properties in Denver, Colorado and Houston, Texas and one retail property in Manassas,Virginia. Expenses Total expenses were $20,502,000 in fiscal 1996 compared to $26,556,000 in fiscal 1995. Included in fiscal 1995 expenses were write-downs in the carrying value of investments of $7,000,000 to the carrying values of two of the Trust's non-core properties to their estimated net realizable values. (See discussion under Liquidity and Capital Resources). Property expenses totalled $8,780,000 in fiscal 1996, compared to $7,691,000 in fiscal 1995. For properties owned during both 1996 and 1995, expenses in fiscal 1996 increased by 12% principally from higher snow removal costs, real estate taxes, and repairs. The increase in property expenses related to properties acquired or sold during fiscal 1996 and 1995 amounted to $370,000 in fiscal 1996. Interest expense in fiscal 1996 decreased from the repayment of outstanding borrowings under the Trust's credit lines and approximately $16.6 million in mortgage notes payable. The credit lines and mortgage notes payable were repaid from proceeds of sales of properties. Depreciation and amortization increased to $5,132,000 in fiscal 1996 from $4,804,000 in fiscal 1995 from the addition of two properties acquired in fiscal 1995 and capital expenditures for tenant improvements and deferred charges. General and administrative expenses decreased in fiscal 1996 principally from the absence of rental expense incurred under a lease agreement which expired in December 1995 for the Trust's former executive office space. The Trust currently occupies space in one of its office properties. Fiscal 1995 vs. Fiscal 1994 Revenues Total revenues increased 20.5% to $22,853,000 in fiscal 1995 compared to $18,969,000 in fiscal 1994. Rental income, including the income portion of rentals received in respect of direct finance leases, comprised 93% of total revenues (94% in fiscal 1994). Rental income from retail properties increased 25.9% to $14.5 million from $11.5 million in fiscal 1994. Most of the increase was attributable to two retail properties acquired during fiscal 1995 which increased rental income by $2.1 million. During the year, the Trust leased or renewed 153,400 square feet of retail space (9% of the Trust's gross retail leasable space). Gross rents from office properties increased nearly 10% to $5.4 million compared to $4.9 million in fiscal 1994 from higher occupancy and rent levels. Other income in fiscal 1995 included $600,000 of non- recurring contract extension and other fees earned in connection with the sale of a department store property. Expenses Total expenses were $26,556,000 in fiscal 1995, compared to $17,707,000 in fiscal 1994. Included in expenses in fiscal 1995 and 1994 were write-downs in the carrying values of investments of $7,000,000(see discussion under Liquidity and Capital Resources) and $1,086,000, respectively. The $1,086,000 write-down reflects a charge to record a $4,836,000 mortgage note receivable held by the Trust and collateralized by an office building at its net realizable value. The Trust had previously determined that the long term economic prospects for the building had declined and decided to offer the mortgage note for sale. The mortgage note was subsequently sold at its net realizable value. Property expenses increased 7% to $7,691,000 in fiscal 1995, from $7,185,000 in fiscal 1994. The increase in property expenses was primarily the result of the addition of new properties. The level of property expenses in 1995 for properties owned during both 1995 and 1994 decreased by 2%. Interest expense rose by $1,506,000 from the addition of $30.7 million of new mortgage notes payable in fiscal 1995 and late 1994. Also, interest expense on credit line borrowings rose from increases in the prime rate and LIBOR during the period. General and administrative expenses increased in fiscal 1995 principally from professional fees incurred in connection with the Trust's proxy and other filings during the year, and costs and expenses related to the relocation of the Trust to its new headquarters. Depreciation and amortization increased to $4,804,000 in fiscal 1995 from $4,075,000 in fiscal 1994 from the addition of three properties acquired at an aggregate cost of $52.6 million in fiscal 1995 and 1994 and capital expenditures for tenant improvements and deferred charges. Item VIII. Financial Statements and Supplementary Data. The consolidated financial statements required by this Item, together with the report of the Trust's independent public accountants thereon and the supplementary financial information required by this Item are included under Item XIV of this Annual Report. Item IX. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. No information is required to be reported under this Item. PART III Item X.Directors and Executive Officers of the Registrant. The Trust has filed with the Securities and Exchange Commission its definitive Proxy Statement for its Annual Meeting of Shareholders to be held on March 12, 1997. The additional information required by this Item is included under the caption "ELECTION OF TRUSTEES" of such Proxy Statement and is incorporated herein by reference. Executive Officers of the Registrant. The following sets forth certain information regarding the executive officers of the Trust: Name Age Offices Held Charles J. Urstadt 68 Chairman and Chief Executive Officer (since September 1989) Willing L. Biddle 35 President and Chief Operating Officer (since December, 1996); Executive Vice President and Chief Operating Officer (since March, 1996); Senior Vice President - Management (since June, 1995); Vice President - Retail (June, 1994 to June, 1995); Vice President - Asset Management (April 1993 to 1994); Vice President, Levites Realty Management Corp (1989 to 1993); prior to 1989, Second Vice President, Chase Manhattan Bank James R. Moore 48 Executive Vice President and Chief Financial Officer (since March, 1996); Senior Vice President and Chief Financial Officer (since September 1989); Secretary (since April 1987) and Treasurer (since December 1987); Vice President-Finance and Administration (April 1987 to September 1989); prior to April 1987, Senior Manager, Ernst & Young Raymond P. Argila 48 Senior Vice President and Chief Legal Officer (since June 1990); formerly Senior Counsel, Cushman & Wakefield, Inc., (September 1987 to May 1990) and associated with Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson & Casey (from March to June 1987); Vice President and Chief Legal Officer, Pearce, Urstadt, Mayer & Greer Realty Corp. from (January 1984 to March 1987.) Officers of the Trust are elected annually by the Trustees. Mr. Urstadt has been the Chairman of the Trustees since 1986, and a Trustee since 1975. Mr. Urstadt also serves as the President of Urstadt Property Company, Inc. (formerly Pearce, Urstadt, Mayer & Greer Inc.) and has served in such capacity for more than five years. Item XI. Executive Compensation. The Trust has filed with the Securities and Exchange Commission its definitive Proxy Statement for its Annual Meeting of Shareholders to be held on March 12, 1997. The information required by this Item is included under the caption "ELECTION OF TRUSTEES - Compensation and Transactions with Management and Others of such Proxy Statement and is incorporated herein by reference. Item XII. Security Ownership of Certain Beneficial Owners and Management. The Trust has filed with the Securities and Exchange Commission its definitive Proxy Statement for its Annual Meeting of Shareholders to be held on March 12, 1997. The information required by this Item is included under the caption ELECTION OF TRUSTEES - Security Ownership of Certain Beneficial Owners and Management of such Proxy Statement and is incorporated herein by reference. Item XIII. Certain Relationships and Related Transactions. The Trust has filed with the Securities and Exchange Commission its definitive Proxy Statement for its Annual Meeting of Shareholders to be held on March 12, 1997. The information required by this Item is included under the caption ELECTION OF TRUSTEES - Compensation and Transactions with Management and Others of such Proxy Statement and is incorporated herein by reference. PART IV Item XIV. Exhibits, Financial Statements,Schedules and Reports on Form 8-K. A. Financial Statements and Financial Statement Schedules 1. Financial Statements -- The consolidated financial statements listed in the accompanying index to financial statements on Page 23 are filed as part of this Annual Report. 2. Financial Statement Schedules -- The financial statement schedules required by this Item are filed with this report and are listed in the accompanying index to financial statements on Page 23. All other financial statement schedules are inapplicable. B. Reports on Form 8-K No reports on Form 8-K were filed by the Registrant during the last quarter of the fiscal year ended October 31, 1996. C. Exhibits. Listed below are all Exhibits filed as part of this report. Certain Exhibits are incorporated by reference from documents previously filed by the Trust with the Securities and Exchange Commission pursuant to Rule 12b-32 under the Securities Exchange Act of 1934, as amended. Exhibit (3) Articles of Incorporation and By-laws. 3.1 Fourth Amended and Restated Declaration of Trust of the Trust, as amended, (incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended April 30, 1995). 3.2 By-laws of the Trust, as amended (incorporated by reference to Exhibit 4.2 of the Registrant's Registration Statement on Form S-8 (No. 33-41408)). (4) Instruments Defining the Rights of Security Holders, Including Indentures. 4.1 Common Shares: See Exhibit 3.1 hereto. 4.2 Preferred Shares: See Exhibit 3.1 hereto. 4.3 Preferred Share Purchase Rights: See Exhibits 3.1, 10.3 and 10.3.1 hereto. (10) Material Contracts. 10.1 Form of Indemnification Agreement entered into between the Registrant and each of its Trustees and for future use with Trustees and officers of the Trust (incorporated herein by reference to Exhibit 10.1 of the Registrant's Annual Report on Form 10-K for the year ended October 31, 1989).* 10.2 Amended and Restated Change of Control Agreement between the Registrant and James R. Moore dated November 15, 1990 (incorporated herein by reference to Exhibit 10.3 of the Registrant's Annual Report on Form 10-K for the year ended October 31, 1990).* 10.3 Rights Agreement between the Trust and The First National Bank of Boston, as Rights Agent, dated as of October 28, 1988 (incorporated herein by reference to Exhibit 1 of the Registrant's Current Report on Form 8-K dated October 28, 1988). 10.3.1 Amendment No. 1 dated May 14, 1996 to the Rights Agreement, dated as of October 28, 1988 (incorporated herein by reference to Exhibit 4 of the Registrant's Current Report on Form 8-K dated May 2, 1996). 10.4 Change of Control Agreement dated as of June 12, 1990 between the Registrant and Raymond P. Argila (incorporated herein by reference to Exhibit 10.7 of the Registrant's Annual Report on Form 10-K for the year ended October 31, 1990).* 10.4.1 Agreement dated December 19, 1991 between the Registrant and Raymond P. Argila amending the Change of Control Agreement dated as of June 12, 1990 between the Registrant and Raymond P. Argila (incorporated herein by reference to Exhibit 10.6.1 of the Registrant's Annual Report on Form 10-K for the year ended October 31, 1991).* 10.5 Change of Control Agreement dated as of December 20, 1990 between the Registrant and Charles J. Urstadt (incorporated herein by reference to Exhibit 10.8 of the Registrant's Annual Report on Form 10-K for the year ended October 31, 1990).* 10.6 Amended and Restated HRE Properties Stock Option Plan (incorporated herein by reference to Exhibit 10.8 of the Registrant's Annual Report on Form 10-K for the year ended October 31, 1991).* 10.6.1 Amendments to HRE Properties Stock Option Plan dated June 9, 1993 (incorporated by reference to Exhibit 10.6.1 of the Registrant's Annual Report on Form 10-K for the year ended October 31, 1995).* 10.7 Amended and Restated Change of Control Agreement dated as of November 6, 1996 between the Registrant and Willing L. Biddle*. 10.8 Countryside Square Limited Partnership Agreement of Limited Partnership dated as of November 22, 1996 between HRE Properties, as General Partner and the persons whose names are set forth on Exhibit A of the Agreement, as Limited Partners (incorporated by reference to Exhibit I of the Registrant's Current Report on Form 8-K dated November 22, 1996). (21) Subsidiaries. 21.1 List of Trust's subsidiaries (incorporated by reference to Exhibit 22.1 of the Registrant's Annual Report on Form 10-K for the year ended October 31, 1988). (23) Consents of Experts and Counsel. 23.1 The consent of Arthur Andersen LLP to the incorporation by reference of their reports included or incorporated by reference herein in the Registrant's Registration Statements on Form S-3 (No.33-57119), Form S-8 (No.2-93146) and Form S-8 (No. 33-41408) is filed herewith as part of this report. (27) Financial Data Schedule. 27.1 Financial Data Schedule *Management contract, compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 14(c). HRE PROPERTIES Item XIVa. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES Page Consolidated Balance Sheets at October 31, 1996 and 1995 24 Consolidated Statements of Income for each of the three years ended October 31, 1996 25 Consolidated Statements of Cash Flows for each of the three years ended October 31, 1996 26 Consolidated Statements of Shareholders' Equity for each of the three years ended October 31, 1996 27 Notes to Consolidated Financial Statements 28-35 Report of Independent Public Accountants 36 Schedule. The following consolidated financial statement schedules of HRE Properties are included in Item XIV(d): III Real Estate and Accumulated Depreciation - October 31,1996 37 IV Mortgage Loans on Real Estate - October 31, 1996 41 All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. CONSOLIDATED BALANCE SHEETS (In thousands, except share data) October 31, ASSETS 1996 1995 Real Estate Investments: Properties owned - at cost, net of accumulated depreciation $ 88,280 $ 85,966 Properties available for sale - at cost, net of accumulated depreciation and recoveries 32,986 46,212 Mortgage notes receivable 3,706 3,937 124,972 136,115 Cash and cash equivalents 1,819 7,097 Interest and rent receivable 2,795 2,691 Deferred charges, net of accumulated amortization 1,592 1,913 Other assets 982 1,283 $132,160 $149,099 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Bank loan $ - $ 2,500 Mortgage notes payable 39,798 57,212 Accounts payable and accrued expenses 774 1,014 Deferred trustees' fees 470 436 Other liabilities 1,152 1,355 42,194 62,517 Shareholders' Equity: Preferred shares, without par value; 2,000,000 shares authorized; none issued Common shares, without par value; unlimited shares authorized; 5,565,129 and 5,545,574 issued in 1996 and 1995, respectively 124,126 123,844 Less 219,048 and 178,348 common shares held in treasury, at cost, respectively (3,492) (2,861) Distributions in excess of accumulated net income (30,668) (34,401) 89,966 86,582 $132,160 $149,099 The accompanying notes to consolidated financial statements are an integral part of these balance sheets. CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) Year Ended October 31, 1996 1995 1994 Revenues: Operating leases $ 22,770 $20,003 $16,498 Financing leases 612 1,165 1,392 Interest and other 1,050 1,685 1,079 24,432 22,853 18,969 Operating Expenses: Property expenses 8,780 7,691 7,185 Interest 4,867 5,281 3,775 Depreciation and amortization 5,132 4,804 4,075 General and administrative expenses 1,545 1,610 1,423 Trustees' fees and expenses 178 170 163 Write-downs in carrying value of investments - 7,000 1,086 20,502 26,556 17,707 Operating Income (Loss) 3,930 (3,703) 1,262 Gains on Sales of Properties 6,341 7,567 82 Net Income $10,271 $ 3,864 $ 1,344 Net Income Per Common Share $ 1.91 $ .72 $ .26 Weighted Average Number of Common Shares Outstanding 5,365 5,349 5,330 The accompanying notes to consolidated financial statements are an integral part of these statements. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Year Ended October 31, 1996 1995 1994 Operating Activities: Net income $10,271 $ 3,864 $ 1,344 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 5,132 4,924 4,151 Recovery of investment in properties owned subject to financing leases 954 1,355 1,471 Minority interests in results of consolidated jointventure -- -- (20) Gains on sales of properties (6,341) (7,567) (82) Write-downs in carrying value of investments -- 7,000 1,086 (Increase) in interest and rent receivable (104) (348) (1,039) Increase (decrease) in accounts payable and accrued expenses (206) (95) 97 (Increase) decrease in other assets and other liabilities, net 95 (98) (619) Net Cash Provided by Operating Activities 9,801 9,035 6,389 Investing Activities: Acquisitions of properties (880) (26,809) (25,816) Improvements to existing properties owned and deferred charges (5,617) (2,959) (1,764) Proceeds from sale of mortgage note receivable -- 3,750 -- Net proceeds from sale of investment in unconsolidated joint venture -- -- 250 Net proceeds from sales of properties 17,988 12,822 454 Contract deposit received -- -- 500 Payments received on mortgage notes receivable 231 76 68 Miscellaneous -- (119) (4) Net Cash Provided by (Used in) Investing Activities 11,722 (13,239) (26,312) Financing Activities: Proceeds from bank loans 5,250 -- 5,000 Proceeds from mortgage notes 6,000 11,250 22,500 Dividends paid (6,538) (6,100) (5,861) Proceeds from sales of common shares 282 337 302 Purchases of common shares for treasury (631) -- -- Payments on mortgage notes payable and bank loan (31,164) (2,924) (341) Net Cash Provided by (Used in) Financing Activities (26,801) 2,563 21,600 Net Increase (Decrease) In Cash and Cash Equivalents (5,278) (1,641) 1,677 Cash and Cash Equivalents at Beginning of Year 7,097 8,738 7,061 Cash and Cash Equivalents at End of Year $ 1,819 $ 7,097 $ 8,738 The accompanying notes to consolidated financial statements are an integral part of these statements. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands, except shares and per share data) Common Shares (Distributions Treasury In Excess of Outstanding Issued Shares, Accumulated Number Amount at Cost Net Income) Total Balances - October 31, 1993 5,320,106 $123,205 $(2,861) $(27,648) $92,696 Net income -- -- -- 1,344 1,344 Cash dividends paid ($1.10 per share) -- -- -- (5,861) (5,861) Sale of additional common shares under dividend reinvestment plan 18,048 261 -- -- 261 Common shares issued upon exercise of stock options 3,542 41 -- -- 41 Balances - October 31, 1994 5,341,696 123,507 (2,861) (32,165) 88,481 Net income -- -- -- 3,864 3,864 Cash dividends paid ($1.14 per share) -- -- -- (6,100) (6,100) Sale of additional common shares under dividend reinvestment plan 18,862 260 -- -- 260 Common shares issued upon exercise of stock options 6,668 77 -- -- 77 Balances - October 31, 1995 5,367,226 123,844 (2,861) (34,401) 86,582 Net income -- -- -- 10,271 10,271 Cash dividends paid ($1.22 per share) -- -- -- (6,538) (6,538) Sale of additional common shares under dividend reinvestment plan 19,555 282 -- -- 282 Purchases of common shares held in treasury (40,700) -- (631) -- (631) Balances - October 31, 1996 5,346,081 $124,126 (3,492) $(30,668) $89,966 The accompanying notes to consolidated financial statements are an integral part of these statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business HRE Properties, a real estate investment trust, is engaged in the acquisition, ownership and management of commercial real estate, primarily neighborhood and community shopping centers in the northeastern part of the United States. Other assets include office and retail buildings and industrial properties. The Trust's major tenants include supermarket chains and other retailers who sell basic necessities and multi-national industrial corporations. Principles of Consolidation The consolidated financial statements include the accounts of HRE Properties (the Trust), its wholly-owned subsidiary, and a joint venture in which the Trust has the ability to control the affairs of the venture. All significant intercompany transactions and balances have been eliminated in consolidation. Accounting for Leases The Trust accounts for its leases of real property in accordance with the provisions of Financial Accounting Standards Statement No. 13, "Accounting for Leases," as amended. This Statement sets forth specific criteria for determining whether a lease should be accounted for as an operating lease or a direct financing lease. In general, the financing lease method applies where property is under long-term lease to a creditworthy tenant and the present value of the minimum required lease payments at the inception of a lease is at least 90% of the market value of the property leased. Other leases are accounted for as operating leases. Federal Income Taxes The Trust believes it qualifies and intends to continue to qualify as a real estate investment trust under Sections 856-860 of the Internal Revenue Code. Under those sections, a trust, among other things, that distributes at least 95% of its real estate trust taxable income will not be taxed on that portion of its taxable income which is distributed. The Trust has distributed all of its taxable income for the fiscal years through 1996. Accordingly, no provision has been made for Federal income taxes in the accompanying consolidated financial statements. Taxable income of the Trust prior to the dividends paid deduction for the years ended October 31, 1996, 1995 and 1994 was approximately $5,200,000, $3,600,000, and $2,200,000, respectively. Taxable income in fiscal 1996 and 1995 was reduced through the utilization of available capital loss carry-overs of $2,600,000 and $2,900,000, respectively. The difference between net income for financial reporting purposes and taxable income results from, among other things, differences in adjusted bases for capital gains and losses and different methods of accounting for leases and depreciable lives related to the properties owned. Depreciation and Amortization The Trust uses the straight-line method for depreciation and amortization. Properties owned and properties available for sale are depreciated over the estimated useful lives of the properties, which range from 30 to 45 years. Furniture and equipment are depreciated over their estimated useful lives, which range from 3 to 20 years. Tenant improvements, deferred leasing costs and leasehold improvements are amortized over the life of the related leases. All other deferred charges are amortized over the terms of the agreements to which they relate. Properties Available for Sale A property is classified as available for sale upon determination by the Trustees that the property is to be marketed for sale in the normal course of business over the next several years. In March 1995, the Financial Accounting Standards Board issued Statement No. 121 (the "Statement") on accounting for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to assets to be held and used. The Statement also establishes accounting standards for long-lived assets and certain identifiable intangibles to be disposed of. The Trust is required and plans to adopt the Statement on November 1, 1996. The Statement requires, among other things, that assets to be disposed of be carried at the lower of cost or fair value less costs to dispose. Management does not expect the impact on the consolidated financial statements resulting from the adoption of the provisions of this Statement to be material. Capitalization The Trust capitalizes all direct costs relating to the acquisition of real estate investments and costs relating to improvements to properties. The Trust also capitalizes all direct costs relating to its successful leasing activities. Income Recognition Revenues from operating and finance leases include revenues from properties owned and properties available for sale. Rental income is generally recognized based on the terms of leases entered into with tenants. Rental income from leases with scheduled rent increases is recognized on a straight- line basis over the lease term. Additional rents which are provided for in leases, are recognized as income when earned and their amounts can be reasonably estimated. Interest income is recognized as it is earned. Gains and losses on sales of properties are recorded when the criteria for recognizing such gains or losses under generally accepted accounting principles have been met. Statements of Cash Flows The Trust considers short-term investments with original maturities of 90 days or less to be cash equivalents. Use of Estimates The preparation of financial statements requires management to make use of estimates and assumptions that affect amounts reported in the financial statements as well as certain disclosures. Actual results could differ from those estimates. Allowance For Possible Investment Losses The Trust's real estate investments are recorded at the lower of depreciated historical cost or estimated net realizable values. The Trust periodically reviews each of its investments for declines in net realizable values, to amounts below recorded balances, based on its present investment strategies. Future changes in such investment strategies and other circumstances may affect estimates of net realizable values and therefore the carrying amount of investments. Net Income Per Common Share Computations of net income per common share are based on the weighted average number of common shares outstanding during the respective periods. The additional shares issuable upon exercise of stock options (see Note 8) have not been included in the computations since their effect is immaterial. (2) REAL ESTATE INVESTMENTS The Trust's investments in real estate were composed of the following at October 31, 1996 and 1995 (in thousands): Properties Mortgage Properties Available Notes 1996 1995 Owned for Sale Receivable Totals Totals Retail $ 86,469 $ 16,553 $ 3,706 $ 106,728 $ 105,330 Office 1,507 7,864 -- 9,371 20,945 Distribution and Service -- 7,769 -- 7,769 8,736 Undeveloped Land 304 800 -- 1,104 1,104 $ 88,280 $ 32,986 $ 3,706 $ 124,972 $136,115 The Trust's investments at October 31, 1996, consisted of equity interests in 18 properties which are located in various regions throughout the United States and mortgage notes. The following is a summary of the geographic locations of the Trust's investments at October 31, 1996 and 1995 (in thousands): 1996 1995 Northeast $90,649 $89,211 Southeast 14,137 15,153 Midwest 10,418 10,910 Rocky Mountain 800 8,916 Southwest 7,015 9,909 Pacific Coast and Northwest 1,953 2,016 $124,972 $136,115 (3) PROPERTIES OWNED The components of properties owned were as follows (in thousands): 1996 1995 Land $ 17,068 $ 17,068 Buildings and improvements 84,034 79,165 101,102 96,233 Accumulated depreciation (12,822) (10,267) $ 88,280 $ 85,966 Space at properties owned by the Trust is generally leased to various individual tenants under short and intermediate term leases which are accounted for as operating leases. Minimum rental payments on noncancellable operating leases become due as follows: 1997 - $15,373,000; 1998 - $14,436,000; 1999 - $13,007,000; 2000 - $11,664,000; 2001 - $8,685,000; and thereafter - - $62,415,000. In addition to minimum rental payments, certain tenants are required to pay additional rental amounts based on increases in property operating expenses and/or their share of the costs of maintaining common areas. Certain of the Trust's leases provide for the payment of additional rent based on a percentage of the tenant's revenues. Such additional rents are included in rental income and aggregated approximately $281,000, $483,000, and $515,000 in 1996, 1995 and 1994, respectively. (4) PROPERTIES AVAILABLE FOR SALE In fiscal 1995, the Board of Trustees authorized a plan to sell all of the non-core properties of the Trust over the next several years. The non-core properties consist of all of the Trust's distribution and service properties, the Trust's office properties (with the exception of its headquarters), and certain retail properties located outside of the Northeast region of the United States. These properties, having a net carrying amount of $32,986,000 at October 31, 1996, have been classified as Properties Available for Sale in the accompanying consolidated financial statements. As a result of this change in investment strategy, the Trust recorded a charge of $7,000,000 in the 1995 consolidated statement of income to write-down the carrying value of the properties available for sale to their respective estimated net realizable values. At October 31, 1996 and 1995, properties available for sale consisted of the following (in thousands): 1996 1995 Properties available for sale subject to: Operating leases $ 25,832 $38,104 Direct financing leases 7,154 8,108 $ 32,986 $46,212 Operating Leases The components of properties available for sale subject to operating leases were as follows (in thousands): 1996 1995 Land $ 6,675 $ 8,898 Buildings and improvements 32,871 48,874 39,546 57,772 Accumulated depreciation (13,714) (19,668) $ 25,832 $38,104 Direct Financing Leases The components of properties available for sale subject to direct financing leases were as follows (in thousands): 1996 1995 Total minimum lease payments to be received $ 5,900 $ 7,431 Assumed residual values of leased property 2,404 2,412 Unearned income (1,150) (1,735) Investment in property subject to direct financing leases $ 7,154 $ 8,108 Original cost of property subject to direct financing leases $16,276 $16,276 Assumed residual values are based upon a depreciated cost concept using estimated useful lives and thus do not contain an element of appreciation which may result by reason of inflation or other factors. Minimum lease payments receivable on direct financing leases become due at a rate of $1,468,000 in 1997, $1,468,000 in 1998, $1,468,000 in 1999, $1,299,000 in 2000 and $197,000 in 2001. In fiscal 1996, the Trust acquired one retail property at a purchase price of $880,000. The property is located adjacent to property already owned by the Trust. Sales of Properties In fiscal 1996, the Trust sold three properties for a net gain on sales of properties of $6,341,000. In fiscal 1995 the Trust sold four industrial properties for gains on sales of properties of $7,567,000. In fiscal 1994, the Trust sold an industrial property for a gain on sale of property of $82,000. (5) WRITE-DOWNS IN CARRYING VALUE OF INVESTMENTS In connection with the Trust's change in investment strategy and plan to sell its non-core properties, the Trust recorded a charge of $7,000,000 in fiscal 1995 to write-down the carrying value of the properties available for sale to their respective estimated net realizable values. (See Note 4) The Trust held a participating mortgage in the principal amount of $4,836,000. The participating mortgage note was collateralized by an office property and entitled the Trust to a fixed rate of interest plus a participation in increases in the property's income and market value. In fiscal 1994,the Trust determined that the long-term outlook for the property had declined due to, among other things, significant tenant turnover. As a result of these circumstances, the Trust changed its investment strategy with respect to this asset and offered the mortgage loan for sale and, in December 1994, the mortgage loan was sold for net proceeds of $3,750,000. As a result, the Trust recorded a charge of $1,086,000 in fiscal 1994, to write down the carrying value of the mortgage loan to its selling price, which charge is reflected in "Write- downs in carrying value of investments" in the 1994 consolidated statement of income. (6) MORTGAGE NOTES RECEIVABLE The Trust's mortgage notes receivable consist of fixed rate mortgages. The components of the mortgage notes receivable at October 31, 1996 and 1995 were as follows (in thousands): 1996 1995 Remaining principal balance $ 4,690 $ 4,977 Unamortized discounts to reflect market interest rates at time of acceptance of notes ( 984) (1,040) $ 3,706 $ 3,937 At October 31, 1996, principal payments on mortgage notes receivable become due as follows: 1997 - $158,000; 1998 - $172,000; 1999 - $189,000; 2000 - $206,000; 2001 - $160,000; thereafter - $ 3,805,000. At October 31, 1996, the remaining principal balance was due from two borrowers. The amount due from the largest individual borrower at October 31, 1996 was $2,346,000. The contractual interest rates on mortgage notes receivable range from 12% to 14%. (7) MORTGAGE NOTES PAYABLE AND LINES OF CREDIT At October 31, 1996 the Trust had seven nonrecourse mortgage notes payable totalling $39,798,000 ($51,606,000 at October 31, 1995) which are due in installments over various terms extending to the year 2002 and which bear interest at rates ranging from 7.5% to 9.75%. The mortgage notes payable are collateralized by real estate investments having a net carrying value of $68.4 million as of October 31, 1996. Scheduled principal payments during the next five years are as follows: 1997 - $ 3,089,000; 1998 - $24,267,000; 1999 - $257,000; 2000 - $2,236,000; 2001 - $4,309,000; and thereafter - $5,640,000. The Trust also has available $15 million in unsecured lines of credit. Extensions of credit under one of the lines of credit in the amount of $10 million is subject to the bank's satisfaction of certain conditions, including the intended use of proceeds. The lines of credit expire in fiscal 1997 and bear interest at rates tied to the prime rate or LIBOR. A condition for one of the credit lines in the amount of $5 million requires the Trust to maintain a compensating balance of $525,000. The Trust had no outstanding borrowings under either line of credit at October 31, 1996 ($2,500,000 at October 31, 1995). Interest paid for the years ended October 31, 1996, 1995 and 1994 was $4,945,000, $5,304,000, and $3,668,000 respectively. (8) STOCK OPTIONS AND SHAREHOLDER RIGHTS PLAN At October 31, 1996, 453,665 shares of the Trust's authorized but unissued stock were reserved for issuance to key employees of the Trust and certain non-employee trustees under the Trust's stock option plan. Options are granted at fair market value on the date of the grant and are generally exercisable in installments over a maximum period of four years from the date of grant. A summary of stock options at October 31, 1996 and 1995 is as follows: Number Option Price of Shares Per Share Outstanding at October 31, 1996 440,082 $11.38-$25.50 1995 376,248 $11.38-$25.50 Exercisable at October 31, 1996 285,330 $11.38-$25.50 No accounting recognition is given to stock options until they are exercised, at which time the proceeds are credited to shareholders' equity. During the year ended October 31, 1995, options to purchase 6,668 common shares were exercised. There were no options exercised in fiscal 1996. Stock appreciation rights may be issued in tandem with the stock options, in which case, either the option or the right can be exercised. Such rights entitle the grantee to payment in cash or a combination of common shares and cash equal to the increase in the value of the shares covered by the option to which the stock appreciation right is related. The plan limits the value of the stock appreciation rights to 150% of the option price for the related shares. The excess of the market price of the shares over the exercise price of vested options is charged to expense. For the years ended October 31, 1996, 1995 and 1994, there were no amounts charged to expense. The Board of Trustees adopted a Preferred Share Purchase Rights Plan in 1988 and declared a dividend distribution of one preferred share purchase right for each outstanding common share. The Plan was amended in 1996 to increase the beneficial ownership threshold which triggers the exercisability of the rights. The rights, which expire on November 13, 1998, are not currently exercisable. When they are exercisable, the holder will be entitled to purchase from the Trust one one-hundredth of a share of a newly-established Series A Participating Preferred Stock at a price of $65 per one one-hundredth of a preferred share, subject to certain adjustments. The rights will become exercisable 10 days after a person or group either acquires 25% ("acquiring person") or more of the Trust's shares, or announces an offer the consummation of which would result in such person or group owning 30% or more of the shares. Following any such 25% acquisition, shareholders other than the acquiring person will be entitled to use the rights to purchase common shares of the Trust at 50% of market value. If the Trust is involved in a merger or other business combination at any time after the rights become exercisable, the rights will be modified to entitle a holder other than the acquiring person to purchase a number of shares of common stock of the acquiring company having a market value of twice the exercise price of each right. (9) OTHER MATTERS In a prior year, as a part of a real property transfer and mortgage transaction, the Trust negotiated an option to purchase a 117,500 square foot retail property upon the occurrence of certain events, for one dollar. The property is triple net leased to a single tenant under a long-term lease arrangement. In fiscal 1996, the Trust exercised its option. However, the property's owner of record has contested the option and has commenced an action against the Trust to declare the option unenforceable. The Trust has counterclaimed, and intends to vigorously pursue the litigation. There is a $2 million mortgage lien recorded against the property, the priority of which is being evaluated. In March 1996, the Trust's Board of Trustees authorized a program to purchase up to one million of the Trust's common shares periodically. The Trust purchased 40,700 common shares in fiscal 1996 which are held in treasury. (10) DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosures of estimated fair value were determined by management using available market information and appropriate valuation methodologies. Considerable judgement is necessary to interpret market data and develop estimated fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Trust could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Cash and cash equivalents, rents receivable, interest receivable, accounts payable and accrued expenses and other liabilities are carried at amounts which reasonably approximate their fair values. The estimated fair value of mortgage notes receivable collateralized by real property is based on discounting the future cash flows at a year-end risk adjusted lending rate that the Trust would utilize for loans of similar risk and duration. At October 31, 1996, the estimated aggregate fair value of the mortgage notes receivable is $3,900,000. Mortgage notes payable with an aggregate carrying value of $39,798,000 have an estimated aggregate fair value of $40,000,000 at October 31, 1996. Estimated fair value is based on discounting the future cash flows at a year-end risk adjusted lending rate currently available to the Trust for issuance of debt with similar terms and remaining maturities. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein. (11) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The unaudited quarterly results of operations for the years ended October 31, 1996 and 1995 are as follows (in thousands, except per share data): Year Ended October 31, 1996 Year Ended October 31, 1995 Quarter Ended Quarter Ended Jan 31 Apr 30 July 31 Oct 31 Jan 31 Apr 30 July 31 Oct 31 Revenues $ 6,154 $ 6,076 $ 5,955 $ 6,247 $ 5,169 $ 5,606 $ 5,815 $6,263 Income (loss) before gains on sales of properties (1) $ 778 $ 914 $1,053 $ 1,185 $ 575 $ 668 $ (6,252) $1,306 Gains (losses) on sales of properties 6,252 -- 389 (300) -- 5,502 -- 2,065 Net Income (loss) $ 7,030 $ 914 $1,442 $ 885 $ 575 $ 6,170 $ (6,252) $3,371 Per share: Net Income (loss) $ 1.31 $ .17 $ .26 $ .17 $ .11 $ 1.15 $ (1.17) $ .63 (1) Quarter ended October 31, 1995 results include other income of $600,000 earned in connection with the contract for sale of one of the Trust's properties. Quarter ended July 31, 1995 results include a charge of $7,000,000 to reflect the carrying values of two properties available for sale at their net realizable values. (12) SUBSEQUENT EVENTS In December 1996, subject to shareholder approval, the Board of Trustees approved a plan of reorganization of the Trust from a Massachusetts business trust to a corporation organized in Maryland to, among other things, provide for enhanced flexibility in the conduct of its business in carrying out the strategic objectives of the Trust. The plan of reorganization will be effected by means of a merger of the Trust into a Maryland corporation wholly owned by the Trust under which each outstanding common share of the Trust will be converted into one share of common stock of the corporation. The plan of reorganization is subject to, among other things, approval of the shareholders of the Trust at its annual meeting in March, 1997. In December 1996, the Trust obtained a commitment from a bank for a $2 million non recourse first mortgage loan secured by a retail property having a book value of approximately $3.1 million. In December 1996, the Trust purchased approximately 85 acres of land in Carmel, New York at a cost of $275,000. In November 1996, the Trust negotiated a settlement proposal with one of its tenants to recover, among other things, unpaid additional percentage rents including interest totalling $3.25 million. In accordance with the terms of its lease, the tenant will be required to aggregate the sales of all its stores in a specified radius when computing percentage rent due the Trust. The settlement proposal, including certain other modifications to the lease is expected to be completed and recorded as income in the Trust's first quarter of fiscal 1997. On November 22, 1996, the Trust formed a limited partnership with certain shareholders of the Trust. The purpose of the partnership is to own, manage and redevelop the Trust's Countryside Square shopping center in Clearwater, Florida, a property available for sale in the accompanying Consolidated Balance Sheet at October 31, 1996. The Trust, as the general partner, contributed the shopping center at its net carrying amount (which amount approximates its fair value of $13 million), and the limited partners, including Kimco Realty Corp. who will manage the property, contributed 600,000 common shares of the Trust to the limited partnership. The partnership agreement provides for the limited partners to receive an annual cash preference from available cash of the partnership, as defined. Upon liquidation, proceeds from the sale of the partnership assets are to be distributed to the partners as follows: first, $12 million to the limited partners, next, $25 million to the Trust and the balance to the partners in proportion to the respective partnership interests. The property may be sold at any time after the third year of operation and the Trust has a right of first refusal on the sale of the property. The partners are not obligated to make any additional capital contributions, however, to the extent that there is a shortfall in cash available for distributions, the general partner may elect to sell the common shares of the Trust held by the partnership in an amount equal to the shortfall amount, or contribute such shortfall amount to the partnership. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders of HRE Properties: We have audited the accompanying consolidated balance sheets of HRE Properties (the Trust), a Massachusetts voluntary association, and subsidiary as of October 31, 1996 and 1995, and the related consolidated statements of income, cash flows and shareholders' equity for each of the three years in the period ended October 31, 1996. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of HRE Properties and subsidiary as of October 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 1996 in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the accompanying index to financial statements are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP New York, New York December 18, 1996 HRE PROPERTIES OCTOBER 31, 1996 SCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION - ----------------------------------------------------- (In thousands) COL. A COL. B COL. C COL. D COL. E COL. F COL. G/H Costs Capitalized Sub. Amount at which Carried Initial Cost to Trust to Acquisition at Close of Period Accumulated Date Description Building & Carrying Building & Building & Depreciation Constructed and Location Encumbrances Land Improvements Costs Improvements Land Improvements Total Note(b) or Acquired - ------------------------------------------------------------------------------------------------------------------------------------ REAL ESTATE SUBJECT TO OPERATING LEASES (Note (a) ): - ----------------------------------- OFFICE BUILDINGS: Greenwich, Connecticut $575 $199 $795 $0 $45 $199 $840 $1,039 $76 1993 31.5 Greenwich, Connecticut 0 111 444 0 21 111 465 576 33 1994 31.5 Southfield, Michigan 0 1,000 10,280 0 833 1,000 11,113 12,113 4,249 1983 35 575 1,310 11,519 0 899 1,310 12,418 13,728 4,358 SHOPPING CENTERS: Clearwater, Florida 0 3,689 17,273 0 2,881 3,689 15,354 19,043 6,439 1985 40 Springfield, Massachusetts 0 1,372 3,656 0 12,147 1,372 15,803 17,175 5,397 1970 40 Farmingdale, New York 2,575 1,029 4,174 0 106 1,029 4,280 5,309 437 1993 31.5 Somers, New York 2,458 821 2,600 0 30 821 2,630 3,451 325 1992 31 Wayne, New Jersey 9,100 2,492 9,966 0 273 2,492 10,239 12,731 1,056 1992 31 Meriden, Connecticut 14,722 5,000 20,309 0 467 5,000 20,776 25,776 1,910 1993 31.5 Danbury, Connecticut 5,940 3,850 15,811 0 597 3,850 16,408 20,258 782 1994 31.5 Tempe, Arizona 0 114 766 0 0 114 766 880 14 1996 40 Carmel, New York 0 1,470 5,973 0 26 1,470 5,999 7,469 163 1995 31.5 34,795 19,837 80,528 0 16,527 19,837 92,255 112,092 16,523 DEPARTMENT STORES: Tempe, Arizona 0 378 1,518 0 970 378 2,488 2,866 1,387 1970 40 Mesa, Arizona 0 440 1,631 0 989 440 2,620 3,060 1,457 1971 40 0 818 3,149 0 1,959 818 5,108 5,926 2,844 INDUSTRIAL SERVICE CENTER: Syracuse, New York 0 253 530 0 0 253 530 783 168 1973 40 0 253 530 0 0 253 530 783 168 MIXED USE FACILITY: RETAIL/OFFICE: Newington, New Hampshire 4,428 421 1,997 0 4,597 421 6,594 7,015 2,643 1979 40 LAND: Newington, New Hampshire 0 305 0 0 0 305 0 305 0 1981 - Denver, Colorado 0 799 0 0 0 799 0 799 0 1988 - TOTAL REAL ESTATE SUBJECT TO OPERATING LEASES... $39,798 $23,743 $97,723 $0 $23,982 $23,743 $116,905 $140,648 $26,536 HRE PROPERTIES OCTOBER 31, 1996 SCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION - CONTINUED - ------------------------------------------------------------------ (In thousands) COL. A COL. B COL. C COL. D COL. E COL. F Net Investment Remaining in Properties Description Building & Carrying Building & Minimum Lease Residual Unearned Subject to and Location Encumbrances Land Improvements Costs Improvements Payments Value Income Financin REAL ESTATE SUBJECT TO FINANCING LEASES (Notes (c) and (e) ): - ----------------------------------- INDUSTRIAL DISTRIBUTION CENTERS: (Leased to Chrysler Corporation) St. Louis, Missouri 0 523 2,253 0 2,363 1,585 1,167 (333) 2,419 1970 Dallas, Texas 0 193 2,266 0 4,195 2,547 841 (482) 2,906 1970 Deferred Lease Renewal Rights 0 0 0 0 296 0 296 0 296 1981 0 716 4,519 0 6,854 4,132 2,304 (815) 5,621 INDUSTRIAL DISTRIBUTION CENTER: (Leased to Firestone Tire and Rubber Company): Albany, Georgia 0 835 3,343 0 0 1,768 100 (335) 1,533 1972 TOTAL REAL ESTATE SUBJECT TO FINANCING LEASES... $0 $ 1,551 $ 7,862 $ 0 $ 6,854 $5,900 $2,404 ($1,150) $7,154 HRE PROPERTIES OCTOBER 31, 1996 SCHEDULE III- REAL ESTATE AND ACCUMULATED DEPRECIATION -CONTINUED - ----------------------------------------------------------------- (In thousands) NOTES: 1996 1995 1994 (a) RECONCILIATION OF PROPERTIES OWNED SUBJECT TO OPERATING LEASES Balance at beginning of year $154,005 $132,085 $105,926 Property improvements during the year 5,263 1,816 907 Property acquired during the year 880 27,104 25,816 Writedown in carrying value of properties -- (7,000) -- Property sold or disposed of during the year (19,500) -- (564) Balance at end of year $140,648 $154,005 $132,085 (b) RECONCILIATION OF ACCUMULATED DEPRECIATION Balance at beginning of year $29,935 $26,173 $22,837 Provision during the year charged to income 4,454 4,099 3,531 Property sold during the year (7,853) (337) (195) Balance at end of year $26,536 $29,935 $26,173 (c) RECONCILIATION OF PROPERTIES OWNED SUBJECT TO FINANCING LEASES- Balance at beginning of year $ 8,108 $14,719 $16,190 Recovery of investment in property owned subject to financing leases ( 954) (1,355) (1,471) Property sold during the year -- (5,256) -- Balance at end of year $7,154 $ 8,108 $14,719 (d)Tenant improvement costs are depreciated over the life of the related leases, which range from 3 to 25 years. (e)The difference between the initial costs tothe Trust and costs capitalized subsequent to acquisition and the amount at which carried at close of period represents accumulated depreciation for the period prior to classification of these the period thereafter. (f)The aggregate cost basis of real estate for Federal income tax purposes at October 31,1996 is $173,040,000. HRE PROPERTIES OCTOBER 31, 1996 SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE - ------------------------------------------- COL. A COL.B COL. C COL. D COL. E COL. F Face Amount Carrying Amount of Mortgages of Mortgages Interest Rate Final Maturity Periodic (Note (b) ) (Note (a) ) Description Coupon Effective Date Payment Terms (In Thousands) (In Thousands) I. FIRST MORTGAGE LOANS ON BUSINESS PROPERTIES (NOTES (c) and (d): Retail Store: Fall River, Massachusetts 9% 14% 04-01-2013 Payable in monthly $1,225 $918 Installments of $11,920. Retail Store: Erie, Pennsylvania 9% 14% 07-01-2013 Payable in monthly 1,119 835 Installments of $10,787. Retail Store: Riverside, California 9% 12% 01-15-2013 Payable in quarterly 2,050 1,673 Installments of $54,313. Total First Mortgage Loans 4,394 3,426 II. SECOND MORTGAGE LOAN ON BUSINESS PROPERTY (Notes (c) and (e) ): Retail Store: Riverside, California 9% 12% 01-15-2001 Payable in quarterly Installments of $21,135. 296 280 TOTAL MORTGAGE LOANS ON REAL ESTATE $4,690 $3,706 SCHEDULE IV- MORTGAGE LOANS ON REAL ESTATE (CONTINUED) NOTES TO SCHEDULE IV Year Ended October 31, Reconciliation of Mortgage Loans on Real Estate - ------------------------------------------------- 1996 1995 1994 ------------ ---------- ------ (a) Balance at beginning of period: $3,937 $7,763 $8,917 Deductions during current period: Prepayment of Mortgage Loan (143) ---- ---- Sale of Mortgage ---- (3,750) ---- Collections of principal and amortization of discounts (88) (76) (68) Writedown in carrying value of Mortgage Loan ----- ----- (1,086) Balance at close of period: $3,706 $3,937 $ 7,763 (b) The aggregate cost basis for Federal income tax purposes is equal to the face amount of the mortgages. (c) At October 31, 1996 no mortgage loans were delinquent in payment of currently due principal or interest. (d) There are no prior liens for any of the First Mortgage Loans on Real Estate. (e) The First Mortgage Loan on this property is held by the Trust. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. HRE PROPERTIES By: /S/ CHARLES J. URSTADT Charles J. Urstadt Chairman and Chief Executive Officer Dated: January 22, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated. /s/ CHARLES J. URSTADT January 22, 1997 Charles J. Urstadt Chairman and Trustee (Principal Executive Officer) /s/ JAMES R. MOORE January 22, 1997 James R. Moore Executive Vice President - Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) /s/ E. VIRGIL CONWAY January 22, 1997 E. Virgil Conway Trustee /s/ ROBERT R. DOUGLASS January 22, 1997 Robert R. Douglass Trustee /s/ PETER HERRICK January 22, 1997 Peter Herrick Trustee /s/ GEORGE H. C. LAWRENCE January 22, 1997 George H. C. Lawrence Trustee /s/ PAUL D. PAGANUCCI January 22, 1997 Paul D. Paganucci Trustee /s/ JAMES O. YORK January 22, 1997 James O. York Trustee CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Annual Report on Form 10-K for the year ended October 31,1996 of HRE Properties, into its previously filed Registration Statement on Form S-3 (No.33-57119) and its previously filed Registration Statements on Form S-8 (No.2-93146 and No. 33-41408), and to the reference to our Firm under the caption"Experts" in said Registration Statements. ARTHUR ANDERSEN LLP New York, New York January 22, 1997