VANGUARD
REAL ESTATE FUND I
ANNUAL REPORT 1993
[PHOTO -- SEE EDGAR APPENDIX]
0
CHAIRMAN'S LETTER
[PHOTO OF JOHN C. BOGLE -- SEE EDGAR APPENDIX]
FELLOW SHAREHOLDER:
Amid some encouraging signs of improvement in the nation's real estate
markets, Vanguard Real Estate Fund I enjoyed a year of relative stability in
1993. The cash flow on the Fund's holdings held up, and in fact increased
modestly, and the appraised valuations of our overall portfolio remained
steady. As a result, the Fund provided a reasonable return to shareholders
during the year. The Fund also made a special return of capital distribution at
year-end in the amount of $1.00 per share, signaling the commencement of the
liquidation phase of the Fund's life cycle, as planned at the time of our
original offering.
FINANCIAL RESULTS
The Fund's net income amounted to $.30 per share in 1993, which compares
favorably to $.12 per share in 1992 when we had a higher provision for possible
losses.
Funds from operations--which adds back to net income amortization,
depreciation and provisions for losses--gives a better indication of the cash
actually generated by our property portfolio. This measure was $.69 per share
in 1993, slightly improved over the $.67 per share of 1992.
During December 1993, the Fund made its fourth distribution of the
year, in the amount of $1.24 per share. This payment consisted of three
distinct pieces: (1) the regular quarterly $.15 distribution; (2) a year-end
"extra" of $.09; and (3) a special return of capital distribution of $1.00.
This special distribution of $1.00 per share--representing most of the proceeds
from the liquidation of our Carmel investment--has the effect of lowering our
book value per share, and our estimated fair value per share. It will also
reduce our ability to earn as high a level of income during 1994 and subsequent
years. All of the Fund's distributions for 1993--totaling $1.69 per
share--qualify as a non-taxable return of capital (accordingly, taxable
shareholders should reduce their cost basis in the Fund's shares by the total
amount of the distributions).
PORTFOLIO ACTIVITY
The Fund benefited during the year from high occupancy in most of its
properties, and from higher rental rates on our Seattle Industrial Properties.
The Fund's occupancy level is now 99% on its commercial properties and 93% on
its one apartment complex. The table on page 4 provides a summary of the Fund's
holdings.
As noted above, the Fund's Adviser, Aldrich, Eastman & Waltch, L.P.
(AEW), completed important dispositions of two problem properties during the
year. In the case of Citadel II, our office building in the Orlando, Florida
area, the value of the property had fallen well below the amount owed on the
mortgage on the property and the property did not generate enough cash flow to
meet the payments on the mortgage. As a result, AEW recommended that it was in
the best interests of the
1
Fund to liquidate its holding by transferring title to the mortgage lender. In
all frankness, this investment, made in 1988, proved to be a very poor one for
the Fund. The growth prospects for the Orlando airport area did not materialize
as AEW had expected, and we incurred a capital loss of $6.4 million over our
holding period.
The second disposition was the settlement of our loan on the Carmel
Office Park in North Carolina at a discount to our original loan amount. The
loss of approximately $3.4 million on this property investment was a bitter
pill to swallow, but conditions in the market had deteriorated to the point
that AEW believed the settlement offer, at a level above AEW's estimate of the
property's value, was the best course of action. In spite of the capital loss,
the Fund earned a moderate positive return on this investment as income over
the holding period exceeded the capital decline.
Having dealt with the most difficult issues, the portfolio of
investments that remains appears to be in reasonable shape. During 1994, AEW
expects to resolve some issues with our Sheffield Forest apartment complex
mortgage loan by taking control of the property and concentrating on improving
its rental income stream. We do not anticipate significant change in the other
properties during 1994. The portfolio is discussed in more detail in the
Adviser's report beginning on page 4.
MEASURES OF VALUE
At the end of each year, we obtain independent appraisals of the value of each
of our properties. We then report to you an appraised value per share figure
that reflects the lower of the appraiser's and AEW's estimates. On this basis,
the estimated fair value per share at the end of 1993 was $7.15, or about one
percent less than the comparable level of $7.23 ($8.23 less the $1.00 special
return of capital) reported last year.
For the first time, there is a substantive difference in the opinions
of AEW and the appraisers, with AEW's estimate stated approximately 8% lower
than the appraisers'. This discrepancy illustrates that valuations are only
estimates of worth; the only true test of value is eventual sale of the
properties. (Please note that these valuations are quoted before the deduction
of the costs that may be incurred in the disposition of the properties.)
The Fund's share price on the American Stock Exchange showed
substantial improvement over the course of the year. The last trade of 1993 was
completed at $7.38 per share, a level equivalent to $8.38 per share after
adjusting for 1993's year-end $1.00 return of capital distribution. This
adjusted figure compares to $6.38 per share at year-end 1992. The increase in
the Fund's share price of +31% (excluding dividends) was consistent with the
rally in REIT stock prices during the past year. The NAREIT Index increased
10.6% in 1993. Since the secondary market share price is approximately equal to
the Fund's appraised market value, we have discontinued the share repurchase
program for the time being.
LONGER-TERM PERFORMANCE
The Fund has now completed six and a half years of operations. The chart at the
top of the next page shows the Fund's total return (dividend income plus change
in appraised value per share) compared to the total return of the
Russell-NCREIF Index, the most widely used measure of real estate performance,
for each of the six full years of our operations. As the chart shows, it has
been a period of low returns for real estate as an asset class. In particular,
the years from 1990 to 1993 have been very difficult. The Fund has not been
exempt from "slings and arrows" of the worst real estate markets since the
1930s, but has in most years outperformed the Index. This result is even more
significant when you consider that the Fund's return is computed net of all
expenses, while the return for the Index is calculated prior to deducting
managers' fees.
2
[TOTAL RETURN BAR CHART -- SEE EDGAR APPENDIX]
LOOKING AHEAD
As discussed in our Adviser's report in more detail, there are some positive
indicators in the nation's real estate markets. Economic growth has picked up
somewhat (real GDP growth of 2.8% in 1993), increasing the level of employment.
With new commercial construction declining dramatically over the last several
years, vacancy rates have inched down, but remain near historically high
levels.
Reflecting, at least in part, growing optimism about real estate, REIT
prices rallied and record numbers of newly established REITs were offered
during the past year. The primary appeal of real estate to most investors today
is the high yield offered relative to competing asset classes, such as stocks,
bonds, and money market investments. As you know, yields on each of these
securities markets investments have declined to low levels not seen since the
1960s (2.7% for stocks, 6.3% for long-term U.S. Treasury bonds, and 3.2% for
short-term U.S. Treasury bills). By contrast, the yield of the average REIT is
7.3%. The valuations for the Fund's properties are estimated on average "cap"
rates (essentially current yields before Fund expenses) of approximately 10%.
Of course, the risk in real estate today is that the income stream on
which the yield is quoted may be jeopardized by the ongoing problem of excess
supply of available space. Some markets continue to face downward rental
pressures, while other markets have seen some firming in rental rates.
Our Portfolio remains well leased, and our exposure to lease rollover
is quite modest during 1994, so we would expect the income from our remaining
properties to be steady. However, due to the return to shareholders of a
significant amount of our capital (17%), the Fund's operating cash flow is
expected to be reduced from 1993's level.
As you recall, Vanguard Real Estate Fund I was designed to be
liquidated between the seventh and twelfth years of operation. This liquidation
process effectively began in 1993 with the disposition of two property
investments. As a result, our portfolio is now more concentrated, comprising
just five properties. Our challenge is to manage these properties effectively
to maximize income while also seeking, in the years ahead, the best
opportunities to liquidate the Fund's investments and return capital to
investors. We will keep you informed of our progress in this endeavor.
Sincerely,
/S/ JOHN C. BOGLE
- -----------------------
John C. Bogle
Chairman of the Board
January 14, 1994
3
REPORT FROM THE INVESTMENT ADVISER
REAL ESTATE MARKET OVERVIEW
Evidence continues to mount that the worst of the current downturn in
commercial real estate is over. However, while economic fundamentals are slowly
improving, the basic problem confronting real estate investors persists:
significant over-supply with little or no demand growth. Our analysis suggests
that average building net operating income (NOI) continues to deteriorate or
remain flat, reflecting both continued high vacancy and lease rollover. In our
view, there can be no overall improvement in property values until NOI begins
to rise, and NOI will not improve until the current tenant turnover cycle has
been completed. Despite the prolonged downturn in the nation's real estate
markets, many tenants are still re-leasing, albeit at lower rates, as their
current leases come due.
Nonetheless, there are signs of improvement. Aggregate new
construction remains significantly below levels recorded over the past twenty
years, permitting limited absorption of existing space and some reduction in
vacancy rates, particularly in the office and industrial sectors. Job growth
should bring additional improvement in many markets.
PORTFOLIO OVERVIEW
One of our key objectives during 1993 has been to maintain high occupancy
throughout the portfolio, and we have been largely successful in this area.
Relative to year-end 1992, occupancy has improved at Plaza del Amo (from 94% to
98%) and Oakcreek Village (from 95% to 96%) and remained stable at Seattle
Industrials and Minnesota Portfolio (both at 99%) and at Sheffield Forest
(93%). Occupancy at all properties is equal to or above market averages. Net
operating income was substantially in line with our 1993 budget projections at
all properties except Sheffield Forest, which suffered from lower-than-expected
rents and higher-than-expected tenant turnover.
VALUATION
Partially as a result of continued strong occupancy, the value of the Fund's
assets remained stable during the year. As is our practice, AEW completed a
thorough review of the valuation of each asset during the third quarter of the
year, and independent appraisals were completed prior to year-end. The
appraisal results reflected increases of 1% to 4% in the value of four of the
Fund's five assets. Nonetheless, based on AEW's analyses, we have not reflected
these increases in our estimates of value pending further stabilization of
market conditions. With regard to Sheffield Forest, both AEW's analysis and
that of the independent appraiser reflected a decline of approximately 10% in
the property's fair market value. This is attributable to continued declines in
rent levels in this highly competitive market.
===============================================================================================================
PROPERTY DECEMBER 31, 1993 DECEMBER 31, 1992
PROPERTY TYPE INVESTMENT TYPE OCCUPANCY RATE OCCUPANCY RATE
- ---------------------------------------------------------------------------------------------------------------
1. PLAZA DEL AMO Retail Shared-Appreciation 98% 94%
Wraparound Mortgage
- --------------------------------------------------------------------------------------------------------------
2. OAKCREEK VILLAGE Retail Direct Ownership 96% 95%
- --------------------------------------------------------------------------------------------------------------
3. SEATTLE INDUSTRIAL Industrial Direct Ownership 99% 99%
PARKS
- --------------------------------------------------------------------------------------------------------------
4. MINNESOTA PORTFOLIO Office Direct Ownership 99% 99%
- --------------------------------------------------------------------------------------------------------------
5. SHEFFIELD FOREST Residential Participating Shared- 93% 93%
APARTMENTS Appreciation Mortgage
==============================================================================================================
4
PROPERTY HIGHLIGHTS
The Fund's fee-owned properties continued to generate a strong level of current
income during the year. At Oakcreek Village (Durham, North Carolina), year-end
occupancy was 96%. The 7,500-square-foot expansion of the center's anchor
tenant opened in October, and initial sales results are encouraging. Seattle
Industrials and the Minnesota Portfolio were 99% leased throughout the year.
Lease rollover exposure is very limited at all three of these properties
during 1994.
The borrower at Plaza del Amo (Torrance, California) continued to meet
all debt service obligations to the Fund during 1993. Despite the continuing
recession in southern California, the borrower has been very effective in
keeping the center well-leased, and year-end occupancy was 98%. Competition for
tenants has continued to push down rent levels, however, resulting in an
operating deficit over the past twelve months. Because the borrower has
considerable equity to protect in the property, we anticipate the borrower will
continue to fund these deficits while seeking an appropriate buyer for the
center.
The performance of Sheffield Forest (Silver Spring, Maryland) did not
meet our expectations during the year, as the property continued to operate at
a loss. We are currently negotiating with the borrower to take title to the
property early in 1994. The borrower has lacked the capital to maintain the
property adequately or to sustain an aggressive marketing campaign. While
market conditions are competitive, we are confident that stronger management
will have a substantial positive effect on operating performance.
Sincerely,
Aldrich, Eastman & Waltch, L.P.
January 14, 1994
5
BALANCE SHEETS
December 31, 1993 December 31, 1992
ASSETS (000) (000)*
------------ ------------
Investments in Real Estate:--
Direct Ownership Investments:
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,790 $ 16,090
Buildings and Improvements . . . . . . . . . . . . . . . . . . . . . . 31,432 47,532
------------ ------------
44,222 63,622
Less--Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . 4,789 5,862
------------ ------------
39,433 57,760
Mortgage Loans Receivable . . . . . . . . . . . . . . . . . . . . . . . . 10,646 10,646
In-Substance Foreclosed Assets . . . . . . . . . . . . . . . . . . . . . . 17,192 31,386
------------ ------------
67,271 99,792
Less: Allowance for Possible Losses . . . . . . . . . . . . . . . . . . . 2,410 7,248
------------ ------------
Net Investment Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . 64,861 92,544
Marketable Securities--REMICs . . . . . . . . . . . . . . . . . . . . . . . . 1,684 --
Short-Term Investments:
Vanguard Money Market Reserves-Prime Portfolio
(2,482,738 and 2,362,508 shares, respectively . . . . . . . . . . . . . 2,483 2,363
Temporary Cash Investments . . . . . . . . . . . . . . . . . . . . . . . 6,000 6,003
Other Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,897 3,949
------------ ------------
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $76,925 $104,859
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Mortgage Loans (including current portion of $93 and $170,
respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,477 $ 14,404
Due to Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 285
Other Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 558 628
------------ ------------
TOTAL LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,184 15,317
------------ ------------
Shares of Beneficial Interest, without par value, unlimited shares
authorized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80,608 99,747
Accumulated Distributions in Excess of Net Income . . . . . . . . . . . . . (6,867) (10,205)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY . . . . . . . . . . . . . . . . . . . . . . . . . 73,741 89,542
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY . . . . . . . . . . . . . . . . . $76,925 $104,859
============ ============
The accompanying notes are an integral part of these statements.
*Certain amounts have been reclassified to comform to current year
presentation.
6
STATEMENTS OF OPERATION
Year Ended December 31,
1993 1992 1991
REAL ESTATE INCOME (000) (000) (000)
---------- ---------- ----------
Rental Income . . . . . . . . . . . . . . . . . . . . . . $7,517 $7,588 $7,560
Mortgage Interest Income . . . . . . . . . . . . . . . . . 1,279 1,106 2,170
Net Income from In-Substance Foreclosed Assets . . . . . . 2,499 3,137 2,119
---------- ---------- ----------
11,295 11,831 11,849
---------- ---------- ----------
REAL ESTATE EXPENSES
Mortgage Interest Expense . . . . . . . . . . . . . . . . 1,030 1,433 1,674
Real Estate Taxes . . . . . . . . . . . . . . . . . . . . 823 887 897
Property Operating Expenses . . . . . . . . . . . . . . . 1,042 1,244 1,380
Depreciation and Amortization . . . . . . . . . . . . . . 1,503 1,610 1,519
Provision for Possible Losses . . . . . . . . . . . . . . 2,798 4,501 6,600
---------- ---------- ----------
7,196 9,675 12,070
---------- ---------- ----------
INCOME (LOSS) FROM REAL ESTATE . . . . . . . . . . . . . . 4,099 2,156 (221)
INVESTMENT INCOME FROM SHORT-TERM
INVESTMENTS . . . . . . . . . . . . . . . . . . . . . 367 444 1,052
---------- ---------- ----------
4,466 2,600 831
---------- ---------- ----------
ADMINISTRATIVE EXPENSES
Investment Advisory Fee . . . . . . . . . . . . . . . . . 421 470 489
Administrative Fee . . . . . . . . . . . . . . . . . . . . 350 380 398
Other Administrative Expenses . . . . . . . . . . . . . . 357 405 432
---------- ---------- ----------
1,128 1,255 1,319
---------- ---------- ----------
INCOME (LOSS) BEFORE NET GAIN ON SALES . . . . . . . . . .
OF INVESTMENTS . . . . . . . . . . . . . . . . . . . . 3,338 1,345 (488)
Net Gain on Sales of Investments . . . . . . . . . . . . . -- -- 882
---------- ---------- ----------
NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . $3,338 $1,345 $394
========== ========== ==========
Weighted Average Number of Shares Outstanding . . . . . . 11,039,590 11,176,864 11,339,668
========== ========== ==========
Net Income Per Share:
Income (Loss) Before Net Gain on Sales of Investments . $.30 $.12 $(.04)
Net Gain on Sales of Investments . . . . . . . . . . . -- -- .07
---------- ---------- ----------
Net Income Per Share . . . . . . . . . . . . . . . . . . . $.30 $.12 $(.03)
========== ========== ==========
Ordinary Income Distributions Per Share . . . . . . . . . -- $.57 $(.29)
Return of Capital Distributions Per Share . . . . . . . . $1.69 .12 .40
---------- ---------- ----------
Total Distributions Per Share . . . . . . . . . . . . . . $1.69 $.69 $(.69)
========== ========== ==========
The accompanying notes are an integral part of these statements.
7
STATEMENTS OF CASH FLOWS
Year Ended December 31,
1993 1992 1991
CASH FLOWS FROM OPERATING ACTIVITIES (000) (000) (000)
-------- -------- --------
Real Estate Investments:
Rental Income . . . . . . . . . . . . . . . . . . . . $ 7,564 $ 7,695 $ 7,500
Mortgage Interest Income . . . . . . . . . . . . . . . 3,896 4,221 4,184
Mortgage Interest Payments . . . . . . . . . . . . . . (609) (1,433) (1,705)
Operating Expense Payments . . . . . . . . . . . . . . (1,780) (2,545) (2,267)
-------- -------- --------
Net Cash Provided by Real Estate
Investments . . . . . . . . . . . . . . . . . . . 9,071 7,938 7,712
Interest from Short-Term Investments . . . . . . . . . . . 367 560 1,106
Administrative Expenses . . . . . . . . . . . . . . . . . (1,180) (1,247) (1,284)
-------- -------- --------
Net Cash Provided by Operating Activities . . . . . 8,258 7,251 7,534
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Investments in Real Estate:
Citadel II Purchase Price Adjustment . . . . . . . . . -- -- 20
Citadel III Partnership . . . . . . . . . . . . . . . . -- -- (3,235)
Mortgage Loans . . . . . . . . . . . . . . . . . . . . . -- (76) --
Principal Repayments . . . . . . . . . . . . . . . . . . -- 90 --
Building Improvements . . . . . . . . . . . . . . . . . (360) (430) (613)
Payoff from In-Substance Foreclosed Asset . . . . . . . 13,500 -- --
Transaction Fees . . . . . . . . . . . . . . . . . . . (270) -- --
Sales of Investments . . . . . . . . . . . . . . . . . -- -- 8,789
Marketable Securities Acquired . . . . . . . . . . . . . (15,846) -- --
Marketable Securities Sold . . . . . . . . . . . . . . . 13,713 -- --
Principal Repayments on Marketable Securities . . . . . 423 -- --
-------- -------- --------
Net Cash Provided by (Used In) Investing Activities 11,160 (416) 4,961
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Mortgage Principal Payments . . . . . . . . . . . . . . (85) (154) (139)
Investment Financing Fees and Costs . . . . . . . . . . -- -- (8)
Repayment of Mortgage Loan . . . . . . . . . . . . . . -- -- (4,200)
Distributions Paid . . . . . . . . . . . . . . . . . . (18,629) (7,694) (7,805)
Shares Repurchased . . . . . . . . . . . . . . . . . . . (587) (1,263) (1,262)
-------- -------- --------
Net Cash Used in Financing Activities . . . . . . . (19,301) (9,111) (13,414)
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS . . . . . . . . . . . . . . . . 117 (2,276) (919)
CASH AND CASH EQUIVALENTS--BEGINNING
OF YEAR . . . . . . . . . . . . . . . . . . . . . 8,366 10,642 11,561
-------- -------- --------
CASH AND CASH EQUIVALENTS--END OF YEAR . . . . . . . . $ 8,483 $ 8,366 $10,642
======== ======== ========
(continued on next page)
8
STATEMENTS OF CASH FLOWS (continued)
Year Ended December 31,
1993 1992 1991
(000) (000) (000)
------ ------ ------
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
Net Income . . . . . . . . . . . . . . . . . . . . . . $3,338 $1,345 $3,394
Adjustments to Reconcile Net Income to Net Cash Provided
by Operating Activities:
Property Depreciation and Amortization . . . . . . 1,503 1,610 1,519
Provision for Possible Losses . . . . . . . . . . . 2,798 4,501 6,600
Decrease in Deferred Rent Receivable . . . . . . . -- 106 66
Increase in Deferred Mortgage Interest Receivable . -- (27) (128)
Net Gain on Sales of Investments . . . . . . . . . . -- -- (882)
Interest Payable Satisfied . . . . . . . . . . . . . 421 -- --
Changes in Other Assets and Liabilities . . . . . . 198 (284) (35)
------ ------ ------
NET CASH PROVIDED BY OPERATING ACTIVITIES . . . . . . . . $8,258 $7,251 $7,534
====== ====== ======
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
On September 1, 1993, the Fund ceded title to its Citadel II investment to the
lender in full satisfaction of amounts due under the non- recourse mortgage
loan secured by Citadel II. The excess of recorded assets over liabilities
related to the investment were written off against the allowance for possible
losses as follows (amounts in 000's):
Land $ 3,300
Building and Improvements (net of accumulated
depreciation of $2,234) 14,170
Other Assets 1,337
--------
Total Assets 18,807
--------
Write-off to Allowance (6,398)
--------
Mortgage Loans 11,842
Interest Payable 421
Other Liabilities 146
--------
Liabilities Satisfied $12,409
========
On July 30, 1993, the Fund accepted a discounted payoff on its mortgage loan
secured by Carmel Executive Park. The excess of recorded assets over the payoff
amount were written off against the allowance for possible losses as follows
(amounts in 000's):
In-Substance Foreclosed Asset $14,284
Other Assets 184
Write-off to Allowance (1,238)
========
Payoff Amount, Net of Transaction Fee $13,230
========
During the year, the Fund wrote-off fully depreciated tenant improvements of
$56,000 related to its Seattle Industrial Park investment.
The accompanying notes are an integral part of these statements.
9
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Undistributed
(Accumulated
Shares of Distributions
Beneficial Interest in Excess of) Total Shareholders'
Number Amount Net Income Equity
(000) (000) (000)
-----------------------------------------------------------------
Balance: January 1, 1991 . . . . . . . . . 11,426,803 $108,183 $(2,307) $105,876
Net Income for the Year . . . . . . . . . 394 394
Less Distributions:
Ordinary Income . . . . . . . . . . . . (3,307) (3,307)
Return of Capital . . . . . . . . . . . (4,498) (4,498)
Shares Repurchased . . . . . . . . . . . . (179,825) (1,447) (1,447)
-----------------------------------------------------------------
Balance: December 31, 1991 . . . . . . . . 11,246,978 102,238 (5,220) 97,018
Net Income for the Year . . . . . . . . . 1,345 1,345
Less Distributions:
Ordinary Income . . . . . . . . . . . . (6,330) (6,330)
Return of Capital . . . . . . . . . . . (1,364) (1,364)
Shares Repurchased . . . . . . . . . . . . (159,100) (1,127) (1,127)
-----------------------------------------------------------------
Balance: December 31, 1992 . . . . . . . . 11,087,878 99,747 (10,205) 89,542
Net Income for the Year . . . . . . . . . 3,338 3,338
Less Distributions:
Return of Capital . . . . . . . . . . . (18,629) (18,629)
Shares Repurchased . . . . . . . . . . . . (67,900) (510) (510)
-----------------------------------------------------------------
Balance: December 31, 1993 . . . . . . . . 11,019,978 $ 80,608 $(6,867) $ 73,741
=================================================================
The accompanying notes are an integral part of these statements.
10
NOTES TO FINANCIAL STATEMENTS
A. GENERAL DESCRIPTION: The Fund, a finite-life real estate investment trust,
was organized on September 10, 1986, as a Massachusetts business trust that
intends to continue to qualify as a real estate investment trust under the
Internal Revenue Code of 1986. In accordance with the Fund's Declaration of
Trust, the Fund: (i) is precluded from making any additional real estate
investments after December 31, 1993; (ii) must distribute to shareholders
proceeds received from sales of real estate investments after December 31,
1993; and (iii) intends to complete liquidation of real estate investments
between 1994 and 1999.
B. The following significant accounting policies are in conformity with
generally accepted accounting principles for real estate investment trusts.
Such policies are consistently followed by the Fund in the preparation of
financial statements. Certain prior year amounts have been reclassified to
conform to current year presentation.
1. ORGANIZATION COSTS: Costs incurred in conjunction with the organization of
the Fund were deferred and were amortized on a straight-line basis over a
60-month period from the date the Fund commenced operations.
2. INVESTMENTS IN REAL ESTATE: Real estate directly owned by the Fund is
carried at cost. Major renovations are capitalized, and routine maintenance
and repairs are charged to expense as incurred.
The Fund holds a mortgage loan receivable accounted for as an
in-substance foreclosure. In general, property is deemed to be an in-
substance foreclosure when a debtor has little or no equity in the
collateral and proceeds for repayment of the loan can be expected to come
only from the sale or operation of the collateral. Although legal title to
such property has not been obtained, the Fund is considered to have
substantially the same risks and rewards as a mortgagee.
3. REVENUE RECOGNITION: Rental income is accrued as rents are due. For those
operating leases that provide for rental concessions or fixed escalation
increases, rental income is recognized on a straight-line basis over the
term of the lease. For those operating leases that provide for
reimbursement of expenses for real estate taxes, common area maintenance,
utilities and insurance, income is recognized in the period in which the
expenses are incurred.
Mortgage interest income is recorded based on the annual effective
yield of the respective loans. For mortgage loans treated for accounting
purposes as in-substance foreclosures, revenue is recognized only to the
extent of cash receipts.
4. ALLOWANCE FOR POSSIBLE LOSSES: An allowance for possible losses is provided
for estimated losses based upon management's regular evaluation of the
recoverability of each investment in the portfolio. Management's evaluation
includes consideration of each investment's estimated remaining holding
period. The allowance includes a provision to reduce the carrying value of
a mortgage loan receivable, which has been determined to be an in-substance
foreclosure for accounting purposes, to its estimated fair value minus
selling costs.
5. DEPRECIATION: Depreciation on real estate owned is computed using the
straight-line method over 40 years for buildings.
6. ACQUISITION COSTS: Costs incurred in conjunction with the acquisition of
real estate investments are deferred and are amortized on a straight-line
basis over the life of the loan for mortgage loan investments and the life
of the property for equity investments.
7. SHORT-TERM AND MARKETABLE SECURITIES INVESTMENTS: Investments in marketable
securities, including Vanguard Money Market Reserves-Prime Portfolio, are
carried at the lower of cost or market. Temporary cash investments are
carried at amortized cost, which approximates market value. The Fund's
temporary cash investments are comprised of certificates of deposit at
December 31, 1993.
8. CASH EQUIVALENTS: For purposes of the Statements of Cash Flows, the Fund
considers all highly liquid short-term investments with original maturities
of less than three months to be cash equivalents.
11
9. FEDERAL INCOME TAXES: It is the Fund's intention to continue to qualify as
a real estate investment trust and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the
financial statements. Differences between net income determined in
accordance with generally accepted accounting principles and taxable income
before dividend distributions result primarily from timing differences
relating to the accounting for the provision for possible losses, equity in
net losses of joint venture, depreciation on tenant improvements, and
certain rental income.
10. PER SHARE AMOUNTS: The calculation of the Fund's net income per share is
based upon the weighted average number of shares outstanding during the
year. Income and return of capital distributions per share represent actual
distributions made during the year.
C. Under the terms of a contract expiring December 31, 1994, the Fund pays
Aldrich, Eastman and Waltch, L.P. (the "Adviser") an annual investment advisory
fee equal to .5% of the average fair market value of the Fund's real estate
investments. The Fund also pays the Adviser investment transaction fees
generally equal to 2% of the purchase price of, or the proceeds from, its real
estate investment. The Fund incurred real estate investment transaction fees of
$270,000 and $171,000 for the years ended December 31, 1993 and 1991,
respectively. The Fund did not incur real estate investment transaction fees
during the year ended December 31, 1992.
D. Under the terms of a contract expiring December 31, 1993, the Fund pays The
Vanguard Group, Inc. (the "Sponsor") an administrative fee calculated at an
annual percentage rate of the average fair market value of the Fund's real
estate investments and temporary cash investments (excluding investments in
Vanguard Money Market Reserves-Prime Portfolio). The administrative fee
represents an effective annual rate of .4% for the years ended December 31,
1993, 1992, and 1991.
E. The Fund's wholly owned direct real estate investments consisted of the
following:
December 31, 1993 December 31, 1992
(In thousands) (In thousands)
---------------------------- -----------------------------
ACCUMULATED ACCUMULATED
DESCRIPTION COST DEPRECIATION NET COST DEPRECIATION NET
- -------------- ---------------------------- -----------------------------
SHOPPING CENTER
Land $ 3,100 $ -- $ 3,100 $ 3,100 $ -- $ 3,100
Buildings and
Improvements 8,098 (1,304) 6,794 7,804 (1,059) 6,745
------- -------- ------- ------- -------- -------
11,198 (1,304) 9,894 10,904 (1,059) 9,845
------- -------- ------- ------- -------- -------
INDUSTRIAL PARKS
Land 8,250 -- 8,250 8,250 -- 8,250
Buildings and
Improvements 14,844 (2,232) 12,612 14,887 (1,874) 13,013
------- -------- ------- ------- -------- -------
23,094 (2,232) 20,862 23,137 (1,874) 21,263
------- -------- ------- ------- -------- -------
OFFICE BUILDINGS
Land 1,440 -- 1,440 4,740 -- 4,740
Buildings and
Improvements 8,490 (1,253) 7,237 24,841 (2,929) 21,912
------- -------- ------- ------- -------- -------
9,930 (1,253) 8,677 29,581 (2,929) 26,652
------- -------- ------- ------- -------- -------
TOTAL $44,222 $(4,789) $39,433 $63,622 $(5,862) $57,760
======= ======== ======= ======= ======== =======
12
F. The Fund's mortgage loans receivable and in-substance foreclosures
consisted of the following:
(In thousands)
-------------------------------------------------------------------------
MATURITY CALL EFFECTIVE PAY DECEMBER 31,
DESCRIPTION DATE DATE RATE RATE 1993 1992
- ---------------------------------------------------------------------------------------------------
PLAZA DEL AMO:
shared-appreciation wrap-
around mortgage loan 1997 1994 10.3% 9.7%-10.8% $10,646 $10,646
CARMEL EXECUTIVE PARK:
participating mortgage
loan with purchase option 1998 1996 9.558% 9.558% -- 14,239(1)
SHEFFIELD FOREST APARTMENTS:
participating shared-
appreciation mortgage loan 1998 1994 n/a 8%-9% 17,192(1) 17,147(1)
------- -------
TOTAL $27,838 $42,032
======= =======
Upon repayment of the Plaza del Amo loan, the Fund is entitled to a share
of the property's appreciation, if any, equal to 50% of Plaza del Amo's fair
market value in excess of the original wraparound mortgage loan balance of
$10.6 million.
On July 30,1993, the Fund accepted a discounted payoff of $13,500,000 on
its mortgage loan secured by Carmel. The loss resulting from this payoff was
charged to the allowance for possible losses.
The partnership that owns and operates Sheffield Forest Apartments funded,
pursuant to a guarantee which expired on December 7, 1993, interest on the
mortgage loan secured by the Sheffield property in excess of cash flow
generated by the property during 1993. The Fund and the borrower have been
unable to reach satisfactory restructuring terms on the loan, and the borrower
has defaulted on the loan in January 1994 by making only a partial payment of
its then-due interest installment. Accordingly, the Fund is presently pursuing
foreclosure to take title to the property. A provision to reduce the carrying
value of the Sheffield investment to its estimated fair value minus selling
costs is included in the allowance for possible losses at December 31, 1993.
In 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 114 (SFAS 114), "Accounting by Creditors for
the Impairment of a Loan." Adoption of SFAS 114 is required for the year
beginning January 1, 1995. It requires that loans, such as the Fund's mortgage
loan receivable classified as an in-substance foreclosed asset, if impaired, be
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate, or as a practical expedient, at the loan's
observable market price or the fair value of the collateral. In 1992, the
American Institute of Certified Public Accountants issued Statement of Position
92-3 (SOP 92-3), "Accounting for Foreclosed Assets," which requires that
in-substance foreclosed assets be carried at the lower of estimated fair value
minus selling costs or cost. Because the Fund already recognizes such
reductions of value, if present, through its provision for possible losses,
adoption of SOP 92-3 and SFAS 114 has not had, and is not expected to have,
respectively, a significant effect on the Fund's financial position or results
of operations.
(1) Classified as in-substance foreclosed assets.
13
G. Activity relating to the allowance for possible losses on real estate is as
follows:
(In thousands)
--------------------------------------------------------------------------
DECEMBER 31, 1993 DECEMBER 31, 1992 DECEMBER 31, 1991
--------------------------------------------------------------------------
Balance--Beginning of Year $ 7,248 $ 5,755 $ 2,500
Provision for Losses 3,500 4,501 6,600
Amounts Charged Off (702) (8) (3,345)
Write-down of In-Substance Foreclosed Assets -- (3,000) --
Write-off--Carmel Executive Park (1,238) -- --
Write-off--Citadel II (6,398) -- --
-------- -------- --------
Balance--End of Year $ 2,410 $ 7,248 $ 5,755
======== ======== ========
Upon adoption of SOP 92-3, the Fund reclassified the amounts provided in
the allowance for possible losses to reduce the carrying value of its
in-substance foreclosed assets to their fair value minus selling costs from the
allowance and recorded such amounts as a direct write-down of each of the
in-substance foreclosed asset investments.
H. The Fund's mortgage loans payable consisted of the following:
(In thousands)
---------------------------------
DECEMBER 31, DECEMBER 31,
DESCRIPTION 1993 1992
- ----------------------------------------------------------------------------------------------------------
PLAZA DEL AMO:
senior mortgage loans, secured by the shopping center, principal and
interest payable over term
10%, matures June, 2007 $2,324 $ 2,403
9.5%, matures June, 2007 153 158
CITADEL II OFFICE BUILDING:
senior mortgage loan, secured by the office building, principal and
interest payable over term
9.875%, matures November, 1997 -- 11,843
------ -------
TOTAL $2,477 $14,404
====== =======
Scheduled principal payments for each of the next five years and thereafter
are as follows:
Year Ending December 31, (In thousands)
---------------
1994 $ 93
1995 102
1996 113
1997 125
1998 139
Thereafter 1,905
-----------
TOTAL PRINCIPAL PAYMENTS $2,477
===========
14
I. In the first quarter of 1993, the Fund defaulted on its mortgage loan
obligation secured by the Citadel II investment in Orlando, Florida. During
the period of default, the net cash flow generated from the property's
operations were remitted to the lender on a monthly basis, under terms of a
cash flow agreement. Accordingly, the Fund did not realize any net income or
receive any cash flow from the property during the default period. The Fund's
Adviser had previously approached the lender in an effort to restructure the
loan; however, a restructuring satisfactory to both the Fund and the lender
could not be achieved. Accordingly, on September 1, 1993, the Fund ceded title
of the property to the lender in full satisfaction of amounts due under the
non-recourse mortgage loan obligation. Since the Citadel II investment had
previously been written down to the remaining principal balance of the loan, no
loss on this transaction was recognized in the year ended December 31, 1993.
J. For the Fund's wholly owned direct real estate investments, annual minimum
future rentals to be received under operating leases in effect at December 31,
1993, are as follows:
Year Ending December 31, (In thousands)
-----------
1994 $ 5,789
1995 5,473
1996 5,076
1997 3,270
1998 1,572
Thereafter 2,711
-----------
TOTAL MINIMUM FUTURE RENTALS $23,891
===========
Total minimum future rentals do not include contingent rentals under
certain leases based upon lessees' sales volumes. Contingent rentals
aggregating $37,000, $30,000, and $32,000 were received during 1993, 1992, and
1991, respectively. Certain leases also require lessees to pay all or a portion
of real estate taxes and operating costs.
K. The following is a summary of the net assets and liabilities, and results
of operations of Sheffield Forest Apartments, the property which underlies the
Sheffield mortgage loan investment, in which the Fund has invested more than
10% of its net offering proceeds:
SHEFFIELD FOREST APARTMENTS
(In thousands)
BALANCE SHEETS OCTOBER 31, 1993 OCTOBER 31, 1992
- ---------------------------------------------------------------------------------
ASSETS
Property and Equipment $ 10,615 $11,016
Due from Affiliate 1,789 2,016
Other Assets 433 448
--------- ---------
12,837 13,480
--------- ---------
LIABILITIES
Mortgage Payable 18,620 18,479
Accounts Payable 303 --
Other Liabilities 76 250
--------- ---------
18,999 18,729
--------- ---------
NET LIABILITIES $(6,162) $(5,249)
========= =========
15
K. (continued)
(In thousands)
FISCAL YEAR ENDED
STATEMENTS OF OPERATIONS OCTOBER 31, 1993 OCTOBER 31, 1992
- ---------------------------------------------------------------------------------
REVENUE
Rental Income $ 2,016 $ 2,141
-------- --------
EXPENSES
Mortgage Interest 1,669 1,661
Operating 815 663
Depreciation and Amortization 447 546
-------- --------
2,931 2,870
-------- --------
NET LOSS $ (915) $ (729)
======== ========
Property and equipment are carried at cost at the date of acquisition by
the mortgagor, net of accumulated depreciation. In addition, mortgage interest
expense is determined based on the effective interest rate of the mortgage loan
which exceeds the current cash payments by $92,000 for both 1993 and 1992,
respectively.
L. During the fourth quarter of 1990, the Fund's Board of Trustees authorized
the Fund to repurchase in the open market from time to time up to 500,000 of
the Fund's outstanding shares. As of December 31, 1993, 413,725 shares have
been repurchased at an aggregate cost of $3,134,000.
M. The Fund's investment in marketable securities consisted of the following:
(In thousands)
--------------------------------
DESCRIPTION (COST IN THOUSANDS) STANDARD & POOR'S RATING DECEMBER 31, DECEMBER 31,
(UNAUDITED) 1993 1992
- -------------------------------------------------------------------------------------------------------
Resolution Trust Corporation (RTC) AA $1,684 --
Series 1992-C5, Class B REMIC
6.9%, cost $1,698
A valuation allowance of $14,000 was established, with a corresponding
charge to net income, to reduce the carrying value of the security to its
market value at December 31, 1993. During 1993, four other RTC REMIC securities
were purchased and subsequently sold at a realized gain of $8,000. Such gain,
determined based on the cost of the specific securities sold, is included in
mortgage interest income for the year ended December 31, 1993.
Statement of Financial Accounting Standards No. 115 (SFAS 115), Accounting
for Certain Investments in Debt and Equity Securities, was issued by the
Financial Accounting Standards Board in May 1993. SFAS 115, which addresses the
accounting and reporting for investments in equity securities that have readily
determinable fair values and all debt securities, must be adopted for the year
beginning January 1, 1994. Adoption of SFAS 115 is not currently expected to
materially affect the Fund's financial position or results of operations.
16
N. The unaudited quarterly results of operations for the years ended December
31, 1993, and 1992, are as follows:
Quarter Ended Quarter Ended
(amounts in thousands, Mar. 31, Jun. 30, Sep. 30, Dec. 31, Mar. 31, Jun. 30, Sep. 30, Dec. 31,
except per share data) 1993 1993 1993 1993 1992 1992 1992 1991
- -----------------------------------------------------------------------------------------------------------
Real Estate and Short-
term Investment
Income $3,140 $ 3,228 $2,861 $2,433 $3,012 $3,171 $ 3,052 $3,040
======= ======= ======= ======= ======= ======= ======= =======
Net Income (Loss) $1,783 $ (239) $ 81 $1,713 $1,202 $1,384 $(2,646) $1,405
Per Share ======= ======= ======= ======= ======= ======= ======= =======
Net Income (Loss) $ .16 $ (.02) $ .01 $ .15 $ .11 $ .12 $ (.24) $ .13
======= ======= ======= ======= ======= ======= ======= =======
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees of
Vanguard Real Estate Fund I
In our opinion, the accompanying balance sheets and the related statements of
operations, changes in shareholders' equity and cash flows present fairly, in
all material respects, the financial position of Vanguard Real Estate Fund I at
December 31, 1993 and 1992, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1993, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Fund's management; our responsibility
is to express an opinion on these statements based on our audits. We conducted
our audits of these financial statements in accordance with generally accepted
auditing standards, which 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, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
January 27, 1994
17
SELECTED FINANCIAL DATA
(amounts in thousands, except per share data)
The following table sets forth selected financial data for the Fund and should
be read in conjunction with the financial statements included elsewhere herein.
Year Ended December 31,
RESULTS OF OPERATIONS:
1993 1992 1991 1990 1989
-------- -------- -------- -------- --------
Real estate and short-term
investment income . . . . . . $ 11,662 $ 12,275 $ 12,901 $ 13,343 $013,489
Income (loss) from real estate 4,099 2,156 (221) 4,943 8,056
Funds from operations (a) . . 7,639 7,456 7,631 8,201 8,631
Net income . . . . . . . . . . 3,338 1,345 394 3,973 7,123
PER SHARE (b):
Net income . . . . . . . . . . $ .30 $ .12 $ .03 $ .35 $ .62
Income distributions . . . . . .00 .57 .29 .62 .60
Return of capital distributions 1.69 .12 .40 .07 .08
Total distributions . . . . . 1.69 .69 .69 .69 .68
FINANCIAL POSITION:
Real estate investments (c) . . $ 64,989 $ 92,940 $ 98,464 $112,914 $114,952
Total assets . . . . . . . . . 76,925 104,859 112,606 128,430 122,476
Long-term obligations . . . . 2,384 14,234 14,404 16,834 6,908
Total liabilities . . . . . . 3,184 15,317 15,588 22,554 12,635
Total shareholders' equity . . 73,741 89,542 97,018 105,876 109,841
(a) Funds from operations is calculated by adding back depreciation,
amortization, and the Fund's provision for possible losses to income (loss)
before net gain on sales of investments. Funds from operations should not
be considered as an alternative to net income as an indicator of the Fund's
operating performance or to cash flows as a measure of liquidity.
(b) Net income per share is calculated based upon the weighted average number
of shares outstanding during the year. Income and return of capital
distributions per share designations are made based on their treatment for
Federal Income Tax purposes and represent actual distributions made during
the year.
(c) Net of accumulated depreciation and the allowance for possible losses.
18
MARKET AND DISTRIBUTION INFORMATION
The Fund's Shares of Beneficial Interest ("Shares") are traded on the American
Stock Exchange under the symbol "VRO." As of December 31, 1993, there were
approximately 16,014 shareholders of record of the Fund's Shares.
Year Ended December 31, 1993
---------------------------------------------------------------------
Share Prices Distributions Declared
High Low Income Return of Capital
---------------------- ------------------------------
For the Quarter Ended:
March 31, 1993 . . . . . . . . $8 1/4 $6 5/8 $.00 $1.15
June 30, 1993 . . . . . . . . . 8 7 1/4 .00 .15
September 30, 1993 . . . . . . . 8 1/4 7 3/8 .00 .15
December 31, 1993 . . . . . . . 8 3/4 7 3/8 .00 1.24
====================== ==============================
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Vanguard Real Estate Fund I, A Sales-Commission-Free Income Properties
Fund (the "Fund"), is a Massachusetts business trust that intends to continue
to qualify as a real estate investment trust ("REIT") under the Internal
Revenue Code. The Fund's investments include both direct ownership and shared
appreciation mortgages consisting of four income-producing commercial
properties (composed of one office building, two shopping centers and one
industrial park) and one income-producing apartment complex. Geographically,
the Fund's investments are located in various regions of the United States with
two properties located in the Mideast, and one property located in each of the
North Central, Pacific Northwest and Pacific Southwest regions. In accordance
with the Fund's Declaration of Trust, net proceeds from sale or repayment may
not be reinvested in real estate investments after December 31, 1993. The Fund
presently intends to liquidate all investments between 1994 and 1999.
RESULTS OF OPERATION
1993 as compared to 1992
For the year ended December 31, 1993, the Fund earned net income
of $3,338,000, or $.30 per share, compared to net income for the year ended
December 31, 1992, of $1,345,000, or $.12 per share. As more fully described
below, this increase in net income reflects: (i) a 1993 provision for possible
losses of $2,798,000 as compared to $4,501,000 in 1992; (ii) an increase in net
rental income and mortgage interest income; (iii) a decrease in mortgage
interest expense; and (iv) a decrease in investment income from short-term
investments and net income from in-substance foreclosed assets, in each case as
compared to such items in 1992.
The 1993 provision for possible losses in the amount of $2,798,000
($3,500,000 net of charge-offs of $702,000 recorded during 1993) was recorded
to write-down the carrying value of two of the Fund's in-substance foreclosed
assets, Sheffield and Carmel. Both the owner of the property underlying the
Fund's Sheffield investment and the owner of the property underlying the Carmel
investment approached the Fund in an effort to restructure their respective
loans. With respect to Carmel, in July 1993 the Fund accepted a discounted
payoff in the amount of $13,500,000 on its then-outstanding mortgage loan
balance. Due to continued weak market conditions which prompted the borrower to
request restructuring of the loan, the Fund had provided an additional
provision for possible losses in the second quarter of 1993. The difference
between the carrying value of the mortgage loan, net of the allowance for
possible losses associated with Carmel, and the payoff amount was charged to
the Fund's allowance for possible losses. With respect to Sheffield, cash flow
from the property has been insufficient to cover debt service obligations owing
to the Fund. As a result, the property's owner, which was funding the
shortfalls pursuant to a guarantee which expired on December 7, 1993,
approached the Fund in an effort to restructure the loan. Accordingly, a
provision for possible losses was added to reflect the effect on the net
realizable value of the loan due to the deteriorating conditions in the market
in which the Sheffield Apartment complex is located and the continuing debt
service deficits. At present, the Fund and the borrower have been unable to
reach satisfactory restructuring terms and the borrower has defaulted on the
loan in January 1994 by making only a partial payment of the then-due interest
installment. As a result, the Fund is pursuing foreclosure to take title to the
property.
The provision for possible losses is based upon management's
regular evaluation of the recoverability of each investment in the portfolio.
While management of the Fund believes the resultant allowance for possible
losses, aggregating $2,410,000 at December 31, 1993, and write-down in the
carrying value of its in-substance foreclosed asset investment, is adequate at
December 31, 1993, based upon (i) the Adviser's analysis of current property
values (adjusted for estimated selling costs), (ii) independent appraisals and
(iii) management's estimate of each investment's remaining holding period, the
allowance is based on estimates, and actual results may vary from current
estimates.
Net rental income (rental income less real estate taxes and
property operating expenses) increased by $195,000, or 4%, from $5,457,000 for
the year ended December 31, 1992, to $5,652,000 for the year ended December 31,
1993. This increase in net rental income was attributable primarily to an
increase of $538,000, or 20%, in the net rental income from the Fund's direct
investment in the Seattle Industrial Parks
20
("Seattle") which increased from $2,634,000 for the year ended December 31,
1992, to $3,172,000 for the comparable period of 1993. This increase was due to
a 57% increase in the rental rates on one of the major leases (502,500 square
feet), which was renewed in the fourth quarter of 1992 for a term of five
years.
In addition, net rental income at the Fund's Oakcreek investment
increased by $95,000, or 11%, from $875,000 for the year ended December 31,
1992, to $970,000 for the comparable period of 1993.
Increases in the net rental income of Seattle and Oakcreek were
offset by a decrease of $442,000 in net rental income from the Fund's direct
investment in Citadel II--an office building in Orlando, Florida with
approximately 139,000 square feet of rentable office space. In consideration
of several factors resulting from weak local market conditions in the Orlando
Airport area, including; (i) insufficient net rental income in 1992 to cover
debt service on the non-recourse mortgage loan secured by Citadel II; (ii) the
expected continuation of such debt service deficits over the next several
years; and (iii) a decline in the independent appraised value of the property
to a point below the outstanding principal balance of the loan at December 31,
1992, the Fund defaulted on the mortgage loan obligation secured by Citadel II
in the first quarter of 1993. During the period of default, the net cash flow
generated from the property's operations were remitted to the lender on a
monthly basis under terms of a cash flow agreement. Accordingly, the Fund did
not realize any net income or receive any cash flow from the property during
the default period. The Fund's Adviser had previously approached the lender in
an effort to restructure the loan; however, a restructuring satisfactory to
both the Fund and the lender could not be achieved. Accordingly, on September
1, 1993, the Fund ceded title of the property to the lender in full
satisfaction of amounts due under the non-recourse mortgage loan obligation.
Since the Citadel II investment had previously been written down to the
remaining principal balance of the loan, no loss on this transaction was
recognized in the year ended December 31, 1993. Net rental income at Citadel II
decreased from $1,105,000 for the year ended December 31, 1992, to $663,000 for
the comparable period of 1993, reflecting the disposition of the property on
September 1, 1993, and, to a lesser extent, the lower average occupancy rate
and lower rental rates on lease renewals during the eight-month period ended
August 31, 1993, as compared to the comparable period of 1992.
At December 31, 1993, and 1992, the overall occupancy rate of the
Fund's remaining three direct ownership investments was 99% and 98%,
respectively. The overall occupancy rate of the properties underlying the
Fund's remaining two mortgage loan investments, including one investment
treated for accounting purposes as an in-substance foreclosure, was 96% at
December 31, 1993, as compared to 94% at December 31, 1992. Leases for 3% of
the rentable space of the properties directly owned by the Fund and for 5% at
the property underlying the Fund's Plaza del Amo mortgage investment expire
during 1994, respectively. Leases for units at the property underlying the
Fund's Sheffield mortgage loan investment are for one-year terms as is
customary for apartment leases. The Fund's Adviser is currently working to
renew leases and to identify new tenants for space covered by leases that have
expired or are expiring. However, there is no assurance that the Fund will be
able to maintain its current occupancy rate and level of income.
Mortgage interest income increased by $173,000, or 16%, from
$1,106,000 in the year ended December 31, 1992, to $1,279,000 in the year ended
December 31, 1993. In early June 1993, the Fund began acquiring RTC-issued
mortgage-backed securities as an additional temporary investment vehicle for
excess working capital reserve balances. The Fund acquired five such
securities, four of which were sold prior to September 30, 1993. All such
securities purchased were rated AA or better by Standard and Poor's. Income of
$174,000 earned on these investments during the year ended December 31, 1993,
is included in Mortgage Interest Income.
Net income from in-substance foreclosed assets decreased by
$638,000, or 20%, primarily as a result of the discounted payoff in late July
1993, of the Carmel mortgage loan investment, which had been classified as an
in-substance foreclosed asset in 1991.
Investment income from short-term and other investments decreased
by $77,000, or 17%, as compared to such income in the comparable period of
1992, primarily as a result of a decrease in the average amount of short-term
investments for the year ended December 31, 1993, as compared to such
investments during the same period of 1992.
21
Mortgage interest expense decreased by $403,000, or 28%, primarily
as a result of the Fund's ceding title to its Citadel II investment on
September 1, 1993, in full satisfaction of the non-recourse mortgage loan
obligation secured by the Citadel II property.
1992 as compared to 1991
For the year ended December 31, 1992, the Fund had net income of
$1,345,000, or $.12 per share, compared to net income for the year ended
December 31, 1991, of $394,000 or $.03 per share. Net income for the year ended
December 31, 1991 also included a net gain on sales of investments of $882,000
realized from the Fund's sale of two of its income-producing property
investments. The increase in net income was primarily attributable to the
provision for possible losses of $4,501,000 recorded during 1992 compared to a
similar provision for possible losses of $6,600,000 in 1991. The provision for
possible losses recorded in 1992 reduced the carrying value of the Fund's
Citadel II investment to its estimated recoverable amount.
Net rental income increased by $175,000, or 3%, from $5,282,000
for the year ended December 31, 1991, to $5,457,000 for the year ended December
31, 1992. This increase in net rental income was attributable primarily to an
increase in net rental income from the Fund's Seattle investment of $637,000,
resulting from increased rental rates on the renewal of two significant leases
with the property's major tenant in December 1991 and 1992 and from the
recovery of legal expenses incurred by the Fund prior to 1992 in connection
with a lawsuit with a former tenant; offset by a decrease in net rental income
of $408,000 from the Fund's direct investment in Citadel II, attributable to a
decrease in occupancy and lower rental rates on lease renewals and leases with
new tenants.
Mortgage interest expense decreased $241,000, or 14%, as compared
to such expense in 1991, as a result of the decline in the Fund's average
mortgage loan payable balance for 1992 as compared to 1991. This decline was
attributable to the payoff in October 1991, of the $4.2 million senior mortgage
loan secured by the Fund's investment in Carmel.
Investment income from short-term investments decreased by
$608,000, or 58%, as compared to such income in 1991, as a result of both a
decline in prevailing money market interest rates, which averaged 3.7% in 1992
as compared to 5.9% in the corresponding period of 1991, and a decrease of
approximately $5.3 million in average short-term investments in 1992 as
compared to average short-term investments in 1991.
Inflation has not had a material impact in the Fund's operations to date.
Distributions
The Fund's policy is to distribute, at a minimum, all of its
taxable income to shareholders. In establishing distribution rates, the Fund's
Trustees also consider the operating performance of the Fund and the Fund's
cash position. Total distributions declared by the Fund during 1993 aggregated
$18,629,000, or $1.69 per share, compared to such distributions in the amount
of $7,694,000, or $.69 per share, and $7,805,000, or $.69 per share, made in
1992 and 1991, respectively. Distributions to shareholders in 1993 included a
special $11,020,000, or $1.00 per share, return of capital distribution. This
special distribution resulted primarily from the $13,500,000 payoff of the
Fund's Carmel mortgage loan investment in July 1993. The Fund's Board of
Trustees reviewed opportunities to invest these funds in additional property
investments; however, since the Fund's liquidation period begins in 1994, and
was originally projected to be completed by 1999, the Board decided not to
proceed with additional investments due to the short amount of time available
to earn a satisfactory return for shareholders. Accordingly, the Board
believed it was in the best interests of shareholders to return the majority of
its cash to shareholders with the year- end distribution.
All, or a portion of, the past three years' distributions
represented a non-taxable return of share- holders' capital. Non-taxable return
of capital distributions aggregated $18,629,000, or $1.69 per share,
$1,364,000, or $.12 per share, and $4,498,000, or $.40 per share, for 1993,
1992, and 1991, respectively.
22
LIQUIDITY AND CAPITAL RESOURCES
During the past three years, the cumulative amount of
distributions (excluding the special $1.00 per share distribution described
above) to shareholders in the amount of $23,108,000 exceeded by approximately
$380,000 the aggregate funds from operations for the three-year period. Funds
from operations are generated from the ongoing operations of direct real estate
investments and interest income on short-term investments and mortgage loans.
Accordingly, unfavorable economic conditions, vacancies, environmental
requirements, reductions in prevailing short-term interest rates or increases
in major expenses such as energy, insurance and real estate taxes could have an
adverse impact upon the Fund's future funds from operations and distributions
to shareholders.
As a matter of policy, the Fund seeks to maintain working capital
reserves in an amount not less than $2,300,000, which constitutes 2% of the
gross proceeds of the Fund's initial public offering. Working capital reserves
is defined as cash and cash equivalents and other assets expected to be
realized over the next year less liabilities expected to be paid over the next
year. Working capital reserves at December 31, 1993, after payment of the
special $1.00 per share distribution discussed above, aggregated approximately
$8.5 million, representing 7.4% of the Fund's initial offering proceeds,
compared to working capital reserves of $8.7 million at December 31, 1992,
which represented 7.7% of the Fund's initial offering proceeds. The Fund's
present working capital reserves balance is based, in large part, on the
Trustees' desire to maintain a reasonable degree of liquidity in the current
real estate environment.
During the fourth quarter of 1990, the Fund instituted a share
repurchase program. Under the program, the Fund is authorized to repurchase in
the open market from time to time up to 500,000 of the Fund's outstanding
shares. During 1993, the Fund repurchased 67,900 shares at an aggregate cost of
$510,000, and as of December 31, 1993, an aggregate 413,725 shares have been
repurchased under the program at an aggregate cost of $3,134,000. No shares
have been repurchased subsequent to December 31, 1993.
The Fund intends to continue to qualify as a real estate
investment trust under the Internal Revenue Code and distribute all of its
taxable income. The Fund's management considers the Fund's liquidity, as well
as its ability to generate cash, as adequate to meet its presently foreseeable
operating and shareholder distribution requirements and to fund both its share
repurchase program and capital improvements. However, if additional funds are
required, the Fund may borrow to meet its distribution requirements, subject to
the availability of financing in the marketplace. At December 31, 1993, the
Fund's debt-to-equity ratio was .03 to 1.
23
TRUSTEES & OFFICERS
JOHN C. BOGLE, Chairman
Chairman, Chief Executive Officer, and Director of The Vanguard Group, Inc.,
and each of the investment companies in The Vanguard Group.
J. MAHLON BUCK, JR.
Chairman and President of TDH Capital Corporation; Director, Alco Standard
Corporation.
WILLIAM S. CASHEL, JR.
Private Investor; formerly Vice Chairman, American Telephone & Telegraph, Inc.
DAVID C. MELNICOFF
Adjunct Professor of Finance, Temple University; Director, Seamens' Capital
Corporation; Director, Cortland Trust; President, Samuel F. Fels Fund; formerly
Executive Vice President of Meritor Financial Group.
J. LAWRENCE WILSON
Chairman and Director of Rohm & Haas Company; Director of Cummins Engine
Company; Trustee of Vanderbilt University and the Culver Educational
Foundation.
OTHER OFFICERS
JOHN J. BRENNAN, President
President and Director of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
RALPH K. PACKARD, Vice President and Controller
Senior Vice President and Chief Financial Officer of The Vanguard Group, Inc.
RAYMOND J. KLAPINSKY, Secretary
Senior Vice President and Secretary of The Vanguard Group, Inc., and Secretary
of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, Treasurer
Treasurer of The Vanguard Group, Inc., and each of the investment companies in
The Vanguard Group.
[VANGUARD LOGO]
Vanguard Real Estate Fund I * Valley Forge, Pennsylvania 19482
Investor Information: 1 (800) 662-7447
Real Estate Shareholder Account Service: 1 (800) 662-2739
A copy of the Fund's Annual Report on Form 10-K
filed with the Securities and Exchange Commission
may be obtained by shareholders without charge
by calling 1-800-662-7447 or by writing the Fund's
Investor Relations office at P.O. Box 2600,
V35, Valley Forge, PA 19482.
EDGAR Appendix
This appendix dexcribes components of the printed version of this report
that do not translate into a format acceptable to the EDGAR system.
The cover of the printed version of this report features the flags of
the United States of America and Vanguard flying from a halyard.
A photograph of John C. Bogle appears at the upper-right of page one.
A bar chart of the Total Return, Vanguard Real Estate Fund I vs.
Russell-NCREIF Index, for the years 1988 - 1993 appears at the upper-left
of page 3.