FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996. Commission File No. 0-12708
FRANKLIN SELECT REALTY TRUST
(Exact Name of Company as Specified in its Charter)
California 94-3095938
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(State or other jurisdiction (I.R.S. Employer Identification number)
or incorporation or organization)
P.O. Box 7777, San Mateo, CA 94403-7777 (415) 312-2000
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(Address of principal and executive Office) Company's telephone number, including Area Code
Securities registered pursuant to Section 12(b) of Act:
Title of each class Name of each exchange on which registered
Common Stock Series A American Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the Company (1) has filed all reports required to
be filed by Section 12 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
At March 3, 1997, 10,529,765 shares of the Company's Series A common stock were
held by non-affiliates of the Company. The aggregate market value of the voting
stock held by non-affiliates of the Company, based upon the closing price of
$5.50 as of March 3, 1997, is $57,913,706.
Indicate the number of shares outstanding of each of the Company's classes of
common stock at December 31, 1996: 12,250,384 shares of Series A common stock
and 745,584 shares of Series B common stock.
PART I
Item 1. BUSINESS
DESCRIPTION OF BUSINESS
Franklin Select Realty Trust, formerly Franklin Select Real Estate Income Fund,
(the "Company") is a California corporation formed on January 5, 1989, for the
purpose of acquiring, managing and holding for investment income-producing real
estate assets. The Company is a real estate investment trust ("REIT"). At
December 31, 1996, the Company's property portfolio consisted of ownership
interests in the following eight properties: (i) two industrial research and
development properties containing approximately 356,000 rentable square feet of
space; (ii) three suburban office properties containing approximately 403,000
rentable square feet of space; and (iii) three neighborhood shopping centers
containing approximately 204,000 rentable square feet of space. The Company's
properties are concentrated in the greater San Francisco and Los Angeles areas
from which the Company derived 45% and 43% of its 1996 rental revenue
respectively. The Company also owns one property in San Diego and one property
in Reno, Nevada.
The Company's day-to-day operations are managed by Franklin Properties, Inc.
(the "Advisor") under the terms of an advisory agreement which is renewable
annually. The Company does not have any employees. Seven of the Company's
properties are managed by Continental Property Management Co. ("CPMC"), an
affiliate of the Advisor, and the remaining property is managed by an
unaffiliated company, Cupertino Capital. Both management companies perform the
leasing, re-leasing and management-related services for their respective
properties. The Advisor is a wholly-owned subsidiary of Franklin Resources,
Inc., ("Franklin") whose primary business is the $186 billion Franklin Templeton
Group of Funds.
In 1995, the Boards of Directors of the Company and of two other real estate
investment trusts that the Advisor advised, Franklin Real Estate Income Fund
("FREIF") and Franklin Advantage Real Estate Income Fund ("Advantage"), agreed
to the merger of the three real estate investment trusts. At a Special Meeting
of Stockholders held on May 7, 1996, the proposed merger of Advantage and FREIF
into the Company was approved (the "Merger") by a majority of the outstanding
shares of each of the three companies, and the surviving entity was renamed
Franklin Select Realty Trust. Shares of the Company were issued in exchange for
the shares of Advantage and FREIF on the basis described in a Joint Proxy
Statement/Prospectus filed with the Securities and Exchange Commission. The
financial and operating results of periods prior to the Merger have been
restated to give effect to the Merger.
In 1996, the Company formed a limited partnership, FSRT L.P.("FSRT"), in order
to acquire two industrial R & D buildings located in Fremont, California (the
"Lam Research Buildings"). FSRT assumed the existing financing on the Lam
Research Buildings and issued 1,625,000 limited partnership units to the owner
of the property in exchange for its equity interest in the property. The limited
partnership units are convertible into Series A shares of the Company's common
stock on a one-for-one basis commencing October 31, 1997. The Company
contributed its fee title interest in the Data General Building to FSRT and
approximately $1.4 million in cash to cover transaction and closing costs. The
Company is the sole general partner of FSRT and for its contribution, the
Company received an approximate 70% ownership interest in FSRT. The Company may
contribute all of its remaining properties to FSRT at some later date. The
Company is subject to certain restrictions regarding the sale or refinance of
properties owned by FSRT.
All references to the Company in this report refer to Franklin Select Realty
Trust and its majority owned, consolidated limited partnership, FSRT. Unless
otherwise specified, information about the Company and the properties includes
the operations of FSRT, and refers to the Company after the completion of the
Merger, and the combined operations of the Company, FREIF, and Advantage prior
to the completion of the Merger.
INVESTMENT AND OPERATING STRATEGY
The Company acquires income-producing real estate investments located in
California with cash flow growth potential, although it has the flexibility to
purchase properties elsewhere. The Company's investment focus is on the five
major metropolitan areas in California: the Los Angeles metropolitan area,
Orange County, San Diego County, the Sacramento metropolitan area and the San
Francisco metropolitan area. In addition, the Company may consider strategic
acquisitions in other states.
The Company's investment program includes providing stockholders with a
professionally managed diversified portfolio of income-producing equity real
estate investments in strategic markets which represent the potential for
current cash flow and for capital appreciation. The Company's business strategy
is to expand the size and scope and increase the profitability of its current
operations. Traditionally, the Company has identified individual properties
suitable for acquisition and acquired them for cash. The Company now also
acquires property portfolios in exchange for equity. In particular, the Company
seeks to establish strategic relationships with, and acquire property portfolios
from, selected real estate operating companies that appear to have competitive
advantages within their local market areas. This strategy potentially will allow
the Company to increase its asset size, significantly diversify its portfolio
and increase its revenues and profitability while reducing its exposure to any
single property type or market area. In October 1995, the Company retained
Prudential Securities Incorporated as its exclusive financial advisor in
connection with the implementation of its portfolio acquisition strategy.
The Company anticipates that a portion of its future acquisitions may be
achieved through the issuance of common stock or partnership interests. The
Company will carefully limit its use of debt financing as discussed under
"Financing Policy and Related Matters". It is anticipated that the Company will
issue additional limited partnership units of FSRT, or of similarly structured
partnerships, to make certain acquisitions. The issuance or exchange of such
partnership units can provide important tax benefits to a real estate seller
that can enhance the price and other terms of the acquisition, or induce a
seller to sell its property when other forms of consideration may not be as
attractive. The Company may decide to contribute all of its remaining properties
to FSRT at some later date. It is expected that the Company will serve as the
general partner and hold a majority ownership interest in any new acquisition
partnership vehicles.
After properties are acquired, the Company places a strong emphasis on leasing
and tenant retention in combination with a program of regular maintenance,
periodic renovation and capital improvement. Sophisticated management and
accounting systems linked together through a computer network provide detailed
and timely reports on property operations to the Advisor's asset management
staff. The Company views aggressive and involved property management as crucial
to maintaining and improving both cash flow from, and the market value of, its
properties.
Properties are acquired with a view to holding them as long-term investments.
When appropriate, however, the Company seeks to realize the value of its
properties through financings, refinancings, sales or exchanges.
While the Company currently follows the investment policies described above,
they are guidelines only and may be changed by the Board of Directors without a
vote of the Company's stockholders.
FINANCING POLICY AND RELATED MATTERS
The Company's present policy is to maintain a debt to total assets ratio not to
exceed 50%. At December 31, 1996, the Company's debt to total assets ratio was
17%. The Company may from time to time modify its debt policy in light of then
current economic conditions, relative costs of debt and equity financings,
fluctuations in the fair market price of the Company's common stock, growth and
acquisition opportunities and other factors. Accordingly, the Company may
increase its debt to total assets ratio beyond the limit described above.
However, the Company's organizational documents prohibit the aggregate amount of
the Company's indebtedness to exceed 300% of its net assets, and prohibit
unsecured borrowings which result in asset coverage of less than 300%.
The Company expects to fund the cost of acquisitions, capital expenditures,
costs associated with lease renewals and reletting of space, repayment of
indebtedness, and development of properties from (i) cash flow from operations,
(ii) borrowings under its credit facility and, if available, other indebtedness
(which may include indebtedness assumed in acquisitions), (iii) the sale of real
estate investments, (iv) the sale of the Company's equity securities, and (v)
the issuance of partnership interests in connection with acquisitions.
The Company is subject to the risks normally associated with debt financing,
including the risk that the Company's cash flow will be insufficient to meet
required payments of principal and interest, that the Company will not be able
to refinance existing indebtedness on the encumbered properties or that the
terms of such refinancing will not be as favorable as the terms of existing
indebtedness.
Debt Financing: Balloon Payments. The Company's mortgage indebtedness has the
following balloon payments: 1999-$4.0 million; and 2006-$13.4 million. In
addition, the Company's $25 million credit facility, which had no outstanding
balance at December 31, 1996, matures in 1998. The Company does not anticipate
that its cash flow from operations will be sufficient to make all of the balloon
payments of principal when due under its mortgage indebtedness and its credit
facility. The Company intends to make such payments by refinancing or extending
the indebtedness or by raising funds through the sale of equity securities or
properties. If the Company is unable to extend, refinance, or payoff its
indebtedness when due, the mortgaged properties could be foreclosed upon by or
otherwise transferred to the mortgagee with a subsequent loss of income and
asset value to the Company.
Debt Financing: Variable Interest Rates. As of December 31, 1996, the Company
had approximately $4.2 million of variable rate mortgage indebtedness
outstanding which bears interest at a floating rate tied to the Union Bank
Reference Rate. In addition, the Company has access to a revolving line of
credit in the amount of $25 million which bears interest at a floating rate tied
to either (i) the London Interbank Offered Rates ("LIBOR"), or (ii) the Bank of
America Reference Rate at the Company's option. Although there were no amounts
outstanding under the line of credit at December 31, 1996, the Company intends
to use the line of credit to provide short term financing for future
acquisitions. An increase in interest rates will have an adverse effect on the
Company's net income and Funds from Operations.
CASH DISTRIBUTION POLICY
Distributions are declared quarterly at the discretion of the Board of
Directors. The Company's present distribution policy is to evaluate the current
distribution rate, at least annually, in light of anticipated tenant turnover
over the next two or three years, the estimated level of associated improvements
and leasing commissions, planned capital expenditures, any debt service
requirements and the Company's other working capital requirements. After
balancing these considerations, and considering the Company's earnings and cash
flow, the level of its liquid reserves and other relevant factors, the Company
seeks to establish a distribution rate which:
i) provides a stable distribution which is sustainable despite short term
fluctuations in property cash flows;
ii) maximizes the amount of cash flow paid out as distributions consistent
with the above listed objective; and
iii) complies with the Internal Revenue Code requirement that a REIT
annually pay out as distributions not less than 95% of its taxable
income.
MATTERS THAT MAY AFFECT THE COMPANY'S RESULTS
The Company is subject to the risks generally associated with the ownership of
real property, including the possibility that operating expenses, debt service
payments and fixed costs may exceed property revenues; economic conditions may
adversely change in the California, Nevada and the national markets; the real
estate investment climate may change; local market conditions may change
adversely due to general or local economic conditions and neighborhood
characteristics; interest rates may fluctuate and the availability, costs and
terms of mortgage financing may change; unanticipated maintenance and
renovations may arise; changes in real estate tax rates and other operating
expenses may arise; governmental rules and fiscal policies may change; natural
disasters, including earthquakes, floods or tornadoes may result in losses
beyond the coverage of the Company's insurance policies; the financial condition
of the tenants of properties may deteriorate; and other factors which are beyond
the control of the Company may occur.
All of the Company's properties are located in areas that are subject to
earthquake activity. The Company currently carries earthquake insurance coverage
for its properties and intends to continue to carry earthquake coverage to the
extent that it is available at economically reasonable rates. However, the
Company's earthquake insurance coverage may, from time to time, be subject to
substantial deductibles.
The real estate business is competitive, and the Company is in competition with
many other entities engaged in real estate investment activities, many of which
have greater assets than the Company. The Company's real estate investments in
rental properties are subject to the risk of the Company's inability to attract
or retain tenants and a consequent decline in rental income. Furthermore, real
estate investments tend to be long-term, and under the REIT provisions of the
Internal Revenue Code, might be subject to minimum holding periods to avoid
adverse tax consequences; consequently, the Company will have only minimal
ability to vary its property portfolio in response to changing economic,
financial and investment conditions. To the extent that the Company's rental
income is based on a percentage of the gross receipts of retail tenants, its
cash flow is dependent on the retail success achieved by such tenants.
In connection with any lease renewal or new lease, the Company typically incurs
costs for tenant improvements and leasing commissions which will be funded first
from operating cash flow and, if necessary, from cash reserves or the line of
credit. In addition, while the Company has historically been successful in
renewing and releasing space, it will be subject to the risk that leases
expiring in the future may be renewed or released at terms that are less
favorable than current lease terms.
The opportunities for sale, and the profitability of any sale, of any particular
property by the Company will be subject to the risk of adverse changes in real
estate market conditions, which may vary depending upon the size, location and
type of each property.
GOVERNMENT REGULATION
Under various federal, state and local laws, ordinances and regulations, an
owner or operator of real property may become liable for the costs of removal or
remediation of certain hazardous substances released on or in its property. Such
laws often impose such liability without regard to whether the owner or operator
knew of, or was responsible for, the release of such hazardous substances, the
presence of such substances, or the failure to properly remediate such
substances, when released. As part of the investigation of properties prior to
acquisition, the Company typically has obtained inspection reports concerning
the condition of the property, including specialized environmental inspection
reports concerning the presence of hazardous substances on the property. The
Company intends to continue this practice. None of these inspection reports has
revealed any environmental conditions requiring material expenditures for
remediation.
Such inspection reports, however, do not necessarily reveal all hazardous
substances or sources thereof, and substances not considered hazardous when a
property is acquired may subsequently be classified as such by amendments to
local, state, and federal laws, ordinances, and regulations. If it is ever
determined that hazardous substances on or in a Company property must be removed
or the release of such substances remediated, the Company could be required to
pay all costs of any necessary cleanup work, although under certain
circumstances, claims against other responsible parties could be made by the
Company. The Company could also experience lost revenues during any such
cleanup, or lower lease rates, decreased occupancy or difficulty selling or
borrowing against the affected property either prior to or following any such
cleanup. The Company believes that it is in compliance in all material respects
with all federal, state and local laws regarding hazardous or toxic substances,
and the Company has not been notified by any governmental authority of any
non-compliance or other claim in connection with any of its present or former
properties. The Company does not anticipate that compliance with federal, state
and local environmental protection regulations will have any material adverse
impact on the financial position, results of operations or liquidity of the
Company.
The Company is aware of the existence of certain hazardous substances at the
Data General Building site. The Data General Building is located on property
that was formerly part of a site used for storage of crude oil and various
refined petroleum products. As a result, methane gas is present in the soil and
the groundwater is contaminated throughout the area where the property is
located. According to environmental reports prepared at the time the Data
General Building was acquired, a vapor ventilation system on the property, which
was installed and is maintained and monitored by a prior owner of the property,
Chevron Land Development Company, has mitigated any material risk associated
with the presence of the methane gas. The Company has not incurred any costs for
monitoring and remediating the presence of methane gas or the groundwater
contamination at the Data General Building and does not anticipate incurring any
cost with regard to such activities in the future. The contamination in the
groundwater generally presents a risk only if the groundwater is used as
drinking water, which it is not.
The Company has not received any reports from federal or state agencies
relieving it of future clean-up responsibilities, but federal and state agencies
have investigated these matters and have not, to date, required any clean-up.
The Company has no reason to believe at this time that it will be required to
take remediation steps in the future, particularly given the geographic scope of
the contaminated area. It is therefore difficult to predict what, if any, costs
might be incurred by the Company should the position of the federal or state
agencies change. In any event, if the Company is required to cure the
contamination on the Data General Building site, it would seek full indemnity
from the oil companies which were the source of the contamination.
The Data General Building's transite exterior panels and roof coverings contain
asbestos. Transite is "non-friable," which means that the asbestos fibers are
not released into the air, unless the transite is broken, cut or otherwise
damaged. The Company believes that absent such breakage or damage, the existence
of asbestos in the transite presents no measurable risk of asbestos-related
injuries. However, the presence of asbestos in the transite panels means that
protective measures may need to be taken if the transite panels are repaired or
if they are damaged by the elements.
The Americans with Disabilities Act ("ADA"), which generally requires that
buildings be made accessible to people with disabilities, has separate
compliance requirements for "public accommodations" and "commercial facilities".
If certain uses by tenants of a building constitute a "public accommodation",
the ADA imposes liability for non-compliance on both the tenant and the
owner/operator of the building. The Company has conducted inspections of its
properties to determine whether the exterior and common area of such properties
are in compliance with the ADA and it believes that its properties are in
compliance. If, however, it were ever determined that one or more of the
Company's properties were not in compliance, the Company may be subjected to
unanticipated expenditures incurred to remove access barriers, or to pay fines
or damages related to such non-compliance.
The Company's due diligence review of prospective acquisitions of office,
industrial and retail property includes an examination of such property's
compliance with the ADA, and the cost of remedial work, if any, believed to be
required to meet such requirements.
Item 2. PROPERTIES
PORTFOLIO SUMMARY
At December 31, 1996, the Company's property portfolio consisted of eight
properties located in the greater San Francisco, Los Angeles and San Diego
metropolitan areas of California and in Reno, Nevada. At year-end, the Company's
properties were 98% leased compared to 97% leased at the end of 1995. The
Company's real estate investments (net of accumulated depreciation) were
diversified by property type as follows:
Number of Investment
Properties -------------- -------------------
Amounts % of Total
Industrial R&D Properties 2 $36,834,000 30%
Office Properties 3 64,380,000 52%
Retail Properties 3 22,828,000 18%
Total 8 $124,042,000 100%
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The following table describes the Company's properties:
Total Average
Rentable Year cupancy 1996
Property Name/ Location Square Acquired During Rental
Footage 1996 Revenue
Industrial R&D Properties:
The Northport Buildings
Fremont, California 144,568 1991 96% $1,627,000
The Lam Research Buildings
Fremont, California 211,680 1996 100% 407,000
Office Properties:
The Shores
Redwood City, California 138,546 1989 100% 3,286,000
The Data General Building
Manhattan Beach, California 118,443 1989 100% 2,657,000
The Fairway Center
Brea, California 146,131 1992 100% 3,286,000
Retail Centers
Mira Loma Shopping Center
Reno, Nevada 94,026 1988 83% 973,000
Glen Cove Center
Vallejo, California 66,000 1994 97% 901,000
Carmel Mountain Gateway Plaza
San Diego, California 44,230 1994 77% 789,000
Total 963,624 95% $13,926,000
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The Company or FSRT owns a fee interest in each property. For information
related to the encumbrances of the individual properties, see the Notes to
Consolidated Financial Statements on pages 39 and 41.
At December 31, 1996, the Company's property portfolio contained a total of 70
leases. The Company's portfolio represents in the aggregate, 963,624 rentable
square feet. The following table sets forth for all of the Company's properties
the lease expiration dates and the related annual base rental income at December
31, 1996.
No. of
Leases Total Current Annual % of Current
Year Expiring Sq. Ft. Base Rent1 Annual Rent
1997 11 161,892 $3,104,000 22%
1998 13 32,093 632,000 4%
1999 10 92,925 1,884,000 13%
2000 8 38,789 874,000 6%
2001 6 86,163 1,480,000 10%
2002 4 31,380 616,000 4%
2003 4 63,157 579,000 4%
2004 3 63,555 621,000 4%
2005 3 40,525 392,000 3%
2006 1 12,078 193,000 1%
2008 1 22,400 311,000 2%
2009 1 16,648 372,000 3%
2010 1 50,360 552,000 4%
2012 2 6,000 271,000 2%
2013 1 15,025 109,000 1%
2014 1 211,680 2,386,000 17%
Total 70 944,670 $14,376,000 100%
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1 Annualized Base Rent means the product of (i) the monthly base
rent in effect with respect to each property at December 31,
1996 or, if such monthly base rent has been reduced by a
temporary rent concession, the monthly base rent that would
have been in effect at such date in the absence of such
concession, multiplied by (ii) 12. Annualized Base Rent does
not reflect any increases or decreases in monthly rental rates
or lease expirations which are scheduled to occur or which may
occur after the date of calculation or the cost of any leasing
commissions or tenant improvements.
SIGNIFICANT TENANTS
Two of the Company's tenants provide 10% or more of the Company's annual base
rental income at December 31, 1996.
Annualized Total % of
Tenant Name/Property Square Base Rent Base Lease Renewal
Feet at 12/31/96 Rent Expiration Options
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Lam Research
Corporation
Lam Research Buildings 211,680 $2,386,000 17% 12/31/2014 2-5 yr.
Northport Buildings 58,130 506,000 4% 7/31/2003 1-5 yr.
Continental Casualty Company
The Fairway Center 74,515 $1,699,000 12% 10/31/97 1-5 yr.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" for a discussion of the estimated
financial effects of renewing the Continental Casualty Company lease or
re-leasing the space.
Item 3. LEGAL PROCEEDINGS
On December 2, 1996, two stockholders, for themselves and purportedly on behalf
of certain other minority stockholders of Advantage, filed a purported class
action complaint in the California Superior Court for San Mateo County against
Advantage, its directors, the Advisor, Franklin Resources, Inc. and the
Massachusetts State Teachers' and Employees' Retirement Systems Trust
("MASTERS"). The complaint alleges that defendants breached fiduciary duties to
plaintiffs and other minority stockholders in connection with the purchase by
Franklin Resources, Inc. in August 1994 of MASTERS' 46.6% interest in Advantage
and in connection with the Merger of Advantage into the Company in May 1996,
which was approved by a majority of the outstanding shares of each of the three
companies. Plaintiffs also allege that defendants misstated certain material
facts or omitted to state material facts in connection with these transactions.
The complaint includes a variety of additional claims, including claims relating
to the investment of Advantage assets, the suspension of the dividend
reinvestment program, the allocation of merger-related expenses, revisions to
the investment policies of Advantage, and the restructuring of the contractual
relationship with the Advisor. Plaintiffs seek damages in an unspecified amount
and certain equitable relief. The defendants deny any wrongdoing in these
matters and intend to vigorously defend the action. Management does not believe
that the outcome of this litigation will have a material adverse affect on the
Company's financial condition or results of operations.
The properties are subject to certain routine litigation and administrative
proceedings arising in the ordinary course of business, which, taken together,
are not expected to have a material adverse impact on the Company's financial
condition or results of operations.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the last
quarter covered by this report.
PART II
Item 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company has one class of common stock in two series, designated Series A and
Series B (the "Common Stock"). At December 31, 1996, the Company had 12,250,384
Series A common shares outstanding and 745,584 Series B common shares
outstanding, and there were approximately 3,750 Series A stockholders of record.
The Common Stock votes together as one class with each share being entitled to
one vote. The Series B shares are owned by Franklin Properties, the Advisor.
There are no restrictions on sales or purchases of the Company's Series A common
stock other than those that may be imposed by any applicable federal or state
securities laws or by the Company's Articles of Incorporation or Bylaws with
respect to maintaining the Company's status as a qualified real estate
investment trust under applicable tax rules and regulations.
On January 14, 1994, the Company registered its Series A common stock on the
American Stock Exchange (AMEX) where it is currently traded under the symbol
"FSN". Prior to January 14, 1994, there was no established public trading market
for the common stock. Set forth below are the quarterly high and low share
reported sales prices for the past two years and the distributions per share
declared each quarter. For periods prior to the Merger on May 7, 1996, the
amounts shown do not reflect those of FREIF and Advantage.
DISTRIBUTIONS
QUARTER ENDED HIGH LOW DECLARED
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December 31, 1996 $ 5 7/8 $ 4 11/16 .11
September 30, 1996 5 4 1/2 .11
June 30, 1996 5 1/4 4 1/2 .11
March 31, 1996 5 1/8 3 15/16 .11
December 31, 1995 4 5/8 3 15/16 .11
September 30, 1995 4 11/16 3 7/8 .11
June 30, 1995 4 5/8 3 3/4 .11
March 31, 1995 4 3/8 3 3/4 .11
The Company has a policy, subject to the discretion of the Board of Directors,
of making quarterly cash distributions to stockholders aggregating on an annual
basis at least 95% of its taxable income. For the years ended December 31, 1996,
and 1995, the Company declared distributions of approximately $5,860,000 ($.44
per share) and $6,206,000 ($.44 per share). Cash distributions to stockholders
are currently paid on approximately the 15th day of January, April, July and
October. Stockholders may elect to direct their distributions into any or one of
the eligible funds in the Franklin Templeton Group of Funds, which are managed
by an affiliate of the Advisor, or participate in the Company's Dividend
Reinvestment Plan.
DIVIDEND REINVESTMENT PLAN
The Company has established a Dividend Reinvestment Plan (the "Plan") which is
designed to enable Company Series A stockholders to choose to have distributions
automatically invested in additional shares of Company common stock at market
value, without the payment of any brokerage commission, service charge or other
expense. Under the Plan, the Company's Dividend Reinvestment Agent makes open
market purchases of the Company's Series A common stock, administers the Plan
and performs other duties related to the Plan. No new shares have been issued in
connection with the Plan. In order to participate in the Plan, investors must
designate that they would like their distributions reinvested. Company Series A
stockholders may elect to participate in the Plan at any time. The Plan does not
accept cash contributions from Company stockholders to purchase additional
shares of existing Company common stock. Only distributions on existing Company
common stock may be reinvested. For information on how to participate in the
Dividend Reinvestment Plan, please contact the Company's transfer agent at (800)
851-4217.
RETURN OF CAPITAL
Because depreciation is a non-cash expense, cash flow will typically be greater
than earnings from operations and net income. Therefore, quarterly distributions
will generally be higher than quarterly earnings which causes a portion of the
distributions to be considered a return of capital. The portion of distributions
that represented a return of capital for financial statement purposes on a
consolidated basis, for the years ended December 31, 1996, and 1995, were
$2,053,000 and $1,744,000, respectively.
REIT QUALIFICATION MATTERS
The Company is a REIT and elected REIT status commencing with the 1989 tax year
pursuant to the provisions of the Internal Revenue Code (the "Code") and
applicable state income tax law. Under those provisions, the Company will not be
subject to income tax on that portion of its taxable income which is distributed
annually to stockholders if at least 95% of its taxable income (which term
excludes capital gains) is distributed and if certain other conditions are met.
During such time as the Company qualifies as a REIT, the Company intends to make
quarterly cash distributions to the stockholders aggregating on an annual basis
at least 95% of its taxable income.
Among other requirements, the Company must, in order to continue its status as a
REIT under the Code, not have more than 50% in value of its outstanding shares
owned by five or fewer individuals during the last half of a taxable year (the
"5/50 Provision"). In order to meet these requirements, the Company has the
power to redeem a sufficient number of shares in order to maintain or to bring
the ownership of the shares into conformity with these requirements, and to
prohibit the transfer of shares to persons whose acquisition would result in a
violation of these requirements. The price to be paid in the event of the
redemption of shares will be the last reported sale price of the Series A common
stock on the last business day prior to the redemption date on the principal
national securities exchange on which the Series A common stock is listed or
admitted to trading or otherwise, as determined in good faith by the Board of
Directors of the Company.
In order to assure compliance with the 5/50 Provision of the Code, described
above, the Company's Bylaws permit the Directors of the Company to impose a
lower percentage limit on the remaining stockholders, in the event certain
stockholders (including Franklin and its affiliates) acquire in excess of 9.9%
of the outstanding shares of Common Stock during the offering period. The
Directors of the Company have exercised this authority under the Bylaws to lower
the percentage limitation such that stockholders may not acquire additional
shares if such shareholder then holds, or would then hold, in excess of 7% of
the total outstanding voting shares of the Company. Any shares acquired in
excess of the foregoing limitation will be deemed to be held in trust for the
Company, and will not be entitled to receive distributions or to vote.
The Directors of the Company may impose, or seek judicial or other imposition of
additional restrictions if deemed necessary or advisable, including but not
limited to further reductions in the foregoing percentage limitation with or
without notice, or redemption of shares, in order to protect the Company's
status as a qualified REIT.
Item 6. SELECTED FINANCIAL DATA
(Dollars in 000's except
per share amounts) Restated1 Restated1 Restated1 Restated1
1996 1995 1994 1993 1992
Total revenue $14,568 $14,111 $12,990 $12,877 $12,422
Net income $3,807 $4,462 $4,273 $4,438 $4,328
Per Series A common share1:
Net income $0.28 $0.32 $0.30 $0.31 $0.30
Distributions declared $.44 $0.44 $0.44 $0.43 $0.47
Weighted average number
- -------------------------------------------
of shares of Series A 13,830 14,145 14,145 14,145 14,223
common stock outstanding
Balance Sheet Data:
Total assets $131,298 $116,457 $117,873 $114,820 $117,057
Notes and bonds payable $22,745 $7,145 $7,279 $3,015 $3,075
Stockholders' equity $96,653 $106,986 $108,316 $111,000 $113,204
Other Data:
Funds from operations2 $7,235 $7,795 $7,396 $7,337 $6,079
Cash flow provided by (used in)
Operating activities $7,831 $8,359 $8,771 $5,282 $6,039
Investing activities $4,140 $31 ($5,904) $3,940 ($11,986)
Financing activities ($15,599) ($6,404) ($3,184) ($6,173) ($6,868)
Total rentable square footage
of properties at end of period 963,624 751,944 751,944 641,714 641,714
Number of properties at end of
period 8 7 7 5 5
1 Amounts reported for 1992 through 1995 have been restated to give
effect to the Merger.
2 Funds from operations, as defined by the National Association of Real
Estate Investment Trusts, means net income (loss) from operations,
excluding gains or losses from debt restructuring and sales of
property, plus depreciation and amortization, and after adjustment for
unconsolidated joint ventures. The Company considers funds from
operations to be a useful measure of the operating performance of an
equity REIT because, together with net income and cash flows, funds
from operations provides investors with an additional basis to evaluate
the ability of a REIT to support general operating expense and interest
expense before the impact of certain activities, such as gains and
losses from property sales and changes in the accounts receivable and
accounts payable. Funds from operations does not represent net income
or cash flows from operations as defined by GAAP and does not
necessarily indicate that the cash flows will be sufficient to fund
cash needs. It should not be considered as an alternative to net income
as an indicator of the Company's operating performance or as an
alternative to cash flows from operating, investing or financing
activities as a measure of liquidity. Funds from operations does not
measure whether income is sufficient to fund all of the Company's cash
needs including principal amortization, capital improvements and
distributions to stockholders. The Company reports funds from
operations in accordance with the revised NAREIT definition. The change
in the NAREIT definition in 1995 had no material effect on the amounts
previously reported by the Company as funds from operations. Funds from
operations disclosed by other REITs may not be comparable to the
Company's calculation of funds from operations.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
On May 7, 1996, the Company merged with two other real estate investment trusts
that Franklin Properties, Inc. advised, Franklin Real Estate Income Fund
("FREIF"), and Franklin Advantage Real Estate Income Fund ("Advantage"). The
consolidated financial information of the Company has been presented as a
reorganization of entities under common control; therefore, the historical
amounts reported for prior periods have been restated so as to report them on a
combined basis.
The following discussion is based primarily on the consolidated financial
statements of the Company for the year ended December 31, 1996 and the restated,
combined financial statements of the Company, FREIF and Advantage for the prior
periods presented. The information should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
When used in the following discussion, the words "believes," "anticipates" and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties which could cause
actual results to differ materially from those projected, including, but not
limited to, those set forth in the section entitled "Potential Factors Affecting
Future Operating Results," below. Readers are cautioned not to place undue
reliance on these forward-looking statements which speak only as of the date
hereof. The Company undertakes no obligation to publicly release the result of
any revisions to these forward-looking statements which may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
GENERAL BACKGROUND
The Company's rental revenue is generated by investments in the following eight
properties: (i) two industrial R&D properties comprising 356,000 rentable square
feet of space, (ii) three office properties comprising 403,000 rentable square
feet of space, and (iii) three neighborhood shopping centers, comprising 204,000
rentable square feet of space. Six of the properties are concentrated in the
greater San Francisco and Los Angeles areas from which the Company derived 45%
and 43% of its 1996 rental revenue, respectively. The remaining two properties
are located in San Diego, California and Reno, Nevada.
The Company's day-to-day operations are managed by Franklin Properties, Inc.
(the "Advisor", or "Management") under the terms of an advisory agreement which
is renewable annually. The Company does not have any employees. Property
management for seven of the Company's eight properties is provided by
Continental Property Management Co. ("CPMC"), an affiliate of the Advisor, and
the remaining property is managed by an unaffiliated company, Cupertino Capital.
Both management companies perform the leasing, re-leasing and management related
services for their respective properties. The Advisor is a wholly owned
subsidiary of Franklin Resources, Inc. whose primary business is the $186
billion Franklin Templeton Group of Funds.
1996 SUMMARY
The Company's property operations were stable with the prior year, both with
respect to rental rates and average occupancy. The transactions that had the
greatest influence on the Company's reported results in 1996 were:
(i) the Merger of the Company with two other real estate investment trusts in
May 1996,
(ii) the sale of a large portion of the Company's investments in mortgage-backed
securities in October 1996, which provided cash used to repurchase
approximately 13.4% of the Series A common stock held by stockholders who
dissented from the Merger; and,
(iii)the acquisition of two industrial research and development buildings in
October 1996 (the "Lam Research Buildings"). To acquire the buildings, the
Company and the buildings' owner formed a limited partnership, FSRT, which
issued convertible limited partnership units to the owner in return for the
owner's equity interest in the property. FSRT also assumed the existing
indebtedness on the buildings which was subsequently refinanced with fixed
rate debt carrying a lower interest rate. The Company holds a 70% interest
in FSRT, and it is the sole general partner of the partnership.
The Company also arranged for a $25 million line of credit in December 1996,
which was unused at year end, but which is expected to provide capital for
future acquisitions and for other liquidity needs.
RESULTS OF OPERATIONS
COMPARISON OF YEAR ENDED DECEMBER 31, 1996 TO YEAR ENDED DECEMBER 31, 1995
Total revenue increased approximately 3% compared to 1995 primarily due to
rental revenue provided by the Lam Research Buildings which were acquired on
October 31, 1996. Rental revenue for the seven properties that the Company owned
for the entire year improved 1% in 1996, reflecting stable rental rates and
occupancy rates for both periods. Interest income declined $75,000 compared to
1995 due to the sale of mortgage-backed securities in October 1996.
Total expenses increased approximately $1,112,000, or 12%, compared to 1995
primarily due to an increase in expenses related to the Merger, and due to
interest expense, depreciation expense and minority interest expense related to
the Lam Research Buildings which were acquired in 1996.
During 1996, the Company incurred non-recurring expenses related to the Merger,
totaling approximately $919,000 compared to $456,000 in 1995. The expenses were
comprised of: (i) consolidation expense of $695,000 and $394,000, respectively,
(ii) general and administrative expenses of $73,000 and $62,000, respectively,
and (iii) a loss on the sale of mortgage-backed securities of $151,000 in 1996,
which was recorded when the Company sold securities to provide cash for the
repurchase of shares dissenting from the Merger.
Property operating expenses, which generally include maintenance and repairs,
property taxes, utilities, and on-site administrative expense, declined slightly
compared to 1995 due to non-recurring expenses recorded in 1995 related to
discontinuing operations of a self service car wash at the Mira Loma Center.
Excluding those expenses, operating expenses increased approximately 1% compared
to 1995. In 1996, minor increases in several expense categories were offset by a
decline in electricity expense caused by milder summertime temperatures in
Southern California. The acquisition of the Lam Research Buildings did not cause
property operating expenses to increase in 1996 since the tenant pays the
expenses directly.
Related party expense increased $175,000, or 17% in 1996 reflecting an increase
in advisory fees of $201,000, and an increase in property management fees of
$12,000, which were partially offset by a decline of $38,000 in reimbursements
to the Advisor for accounting and data processing costs. The increase in
advisory fees was caused by the acquisition of the Lam Research Buildings, and
the adoption of the Company's advisory agreement by the two REITs that merged
with the Company in May 1996. Prior to the Merger, the REITs operated under
advisory agreements containing different methods of compensation to the Advisor.
General and administrative expense increased approximately $136,000 in 1996
primarily due to legal and consulting fees related to locating potential
property acquisitions, expenses of transferring ownership of the Data General
Building to FSRT, and a temporary increase in stock exchange fees that was
attributable to the Merger. Partly offsetting these increases were declines in
the cost of directors' and officers' insurance coverage and transfer agent
expense, reflecting economies of scale after the Merger.
Net income declined approximately $655,000, or 15% in 1996 largely due to an
increase in Merger related expenses, an increase in advisory fees subsequent to
the Merger, and a decline in interest income caused by the sale of
mortgage-backed securities. Net income per share also declined, but by a lesser
percentage, due to a decline in the number of shares outstanding after the
Company purchased the dissenting shares.
COMPARISON OF YEAR ENDED DECEMBER 31, 1995 TO YEAR ENDED DECEMBER 31, 1994
Net income for 1995 increased $189,000, or 4%, compared to 1994 primarily as a
result of an increase in rental revenues exceeding increases in interest
expense, depreciation and amortization, operating expense, related party and
consolidation expense, as more fully described below.
Total revenue increased $1,121,000, or 9%, in 1995 primarily due to a full
year's operations from two properties which were acquired in 1994. The increase
in rental revenue was also attributable to increased rental income from Shores
Office Complex due to improved occupancy and rental rates at that property.
Total expenses increased $932,000, or 11%, in 1995. Increases in interest
expense, depreciation and amortization, operating expense, and related party
expense were primarily a result of a full year's operations from properties
acquired in 1994. Other items affecting the change from year to year included
$394,000 of consolidation expense incurred in 1995 and a loss on the sale of
mortgage-backed securities of $318,000 recorded in 1994.
General and administrative expense decreased $155,000 in 1995 primarily due to
non-recurring costs incurred in 1994 associated with listing the Company's,
FREIF's and Advantage's stock on the American Stock Exchange.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company's cash and cash equivalents aggregated
$2,558,000 which the Company believes is adequate to meet its short term
operating cash requirements. The Company also has access to a revolving line of
credit in the amount of $25 million and holds $578,000 of mortgage-backed
securities. At year end, there were no amounts outstanding under the Company's
credit facility.
During 1996, the Company's cash balance declined to $2,558,000 compared to
$6,186,000 at December 31, 1995. This decline in cash reflects cash provided by
operating activities of $7,831,000, plus cash provided by investing activities
of $4,140,000, and reduced by cash used by financing activities of $15,599,000.
The $4,140,000 of net cash provided by investing activities reflects $6,534,000
of proceeds from the sale of mortgage-backed securities, which was partially
offset by $1,428,000 used to acquire the Lam Research Buildings, $627,000 used
for improvements to rental properties, and $339,000 used for leasing
commissions. The mortgage-backed securities were sold in order to provide funds
to purchase the dissenting shares as described below, and to pay for transaction
and closing costs related to the property acquisition. The $15,599,000 of net
cash used in financing activities primarily reflects $8,408,000 of funds used to
purchase the dissenting shares, and $6,033,000 of cash distributions.
The Company's investment in mortgage-backed securities at December 31, 1996, is
represented by a FNMA adjustable rate pass-through certificate with a market
value of approximately $578,000. Although payments of principal and interest are
guaranteed by FNMA, changes in market interest rates may cause the security's
market value to fluctuate, which could result in a gain or loss if the security
is sold before maturity.
In 1996, the Company formed a limited partnership, FSRT, in order to acquire two
industrial R & D buildings located in Fremont, California (the "Lam Research
Buildings"). FSRT assumed the existing financing on the Lam Research Buildings,
which was subsequently refinanced, and issued 1,625,000 limited partnership
units to the prior owner in exchange for its equity interest in the buildings.
The limited partnership units are convertible into Series A shares of the
Company's common stock on a one-for-one basis after November 1, 1997. The
Company contributed its fee title interest in the Data General Building to FSRT
and approximately $1.4 million in cash to cover transaction and closing costs.
The Company is the sole general partner of FSRT and for its contribution, the
Company received an approximate 70% ownership interest in the partnership. The
Company may contribute all of its remaining properties to FSRT at some later
date. The Company is subject to certain restrictions regarding the sale or
refinance of properties owned by FSRT.
In connection with the Merger, stockholders representing approximately 635,638
shares of FREIF Series A common stock and 1,077,677 shares of Company Series A
common stock elected to exercise dissenter's rights pursuant to Chapter 13 of
the California General Corporation Law. No Advantage stockholders elected to
exercise dissenter's rights. On November 1, 1996, the Company purchased all of
the remaining dissenting shares of Series A common stock arising from the Merger
for an aggregate price of $8.4 million. After giving effect to the transaction,
the total number of shares of Series A common stock of the Company outstanding
is 12,250,384. Cash for the purchase price was provided by the sale of a portion
of the Company's mortgage-backed securities.
On December 10, 1996, the Company entered into an agreement with the Bank of
America for a $25 million secured revolving line of credit to provide funding
for future acquisitions and general business purposes. Borrowings under the line
of credit bear interest at the London Interbank Offered Rate ("LIBOR") plus
1.90%, or at the bank's Reference rate at the Company's option. The credit
facility is secured by mortgages on three of the Company's properties (which
collectively accounted for 52% of the Company's annualized base rent as of
December 31, 1996), together with the rental proceeds from such properties. At
December 31, 1996, these properties comprised approximately 45% of the Company's
gross real estate assets. The credit agreement contains customary
representations, restrictive covenants, and events of default, including a
covenant limiting quarterly distributions to 98% of funds from operations. The
Company does not anticipate that this covenant will adversely affect the ability
of the Company to declare distributions under the Company's current distribution
policy. At December 31, 1996, the Company had no borrowings outstanding under
the line of credit.
In connection with any lease renewal or new leasing, the Company would incur
costs for tenant improvements and leasing commissions which would be funded
first from operating cash flow and, if necessary, from cash reserves or the line
of credit.
IMPACT OF INFLATION
The Company's policy of negotiating leases which incorporate operating expense
"pass-through" provisions is intended to protect the Company against increased
operating costs resulting from inflation. Inflation, however, would increase the
Company's borrowing costs.
POTENTIAL FACTORS AFFECTING FUTURE OPERATING RESULTS
DECLINE IN INTEREST INCOME, LOSS ON SALE OF MORTGAGE-BACKED SECURITIES
In prior years, net income has been positively affected by interest income that
the Company earned on its investments in mortgage-backed securities. In
addition, the Company periodically incurred losses upon the sale of certain of
the securities. Late in 1996, the Company liquidated substantially all of its
mortgage-backed securities in order to provide funds to repurchase a portion of
its outstanding common stock. Therefore, the Company does not anticipate
generating significant amounts of interest income, or losses on the sale of
mortgage-backed securities, in future years. The repurchase of the Company's
common stock was not detrimental to the Company's operating results in 1996
calculated on a per share basis, due to the related decline in the number of
shares outstanding.
LEASING TURNOVER
In connection with any lease renewal or new lease, the Company typically incurs
costs for tenant improvements and leasing commissions which will be funded first
from operating cash flow and, if necessary, from cash reserves or the line of
credit. In addition, while the company has historically been successful in
renewing and releasing space, the Company will be subject to the risk that
leases expiring in the future may be renewed or released at terms that are less
favorable than current lease terms.
LEASING TURNOVER - CONTINENTAL CASUALTY COMPANY
An important event in the near term is the expiration of the Continental
Casualty Company ("CNA") lease in November, 1997. The lease covers 74,515 square
feet of space and represents approximately 12% of the Company's current base
rental income. The Company has commenced renewal negotiations with CNA; however,
it is currently unknown whether an agreement will be consummated. Currently, the
base annual rental rate of this lease is $22.80 per square foot, and the Company
has offered to extend the tenant's lease for five years at a lower rental rate.
The Company has also offered to provide the tenant with tenant improvements and
to pay leasing commissions, which total approximately $870,000. Although it is
impossible to predict the final outcome of negotiations with CNA, if the tenant
were to accept the Company's proposal, the Company's annual rental income and
expense reimbursements would decline by approximately $420,000, or 2.9% of the
Company's total revenue in 1996. Alternatively, if CNA were to vacate its space
and a single replacement tenant could not be located, the Company may have to
reconfigure the space for multiple tenants at a cost which could exceed $2
million. The most likely sources for such funds are the Company's cash reserves,
debt financing, or the sale of an undeveloped parcel of land at the Fairway
Center. No assurance can be given that CNA will renew under the terms set forth
above or whether the space currently occupied by CNA can be rented without
detrimental impact to the Company's current annual rental income and expense
reimbursements.
LEASING TURNOVER - DATA GENERAL BUILDING
The Data General Building is located in an area of Los Angeles County that is
dominated by aerospace and defense related companies. Because many of the
defense programs that these companies are engaged in have been curtailed, their
office space requirements were substantially reduced, causing greater vacancies
and lower market rental rates. Based on reports from CB Commercial Real Estate
Group, at December 31, 1996, the Manhattan Beach/El Segundo sub-market, had a
total vacancy factor of 31% and an average asking full service rental rate of
$19.32 per square foot. New leases and renewals that the Company executes while
these soft market conditions persist may be at lower rental rates and require
greater tenant improvements than current leases at the property. However,
according to the CB Commercial reports, the severe job losses experienced by the
aerospace and defense industries appear to have bottomed out in February of
1996, and occupancy rates in the El Segundo market are expected to increase in
1997. No assurance can be given, however, that this will occur.
Over the next two years, the Company's leasing exposure at the Data General
Building consists of two leases each covering 48,000 square feet, which expire
in November, 1997 and January 1999. The Company believes that the effective
rental rate that is provided by the lease expiring in 1997 is substantially at
the current market rate. However, the lease expiring in 1999 carries a triple
net rental rate that is equivalent to approximately $28.00 per square foot on a
full service basis. Compared to the current market asking rate of $19.32 per
square foot, this lease provides overmarket rent of approximately $417,000
annually, or 2.9% of the Company's total revenue in 1996. It is impossible to
predict the market rental rate in 1999; however, the Company expects that when
this lease expires, the rental income related to this space will be less than
$28.00 per square foot regardless of whether the lease is renewed or new leases
are signed. The Company will also incur costs for tenant improvements and
leasing commissions related to both spaces upon the renewal or re-leasing of the
spaces, however, the amounts are unknown at this time.
Management believes that the Company's sources of capital as described under
Liquidity and Capital Resources are adequate to meet its liquidity needs in the
foreseeable future.
FUNDS FROM OPERATIONS
The Company considers funds from operations to be a useful measure of the
operating performance of an equity REIT because, together with net income and
cash flows, Funds from Operations provides investors with an additional basis to
evaluate the ability of a REIT to support general operating expense and interest
expense before the impact of certain activities, such as gains and losses from
property sales and changes in the accounts receivable and accounts payable.
However, it does not measure whether income is sufficient to fund all of the
Company's cash needs including principal amortization, capital improvements and
distributions to stockholders. Funds from operations should not be considered an
alternative to net income or any other GAAP measurement of performance, as an
indicator of the Company's operating performance or as an alternative to cash
flows from operating, investing or financing activities as a measure of
liquidity. As defined by the National Association of Real Estate Investment
Trusts, funds from operations is net income (computed in accordance with GAAP),
excluding gains or losses from debt restructuring and sales of property, plus
depreciation and amortization, and after adjustment for unconsolidated joint
ventures. The Company reports funds from operations in accordance with the
revised NAREIT definition. The change in the NAREIT definition in 1995 had no
material effect on the amounts reported by the Company as funds from operations
in prior periods. The measure of funds from operations as reported by the
Company may not be comparable to similarly titled measures of other companies
that follow different definitions.
FUNDS FROM OPERATIONS
(dollars in thousands)
Year ended December 31,
1996 1995 1994
Net income $3,807 $4,462 $4,273
Add: Depreciation and
Amortization 3,428 3,333 3,123
Funds from Operations $7,235 $7,795 $7,396
===============================================================================
The primary difference between the periods reflects the changes in Merger
related expenses and losses on the sale of mortgage-backed securities as
discussed under "Results of Operations".
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGE
Report of Independent Accountants 29
Consolidated Balance Sheets as of December 31, 1996 and 1995 30
Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994 32
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1996, 1995 and 1994 33
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994 35
Notes to Financial Statements 36
Schedule III - Real Estate and Accumulated Depreciation 49
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable, and therefore have been omitted.
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
Franklin Select Realty Trust
We have audited the accompanying consolidated balance sheets of Franklin Select
Realty Trust as of December 31, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1996, and the financial statement
schedule of Real Estate and Accumulated Depreciation. These financial statements
and financial statement schedule are the responsibility of Franklin Select
Realty Trust's management. Our responsibility is to express an opinion on these
financial statements and the financial statement schedule 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 consolidated financial position of Franklin Select
Realty Trust as of December 31, 1996, and 1995, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996 in conformity with generally accepted accounting
principles. In addition, in our opinion, the financial statement schedule
referred to above, when considered in relation to the basic financial statements
taken as a whole, presents fairly, in all material respects, the information
required to be included therein.
COOPERS & LYBRAND L.L.P.
San Francisco, California
February 7, 1997
C O N S O L I D A T E D B A L A N C E S H E E T S
FRANKLIN SELECT REALTY TRUST
Restated
- ------------------------------------------------------------------ ----------------- -------------------
as of December 31, 1996 and 1995
(Amounts in 000's except per share amounts) 1996 1995
- ------------------------------------------------------------------ ----------------- -------------------
ASSETS
Rental property:
Land $38,286 $30,949
Buildings and improvements 103,339 83,121
----------------- -------------------
141,625 114,070
Less: accumulated depreciation 17,583 14,416
----------------- -------------------
124,042 99,654
Cash and cash equivalents 2,558 6,186
Mortgage-backed securities,
available for sale 578 7,135
Deferred rent receivable 1,916 1,970
Deferred costs and other assets 2,204 1,512
================= ===================
Total assets $131,298 $116,457
================= ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes and bonds payable $22,745 $7,145
Tenant deposits, accounts payable
and accrued expenses 1,197 741
Advance rents 26 64
Distributions payable 1,348 1,521
----------------- ------------------
Total liabilities 25,316 9,471
----------------- ------------------
Minority interest 9,329 -
----------------- ------------------
Commitments and contingencies
Stockholders' equity:
Common stock, Series A, without par value;
stated value $10 per share; 110,000
shares authorized; 12,250 and 14,145 shares
issued and outstanding, respectively 103,161 111,569
Common stock, Series B, without par value;
stated value $10 per share; 2,500
shares authorized;
746 shares issued and outstanding 6,294 6,294
Unrealized loss on mortgage-backed
securities (36) (164)
Accumulated distributions in excess
of net income (12,766) (10,713)
----------------- ------------------
Total stockholders' equity 96,653 106,986
----------------- ------------------
Total liabilities and stockholders'
equity $131,298 $116,457
================= ==================
The accompanying notes are an integral part of these consolidated financial
statements.
C ON S O L I D A T E D S T A T E M E N T S O F O P E R A T I O N S
FRANKLIN SELECT REALTY TRUST
Restated Restated
- ------------------------------------------------------------- -------------- ---------------- --------------
for the years ended December 31,
1996, 1995 and 1994
(Amounts in 000's except per share
amounts) 1996 1995 1994
- ------------------------------------------------------------- -------------- ---------------- --------------
REVENUE:
Rent $13,926 $13,383 $12,099
Interest, dividends, and other 642 728 891
-------------- ---------------- --------------
Total revenue 14,568 14,111 12,990
-------------- ---------------- --------------
EXPENSES:
Interest 886 679 466
Depreciation and amortization 3,440 3,335 3,124
Property operating 3,635 3,705 3,246
Related party 1,205 1,030 897
Consolidation expense 695 394 5
General and administrative 642 506 661
Loss on sale of mortgage-backed
securities 151 - 318
Minority interest 107 - -
-------------- ---------------- --------------
Total expenses 10,761 9,649 8,717
-------------- ---------------- --------------
NET INCOME $3,807 $4,462 $4,273
============== ================ ==============
Net income per share, based on the weighted
average shares outstanding of Series
A common stock of 13,830, 14,145 and 14,145
for the years ended December 31,
1996, 1995 and 1994, respectively $ .28 $ .32 $ .30
============== ================ ==============
Distributions per share, based on the weighted
average shares outstanding of
Series A common stock of 13,343, 14,145
and 14,145 for the years ended December
31, 1996, 1995 and 1994, respectively $ .44 $ .44 $ .44
============== ================ ==============
- ------------------------------------------------------------- -------------- ---------------- --------------
The accompanying notes are an integral part of these consolidated financial
statements.
C O N S O L I D A T E D S T A T E M E N T S O F S T O C K H O L D E R S'
E Q U I T Y
FRANKLIN SELECT REALTY TRUST
for the years ended December 31, 1996, 1995, and 1994 (Amounts in 000's)
Unrealized Accumulated
COMMON STOCK (loss)/gain on distributions
Series A Series B mortgate- in excess
Shares Amount Shares Amount securities of net income Total
--------------------------------------------------- ----------------- -------------------- ------------
Balance,
December 31,
1993, Restated 14,146 $111,574 746 $6,294 - $(7,076) $110,792
Redemption of
Series A
common stock (1) (2) - - - - (2)
Unrealized loss
on mortgage-
backed
securities - - - - $(581) - (581)
Net income - - - - - 4,273 4,273
Distributions
declared - - - - - (6,166) (6,166)
Balance,
December 31,
1994, Restated 14,145 111,572 746 6,294 (581) (8,969) 108,316
Redemption of
Series A
common stock - (3) - - - - (3)
Unrealized gain
on mortgage-
backed
securities - - - - 417 - 417
Net income - - - - - 4,462 4,462
Distributions declared - - - - - (6,206) (6,206)
Balance,
December 31,
1995, restated 14,145 111,569 746 6,294 (164) (10,713) 106,986
Dissenting
stockholders'
interest (1,895) (8,408) - - - - (8,408)
Unrealized gain
on mortgage-
backed
securities - - - - 128 - 128
Net income - - - - - 3,807 3,807
Distributions
declared - - - - - (5,860) (5,860)
Balance,
December 31,
1996 12,250 $103,161 746 $6,294 $(36) $(12,766) $96,653
=========================== ============= ============== ========== ======================= ======================== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S
FRANKLIN SELECT REALTY TRUST
Restated Restated
- ---------------------------------------------------------- ------------- -------------- --------------
for the years ended December 31,
1996,1995 and 1994 (Dollars in 000's) 1996 1995 1994
- ---------------------------------------------------------- ------------- -------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $3,807 $4,462 $4,273
------------- -------------- --------------
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 3,440 3,335 3,124
Loss on sale of mortgage-backed
securities 151 - 318
Minority interest 107 - -
Loss on disposition of rental property - 100 -
Decrease in deferred rent receivable 54 44 -
(Increase) decrease in other assets (27) 309 873
Increase in tenant deposits, accounts
payable, and accrued expenses 337 148 125
(Decrease) increase in advance rents (38) (39) 58
------------- -------------- --------------
4,024 3,897 4,498
------------- -------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 7,831 8,359 8,771
------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of rental property (1,428) - (12,910)
Improvements to rental property (627) (390) (1,120)
Leasing commissions paid (339) (371) (467)
Investment in mortgage-back securities - - (3,235)
Disposition of mortgage-back securities 6,534 792 11,828
------------- -------------- --------------
-------------
NET CASH PROVIDED BY (USED IN) INVESTING
ACTIVITIES 4,140 31 (5,904)
------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under notes payable 16,222 - 2,000
Repayment of notes payable (16,781) (134) (86)
Payment of loan costs (599) - (12)
Repurchase of dissenting stockholders'
interest (8,408) - -
Redemption of Series A common stock - (3) (2)
Distributions paid (6,033) (6,267) (5,084)
-------------- --------------
-------------
NET CASH USED IN FINANCING ACTIVITIES (15,599) (6,404) (3,184)
------------- -------------- --------------
NET (DECREASE) INCREASE IN CASH
AND CASH EQUIVALENTS (3,628) 1,986 (317)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 6,186 4,200 4,517
============= ============== ==============
CASH AND CASH EQUIVALENTS,
END OF YEAR $2,558 $6,186 $4,200
============= ============== ==============
Supplemental cash flow information and non-cash investing and financing
activities - Notes 2 and 4.
The accompanying notes are an integral part of these consolidated financial
statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS ACTIVITY
Franklin Select Realty Trust (the "Company") (formerly Franklin Select Real
Estate Income Fund) is a California corporation formed on January 5, 1989 for
the purpose of investing in income-producing real property. The Company is a
real estate investment trust ("REIT") having elected to qualify as a REIT under
the applicable provisions of the Internal Revenue Code since 1989. Under the
Internal Revenue Code and applicable state income tax law, a qualified REIT is
not subject to income tax if at least 95% of its taxable income is currently
distributed to its stockholders and other REIT tests are met. The Company has
distributed at least 95% of its taxable income and intends to distribute
substantially all of its taxable income in the future. Accordingly, no provision
is made for income taxes in these financial statements.
On May 7, 1996 Franklin Real Estate Income Fund ("FREIF") and Franklin Advantage
Real Estate Income Fund ("Advantage") merged into the Company. In connection
with the Merger of the three companies (the "Merger"), the Company issued
approximately 7,945,000 shares of Series A common stock and 559,718 shares of
Series B common stock in exchange for 3,363,877 and 3,013,713 shares of Series A
common stock and 319,308 and 124,240 shares of Series B common stock of FREIF
and Advantage, respectively, in each case excluding dissenting shares.
Stockholders representing approximately 635,638 shares of FREIF Series A common
stock and 1,077,667 shares of Company Series A common stock elected to exercise
dissenter's rights pursuant to Chapter 13 of the California General Corporation
Law. On November 1, 1996, the Company paid the dissenting stockholders
approximately $8.4 million for their shares. The dissenting shares were
repurchased by the Company as more fully described under Note 6 Repurchase of
Dissenting Shares.
At December 31, 1996, the Company's real estate portfolio consisted of fee
interests in the Shores Office Complex, a three-building office complex located
in Redwood City, California; the Data General Building located in Manhattan
Beach, California; the Mira Loma Shopping Center, a shopping center located in
Reno, Nevada; three separate research and development buildings in the Northport
Business Park, located in Fremont, California; the Glen Cove Shopping Center
located in Vallejo, California; the Fairway Center, a two story office building
located in Brea, California; the Carmel Mountain Gateway Plaza, a retail center
located in San Diego, California; and the LAM Research Buildings, two separate
research and development buildings also located in the Northport Business Park,
located in Fremont, California.
BASIS OF PRESENTATION
The accompanying consolidated financial statements of the Company include all
accounts of the Company and its majority owned partnership, FSRT L.P. All
significant intercompany amounts and transactions have been eliminated. Certain
1995 and 1994 amounts have been reclassified to conform to the 1996
presentation. Such reclassifications had no effect on previously reported
results.
The accompanying consolidated financial statements have been presented as a
reorganization of entities under common control due to the common management of
the Company, FREIF and Advantage by the Advisor and are reflected in the
financial statements at their historical bases. Prior periods have been restated
to give effect to the Merger.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
RENTAL PROPERTY
Rental property is stated at cost and depreciated using the straight-line method
over an estimated useful life of 35 years for buildings and improvements. Tenant
improvements are generally amortized over the lesser of the improvements' useful
life or the lease term. Significant improvements and betterments are
capitalized. Maintenance, repairs and minor renewals are charged to expense when
incurred.
Pursuant to the Company's investment objectives, property purchased is generally
held for extended periods. During the holding period, management periodically,
but at least annually, evaluates whether rental property has suffered an
impairment in value. Management's analyses include consideration of estimated
undiscounted future cash flows during the expected holding period in comparison
with carrying values, prevailing market conditions and other economic matters.
If the current carrying value of an individual property exceeds estimated future
undiscounted cash flows, the Company would reduce the carrying value of the
asset to fair value; however, to date, such adjustments have not been required.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, demand deposits with banks, debt
instruments with original maturities of three months or less, and money market
funds, which are readily convertible into cash. Due to their relatively
short-term nature, the carrying value of these instruments approximates fair
value.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities held by the Company are classified as available for
sale and are carried at fair value. The resulting unrealized gains and losses
are reported as a separate component of stockholders' equity until realized.
Realized gains and losses are recognized on the specific identification method
and are included in earnings.
DEFERRED COSTS
Lease commissions are deferred and amortized using the straight-line method over
the term of the related lease. Loan fees and loan costs are deferred and
amortized using the straight-line method, which approximates the effective
interest method, over the term of the related loan.
RENTAL REVENUES
Rental revenues are recorded on the straight-line method to reflect scheduled
rent increases and free rent over the related lease term. As a result, a
deferred rent receivable is created when rental receivables are less than the
amount earned using the straight-line method or when rental income is recognized
during free rent periods of a lease.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of mortgage-backed securities and operating
leases with tenants.
The Company places excess cash in short-term deposits with Franklin Money Fund,
an investment company managed by an affiliate of the Advisor, and in money
market securities of companies with strong credit ratings and, by policy, limits
credit exposure to any one issuer. The Company performs ongoing credit
evaluations of its tenants and generally does not require collateral for
commercial tenants. The Company reserves for potential credit losses, as
appropriate.
NOTE 2 - RENTAL PROPERTY ACQUISITION
In October, 1996, the Company formed FSRT, L.P. ("FSRT"), a limited partnership
in which the Company is the sole general partner. Upon formation, an
unaffiliated party contributed the Lam Research Buildings in exchange for
1,625,000 limited partnership units (the "FSRT Units"), representing an
approximate 30% interest in FSRT. In addition, FSRT assumed approximately $16.6
million of existing non-recourse debt which was subsequently refinanced with new
debt at a reduced interest rate. The limited partner contribution was recorded
based on the fair value of the LAM Research Buildings of approximately $25.5
million. The Company contributed its interest in the Data General Building and
$1.4 million in cash to FSRT to cover transaction and closing costs in
connection with the Lam Research Building. The FSRT Units, which are convertible
into a like number of the Company's Series A common shares after one year, are
entitled to receive quarterly distributions of $.11 per unit, subject to
periodic annual increases commencing in June, 1998, as specified in the
partnership agreement. Residual cash flow after distributions to the FSRT Units
is distributable to the Company. In the future, the Company may contribute its
remaining assets to FSRT at which time the distribution rate on the FSRT Units
may be modified at the Company's discretion in accordance with the partnership
agreement. The Company is subject to certain restrictions regarding the sale or
refinance of the properties owned by FSRT.
NOTE 3 - MORTGAGE-BACKED SECURITIES, AVAILABLE FOR SALE
Mortgage-backed securities, available for sale at December 31, 1996, had a
coupon rate of 7.18% and a maturity date of July 17, 2001. Amortized cost was
$614,000 and the fair value was $578,000 resulting in a gross unrealized loss of
$36,000 at December 31, 1996. Mortgage-backed securities at December 31, 1995
had an aggregate market value of $7,135,000 and an amortized cost of $7,298,000
resulting in a gross unrealized loss of $164,000.
NOTE 4 - NOTES AND BONDS PAYABLE
Notes and bonds payable at December 31, 1996, 1995 and 1994 are comprised of the
following:
Restated
In thousands 1996 1995
----------------- ----------------
FAIRWAY CENTER
Note payable, collateralized by a deed
of trust, payable interest only until
maturity in March, 1996. Interest is
paid monthly at a rate of 9% annually. - $480
Bonds payable, net of prepaid reserve of $300,000,
collateralized by a lien, including serial bonds maturing
through October 1, 2000, at interest rates ranging from
5.75% to 7.60%, and term bonds maturing October 1, 2006, and
October 1, 2013, at interest rates of 8% and 8.125%,
respectively. The payments on the bonds are calculated in an
amount sufficient to fully amortize the indebtedness. $2,335 2,405
GLEN COVE
Note payable, collateralized by a deed of trust. The note
bears interest, payable monthly, at the Union Bank Reference
Rate plus 1.5%, together with monthly principal payments of
$3,700 until maturity in 1999. 1,893 1,937
CARMEL MOUNTAIN
Note payable, collateralized by a deed of trust. The note
bears interest, payable monthly, at the Union Bank Reference
Rate plus 1.5%, together with variable monthly principal
payments until maturity in 1999. 2,295 2,323
LAM RESEARCH BUILDINGS
Notes payable, collateralized by deeds of trust. The two
notes bear interest at a fixed rate of 8.44%. The combined
principal and interest payment of $129,969 is payable
monthly until maturity in 2006. 16,222 -
================= ================
$22,745 $7,145
================= ================
Aggregate principal payments required in future years are as follows:
In thousands
1997 $347
1998 378
1999 4,360
2000 350
2001 383
Thereafter 16,927
===================
$22,745
===================
For the years ended December 31, 1996, 1995 and 1994, interest paid was
$773,000, $687,000 and $444,000, respectively.
Subsequent to December 31, 1996, the bonds payable were refinanced lowering the
interest rate and extending the maturity date of the bonds to October 1, 2026.
Management estimates that the carrying amount of aggregate notes and bonds
payable approximate fair value.
In December 1996, the Company entered into a $25 million secured line of credit
agreement with a bank to provide funding for future acquisitions and working
capital. Borrowings under the line of credit bear interest at the applicable
London Interbank Offered Rate plus 1.9%, or at the bank's reference rate, and
is secured by three of the Company's rental properties. Among other covenants,
the agreement restricts payment of quarterly dividends to an amount not to
exceed 98% of funds from operations, as defined. In addition, the Company pays
an annualized fee of .25% of the unused portion of the line of credit, payable
quarterly. At December 31, 1996, no borrowings were outstanding under the line
of credit.
NOTE 5 - COMMON STOCK AND INCOME PER SHARE
In 1994, the Company issued to the Advisor an exchange right to exchange the
Series B common stock held by the Advisor (Note 8) for Series A common stock. In
connection with the Merger, the Company issued an additional exchange right to
the Advisor with respect to the shares of Series B common stock held by Advisor
in FREIF and Advantage which were exchanged in the Merger for Series B shares of
the Company, The exchange rights are exercisable only when the Series A common
stock achieves certain trading prices for 20 consecutive trading days. The
number of shares of Series B common stock that will exchange for Series A common
stock, and the related trading prices are as follows: 149,088 Series B shares
will be exchanged for 149,088 Series A shares at $8.42, 185,866 Series B shares
will be exchanged for 185,866 Series A shares at $10.35, and 410,630 Series B
shares will be exchanged for 287,441 Series A share at $11.33. The rates of
exchange and trading prices will be subject to change under certain
circumstances as provided in the Exchange Rights Agreement.
No distribution may be paid on the Series B shares prior to exercise of the
exchange rights. After exercise of the exchange rights, the Advisor will receive
distributions on its Series A shares.
Series A and Series B common stock have the same voting rights. Distributions on
Series A common stock are declared at the discretion of the Board of Directors.
For the purpose of calculating net income per share for the year ended December
31, 1996, the weighted average number of shares outstanding of Series A common
stock has been calculated assuming the shares attributable to dissenting
stockholders (equivalent to approximately 1.9 million shares of the Company's
common stock) were converted into the Company's common stock and were
outstanding for the period May 7, 1996 to the repurchase date of November 1,
1996. For the period May 7, 1996, to November 1, 1996, the Company was not
obligated to, and did not, pay dividends related to 635,638 Series A shares of
FREIF that dissented from the Merger.
NOTE 6 - REPURCHASE OF DISSENTING SHARES
On November 1, 1996 the Company purchased all the remaining "dissenting shares"
of Class A common stock arising from the Merger for an aggregate price of $8.4
million. After giving effect to the transaction, the total number of shares of
Series A common stock of the Company outstanding is approximately 12.25 million.
Cash for the purchase price was provided by the sale of a portion of the
Company's mortgage-backed securities. The Company incurred a loss on the sale of
the securities of approximately $151,000.
NOTE 7 - RENTAL INCOME
The Company's rental income from commercial property is received principally
from tenants under non-cancelable operating leases. The tenant leases typically
provide for guaranteed minimum rent plus contingent rents. Minimum future
rentals on non-cancelable tenant operating leases at December 31, 1996 are as
follows:
In thousands
1997 13,723
1998 11,167
1999 9,780
2000 8,540
2001 7,204
Thereafter 52,348
-------------------
102,762
===================
Minimum future rentals do not include contingent rents which represent
reimbursements of property operating expenses. Contingent rents amounted to
$1,725,000, $1,567,000 and $1,452,000 for the years ended December 31, 1996,
1995 and 1994, respectively.
During the years ended December 31, 1996, 1995 and 1994, one of the Company's
tenants, the Continental Casualty Company, provided 13.8%, 14.3% and 15.8% of
the Company's base rental income under a lease which expires in October 1997.
Late in 1996, the Company acquired two industrial buildings that are occupied by
Lam Research Corporation under leases that expire in 2014. In addition, Lam
Research Corporation leases other space from the Company at the Northport
Buildings under a lease that expires in 2003. Subsequent to the acquisition of
the Lam Research Buildings, the percentage of the Company's base rental income
that is received from Lam Research Corporation increased to a total of
approximately 20%, based upon leases in effect at December 31, 1996.
Leases covering 162,000 square feet, and representing approximately 22%, of the
Company's base rental income at December 31, 1996, are scheduled to expire
during 1997. The Company may incur significant costs related to the releasing or
renewing of the leases. In addition, the Company anticipates releasing 75,000
square feet of this space at a rental rate substantially below the existing
lease rate.
NOTE 8 - RELATED PARTY TRANSACTIONS
The Company has an agreement with Franklin Properties, Inc. (the "Advisor") to
administer the day-to-day operations of the Company. Under the terms of the
agreement, which is renewable annually, the Advisor will receive an annualized
fee equal to .5% of the Company's gross real estate assets, defined generally as
the book value of the assets before depreciation, payable quarterly. The fee
will be reduced to .4% for gross real estate assets exceeding $200 million.
Prior to October 1, 1994, the Advisor received an annualized fee equal to 1% of
invested assets and .4% of mortgage investments, paid quarterly. One half of the
fee was subordinate to declaring distributions to Series A common stockholders
totaling at least 7% per annum on their adjusted price per share, as defined.
Prior to the Merger, fees paid to the Advisor by FREIF and Advantage were
calculated in a manner similar to that used by the Company prior to October 1,
1994, except that for FREIF, the entire fee was subordinated to declaring
distributions to the Series A common stockholders totaling 8% of the adjusted
price per share. If the advisory fees for FREIF and Advantage had been
calculated under terms of the Company's current advisory agreement, the
aggregate advisory fees for the Company, FREIF and Advantage would have been
$606,000, $570,000 and $528,000 for the years ended December 31, 1996, 1995 and
1994, respectively. In addition, FREIF and Advantage paid the Advisor
acquisition fees equal to 6% of the asset purchase price which are not payable
under the terms of the Company's current advisory agreement.
Seven of the Company's properties are managed by Continental Property Management
Co. ("CPMC"), an affiliate of the Advisor, and the remaining property is managed
by an unaffiliated company, Cupertino Capital. The Company pays a property
management fee, leasing commission and construction supervision fee to CPMC
based on actual services performed. The fees paid to CPMC do not include any
fees or expenses paid to on-site property managers or leasing commissions paid
to third parties, both of which are borne by the Company.
The agreements between the Company and the Advisor, or affiliates of the
Advisor, provide for certain types of compensation and payments including, but
not limited to, the following for the years ended December 31, 1996, 1995 and
1994:
Restated Restated
In thousands 1996 1995 1994
------- ----------------- ----------------
Advisory fee, charged to
related party expense $551 $350 $264
Reimbursement for data
processing, accounting
and certain other expenses,
charged to related party expense 63 101 109
Property management fee, charged
to related party expense 591 579 524
Property acquisition fee,
capitalized and amortized
over the life of the related
investment - - 730
Leasing commissions, capitalized
and amortized over the term of
the related lease 97 187 99
Construction supervision fee,
capitalized and amortized over the
life of the related investment or
the term of the related lease,
as applicable 33 30 47
The Company's Board of Directors (including all of its Independent Directors)
have determined that the compensation paid to the Advisor and to CPMC is fair
and reasonable to the Company.
At December 31, 1996 and 1995, cash equivalents included $1,764,000 and
$1,014,000, respectively, which was invested in Franklin Money Fund, an
investment company managed by an affiliate of the Advisor. Distributions earned
from Franklin Money Fund totaled $60,000, $23,000 and $21,000 for the years
ended December 31, 1996, 1995 and 1994, respectively.
At December 31, 1996 and 1995, accrued expenses included $177,000 and $103,000,
respectively, payable to the Advisor or affiliates.
NOTE 9 - DISTRIBUTIONS
The allocation of cash distributions per share for individual stockholders'
income tax purposes, as reported on Internal Revenue Service Form 1099-DIV, for
the years ended December 31, 1996, 1995 and 1994 was as follows:
Ordinary Return of Total
Year Paid Income Capital Paid
- ------------------------ ------------------ -------------------- --------------
Franklin Select Realty Trust
1996 $.42 $.02 $.44
1995 $.35 $.09 $.44
1994 $.34 $.07 $.41
Franklin Real Estate Income Fund
1996(to May 7, 1996) $.18 $.03 $.21
1995 $.49 $.01 $.50
1994 $.41 $.09 $.50
Franklin Advantage Real Estate Income Fund
1996 (to May 7, 1996) $.19 $.03 $.22
1995 $.60 $.01 $.61
1994 $.51 $.14 $.65
In December 1994, the Company implemented a Dividend Reinvestment and Share
Purchase Plan (the "Plan"), under which a stockholder's cash distributions may
be reinvested in shares of Series A common stock of the Company, subject to the
terms and conditions of the Plan. Under the Plan, the Company's Dividend
Reinvestment Agent makes open market purchases of the Company's Series A common
stock, administers the Plan and performs other duties related to the Plan. No
new shares have been issued in connection with the Plan.
NOTE 10 - SUPPLEMENTARY QUARTERLY FINANCIAL DATA (UNAUDITED)
In thousands, except per share amounts, as restated to give effect to the
merger.
THREE MONTHS ENDED
-------------------- ------------------ ------------------------- ---------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1996 1996 1996 1996
-------------------- ------------------ ------------------------- ---------------------
Revenue $3,474 $3,613 $3,597 $3,884
Net income $753 $1,078 $1,187 $789
Net income
per share $ .05 $ .08 $ .08 $ .06
THREE MONTHS ENDED
-------------------- ------------------ ------------------------- ---------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1995 1995 1995 1995
-------------------- ------------------ ------------------------- ---------------------
Revenue $3,452 $3,569 $3,597 $3,493
Net income $1,279 $1,318 $893 $972
Net income per
share $ .09 $ .09 $ .06 $ .07
NOTE 11 - PRO FORMA FINANCIAL INFORMATION
The pro forma financial information set forth below is presented as if: (i) the
Merger and the related repurchase of dissenting shares and (ii) the formation of
FSRT and the limited partners' contribution of the LAM Research Buildings had
occurred on January 1, 1995. The pro forma financial information is not
necessarily an indication of what actual results of operations of the Company
would have been assuming the transaction had occurred on January 1, 1995, nor
does it purport to present the results of operations for future periods.
December 31
Dollars in thousands 1996 1995
(Unaudited)
- ------------------------------------
Rent $15,867 $15,731
Net income $3,023 $3,479
Net income per share $ .25 $ .28
Weighted average Series A
common stock outstanding 12,250 12,250
NOTE 12 - LITIGATION
On December 2, 1996, two stockholders, for themselves and purportedly on behalf
of certain other minority stockholders of Advantage, filed a purported class
action complaint in the California Superior Court for San Mateo County against
Advantage, its directors, the Advisor, Franklin Resources, Inc. and the
Massachusetts State Teachers' and Employees' Retirement Systems Trust
("MASTERS"). The complaint alleges that defendants breached fiduciary duties to
plaintiffs and other minority stockholders in connection with the purchase by
Franklin Resources, Inc. in August 1994 of MASTERS' 46.6% interest in Advantage
and in connection with the Merger of Advantage into the Company in May 1996,
which was approved by a majority of the outstanding shares of each of the three
companies. Plaintiffs also allege that defendants misstated certain material
facts or omitted to state material facts in connection with these transactions.
The complaint includes a variety of additional claims, including claims relating
to the investment of Advantage assets, the suspension of the dividend
reinvestment program, the allocation of merger-related expenses, revisions to
the investment policies of Advantage, and the restructuring of the contractual
relationship with the Advisor. Plaintiffs seek damages in an unspecified amount
and certain equitable relief. The defendants deny any wrongdoing in these
matters and intend to vigorously defend the action. Management does not believe
that the outcome of this litigation will have a material adverse affect on the
Company's financial condition or results of operations.
The properties are subject to certain routine litigation and administrative
proceedings arising in the ordinary course of business, which, taken together,
are not expected to have a material adverse impact on the Company's financial
condition or results of operations.
- --------------------------------------------------------------------------------
R E A L E S T A T E A N D A C C U M U L A T E D D E P R E C I A T I O N
- --------------------------------------------------------------------------------
FRANKLIN SELECT REALTY TRUST
as of, and for the years ended December 31, 1996, 1995 and 1994
Dollars in thousands
Cost Capitalized
Initial Subsequent To Gross Amount at Which
Cost to Carried at
Fund Acquisition Close of
Period
Life on
Which
Deprec-
iation
in
Latest
Build- Date Operat-
ings Accumu- of ions
Carry- and lated con- Date State-
Encum- Build- Improve- ing Improve- Depreci- struc- Acqu- ment is
Description brances Land ings ments Costs Land ments Total ation tion ired Computed
----------------------------------------------------------------------------------------------------------------------------------
The Shores
Redwood City, CA - (4) $7,033 $20,499 $2,108 - $7,033 $22,607 $29,640 $5,488 82-87 09/89 35
Data General
Building
Manhattan Beach, CA - 5,372 16,994 2,707 - 5,372 19,701 25,073 4,985 82 12/89 35
Mira Loma 11/88
Shopping Center &
Reno, Nevada - 2,233 7,006 801 - 2,233 7,807 10,040 1,926 85-88 09/92 35
Northport Buildings
Fremont, CA - (4) 2,874 8,708 534 - 2,874 9,242 12,116 2,116 85 01/91 35
Glen Cove
Shopping Center
Vallejo, CA $1,893 2,500 4,200 104 - 2,500 4,304 6,804 361 89 01/94 35
Fairway Center
Brea, CA 2,335 (4) 7,430 14,273 729 - 7,430 15,002 22,432 2,292 87 01/92 35
Carmel Mountain
Gateway Plaza
San Diego, CA 2,295 3,507 5,053 32 - 3,507 5,085 8,592 321 94 11/94 35
Lam Research
Buildings
Fremont, CA 16,222 7,337 19,591 - - 7,337 19,591 26,928 94 96 10/96 35
- ------------------------------------------------------------------------------------------------------------------------------------
$22,745 $38,286 $96,324 $7,015 - $38,286 $103,339 $141,625 $17,583
(1) (2) (3)
================================================================================
R E A L E S T A T E A N D A C C U M U L A T E D D E P R E C I A T I O N
================================================================================
NOTES:
(1) The aggregate cost for federal income tax purposes is $123,528.
(2) RECONCILIATION OF REAL ESTATE
Restated Restated
1996 1995 1994
-------------- ---------------- -------------------
Balance at beginning of period $114,070 $113,833 $97,453
Dispositions - (153) -
Additions during period:
Acquisitions 26,928 - 15,260
Improvements 627 390 1,120
-------------- -------------- -----------------
Balance at end of period $141,625 $114,070 $113,833
============== =============== =================
(3) RECONCILIATION OF ACCUMULATED DEPRECIATION
Restated Restated
1996 1995 1994
------------- ---------------- -------------------
Balance at beginning of period $14,416 $11,383 $8,488
Dispositions - (53) -
Depreciation expense
for the period 3,167 3,086 2,895
------------- ------------- -----------------
Balance at end of period $17,583 $14,416 $11,383
============= ============= =================
(4) These assets are pledged as collateral under the Company's $25 million line
of credit. At December 31, 1996, no borrowings were outstanding under the line
of credit.
Item 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
The information required by Items 10 through 12 of Part III is incorporated
herein by reference from the Company's Proxy Statement which will be mailed to
stockholders in connection with the Registrant's annual meeting of stockholders
scheduled to be held on June 5, 1997.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company is managed by the Advisor under the terms of an Advisory Agreement,
which is renewable annually and is subject to the overall approval of the Board
of Directors, a majority of whom are independent of the Advisor. The Company
pays the Advisor, as an asset management fee, an annualized fee of .5% of the
book value of its real estate assets before depreciation. This fee is reduced to
.4% of the book value before depreciation of real estate assets exceeding $200
million. The fee is calculated and paid at the end of each fiscal quarter of the
Company, based on the real estate assets at the end of such quarter. The Company
changed its advisory fee structure after its conversion to an infinite life REIT
in 1994. The properties formerly owned by FREIF and Advantage became subject to
the Company's advisory fee structure upon the Merger of FREIF and Advantage into
and with the Company in May 1996. The Advisory fee paid to the Advisor during
the year ended December 31, 1996, is stated in the table below.
The Company pays all expenses of its operations except for the following, which
are borne by the Advisor (i) employment expenses of the Company's Chairman,
President, Senior Vice President, Chief Financial Officer, Secretary and of the
Company's directors who are also officers of the Advisor, (ii) office expenses
of the Advisor, and (iii) overhead expenses of the Advisor not properly
attributable to the performance of its duties and obligations under the Advisory
Agreement.
Seven of the Company's properties are managed by Continental Property Management
Co. ("CPMC"), an affiliate of the Advisor, and the remaining property is managed
by an unaffiliated company, Cupertino Capital. The Company pays a property
management fee, leasing commission and construction supervision fee to CPMC
based on actual services performed. The fees paid to CPMC do not include any
fees or expenses paid to on-site property managers or leasing commissions paid
to third parties, both of which are borne by the Company. The fees paid to CPMC
for the year ended December 31, 1996, are listed in the table below.
During the year ended December 31, 1996, the Company paid or accrued the
following amounts for the reimbursements and services noted above:
Advisory fee, charged to related party expense $551,000
Reimbursement for data processing, accounting
and certain other expenses charged to related
party expense 63,000
Property management fee, charged to related
party expense 591,000
Leasing commission, capitalized and amortized
over the term of the related lease 97,000
Construction supervision fee, capitalized
and amortized over the life of the related
investment or the term of the related lease 33,000
The Company's Board of Directors (including all of its Independent Directors)
have determined that the compensation paid to the Advisor and to CPMC is fair
and reasonable to the Company.
David P. Goss, Mark A. TenBoer and Richard S. Barone, who are officers of the
Company, are also officers of the Advisor.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. The financial statements of the Company included in Item 8 of
this report are listed on the index on page 28.
2. The supplemental financial statement schedule of the Company
included in Item 8 of this report is listed on the index on page
28.
3. Exhibits:
Exhibit
NO. LIST OF EXHIBITS FOOTNOTE
3.1 Articles of Incorporation (1)
3.2 First Amendment to Articles of Incorporation (2)
3.2a Second Amended and Restated Bylaws of
Franklin Select Realty Trust (2)
10.1* Amended and Restated Advisory Agreement
10.2 Property Management Agreement (3)
10.3 Agreement of Limited Partnership of
FSRT, L.P. between the Company and (4)
Northport Associates No. 18, a California
limited liability company, dated as of October 30, 1996.
10.4 Contribution Agreement, dated as of October 30, 1996,
between FSRT, L.P., (4)
the Company, Northport Associates No. 18,
a California limited liability company,
and the members of Northport Associates No. 18.
10.5 Exchange Rights Agreement, dated as of
October 30, 1996, among the Company, (4)
FSRT, L.P., and Northport Associates No. 18,
a California limited liability company.
10.6 Registration Rights Agreement, dated as of
October 30, 1996, among the (4)
Company and Northport Associates No. 18,
a California limited liability company.
10.7* Secured line of credit loan agreement, dated December 10, 1996,
by and between the Company and Bank of America.
21.1* Subsidiaries of the Company.
* Filed herewith.
FOOTNOTES
(1) Documents were filed in the Company's Form S-11 Registration Statement,
dated March 30, 1989 (Registration No. 033-26562) and are incorporated
herein by reference.
(2) Documents were filed in the Company's Form S-4 Registration Statement,
dated November 13, 1995, (Registration No. 033-64131), and are incorporated
herein by reference.
(3) Documents were filed in the Company's Form 10-K for the year ended December
31, 1994, and are incorporated herein by reference.
(4) Documents were filed in the Company's Form 8-K, dated October 31, 1996, and
are incorporated herein by reference.
(b) Reports filed on Form 8-K.
During the quarter ended December 31, 1996, the Company filed a
report dated October 31, 1996, (date of earliest event reported)
on Form 8-K, with respect to the acquisition of the Lam Research
Buildings and the repurchase of dissenting shares.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
FRANKLIN SELECT REALTY TRUST
(Company)
Date: 03/27/97 By: /S/ DAVID P. GOSS
David P. Goss
Chief Executive Officer
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 Company, and in
the capacities and on the dates indicated.
SIGNATURE TITLE DATE
Chief Executive Officer, and
Director
s/David P. Goss 3/27/97
- ----------------------------- -------------------
David P. Goss
s/Barry C. L. Fernald Director1 3/27/97
- ----------------------------- -------------------
Barry C. L. Fernald
s/Lloyd D. Hanford, Jr. Director1 3/27/97
- ----------------------------- -------------------
Lloyd D. Hanford, Jr.
s/Egon H. Kraus Director1 3/27/97
- ----------------------------- -------------------
Egon H. Kraus
s/Frank W. T. LaHaye Director1 3/27/97
- ----------------------------- -------------------
Frank W. T. LaHaye
s/Larry D. Russel Director1 3/27/97
- ----------------------------- -------------------
Larry D. Russel
s/E. Samuel Wheeler Director1 3/27/97
- ----------------------------- -------------------
E. Samuel Wheeler
1 Independent Director
Exhibit 21.1
Subsidiaries of Franklin Select Realty Trust
State of Name under which
SUBSIDIARY NAME ORGANIZATION SUBSIDIARYIS DOING BUSINESS
FSRT, L.P. Delaware FSRT, L.P.