1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A Amendment No. 1 For the year ended December 31, 1998 of CAREY DIVERSIFIED LLC CD LLC A Delaware Limited Liability Company IRS Employer Identification No. 13-3912578 SEC File Number 001-13779 50 Rockefeller Plaza, New York, New York 10020 (212) 492-1100 CD LLC has LISTED SHARES registered pursuant to Section 12(g) of the Act. CD LLC is registered on the New York Stock Exchange. CD LLC does not have any Securities registered pursuant to Section 12(b) of the Act. CD LLC is unaware of any delinquent filers pursuant to Item 405 of Regulation S-K. CD LLC (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Non-affiliates held 24,511,522 Listed Shares at March 24, 1999. There are 25,551,794 Listed Shares outstanding at March 24, 1999. 2 PART I Item 1. Business. Carey Diversified LLC (or the "Company" or "CDC") is a real estate investment company that acquires and owns commercial properties leased to companies nationwide, primarily on a triple net basis. As of December 31, 1998, Carey Diversified's portfolio consisted of 202 properties in the United States and three properties in Europe and totaling more than 20 million square feet. Carey Diversified's core investment strategy is to purchase and own properties leased to a variety of companies on a single tenant net lease basis. These leases generally place the economic burden of ownership on the tenant by requiring them to pay the costs of maintenance, insurance, taxes, structural repairs and other operating expenses. Carey Diversified also generally seeks to include in its leases: o clauses providing for mandated rent increases or periodic rent increases tied to increases in the consumer price index or other indices or, when appropriate, increases tied to the volume of sales at the property; o covenants restricting the activity of the tenant to reduce the risk of a change in credit quality; o indemnification of Carey Diversified for environmental and other liabilities; and o guarantees from parent companies or other entities. Carey Diversified was formed as a limited liability company under the laws of Delaware on July 15, 1996. On January 1, 1998, Carey Diversified was consolidated with nine Corporate Property Associates limited partnerships and became the General Partner and owner of over 90% of the limited partnership interests in each partnership. Carey Diversified's shares began trading on the New York Stock Exchange on January 21, 1998 under the symbol "CDC". On July 15, 1998, each CPA(R) Partnership redeemed the interests of the holdover CPA(R) limited partners and became the owner of virtually all of the limited partnership interests in the CPA(R) Partnerships. The former general partners of each partnership have a right to receive a portion of the distributions made by each partnership. As a limited liability company, Carey Diversified is not subject to federal income taxation as long as it satisfies certain requirements relating to its operations. Carey Management LLC (the "Manager") provides both strategic and day-to-day management for Carey Diversified, including acquisition services, research, investment analysis, asset management, capital funding services, disposition of assets, investor relations and administrative services. Carey Management also provides office space and other facilities for Carey Diversified. The Manager has dedicated senior executives in each area of its organization so that Carey Diversified functions as a fully integrated operating company. Carey Diversified's principal executive offices are located at 50 Rockefeller Plaza, New York, NY 10020 and its telephone number is (212) 492-1100. Carey Diversified's website address is http://www.careydiv.com. As of March 15, 1999, Carey Diversified employed one person. An affiliate of Carey Management employs 82 individuals who perform services for Carey Diversified. Business Objectives and Strategy Carey Diversified's objective is to increase shareholder value and its funds from operations through prudent management of its real estate assets and opportunistic investments. Carey Diversified expects to evaluate a number of different opportunities in a variety of property types and geographic locations and to pursue the most attractive based upon its analysis of the risk/return tradeoffs. Carey Diversified will continue to own properties as long as it believes ownership helps attain its objectives. -1- 3 Carey Diversified presently intends to: o seek additional investment and other opportunities that leverage core management skills (which include in-depth credit analysis, asset valuation and sophisticated structuring techniques); o optimize the current portfolio of properties through expansion of existing properties, timely dispositions and favorable lease modifications; o utilize its size and access to capital to refinance existing debt; and o increase its access to capital. Recent Developments During 1998, Carey Diversified purchased properties and entered into net leases with America West Holdings Corporation ("America West"), Federal Express Corporation ("Federal Express") and Eagle Hardware and Garden, Inc. ("Eagle"); purchased a portfolio of seven properties in Houston, Texas and assumed 15 leases, purchased a multi-tenant property in Pantin, France; purchased a property in Mont Saint Aignan, France leased to Tellit Assurance ("Tellit") and purchased and completed a build-to-suit project in Rio Rancho, New Mexico leased to Sprint Spectrum L.P. ("Sprint"). A summary of the transactions is as follows: On February 18, 1998, Carey Diversified and an unaffiliated limited liability company, AWHQ LLC, acquired land in Tempe, Arizona as tenants-in-common with 80% and 20% interests, respectively. An office building with an attached parking garage is being constructed on the land pursuant to construction agency and net lease agreements with America West. Total costs are estimated to be $37,000,000. America West has the obligation for any costs in excess of such amount necessary to complete the project. The lease provides for an initial term of 15 years, commencing May 1, 1999, with two five-year renewal terms. Annual rent will initially be equal to total project costs multiplied by 9.2%. Rent increases are scheduled for May 2003 and every five-years thereafter, on a formula indexed to increases in the Consumer Price Index ("CPI"), with each increase capped at 11.77%. On March 17, 1998, the Company acquired approximately 46 acres of land in Collierville, Tennessee upon which four office buildings are being constructed. At the end of the construction period, the buildings will be occupied by Federal Express. In connection with the acquisition of the land, Carey Diversified entered into a lease agreement with FEEC II, L.P. ("FEEC") which in turn is the sublessor to Federal Express. The lease between the Company and FEEC provides for a development period ending on the earlier of the completion of the project or November 30, 1999 followed by a twenty-year initial term. The FEEC lease grants the Company an exclusive option to acquire FEEC's leasehold estate in the Federal Express net lease, with such option exercisable at any time after the end of the development period. The option price will be based on a formula indexed to Federal Express' annual rent under its lease with FEEC less all amounts previously advanced by the Company to FEEC for project costs. The Company expects that the total cost, including exercise of the option, will not exceed $77,000,000. The Company intends to exercise its option to assume the Federal Express lease. Federal Express' initial annual rent will be based on the actual costs necessary to complete the build-to-suit project up to a maximum of $6,628,000. Rent increases are scheduled annually and are indexed to increases in the CPI with annual increases limited to 1.7%. The Federal Express lease provides for an initial term of 20 years with two ten-year renewal terms at the option of the tenant. On April 23, 1998, the Company acquired a retail property in Bellevue, Washington leased to Eagle, in exchange for 721,695 shares of Carey Diversified. Based on the value of the shares issued, the cost of acquiring the property was $15,065,000. The lease with Eagle has a remaining term of 19 years and currently provides for annual rent of $1,058,000 with annual increases based on a formula indexed to increases in the CPI. In addition, for each lease year, Eagle is required to pay 1.50% of gross sales in excess of a stated amount. Such percentage rents currently approximate $300,000 annually. If gross sales at the Eagle property reach levels of $50,000,000 in any twelve month period, the Company will be obligated to issue the sellers of -2- 4 the property an additional 17,504 shares of Carey Diversified and up to 50,001 shares if gross sales reach $57,500,000. On May 27, 1998, the Company, through its 75% majority interest in a newly-formed subsidiary, acquired an office building in Pantin, France, located in the Paris metropolitan area. The purchase price for the property was $10,269,000 and was financed by a limited recourse mortgage loan of $8,343,000. The building is leased to four tenants. Annual rent from these leases approximates $1,007,000. The leases have initial terms of six years and expire between March 2004 and August 2004 with each tenant having a six-year renewal option. The $8,343,000 mortgage loan collateralized by the Pantin property has a 15-year term with 75% of the balance amortizing over that period with a balloon payment of approximately $2,086,000 scheduled on the maturity date. The loan bears annual interest of 5.50% during the first five years with the rate to be reset based on the then prevailing interest rates. On June 10, 1998, the Company, through its 75% majority interest in a newly-formed subsidiary, purchased land for $265,000 in Mont Saint Aignan, France upon which an office facility was constructed pursuant to a lease with Tellit. Construction was completed in August 1998 at a total cost of $5,458,000. The Tellit lease has a term of 12 years and provides initially for annual rent of approximately $554,000 with annual rent increases based on increases in the INSEE index. Tellit has an option to terminate the lease at the end of the ninth lease year. The lease obligations of Tellit are unconditionally guaranteed by its parent company, Sun Alliance Assurances S.A., a subsidiary of Royal Sun Alliance Insurance Group plc. In connection with the Tellit property purchase, the subsidiary obtained a limited recourse mortgage of $4,401,000. The loan, has a 15-year term and provides for an annual interest rate at a floating rate of .85% above the Paris InterBank Offered Rate to a maximum annual interest rate of 7% during the first five years. 75% of the loan balance will amortize over the term of the loan with a balloon payment of approximately $1,100,000 due on the maturity date. On June 15, 1998, the Company acquired a portfolio of seven properties in the Houston, Texas metropolitan area from J. A. Billipp Development Corporation and certain of its affiliates ("Billipp") for $9,845,000 in cash, assumption of $13,593,000 of mortgage debt and 62,474 shares of Carey Diversified with a value of $1,312,000 on that date. In connection with the purchase, Billipp assigned and the Company assumed, as lessor, 15 leases. Annual rents from the assumed leases aggregate approximately $2,345,000. Among the lessees are Sears Roebuck & Co., Chrysler Corporation, Lockheed Martin Corporation, Continental Airlines, Inc. and Honeywell, Inc. The initial lease terms are scheduled to expire between January 1999 and June 2006. Subsequent to the purchase of the properties, the Company paid off $3,097,000 of the mortgage debt assumed. The remaining mortgage debt of $10,496,000 is comprised of three loans. The loans are scheduled to mature between January 2002 and October 2006 at which time balloon payments ranging from $1,442,000 to $4,918,000 will be due. The loans bear annual interest ranging from 7.75% to 9.125% and provide for combined monthly principal and interest payments of $98,000. On July 1, 1998, the Company purchased land in Rio Rancho, New Mexico for $1,120,000 upon which a building was constructed pursuant to a construction management agreement with Teleservices Development International LLC ("Teleservices"). In connection with the purchase, Teleservices assigned its lessor's interest in its lease with Sprint Spectrum L.P. ("Sprint") to Carey Diversified. The construction was completed in October 1998 at a total cost of $7,891,000 at which time a ten-year lease with Sprint commenced. The lease provides for two five-year renewal terms with Sprint having an option to terminate the lease on the seventh anniversary of the lease commencement in consideration for an amount equal to all base rent payable for the remainder of the initial term. Annual rent during the initial term is $1,154,000. On April 1, 1998 Simplicity Manufacturing, Inc. purchased its leased property in Port Washington, Wisconsin for $9,684,000 pursuant to a purchase option exercised in 1997. Annual cash flow (rent less mortgage debt service on the property) from Simplicity was $934,000. Since September 30, 1998, Carey Diversified has purchased an office building in Rouen, France leased to Direction Regional des Affaires Sanitaires et Sociales and sold a property in Pittsburgh Pennsylvania leased to NVR, Inc. On November 16, 1998, Carey Diversified purchased the Rouen property for $2,336,000, of which $1,788,000 was financed by a limited recourse mortgage loan. The lease has a nine-year term and provides for annual rent of $243,000. The NVR property was sold in December 1998 for $12,193,000 pursuant to NVR's exercise of a purchase option. These transactions are described in Note 17 and Note 11, -3- 5 respectively, in Item 8. Additionally the Company has obtained $11,000,000 of mortgage financing on the Eagle property. During 1998, Carey Diversified obtained a $185,000,000 credit facility from which it has used $129,000,000, including $101,553,000 used to prepay mortgage loans and meet scheduled balloon payments. Acquisition Strategies The Manager has a well-developed process with established procedures and systems for acquiring net leased property. As a result of its reputation and experience in the industry and the contacts maintained by its professionals, the Manager has a presence in the net lease market that has provided it with the opportunity to invest in a significant number of transactions on an ongoing basis. Carey Diversified takes advantage of the Manager's presence in the net lease market to acquire additional properties in transactions with both new and current tenants. In evaluating opportunities for Carey Diversified, the Manager carefully examines the credit, management and other attributes of the tenant and the importance of the property under consideration to the tenant's operations. Careful credit analysis is a crucial aspect of every transaction. Carey Diversified believes that the Manager has one of the most extensive underwriting processes in the industry and has an experienced staff of professionals involved with underwriting transactions. The Manager seeks to identify those prospective tenants whose creditworthiness is likely to improve over time. Carey Diversified believes that the experience of the Manager's management in structuring sale-leaseback transactions to meet the needs of a prospective tenant enables the Manager to obtain a higher return for a given level of risk than would typically be available by purchasing a property subject to an existing lease. The Manager's strategy in structuring its net lease investments for Carey Diversified is to: (i) combine the stability and security of long-term lease payments, including rent increases, with the appreciation potential inherent in the ownership of real estate; (ii) enhance current returns by utilizing varied lease structures; (iii) reduce credit risk by diversifying investments by tenant, type of facility, geographic location and tenant industry; and (iv) increase potential returns by obtaining equity enhancements from the tenant when possible, such as warrants to purchase tenant common stock. Financing Strategies Consistent with its investment policies, Carey Diversified uses leverage when available on favorable terms. Carey Diversified has in place a $185,000,000 credit facility, which it has used and intends to continue to use in connection with acquiring additional properties, funding build-to-suit projects and refinancing existing debt. As of December 31, 1998, Carey Diversified also had approximately $139,000,000 in property level debt outstanding. The Manager continually seeks opportunities and considers alternative financing techniques to refinance debt, reduce interest expense or improve its capital structure. Transaction Origination In analyzing potential acquisitions, the Manager reviews and structures many aspects of a transaction, including the tenant, the real estate and the lease, to determine whether a potential acquisition can be structured to satisfy Carey Diversified's acquisition criteria. The aspects of a transaction which are reviewed and structured by the Manager include the following: Tenant Evaluation. The Manager subjects each potential tenant to an extensive evaluation of its credit, management, position within its industry, operating history and profitability. The Manager seeks tenants it believes will have stable or improving credit. By leasing properties to these types of tenants, Carey Diversified can generally charge rent that is higher than the rent charged to tenants with recognized credit and, thereby, enhance its current return from these properties as compared with properties leased to companies -4- 6 whose credit potential has already been recognized by the market. Furthermore, if a tenant's credit does improve, the value of Carey Diversified's properties leased to that tenant will likely increase (if all other factors affecting value remain unchanged). The Manager may also seek to enhance the likelihood of a tenant's lease obligations being satisfied, such as through a letter of credit or a guaranty of lease obligations from the tenant's corporate parent. This credit enhancement provides Carey Diversified with additional financial security. Leases with Increasing Rents. The Manager seeks to include clauses in Carey Diversified's leases that provide for increases in rent over the term of the leases. These increases are generally tied to increases in certain indices such as the consumer price index, in the case of retail stores, participation in gross sales above a stated level, mandated rental increases on specific dates and through other methods. Carey Diversified seeks to avoid entering into leases that provide for contractual reductions in rents during their primary term (other than reductions related to reductions in debt service). Properties Important to Tenant Operations. The Manager, on behalf of Carey Diversified, generally seeks to acquire properties with operations that are essential or important to the ongoing operations of the tenant. Carey Diversified believes that these properties provide better protection in the event that tenants file for bankruptcy, because leases on properties essential or important to the operations of a bankrupt tenant are less likely to be rejected and terminated by a bankrupt tenant. The Manager also seeks to assess the income, cash flow and profitability of the business conducted at the property, so that, if the tenant is unable to operate its business, Carey Diversified can either continue operating the business conducted at the property or re-lease the property to another entity in the industry which can operate the property profitably. Lease Provisions that Enhance and Protect Value. When appropriate, the Manager attempts to include provisions in Carey Diversified's leases that require Carey Diversified's consent to certain tenant activities or require the tenant to satisfy certain operating tests. These provisions include, for example, operational and financial covenants of the tenant, prohibitions on a change in control of the tenant and indemnification from the tenant against environmental and other contingent liabilities. Including these provisions in its leases enables Carey Diversified to protect its investment from changes in the operating and financial characteristics of a tenant that may impact its ability to satisfy its obligations to Carey Diversified or could reduce the value of Carey Diversified's Properties. Diversification. The Manager tries to diversify Carey Diversified's portfolio of properties to avoid dependence on any one particular tenant, type of facility, geographic location and tenant industry. By diversifying its portfolio, Carey Diversified reduces the adverse effect on Carey Diversified of a single underperforming investment or a downturn in any particular industry or geographic location. The Manager employs a variety of other strategies and practices in connection with Carey Diversified's acquisitions. These strategies include attempting to obtain equity enhancements in connection with transactions. Typically, these equity enhancements involve warrants to purchase stock of the tenant to which the property is leased or the stock of the parent of the tenant. In certain instances, Carey Diversified grants to the tenant a right to purchase the property leased by the tenant, but generally the option purchase price will be not less than the fair market value of the property. The Manager's practices include performing evaluations of the physical condition of properties and performing environmental surveys in an attempt to determine potential environmental liabilities associated with a property prior to its acquisition. As a transaction is structured, it is evaluated by the Chairman of the Investment Committee with respect to the potential tenant's credit, business prospects, position within its industry and other characteristics important to the long-term value of the property and the capability of the tenant to meet its lease obligations. Before a property is acquired, the transaction is reviewed by the Investment Committee to ensure -5- 7 that it satisfies Carey Diversified's investment criteria. Aspects of the transaction that are typically reviewed by the Investment Committee include the expected financial returns, the creditworthiness of the tenant, the real estate characteristics and the lease terms. The Investment Committee is not directly involved in originating or negotiating potential acquisitions, but instead functions as a separate and final step in the acquisition process. The Manager places special emphasis on having experienced individuals serve on its Investment Committee and does not invest in a transaction unless it is approved by the Investment Committee. Carey Diversified believes that the Investment Committee review process gives it a unique, competitive advantage over other unaffiliated net lease companies because of the substantial experience and perspective that the Investment Committee has in evaluating the blend of corporate credit, real estate and lease terms that combine to make an acceptable risk. The following people serve on the Investment Committee: George E. Stoddard, Chairman, was formerly responsible for the direct corporate investments of The Equitable Life Assurance Society of the United States and has been involved with the CPA(R) Programs for over 19 years. Frank J. Hoenemeyer, Vice Chairman, was formerly Vice Chairman, Director and Chief Investment Officer of The Prudential Insurance Company of America. As Chief Investment Officer, Mr. Hoenemeyer was responsible for all of Prudential's investments, including stocks, bonds, private placements, real estate and mortgages. Nathaniel S. Coolidge previously served as Senior Vice President - Head of Bond & Corporate Finance Department of the John Hancock Mutual Life Insurance Company. His responsibilities included overseeing $21 billion of fixed income investments for Hancock, its affiliates and outside clients. Lawrence R. Klein is Benjamin Franklin Professor of Economics Emeritus at the University of Pennsylvania and its Wharton School. Dr. Klein has been awarded the Alfred Nobel Memorial Prize in Economic Sciences and currently advises various governments and government agencies. Dr. Klein serves as an alternate member of the Investment Committee Asset Management Carey Diversified believes that effective management of net lease assets is essential to maintain and enhance property values. Important aspects of asset management include restructuring transactions to meet the evolving needs of current tenants, re-leasing properties, refinancing debt, selling properties and knowledge of the bankruptcy process. The Manager monitors, on an ongoing basis, compliance by tenants with their lease obligations and other factors that could affect the financial performance of any of its Properties. Monitoring involves receiving assurances that each tenant has paid real estate taxes, assessments and other expenses relating to the Properties it occupies and confirming that appropriate insurance coverage is being maintained by the tenant. The Manager reviews financial statements of its tenants and undertakes regular physical inspections of the condition and maintenance of its Properties. Additionally, the Manager periodically analyzes each tenant's financial condition, the industry in which each tenant operates and each tenant's relative strength in its industry. Competition Carey Diversified faces competition for the acquisition of office and industrial properties in general, and such properties net leased to major corporations in particular, from insurance companies, credit companies, pension funds, private individuals, investment companies and REITs. Carey Diversified also faces competition from institutions that provide or arrange for other types of commercial financing through private or -6- 8 public offerings of equity or debt or traditional bank financings. Carey Diversified believes its management's experience in real estate, credit underwriting and transaction structuring will allow Carey Diversified to compete effectively for office and industrial properties. Environmental Matters Under various federal, state and local environmental laws, regulations and ordinances, current or former owners of real estate, as well as certain other categories of parties, may be required to investigate and clean up hazardous or toxic chemicals, substances or waste or petroleum product or waste (collectively, "Hazardous Materials") releases on, under, in or from such property, and may be held liable to governmental entities or to third parties for certain damage and for investigation and cleanup costs incurred by such parties in connection with the release or threatened release of Hazardous Materials. Such laws typically impose responsibility and liability without regard to whether the owner knew of or was responsible for the presence of Hazardous Materials, and the liability under such laws has been interpreted to be joint and several under certain circumstances. Carey Diversified's leases often provide that the tenant is responsible for all environmental liability and for compliance with environmental regulations relating to the tenant's operations. Carey Diversified typically undertakes an investigation of potential environmental risks when evaluating an acquisition. Phase I assessments are performed by independent environmental consulting and engineering firms for all acquisitions. Where warranted, Phase II assessments are performed. Phase I assessments do not involve subsurface testing, whereas Phase II assessments involve some degree of soil and/or groundwater testing. Carey Diversified may acquire a property which is known to have had a release of Hazardous Materials in the past, subject to a determination of the level of risk and potential cost of remediation. Carey Diversified normally requires property sellers to fully indemnify it against any environmental problem existing as of the date of purchase. Additionally, Carey Diversified often structures its leases to require the tenant to assume most or all responsibility for environmental compliance or environmental remediation relating to the tenants operations and to provide that non-compliance with environmental laws is deemed a lease default. In certain instances, Carey Diversified may also require a cash reserve, a letter of credit or a guarantee from the tenant, the tenant's parent company or a third party to assure lease compliance and funding of remediation. The value of any of these protections depends on the amount of the collateral and/or financial strength of Carey Diversified providing the protection. Such a contractual arrangement does not eliminate Carey Diversified's statutory liability or preclude claims against Carey Diversified by governmental authorities or persons who are not a party to such an arrangement. Contractual arrangements in Carey Diversified's leases may provide a basis for Carey Diversified to recover from the tenant damages or costs for which Carey Diversified has been found liable. Some of the properties are located in urban and industrial areas where fill or current or historic industrial uses of the areas may have caused site contamination at the properties. In addition, Carey Diversified is aware of environmental conditions at certain of the properties that require some degree of remediation. All such environmental conditions are primarily the responsibility of the respective tenants under their leases. Carey Diversified and its consultants estimate that the majority of the aggregate cost of addressing environmental conditions known to require remediation at the properties is covered by existing letters of credit and corporate guarantees. Carey Diversified believes that its tenants are taking or will soon be taking all required remedial action with respect to any material environmental conditions at the properties. However, Carey Diversified could be responsible for some or all of these costs if one or more of the tenants fails to perform its obligations or to indemnify Carey Diversified. Furthermore, no assurance can be given that the environmental assessments that have been conducted at the properties disclosed all environmental liabilities, that any prior owner did not create a material environmental condition not known to the Company, or that a material condition does not otherwise exist as to any of the properties. Operating Segments Carey Diversified operates in two operating segments, real estate operations, with investments in the United States and Europe, and hotel operations. For the year ended December 31, 1998, no lessee represented 10% or more of the total operating revenue of Carey Diversified. Factors Affecting Future Operating Results -7- 9 The provisions of the Private Securities Litigation Reform Act of 1995 (the "Act") became effective in December 1995. The Act provides a "safe harbor" for companies which make forward-looking statements providing prospective information. The "safe harbor" under the Act relates to protection for companies with respect to litigation filed on the basis of such forward-looking statements. Carey Diversified wishes to take advantage of the "safe harbor" provisions of the Act and is therefore including this section in its Annual Report on Form 10-K. The statements contained in this Annual Report, if not historical, are forward-looking statements and involve risks and uncertainties which are described below that could cause actual results to differ materially from the results, financial or otherwise, or other expectations described in such forward-looking statements. These statements are identified with the words "anticipated," "expected," "intends," "seeks" or "plans" or words of similar meaning. Therefore, forward-looking statements should not be relied upon as a prediction of actual future results or occurrences. Carey Diversified's future results may be affected by certain risks and uncertainties including the following: Single Tenant Leases Increases Exposure to Failure of Tenant We focus our acquisition activities on net leased real properties or interests therein. Due to the fact that our net leased real properties are leased to single tenants, the financial failure of or other default by a tenant resulting in the termination of a lease is likely to cause a reduction in the operating cash flow of Carey Diversified and might decrease the value of the property leased to such tenant. Dependence on Major Tenants Revenues from several of our tenants and/or their guarantors constitute a significant percentage of our consolidated rental revenues. Our five largest tenants/guarantors, which occupy 11 properties, represent 23% of annualized revenues. The default, financial distress or bankruptcy of any of the tenants of such Properties could cause interruptions in the receipt of lease revenues from such tenants and/or result in vacancies in the respective Properties, which would reduce our revenues until the affected property is re-let, and could decrease the ultimate sale value of each such property. Upon the expiration of the leases that are currently in place with respect to these Properties, we may not be able to re-lease the vacant property at a comparable lease rate or without incurring additional expenditures in connection with such re-leasing. There Are No Limits on the Amounts We Can Borrow We have incurred, and may continue to incur, indebtedness (secured and unsecured) in furtherance of our activities. Neither the Operating Agreement nor any policy statement formally adopted by the Board of Directors limits either the total amount of indebtedness or the specified percentage of indebtedness (based upon the total market capitalization of Carey Diversified) which may be incurred. Accordingly, we could become more highly leveraged, resulting in increased risk of default on our obligations and in an increase in debt service requirements which could adversely affect our financial condition and results of operations and our ability to pay distributions. Our current unsecured revolving credit facility with Chase Manhattan Bank, as agent, contains various covenants which limit the amount of secured and unsecured indebtedness we may incur. Possible Inability to Refinance Balloon Payment on Mortgage Debt A significant number of our properties are subject to mortgages with balloon payments. Scheduled balloon payments for the next five years are as follows: 1999 - $ 8 million; 2001 - $13 million; 2003 - $ 3 million; Our credit facility matures in 2001. As of December 31, 1998, the Company had $129,000,000 drawn from the line of credit. An additional $29,000,000 was drawn from the line of credit through March 22, 1999. Our ability to make such balloon payments will depend upon our ability either to refinance the mortgage related thereto, -8- 10 invest additional equity in the property or to sell the related property. Our ability to accomplish these goals will be affected by various factors existing at the relevant time, such as the state of the national and regional economies, local real estate conditions, available mortgage rates, our equity in the mortgaged properties, our financial condition, the operating history of the mortgaged properties and tax laws. There are Uncertainties Relating to Lease Renewals and Re-letting of Space We will be subject to the risks that, upon expiration of leases, the premises may not be re-let or the terms of re-letting (including the cost of concessions to tenants) may be less favorable than current lease terms. If we are unable to re-let promptly all or a substantial portion of our properties or if the rental rates upon such re-letting were significantly lower than current rates, our net income and ability to make expected distributions to our shareholders would be adversely affected. There can be no assurance that we will be able to retain tenants in any of our properties upon the expiration of their leases. Our scheduled lease expirations, as a percentage of annualized revenues for the next five years, are as follows: 1999 - 3% 2000 - 2% 2001 - 3% 2002 - 1% 2003 - 4% Possible Liability Relating to Environmental Matters We own industrial and commercial properties and are subject to the risk of liabilities under federal, state and local environmental laws. Some of these laws could impose the following on Carey Diversified: o Responsibility and liability for the cost of investigation and removal or remediation of hazardous substances released on our property, generally without regard to our knowledge or responsibility of the presence of the contaminants; o Liability for the costs of investigation and removal or remediation of hazardous substances at disposal facilities for persons who arrange for the disposal or treatment of such substances; and o Potential liability for common law claims by third parties based on damages and costs of environmental contaminants. We May be Unable to Make Acquisitions on an Advantageous Basis A significant element of our business strategy is the enhancement of our portfolio through acquisitions of additional properties. The consummation of any future acquisition will be subject to satisfactory completion of our extensive analysis and due diligence review and to the negotiation of definitive documentation. There can be no assurance that we will be able to identify and acquire additional properties or that we will be able to finance acquisitions in the future. In addition, there can be no assurance that any such acquisition, if consummated, will be profitable for us. If we are unable to consummate the acquisition of additional properties in the future, there can be no assurance that we will be able to increase the cash available for distribution to our shareholders. We May Suffer Uninsured Loss We require most of our tenants to carry comprehensive liability, fire, extended coverage [and carry rent loss insurance] on most of our Properties, with policy specifications and insured limits customarily carried for similar properties. Carey Diversified carries similar insurance coverages for properties if the tenant is not required to do so. Carey Diversified also has obtained contingent property and liability coverages. However, there are certain types of losses (such as due to wars or acts of God) that generally are not insured because they are either uninsurable or not economically insurable. Should an uninsured loss or a loss in excess of insured limits occur, we could lose capital invested in a property, as well as the anticipated future revenues from a property, while remaining obligated for any mortgage indebtedness or other financial obligations related to the property. Any such loss would adversely affect our financial condition. We believe that the Properties are adequately insured in accordance with industry standards. -9- 11 Changes in Market Interest Rates Could Cause Our Stock Price to Go Down The trading prices of equity securities issued by real estate companies have historically been affected by changes in broader market interest rates, with increases in interest rates resulting in decreases in trading prices, and decreases in interest rates resulting in increases in such trading prices. An increase in market interest rates could therefore adversely affect the trading prices of any equity securities issued by us. We Face Intense Competition The real estate industry is highly competitive. Our principal competitors include national REITs, many of which are substantially larger and have substantially greater financial resources than us. The Value of our Real Estate is Subject to Fluctuation We are subject to all of the general risks associated with the ownership of real estate. In particular, we face the risk that rental revenue from the properties will be insufficient to cover all corporate operating expenses and debt service payments on indebtedness we incur. Additional real estate ownership risks include: o Adverse changes in general or local economic conditions, o Changes in supply of or demand for similar or competing properties, o Changes in interest rates and operating expenses, o Competition for tenants, o Changes in market rental rates, o Inability to lease properties upon termination of existing leases, o Renewal of leases at lower rental rates, o Inability to collect rents from tenants due to financial hardship, including bankruptcy o Changes in tax, real estate, zoning and environmental laws that may have an adverse impact upon the value of real estate, o Uninsured property liability, property damage or casualty losses, o Unexpected expenditures for capital improvements or to bring properties into compliance with applicable federal, state and local laws, and o Acts of God and other factors beyond the control of our management. Our Systems May Not Be Year 2000 Compliant The "Year 2000 issue" refers to the series of problems that have resulted or may result from the inability of certain computer software and embedded processes to properly process dates. Substantially This shortcoming could result in the failure of major systems or miscalculations causing major disruptions to business operations. The Company has no computer systems of its own, but is dependent upon the systems maintained by an affiliate of its Manager and certain other third parties including its bank and transfer agent. The Company and its affiliates are actively evaluating their readiness relating to the Year 2000 issue. In 1998, the Company, its Manager, and affiliates commenced an assessment of their local area network of personal computers and related equipment and are in the process of replacing or upgrading the equipment that has been identified as not being Year 2000 compliant. The program is expected to be substantially completed in the second quarter of 1999. The Company and its affiliates have also engaged outside consultants experienced in detecting and addressing Year 2000 issues, and they currently are remediating certain of the affiliate's applications and systems. At the same time, the Company, its Advisor, and affiliates are evaluating their applications software, all of which are commercial "off the shelf" programs that have not been customized. During 1998, the Company commenced a project to select a comprehensive integrated real estate accounting and asset management software package to replace its existing applications. A commercial Windows-based integrated accounting and asset management based application is being tested and installation is scheduled to be completed during the third quarter of 1999. This software has been designed to use four digits to define a year. Because the Company's primary operations consist of investing in and receiving rents on long-term net leases of real estate, while the failure of the Manager and its affiliates to correct fully Year 2000 issues could disrupt its -10- 12 administrative operations, the resulting disruptions would not likely have a material impact on the Company's results of operations, financial condition or liquidity. Contingency plans to address potential disruptions are in the process of being developed. The Company's share of costs associated with required modifications to become Year 2000 compliant is not expected to be material to the Company's financial position. The Company's share of the estimated total cost of the Year 2000 project is expected to be approximately $280,000, of which $215,000 have been incurred to date. Although the Company believes that it will address its internal Year 2000 issues in a timely manner, there is a risk that the inability of third-party suppliers and lessees to meet Year 2000 readiness issues could have an adverse impact on the Company. The Company and its affiliates have identified their critical suppliers and are requiring that these suppliers communicate their plans and progress in addressing Year 2000 readiness. The most critical processes provided by third-party suppliers are the Company's bank and transfer agent. The Company's operations may be significantly affected if such providers are ineffective or untimely in addressing Year 2000 issues. The Company contacted each of its lessees regarding Year 2000 readiness and has emphasized the need to address Year 2000 issues. Generally, lessees are contractually required to maintain their leased properties in good working order and to make necessary alterations, foreseen or unforeseen, to meet their contractual obligations. Because of those obligations, the Company believes that the risks and costs of upgrading systems related to operations of the buildings and that contain technology affected by Year 2000 issues will generally be absorbed by lessees rather than the Company. The major risk to the Company is that Year 2000 issues have such an adverse effect on the financial condition of a lessee that its ability to meet its lease obligations, including the timely payment of rent, is impaired. In such an event, the Company may ultimately incur the costs for Year 2000 readiness at the affected properties. The potential materiality of any impact is not known at this time. We Depend on Key Personnel for Our Future Success We depend on the efforts of the executive officers and key employees of the merger. The loss of the services of these executive officers and key employees could have a material adverse effect on our operations. The risk factors may have affected, and in the future could affect, our actual operating and financial results and could cause such results to differ materially from those in any forward-looking statements. You should not consider this list exhaustive. New risk factors emerge periodically, and we cannot completely assure you that the factors we describe above list all material risks to Carey Diversified at any specific point in time. We have disclosed many of the important risk factors discussed above in our previous filings with the Securities and Exchange Commission. -11- 13 Item 2. PROPERTIES Set forth below is certain information relating to the Company's properties owned as of March 15, 1999: Property Square Current Increase Lease Maximum Lessee/Guarantor Location Footage Annual Rent Factor Expiration Term - ------------------------------------------------------------------------------------------------------------------------------------ Dr Pepper Bottling Company of Texas Irving, TX 459,497 Houston, TX 262,450 ----------------------------- 721,947 $3,998,000 CPI Jun-14 Jun-14 Detroit Diesel Corporation Detroit, MI 2,730,750 3,658,060 PPI Jun-10 Jun-30 Sybron International Corporation Dubuque, IA 144,300 496,161 Glendora, CA 25,000 404,401 Portsmouth, NH 95,000 588,285 Rochester, NY 221,600 1,079,369 Romulus, MI 220,000 1,058,694 ------------------------------ 705,900 3,626,910 CPI Dec-13 Dec-38 Gibson Greetings, Inc. Cincinnati, OH 593,340 Berea, KY 601,500 ----------------------------- 1,194,840 3,100,000 Stated Nov-13 Nov-23 Livho, Inc. Livonia, MI 158,000 2,923,038 Stated Jan-08 Jan-28 Quebecor Printing Inc. Doraville, GA 432,559 1,522,498 CPI Dec-09 Dec-34 Olive Branch, MS 270,500 980,643 CPI Jun-08 Jun-33 ----------------------------- 703,059 2,503,141 Furon Company New Haven, CT 110,389 Mickleton, NJ 86,175 Aurora, OH 147,848 Mantua, OH 150,544 Bristol, RI 105,642 Aurora, OH 26,692 ----------------------------- 627,290 2,416,050 PPI Jul-12 Jul-37 AutoZone, Inc. 31 Locations: 185,990 1,321,568 % Sales Jan-11 Feb-26 NC, TX, AL, GA, IL, LA, MO AutoZone, Inc. 13 Locations: 70,425 393,599 % Sales Aug-12 Aug-37 FL, LA, MO, NC, TN AutoZone, Inc. 11 Locations: 54,000 524,390 % Sales Aug-13 Aug-38 FL, GA, NM, SC, TX ----------------------------- 310,415 2,239,557(5) -12- 14 Property Square Current Increase Lease Maximum Lessee/Guarantor Location Footage Annual Rent Factor Expiration Term - ------------------------------------------------------------------------------------------------------------------------------------ Thermadyne Holdings Corp. Industry, CA 325,800 $2,234,191 CPI Feb-10 Feb-35 The Gap, Inc. Erlanger, KY 391,000 1,252,636 CPI Feb-03 Feb-43 Erlanger, KY 362,750 952,749 CPI Feb-03 Feb-43 ----------------------------- 753,750 2,205,385 Orbital Sciences Corporation Chandler, AZ 280,000 2,153,740 CPI Sep-09 Sep-29 Copeland Beverage, Inc. Los Angeles, CA 390,000 1,800,000 CPI Apr-07 Apr-07 United States Postal Service Bloomingdale, IL 116,000 1,089,982 Stated Apr-06 Apr-06 Comark Inc. Bloomingdale, IL 36,967 268,396 Stated May-00 May-00 ----------------------------- 152,967 1,358,378 Lockheed Martin Corporation King of Prussia, PA 88,578 974,358 Market Jul-03 Jul-08 Glen Burnie, MD 45,804 333,333 Stated Apr-01 Apr-21 ----------------------------- 134,382 1,307,691 AP Parts International, Inc. Toledo, OH 1,160,000 1,617,252 CPI Dec-07 Dec-22 Unisource Worldwide, Inc. Commerce, CA 411,579 1,292,800 Stated Apr-10 Apr-30 Anchorage, AK 44,712 312,700 Stated Dec-09 Dec-29 ----------------------------- 456,291 1,605,500 Brodart Company Williamsport, PA 309,030 Williamsport, PA 212,201 ----------------------------- 521,231 1,519,229 CPI Jun-08 Jun-28 Cleo Inc/CSS Industries, Inc.. Memphis, TN 1,006,566 1,500,000 CPI Dec-05 Dec-15 Peerless Chain Company Winona, MN 357,760 1,463,425 CPI Jun-11 Jun-26 Information Resources, Inc. Chicago, IL 159,600 Chicago, IL 92,400 ----------------------------- 252,000 1,457,934(6) CPI Oct-10 Oct-15 Red Bank Distribution, Inc. Cincinnati, OH 589,150 1,400,567 CPI Jul-15 Jul-35 High Voltage Engineering Corp. Lancaster, PA 70,712 679,088 Sterling, MA 70,000 649,544 ----------------------------- 140,712 1,328,632 CPI Nov-13 Nov-30 Duff-Norton Company, Inc. Forrest City, AR 265,000 1,164,280 CPI Dec-12 Dec-32 Sprint Spectrum, Inc. Albuquerque, NM 74,714 1,154,331 CPI Sep-08 Sep-08 Eagle Hardware & Garden, Inc. Bellevue, WA 127,360 1,086,864(5) CPI & Sep-17 Sep-17 %sales -13- 15 Property Square Current Increase Lease Maximum Lessee/Guarantor Location Footage Annual Rent Factor Expiration Term - ------------------------------------------------------------------------------------------------------------------------------------ Lockheed Martin Services Group Houston, TX 60,364 $ 526,270 Stated Jul-04 Jul-04 Johnson Engineering Corporation Houston, TX 48,214 476,964 Stated Jun-03 Jun-03 ----------------------------- 108,578 1,003,234 DeVlieg-Bullard, Inc. McMinnville, TN 276,991 Frankenmuth, MI 132,400 ----------------------------- 409,391 953,803 CPI Apr-06 Apr-26 Anthony's Manufacturing Company, San Fernando, CA 95,420 Inc. San Fernando, CA 7,220 San Fernando, CA 40,285 San Fernando, CA 39,920 ----------------------------- 182,845 945,444 CPI May-07 May-12 United Stationers Supply Company New Orleans, LA 59,000 Memphis, TN 75,000 San Antonio, TX 63,321 ----------------------------- 197,321 915,834 CPI Mar-10 Mar-30 Wal-Mart Stores, Inc. West Mifflin, PA 118,125 891,129 CPI Jan-07 Jan-37 Hotel Corporation of America Topeka, KS 117,590 842,184 Stated Sep-03 Sep-03 Pre Finish Metals Incorporated Walbridge, OH 313,704 828,506 CPI Jun-03 Jun-28 IMO Industries, Inc. Garland, TX 150,203 822,750 Stated Sep-02 Sep-07 Continental Casualty Company College Station, TX 97,567 771,666 Stated Dec-99 Oct-03 Verifications Nationales et Internationales des Imports (2) Pantin, France National Pour L'Emploi (2) Pantin, France Direction Departmentale du Travail et de L'Equipment (2) Pantin, France Hoechst Roussel Vet (2) Pantin, France ----------------------------- 51,714 755,358 INSEE(4) Jun-04 Jun-04 Winn-Dixie Stores, Inc. Montgomery, AL 32,690 191,534 % Sales Mar-08 Mar-38 Panama City, FL 34,710 170,399 % Sales Mar-08 Mar-38 Leeds, AL 25,600 144,713 % Sales Mar-04 Mar-34 Bay Minette, AL 34,887 128,472 % Sales Jun-07 Jun-37 Brewton, AL 30,625 134,500 % Sales Oct-10 Oct-30 ------------------------------ 158,512 769,618(5) AT&T Corporation Bridgeton, MO 55,810 757,846 Stated Nov-01 Nov-11 -14- 16 Property Square Current Increase Lease Maximum Lessee/Guarantor Location Footage Annual Rent Factor Expiration Term - ---------------------------------------------------------------------------------------------------------------------------------- NV Ryan, Inc.. Thurmont, MD 150,468 Farmington, NY 29,273 ----------------------------- 179,741 $ 729,114 CPI Mar-14 Mar-30 Harcourt General, Inc. Burnsville, MN 31,837 467,500 % Sales Jul-06 Jul-31 Canton, MI 29,818 233,750 % Sales Jul-05 Jul-30 ----------------------------- 61,655 701,250(5) KSG, Inc. St. Louis, MO 148,100 690,849 CPI (9) Bell South Entertainment, Inc. Ft. Lauderdale, FL 80,540 655,066(10) CPI Jul-06 Jul-09 Family Dollar Service, Inc. Salisbury, NC 311,182 662,400 Stated Jan-00 Jan-00 Motorola, Inc. Urbana, IL 46,350 600,000 Stated (9) Various Broomfield, CO 60,660 267,491 CPI May-02 May-02 Broomfield, CO 40,440 268,122 CPI Dec-01 Dec-01 ------------------------------ 101,100 535,613 Western Union Financial Services, Inc. Bridgeton, MO 78,080 573,221 Stated Nov-01 Nov-11 Exide Electronics Corporation Raleigh, NC 27,770 572,130 CPI Jul-06 Jul-06 Lockheed Martin Corporation Oxnard, CA 142,796 369,600 Stated Aug-00 Aug-02 Merchants Home Delivery, Inc. Oxnard, CA 22,716 189,000(10) Stated Jan-04 Jan-14 ----------------------------- 165,512 558,600 United Space Alliance LLC Webster, TX 88,200 505,020 Stated Sep-06 Sep-06 Caleb Brett USA, Inc. Webster, TX 3,600 34,992 Stated Jun-00 Jun-00 ----------------------------- 91,800 540,012 Excel Communications, Inc. Reno, NV 53,158 532,802 Stated Dec-06 Dec-20 Stoody Deloro Stellite, Inc./ Goshen, IN 54,270 500,212 CPI Feb-10 Feb-35 DS Group Limited Wozniak Industries, Inc. Schiller Park, IL 84,197 497,400 Stated Aug-05 Dec-23 Titan Corporation San Diego, CA 166,403 485,084(7) CPI Jul-07 Jul-31 Swiss-M-Tex, L.P. Travelers Rest, SC 178,693 480,000 CPI Aug-07 Aug-17 CSK Auto, Inc. Denver, CO 8,129 58,910 CPI Jan-08 Jan-38 Glendale, AZ 3,406 66,720 CPI Jan-02 Jan-22 Apache Junction, AZ 5,055 49,348 CPI Jan-02 Jan-22 Casa Grande, AZ 11,588 64,590 CPI Jan-02 Jan-22 Scottsdale, AZ 8,000 135,100 CPI Jan-02 Jan-22 Mesa, AZ 3,401 68,304 CPI Jan-02 Jan-22 ----------------------------- 39,579 442,972 -15- 17 Property Square Current Increase Lease Maximum Lessee/Guarantor Location Footage Annual Rent Factor Expiration Term - ------------------------------------------------------------------------------------------------------------------------------------ Tellit Assurances (2) Rouen, France 27,593 $ 415,283 INSEE(4) Aug-04 Aug-09 Childtime Childcare, Inc. 12 Locations: 83,694 413,638(8) CPI Jan-16 Jan-41 AZ, CA, MI,TX Petrocon Engineering, Inc. Beaumont, TX 48,700 363,516 Stated Jan-99 Jan-00 Olmstead Kirk Paper Company Beaumont, TX 5,760 36,000 Stated Jan 03 Jan 03 ----------------------------- 54,460 399,516 Yale Security Inc. Lemont, IL 130,000 399,000 Stated Apr-11 Apr-11 Penn Crusher Corporation Cuyahoga Falls, OH 80,445 197,234 Broomall, PA 22,810 180,000 ----------------------------- 103,255 377,234 Market Jan-05 Jan-20 B&G Contract Packaging, Inc. Maumelle, AR 160,000 339,120 Stated Dec-99 Dec-03 Honeywell, Inc. Houston, TX 32,320 211,200 Honeywell, Inc. (2 acres land) Houston, TX 124,284 ----------------------------- 32,320 335,484 Stated Sep-02 Sep-02 Adaptive Controls, Inc. Houston, TX 18,058 104,280 Stated Nov-00 Nov-00 AdPlex, Inc. Houston, TX 13,698 92,280 Stated May-01 May-01 Work Ready, Inc Houston, TX 7,306 59,640 Stated Aug-01 Aug-01 Chrysler Corporation Houston, TX 7,248 18,844 Stated Apr-99 Apr-99 The Terminex International Company, Inc. Houston, TX 3,330 25,980 Stated Sep-00 Sep-00 ----------------------------- 49,640 301,024 Kobacker Stores, Inc. Fontana, CA 4,500 Rialto, CA 4,500 Reynoldsburg, OH 3,840 Tallmadge, OH 4,000 Anderson, IN 4,500 Cuyahoga Falls, OH 3,792 Marion, OH 3,900 Fremont, OH 4,000 Merced, CA 4,500 Sacramento, CA 4,400 Stockton, CA 4,500 Sacramento, CA 4,400 ----------------------------- 50,832 267,314 None Dec-06 Dec-36 Sears Roebuck and Co. Houston, TX 21,069 200,372 Stated Sep-05 Sep-05 Bike Barn Holding Company, Inc. Houston, TX 6,216 59,160 Stated Aug-05 Aug-05 ----------------------------- 27,285 259,532 Direction Regional des Affaires Sanitaires et Sociales (3) Rouen, France 25,228 239,122 INSEE(4) Oct-04 Oct-04 Bell Atlantic Corporation Milton, VT 30,624 231,000 Stated Feb-03 Feb-13 -16- 18 Property Square Current Increase Lease Maximum Lessee/Guarantor Location Footage Annual Rent Factor Expiration Term - ------------------------------------------------------------------------------------------------------------------------------------ Northern Tube, Inc. Pinconning, MI 220,588 $219,282 CPI Dec-07 Dec-22 Penberthy Products, Inc. Prophetstown, IL 161,878 209,507 CPI Apr-06 Apr-26 Allied Plywood Corporation Manassas, VA 60,446 200,683 Stated Mar-02 Mar-02 Rochester Button Company South Boston, VA 43,387 Kenbridge, VA 38,000 ----------------------------- 81,387 180,000 None Dec-16 Dec-36 Sunds Defibrator Woodhandling, Inc. Carthage, NY 76,000 144,239 CPI Aug-05 Jul-07 Federal Express Corporation Corpus Christi, TX 30,212 79,160 Market May-99 May-09 College Station, TX 12,080 63,610 Market Feb-02 Feb-09 ----------------------------- 42,292 142,770 Continental Airlines, Inc. Houston, TX 25,125 132,000 Stated Jul-03 Jul-03 Pepsi-Cola Metropolitan Bottling Company, Inc. Houston, TX 17,725 99,899 Stated Oct-04 Oct-04 Popular Stores, Inc. Scottsdale, AZ 11,800 94,266(5) % Sales Jul-00 Jul-10 Stair Pans of America, Inc. Fredericksburg, VA 45,821 92,055 Stated Jul-07 Jul-07 Lockheed Martin Services. Webster, TX 10,960 82,200 Stated Jul-00 Jul-00 Lutz Bagels LLC Canton, OH 4,800 76,800 Stated Dec-07 Dec-17 Penn Virginia Coal Company Duffield, VA 12,804 74,000 CPI Nov-04 Nov-04 Cents Stores, Inc. Mesa, AZ 11,039 55,485 Stated Jan-13 Jan-13 Family Bargain Center Colville, WA 15,300 50,733 CPI Jan-00 Jan-15 The Crafters Mall, Inc. Glendale, AZ 11,760 47,964 None Quarterly Renewals Capin Mercantile Corporation Silver City, NM 11,280 36,660 None May-00 May-05 Kinko's of Ohio, Inc. Canton, OH 1,700 26,010(5) % Sales Aug-00 Aug-10 Reclamation Foods, Inc. Apache Junction, AZ 9,945 24,029 CPI Jun-01 Jun-06 Wexler & Wexler New Orleans, LA 1,641 19,692(5) % Sales Oct-05 Oct-15 Scallon's Carpet Castle, Inc. Casa Grande, AZ 3,134 18,480 Stated Dec-03 Dec-03 -17- 19 Property Square Current Increase Lease Maximum Lessee/Guarantor Location Footage Annual Rent Factor Expiration Term - ------------------------------------------------------------------------------------------------------------------------------------ Arthur L. Jones Greensboro, NC 1,700 $ 3,575 CPI Apr-99 Apr-01 Alpena Holiday Inn Alpena, MI 96,333 785,530(1) Petoskey Holiday Inn Petoskey, MI 83,462 383,469(1) (1) The Company operates a hotel business at this property. Dollar amounts are net operating income for 1998 for the hotel business. (2) CD owns 75% of this property and rents are collected in French Francs, conversion rate at December 31, 1998 used. (3) CD owns 99% of this property and rents are collected in French Francs, conversion rate at December 31, 1998 used. (4) INSEE construction index, an index published quarterly by the French Government. (5) Current annual rent amount before any percentage of sales rent. (6) Current annual rent represents the 33.33% ownership interest in this property. (7) Current annual rent represents the 18.54% ownership interest in this property. (8) Current annual rent represents the 33.93% ownership interest in this property. (9) Purchase option has been exercised by the lessee. (10) Annualized rent for leases commencing after April 1, 1999. -18- 20 Item 3. Legal Proceedings. As of the date hereof, the Company is not a party to any material pending legal proceedings. Item 4. Submission of Matters to a Vote of Security Holders. No matter was submitted during the fourth quarter of the year ended December 31, 1998 to a vote of security holders, through the solicitation of proxies or otherwise. -19- 21 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. Listed Shares are listed on the New York Stock Exchange. Trading commenced on January 21, 1998. As of December 31, 1998 there were 22,224 shareholders of record. Dividend Policy Quarterly cash dividends are usually declared in December, March, June and September and paid in January, April, July and October. Quarterly cash dividends have been paid since April 1998. Cash dividends declared per share: Quarter 1998 - ------- ---- 1 $ .4125 2 .4125 3 .4125 4 .4125 ---------- Total $ 1.6500 Listed Shares The high, low and closing prices on the New York Stock Exchange for a Listed Share for each fiscal quarter of 1998 were as follows (in dollars): 1998 High Low Close - ---- ---- --- ----- First Quarter $22.3750 $20.1250 $20.1250 Second Quarter 22.2500 19.7500 19.7500 Third Quarter 20.9375 18.5000 19.8750 Fourth Quarter 21.3125 18.1875 19.6875 -20- 22 Item 6. Selected Financial Data. The following table sets forth selected combined operating and balance sheet information on a combined historical basis for the CPA(R) Partnerships for the years 1994 through 1997. The 1998 data sets forth consolidated operating and balance sheet data on a consolidated basis for the Company which commenced operations on January 1, 1998. The following information should be read in conjunction with the financial statements and notes thereto for the Company included in Item 8. The combined historical operating and balance sheet information of the CPA(R) Partnerships as of December 31, 1997, 1996, and 1995, and for the years ended December 31, 1997, 1996, 1995, and 1994 have been derived from the historical Combined Financial Statements audited by PricewaterhouseCoopers LLP, independent accountants. The combined historical balance sheet information as of December 31, 1994, has been derived from the unaudited combined financial statements of the Company. (in thousands, except per share data) The Company The Predecessor Consolidated Combined ------------ --------------------------------------------------------- Operating Data 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Revenues $ 85,330 $ 96,271 $ 101,576 $ 107,946 109,137 Income before extraordinary items 39,085 40,561 45,547 49,363 38,456 Basic and diluted earnings per Listed Share 1.55 Cash distributions (1) 30,820 43,620 34,173 57,216 35,589 Cash provided by operating activities 51,944 51,641 53,317 63,276 45,131 Cash (used in) provided by investing activities (71,525) (273) 19,545 24,327 37,136 Cash provided by (used) in financing activities 6,668 (61,335) (72,020) (105,578) (70,045) Cash dividends declared per Listed Share 1.65 Balance Sheet Data: Real estate, net (2) $ 453,181 $ 240,498 $ 271,660 $ 301,505 $ 330,671 Investment in direct financing leases 295,826 216,761 215,310 218,922 244,746 Total assets 813,264 523,420 544,728 582,324 659,047 Long-term obligations (3) 254,827 150,907 187,414 233,300 284,291 (1) 1998 amount represents cash distributions to holders of Listed Shares. (2) Includes real estate accounted for under the operating method, operating real estate and real estate under construction leased to others net of accumulated depreciation. (3) Represents mortgage and note obligations and deferred acquisition fees due after more than one year. -21- 23 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. (dollar amounts in thousands) Overview The following discussion and analysis of financial condition and results of operations of Carey Diversified LLC ("CDC") should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 1998. The following discussion includes forward looking statements. Forward looking statements, which are based on certain assumptions, describe future plans, strategies and expectations of CDC. Such statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievement of CDC to be materially different from the results of operations or plan expressed or implied by such forward looking statements. Accordingly, such information should not be regarded as representations by CDC that the results or conditions described in such statements or objectives and plans of CDC will be achieved. CDC was organized to combine and continue the business of the nine Corporate Property Associates real estate limited partnerships (the "CPA(R) Partnerships") and began trading on the New York Stock Exchange on January 21, 1998. CDC owns and manages a diverse portfolio of real properties, generally leased to corporate tenants under long-term net leases. CDC intends to continue to expand the existing net lease portfolio and, as appropriate, engage in new lines of business. During 1998, CDC expanded its scope of operations into Europe with three property acquisitions in France. From 1979 through 1990, the CPA(R) Partnerships raised approximately $400 million of equity through public offerings of limited partnership units. Each CPA(R) Partnership was structured so that each limited partner anticipated a return of their investment over the finite life of the Partnership, with a disposition strategy that included the sale of assets and liquidation of the Partnership. Accordingly, each CPA(R) Partnership was structured so that no additional equity would be raised after the initial offering, nor, would there be after a defined period, reinvestment of sales proceeds in new properties. This structure restricted the ability of a CPA(R) Partnership to increase its asset base after the investment of offering proceeds was completed. As a CPA(R) Partnership disposed of properties, its asset base and income from continuing operations decreased. Further, the stated objective of each CPA(R) Partnership was to use its cash flow to pay distributions at an increasing rate rather than for reinvestment. In contrast, CDC is an infinite life entity that has the ability to raise additional capital and acquire additional properties either through stock or debt offerings or by exchanging shares in CDC for properties. Accordingly, the comparison of historical results of operations for 1997 and 1996 with 1998 is limited because of (i) the limitations imposed by the Partnership structure as reflected in 1997 and 1996 and (ii) the change in the basis of accounting as of January 1, 1998 due to the application of purchase accounting. The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 131, Disclosure about Segments of Enterprise and Related Information, which is effective for fiscal years beginning after December 15, 1997. This statement requires that a public business enterprise report financial and descriptive information about its reportable operating segments. CDC's management evaluates the performance of its portfolio as a whole, but allocates its resources between two operating segments: Real estate operations, with domestic and international investments, and hotel operations. In 1991 and 1992, the CPA(R) Partnerships assumed the operations of five hotels when the financial difficulties of two tenant companies resulted in lease terminations on these properties. Accordingly, the decision to engage in the hotel operating segment was created by the inability of the tenant companies to meet their obligations rather than by a decision by management to allocate resources for the purpose of engaging in a new business. In 1996, CDC sold one of the hotels and exchanged its ownership interest in another of its hotels for limited partnership units in the operating partnership of a publicly-traded real estate investment trust. During 1998, the operations of its hotel in Livonia, Michigan were transferred to an affiliate, which entered into a long-term net lease with CDC. With the transfer of the Livonia hotel, CDC has reduced its -22- 24 hotel operating segment to two hotel properties. To retain publicly-traded partnership status for federal tax purposes, CDC is limited in the amount of gross revenues it can generate from actively participating in operating businesses. CDC, therefore, intends to allocate to its hotel operating segment only resources sufficient to maintain the hotel business at its two existing properties, and does not intend to expand the hotel business. Over the past three years, hotel revenues as a percentage of overall revenues has decreased from 21.6% to 7.4%. CDC has not made a strategic decision to discontinue its activities in this operating segment, but it is actively seeking to minimize revenues from operating businesses. During 1998, CDC purchased three properties in France. CDC is actively evaluating other opportunities internationally and expects its activities outside of the United States to grow significantly over the next several years. Because the first of the acquisitions in France occurred in June 1998, international real estate investments did not significantly contribute to 1998 revenues or earnings. Results of Operations: Year-Ended December 31, 1998 Compared to Year-Ended December 31, 1997 Net income for 1998 is not fully comparable to net income for 1997. CDC commenced operations on a consolidated basis as an ongoing and growing business on January 1, 1998, while the prior year's reflect the results of a combination of static and liquidating Partnership portfolios. In addition, the results for 1997 reflect several nonrecurring items. During that period, CDC recognized other income of $2,859 primarily in connection with bankruptcy claims and revenues of $1,600 in excess of market rates for a property under a lease with Advanced System Applications, Inc. ("ASA") that ended in June 1997. That lease represented 3% of 1997 revenues (rental income and interest income from direct financing leases), and had been renegotiated in 1994 to allow the lessee to terminate the lease in 1997 rather than 2003. The rents received during the abbreviated term were intended to provide a significant portion of the rents that would have been due over the remainder of the original lease term. Lease revenues decreased by $319 for 1998. The decrease was primarily a result of the termination of the ASA lease in June 1997 and the termination of the Hughes Markets, Inc. lease. Lease revenues from ASA and Hughes for 1997 were $2,267 and $5,784, respectively. This was offset, in part, by $2,958 from lease revenues in 1998 from rentals on the Livonia, Michigan hotel property, which has been leased since February 1, 1998 and an increase of annualized revenue of $6,653 from leases on the properties acquired in 1998 with (i) Eagle Hardware & Garden, Inc., (ii) properties in Houston, Texas,(iii) the French properties and (iv) the commencement of the lease with Sprint Spectrum LP subsequent to the completion of construction. On April 30, 1998, CDC's two-year extension term with Hughes Markets for a dairy processing plant in Los Angeles, California at above-market rental rates ended, and a new lease for the property with Copeland Beverage Group, Inc. became effective. The Hughes Market lease had been renegotiated at the end of the initial lease term in 1996 for a two-year period because Hughes needed a holdover period to complete its new dairy processing plant. Annual rentals from Copeland will approximate the rents that were in effect before Hughes' two-year extension term. In April 1998, CDC received a final rent payment of $3,500 from Hughes. At the time the extension term was negotiated, management had anticipated that the funds would be used to retrofit the property for alternative uses and to cover carrying costs during a period of vacancy. As a result of entering into the Copeland lease, no significant expenditures were required. The decrease in hotel revenues and related operating expenses resulted from the change in status of the Livonia property in February 1998 to a leased property. As a result, the percentage of hotel revenues has decreased to 7% of overall revenues. The hotel operating income of the two remaining hotels increased by over $115 or 11% in 1998 as compared to 1997. The increase was primarily attributable to an increase in the average room rates. Occupancy levels were stable. -23- 25 Interest expense has continued to decrease as a result of paying off several mortgage loans in 1997, the continuing amortization of mortgage debt and the June 1997 refinancing of a $12,700 limited recourse mortgage loan collateralized by properties leased to Furon Company at a lower rate of interest. Additionally, CDC has used draws from its $185,000 line of credit from a syndicate of banks to refinance high interest debt and fund acquisitions on a transitional basis. In connection with paying off three mortgage loans with funds advanced from the line of credit, CDC incurred an extraordinary charge on the early extinguishment of debt of $621. Limited recourse mortgage debt financing will remain an integral part of CDC's financing strategy. In addition to obtaining $11,000 of mortgage financing on the Eagle property in December 1998, CDC continues to evaluate opportunities for re-leveraging certain of its properties with limited recourse mortgage debt. A portion of any new mortgage debt may be used to pay down advances under the line of credit, thereby increasing the availability under the line of credit. CDC is currently seeking new mortgage financing in excess of $70,000 on existing properties. The increase in general and administrative expense was due, in part, to CDC's transition from a collection of static finite-life entities to a publicly-traded infinite-life entity. These expenses include the cost of a full-time chief executive officer and additional professional fees. As an infinite-life and growing entity, CDC will continue to incur business development and acquisition expenses that had not been necessary or appropriate in the past. The decrease in property expenses resulted from a lower provision for potential future uncollected rents, lower legal costs in connection with lease disputes, all of which were partially offset by higher overall management and performance fees. Management and performance fees are now based on the market capitalization of CDC. CPA(R) Partnership management fees were based on operating cash flow and/or rent collections. As a result, fees for CDC are not comparable with fees for the Predecessor. Noncash charges for property writedowns to fair value of $1,585 in 1998 included CDC's writedown of a property in Urbana, Illinois. The writedown on the Urbana property was based on the expected sales price pursuant to the exercise of a purchase option by the tenant, Motorola Inc. The $1,512 gain on sales of real estate resulted from the sales of the Simplicity and NVR properties in Port Washington, Wisconsin and Pittsburgh, Pennsylvania, respectively. The $958 of other income resulted primarily from proceeds from bankruptcy claims and reimbursements from a tenant in connection with a lease dispute. Income from equity investments decreased $239 primarily due to lower earnings from CDC's investment in the operating partnership of Meristar Hospitality Corporation, a publicly traded real estate investment trust specializing in hotels. The decreased earnings for Meristar for 1998 include an extraordinary charge and one-time restructuring charges. CDC has the right to exchange its Meristar units on a one-for-one basis for shares of Meristar common stock. Conversion of units to shares would be taxable to holders of Listed Shares of CDC. CDC, therefore, would likely convert only in connection with the disposition of this investment. The quoted market value of a share of common stock at December 31, 1998 was $18.56 resulting in an aggregate value as of that date of approximately $14,484, if converted. Year-Ended December 31, 1997 Compared to Year-Ended December 31, 1996 Net income for 1997 decreased by $4,734 as compared with 1996. The decrease was due to increases in general and administrative and property expenses, property writedowns, a decrease in earnings from hotel operations and lower gains from asset dispositions. The effect of these items was partially offset by an increase in other income and decreases in interest expense and depreciation. Lease revenues (rental income and interest income from direct financing leases) were substantially unchanged. The increase in general and administrative costs for 1997 was primarily the result of administrative costs incurred in connection with the evaluation of Partnership liquidity alternatives and the structuring of the Consolidation. The increase in property expenses reflected (i) higher management fees, (ii) increased legal fees as a result of the CPA(R) Partnerships' seeking to preserve their interests in existing bankruptcy claims against former and current lessees and disputes with current lessees, (iii) leasing commissions paid to brokers in the remarketing of properties, (iv) operating costs for those properties that were not subject to net leases and (v) charges incurred in connection with increasing reserves for uncollected rent. The increase in property writedowns reflected the writedown of a property held for sale pursuant to the exercise of a purchase option to an amount equal to the estimated sales proceeds and the evaluation of the fair value on -24- 26 two other properties during the year. A full year's lease revenues from leases with Sports & Recreation, Inc. and Excel Communications, Inc., an increase by the United States Postal Service for space leased at the property in Bloomingdale, Illinois from 34% to 52% of such leasable space, the benefit from the 1996 lease modification and extension agreement with Hughes Markets, and several rent increases, generally based on formulas indexed to increases in the consumer price index, offset the reduction in lease revenues resulting from the sale of properties in 1996 and the expiration of the ASA lease at the Bloomingdale property during 1997. The decrease in earnings from hotel operations in 1997 resulted from the disposition of two hotel properties in 1996. Earnings for the three hotels operated by CDC in 1997 located in Alpena, Petosky and Livonia, Michigan increased. Operating earnings from these hotels increased by more than $400, or approximately 12%, as a result of a 3.5% increase in revenues with no change in operating expenses. The increase in revenues resulted from moderate increases in both overall occupancy levels and average room rates. Other income included $2,467, received as distributions in bankruptcy claims from former tenants. Equity income of $2,076 included $1,472 from CDC's equity interest in the former operating partnership of American General Hospitality Corporation, now Meristar. The decrease in interest expense was the result of decreasing mortgage balances resulting from both prepayments and amortizing mortgage debt. The decrease in depreciation was due to the disposition of properties in both 1997 and 1996. Because of the long-term nature of CDC's net leases, inflation and changing prices should not unfavorably affect revenues and net income or have an impact on the continuing operations of CDC's properties. CDC's leases usually have rent increases based on the consumer price index and other similar indexes and may have caps on such increases, or sales overrides, which should increase operating revenues in the future. The moderate increases in the consumer price index over the past several years will affect the rate of such future rent increases. Management believes that hotel operations will not be significantly impacted by changing prices. In addition, management believes that reasonable increases in hotel operating costs may be partially or entirely offset by increases in room rates. Financial Condition: The CPA(R) Partnerships' portfolio of properties was acquired with funds from the offering of each Partnership and with financing provided by limited recourse mortgage debt. Cash flow from operations was used to pay scheduled mortgage debt service and to fund quarterly distributions to partners, generally at an increasing rate each quarter. Net proceeds from the sale of assets and lump sums received in the settlement of bankruptcy and other claims were used to pay off high rate mortgage debt or to fund special distributions to partners. CDC has to date distributed a significant portion of its cash flow to shareholders, but will review from time to time whether a greater benefit to shareholders may be realized by reinvesting rather than distributing a greater or smaller proportion of its available excess cash flow. In March 1999, the annual dividend rate was increased by 1.2%. CDC now has more flexibility in structuring its debt and lowering debt service such as through the use of non-amortizing and unsecured debt, issued in the private or public markets. In March 1998, CDC entered into a three year revolving credit agreement which provided CDC with a line of credit of $150,000. In October 1998, the revolving credit agreement was amended to increase capacity available under the line of credit to $185,000 and to increase the number of lenders participating in the syndication from three to eight. CDC has used the line to fund acquisitions and build-to-suit projects, to pay off higher interest and/or maturing debt and for certain working capital purposes. Since December 31, 1998 CDC, has drawn an additional $29,000 from its line of credit to pay for construction draws on build-to-suit properties. The use of unsecured financing requires CDC to comply with certain financial covenant requirements. The requirements include maintaining defined net worth levels, as well as operating cash flow and interest coverage ratios. During 1998, CDC's other significant financing activities included raising additional equity capital of $7,304 from its dividend reinvestment and stock purchase plan, paying scheduled principal payments of $6,627 on CDC's limited recourse mortgage debt and paying preferred distributions of $4,422 to the former general partners of the CPA(R) Partnerships. The payment of the preferred distributions was a one-time -25- 27 contractual obligation and was based upon cumulative proceeds from the sale of the assets of each Partnership (see Note 3 to the accompanying consolidated financial statements). There is a remaining preferred distribution obligation of $1,423, which will only be paid when CDC's stock price reaches a specified closing price for five consecutive days. In July 1998, CDC used $8,377 to redeem the subsidiary partnership units of the CPA(R) Partnerships. Management believes that their redemption provides CDC with greater operational flexibility than previously available because the objectives of its shareholders and subsidiary partnership unitholders differed. CDC's investing activities consisted primarily of using cash and the issuance of shares. In 1998, CDC used (i) $8,086 of cash in connection with build-to-suit projects, (ii) $14,040 of cash in connection with the purchase of a portfolio of properties in Houston, Texas and for three properties in France, (iii) assumed mortgage debt of $13,593 in connection with the Houston, Texas acquisition and (iv) issued 784,169 shares in connection with the acquisition of the Houston properties and the Eagle Hardware property in Bellevue, Washington. In April 1998, CDC registered 4,500,000 shares with the Securities and Exchange Commission. In 1998, CDC sold the properties leased to Simplicity Manufacturing, Inc. and NVR, Inc. for $9,684 and $12,193, respectively, pursuant to the tenants' exercise of purchase options. CDC has a build-to-suit project for four buildings in Colliersville, Tennessee leased to Federal Express Corporation, and has undertaken another for an office building complex in Tempe, Arizona leased to America West Holdings. Completion of the construction of the first two projects is scheduled for May and the first quarter of 2000, at which time CDC's share of annual rent will be $9,989, assuming maximum project costs of $107,354 are incurred. Project costs incurred through March 15, 1999 on the Federal Express and America West projects total $69,177. Generally accepted accounting principles requires that rents received and interest paid during the construction period be capitalized to the project rather than reflected in earnings even though CDC generated a positive return from these projects in 1998. CDC completed the retrofit of a property in Salisbury, North Carolina in October 1998 that is now leased on a short-term basis to Family Dollar Stores, Inc. CDC is now actively seeking a long-term lease on the property. Annualized rent from Family Dollar is $662. In February 1999, CDC entered into a joint venture to redevelop its property in Moorestown, New Jersey that had been vacant for a number of years. In 1998, CDC accepted a lease termination settlement from Sports & Recreation, Inc. Sports & Recreation had leased the Moorestown property since 1995 at an annual rent of $308 but had never occupied it. The joint venture has entered into a five-year lease for the property with Cendant Operations, Inc. at an annual rent of $1,016. In connection with entering into this lease, CDC has committed to fund improvements to the property of $3,100. In addition CDC is also funding a $2,225 expansion of its property in Chandler, Arizona leased to Orbital Sciences Corporation. After the construction is completed, Orbital Sciences annual rent will increase by $245. CDC also has budgeted commitments of $2,183 in 1999 for the Livonia property. The Sprint Spectrum build-to-suit project in Rio Rancho, New Mexico was completed in October 1998. Sprint Spectrum's annual rent is $1,154. In September 1998, CDC also completed construction of a property in Rouen, France at a cost of $5,638, of which $4,636 was financed by a limited recourse mortgage loan. During 1998, CDC purchased three properties in France. All of the transactions use the local currency, French Francs, as the functional currency. Because the transactions are also leveraged with mortgage debt denominated in French Francs of at least 75% of the purchase price, CDC believes that its exposure to foreign currency fluctuations is mitigated. CDC is actively evaluating additional real estate investments internationally that have higher yields and acceptable risk profiles. Since December 31, 1997, cash balances have decreased by $12,913 to $5,673. Cash flow from operations of $51,994 was sufficient to fund three quarterly distributions of $30,820 and scheduled mortgage principal payments of $6,627. The reduction in debt service through the use of the line of credit to pay off higher interest rate debt as well as rent from the acquisitions of the Eagle Hardware retail property, the portfolio of properties in Houston, Texas, the French properties and Sprint Spectrum property have had a positive impact on operating cash flow. CDC expects to meet its short-term liquidity requirements, including payment of scheduled debt service obligations and meeting its dividend objective, from cash generated from -26- 28 operations and from existing cash balances. Cash flow from operations will increase as (i) the build-to-suit projects are completed and (ii) rents from the Cendant lease commence. In the case of limited recourse mortgage financing that does not fully amortize over its term or is currently due, CDC is responsible for the balloon payment only to the extent of its interest in the encumbered property because the holder has recourse only to the collateral. In the event that balloon payments come due, CDC may seek to refinance the loans, restructure the debt with the existing lenders or evaluate its ability to satisfy the obligation from its existing resources including its line of credit to satisfy the mortgage debt. To the extent the remaining initial lease term on any property remains in place for a number of years beyond the balloon payment date, CDC believes that the ability to refinance balloon payment obligations is enhanced. CDC also evaluates all its outstanding loans for opportunities to refinance debt at lower interest rates that may occur as a result of decreasing interest rates or improvements in the credit rating of tenants. There are scheduled balloon payments of approximately $7,850 in 1999 and $12,925 in 2001. On March 1, 1999, Armel, Inc. and CDC finalized an agreement to terminate Armel's lease for a property in Ft. Lauderdale, Florida. Under the termination agreement, Armel is paying termination fees of $1,540. The Armel lease had a term through September 2001 and provided for annual rent of $965. CDC believes that the termination of the lease and the settlement were in its best interest. CDC has entered into a lease for the property with Bell South Entertainment, Inc., effective July 1999 for a ten year term. Annual rent will initially be $300 increasing to $630 by the end of the term . Bell South has the right to cancel the lease if it does not receive municipal approvals for certain improvements to be made to the property. In 1998, Swiss M-Tex, L.P. experienced financial difficulties and is not paying its rent currently. CDC is evaluating several alternatives including a restructuring of the tenant's lease or evicting the tenant and seeking a replacement tenant. There is no mortgage debt on the Swiss M-Tex property. Annual rent from Swiss M-Tex is $480. In connection with the purchase of many of its properties, CDC required the sellers to perform environmental reviews. Management believes, based on the results of such reviews, that CDC's properties were in substantial compliance with Federal and state environmental statutes at the time the properties were acquired. However, portions of certain properties have been subject to some degree of contamination, principally in connection with leakage from underground storage tanks, surface spills or historical on-site activities. In most instances where contamination has been identified, tenants are actively engaged in the remediation process and addressing identified conditions. Tenants are generally subject to environmental statutes and regulations regarding the discharge of hazardous materials and any related remediation obligations. In addition, CDC's leases generally require tenants to indemnify CDC from all liabilities and losses related to the leased properties with provisions of such indemnification specifically addressing environmental matters. The leases generally include provisions that allow for periodic environmental assessments, paid for by the tenant, and allow CDC to extend leases until such time as a tenant has satisfied its environmental obligations. Certain of the leases allow CDC to require financial assurances from tenants such as performance bonds or letters of credit if the costs of remediating environmental conditions are, in the estimation of CDC, in excess of specified amounts. Accordingly, Management believes that the ultimate resolution of environmental matters will not have a material adverse effect on CDC's financial condition, liquidity or results of operations. The "Year 2000 issue" refers to the series of problems that have resulted or may result from the inability of certain computer software and embedded processes to properly process dates. This shortcoming could result in the failure of major systems or miscalculations causing major disruptions to business operations. CDC has no computer systems of its own, but is dependent upon the systems maintained by an affiliate of its Manager, Carey Management LLC, and certain other third parties including its banks and transfer agent. CDC and its affiliates are actively evaluating their readiness relating to the Year 2000 issue. In 1998, CDC, its Advisor and affiliates commenced an assessment of their local area network of personal computers and related equipment and are in the process of replacing or upgrading the equipment that has been identified as not being Year 2000 compliant. The program is expected to be substantially completed in the second quarter of 1999. CDC and its affiliates have also engaged outside consultants experienced in diagnosing systems and software applications and addressing Year 2000 issues, and with the help of these consultants, its Manager and affiliates currently are remediating as necessary. -27- 29 At the same time, CDC, its Manager, and affiliates are evaluating their applications software, all of which are commercial "off the shelf" programs that have not been customized. During 1998, CDC commenced a project to select a comprehensive integrated real estate accounting and asset management software package to replace its existing applications. A commercial Windows-based integrated accounting and asset management based application is being tested and installation is scheduled to be completed during the third quarter of 1999. This software has been designed to use four digits to define a year. Because CDC's primary operations consist of investing in and receiving rents on long-term net leases of real estate, while the failure of the Manager and its affiliates to correct fully Year 2000 issues could disrupt CDC's administrative operations, the resulting disruptions would not likely have a material impact on its results of operations, financial condition or liquidity. Contingency plans to address potential disruptions are in the process of being developed. CDC's share of costs associated with required modifications to become Year 2000 compliant is not expected to be material to CDC's financial position. CDC's share of the estimated total cost of the Year 2000 project is expected to be approximately $280, of which $215 have been incurred to date. Although CDC believes that it will address its internal Year 2000 issues in a timely manner, there is a risk that the inability of third-party suppliers and lessees to meet Year 2000 readiness issues could have an adverse impact on CDC. CDC and its affiliates have identified their critical suppliers and are requiring that these suppliers communicate their plans and progress in addressing Year 2000 readiness. The most critical processes provided by third-party suppliers are CDC's banks and transfer agent. CDC's operations may be significantly affected if such providers are ineffective or untimely in addressing Year 2000 issues. CDC has contacted each of its lessees regarding Year 2000 readiness and emphasized the need to address Year 2000 issues. Generally, lessees are contractually required to maintain their leased properties in good working order and to make necessary alterations, foreseen or unforeseen, to meet their contractual obligations. Because of those obligations, CDC believes that the risks and costs of upgrading systems related to operations of the buildings and that contain technology affected by Year 2000 issues will generally be absorbed by lessees rather than CDC. The major risk to CDC is that Year 2000 issues have such an adverse effect on the financial condition of a lessee that its ability to meet its lease obligations, including the timely payment of rent, is impaired. In such an event, CDC may ultimately incur the costs for Year 2000 readiness at the affected properties. The potential materiality of any such impact is not known at this time. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133 is effective for all quarters of fiscal years beginning after June 15, 1999. CDC believes the adoption of SFAS No. 133 will not have a material impact on the consolidated financial statements. -28- 30 Item 7A.Quantitative and Qualitative Disclosures about Market Risk: (in thousands) $109,539 of the CDC's long-term debt bears interest at fixed rates, and therefore the fair value of these instruments is affected by changes in the market interest rates. The following table presents principal cash flows based upon expected maturity dates of the debt obligations and the related weighted-average interest rates by expected maturity dates for the fixed rate debt. The interest rate on the variable rate debt as of December 31, 1998 ranged from 4.85% to 10.00%. Advances from the line of credit bear interest at an annual rate of either (i) the one, two, three or six-month LIBOR, plus a spread which ranges from 0.6% to 1.45% depending on leverage or corporate credit rating or (ii) the greater of the bank's Prime Rate and the Federal Funds Effective Rate, plus .50%, plus a spread of up to .125% depending on CDC's leverage. 1999 2000 2001 2002 2003 Thereafter Total Fair Value ---- ---- ---- ---- ---- ---------- ----- ---------- Fixed rate $10,851 $4,947 $ 8,701 $7,285 $7,614 $70,141 $109,539 $110,316 Average interest rate 7.58% 8.00% 7.86% 7.88% 7.97% 7.88% Variable rate $ 8,757 $ 805 $138,888 $ 605 $ 639 $12,065 $161,759 $161,759 -29- 31 REPORT of INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Carey Diversified LLC and Subsidiaries: In our opinion, the consolidated / combined financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Carey Diversified LLC and Subsidiaries (the "Company") at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated / combined financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP New York, New York January 26, 1999 -30- 32 CAREY DIVERSIFIED LLC and SUBSIDIARIES CONSOLIDATED / COMBINED BALANCE SHEETS (In thousands) The Company The Predecessor Consolidated Combined December 31, December 31, 1998 1997 -------------- --------------- ASSETS: Real estate leased to others: Accounted for under the operating method, net $ 390,312 $ 217,165 Net investment in direct financing leases 295,826 216,761 --------- --------- Real estate leased to others 686,138 433,926 Operating real estate, net of accumulated depreciation of $300 and $14,627 at December 31, 1998 and 1997 7,013 23,333 Real estate under construction leased to others 55,856 Assets held for sale 12,842 14,382 Cash and cash equivalents 5,673 18,586 Equity investments 29,532 13,415 Other assets, net of accumulated amortization of $375 and $2,109 at December 31, 1998 and 1997 and reserve for uncollected rent of $1,353 and $1,103 at December 31, 1998 and 1997 16,210 19,778 --------- --------- Total assets $ 813,264 $ 523,420 ========= ========= LIABILITIES: Mortgage notes payable $ 138,964 $ 182,718 Notes payable to affiliate 200 Notes payable 132,334 24,709 Accrued interest payable 2,128 1,798 Dividends payable 10,447 Accounts payable to affiliates 7,013 8,792 Other liabilities 11,771 10,565 --------- --------- Total liabilities 302,657 228,782 --------- --------- Minority interest (3,626) (6,250) --------- --------- Commitments and contingencies PARTNERS' CAPITAL/ MEMBERS' EQUITY: Partners' capital 300,888 --------- Listed Shares, no par value, 25,343,402 Shares issued and outstanding 517,755 Dividends in excess of accumulated earnings (2,803) --------- Accumulated other comprehensive income (719) --------- Total members' equity 514,233 Total liabilities and partners' capital/members' equity $ 813,264 $ 523,420 ========= ========= The accompanying notes are an integral part of the consolidated/combined financial statements. -31- 33 CAREY DIVERSIFIED LLC and SUBSIDIARIES CONSOLIDATED / COMBINED STATEMENTS of INCOME (In thousands except share and per share amounts) The Company Consolidated The Predecessor Combined For the Year Ended For the Years Ended December 31, December 31, ------------------------- -------------------- 1998 1997 1996 ---- ---- ---- Revenues: Rental income $ 42,771 $ 43,045 $ 44,576 Interest income from direct financing leases 34,529 34,574 32,644 Other interest income 783 1,270 1,681 Other income 958 2,859 746 Revenues of hotel operations 6,289 14,523 21,929 ------------ ------------ ------------ 85,330 96,271 101,576 ------------ ------------ ------------ Expenses: Interest 18,266 19,888 23,200 Depreciation and amortization 8,406 10,628 11,274 General and administrative 6,660 5,275 3,747 Property expenses 5,059 6,430 4,008 Writedowns to fair value 1,585 3,806 1,300 Operating expenses of hotel operations 4,956 10,748 15,947 ------------ ------------ ------------ 44,932 56,775 59,476 ------------ ------------ ------------ Income before income from equity investments, net gains, minority interest in income and extraordinary items 40,398 39,496 42,100 Income from equity investments 1,837 2,076 1,155 ------------ ------------ ------------ Income before net gains, minority interest in income and extraordinary items 42,235 41,572 43,255 Gain on sales of real estate and securities, net 1,512 1,565 5,474 ------------ ------------ ------------ Income before minority interest in income and extraordinary items 43,747 43,137 48,729 Minority interest in income (4,662) (2,576) (3,182) ------------ ------------ ------------ Income before extraordinary items 39,085 40,561 45,547 Extraordinary losses on extinguishment of debt, net of minority interest of $79 and $3 in 1998 and 1996 (621) (252) ------------ ------------ ------------ Net income $ 38,464 $ 40,561 $ 45,295 ============ ============ ============ Basic and diluted earnings per Listed Share: Earnings before extraordinary item $ 1.57 Extraordinary item (.02) ------------ 1.55 ============ Weighted average listed shares outstanding: Basic 24,866,225 ============ Diluted 24,869,570 ============ The accompanying notes are an integral part of the consolidated/combined financial statements. -32- 34 CAREY DIVERSIFIED LLC and SUBSIDIARIES CONSOLIDATED STATEMENT of MEMBERS' EQUITY For the year ended December 31, 1998 (In thousands) Dividends Accumulated In Excess Of Other Listed Paid-in Accumulated Comprehensive Shares Capital Earnings Income Total ------ ------- -------- ------ ----- Balance at January 1, 1998 23,959,101 $490,820 $490,820 Cash proceeds on issuance of Listed Shares, net 384,708 6,191 6,191 Listed Shares issued in connection with services rendered and properties acquired 999,593 20,744 20,744 Dividends $(41,267) (41,267) Net income 38,464 38,464 Other comprehensive income $(719) (719) ---------- -------- ------- ----- -------- Balance at December 31, 1998 25,343,402 $517,755 $(2,803) $(719) $514,233 ========== ======== ======= ===== ======== The accompanying notes are an integral part of the consolidated/combined financial statements. -33- 35 CAREY DIVERSIFIED LLC COMBINED STATEMENTS of PARTNERS' CAPITAL For the years ended December 31, 1996 and 1997 (In thousands) The Predecessor Company ------- Balance, January 1, 1996 $ 292,896 Distributions to partners (34,173) Purchase of Limited Partnership Units (17) Change in unrealized appreciation, marketable securities 44 Net income 45,295 --------- Balance, December 31, 1996 304,045 Distributions to partners (43,620) Change in unrealized appreciation of marketable securities (98) Net income 40,561 Balance, December 31, 1997 $ 300,888 ========= The accompanying notes are an integral part of the consolidated/combined financial statements. -34- 36 CAREY DIVERSIFIED LLC and SUBSIDIARIES COMBINED / CONSOLIDATED STATEMENTS of COMPREHENSIVE INCOME (In thousands) The Company The Predecessor Consolidated For Combined the Year Ended For the Years Ended December 31, December 31, -------------- ------------------- 1998 1997 1996 ---- ---- ---- Net income $ 38,464 $ 40,561 $ 45,295 Change in unrealized depreciation of marketable securities (233) (98) 44 Foreign currency translation adjustments (486) -------- --------- --------- Other comprehensive income (719) (98) 44 -------- -------- -------- Comprehensive income $ 37,745 $ 40,463 $ 45,339 ======== ======== ======== The accompanying notes are an integral part of the consolidated/combined financial statements. -35- 37 CAREY DIVERSIFIED LLC CONSOLIDATED / COMBINED STATEMENTS of CASH FLOWS (In thousands) The Company The Predecessor Consolidated Combined For the Year For the Years Ended Ended December 31, December 31, ------------ ------------ 1998 1997 1996 ---- ---- ---- Cash flows from operating activities: Net income $ 38,464 $ 40,561 $ 45,295 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization of deferred financing costs, net of amortization of deferred gains and deferred rental income 7,442 10,280 10,905 Extraordinary loss 621 252 Gain on sales, net (1,512) (1,565) (5,474) Securities received in connection with settlement (1,690) Minority interest in income 4,662 2,576 3,182 Straight-line rent adjustments and other noncash rent adjustments (2,642) (2,310) (1,343) Writedowns to fair value 1,585 3,806 1,300 Provision for uncollected rents 682 1,576 247 Payment of deferred management fees (1,509) Compensation costs paid by issuance of shares 881 Equity income from equity investments in excess of distributions received (107) Net changes in operating assets and liabilities and other 3,270 (1,593) (940) -------- -------- -------- Net cash provided by operating activities 51,944 51,641 53,317 -------- -------- -------- Cash flows from investing activities: Purchases of real estate (89,650) Additional capital expenditures (5,156) (1,955) (3,420) Proceeds from sales of real estate and securities 21,567 1,242 23,394 Accrued disposition fees payable 1,007 Purchase of marketable securities (65) Distributions received from equity investments in excess of equity income 763 245 Other 9 195 (429) -------- -------- -------- Net cash (used in) provided by investing activities $(71,525) $ (273) $ 19,545 -------- -------- -------- (Continued) The accompanying notes are an integral part of the consolidated/combined financial statements. -36- 38 CAREY DIVERSIFIED LLC CONSOLIDATED / COMBINED STATEMENTS of CASH FLOWS, Continued (In thousands) The Company The Predecessor Consolidated Combined For the Year For the Years Ended Ended December 31, December 31, ------------ ------------ 1998 1997 1996 ---- ---- ---- Cash flows from financing activities: Dividends paid (30,820) Distributions to partners (43,620) (34,173) Payment of accrued preferred distributions (4,422) Distributions paid to special limited partners (1,903) (2,327) (2,334) Accrued distributions paid (596) Distributions to and redemptions of subsidiary partnership unitholders (8,789) Payments of mortgage principal (6,627) (27,565) (63,171) Proceeds from mortgages and notes payable 157,823 12,700 28,189 Prepayments of mortgages and notes payable (101,555) Prepayment charges (700) Proceeds from notes payable to affiliate 200 1,000 Payments of notes payable to affiliate (200) (500) (3,050) Deferred financing costs (1,963) (66) (603) Issuance of Listed Shares 7,304 Other (884) (157) 2,122 --------- --------- --------- Net cash provided by (used in) financing activities 6,668 (61,335) (72,020) --------- --------- --------- Net (decrease) increase in cash and cash equivalents (12,913) (9,967) 842 Cash and cash equivalents, beginning of year 18,586 28,553 27,711 --------- --------- --------- Cash and cash equivalents, end of year $ 5,673 $ 18,586 $ 28,553 ========= ========= ========= The accompanying notes are an integral part of the consolidated/combined financial statements. -37- 39 CAREY DIVERSIFIED LLC CONSOLIDATED/COMBINED STATEMENTS of CASH FLOWS, Continued Supplemental schedule of noncash investing and financing activities: 1998 A. The Company issued 215,424 restricted shares valued at $4,367 to certain directors, officers and affiliates as consideration for services rendered, including performance fee (see Note 3). B. In connection with the acquisition of properties, the Company assumed mortgage obligations of $13,593 and issued 784,169 shares valued at $16,377, before issuance costs. C. Deferred acquisition fees payable to an affiliate at December 31, 1998 are $3,137. 1997 In connection with foreclosure of a property, the Company transferred the property to the lender and was released from the obligations of the limited recourse mortgage loan. The gain on the foreclosure was as follows (see Note 11): Mortgage loan payable released $ 4,755 Other liabilities and assets, net 91 Carrying value of property transferred (3,889) ------- Gain on foreclosure $ 957 ======= 1996 In July, the Company exchanged its interest in a hotel property and related assets and liabilities for units in the operating partnership of a publicly-traded real estate investment trust (see Note 14). The assets and liabilities transferred were as follows: Operating real estate, net of accumulated depreciation $16,098 Mortgage note payable (7,304) Other assets and liabilities transferred, net 69 ------- Equity investment $ 8,863 ======= The accompanying notes are an integral part of the consolidated/combined financial statements. -38- 40 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS (All amounts in thousands except share and per share amounts) 1. Organization and Basis of Consolidation: A. The combined financial statements for years ended December 31, 1997 and 1996 have been presented as those of a predecessor company consisting of interests in nine Corporate Property Associates ("CPA(R)") real estate limited partnerships (individually, a "Partnership"), their wholly-owned subsidiaries and Carey Diversified LLC ("Carey Diversified") (collectively, the "Company"). The financial statements have been presented on a combined basis at historical cost because of affiliated general partners, common management and common control and because the majority ownership interests in the CPA(R)Partnerships were transferred to Carey Diversified effective January 1, 1998, pursuant to a consolidation transaction described below. The consolidated financial statements for the year ended December 31, 1998 are those of Carey Diversified and its wholly-owned and majority-owned subsidiaries including the nine CPA Partnerships. All material inter-entity transactions have been eliminated. The former General Partners' interest in the CPA(R)Partnerships is classified under minority interest because that interest was retained subsequent to January 1, 1998 by two special limited partners, William Polk Carey, formerly the Individual General Partner of the nine CPA(R)Partnerships and Carey Management LLC ("Carey Management"). B. In 1997, each limited partner of the CPA(R)Partnerships was asked to approve the merger of the Partnerships with Carey Diversified, and had the option of either exchanging his or her limited partnership interests for an interest in Carey Diversified or retaining a limited partnership interest in the applicable subsidiary partnership. On January 1, 1998, 23,225,967 shares were issued in exchange for limited partnership units. The shares commenced public trading on the New York Stock Exchange on January 21, 1998. The former General Partners received 733,134 shares for their share of the appreciation in the Company's properties. W.P. Carey & Co., Inc. ("W. P. Carey"), received warrants to purchase 2,284,800 shares at $21 per share and 725,930 shares at $23 per share as compensation for investment banking services performed in connection with structuring the consolidation. The warrants are exercisable for 10 years beginning January 1, 1999 (see Note 20). Effective January 1, 1998, the exchange of CPA(R) Partnership limited partner interests for interests in Carey Diversified has been accounted for as a purchase with the limited partner interests recorded at the fair value of the shares exchanged. The excess of fair value over the related historical cost basis of $189,932 was allocated principally to real estate under operating leases, net investment in direct financing leases and equity investments. The exchange of the former General Partners' interests for shares has been accounted for at their historical cost basis. As a result of the Consolidation transaction, the results of operations of the Company are not directly comparable to those of any prior period of the Predecessor. C. Limited partners who did not elect to receive shares retained a direct ownership interest in the applicable Partnership as subsidiary partnership unitholders. The Company had an obligation to redeem in cash all subsidiary partnership units of each Partnership by no later than a specified date. On July 15, 1998, the Company redeemed all subsidiary partnership units for $8,377. The redemption values were determined by an independent valuation of each of the CPA(R) Partnerships as of May 31, 1998. The redemption amounts approximated the carrying amount of the subsidiary partnership units and, accordingly, no purchase accounting adjustment was required. The subsidiary partnership unitholders' share of income in 1998 is included in minority interest in income in the accompanying consolidated financial statements. -39- 41 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued 2. Summary of Significant Accounting Policies: Use of Estimates: 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. The most significant estimates relate to the assessment of recoverability of real estate assets. Actual results could differ from those estimates. Real Estate Leased to Others: Real estate is leased to others on a net lease basis, whereby the tenant is generally responsible for all operating expenses relating to the property, including property taxes, insurance, maintenance, repairs, renewals and improvements. The Company diversifies its real estate investments among various corporate tenants engaged in different industries and by property type. No lessee currently represents 10% or more of total leasing revenues (see Note 10). The leases are accounted for under either the direct financing or operating methods. Such methods are described below: Direct financing method - Leases accounted for under the direct financing method are recorded at their net investment (Note 5). Unearned income is deferred and amortized to income over the lease terms so as to produce a constant periodic rate of return on the Company's net investment in the lease. Operating method - Real estate is recorded at cost, rental revenue is recognized on a straight-line basis over the term of the related leases and expenses (including depreciation) are charged to operations as incurred. Substantially all of the Company's leases provide for either scheduled rent increases, periodic rent increases based on formulas indexed to increases in the Consumer Price Index or sales overrides. Operating Real Estate: Land and buildings and personal property are carried at cost. Renewals and improvements are capitalized, while replacements, maintenance and repairs that do not improve or extend the lives of the respective assets are expensed currently. Real Estate Under Construction, Leased to Others: For properties under construction, interest charges are capitalized rather than expensed and rentals received are recorded as a reduction of capitalized project (i.e., construction) costs. The amount of interest capitalized is determined by applying the interest rate applicable to outstanding borrowings on the line of credit to the average amount of accumulated expenditures for properties under construction during the period. -40- 42 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued Assets Held for Sale: Assets held for sale are accounted for at the lower of cost or fair value, less costs to dispose. The Company recognizes gains and losses on the sale of properties when among other criteria, the parties are bound by terms of the contract, all consideration has been exchanged and all conditions precedent to closing have been performed. At the time the sale is consummated, a gain or loss is recognized as the difference between the sales price less any closing costs and the carrying value of the property. Long-Lived Assets: The Company assesses the recoverability of its long-lived assets, including residual interests of real estate assets and investments, based on projections of undiscounted cash flows over the life of such assets. In the event that such cash flows are insufficient, the assets are adjusted to their estimated fair value. Depreciation: Depreciation is computed using the straight-line method over the estimated useful lives of the properties, (generally forty years) and for furniture, fixtures and equipment (generally seven years). Foreign Currency Translation: The Company consolidates its real estate investments in France. The functional currency for these investments is the French Franc. The translation from the French Franc to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The gains and losses resulting from such translation are included in other comprehensive income as part of members' equity. Cash Equivalents: The Company considers all short-term, highly liquid investments that are both readily convertible to cash and have a maturity of generally three months or less at the time of purchase to be cash equivalents. Items classified as cash equivalents include commercial paper and money market funds. Substantially all of the Company's cash and cash equivalents at December 31, 1998 and 1997 were held in the custody of four and three financial institutions, respectively, and which exceed federally insurable limits. The Company mitigates this risk by depositing funds with major financial institutions. Other Assets and Liabilities: Included in other assets are accrued rents and interest receivable, deferred rental income, deferred charges and marketable securities. Included in other liabilities are accrued interest payable, accounts payable and accrued expenses and deferred gains. Deferred charges include costs incurred in connection with debt financing and refinancing and are amortized over the terms of the obligations. Deferred rental income is the aggregate difference for operating method leases between scheduled rents which vary during the lease term and rent recognized on a straight-line basis. Also included in deferred rental income are lease restructuring fees received which are recognized over the remainder of the initial lease terms. Deferred gains consisted of (a) the excess assets acquired over the liabilities assumed in connection with the acquisition of certain hotel operations and (b) certain funds received in connection with two loan refinancings, and which were being amortized into income. All unamortized deferred gain balances as of December 31, 1997 were written off in connection with purchase accounting. Marketable securities are classified as available-for-sale securities and reported at fair value with the Company's interest in unrealized gains and losses on these securities reported as a component of other comprehensive income. Such marketable securities had a cost basis of $1,800 and reflected a fair value of $1,513 at December 31, 1998. Equity Investments: The Company's limited partner interests in two real estate limited partnerships in which the Company's ownership is less than 50% are accounted for under the equity method, i.e., at cost, increased or decreased by the Company's pro rata share of earnings or losses, less distributions. The Company is the sole limited partner in the two partnerships both of which own net leased properties. -41- 43 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued An interest in the operating partnership of a publicly-traded real estate investment trust acquired in July 1996 is also accounted for under the equity method. Accounts Payable to Affiliates: Included in accounts payable to affiliates are deferred acquisition fees which are payable for services provided by Carey Management, relating to the identification, evaluation, negotiation, financing and purchase of properties. The fees are payable in eight annual installments, beginning January 1 following the first anniversary of the date a property was purchased, with each installment equal to .25% of the purchase price of the property. Income Taxes: The Company is a limited liability company and has elected partnership status for federal income tax purposes. The Company is not liable for Federal income taxes as each member recognizes his or her proportionate share of income or loss in his or her tax return. Accordingly, no provision for income taxes is recognized for financial statement purposes. The Company is subject to certain state and local taxes. Earnings Per Share: In accordance with the Statement of Financial Accounting Standards ("SFAS") No. 128, the Company presents both basic and diluted earnings per share ("EPS"). Basic EPS excludes dilution and is computed by dividing net income available to shareholders by the weighted average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue shares were exercised or converted into common stock, where such exercise or conversion would result in a lower EPS amount. Stock Based Compensation: The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations ("APB No. 25"). Under APB No. 25, compensation cost is measured as the excess, if any, of the quoted market price of the Company's shares at the date of grant over the exercise price of the option granted. Compensation cost for stock options, if any, is recognized ratably over the vesting period. No compensation cost was recognized in 1998 in connection with the Company's share option plans. The Company provides additional pro forma disclosures as required under SFAS No. 123, "Accounting for Stock Based Compensation" (see Note 20). All transactions with non-employees in which the Company issues stock as consideration for services received are accounted for based on the fair value of the stock issued or services received whichever is more reliably determinable. Reclassification: Certain 1997 and 1996 amounts have been reclassified to conform to the 1998 financial statement presentation. 3. Transactions with Related Parties: Through December 31, 1997, the Partnership agreements of each of the Company's Partnerships provided that the former General Partners (consisting of W. P. Carey & Co., Inc. ("W.P. Carey") or affiliated companies as Corporate General Partners and William P. Carey as Individual General Partner) were allocated between 1% and 10%, for the applicable Partnership, of the profits and losses and distributable cash from operations, as defined, and the Limited Partners were allocated between 90% and 99% of the profits and losses as well as -42- 44 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued distributable cash from operations. The Partners were also entitled to receive an allocation of gains and losses from the sale of properties and to receive net proceeds as provided in the Partnership agreements. As a result of the merger of the CPA(R) Partnerships into subsidiary partnerships of Carey Diversified, Carey Diversified is the sole general partner of the nine CPA(R) Partnerships. The allocation of profits and losses and cash distributions provided in the Partnership agreements as amended effective January 1, 1998, are on essentially on the same terms as prior to the Consolidation. Carey Diversified is allocated between 90% and 99% of the profits and losses and distributable cash from operations, and two special limited partners, Carey Management LLC ("Carey Management"), an affiliate, and William Polk Carey, are allocated between 1% and 10% of the profits and losses and distributable cash from operations. Until the subsidiary partnership interests, held by the limited partners of the CPA(R) Partnerships were redeemed in July 1998, that portion of the Company's share of profits and losses applicable to each Partnership was allocated to subsidiary partnership unitholders in proportion to their ownership interests. In connection with the merger of the CPA(R) Partnerships with Carey Diversified and the listing of shares of Carey Diversified on the New York Stock Exchange, the former Corporate General Partners of eight of the CPA(R) Partnerships satisfied provisions for receiving a subordinated preferred return from the Partnerships totaling $4,422 based upon the cumulative proceeds from the sale of the assets of each Partnership from inception through the date of the Consolidation. Payment of this preferred return, paid in 1998, was based on achieving a specified cumulative return to limited partners. For the Partnership that has not yet achieved the specified cumulative return, its subordinated preferred return of $1,423 is included in accounts payable to affiliates as of both December 31, 1998 and 1997. To satisfy the conditions for receiving this remaining preferred return, the shares of Carey Diversified must achieve a closing price equal to or in excess of $23.11 for five consecutive trading days. Under the Partnership agreements, certain affiliates were entitled to receive property management fees and reimbursement of certain expenses incurred in connection with the Company's operations. General and administrative reimbursements consist primarily of the actual cost of personnel needed in providing administrative services to the Company. Property management fees in 1998, 1997 and 1996 were $1,288, $1,139 and $916, respectively. General and administrative reimbursements in 1998, 1997 and 1996 were $1,540, $1,788 and $911, respectively. Effective January 1, 1998, the fees and reimbursements are payable to Carey Management. The Company's management and performance fees are payable, each at an annual rate of 1/2% of the total market capitalization of the Company. The Management Agreement, effective January 1, 1998, provides that the performance fee is payable in the form of restricted shares issued by the Company which vest ratably over a five-year period. Performance fees were $757 for 1998. The Company's management fee was $156 for 1998. The management fee reflects a dollar-for-dollar reduction for quarterly distributions paid to special limited partners and property management fees paid by the Partnerships to Carey Management. Carey Management performs certain services for the Company including the identification, evaluation, negotiation, purchase and disposition of property. Carey Management and certain affiliates receive fees and compensation in connection with these services, including acquisition and structuring and development fees, loan refinancing fees and disposition fees. In connection with performing services related to the Company's real estate purchases in 1998, W. P. Carey received structuring and development fees of $2,502. Fees are paid only in connection with completed transactions. The affiliate is entitled to receive deferred acquisition fees of $3,137 in equal annual installments over a period of no less than eight years. Unpaid deferred acquisition fees bear interest at an annual rate of 7%. In connection with the sale of three properties in 1998, the Company incurred disposition fees of $1,007, payable to an affiliate. The fees were paid in February 1999 and are included in accounts payable to affiliates in the accompanying consolidated financial statements as of December 31, 1998. -43- 45 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued For the years ended December 31, 1998, 1997 and 1996, fees aggregating $904, $664 and $902, respectively, were incurred for legal services in connection with the Company's operations and were provided by a law firm in which the Secretary, until July 1997, of the former Corporate General Partners of the CPA(R) Partnerships is a partner. The Company is a participant in an agreement with W.P. Carey and certain affiliates for the purpose of leasing office space used for the administration of the Company, other affiliated real estate entities and W.P. Carey and sharing the associated costs. Pursuant to the terms of the agreement, the Company's share of rental, occupancy and leasehold improvement costs is based on adjusted gross revenues, as defined. Expenses incurred in 1998, 1997 and 1996 were $558, $590 and $720, respectively. An independent director of the Company has an ownership interest in companies that own the minority interest in the Company's three French majority-owned subsidiaries. The director is not involved in the management of the three companies, and his ownership is subject to the same terms as all other ownership interests in the subsidiary companies. The Chairman of the Board of the Company is the sole shareholder of Livho, Inc., a lessee of the Company (see Note 6). 4. Real Estate Leased to Others Accounted for Under the Operating Method: Real estate leased to others, at cost, and accounted for under the operating method is summarized as follows: December 31, ------------ 1998 1997 ---- ---- The The Company Predecessor ------- ----------- Land $ 88,731 $ 69,154 Buildings 309,198 241,601 -------- -------- 397,929 310,755 Less: Accumulated depreciation 7,617 93,590 -------- -------- $390,312 $217,165 ======== ======== The scheduled future minimum rents, exclusive of renewals, under noncancellable operating leases amount to $42,902 in 1999, $40,089 in 2000, $38,346 in 2001, $36,808 in 2002, $32,678 in 2003 and aggregate $334,621 through 2017. Contingent rentals were $614, $2,022 and $1,697 in 1998, 1997 and 1996, respectively. 5. Net Investment in Direct Financing Leases: Net investment in direct financing leases is summarized as follows: December 31, ------------ 1998 1997 ---- ---- The The Company Predecessor ------- ----------- Minimum lease payments receivable $398,520 $402,530 Unguaranteed residual value 294,891 210,887 -------- -------- 693,411 613,417 Less: Unearned income 397,585 396,656 -------- -------- $295,826 $216,761 ======== ======== The scheduled future minimum rents, exclusive of renewals, under noncancellable direct financing leases amount to $32,145 in 1999, $31,138 in 2000, $31,624 in 2001, $30,404 in 2002, $30,402 in 2003 and aggregate $398,520 through 2016. Contingent rentals were approximately $320, $4,533 and $3,444 in 1998, 1997 and 1996, respectively. -44- 46 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued 6. Operating Real Estate: The Company currently owns hotel properties in Alpena and Petoskey, Michigan that are operated as Holiday Inns. A hotel in Rapid City, South Dakota was sold in 1996, and a hotel in Livonia, Michigan was operated by the Company through January 1998. In January 1998, the Company transferred the operations to and entered into a lease with Livho, Inc. ("Livho"). The Livonia hotel was leased to Livho to enable the Company to elect publicly-traded partnership status for Federal income tax purposes. As a publicly traded partnership, at least 90% of revenues must derive from passive activities. Based on its revenue projections, the Company concluded that meeting the passive income criterion could become an issue if it had retained the Livonia hotel operation. In connection with the transfer of the property in Livonia, Michigan, $16,563 of operating real estate was reclassified to real estate accounted for under the operating method. 7. Mortgage Notes Payable and Notes Payable: Mortgage notes payable, substantially all of which are limited recourse obligations, are collateralized by the assignment of various leases and by real property with a carrying value of approximately $254,865. As of December 31, 1998, mortgage notes and notes payable have interest rates varying from 4.85% to 10.00% per annum and mature from 1999 to 2015. On March 26, 1998, the Company obtained a line of credit of $150,000 pursuant to a revolving credit agreement with The Chase Manhattan Bank. The agreement was amended on October 15, 1998 to increase of the line of credit to $185,000 with the number of lenders participating in the syndication increased from three to eight. The revolving credit agreement has a term of three years and all advances are prepayable at any time. As of December 31,1998, the Company had $129,000 drawn from the line of credit. Additional advances of $29,000 were drawn from the line of credit in 1999. Advances made bear interest at an annual rate of either (i) the one, two, three or six-month LIBOR, as defined, plus a spread which ranges from 0.6% to 1.45% depending on leverage or corporate credit rating or (ii) the greater of the bank's Prime Rate and the Federal Funds Effective Rate, plus .50%, plus a spread of up to .125% depending upon the Company's leverage. In addition, the Company will pay a fee (a) ranging between 0.15% and 0.20% per annum of the unused portion of the credit facility, depending on the Company's leverage, if no minimum credit rating for the Company is in effect or (b) equal to .15% of the total commitment amount, if the Company has obtained a certain minimum credit rating. The revolving credit agreement has financial covenants that require the Company to (i) maintain minimum equity value of $400,000 plus 85% of amounts received by the Company as proceeds from the issuance of equity interests and (ii) meet or exceed certain operating and coverage ratios. Such operating and coverage ratios include, but are not limited to, (a) ratios of earnings before interest, taxes, depreciation and amortization to fixed charges for interest and (b) ratios of net operating income, as defined, to interest expense. The Company has always been in compliance with the financial covenants. -45- 47 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued Scheduled principal payments for the mortgage notes and notes payable during each of the next five years following December 31, 1998 and thereafter are as follows: Year Ending December 31, ------------------------ 1999 $ 19,608 2000 5,752 2001 147,589 2002 7,890 2003 8,253 Thereafter 82,206 -------- $271,298 ======== Interest paid by the Company on mortgages and notes payable aggregated approximately $17,936, $19,534 and $23,805 in 1998, 1997 and 1996 respectively. Capitalized interest paid by the Company was $910 for 1998. In connection with the placement of mortgages, fees of $1,001 were paid to an affiliate of the Company in 1998. 8. Distributions and Dividends: Dividends paid to shareholders for 1998 are summarized as follows 1998: Quarterly $30,820 ======= The Company declared a quarterly dividend of $.4125 per share on December 16, 1998 payable to shareholders of record as of December 31, 1998. The dividend was paid in January 1999. Distributions paid to partners for 1997 and 1996 are summarized as follows: 1997: Quarterly $42,828 Special 792 ------- $43,620 ======= 1996: Quarterly $33,350 Special 823 ------- $34,173 ======= -46- 48 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued 9. Earnings Per Share: Basic and diluted earnings per share for the year ended December 31,1998 were calculated as follows: Weighted Income Average Per Available to Listed Shares Share To Members Outstanding Amount ---------- ----------- ------ Basic earnings before extraordinary item $ 39,085 24,866,225 $ 1.57 Extraordinary item (621) (.02) ----------- ----------- Basic earnings $ 38,464 24,866,225 $ 1.55 =========== =========== Effect of dilutive securities - options for shares 3,345 ---------- Diluted earnings before extraordinary item $ 39,085 24,869,570 $ 1.57 Extraordinary item (621) (.02) ----------- ----------- Diluted earnings $ 38,464 24,869,570 $ 1.55 =========== =========== 10. Lease Revenues: For the years ended December 31, 1998, 1997 and 1996, the Company earned its net leasing revenues (i.e., rental income and interest income from direct financing leases) from over 75 lessees. A summary of net leasing revenues including all current lease obligors with more than $1,000 in annual revenues is as follows: Years Ended December 31, ------------------------------------------------------------ 1998 % 1997 % 1996 % ------- ---- ------- ---- ------- ---- Dr Pepper Bottling Company of Texas $ 3,998 5% $ 3,998 5% $ 3,998 5% Gibson Greetings, Inc. 3,870 5 3,466 5 3,384 4 Detroit Diesel Corporation 3,658 5 3,645 5 3,645 5 Sybron International Corporation 3,311 4 3,311 4 3,311 4 Livho, Inc. 2,958 4 Quebecor Printing Inc. 2,523 3 2,618 4 2,533 3 AutoZone, Inc. 2,469 3 2,512 3 2,304 3 Furon Company 2,415 3 2,416 3 2,528 3 Stoody Deloro Stellite, Inc. (a) 2,234 3 2,725 4 2,624 3 The Gap, Inc. 2,199 3 2,154 3 2,154 3 Orbital Sciences Corporation 2,154 3 2,154 3 2,154 3 Hughes Markets, Inc. 1,928 3 5,784 7 4,463 6 AP Parts International, Inc. 1,783 2 1,837 2 1,729 2 NVR, Inc. 1,721 2 1,819 2 1,814 2 Unisource Worldwide, Inc. 1,714 2 1,654 2 1,646 2 Pre Finish Metals Incorporated 1,636 2 2,421 3 2,408 3 Lockheed Martin Corporation 1,621 2 1,131 1 1,035 1 CSS Industries, Inc./Cleo, Inc. 1,580 2 1,844 2 1,793 2 Peerless Chain Company 1,463 2 1,709 2 1,611 2 Brodart, Co. 1,432 2 1,308 2 1,314 2 Red Bank Distribution, Inc. 1,401 2 1,401 2 1,401 2 Copeland Beverage Group, Inc.. 1,200 2 High Voltage Engineering Corp. 1,187 2 1,174 2 1,179 2 Duff-Norton Company, Inc. 1,164 2 1,021 1 1,021 1 United States Postal Service 1,090 1 894 1 482 1 Other 24,591 31 24,623 32 26,689 36 ------- ---- ------- ---- ------- ---- $77,300 100% $77,619 100% $77,220 100% ======= ==== ======= ==== ======= ==== (a) Stoody Deloro Stellite, Inc. assigned its leases in 1997. Leases were assigned to DS Company, Ltd. and Thermodyne Holdings Corp., respectively. -47- 49 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued 11. Gains and Losses on Disposition of Properties: Significant sales of properties are summarized as follows: 1998 On April 1, 1998 Simplicity Manufacturing, Inc. purchased its leased property in Port Washington, Wisconsin for $9,684 pursuant to a purchase option exercised in 1997. A loss of $291 was recognized on the sale. The carrying value of the Simplicity property of $9,684 was included in assets held for sale in the accompanying balance sheet at December 31, 1997 and the Company recognized a noncash charge of $2,316 in 1997 on the writedown of the property to the purchase option price. In December 1998, NVR, Inc. purchased its leased property in Pittsburgh, Pennsylvania for $12,193 pursuant to a purchase option exercised in 1998. A gain of $1,754 was recognized on the sale. In accordance with the partnership agreement of the Partnership that owned the NVR property, the gain was first allocated to a special limited partner with a negative capital balance until the negative balance was eliminated. As a result, $1,381 of the gain was allocated to that partner for financial reporting purposes. 1997 In 1997, the Company sold a property in Louisville, Kentucky leased to Winn-Dixie Stores, Inc. for $1,100 and recognized a gain on sale of $608. The Company owned two properties in Sumter and Columbia, South Carolina that were leased to Arley Merchandise Corporation ("Arley"). In July 1997, the Arley lease was terminated by the Bankruptcy Court in connection with Arley's voluntary petition of bankruptcy. In connection with the termination of the lease, the Company wrote down the Arley properties by $1,350. In May 1997, the lender on the limited recourse mortgage loan collateralized by the Arley properties made a demand for payment for the entire outstanding principal balance of the loan of $4,755. In November 1997 the lender foreclosed on the properties and the ownership of the Arley properties was transferred to the lender. In connection with the foreclosure, the Company recognized a gain of $957 representing the difference between liabilities forgiven and assets surrendered. 1996 In January 1996, the Company sold a multi-tenant property in Helena, Montana with IBM Corporation as the primary tenant for $4,800 and recognized a gain on the sale of $90. All of the Company's leases at the Helena property, including the IBM lease, were assigned to the purchaser. In April 1996, the Company sold its warehouse property in Hodgkins, Illinois leased to GATX Logistics, Inc. ("GATX") for $13,200, assigned the GATX lease to the purchaser and recognized a gain on the sale of $4,408. In 1985, the Company purchased a hotel in Rapid City, South Dakota, operated as a Holiday Inn, with $6,800 of tax-exempt bonds supported by a letter of credit issued by a third party. In September 1994, the Company was advised by Holiday Inn that it would need to upgrade the hotel's physical plant by January 1997 in order to meet Holiday Inn's modernization requirements or surrender its Holiday Inn license. Management concluded that the required additional investment was not in the best interests of the Company and decided to sell the property. In 1995, the Company reevaluated the fair value of the property and recognized a noncash charge of $1,000. In 1996, the Company recognized an additional charge of $1,300 as a writedown to fair value. -48- 50 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued In October 1996, the Company sold the property along with certain operating assets and liabilities of the hotel for $4,105 and recognized a gain on the sale of $785. 12. Extraordinary Gains and Losses on Extinguishment of Debt: 1998 In connection with the prepayment of high interest loans collateralized by properties leased to Dr Pepper Bottling Company of Texas, Orbital Sciences Corporation and Simplicity Manufacturing, Inc., the Company incurred $700 in prepayment charges resulting in an extraordinary loss on the extinguishment of debt of $621, net of $79 attributable to minority interests. 1996 In 1996, the Company obtained $6,400 of new limited recourse mortgage financing on one of its properties leased to The Gap, Inc. (the "Gap"). Proceeds from the mortgage financing were used to pay off the remaining balance of $6,195 on an existing mortgage loan on the Gap property, certain refinancing costs and prepayment charges of $255. The prepayment charges have been recognized as an extraordinary loss on the extinguishment of debt, net of $3 attributable to minority interests. 13. Writedowns to Fair Value: Significant writedowns of properties to fair value are summarized as follows: 1998 The Company owns a property in Urbana, Illinois net leased to Motorola, Inc. ("Motorola"). During 1998, Motorola notified the Company of its intention to exercise its option to purchase the property. The exercise price is determined based on independent appraisals performed on behalf of the Company and Motorola. Based on the appraisal prepared for the Company, the Company believes the fair value of the property, less costs to sell, is $3,012 resulting in a writedown of $1,575. 1997 As described in Note 11, Simplicity Manufacturing, Inc. ("Simplicity") in connection with the exercise of its option to purchase the property it leased from the Company in Port Washington, Wisconsin on or before April 1, 1998, the Company concluded that it was not likely that the agreed-upon exercise price would be in excess of the minimum exercise price of $9,684. Accordingly, the Company recognized a noncash charge of $2,316 on the writedown of the property to the anticipated exercise price. The Company owned two properties in Sumter and Columbia, South Carolina leased to Arley. As more fully described in Note 11, the Company reevaluated the fair value of the property in connection with the termination of the Arley lease and recognized a noncash charge of $1,350. 1996 The Company owned a hotel property in Rapid City, South Dakota that it sold in October 1996. As more fully described in Note 11, the Company reevaluated the fair value of the property in 1996 and recognized a noncash charge of $1,300 on the writedown. -49- 51 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued 14. Equity Investments: The Company purchased a hotel property in Kenner, Louisiana, in June 1988. The Company assumed operating control of the hotel in 1992 after evicting the lessee as a result of its financial difficulties. On July 30, 1996, the Company exchanged the hotel for a partnership interest in American General Hospitality Operating Partnership L.P. the operating partnership of a real estate investment trust, American General Hospitality Corporation, ("AGH"). In connection with the exchange, the Company and the AGH operating partnership assumed the $7,304 mortgage loan obligation collateralized by the hotel property. The exchange of the hotel property for limited partnership units was treated as a nonmonetary exchange for tax and financial reporting purposes. As the result of the August 1998 merger of AGH with Meristar Hospitality Corporation ("Meristar") and CapStar Hotel Co., the Company's 920,672 units of the operating partnership of AGH were exchanged for 780,269 units of the operating partnership of Meristar. The Company's interest in the Meristar operating partnership is being accounted for under the equity method. The Company has the right to convert its equity interest in the Meristar operating partnership to shares of common stock in Meristar at any time on a one-for-one basis. The exchange of operating partnership units for common stock would be taxable in the year of the exchange. The Company's carrying value for the operating partnership units at the time of the exchange of $9,292 was based on the historical basis of assets transferred, net of liabilities assumed by the AGH operating partnership, cash contributed and costs incurred to complete the exchange. As of December 31, 1998, the audited consolidated financial statements of Meristar filed with the United States Securities and Exchange Commission ("SEC") reported total assets of $2,998,460 and shareholders' equity of $1,150,992 and revenues of $525,297 and net income of $43,707 for the year then ended. As of December 31, 1997 and 1996, the audited consolidated financial statements of AGH filed with the SEC reported total assets of $585,088 and $243,115 and stockholders' equity of $443,250 and $127,461, respectively, and revenues of $61,912 and $13,496 and net income of $23,485 and $5,129 for the year ended December 31, 1997 and the period from July 31, 1996 (inception) to December 31, 1996, respectively. As of December 31, 1998, Meristar's quoted per share market value was $18.56 resulting in an aggregate value of approximately $14,484, if converted. The carrying value of the equity interest in the Meristar operating partnership as of December 31, 1998 was $24,070. The Company owns equity interests in two limited partnerships that own net leased real estate as a limited partner with Corporate Property Associates 10 Incorporated, an affiliate, that owns the remaining controlling interests as a general partner. Summarized combined financial information of the two limited partnerships is as follows: December 31, -------------------------- 1998 1997 ---- ---- Assets $46,391 $47,666 Liabilities 32,399 32,986 Capital 13,992 14,680 Year Ended December 31, ---------------------------------- 1998 1997 1996 ---- ---- ---- Revenue $6,990 $6,909 $6,852 Expenses 4,536 4,593 4,647 Net income 2,454 2,316 2,205 -50- 52 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued 15. Assets Held for Sale: In December 1996, KSG, Inc. ("KSG") notified the Company that it was exercising its option to purchase the property it leases in Hazelwood, Missouri. The Company and KSG have not been able to reach an agreement as to the determination of the exercise price between a minimum exercise price of $9,000 and a maximum exercise price of $11,500, but have agreed that the determination of the final exercise price is contingent on the resolution of a dispute regarding the interpretation of the lease. All rental payments due under the lease with KSG are current. The carrying value of the KSG property at December 31, 1998 and 1997 was $9,860 and $4,698 respectively. As described in Note 13, Motorola has exercised its option to purchase the property it leases in Urbana, Illinois. The sale of the property is scheduled to occur no later than January 2000. 16. Disclosures About Fair Value of Financial Instruments: The carrying amounts of cash, accounts receivable, accounts payable and accrued expenses approximate fair value because of the short maturity of these items. The Company estimates that the fair value of mortgage notes payable and other notes payable approximated the carrying amounts for such loans at December 31, 1997 and was $272,075 at December 31, 1998. The fair value of debt instruments was evaluated using a discounted cash flow model with discount rates that take into account the credit of the tenants and interest rate risk. 17. Purchase of Real Estate: Purchases of real estate for the quarter ended December 31, 1998 were as follows: On November 16, 1998, the Company purchased land and an office building in Rouen, France for approximately $2,336 with financing of $1,788 obtained from a limited recourse mortgage loan. The property is leased to a governmental agency, Direction Regional des Affaires Sanitaires et Sociales, at an initial annual rent of $243. Rent will increase annually based on increases in the INSEE index, an index of increases in construction costs published by the French government. The lease has a term of nine years. The mortgage loan is collateralized by the Rouen property, and has a 15-year term with 85% of the balance amortizing over the term of the loan, and a balloon payment of approximately $268 due on the maturity date. The loan bears annual interest at 5.16% during the first five years with the rate to be reset based on the then prevailing interest rates. In connection with performing services relating to the Company's real estate purchases in 1998, an affiliate of the Company received acquisition fees of $1,001 in 1998. 18. Subsequent Events: In 1999, the Company entered into an agreement with J.A. Billipp Development Corporation ("Billipp") to provide Billipp up to $4,100 of limited recourse mortgage financing. As of March 15, 1999, $3,629 has been funded with a commitment to fund the remaining $471 after certain conditions are met. The $4,100 of mortgage loans are collateralized by deed of trust on a property located in Austin, Texas and a lease assignment. The loans provide for monthly payments of interest at an annual rate of 9.5%. In the event the property is not occupied by one or more tenants during the term of the loan, any monthly installments of interest due may be deferred until the maturity date, February 1, 2002, at an annual rate of 12% during the deferral period. In connection with providing the limited recourse mortgage financing, Billipp granted the -51- 53 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued Company a participating interest in the property's operating cash flow. The participation provides that the Company receive 25% of the net cash flow from operations, as defined for twelve years after the earlier of the maturity of the loan and payment in full of the loan. The Company also received an option to purchase the collateralized property. In February 1999, the Company, through a majority owned newly-formed subsidiary, entered into a net lease with Cendant Operations, Inc. ("Cendant") at an existing Company property in Moorestown, New Jersey. Cendant will occupy the property upon completion of the property's renovation, which is expected to occur in the third quarter of 1999. The minority owner of the subsidiary is a real estate developer who will oversee the renovation. The Company has contributed the property to the subsidiary and will fund up to an additional $3,100 for renovations to the property. Cendant is obligated to pay $472 of the renovation costs. The contribution of the property to the majority-owned subsidiary will be recorded at its historical cost. The agreement with the real estate developer provides that the Company will receive a preferred annualized return of 9% on its capital contributions, as defined. After the payment of the preferred return, any remaining cash flow will be allocated 75% to the Company and 25% to the minority owner. The minority owner will receive up to $150 for a development fee and a one-time leasing fee equal to 2% of the annual rent, net of certain expenses. The lease with Cendant has a five-year term that commences upon substantial completion of renovations. Annual rents will initially be $1,016 with stated increases every year. On March 1, 1999, the Company and Armel, Inc., a tenant of a Company property in Ft. Lauderdale, Florida, agreed to a lease termination. Although the lease was scheduled to expire in August 2001, the Company agreed to an early termination in consideration for payments of $1,540, representing approximately 62% of the rents due for what would have been the remaining lease term. Armel's annual rent was $965. Bell South Entertainment, Inc. has entered into a ten-year lease for the property, commencing July 1999, at an annual rent of $300 with stated increases every year. The termination will be amortized into revenue over the remaining life of the Armel lease, which approximately 30 months, as a result of reduced rents under the new lease. 19. Selected Quarterly Financial Data (unaudited): Three Months Three Months Three Months Three Months Year ended ended ended ended ended March 31, June 30, September 30, December 31, December 31, 1998 1998 1998 1998 1998 -------------------------------------------------------------------------------------------- Revenues $21,701 $20,636 $21,306 $21,687 $85,330 Expenses 11,044 10,339 10,646 12,903 44,932 Income before extraordinary items 10,283 9,987 10,138 8,625 39,085 Net income 9,714 9,987 10,138 8,625 38,464 Net income per share - basic and diluted .40 .40 .40 .35 1.55 Dividends declared per share .4125 .4125 .4125 .4125 1.65 20. Stock Options and Warrants: W. P. Carey was granted warrants for 2,284,800 shares exercisable at $21 per share and 725,930 shares exercisable at $23 per share as compensation for investment banking services in connection with structuring the consolidation (see Note 1). The warrants are exercisable over 10 years beginning January 1999. -52- 54 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued The Company maintains stock option plans pursuant to which share options may be issued. The 1997 Share Incentive Plan (the "Incentive Plan") authorizes the issuance of up to 700,000 shares. The Company Non-Employee Directors' Plan (the "Directors' Plan") authorizes the issuance of up to 300,000 shares. The Incentive Plan provides for the grant of (i) share options which may or may not qualify as incentive stock options, (ii) performance shares, (iii) dividend equivalent rights and (iv) restricted shares. On January 1, 1998, share options for 113,500 shares at an exercise price of $20 per share were granted. The options granted under the Incentive Plan have a 10-year term and are exercisable for one-third of the granted options on the first, second and third anniversaries of the date of grant. The vesting of grants; however, may be accelerated upon a change in control of the Company. The Directors' Plan provides for the same terms as the Incentive Plan. In January 1998, 23,846 share options were granted at an exercise price of $20 per share. Share option and warrant activity is as follows: Weighted Average Number of Exercise Price Shares Per Share ------ --------- Balance at January 1, 1998 -- Granted 3,148,076 $ 21.42 Exercised Forfeited --------- --------- Balance at December 31, 1998 3,148,076 $ 21.42 ========= ========= At December 31, 1998, the range of exercise prices and weighted-average remaining contractual life of outstanding share options and warrants was $20 to $23 and ten years, respectively. The per share weighted average fair value of share options and warrants issued during 1998 were estimated to be $1.45 using a binomial option pricing formula. The more significant assumptions underlying the determination of the weighted average fair value include a risk-free interest rate of 5.36%, a volatility factor of 18.16% and a dividend yield of 7.33% and an expected life of ten years. The Company has elected to adopt the disclosure only provisions of SFAS No. 123. If stock based compensation cost had been recognized based upon fair value at the date of grant for options awarded under the two plans in accordance with the provisions of SFAS No. 123, pro forma net income for 1998 would have been $38,299 and pro forma basic and diluted earnings per share would have been $1.54. 38,500 and 3,302 share options were granted under the Incentive Plan and Directors' Plan, respectively, in January 1999. -53- 55 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued 21. Segment Reporting: The Company has adopted Statement of Financial Accounting Standards ("FASB") No. 131 "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131") which establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. The Company operates in two business segments - real estate operations with domestic and international investments and hotel operations. The two segments are summarized as follows: Real Estate Hotel Total Company ----------- ----- ------------- Revenues: 1998 $ 79,041 $ 6,289 $ 85,330 1997 81,748 14,523 96,271 1996 79,647 21,929 101,576 Operating and interest expenses: (excluding depreciation and amoritization) 1998 $ 31,570 $ 4,956 $ 36,526 1997 35,399 10,748 46,147 1996 32,255 15,947 48,202 Income from equity investments: 1998 $ 1,837 $ 1,837 1997 2,076 2,076 1996 1,155 1,155 Net operating income (1): 1998 $ 36,320 $ 1,253 $ 37,573 1997 35,447 3,549 38,996 1996 34,450 5,623 40,073 Total assets: 1998 $804,755 $ 8,509 $813,264 1997 497,722 25,698 523,420 1996 518,577 26,151 544,728 Total long-lived assets: 1998 $784,368 $ 7,013 $791,381 1997 461,723 23,333 485,056 1996 476,984 24,080 501,064 The Company acquired its first international real estate investment in 1998. For 1998, geographic information is as follows: Domestic International Total Company -------- ------------- ------------- Revenues $ 84,503 $ 827 $ 85,330 Operating and interest expense 35,982 544 36,526 Net operating income 37,477 96 37,573 Total assets 789,884 23,380 813,264 Total long-lived assets 772,413 18,968 791,381 (1) Net operating income represents income before gains and extraordinary items. -54- 56 CAREY DIVERSIFIED LLC NOTES to CONSOLIDATED/COMBINED FINANCIAL STATEMENTS, Continued 22. Accounting Pronouncement: In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133 is effective for all quarters of fiscal years beginning after June 15, 1999 (January 1, 2000 for the Company). The Company believes that adoption of SFAS No. 133 will not have a material impact on the consolidated financial statements. -55- 57 Item 9. Disagreements on Accounting and Financial Disclosure. NONE -56- 58 PART III Item 10. Directors and Executive Officers of the Registrant. This information will be contained in Company's definitive Proxy Statement with respect to the Company's 1999 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company's fiscal year, and is hereby incorporated by reference. Item 11. Executive Compensation. This information will be contained in Company's definitive Proxy Statement with respect to the Company's 1999 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company's fiscal year, and is hereby incorporated by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management. This information will be contained in Company's definitive Proxy Statement with respect to the Company's 1999 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company's fiscal year, and is hereby incorporated by reference. Item 13. Certain Relationships and Related Transactions. This information will be contained in Company's definitive Proxy Statement with respect to the Company's 1999 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission within 120 days following the end of the Company's fiscal year, and is hereby incorporated by reference. -57- 59 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) 1. Financial Statements: The following financial statements are filed as a part of this Report: Consolidated/Combined Report of Independent Accountants. Consolidated/Combined Balance Sheets, December 31, 1998 and 1997. Consolidated/Combined Statements of Income for the years ended December 31, 1998, 1997 and 1996. Consolidated Statement of Members' Equity for the year ended December 31, 1998. Consolidated/Combined Statements of Partners' Capital for the years ended December 31, 1996 and1997. Consolidated/Combined Statements of Comprehensive Income for the years ended December 31, 1996, 1997 and 1998. Consolidated/Combined Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996. Notes to Consolidated/Combined Financial Statements. (a) 2. Financial Statement Schedule: The following schedule is filed as a part of this Report: Schedule III - Real Estate and Accumulated Depreciation as of December 31, 1998. Notes to Schedule III. Financial Statement Schedules other than those listed above are omitted because the required information is given in the Financial Statements, including the Notes thereto, or because the conditions requiring their filing do not exist. -58- 60 (a) 3 Exhibits: The following exhibits are filed as part of this Report. Documents other than those designated as being filed herewith are incorporated herein by reference. Exhibit Method of No. Description Filing - ------- ----------- --------------------------- 3.1 Amended and Restated Limited Liability Company Exhibit 3.1 to Registration Agreement of Carey Diversified LLC. Statement on Form S-4 (No. 333-37901) 3.2 Bylaws of Carey Diversified LLC. Exhibit 3.2 to Registration Statement on Form S-4 (No. 333-37901) 4.1 Form of Listed Share Stock Certificate. Exhibit 4.1 to Registration Statement on Form S-4 (No. 333-37901) 10.1 Management Agreement Between Carey Management LLC Exhibit 10.1 to Registration and the Company. Statement on Form S-4 (No. 333-37901) 10.2 Non-Employee Directors' Incentive Plan. Exhibit 10.2 to Registration Statement on Form S-4 (No. 333-37901) 10.3 1997 Share Incentive Plan. Exhibit 10.3 to Registration Statement on Form S-4 (No. 333-37901) 10.4 Investment Banking Engagement Letter between Exhibit 10.4 to Registration W. P. Carey & Co. and the Company. Statement on Form S-4 (No. 333-37901) 10.5 Non-Statutory Listed Share Option Agreement. Exhibit 10.5 to Registration Statement on Form S-4 (No. 333-37901) 10.6 Credit Agreement by and among Carey Diversified LLC, Exhibit 10.1 to Form 8-K Chase Manhattan Bank, and the Bank of New York, dated dated May 15, 1998. March, 26, 1998 21.1 List of Registrant Subsidiaries Filed herewith 23.1 Consent of PricewaterhouseCoopers LLP Filed herewith 99.13 Amended and Restated Agreement of Limited Partnership Exhibit 99.13 to Registration of CPA(R):1. Statement on Form S-4 (No. 333-37901) 99.14 Amended and Restated Agreement of Limited Partnership Exhibit 99.14 to Registration of CPA(R):2. Statement on Form S-4 (No. 333-37901) -59- 61 Exhibit Method of No. Description Filing - ------- ----------- --------------------------- 99.15 Amended and Restated Agreement of Limited Partnership Exhibit 99.15 to Registration of CPA(R):3. Statement on Form S-4 (No. 333-37901) 99.23 Press Release from Carey Diversified LLC Exhibit 99.1 to Form 8-K (March 26, 1998) dated May 15, 1998 99.16 Amended and Restated Agreement of Limited Partnership Exhibit 99.16 to Registration of CPA(R):4. Statement on Form S-4 (No. 333-37901) 99.17 Amended and Restated Agreement of Limited Partnership Exhibit 99.17 to Registration of CPA(R):5. Statement on Form S-4 (No. 333-37901) 99.18 Amended and Restated Agreement of Limited Partnership Exhibit 99.18 to Registration of CPA(R):6. Statement on Form S-4 (No. 333-37901) 99.19 Amended and Restated Agreement of Limited Partnership Exhibit 99.19 to Registration of CPA(R):7. Statement on Form S-4 (No. 333-37901) 99.20 Amended and Restated Agreement of Limited Partnership Exhibit 99.20 to Registration of CPA(R):8. Statement on Form S-4 (No. 333-37901) 99.21 Amended and Restated Agreement of Limited Partnership Exhibit 99.21 to Registration of CPA(R):9. Statement on Form S-4 (No. 333-37901) 99.22 Listed Share Purchase Warrant. Exhibit 99.22 to Registration Statement on Form S-4 (No. 333-37901) 99.23 Press release from Carey Diversified LLC Exhibit 99.1 to Form 8-K (March 26, 1998) dated May 15, 1998 -60- 62 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CAREY DIVERSIFIED LLC 5/1/00 BY: /s/ John J. Park ---------- ------------------------------------------------------ Date John J. Park Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial 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 registrant and in the capacities and on the dates indicated. BY: CAREY DIVERSIFIED LLC 5/1/00 BY: /s/ John J. Park ---------- ------------------------------------------------------ Date John J. Park Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) 5/1/00 BY: /s/ Claude Fernandez ---------- ------------------------------------------------------ Date Claude Fernandez Executive Vice President, Chief Administrative Officer (Principal Accounting Officer) -61- 63 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Company Cost Increase ------------------------------------- Capitalized (Decrease) Personal Subsequent to in Net Description Encumbrances Land Buildings Property Acquisition (a) Investment (b) ----------- ------------ ---- --------- -------- --------------- -------------- Operating Method: Office, warehouse and manufacturing buildings leased to various tenants in Broomfield, Colorado $2,090,065 $ 247,993 $ 2,538,263 Office and manufacturing building leased to IMO Industries Inc. 1,718,172 814,267 4,761,042 Distribution facilities and warehouses leased to The Gap, Inc. 5,728,660 1,525,593 21,427,148 Supermarkets leased to Winn-Dixie Stores, Inc. 855,196 6,762,374 Land leased to Kobacker Stores, Inc. 1,186,443 Warehouse and manufac- turing plant leased to Pre Finish Metals Incorporated 324,046 8,408,833 Retail store leased to A. Jones 16,452 80,937 Retail store leased to Wexler & Wexler 73,267 116,019 Retail stores leased to Kinko's of Ohio, Inc. 14,844 185,541 Warehouse and distribution center leased to, B&G Contract Packaging, Inc. 201,721 2,870,928 Gross Amount at which Carried at Close of Period (c) -------------------------------------------------------------- Personal Accumulated Description Land Buildings Property Total Depreciation ----------- ---- --------- -------- ----- ------------ Operating Method: Office, warehouse and manufacturing buildings leased to various tenants in Broomfield, Colorado $ 247,993 $ 2,538,263 $ 2,786,256 $ 63,457 Office and manufacturing building leased to IMO Industries Inc. 814,267 4,761,042 5,575,309 119,026 Distribution facilities and warehouses leased to The Gap, Inc. 1,525,593 21,427,148 22,952,741 535,678 Supermarkets leased to Winn-Dixie Stores, Inc. 855,196 6,762,374 7,617,570 169,059 Land leased to Kobacker Stores, Inc. 1,186,443 1,186,443 Warehouse and manufac- turing plant leased to Pre Finish Metals Incorporated 324,046 8,408,833 8,732,879 210,222 Retail store leased to A. Jones 16,452 80,937 97,389 2,023 Retail store leased to Wexler & Wexler 73,267 116,019 189,286 2,900 Retail stores leased to Kinko's of Ohio, Inc. 14,844 185,541 200,385 4,638 Warehouse and distribution center leased to, B&G Contract Packaging, Inc. 201,721 2,870,928 3,072,649 71,773 Life on which Depreciation In Latest Statement of Income Description Date Acquired is Computed ----------- ------------- ----------------------- Operating Method: Office, warehouse and manufacturing buildings leased to various tenants in Broomfield, Colorado January 1, 1998 40 yrs. Office and manufacturing building leased to IMO Industries Inc. January 1, 1998 40 yrs. Distribution facilities and warehouses leased to The Gap, Inc. January 1, 1998 40 yrs. Supermarkets leased to Winn-Dixie Stores, Inc. January 1, 1998 40 yrs. Land leased to Kobacker Stores, Inc. January 1, 1998 N/A Warehouse and manufac- turing plant leased to Pre Finish Metals Incorporated January 1, 1998 40 yrs. Retail store leased to A. Jones January 1, 1998 40 yrs. Retail store leased to Wexler & Wexler January 1, 1998 40 yrs. Retail stores leased to Kinko's of Ohio, Inc. January 1, 1998 40 yrs. Warehouse and distribution center leased to, B&G Contract Packaging, Inc. January 1, 1998 40 yrs. -62- 64 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Company Cost Increase ------------------------------------- Capitalized (Decrease) Personal Subsequent to in Net Description Encumbrances Land Buildings Property Acquisition (a) Investment (b) ----------- ------------ ---- --------- -------- --------------- -------------- Operating Method (continued): Land leased to Unisource Worldwide, Inc. 2,056,876 4,573,360 Centralized telephone bureau leased to Excel Communications, Inc. 925,162 4,023,627 Dairy processing facility leased to Copeland Beverage Group, Inc. 2,283,470 10,911,060 $ 373,503 Office building in Beaumont, Texas leased to Petrocon Engineering, Inc. and Olmstead Kirk Paper Company 164,113 2,343,849 Office, manufacturing and warehouse buildings leased to Continental Casualty Company 1,389,951 5,337,002 Warehouse and distribution center in Salisbury, North Carolina leased to Family Dollar Services, Inc. 246,949 5,034,911 1,214,451 Manufacturing and office buildings leased to Penn Virginia Corporation 652,668 4,074,346 Land leased to Exide Electronics Corporation 1,638,012 Motion picture theaters leased to Harcourt General Corporation 1,739,087 1,527,425 5,709,495 Gross Amount at which Carried at Close of Period (c) -------------------------------------------------------------- Personal Accumulated Description Land Buildings Property Total Depreciation ----------- ---- --------- -------- ----- ------------ Operating Method (continued): Land leased to Unisource Worldwide, Inc. 4,573,360 4,573,360 Centralized telephone bureau leased to Excel Communications, Inc. 925,162 4,023,627 4,948,789 100,590 Dairy processing facility leased to Copeland Beverage Group, Inc. 2,656,973 10,911,060 13,568,033 272,776 Office building in Beaumont, Texas leased to Petrocon Engineering, Inc. and Olmstead Kirk Paper Company 164,113 2,343,849 2,507,962 58,596 Office, manufacturing and warehouse buildings leased to Continental Casualty Company 1,389,951 5,337,002 6,726,953 133,425 Warehouse and distribution center in Salisbury, North Carolina leased to Family Dollar Services, Inc. 246,949 6,249,362 6,496,311 131,999 Manufacturing and office buildings leased to Penn Virginia Corporation 652,668 4,074,346 4,727,014 101,858 Land leased to Exide Electronics Corporation 1,638,012 1,638,012 Motion picture theaters leased to Harcourt General Corporation 1,527,425 5,709,495 7,236,920 142,737 Life on which Depreciation In Latest Statement of Income Description Date Acquired is Computed ----------- ------------- ---------------------- Operating Method (continued): Land leased to Unisource Worldwide, Inc. January 1, 1998 N/A Centralized telephone bureau leased to Excel Communications, Inc. January 1, 1998 40 yrs. Dairy processing facility leased to Copeland Beverage Group, Inc. January 1, 1998 40 yrs. Office building in Beaumont, Texas leased to Petrocon Engineering, Inc. and Olmstead Kirk Paper Company January 1, 1998 40 yrs. Office, manufacturing and warehouse buildings leased to Continental Casualty Company January 1, 1998 40 yrs. Warehouse and distribution center in Salisbury, North Carolina leased to Family Dollar Services, Inc. January 1, 1998 40 yrs. Manufacturing and office buildings leased to Penn Virginia Corporation January 1, 1998 40 yrs. Land leased to Exide Electronics Corporation January 1, 1998 N/A Motion picture theaters leased to Harcourt General Corporation January 1, 1998 40 yrs. -63- 65 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Company Cost Increase ------------------------------------- Capitalized (Decrease) Personal Subsequent to in Net Description Encumbrances Land Buildings Property Acquisition (a) Investment (b) ----------- ------------ ---- --------- -------- --------------- -------------- Operating Method (continued): Warehouse/ office research and manufacturing facilities leased to Lockheed Martin Corporation 2,617,330 14,752,353 525,034 Warehouse and office facility leased to Kinney Shoe Corporation/ Armel, Inc. 1,173,108 3,368,141 Manufacturing and office facility leased to Yale Security, Inc. 345,323 3,913,657 Manufacturing facilities leased to AP Parts International, Inc. 4,412,037 447,170 12,337,106 Manufacturing facilities leased to Northern Tube, Inc. 620,000 31,725 1,691,580 Manufacturing facilities leased to Anthony's Manufacturing Company, Inc. 2,051,769 5,321,776 Manufacturing facilities leased to Swiss M-Tex, L.P. 263,618 4,046,406 Land leased to AutoZone, Inc. 9,382,198 Retail stores leased to Northern Auto, Inc. 3,202,467 2,711,994 Retail stores leased tp General Textiles, Inc. 129,173 313,107 Gross Amount at which Carried at Close of Period (c) ------------------------------------------------------------- Personal Accumulated Description Land Buildings Property Total Depreciation ----------- ---- --------- -------- ----- ------------ Operating Method (continued): Warehouse/ office research and manufacturing facilities leased to Lockheed Martin Corporation 2,617,330 15,277,387 17,894,717 373,026 Warehouse and office facility leased to Kinney Shoe Corporation/ Armel, Inc. 1,173,108 3,368,141 4,541,249 84,203 Manufacturing and office facility leased to Yale Security, Inc. 345,323 3,913,657 4,258,980 97,842 Manufacturing facilities leased to AP Parts International, Inc. 447,170 12,337,106 12,784,276 308,428 Manufacturing facilities leased to Northern Tube, Inc. 31,725 1,691,580 1,723,305 42,290 Manufacturing facilities leased to Anthony's Manufacturing Company, Inc. 2,051,769 5,321,776 7,373,545 133,045 Manufacturing facilities leased to Swiss M-Tex, L.P. 263,618 4,046,406 4,310,024 101,160 Land leased to AutoZone, Inc. 9,382,198 9,382,198 Retail stores leased to Northern Auto, Inc. 3,202,467 2,711,994 5,914,461 67,800 Retail stores leased tp General Textiles, Inc. 129,173 313,107 442,280 7,828 Life on which Depreciation In Latest Statement of Income Description Date Acquired is Computed ----------- ------------- ---------------------- Operating Method (continued): Warehouse/ office research and manufacturing facilities leased to Lockheed Martin Corporation January 1, 1998 40 yrs. Warehouse and office facility leased to Kinney Shoe Corporation/ Armel, Inc. January 1, 1998 40 yrs. Manufacturing and office facility leased to Yale Security, Inc. January 1, 1998 40 yrs. Manufacturing facilities leased to AP Parts International, Inc. January 1, 1998 40 yrs. Manufacturing facilities leased to Northern Tube, Inc. January 1, 1998 40 yrs. Manufacturing facilities leased to Anthony's Manufacturing Company, Inc. January 1, 1998 40 yrs. Manufacturing facilities leased to Swiss M-Tex, L.P. January 1, 1998 40 yrs. Land leased to AutoZone, Inc. January 1, 1998 N/A Retail stores leased to Northern Auto, Inc. January 1, 1998 40 yrs. Retail stores leased tp General Textiles, Inc. January 1, 1998 40 yrs. -64- 66 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Company Cost Increase ------------------------------------- Capitalized (Decrease) Personal Subsequent to in Net Description Encumbrances Land Buildings Property Acquisition (a) Investment (b) ----------- ------------ ---- --------- -------- --------------- -------------- Operating Method (continued): Retail stores leased to Fact 2U, Inc. 77,099 236,231 Office facility leased to Bell Atlantic Corporation 219,548 1,578,592 Land leased to Sybron International Corporation 1,135,003 Office facility leased to United States Postal Service and Comark, Inc. 1,074,640 11,452,967 2,530 Manufacturing and office facility leased to Allied Plywood, Inc. 459,593 1,351,737 Manufacturing and office facility leased to StairPans of America, Inc. 139,004 1,758,648 Manufacturing facilities leased to Quebecor Printing Inc. 9,773,836 4,458,047 18,695,004 Land leased to High Voltage Engineering Corp. 1,954,882 Manufacturing facility leased to Wozniak Industries, Inc./ Mayfair Molded Products Corporation 864,638 2,677,512 1,745 Distribution and office facilities leased to Federal Express Corporation 335,189 1,839,331 Gross Amount at which Carried at Close of Period (c) -------------------------------------------------------------- Personal Accumulated Description Land Buildings Property Total Depreciation ----------- ---- --------- -------- ----- ------------ Operating Method (continued): Retail stores leased to Fact 2U, Inc. 77,099 236,231 313,330 5,906 Office facility leased to Bell Atlantic Corporation 219,548 1,578,592 1,798,140 39,465 Land leased to Sybron International Corporation 1,135,003 1,135,003 Office facility leased to United States Postal Service and Comark, Inc. 1,074,640 11,455,497 12,530,137 286,379 Manufacturing and office facility leased to Allied Plywood, Inc. 459,593 1,351,737 1,811,330 33,794 Manufacturing and office facility leased to StairPans of America, Inc. 139,004 1,758,648 1,897,652 43,966 Manufacturing facilities leased to Quebecor Printing Inc. 4,458,047 18,695,004 23,153,051 467,375 Land leased to High Voltage Engineering Corp. 1,954,882 1,954,882 Manufacturing facility leased to Wozniak Industries, Inc./ Mayfair Molded Products Corporation 864,638 2,679,257 3,543,895 66,979 Distribution and office facilities leased to Federal Express Corporation 335,189 1,839,331 2,174,520 45,983 Life on which Depreciation In Latest Statement of Income Description Enc Date Acquired is Computed ----------- ------------- ---------------------- Operating Method (continued): Retail stores leased to Fact 2U, Inc. January 1, 1998 40 yrs. Office facility leased to Bell Atlantic Corporation January 1, 1998 40 yrs. Land leased to Sybron International Corporation January 1, 1998 N/A Office facility leased to United States Postal Service and Comark, Inc. January 1, 1998 40 yrs. Manufacturing and office facility leased to Allied Plywood, Inc. January 1, 1998 40 yrs. Manufacturing and office facility leased to StairPans of America, Inc. January 1, 1998 40 yrs. Manufacturing facilities leased to Quebecor Printing Inc. January 1, 1998 40 yrs. Land leased to High Voltage Engineering Corp. January 1, 1998 N/A Manufacturing facility leased to Wozniak Industries, Inc./ Mayfair Molded Products Corporation January 1, 1998 40 yrs. Distribution and office facilities leased to Federal Express Corporation January 1, 1998 40 yrs. -65- 67 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Company Cost Increase ------------------------------------- Capitalized (Decrease) Personal Subsequent to in Net Description Encumbrances Land Buildings Property Acquisition (a) Investment (b) ----------- ------------ ---- --------- -------- --------------- -------------- Operating Method (continued): Land leased to Dr Pepper Bottling Company of Texas 9,795,193 Manufacturing facility leased to Detroit Diesel Corporation 21,491,461 5,967,620 31,730,547 Engineering and Fabrication facility leased to Orbital Sciences Corporation 5,034,749 18,956,971 408,132 Distribution facility leased to PepsiCo, Inc. 166,745 884,772 Land leased to Childtime Childcare, Inc. 508,692 1,673,925 Hotel Complex leased to Hotel Corporation of America 8,247,292 737,407 4,564,671 $3,401,744 Hotel leased to Livho, Inc. 2,765,094 11,086,650 2,711,519 2,087,322 Retail store leased to Eagle Hardware and Garden, Inc. 11,000,000 4,125,000 11,811,641 Office building in Pantin, France leased to four lessees 8,651,444 2,674,914 8,210,990 Office facility leased to Tellit Assurances 4,580,153 542,968 5,286,915 Portfolio of seven properties In Houston, Texas leased to 15 lessees 10,361,643 3,260,000 22,324,073 Gross Amount at which Carried at Close of Period (c) -------------------------------------------------------------- Personal Accumulated Description Land Buildings Property Total Depreciation ----------- ---- --------- -------- ----- ------------ Operating Method (continued): Land leased to Dr Pepper Bottling Company of Texas 9,795,193 9,795,193 Manufacturing facility leased to Detroit Diesel Corporation 5,967,620 31,730,547 37,698,167 793,263 Engineering and Fabrication facility leased to Orbital Sciences Corporation 5,034,749 19,365,103 24,399,852 473,925 Distribution facility leased to PepsiCo, Inc. 166,745 884,772 1,051,517 22,120 Land leased to Childtime Childcare, Inc. 1,673,925 1,673,925 Hotel Complex leased to Hotel Corporation of America 737,407 4,564,671 3,401,744 8,703,822 600,080 Hotel leased to Livho, Inc. 2,765,094 11,587,712 4,297,779 18,650,585 631,878 Retail store leased to Eagle Hardware and Garden, Inc. 4,125,000 11,811,641 15,936,641 209,002 Office building in Pantin, France leased to four lessees 2,674,914 8,210,990 10,885,904 122,278 Office facility leased to Tellit Assurances 542,968 5,286,915 5,829,883 37,315 Portfolio of seven properties In Houston, Texas leased to 15 lessees 3,260,000 22,324,073 25,584,073 302,166 Life on which Depreciation In Latest Statement of Income Description Date Acquired is Computed ----------- ------------- ---------------------- Operating Method (continued): Land leased to Dr Pepper Bottling Company of Texas January 1, 1998 N/A Manufacturing facility leased to Detroit Diesel Corporation January 1, 1998 40 yrs. Engineering and Fabrication facility leased to Orbital Sciences Corporation January 1, 1998 40 yrs. Distribution facility leased to PepsiCo, Inc. January 1, 1998 40 yrs. Land leased to Childtime Childcare, Inc. January 1, 1998 N/A Hotel Complex leased to Hotel Corporation of America January 1, 1998 7-40 yrs. Hotel leased to Livho, Inc. January 1, 1998 7-40 yrs. Retail store leased to Eagle Hardware and Garden, Inc. April 23, 1998 40 yrs. Office building in Pantin, France leased to four lessees May 27, 1998 40 yrs. Office facility leased to Tellit Assurances June 10, 1998 40 yrs. Portfolio of seven properties In Houston, Texas leased to 15 lessees June 15, 1998 40 yrs. -66- 68 CAREY DIVERSIFIED LLC and Subsidiaries SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Company Cost Increase ------------------------------------- Capitalized (Decrease) Personal Subsequent to in Net Description Encumbrances Land Buildings Property Acquisition (a) Investment (b) ----------- ------------ ---- --------- -------- --------------- -------------- Operating Method (continued): Office facility leased to Sprint Spectrum L.P. 1,190,000 6,700,965 Office facility leased to Direction Regional des Affaires Sanitaires et Sociales 1,779,391 303,061 2,109,736 Vacant 1,098,894 2,545,711 ------------ ----------- ------------ ---------- ---------- ---------- $94,758,809 $88,358,026 $298,845,159 $6,113,263 $4,612,717 -- =========== =========== ============ ========== ========== ========== Gross Amount at which Carried at Close of Period (c) -------------------------------------------------------------- Personal Accumulated Description Land Buildings Property Total Depreciation ----------- ---- --------- -------- ----- ------------ Operating Method (continued): Office facility leased to Sprint Spectrum L.P. 1,190,000 6,700,965 7,890,965 34,661 Office facility leased to Direction Regional des Affaires Sanitaires et Sociales 303,061 2,109,736 2,412,797 944 Vacant 1,098,894 2,545,711 3,644,605 63,642 ----------- ------------- ----------- ------------ ---------- $88,731,529 $301,498,113 $7,699,523 $397,929,165 $7,617,500 =========== ============ ========== ============ ========== Life on which Depreciation In Latest Statement of Income Description Date Acquired is Computed ----------- ------------- ---------------------- Operating Method (continued): Office facility leased to Sprint Spectrum L.P. July 1, 1998 40 yrs. Office facility leased to Direction Regional des Affaires Sanitaires et Sociales November 16, 1998 40 yrs. January 1, 1998 and Vacant July 23, 1998 40 yrs. -67- 69 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Cost Increase Company Capitalized (Decrease) -------------------- Subsequent to in Net Description Encumbrances Land Buildings Acquisition (a) Investment (b) ----------- ---------------- ---- --------- ----------------- --------------- Direct financing method: Office buildings and warehouses leased to Unisource Worldwide, Inc. $4,125,497 $ 331,910 $12,281,102 $ 108,694 Retail stores leased to Kobacker Stores, Inc. 1,938,179 Centralized Telephone Bureau leased to Western Union Financial Services, Inc. 842,233 4,762,302 (16,221) Computer Center leased to AT&T Corporation 269,700 5,099,964 (7,251) Warehouse and manufacturing buildings leased to Gibson Greetings, Inc. 3,495,507 34,016,822 770,843 Warehouse and manufacturing buildings leased to CSS Industries, Inc./ Cleo, Inc. 1,051,005 14,036,912 79,512 Gross Amount at which Carried at Close of Period (c) ----------------------------- Description Total Date Acquired ----------- ----- ------------- Direct financing method: Office buildings and warehouses leased to Unisource Worldwide, Inc. $12,721,706 January 1, 1998 Retail stores leased to Kobacker Stores, Inc. 1,938,179 January 1, 1998 Centralized Telephone Bureau leased to Western Union Financial Services, Inc. 5,588,314 January 1, 1998 Computer Center leased to AT&T Corporation 5,362,413 January 1, 1998 Warehouse and manufacturing buildings leased to Gibson Greetings, Inc. 38,283,172 January 1, 1998 Warehouse and manufacturing buildings leased to CSS Industries, Inc./ Cleo, Inc. 15,167,429 January 1, 1998 -68- 70 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Cost Increase Company Capitalized (Decrease) -------------------- Subsequent to in Net Description Encumbrances Land Buildings Acquisition (a) Investment (b) ----------- ---------------- ---- --------- ----------------- --------------- Direct Financing Method (continued): Manufacturing, distribution and office buildings leased to Brodart Co. 2,877,273 445,383 11,323,899 Manufacturing facility to Duff-Norton Company, Inc. 726,981 8,263,635 Manufacturing facilities leased to Rochester Button Company, Inc. 43,753 1,235,328 Manufacturing facilities leased to Thermadyne Holdings Corp. 3,789,019 13,163,763 Office and research facility leased to Exide Electronics Corporation 2,844,120 Manufacturing facilities leased to DeVlieg Bullard, Inc. 462,295 7,143,644 Gross Amount at which Carried at Close of Period (c) ----------------------------- Description Total Date Acquired ----------- ----- ------------- Direct Financing Method (continued): Manufacturing, distribution and office buildings leased to Brodart Co. 11,769,282 January 1, 1998 Manufacturing facility to Duff-Norton Company, Inc. 8,990,616 January 1, 1998 Manufacturing facilities leased to Rochester Button Company, Inc. 1,279,081 January 1, 1998 Manufacturing facilities leased to Thermadyne Holdings Corp. 16,952,782 January 1, 1998 Office and research facility leased to Exide Electronics Corporation 2,844,120 January 1, 1998 Manufacturing facilities leased to DeVlieg Bullard, Inc. 7,605,939 January 1, 1998 -69- 71 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Cost Increase Company Capitalized (Decrease) -------------------- Subsequent to in Net Description Encumbrances Land Buildings Acquisition (a) Investment (b) ----------- ---------------- ---- --------- ----------------- --------------- Direct Financing Method (continued): Manufacturing facility leased to Penberthy Products, Inc. 70,317 1,476,657 Manufacturing facility and warehouse leased to DS Group Limited 238,532 3,339,449 Manufacturing facilities leased Sunds Defibrator Woodhandling, Inc. 47,632 1,288,327 $ 5,320 Retail stores leased to AutoZone, Inc. 16,416,402 Manufacturing facility leased to Peerless Chain Company 1,307,590 11,026,975 Retail store leased to Wal-Mart Stores, Inc., $3,228,534 1,839,303 6,535,144 Manufacturing and office facilities leased to Sybron International Corporation 2,727,958 31,329,955 22,043 Manufacturing and office facilities leased to NVR, Inc. 728,683 6,092,840 Gross Amount at which Carried at Close of Period (c) ----------------------------- Description Total Date Acquired ----------- ----- ------------- Direct Financing Method (continued): Manufacturing facility leased to Penberthy Products, Inc. 1,546,974 January 1, 1998 Manufacturing facility and warehouse leased to DS Group Limited 3,577,981 January 1, 1998 Manufacturing facilities leased Sunds Defibrator Woodhandling, Inc. 1,341,279 January 1, 1998 Retail stores leased to AutoZone, Inc. 16,416,402 January 1, 1998 Manufacturing facility leased to Peerless Chain Company 12,334,565 January 1, 1998 Retail store leased to Wal-Mart Stores, Inc., 8,374,447 January 1, 1998 Manufacturing and office facilities leased to Sybron International Corporation 34,079,956 January 1, 1998 Manufacturing and office facilities leased to NVR, Inc. 6,821,523 January 1, 1998 -70- 72 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Cost Increase Company Capitalized (Decrease) -------------------- Subsequent to in Net Description Encumbrances Land Buildings Acquisition (a) Investment (b) ----------- ---------------- ---- --------- --------------- -------------- Direct Financing Method (continued): Manufacturing and generating facilities leased to High Voltage Engineering Corp. 973,328 9,166,104 Office/warehouse facilities leased to United Stationers Supply Company $2,264,154 1,882,372 5,846,214 26,581 Bottling and Distribution facilities lease to Dr Pepper Bottling Company of Texas 27,598,638 Land and industrial/ warehouse/office facilities leased to Furon Company 12,213,700 4,221,568 19,676,226 Office/warehouse facility leased to Red Bank Distribution, Inc. 4,852,907 1,629,715 9,396,770 Day care facilities leased to Childtime Childcare, Inc. 733,231 2,412,449 ----------- ----------- ------------ -------- --------- $30,295,296 $27,124,784 $267,711,820 $ 53,944 $ 935,577 =========== =========== ============ ======== ========= Gross Amount at which Carried at Close of Period (c) ----------------------------- Description Total Date Acquired ----------- ----- ------------- Direct Financing Method (continued): Manufacturing and generating facilities leased to High Voltage Engineering Corp. 10,139,432 January 1, 1998 Office/warehouse facilities leased to United Stationers Supply Company 7,755,167 January 1, 1998 Bottling and Distribution facilities lease to Dr Pepper Bottling Company of Texas 27,598,638 January 1, 1998 Land and industrial/ warehouse/office facilities leased to Furon Company 23,897,794 January 1, 1998 Office/warehouse facility leased to Red Bank Distribution, Inc. 11,026,485 January 1, 1998 Day care facilities leased to Childtime Childcare, Inc. 2,412,449 January 1, 1998 ------------ $295,826,125 ============ -71- 73 CAREY DIVERSIFIED LLC and SUBSIDIARIES SCHEDULE III - REAL ESTATE and ACCUMULATED DEPRECIATION as of December 31, 1998 Initial Cost to Company Cost --------------------------------------- Capitalized Personal Subsequent to Description Encumbrances Land Buildings Property Acquisition (a) ----------- ------------ ---- --------- -------- --------------- Operating real estate: Hotels located in: Alpena, Michigan $ 6,955,000 $114,241 $4,256,356 $618,066 $160,717 Petoskey, Michigan 6,955,000 98,326 1,446,757 290,668 328,347 ----------- -------- ---------- -------- -------- $13,910,000 $212,567 $5,703,113 $908,734 $489,064 =========== ======== ========== ======== ======== Gross Amount at which Carried at Close of Period (c) (d) ------------------------------------------------------------- Personal Accumulated Description Land Property Buildings Total Depreciation ----------- ---- -------- --------- ----- ------------ Operating real estate: Hotels located in: Alpena, Michigan $114,241 $ 737,656 $4,297,483 $5,149,380 $201,312 Petoskey, Michigan 98,326 470,259 1,595,513 2,164,098 98,906 -------- ---------- ---------- ---------- -------- $212,567 $1,207,915 $5,892,996 $7,313,478 $300,218 ======== ========== ========== ========== ======== Life on which Depreciation In Latest Statement of Income Description Date Acquired is Computed ----------- ------------- ---------------------- Operating real estate: Hotels located in: Alpena, Michigan January 1, 1998 7-40 yrs. Petoskey, Michigan January 1, 1998 7-40 yrs. -72- 74 CAREY DIVERSIFIED LLC and CORPORATE PROPERTY ASSOCIATES PARTNERSHIPS NOTES to Schedule III - Real Estate and ACCUMULATED DEPRECIATION (a) Consists of the cost of improvements and acquisition costs subsequent to acquisition, including legal fees, appraisal fees, title costs, other related professional fees and purchases of furniture, fixtures, equipment and improvements at the hotel properties. (b) The increase (decrease) in net investment is primarily due to (i) the amortization of unearned income from net investment in direct financing leases producing a periodic rate of return which at times may be greater or less than lease payments received, (ii) sales of properties, and (iii) writedowns of properties to fair value. (c) At December 31, 1998, the aggregate cost of real estate owned by the Company and its subsidiaries for Federal income tax purposes is $695,342,780. Reconciliation of Real Estate Accounted for Under the Operating Method The Company The Predecessor Consolidated Combined December 31, December 31, 1998 1997 ------------- ------------- Balance at beginning of year $ 315,097,546 $ 339,503,452 Additions 4,612,717 1,422,179 Purchases 69,287,712 Sales (3,044,712) (6,458,555) Writedowns to fair value (1,575,000) (1,489,999) Reclassification from (to) investment in direct financing lease 16,563,263 (21,868,468) Reclassification to real estate held for sale (3,012,361) (353,377) ------------- ------------- Balance at end of year $ 397,929,165 $ 310,755,232 ============= ============= -73- 75 CAREY DIVERSIFIED LLC and CORPORATE PROPERTY ASSOCIATES PARTNERSHIPS NOTES to Schedule III - Real Estate and ACCUMULATED DEPRECIATION Reconciliation of Accumulated Depreciation The Company The Predecessor Consolidated Combined December 31, December 31, 1998 1997 ------------- ------------- Balance at beginning of year $ 91,923,183 Depreciation expense $ 7,725,130 8,819,816 Reclassification to real estate held for sale (104,550) (153,377) Reclassification to direct financing lease (4,429,853) Writeoff resulting from sales of property (3,080) (2,569,087) ------------ ------------ Balance at end of year $ 7,617,500 $ 93,590,682 ============ ============ Reconciliation for Operating Real Estate The Company The Predecessor Consolidated Combined December 31, December 31, 1998 1997 ------------- ------------- Balance at beginning of year $ 23,387,677 $ 37,426,984 Additions 489,064 532,751 Reclassification to operating method (16,563,263) ------------ ------------ Balance at close of year $ 7,313,478 $ 37,959,735 ============ ============ -74- 76 CAREY DIVERSIFIED LLC and CORPORATE PROPERTY ASSOCIATES PARTNERSHIPS NOTES to Schedule III - Real Estate and ACCUMULATED DEPRECIATION Reconciliation of Accumulated Depreciation Operating Real Estate The Company The Predecessor Consolidated Combined December 31, December 31, 1998 1997 ------------- ------------- Balance at beginning of year $13,346,982 Depreciation expense $ 300,218 1,279,766 ----------- ----------- Balance at end of year $ 300,218 $14,626,748 =========== =========== -75-