UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
----------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------------- ----------------
Commission File number 001-31659
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Berkshire Income Realty, Inc.
- -------------------------------------------------------------------------------
Maryland 32-0024337
- -------------------------------------- ---------------------------------------
(State or other jurisdiction of (IRS employer identification no.)
incorporation or organization
One Beacon Street, Boston, Massachusetts 02108
- ------------------------------------------ -------------------------------
(Address of principal executive (Zip code)
offices)
(Registrant's telephone number, including area code) (617) 523-7722
--------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------------ -----------------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12(b-2) of the Exchange Act). Yes [ ] No [X]
As of August 13, 2003, there were 1,283,313 shares of Class B common stock
outstanding.
BERKSHIRE INCOME REALTY, INC.
TABLE OF CONTENTS
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
Consolidated Balance Sheets (Unaudited) at June 30, 2003 and
(Unaudited) December 31, 2002
Consolidated Statements of Operations (Unaudited) for the three and
six months ended June 30, 2003 and 2002
Consolidated Statements of Cash Flows (Unaudited) for the six months
ended June 30, 2003 and 2002
Notes to Consolidated Financial Statements (Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Item 4. Controls and Procedures.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except share and per share amounts)
December 31,
June 30, 2002
2003 (Note 1)
---------- ----------
ASSETS
Multi-family apartment communities, net of accumulated
depreciation of $98,347 and $94,712, respectively $ 99,283 $ 94,343
Cash and cash equivalents 10,207 4,852
Cash restricted for tenant security deposits 852 850
Replacement reserve escrow 335 407
Prepaid expenses and other assets 3,027 3,733
Investment in Mortgage Funds 49,146 -
Deferred expenses, net of accumulated amortization of
$250 and $246, respectively 936 1,288
---------- ----------
Total assets $ 163,786 $ 105,473
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY/OWNERS' DEFICIT
Liabilities:
Mortgage notes payable $ 105,135 $ 119,162
Notes payable - 3,155
Due to affiliates 5,477 2,879
Dividend payable 837 -
Accrued expenses and other liabilities 2,926 1,891
Tenant security deposits 981 912
---------- ----------
Total liabilities 115,356 127,999
Minority interest - -
Stockholders' equity / owners' deficit:
Series A 9% Cumulative Redeemable Preferred Stock, no
par value, $25 stated value, 5,000,000 shares authorized,
2,978,110 and 0 shares issued and outstanding at June
30, 2003 and December 31, 2002, 74,453, respectively - -
Class A common stock, $.01 par, 5,000,000 shares
authorized; 0 shares issued and outstanding at June
30, 2003 and December 31, 2002, respectively - -
Class B common stock, $.01 par, 5,000,000 shares
authorized; 1,283,313 and 100 shares issued and
outstanding at June 30, 2003 and December 31, 2002,
respectively 12 -
Excess stock, $.01 par value, 15,000,000 shares authorized,
0 shares issued and outstanding at June 30, 2003 and
December 31, 2002, respectively - -
Accumulated deficit (26,035) -
Owners' deficit - (22,526)
---------- ----------
Total stockholders' equity / owners' deficit $ 48,430 $ (22,526)
Total liabilities and stockholders' equity/owners'
deficit $ 163,786 $ 105,473
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
1
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except share and per share amounts)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenue:
Rental $ 7,081 $ 6,560 $ 13,689 $ 13,001
Interest 35 46 67 72
Utility reimbursement 98 152 207 315
Other 309 228 553 461
---------- ---------- ---------- ----------
Total revenue 7,523 6,986 14,516 13,849
Expenses:
Operating 1,654 1,407 3,275 2,945
Maintenance 598 558 1,069 974
Real estate taxes 610 549 1,175 1,080
General and administrative 525 163 673 351
Organizational costs 213 - 213 -
Management fees 676 459 1,108 900
Depreciation 2,182 1,453 3,635 2,904
Interest 1,822 1,185 3,750 2,320
Loss on extinguishment of debt 252 883 252 883
Participation interest - 44 - 88
---------- ---------- ---------- ----------
Total expenses 8,532 6,701 15,150 12,445
---------- ---------- ---------- ----------
Income (loss) before minority
interest in properties, equity
in income of Mortgage Funds and
minority common interest in
Operating Partnership (1,009) 285 (634) 1,404
Minority interest in properties (94) (1,382) (94) (1,436)
Equity in income of Mortgage
Funds 1,730 - 1,730 -
---------- ---------- ---------- ----------
Income (loss) before minority
common interest in Operating
Partnership 627 (1,097) 1,002 (32)
Minority common interest in
Operating Partnership - - - -
---------- ---------- ---------- ----------
Net income (loss) $ 627 $ (1,097) $ 1,002 $ (32)
========== ========== ========== ==========
Preferred dividend $ (1,601) $ - $ (1,601) $ -
---------- ---------- ---------- ----------
Net loss available to common
shareholders $ (974) $ (1,097) $ (599) $ (32)
========== ========== ========== ==========
Earnings per common share,
basic $ (0.80) $ (0.98)
========== ==========
Weighted average number of
common shares outstanding 1,214,106 610,457
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
2
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
For the Six Months
Ended June 30,
----------------------
2003 2002
---------- ----------
Cash flows from operating activities:
Net income (loss) $ 1,002 $ (32)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Amortization of deferred financing costs 100 20
Depreciation 3,635 2,904
Loss on extinguishment of debt 252 466
Minority interest in properties 94 1,436
Equity in income of Mortgage Funds (1,730) -
Increase (decrease) in cash attributable to changes
in assets and liabilities:
Tenant security deposits, net 67 118
Due to affiliates (1,310) 1,911
Prepaid expenses and other assets 705 (774)
Accrued expenses and other liabilities 1,035 201
---------- ----------
Net cash provided by operating activities 3,850 6,250
---------- ----------
Cash flows from investing activities:
Capital improvements (1,507) (1,606)
Acquisition of property (7,068) -
Distributions from investment in Mortgage Funds 27,250 -
Investment in Mortgage Funds (213) -
Withdrawals from replacement reserve 72 30
---------- ----------
Net cash provided by (used in) investing activities 18,534 (1,576)
---------- ----------
Cash flows from financing activities:
Principal payments on mortgage notes payable (726) (731)
Prepayments on mortgage notes payable (16,456) (35,526)
Borrowings on mortgage notes payable - 49,580
Syndication costs (333) -
Deferred financing costs - (543)
Distributions to owners (104) (13,057)
Distributions to minority interest in properties (94) (2,057)
Distributions to preferred shareholders (764) -
Contributions from owners 1,448 -
---------- ----------
Net cash used in financing activities (17,029) (2,334)
---------- ----------
Net increase in cash and cash equivalents 5,355 2,340
Cash and cash equivalents at beginning of period 4,852 4,395
---------- ----------
Cash and cash equivalents at end of period $ 10,207 $ 6,735
========== ==========
Supplemental disclosure:
Cash paid for interest $ 6,838 $ 2,724
Supplemental disclosure of non cash investing and
financing activities:
Issuance of preferred shares in exchange for interests
in the Mortgage Funds $ 74, 453 -
Syndication costs included in due to affiliates $ 3,908 -
Capital improvements included in accrued expenses and
other liabilities $ 310 $ 584
Dividend declared and unpaid on Preferred Shares $ 837 $ -
The accompanying notes are an integral part of these
consolidated financial statements.
3
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited, in thousands, except share and per share data)
1. ORGANIZATION AND BASIS OF PRESENTATION
Berkshire Income Realty, Inc., (the "Company"), a Maryland corporation, was
organized on July 19, 2002 and 100 Class B common shares were issued. The
Company is in the business of acquiring, owning and operating multi-family
residential properties.
The Company filed a registration statement on Form S-11 with the Securities
and Exchange Commission with respect to its offers (the "Offering") to exchange
its 9% Series A Cumulative Redeemable Preferred Stock ("Preferred Shares") for
interests ("Interests") in the following six mortgage funds: Krupp Government
Income Trust ("GIT"), Krupp Government Income Trust II ("GIT II"), Krupp Insured
Mortgage Limited Partnership ("KIM"), Krupp Insured Plus Limited Partnership
("KIP"), Krupp Insured Plus II Limited Partnership ("KIP II"), and Krupp Insured
Plus III Limited Partnership ("KIP III") (collectively, the "Mortgage Funds").
For each Interest in the Mortgage Funds validly tendered and not withdrawn in
the Offering, the Company offered to exchange its Preferred Shares based on an
exchange ratio applicable to each Mortgage Fund. The registration statement was
declared effective on January 9, 2003. Offering costs incurred in connection
with the Offering have been reflected as a reduction of accumulated deficit.
On April 4, 2003 and April 18, 2003, the Company issued 2,667,717 and
310,393 shares, respectively, of its Preferred Shares, with a $25.00 liquidation
preference per share. The Preferred Shares were issued in exchange for Interests
in the six Mortgage Funds referred to above.
Simultaneously with the completion of the Offering on April 4, 2003, KRF
Company, L.L.C. ("KRF Company"), an affiliate of the Company, contributed its
ownership interests in five multi-family apartment communities (the
"Properties"), to our operating partnership, Berkshire Income Realty-OP, L.P.
(the "Operating Partnership") in exchange for common limited partner interests
in the Operating Partnership. KRF Company then contributed an aggregate of
$1,283 to the Company in exchange for common stock of the Company in an amount
which together with the $100 contributed prior to the offering, equaled
1,283,313 shares of common stock of the Company and equaled 1% of the fair value
of total net assets of the Operating Partnership. This amount was contributed by
the Company to its wholly owned subsidiary, BIR GP, L.L.C., who then contributed
the cash to the Operating Partnership in exchange for the sole general partner
interest in the Operating Partnership.
The Operating Partnership is the successor to the Berkshire Income
Realty Predecessor Group ("the Predecessor"). The combination of the separate
businesses into the Company and the Operating Partnership was considered a
purchase business combination with the Predecessor being the accounting
acquirer. Accordingly, the acquisition or contribution of the various
Predecessor interests was accounted for at their historical cost. The
acquisition of the Interests was accounted for using purchase accounting based
upon the fair value of the Preferred Shares issued.
Certain minority ownership interests in three of the contributed
multi-family properties are owned by an unaffiliated third party. As the
minority interests have not changed in connection with the completion of the
Offering, the accounting for these interests is based on existing carrying
amounts.
4
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
As a result of the common control of ownership between the Predecessor and
the Company, the Company has not been deemed a new reporting entity pursuant to
the provisions of Accounting Principles Board Opinion #20, Accounting Changes.
Accordingly, the financial statements of the Company do not start "fresh" upon
completion of the Offering in April 2003. Rather, the Company's financial
statements are a continuation of the Predecessor `s financial statements and
have been re-titled to those of the Company effective in April 2003.
The Company's consolidated financial statements include the accounts of the
Company, its subsidiary, the Operating Partnership, as well as the various
subsidiaries of the Operating Partnership. The Company owns preferred and
general partner interests in the Operating Partnership. The remaining common
limited partnership interests in the Operating Partnership owned by KRF Company
and affiliates are reflected as Minority Interest in the consolidated financial
statements of the Company.
On March 20, 2003, KRF Company, through a newly formed affiliate, Gables of
Texas Limited Partnership ("Gables"), whose general partner, Gables of Texas,
L.L.C., also a newly formed affiliate, acquired The Gables Apartments, a
140-unit multi-family apartment community located in Houston, Texas, from an
unrelated third party for a purchase price of approximately $6,925. On April 24,
2003, the Operating Partnership acquired the interests in Gables and Gables of
Texas L.L.C. from KRF Company for approximately $6,925 plus closing costs of
approximately $143. The purchase price for Gables and Gables of Texas L.L.C. was
equal to the purchase price KRF Company paid the original seller of The Gables
Apartments (including equity payments, transfer taxes, financing and closing
costs as applicable).
Due to the affiliation of the ownership of the Company and KRF Company, the
acquisition of interests in the Gables property has been accounted for as a
reorganization of entities under common control, requiring the Company to
retroactively restate the consolidated financial statements from March 20, 2003,
the acquisition date of the property by KRF Company, through the period
presented.
On April 29, 2003, the Preferred Shares began trading on the American Stock
Exchange, under the symbol "BIR.PR.A".
On May 30, 2003 the Operating Partnership and its wholly owned subsidiary
BIR McNab Sub, L.L.C., a newly formed Delaware limited liability company,
acquired all of the outstanding limited and general partner units of McNab KC3
Limited Partnership ("McNab") from affiliates of the Company. The acquisition
was structured as a contribution of units from an affiliate of the Company in
exchange for the issuance by the Operating Partnership of 5,000 common limited
partner units valued at $10.00 per unit. McNab is the fee simple owner of a
276-unit multi-family apartment community located in Pompano Beach, Florida that
is referred to as Windward Lakes Apartments. The general and limited partners of
McNab are affiliates of the Company, namely George and Douglas Krupp. Control of
both the Company and McNab rests with George and Douglas Krupp via their 100%
ownership interest in the common stock of the Company and their 100% ownership
interest in the general and limited partnership units of McNab. Therefore, the
acquisition or contribution of the general and limited partnership units of
McNab by the Operating Partnership in exchange for the issuance by the Operating
Partnership of common limited partner units is considered a transfer of net
assets between entities under common control.
Due to the affiliation of the ownership of the Company and McNab, the
acquisition of the interests in McNab has been accounted for as a reorganization
of entities under common control, requiring the Company to retroactively restate
the consolidated financial statements for the periods presented, which is
similar to the accounting for a pooling of interests.
5
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
Properties
A summary of the multi-family communities owned by the Company at June 30,
2003 is presented below.
Year Total Controlling
Description Location Acquired Units Interest
- ------------------------- --------------- ---------- ---------- ----------
Century Cockeysville,
Maryland 1984 468 75.82%
Dorsey's Forge Columbia,
Maryland 1983 251 91.38%
Hannibal Grove Columbia,
Maryland 1983 316 91.38%
Seasons of Laurel Laurel, Maryland 1985 1,088 100.00%
Walden Pond Houston, Texas 1983 416 100.00%
Windward Lakes Pompano, Florida 1992 276 100.00%
Gables of Texas Houston, Texas 2003 140 100.00%
----------
Total 2,955
==========
Newly adopted accounting policies
Purchase Accounting for Acquisition of Real Estate
Purchase accounting was applied for the acquisition of the Gables property
consistent with the provisions of Statement of Financial Accounting Standards
No. 141, Business Combinations. In accordance with FAS 141, the fair value of
the real estate acquired is allocated to the acquired tangible assets,
consisting of land, building and personal property, and identified intangible
assets and liabilities, including the value of in-place leases, based in each
case on their fair values.
6
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
Newly adopted accounting policies, continued
Purchase Accounting for Acquisition of Real Estate, continued
The fair value of the tangible assets of an acquired property (which
includes land, building and personal property) is determined by valuing the
property as if it were vacant, and the "as-is-vacant" value is then allocated to
land, building and improvements based on management's determination of the
relative fair values of these assets. Management determines the as-if-vacant
fair value of a property using methods similar to those used by independent
appraisers. Factors considered by management in performing these analyses
include an estimate of carrying costs during the expected lease-up periods
considering current market conditions and costs to execute similar leases. In
estimating carrying costs, management includes real estate taxes, insurance and
other operating expenses and estimates of lost rental revenue during the
expected lease-up periods based on current market demand. Management also
estimates costs to execute similar leases.
The aggregate value of intangible assets, including in-place leases, is
measured by the excess, if any, of (i) the purchase price paid for a property
over (ii) the estimated fair value of the property as if vacant, determined as
set forth above. The aggregate value allocated to in-place lease values is
amortized to expense over the remaining expected life of the respective leases.
The intangible assets associated with the Gables acquisition are nominal.
Unconsolidated Investments in Mortgage Funds
The acquisition of the Interests in the Mortgage Funds by the Company has
been accounted for using purchase accounting based upon the fair value of the
Preferred Shares issued for the Interests acquired. The market value was
determined to be the $25.00 liquidation preference for the Preferred Shares
since this is the most readily available market value.
This transaction generated a basis difference between the Company's
investment in the Mortgage Funds (fair value) and its underlying equity in the
net assets of the Mortgage Funds (book value). The excess of the book value over
the carrying value for each Mortgage Fund has been allocated to such fund's
mortgage loan investments based upon their relative value. Such allocated
amounts are being amortized into income over the contractual life of the
respective mortgage loans on a basis which approximates the effective interest
method.
The Company is accounting for its investments in the Mortgage Funds, which
it does not control, using the equity method of accounting. Under the equity
method of accounting, the net equity investment of the Company is reflected on
the consolidated balance sheet, and the Company's share of net income or loss
from the Mortgage Funds is included on the consolidated statement of operations.
Debt Extinguishment Costs
Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards No. 145, Rescission of FAS Nos. 4, 44, and 64, Amendment of
FAS 13, and Technical Corrections. Prior periods that included such debt
extinguishment costs will be reclassified to conform to this standard. Prior to
the adoption of FAS 145, the Company classified costs associated with the early
extinguishment of debt as extraordinary items. In accordance with FAS 145, the
Company has determined that such costs do not meet the criteria for
classification as extraordinary pursuant to APB Opinion No. 30. Accordingly,
costs associated with the early extinguishment of debt are included in the
caption "loss on extinguishment of debt" in the consolidated statements of
operations for the three and six months ended June 30, 2003 and 2002.
7
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
1. ORGANIZATION AND BASIS OF PRESENTATION, continued
Recent Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." The objective of this
interpretation is to provide guidance on how to determine whether an investment
or interest in another entity needs to be included (i.e., consolidated) in a
company's consolidated financial statements. The Company is currently evaluating
the impact that this standard may have on the accounting for its consolidated
investment in the Operating Partnership and its off-balance sheet investments,
including its investments in Mortgage Funds, and certain other arrangements. The
Company is required to adopt FIN 46 during the third quarter of 2003.
In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". FAS 150 was
issued as "Phase I" of the FASB's ongoing initiative to establish standards for
classification of financial instruments that have characteristics of
liabilities, equity, or both, and thus ultimately eliminating the "mezzanine"
section of the balance sheet for certain financial instruments. FAS 150 will be
effective for the Company commencing in the third quarter of 2003. The Company
is currently evaluating the impact that FAS 150 may have on the accounting for
its preferred and common operating partnership units and certain non-wholly
owned consolidated subsidiaries.
Income taxes
The Company has elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code upon the filing of its first income tax
return. As of that date, the Company is required to distribute at least 90% of
its REIT taxable income to its shareholders to maintain its REIT status. REITs
are subject to a number of organizational and operational requirements. If the
Company fails to qualify as a REIT in any taxable year, the Company will be
subject to Federal income tax on its taxable income at regular corporate tax
rates. Even if the Company qualifies for taxation as a REIT, the Company may be
subject to state and local taxes on its income and property and to Federal
income and excise taxes on its undistributed income.
Reclassifications
Certain prior period balances have been reclassified in order to conform to
the current period presentation.
Unaudited interim consolidated financial statements
The accompanying interim consolidated financial statements of the Company
are unaudited; however, the financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") for interim financial information and in conjunction with the
rules and regulations of the Securities and Exchange Commission. Accordingly,
certain disclosures accompanying annual financial statements prepared in
accordance with GAAP are omitted. The year-end balance sheet data was derived
from the audited financial statements of the predecessor adjusted for the
acquisition of the interests in McNab as a reorganization of entities under
common control, thereby retroactively restating the consolidated financial
statements for all periods presented, which is similar to the accounting for a
pooling of interests, but does not include all disclosures required by GAAP. In
the opinion of management, all adjustments (consisting solely of normal
recurring matters) necessary for a fair presentation of the consolidated
financial statements for the interim periods have been included. The results of
operations for the interim periods are not necessarily indicative of the results
to be obtained for other interim periods or for the full fiscal year. The
interim consolidated financial statements and notes thereto should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31, 2002 and
Form 8-K/A filed on August 13, 2003 for the significant acquisition of McNab.
8
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
2. INVESTMENT IN MORTGAGE FUNDS
The investments in unconsolidated Mortgage Funds consist of the following:
Mortgage Fund Nominal Ownership
--------------- ------------------
GIT I 30.76%
GIT II 28.81%
KIP 29.66%
KIP II 25.00%
KIP III 28.63%
KIM 28.71%
The summarized balance sheets of the individually significant investments in
Mortgage Funds and the combined investment in Mortgage Funds are as follows:
June 30, 2003
-----------------------------------
GIT GIT II Combined
ASSETS
Mortgage investments $ 15,010 $ 88,168 $ 149,409
Cash and cash equivalents 19,955 6,384 39,711
Other assets 122 1,952 2,391
---------- ---------- ----------
Total assets $ 35,087 $ 96,504 $ 191,511
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities $ 402 $ 30 $ 619
Shareholders' equity 34,685 96,474 190,892
---------- ---------- ----------
Total liabilities and shareholders' equity $ 35,087 $ 96,504 $ 191,511
========== ========== ==========
Company's share of equity $ 10,669 $ 27,794 $ 55,687
Basis differential (1) (1,555) (4,602) (6,730)
---------- ---------- ----------
Carrying value of the Company's investment
in Mortgage Funds $ 9,114 $ 23,381 $ 49,146
========== ========== ==========
(1) This amount represents the difference between the Company's investment in
the Mortgage Funds (fair value) and its underlying equity in the net assets
of the Mortgage Funds (book value). Basis differentials occurred upon the
acquisition of the Mortgage Fund Interests for which the acquisition price
was less than the underlying equity in the net assets of the Mortgage
Funds.
9
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
2. INVESTMENT IN MORTGAGE FUNDS, continued
The summarized statements of operations of each individually significant
investment in Mortgage Funds and the combined investment in Mortgage Funds are
as follows:
Three Months Ended June 30, 2003
-----------------------------------
GIT GIT II Combined
Revenue $ 3,353 $ 1,587 $ 6,533
Expenses 223 521 1,138
---------- ---------- ----------
Net income $ 3,130 $ 1,066 $ 5,395
========== ========== ==========
Company's share of net income $ 955 $ 292 $ 1,541
Amortization of basis differential 120 147 189
---------- ---------- ----------
Equity in income of Mortgage Funds $ 1,075 $ 439 $ 1,730
========== ========== ==========
3. DEBT EXTINGUISHMENT
The McNab partnership interests contributed to the Operating Partnership by
George and Douglas Krupp, were subject to certain obligations of McNab and its
partners including the assumption of $13,398 of first mortgage debt, including
accrued interest, $4,162 of principal, accrued interest, participation interest
and interest rebates collateralized by the partnership interests (the
"Additional Loan") and the assumption of approximately $1,266 of liabilities
payable to other affiliates of the Company. Upon completion of the acquisition,
the Operating Partnership immediately paid off the first mortgage and Additional
Loan debt totaling $18,244 using available cash. The Company recognized a loss
of approximately $252 resulting from the write-off of unamortized deferred
financing costs. In accordance with FAS 145, the Company has determined that
such costs do not meet the criteria for classification as extraordinary pursuant
to APB Opinion No. 30. Accordingly, costs associated with the early
extinguishment of debt are included in the caption "loss on extinguishment of
debt" in the consolidated statements of operations for the three and six months
ended June 30, 2003 and 2002. Furthermore, costs previously classified as
extraordinary in prior periods have been reclassified to conform with the
adoption of this pronouncement.
In accordance with SOP 97-1, Accounting by Participating Mortgage Loan
Borrowers, the Company estimated the fair value of the participation feature in
the first mortgage debt of McNab noted above to be approximately $545 at
December 31, 2001 and $720 at December 31, 2002, and was recorded as due to
affiliates in the consolidated balance sheet at December 31, 2002. The fair
value of the participating interest was deferred and amortized into the
consolidated statement of operations over the first mortgage debt's estimated
life using the effective interest rate method.
The lender on both the Additional Loan and the first mortgage for McNab is
GIT. As of the completion of the Offering, the Operating Partnership owns
approximately 31% of GIT and as such is expected to receive approximately $5,650
as a special distribution from GIT sometime after the payoff of this
indebtedness.
10
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
4. MINORITY INTERESTS
An unaffiliated third party has ownership interests in three of the
contributed multi-family properties. Such interests are accounted for as
minority interests in properties in the accompanying consolidated financial
statements. Allocations of earnings and distributions are made to minority
holders based upon their respective share allocations. Losses in excess of
minority holders investment basis are allocated to the Company. Distributions to
the minority holder in excess of their investment basis are recorded in the
Company's statement of operations as minority interest in properties.
In accordance with Emerging Issues Task Force Issue (EITF) No. 94-2,
Treatment of Minority Interests in Certain Real Estate Investment Trusts, KRF
Company and affiliates' common limited partnership interest in the Operating
Partnership are being reflected as Minority Interest in the consolidated
financial statements of the Company. Upon completion of the Offering, the net
equity to the common and general partner interests in the Operating Partnership
was less than zero after an allocation to the Company and affiliates' preferred
interests in the Operating Partnership. Further, KRF Company and affiliates have
no obligation to fund such deficit. Accordingly, for financial reporting
purposes, KRF Company and affiliates' minority interest in the Operating
Partnership has been reflected as zero with common stockholders' equity being
reduced for the deficit amount.
In accordance with the guidance in EITF No. 95-7, Implementation Issues
Related to the Treatment of Minority Interests in Certain Real Estate Investment
Trusts, earnings of the Operating Partnership are first being allocated to the
preferred interests held by the Company. The remainder of earnings, if any, are
allocated to the Company as general partner and KRF Company and affiliates'
common limited partnership interests in accordance with their relative ownership
percentages. The excess of the allocation of income to KRF Company and
affiliates over cash distributed to them will be credited directly to the
Company's equity (with a corresponding debit to minority interest) until the
minority interest deficit that existed upon the completion of the Offering is
eliminated.
As of June 30, 2003, the minority interest in the Operating Partnership
consisted of 5,242,223 Operating Partnership units held by parties other than
the Company.
No distributions have been paid to holders of minority interest in the
Operating Partnership as of June 30, 2003.
5. PRO FORMA CONDENSED FINANCIAL INFORMATION
The accompanying unaudited pro forma information for the three and six
months ended June 30, 2003 and 2002 is presented as if the Offering for the
Interests in the Mortgage Funds on April 4, 2003 and April 18, 2003 had occurred
on January 1, 2002.
The unaudited pro forma information does not purport to represent what the
actual results of operations of the Company would have been had the above
occurred, nor do they purport to predict the results of operations of future
periods.
11
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
5. PRO FORMA CONDENSED FINANCIAL INFORMATION, continued
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Equity in income of Mortgage
Funds $ 1,802 $ 1,785 $ 3,887 $ 5,418
========== ========== ========== ==========
Net income (loss) $ 699 $ 688 $ 3,159 $ 5,386
========== ========== ========== ==========
Preferred dividend $ (1,675) $ (1,675) $ (3,350) $ (3,350)
---------- ---------- ---------- ----------
Net income (loss) available to
common shareholders $ (976) $ (987) $ (191) $ 2,036
========== ========== ========== ==========
Basic earnings per share:
Net income (loss) available to
common shareholders $ (0.76) $ (0.77) $ (0.15) $ 1.59
========== ========== ========== ==========
Weighted average number of
common shares outstanding 1,283,313 1,283,313 1,283,313 1,283,313
========== ========== ========== ==========
6. DECLARATION OF DIVIDEND AND DISTRIBUTIONS
On March 25, 2003, the Company's Board of Directors (the "Board") declared
a dividend at an annual rate of 9% of the stated liquidation preference of $25
per share of the outstanding Series A Cumulative Redeemable Preferred Stock (the
"Preferred Stock") of the Company and will be payable quarterly in arrears, on
February 15, May 15, August 15 and November 15 of each year to shareholders of
record in the amount of $.5625 per share per quarter. The dividend payable on
May 15, 2003 was prorated to reflect the issue date of the Preferred Shares.
On August 12, 2003, the Board declared a per share dividend on the common
shares of $0.00466 totaling $6. Also on August 12, 2003, the Board declared a
distribution on the Operating Partnership's common limited partnership units of
$0.04655 per unit totaling $244.
7. RELATED PARTY TRANSACTIONS
The Company pays property management fees to an affiliate for property
management services. The fees are payable monthly for the properties under
management. On May 6, 2003, the Company's property manager agreed to reduce the
property management fee payable by the Company from 5% of gross income to 4% of
gross income. This change in the management fee has been applied prospectively
effective April 1, 2003. Upon payoff of the McNab debt (See Note 1), the
property management fee for the Windward Lakes property was increased from 3% to
4% of gross income.
12
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
7. RELATED PARTY TRANSACTIONS, continued
The Company pays asset management fees to an affiliate for asset management
services. These fees are payable quarterly, in arrears, and may be paid only
after all distributions currently payable on the Company's Preferred Shares have
been paid. Effective April 4, 2003, the affiliate is entitled to receive annual
asset management fees equal to 0.40% of the purchase price of real estate
properties owned by the Company, as adjusted from time to time to reflect the
then current fair market value of the properties. The purchase price is defined
as the capitalized basis of an asset under GAAP, including renovation or new
construction costs, costs of acquisition or other items paid or received that
would be considered an adjustment to basis. Prior to April 4, 2003, asset
management fees paid by the Predecessor were based on fees specified under the
terms of the agreements governing the various Predecessor entities.
The Company also reimburses affiliates for certain expenses incurred in
connection with the operation of the properties, including administrative
expenses and salary reimbursements.
The Company pays acquisition fees to an affiliate for acquisition services.
These fees are payable upon the closing of an acquisition of real property. The
fee is equal to 1% of the purchase price of any new property acquired directly
or indirectly by the Company. The purchase price is defined as the capitalized
basis of an asset under GAAP, including renovations or new construction costs,
cost of acquisition or other items paid or received that would be considered an
adjustment to basis. The purchase price does not include acquisition fees and
capital costs of a recurring nature. During the six months ended June 30, 2003,
the Company paid fees on the following acquisitions:
Acquisition Acquisition Fee
--------------- ---------------
Gables $ 69
Windward Lakes 190
---------------
$ 259
===============
The Gables acquisition fee has been capitalized and is included in
multi-family apartments in the accompanying consolidated balance sheet. The
Windward Lakes acquisition fee has been expensed and included in management fees
on the statement of operations because Windward Lakes is included in the
financial statement in a method similar to a pooling of interests. Accordingly,
all expenses associated with the Company's acquisition of Windward Lakes have
been expensed.
During the three months ended June 30, 2002, the Company also paid an
affiliate advisory fees of $124 related to the refinancings of the Dorsey's
Forge, Hannibal Grove and Century mortgage notes payable and are included in
deferred expenses at June 30, 2003 and 2002 in the accompanying consolidated
balance sheet. Such fees are no longer payable under the terms of the advisory
agreement, which became effective on April 4, 2003.
13
BERKSHIRE INCOME REALTY, INC.
(FORMERLY BERKSHIRE INCOME REALTY PREDECESSOR GROUP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(unaudited, in thousands, except share and per share data)
7. RELATED PARTY TRANSACTIONS, continued
Amounts accrued or paid to the Company's affiliates for the six months
ended June 30, 2003 and 2002 were as follows:
For the Six Months
Ended June 30,
-----------------------
2003 2002
---------- ----------
(Unaudited)
Property management fees $ 767 $ 675
Expense reimbursements 4 115
Salary reimbursements 1,245 1,205
Acquisition fees 259 -
Asset management fees 151 225
---------- ----------
Total $ 2,426 $ 2,220
========== ==========
Expense and salary reimbursements due to affiliates of $0 and $122 are
included in accrued expenses and other liabilities at June 30, 2003 and December
31, 2002, respectively.
Due to affiliates of $5,477 at June 30, 2003 represents syndication costs,
developments fees and shared services. Due to affiliates of $2,879 at December
31, 2002, represents accrued interest related to the McNab debt, developments
fees and shared services.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF BERKSHIRE INCOME REALTY, INC. (FORMERLY BERKSHIRE
INCOME REALTY PREDECESSOR GROUP)
(In Thousands, except share and per share amounts)
You should read the following discussion in conjunction with the Berkshire
Income Realty Inc.'s consolidated financial statements and their related notes
and other financial information included in this report. For further information
please refer to the consolidated financial statements and footnotes thereto
included in the Company's annual report on Form 10-K for the year ended December
31, 2002 and Form 8 K/A filed on August 13, 2003 for the significant acquisition
of McNab KC3 Limited Partnership.
Overview
Berkshire Income Realty - OP, L.P.
Berkshire Income Realty - OP, L.P. (Operating Partnership), a Delaware
limited partnership, is the entity through which we conduct substantially all of
our business and own, either directly or through subsidiaries, substantially all
of our assets. Our wholly owned subsidiary, BIR GP, LLC, a Delaware limited
liability company, is the sole general partner of the Operating Partnership. As
of August 13, 2003, the Company is the owner of 100% of the preferred limited
partner units of the Operating Partnership, whose terms mirror the terms of the
Company's Preferred Shares and, through BIR GP, LLC, own 100% of the general
partner interest, which represents approximately 2.39% of the common economic
interest of the Operating Partnership.
Our general limited partner interest in the Operating Partnership entitles
us to share in cash distributions from, and in the profits and losses of the
Operating Partnership in proportion to our percentage interest therein. The
other partners of the Operating Partnership are affilaites who contributed their
direct or indirect interests in certain properties to the Operating Partnership
in exchange for common units of limited partnership interest in the Operating
Partnership.
Preferred units of the Operating Partnership have the rights,
preference and other privileges as set fourth in amendments to the limited
partnership agreement of the Operating Partnership. As of August 13, 2003, the
Operating Partnership had one series of its preferred units outstanding. The
Series A preferred units have an aggregate liquidation preference of
approximately $74,453 and are entitled to a preferred distribution at a rate of
9% per annum, payable quarterly. The Company is the sole owner of the Series A
preferred units.
General
The Company detailed a number of significant trends and specific factors
affecting the real estate industry in general and the Company's business in
particular in "Management's Discussion and Analysis of Financial Condition and
Results of Operations," Item 7 of our Annual Report on Form 10-K for the year
ending December 31, 2002 under several headings, including "Liquidity and
Capital Resources", "Inflation and Economic Conditions" and "Property
Renovations". The Company believes those trends and factors continue to be very
relevant to the Company's performance and financial condition.
Forward Looking Statements
Certain statements contained in this report, including information with
respect to our future business plans, constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. For this purpose, any statements
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements, subject to a number of risks and uncertainties that
could cause actual results to differ significantly from those described in this
report. These forward-looking statements include statements regarding, among
other things, our business strategy and operations, future expansion plans,
future prospects, financial position, anticipated revenues or losses and
projected costs, and objectives of management. Without limiting the foregoing,
the words "may," "will," "should," "could," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of such
15
terms and other comparable terminology are intended to identify forward-looking
statements. There are a number of important factors that could cause our results
to differ materially from those indicated by such forward-looking statements.
These factors include, but are not limited to, changes in economic conditions
generally and the real estate and bond markets specifically,
legislative/regulatory changes (including changes to laws governing the taxation
of real estate investment trusts ("REITs"), availability of capital, interest
rates and interest rate spreads, changes in generally accepted accounting
principles and policies and guidelines applicable to REITs, those set forth in
Part I, Item 1A. "Risk Factors" of the Company's Form 10-K for the year ended
December 31, 2002 and other risks and uncertainties as may be detailed from time
to time in our public announcements and SEC filings.
The risks included here are not exhaustive. Other sections of this report
may include additional factors that could adversely affect our business and
financial performance. Moreover, we operate in a competitive and rapidly
changing environment. New risk factors emerge from time to time and it is not
possible for management to predict all such risk factors, nor can it assess the
impact of all such risk factors on our business or the extent to which any
factor, or combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements. Given these risks and
uncertainties, investors should not place undue reliance on forward-looking
statements as a prediction of actual results.
Critical Accounting Policies
The discussion below describes what we believe are the critical accounting
policies that affect the Company's more significant judgments and the estimates
used in the preparation of its consolidated financial statements. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make estimates
and judgments that affect the reported amounts of assets and liabilities,
revenues and expenses, and related disclosures of contingent assets and
liabilities in the Company's Consolidated financial statements and related
notes. We believe that the following critical accounting policies affect
significant judgments and estimates used in the preparation of the Company's
consolidated financial statements:
Purchase Accounting for Acquisition of Real Estate
Purchase accounting was applied for the acquisition of the Gables property
consistent with the provisions of Statement of Financial Accounting Standards
No. 141, Business Combinations. In accordance with FAS 141, the fair value of
the real estate acquired is allocated to the acquired tangible assets,
consisting of land, building and personal property, and identified intangible
assets and liabilities, including the value of in-place leases, based in each
case on their fair values.
The fair value of the tangible assets of an acquired property (which
includes land, building and improvements) is determined by valuing the property
as if it were vacant, and the "as-is-vacant" value is then allocated to land,
building and improvements based on management's determination of the relative
fair values of these assets. Management determines the as-if-vacant fair value
of a property using methods similar to those used by independent appraisers.
Factors considered by management in performing these analyses include an
estimate of carrying costs during the expected lease-up periods considering
current market conditions and costs to execute similar leases. In estimating
carrying costs, management includes real estate taxes, insurance and other
operating expenses and estimates of lost rental revenue during the expected
lease-up periods based on current market demand. Management also estimates costs
to execute similar leases including legal and other related costs.
The aggregate value of intangible assets, including in-place leases, is
measured by the excess, if any, of (i) the purchase price paid for a property
over (ii) the estimated fair value of the property as if vacant, determined as
set forth above. The aggregate value allocated to in-place lease values is
amortized to expense over the remaining expected life of the respective leases.
The intangible assets associated with the Gables acquisition are nominal.
Unconsolidated Investments in Mortgage Funds
The acquisition of the Interests in the Mortgage Funds by the Company has
been accounted for using purchase accounting based upon the fair value of the
Preferred Shares for the Interests acquired. The fair value was determined to be
the $25.00 liquidation preference for the Preferred Shares since this is the
most readily available market value.
16
This transaction generated a basis difference between the Company's
investment in the Mortgage Funds (fair value) and its underlying equity in the
net assets of the Mortgage Funds (book value). The excess of the book value over
the carrying value for each Mortgage Fund has been allocated to such fund's
mortgage loan investments based upon their relative value. Such allocated
amounts are being amortized into income over the contractual life of the
respective mortgage loans on a basis which approximates the effective interest
method.
The Company is accounting for its investments in the Mortgage Funds, which
it does not control, using the equity method of accounting. Under the equity
method of accounting, the net equity investment of the Company is reflected on
the consolidated balance sheet, and the Company's share of net income or loss
from the Mortgage Funds is included on the consolidated statement of operations.
Recent Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." The objective of this
interpretation is to provide guidance on how to determine whether an investment
or interest in another entity needs to be included (i.e., consolidated) in a
company's consolidated financial statements. The Company is currently evaluating
the impact that this standard may have on the accounting for its consolidated
investment in the Operating Partnership and its off-balance sheet investments,
including its investments in Mortgage Funds, and certain other arrangements. The
Company is required to adopt FIN 46 during the third quarter of 2003.
In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". FAS 150 was
issued as "Phase I" of the FASB's ongoing initiative to establish standards for
classification of financial instruments that have characteristics of
liabilities, equity, or both, and thus ultimately eliminating the "mezzanine"
section of the balance sheet for certain financial instruments. FAS 150 will be
effective for the Company commencing in the third quarter of 2003. The Company
is currently evaluating the impact that FAS 150 may have on the accounting for
its preferred and common operating partnership units and certain non-wholly
owned consolidated subsidiaries.
Liquidity and Capital Resources
Capital Expenditures, Distributions, Cash flow and Indebtedness
As of June 30, 2003 and December 31, 2002, the Company had approximately
$10,207 and $4,852 of cash and cash equivalents, respectively.
Cash provided by operating activities was $3,356 and $6,683 for the six
month periods ended June 30, 2003 and 2002, respectively. Cash provided by and
(used in) investing activities was $18,344 and $(1,642) for the six month
periods ended June 30, 2003 and 2002, respectively. Cash used in financing
activities was $16,345 and $2,170 for the six month periods ended June 30, 2003
and 2002, respectively.
In addition to distributions from its ownership of the Interests in the
Mortgage Funds, discussed below, the Company is expecting to receive proceeds
from refinancing some of its mortgage debt during August 2003. While the Company
is aggressively seeking out real estate investments, the gross proceeds of
approximately $31,469, have
17
not yet been designated for specific real property investments and will be
temporarily placed in short and medium term investments. While these investments
may not yield sufficient returns to offset the costs associated with carrying
the additional debt, the Company believes that the long-term impact on its
financial position, results of operations and cash flows will be enhanced by the
long-term low interest rates obtained on the additional mortgage obligations and
this enhancement will overcome any short or medium term negative arbitrage
associated with the current investment options.
The Company expects its principal liquidity demands to be capital
improvements and repairs and maintenance for our properties, acquisition of
additional properties, repayment of indebtedness, distributions to the holders
of the Company's preferred stock and obligations related to capital commitments
on anticipated joint ventures.
The Company intends to meet all short-term liquidity requirements through
net cash flows provided by operating activities and through distributions of
income on the Interests acquired in the Offering. In order to qualify as a REIT,
the Company is required to make dividend distributions, other than capital gain
dividends, to its shareholders each year in the amount of at least 90% of the
Company's REIT taxable income (computed without regard to the dividends paid
deductions and our net capital gain and subject to certain other potential
adjustments) for all tax years.
To the extent that the Company does not satisfy its long-term liquidity
requirements through net cash flows provided by operating activities and through
distributions of income on the Interests tendered in the Offering, the Company
intends to satisfy those requirements through refinancing of existing
indebtedness or by establishing secondary financing of our real estate
investments.
As of June 30, 2003, approximately 96% of the Company's mortgage
obligations were under fixed interest rates. The weighted average rate of
interest on all mortgage debt was 5.71%. During 2002, the Company took advantage
of the declining interest rate market to fix rates on four of its five mortgage
notes payable. In July 2003, the Company signed commitments and fixed interest
rates on an approximately $31,467 of additional mortgage obligations. These
additional mortgages are expected to close in late August 2003. The Company
anticipates the weighted average rate of interest on the new mortgage
obligations will be 4.96%. The Company anticipates that after these additional
mortgages are completed the weighted average rate of interest on total mortgage
obligations will be approximately 5.91%. The Company believes the actions taken
in 2002 and 2003 limit its exposure to changes in interest rates, minimizing the
effect on its financial condition, results of operations and cash flows. The
proceeds from the additional mortgages are expected to ultimately be used for
the acquisition of additional real estate.
On April 30, 2003, Maryland's three-member Board of Public Works voted
unanimously to increase the state property tax rate from 8.4 cents to 13.2 cents
per one hundred dollars of assessed property value. This represents an increase
of more than fifty percent above the previous rate. The increase is effective
for Maryland's 2004 fiscal year, which begins on July 1, 2003. The impact of
this change in tax rate is an increase in the overall tax paid on the assessed
value of properties located in Maryland of approximately 4%.
On May 6, 2003, our property manager agreed to reduce the property
management fee payable by us from 5% of gross income to 4% of gross income. This
change in the management fee will be applied prospectively effective April 1,
2003.
On May 24, 2003, our Board of Directors, with only the independent
directors participating, authorized the Company to enter into a joint venture
(the "Venture") with an unaffiliated third party. The Venture is being sponsored
by an affiliate of the Advisor. The Company expects the venture to have a finite
life of between three and five years. The Company has verbally committed to
acquiring a 50% stake in the Venture, which will invest in short-term bridge
mortgages secured by first mortgage interests in multi-family apartment
communities located in the United States. The Company believes this investment
will allow it to employ some of its cash reserves at returns greater than those
offered on other short/mid-term investments. The Company believes the life of
the Venture is such that it will not interfere with its primary objective of
investing in multi-family apartment communities. The Venture requires a capital
commitment by the Company of up to $20,000, payable over twenty months based on
the cash requirements of individual investments in bridge mortgages presented to
the Venture's board of governors.
18
The venture intends to utilize a line of credit, secured by the assets of the
venture, to enhance the returns on its investments. The use of a line of credit
increases the risks associated with the Venture; however, the Company believes
that the anticipated returns are sufficient to offset this risk. The Company
expects the sponsor of the Venture and its affiliates, to receive fees
associated with the management of the Venture as well as fees associated with
servicing of the bridge mortgages. The sponsor is also expected to receive a
promotional fee, which is subject to the Venture achieving certain return
objectives. Definitive terms of the joint venture agreement have not yet been
finalized and, as of this filing, no written agreements have been signed.
Acquisitions
On March 20, 2003, KRF Company, through a newly formed affiliate, Gables of
Texas Limited Partnership ("Gables"), whose general partner, Gables of Texas,
L.L.C., was also a newly formed affiliate, acquired The Gables Apartments, a
140-unit multi-family apartment community located in Houston, Texas, from an
unrelated third party for a purchase price of approximately $6,925. On April 24,
2003, the Operating Partnership acquired Gables and Gables of Texas L.L.C. from
KRF Company for approximately $6,925 plus closing costs of approximately $143.
The purchase price for Gables and Gables of Texas L.L.C. was equal to the
purchase price KRF Company paid the original seller of The Gables Apartments
(including equity payments, transfer taxes, financing and closing costs as
applicable).
Due to the affiliation of the ownership of the Company and KRF Company, the
acquisition of interests in the Gables property has been accounted for as a
reorganization of entities under common control, requiring the Company to
retroactively restate the consolidated financial statements from March 20, 2003,
the acquisition date of the property by KRF Company, through the period
presented.
On April 29, 2003, the Preferred Shares began trading on the American Stock
Exchange, under the symbol "BIR.PR.A".
On May 30, 2003 the Operating Partnership and its wholly owned subsidiary
BIR McNab Sub, L.L.C., a newly formed Delaware limited liability company,
acquired all of the outstanding limited and general partner units of McNab KC3
Limited Partnership ("McNab") from affiliates of the Company. The acquisition
was structured as a contribution of units from an affiliate of the Company in
exchange for the issuance by the Operating Partnership of 5,000 common limited
partner units valued at $10.00 per unit. McNab is the fee simple owner of a
276-unit multi-family apartment community located in Pompano Beach, Florida that
is referred to as Windward Lakes Apartments. The general and limited partners of
McNab are affiliates of the Company, namely George and Douglas Krupp. Control of
both the Company and McNab rests with George and Douglas Krupp via their 100%
ownership interest in the common stock of the Company and their 100% ownership
interest in the general and limited partnership units of McNab. Therefore, the
acquisition or contribution of the general and limited partnership units of
McNab by the Operating Partnership in exchange for the issuance by the Operating
Partnership of common limited partner units is considered a transfer of net
assets between entities under common control.
Declaration of Dividend
On March 25, 2003, the Company's Board of Directors (the "Board") declared
a dividend at an annual rate of 9% of the stated liquidation preference of $25
per share of the outstanding Series A Cumulative Redeemable Preferred Stock (the
"Preferred Stock") of the Company and will be payable quarterly in arrears, on
February 15, May 15, August 15 and November 15 of each year to shareholders of
record in the amount of $.5625 per share per quarter. The dividend payable on
May 15, 2003 was prorated to reflect the issue date of the Preferred Shares.
On August 12, 2003, the Board declared a per share dividend on the common
shares of $0.00466 totaling $6. Also on August 12, 2003, the Board declared a
distribution on the Operating Partnership's common limited partnership units of
$0.04655 per unit totaling $244.
Results of Operations
From January 1, 2002 through June 30, 2002, the Company's portfolio
increased from 6 to 7 properties (the "Total Portfolio"). As a result of changes
in the Company's Total Portfolio, the financial statements shows
19
significant changes in revenue and expenses from period-to-period. The Company
does not believe that its period-to-period financial data are comparable.
Therefore, the comparison of operating results for the three and six months
ended June 30, 2003 and 2002 show changes attributable to the properties that
were owned by the Company throughout each period compared (the "Same Property
Portfolio").
The entities comprising the Berkshire Income Realty Predecessor Group are
deemed to be our predecessors for accounting purposes. Because we did not have
any operations until the second quarter of 2003, the following discussion
relates to our operations for the three and six months ended June 30, 2003 and
the operations of the Berkshire Income Realty Predecessor Group for the three
and six months ended June 30, 2002.
Comparison of the Same Property Portfolio results for the three and six months
ended June 30, 2003 to the three and six months ended June 30, 2002
Rental income increased $258 or 3.94% for the three months ended June 30,
2003 and increased $396 or 3.05% for the six months ended June 30, 2003 as
compared to the same periods in 2002, respectively. The increase was a result of
an increase in weighted average rental rates of 4.93% and 4.41% during the three
and six months ended June 30, 2003, respectively, as compared to the same
periods in 2002 offset by a decrease in average occupancy rates to 94.45% from
95.71% for the three months ended June 30, 2003 and 2002, respectively and to
93.94% from 95.49% for the six months ended June 30, 2003 and 2002,
respectively.
Interest income decreased $11 or 26.64% and $5 or 7.46% for the three and
six months ended June 30, 2003 as compared to the same periods in 2002. The
decrease was primarily the result of a decrease in the average interest rates on
short-term cash investments during the period.
Utility reimbursement decreased $54 or 35.53% and $108 or 34.29% for the
three and six months ended June 30, 2003 as compared to the same periods in
2002. The increase is primarily due to the collection of amounts deemed
uncollectible as of December 31, 2001 in 2002, which results in the 2002 amounts
being higher than normal.
Other income increased $74 or 32.48% and $84 or 18.28% for the three months
and six months ended June 30, 2003, respectively, as compared to the same
periods in 2002. This increase was related to increases in the various fees
collected from tenants and recorded as other income.
Operating expenses increased $186 or 13.22% and $262 or 8.90% for the three
and six months ended June 30, 2003, respectively, as compared to the same
periods in 2002. This increase was primarily related to significant increases in
our insurance costs, which were partially offset by savings in onsite personnel
costs. Insurance costs increased $246 as a result of general insurance premiums
on our properties for the six months ended June 30, 2003 with similar increases
occurring for the three months ended June 30, 2003 as compared to the same
periods in 2002. Insurance expense is expected to continue to rise as a result
of the terrorist attacks on September 11, 2001 and their impact on the insurance
industry.
Maintenance expenses increased $34 or 6.09% and 88 or 9.07% for the three
and six months ended June 30, 2003, respectively, as compared to the same
periods in 2002. The increase was primarily the result of significant increases
in snow removal costs associated with significant snowfalls in the Mid-Atlantic
states during February 2003, and a significant increase in janitorial contracts
and increases in painting and decorating within the properties.
Real estate taxes increased $16 or 2.91% and 45 or 4.17% for the three and
six months ended June 30, 2003, respectively, as compared to the same periods in
2002. The increase was primarily related to increases in tax rates on real
property in the various jurisdictions where the initial properties are located.
All of the Company's properties are subject to reassessment on a regular basis.
Future increases in assessments could be significant and would result in
increases to real estate tax expense even if tax rates remained stable. The
Company cannot predict future assessment values, but aggressively arbitrates any
increases in value that it considers to be unreasonable in light of comparable
properties or other economic factors relating to particular properties.
General and administrative expenses increased $354 or 216.88% and $313 or
89.05% for the three and six months ended June 30, 2003, respectively, as
compared to the same periods in 2002. The primary reason for the
20
increase in these expenses were due to increases in legal and audit fees
incurred during the period as a result of the Offering, which the Company has
properly classified as general and administrative expense.
Organizational costs are those costs directly attributable to the Offering
and are expected to be one-time charges.
Management fees increased $206 or 44.93% and $196 or 21.78% for the three
and six months ended June 30, 2003, respectively, as compared to the same
periods in 2002. The increase in fees is primarily the result of the acquisition
fee of $190 paid to the Company's advisor as a result of the acquisition of
Windward Lakes. The fee is included in expenses because the nature of the
transaction required that the acquisition be accounted for in a manner similar
to a pooling of interests, which requires that all costs associated with the
transaction be expensed in the period incurred. Generally acquisition fees a
capitalized and included in multi-family apartment communities on the balance
sheet.
Interest expense increased $637 or 53.76% and $1,430 or 61.64% for the
three and six months ended June 30, 2003, respectively, as compared to the same
periods in 2002. In April and July of 2002, the Company refinanced four of the
five initial properties. The refinancing resulted in an increase in mortgage
indebtedness of approximately $29,000. As a result of these refinancings, the
weighted average interest rate on the mortgage debt increased from approximately
3.00%, the weighted average variable interest rate at June 30, 2002, to
approximately 5.85%, the weighted average fixed interest rate at June 30, 2003.
The combination of these two factors resulted in a significant increase in
interest expense.
Participation interest expense decreased $44 or 100% and $88 or 100% for
the three and six months ended June 30, 2003, respectively, as compared to the
same periods in 2002. Participation interest payable was fully accrued as of
December 31, 2002 therefore no expense was recognized during 2003.
Minority interest in properties decreased $1,288 or 93.20% and $1,342 or
93.45% for the three and six months ended June 30, 2003, respectively, as
compared to the same periods in 2002. The decrease is a result of decreases in
distributions paid to the holders of minority interest in properties which were
in excess of the minority interest holders basis. In April 2002, as a result of
the refinancing of certain properties, the Predecessor distributed significant
amounts to the owners.
Mortgage Debt to Fair Market Value of Real Estate Assets
The Company's total mortgage debt summary and debt maturity schedule, as of
June 30, 2003, is as follows:
Mortgage Debt Summary as of June 30, 2003
$ Thousands Weighted Average Rate
---------- ----------------------
Collateralized - Fixed Rate $ 100,774 5.91%
Collateralized - Floating Rate 4,361 2.64%
---------- ----------------------
Total $ 105,135 5.71%
Debt Maturity Schedule as of June 30, 2003
Year $Thousands % of Total
---------- ----------------------
2003 $ 645 0.61%
2004 1,399 1.33%
2005 1,482 1.41%
2006 1,571 1.49%
2007 47,455 45.13%
Thereafter 52,583 50.03%
---------- ----------------------
Total $ 105,135 100.0%
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The Company's "Consolidated Mortgage Debt-to-Fair Market Value of Real
Estate Assets" as of June 30, 2003 is presented in the following table. The
Company calculates the fair market value of real estate assets based on the most
recently available third party appraisal. The following information is presented
in lieu of information regarding the Company's consolidated Debt-to-Total Market
Capitalization Ratio", which is a commonly used measure in our industry, because
the Company's market capitalization is not readily determinable since there was
no public market for its equity during the periods presented in these financial
statements.
The information regarding "Consolidated Mortgage Debt-to-Fair Market Value
of Real Estate Assets" is presented to allow investors to calculate our
loan-to-value ratios in a manner consistent with those used by management and
others in our industry including those used by our current and potential
lenders. Management uses this information when making decisions about financing
or refinancing properties. Management also uses fair market value information
when making decisions about selling assets as well as evaluating acquisition
opportunities within markets where we have assets. The most directly comparable
financial measure of our property value, calculated and presented in accordance
with accounting principles generally accepted in the United States of America,
is net book value, shown on the balance sheet as multi-family apartment
communities, net of accumulated depreciation. At June 30, 2003 the aggregate net
book value of our real estate assets was $99,473.
Fair Market Value of Real Estate Assets as of June 30, 2003
($ in Thousands)
----------------------------------------------------------------------
Fair Market Value Mortgage Debt Loan-to-Value
---------------------- ---------------------- ----------------------
$ 202,470 $ 105,135 51.92%
The fair market values are based on third party appraisals obtained between
June 2002 and June 2003 for all of the properties within the portfolio. The
individual appraisals range from $7,100 to $90,500.
Funds From Operations
Management considers funds from operations ("FFO") to be an appropriate
measure of the performance of an equity REIT. FFO is generally defined as income
(loss) before minority interest in the Operating Partnership plus real estate
depreciation. Management believes that in order to facilitate a clear
understanding of the consolidated historical operating results of the Company,
FFO should be considered in conjunction with net income as presented in the
consolidated financial statements included elsewhere herein. FFO does not
represent cash generated from operating activities in accordance with accounting
principles generally accepted in the United States of America and is not
necessarily indicative of cash available to fund cash needs. FFO should not be
considered as an alternative to net income as an indication of the Company's
performance or to cash flow as a measure of liquidity.
The calculation of FFO for the three and six month periods ended June 30,
2003 and 2002 are presented below (in thousands):
Three Months ended June 30,
-------------------------
2003
----------
Income (loss) before minority interest in
Operating Partnership $ 627
Depreciation of real property 1,848
----------
FFO $ 2,475
==========
All REITs may not be using the same definition for FFO. Accordingly, the
above presentation may not be comparable to other similarly titled measures of
FFO of other REITs.
Environmental Issues
There are no recorded amounts resulting from environmental liabilities,
because there are no known contingencies with respect to environmental
liabilities. During the past 18 months, the Company has refinanced each of the
initial properties. As part of the refinancing process, the lenders obtained
environmental audits of each of the
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initial properties. The Company was not advised by the lenders as to any
material liability for site restoration or other costs that may be incurred with
respect to any of the initial properties.
Inflation and Economic Conditions
Substantially all of the leases at the initial properties are for a term of
one year or less, which enables the Company to seek increased rents for new
leases or upon renewal of existing leases. These short-term leases minimize the
potential adverse effect of inflation on rental income, although residents may
leave without penalty at the end of their lease terms and may do so if rents are
increased significantly.
Historically, real estate has been subject to a wide range of cyclical
economic conditions, which affect various real estate sectors and geographic
regions with differing intensities and at different times. In 2002 and
continuing into 2003, many regions of the United States experienced varying
degrees of economic recession and certain recessionary trends, such as increased
cost of obtaining sufficient property and liability insurance coverage,
reductions in short-term interest rates, and a temporary reduction in occupancy.
In light of this, we will continue to review our business strategy, however, we
believe that given our property type, garden style residential apartment
communities, and the geographic regions in which the initial properties are
located, these recessionary trends have not had a material effect on our
financial performance and we do not anticipate any changes in our strategy.
Other Matters
The Company at all times intends to conduct its business so as to not
become regulated as an investment company under the Investment Company Act of
1940, as amended (the "Investment Company Act"). If the Company were to become
regulated as an investment company, then, among other things, the Company's
ability to use leverage would be substantially reduced and there would be
restrictions on certain types of fees paid. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interest in real estate" (i.e.,
"Qualifying Interest"). Under the current interpretation of the staff of the
Securities and Exchange Commission, in order to qualify for this exemption, the
Company must maintain at least 55% of its assets directly in Qualifying
Interests. Accordingly, the Company monitors its compliance with this
requirement in order to maintain its exempt status. As of June 30, 2003, the
Company determined that it is in and has maintained compliance with this
requirement.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Our primary market risk exposure is interest rate risk. At June 30, 2003
and December 31, 2002, approximately 96% of the Company's mortgage obligations
were under fixed interest rates. The weighted average rate of interest on
mortgage debt was 5.71% and 5.8% at June 30, 2003 and December 31, 2002,
respectively. The Company has taken advantage of the low interest rate market to
fix rates on the vast majority of its mortgage debt. We believe that this limits
the exposure to changes in interest rates, minimizing the effect on our
financial condition, results of operations and cash flows. However, please see
the discussion in Capital Expenditures, Distributions, Cash flows and Indebtness
with respect to the potential short to medium term impact of these borrowings.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
Within the 90 days prior to the date of this report, we carried out an
evaluation under the supervision and with the participation of our
management, including the principal executive officer and principal
financial officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-14(c) and
15d-14(c) of the Securities Exchange Act). Based upon that evaluation, the
principal executive officer and principal financial officer concluded that
our disclosure controls and procedures are effective to ensure that
information required to be disclosed by us in the reports we file or submit
under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the Securities and Exchange
Commission's rules and forms.
(b) Changes in Internal Controls.
The Company has reviewed its internal controls and there have been no
significant changes in its internal controls or in other factors that could
significantly affect those controls subsequent to the date of its last
evaluation.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
31.1 Certification of Principal Executive Officer and Principal Financial
Officer of Berkshire Income Realty, Inc. Pursuant to Securities Exchange
Act Rules 13a-14 and 15d- 14
32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
Form 8-K was filed on May 19, 2003, with respect to Item 5 and 7 Press
Release, dated May 15, 2003, announcing the results of operations and financial
condition of Berkshire Income Realty Predecessor Group for the three months
ended and as of March 31, 2003.
Form 8-K was filed on June 16, 2003, with respect to Item 2 and Item 5
acquisition of McNab KC3 Limited Partnership on May 30, 2003 and Gables on April
24, 2003, respectively.
Form 8-K/A was filed on August 13, 2003, with respect to Item 7 financial
statements for the acquisition of McNab KC3 Limited Partnership on May 30, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: August 14, 2003
BERKSHIRE INCOME REALTY, INC.
BY: /s/ David C. Quade
--------------------------------
NAME: David C. Quade
TITLE: President and Chief
Financial Officer
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EXHIBIT INDEX
31.1 Certification of Principal Executive Officer and Principal Financial
Officer of Berkshire Income Realty, Inc. Pursuant to Securities Exchange
Act Rules 13a-14 and 15d- 14
32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
27