As filed with the Securities and Exchange Commission on April 30, 2003
File No. ___________
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10
GENERAL FORM FOR REGISTRATION OF SECURITIES
Pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934
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Hartman Commercial Properties REIT
(Exact name of registrant as specified in its charter)
TEXAS 76-0594970
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1450 West Sam Houston Parkway North, Suite 100
Houston, Texas 77043
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (713) 467-2222
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Securities to be registered pursuant to Section 12(b) of the Act:
None
Securities to be registered pursuant to Section 12(g) of the Act:
Common Shares of Beneficial Interest, par value $0.001 per share
(Title of Class)
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This registration statement contains certain "forward-looking
statements" regarding our plans and objectives, including, among other things:
. future economic performance;
. plans and objectives of management for future operations; and
. projections of revenue and other financial items.
Forward-looking statements are typically identified by the use of terms
such as "may," "will," "should," "expect," "intend," "plan," "anticipate,"
"estimate," "believe," "continue," "predict," "potential" or the negative of
such terms and other comparable terminology. These statement are only
predictions and are not historical facts. Actual events or results may differ
materially.
The forward-looking statements included herein are based on our current
expectations, plans, estimates and beliefs that involve numerous risks and
uncertainties. Assumptions relating to the foregoing involve judgments with
respect to, among other things, future economic, competitive and market
conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond our control. Any
of the assumptions underlying the forward-looking statements contained herein
could be inaccurate and, therefore, we cannot assure investors that the
forward-looking statements included in this registration statement will prove to
be accurate.
In light of the significant uncertainties inherent in the
forward-looking statements included in this registration statement, including,
without limitation, the risks set forth in the "Risk Factors" section contained
in Item 1, the inclusion of such information should not be regarded as a
representation by us or any other person that the objectives and plans set forth
in this registration statement will be achieved. We caution investors that
forward-looking statements are not guarantees and that the actual results could
differ materially from those expressed or implied in the forward-looking
statements.
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ITEM 1. BUSINESS.
SUMMARY
We are a Texas real estate investment trust. We invest in commercial
real estate by acquiring retail, office and office/warehouse properties located
primarily in the metropolitan Houston, Texas area. We own all our real estate
properties and conduct our operations through an "UPREIT" called Hartman REIT
Operating Partnership, L.P. To avoid confusion:
. we sometimes refer to ourselves as "HCP";
. we refer to Hartman REIT Operating Partnership, L.P. as the
"Operating Partnership";
. we collectively refer to HCP and the Operating Partnership in
this registration statement as the "Company"; and
. the use of "we," "our" or similar pronouns in this registration
statement refers to HCP or the Company as required by the
context in which such pronoun is used.
The term UPREIT stands for "Umbrella Partnership Real Estate Investment Trust."
We use this structure because a sale of property directly to HCP in exchange for
our shares is generally a taxable transaction to the property owner. In an
UPREIT structure, a seller of a property who desires to defer taxable gain on
the sale of his property may transfer the property to the UPREIT in exchange for
limited partnership units on a tax-free basis. This allows the seller to defer
taxation of gain until the seller exchanges his limited partnership units for
our shares. If our shares are publicly traded, the former property owner may be
able to achieve liquidity for his investment in order to pay taxes. This
structure gives us an advantage in acquiring desired properties from persons who
may not otherwise sell their properties because of unfavorable tax results.
We are the sole general partner of the Operating Partnership and, as of
December 31, 2002, we owned 53.37% of all of its outstanding OP Units. The term
"OP Units" refers to the limited partnership interests in the Operating
Partnership. We owned 32 commercial properties as of December 31, 2002,
consisting of retail centers, office/warehouse properties and office properties
and typically leased to a variety of tenants under long-term leases.
In this registration statement, we refer to an entity that qualifies as
a real estate investment trust for U.S. federal income tax purposes as a "REIT."
We have made an election to be taxed as a REIT. In general, a REIT is an entity
that:
. combines the capital of many investors to acquire or provide
financing for real estate properties;
. offers the benefits of a diversified portfolio of real estate
assets under professional management;
. is able to qualify as a "real estate investment trust" for U.S.
federal income tax purposes and is therefore not generally
subject to federal corporate income taxes on its net income (to
the extent such net income is distributed by it), which
substantially eliminates the "double taxation" (i.e., taxation
at both the corporate and shareholder levels) that generally
results from investments in a corporation; and
. must pay distributions to investors of at least 90% of its
taxable income.
As a REIT, we generally are not subject to federal income tax on income
that we distribute to our shareholders. We refer to the Internal Revenue Code of
1986, as amended, as the "Internal Revenue Code" in this registration statement.
If we fail to qualify for taxation as a REIT in any year, our income will be
taxed at regular corporate rates.
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Our office is located at 1450 West Sam Houston Parkway North, Suite 100,
Houston, Texas 77043. Our telephone number is (713) 467-2222.
OUR BUSINESS
GENERAL
We were formed in August 1998 by Allen R. Hartman as a vehicle to
consolidate Mr. Hartman's real estate operations. Mr. Hartman has been operating
in the Houston, Texas metropolitan real estate industry for over 20 years. On
December 31, 2002, we owned the 32 properties located in the metropolitan
Houston, Texas area. Although our management does not assess our business on a
segment basis, for accounting purposes our properties are divided into the
following three reportable segments:
. Retail properties (17 of our properties);
. Office/Warehouse properties (12 of our properties); and
. Office properties (three of our properties).
Please see Note 12 in the Notes to our Consolidated Financial Statements
contained in this registration statement for certain financial information
related to these segments.
A majority of our properties consist of retail centers and each is
designed to meet the needs of surrounding local communities. A supermarket or
one or more nationally and/or regionally recognized tenants typically anchors
each of our retail properties. In the aggregate, our properties contain
approximately 2,350,000 square feet of the gross leasable area. No individual
property in our portfolio currently accounts for more than 10% of our aggregate
leasable area. No single tenant accounts for more than 10% of our gross rental
income.
We have acquired 28 of our 32 properties from entities managed by
affiliates of Mr. Hartman. During 1999 we acquired 12 properties. We acquired
nine of these properties from six limited partnership affiliated with Mr.
Hartman. We also bought three properties from unrelated third parties during
1999. During 2000, we acquired 10 properties. We acquired nine of these
properties from partnerships affiliated with Mr. Hartman and we purchased one
additional property from Mr. Hartman. During 2001, we bought one property from
an unrelated third party. During 2002, we acquired 10 properties and sold one
property. We acquired all 10 properties from entities affiliated with Mr.
Hartman and sold the one property to an unrelated third party. Overall, we
acquired a majority of our properties by merging the seller with and into either
HCP or the Operating Partnership. We have also acquired properties by paying
cash or issuing common shares or OP Units.
As of December 31, 2002, our properties were approximately 92% leased.
As of December 31, 2002, anchor space at the properties, representing
approximately 12% of total leasable area, was 100% leased, while non-anchor
space, accounting for the remaining 88% balance, was approximately 91% leased.
Approximately 72% of our tenants (based on aggregate leasable area) are local
tenants and approximately 10% and 18% of our tenants are national and regional
tenants, respectively. We define:
. national tenants as any tenant that operates in at least four
metropolitan areas located in more than one region (i.e.
northwest, midwest, southwest or southeast);
. regional tenants as any tenant that operates in two or more
metropolitan areas located within the same region; and
. local tenants as any tenant that operates stores only within the
metropolitan Houston, Texas area.
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Substantially all of our revenues consist of base rents and additional
rents in the form of expense reimbursements received under long-term leases.
Approximately 62% of all existing leases provide for annual increases in the
base rental payments with a "step up" rental clause.
We currently do not own any individual property that is material to our
operations. As of December 31, 2002, we had no property that accounted for over
10% of either our total assets or total gross revenue. The cost of each of our
properties will be depreciated for tax purposes over a 40-year period on a
straight-line basis. We believe all of our properties are adequately covered by
insurance and are suitable for their intended purposes.
See "Item 3--Properties" below for a description of the properties we
owned on December 31, 2002.
We have no employees and are not self-managed. Our operations are
managed by Hartman Management, L.P., which is owned by Mr. Hartman. We refer to
Hartman Management, L.P. as the "Management Company" in this registration
statement.
FINANCING
Description of our Credit Facility
On December 20, 2002, we entered into a credit facility in the aggregate
principal amount of $34,440,000 with GMAC Commercial Mortgage Corporation. In
connection with this financing, we created Hartman REIT Operating Partnership
II, L.P., a Texas limited partnership, which is the borrower under our credit
facility. The Operating Partnership is the sole limited partner of this
partnership. The Operating Partnership also owns 100% of Hartman REIT Operating
Partnership II GP, LLC, the general partner of Hartman REIT Operating
Partnership II, L.P. This entity was formed as a "special purpose entity" solely
for this financing and it holds, as its sole asset, the title to all of the
properties which secure our credit facility.
The indebtedness under the note is secured by, among other things, 18 of
our properties and the improvements, personal property and fixtures thereon, as
well as certain accounts and intangible assets and an assignment of rents
related to such properties. We may prepay the loan after July 1, 2005 without
penalty. We must pay a prepayment fee equal to one percent of the outstanding
principal balance under the facility if we want to prepay the note prior to July
1, 2005.
We are required to make monthly interest payments under this credit
facility. During the initial term of the note, indebtedness under the credit
facility bears interest at LIBOR plus 2.5%, adjusted monthly. The interest rate
was 3.92% as of December 31, 2002. The credit facility will mature on January 1,
2006, though we have the option, subject to certain conditions, of extending the
facility for an additional two-year period. In no event shall the interest rate
be lower than 3.82% during the initial term or lower than 4.32% during the
extension term.
In addition, we entered into certain covenants pursuant to the credit
facility which, among other things, require Hartman REIT Operating Partnership
II, L.P. to maintain specified levels of insurance and use the properties
securing the note only for retail, light industrial, office, warehouse and
commercial office uses. The facility also limits the borrower's ability, without
the approval of the lender, to:
. acquire additional material assets;
. merge or consolidate with any other entity;
. engage in any other business or activity other than the
ownership, operation and maintenance of the properties securing
the note;
. make certain investments;
. incur, assume or guarantee additional indebtedness;
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. grant certain liens; and
. loan money to others. The note and the security documents
related thereto also contain customary events of default,
including, without limitation, payment defaults,
bankruptcy-related defaults and breach of covenant defaults.
Line of Credit
In August 2002, we entered into $2,000,000 line of credit with First
Bank & Trust. We may only use this line of credit in connection with
acquisitions to purchase interests held by investors who do not qualify as
"accredited investors" under the Securities Act of 1933 and the rules and
regulations promulgated thereunder. As of December 31, 2002, there were no
amounts outstanding under this line of credit. This line of credit is secured by
our Bellnot Square property. In the event we borrow amounts under this line of
credit, such amounts will accrue interest at a rate equal to the lender's prime
rate. This line of credit terminates on July 31, 2004, unless the lender elects
to extend the term of the line for additional one year periods. This line of
credit contains customary covenants and events of default.
Houston R.E. XVI Note
In November 2002, we borrowed $3,278,000 from Houston R.E. Income
Properties XVI, L.P. This debt is evidenced by a promissory note and accrues
interest at a rate of 4.25%. The note is secured by our Corporate Park Northwest
property and is payable at any time upon the demand of Houston XVI. We used
these borrowed funds to repay existing debt. Mr. Hartman controls the general
partner of Houston XVI. We are only required to make monthly interest payments
under the note.
COMPETITION
Our properties are all located in areas that include highly competitive
properties. The number of competitive properties in a particular area could have
a material adverse effect on both our ability to lease space at any of our
properties or at newly acquired (or developed) properties, and the amount of
rent we can charge at our properties. We compete with many property owners, such
as corporations, limited partnerships, individual owners, other real estate
investment trusts, insurance companies and pension funds. We also compete with
other entities controlled by Mr. Hartman and operated by the Management Company.
Many of our competitors have greater financial and other resources than
us and may have substantially more operating experience than either us or the
Management Company. Generally, there are other neighborhood and community retail
centers within relatively close proximity to each of our properties. There is,
however, no dominant competitor in the metropolitan Houston, Texas area.
Regarding our retail properties, in addition to competitor retail properties,
our tenants face increasing competition from outlet malls, internet shopping
websites, discount shopping clubs, catalog companies, direct mail and
telemarketing.
INSURANCE
We believe that we have property and liability insurance with reputable,
commercially rated companies. We also believe that our insurance policies
contain commercially reasonable deductibles and limits, adequate to cover our
properties. We expect to maintain such insurance coverage and to obtain similar
coverage with respect to any additional properties we acquire in the near
future. Further, we have title insurance relating to our properties in an
aggregate amount which we believe to be adequate.
EMPLOYEES
We have no employees. All personnel required for our operations are
provided by the Management Company under a management agreement. Please see
"Item 6. Directors and Executive Officers--The Management Company"; and "--The
Management Agreement."
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REGULATIONS
Our properties, as well as any other properties which we may acquire in
the future, are subject to various federal, state and local laws, ordinances and
regulations, including, among other things, zoning regulations, land use
controls, environmental controls relating to air and water quality, noise
pollution and indirect environmental impacts such as increased motor vehicle
activity. We believe that we have all permits and approvals necessary under
current law to operate our properties.
REPORTS TO SHAREHOLDERS
We will furnish each shareholder with an annual report within 120 days
following the close of each fiscal year. These annual reports will contain,
among other things, financial statements, including a balance sheet, statement
of operations, statement of shareholders' equity and statement of cash flows,
prepared in accordance with accounting principles generally accepted in the
United States which are audited and reported on by independent certified public
accountants.
INVESTMENT POLICIES WITH RESPECT TO CERTAIN ACTIVITIES
The following is a discussion of our current policies with respect to
investments, borrowing, affiliate transactions, equity capital, joint ventures
and certain other activities. All of these policies have been established in our
governance documents or by our management and some of our policies may be
amended or revised from time to time (and at any time) by our management or
trust managers without a vote or the approval of our shareholders. Any change to
these policies would be made, however, only after a review and analysis of such
change, in light of then existing business and other circumstances, and then
only if we believe that it is advisable to do so in the best interest of our
shareholders. We may not be able to achieve our policies or investment
objectives at all times.
INVESTMENT POLICIES
Our management and board of trust managers have developed the following
policies to govern our investments and the operation of our business.
Investments in Real Estate or Interests in Real Estate
We invest in commercial real estate properties, primarily neighborhood
retail centers and office and office/warehouse properties. Our primary business
and investment objectives are:
. to maximize cash dividends paid to our shareholders;
. to continue to qualify as a REIT for federal income tax
purposes;
. to obtain and preserve long-term capital appreciation in the
value of our properties to be realized upon any ultimate sale of
such properties; and
. to provide our shareholders with liquidity for their investment
in us by listing our shares on a national securities exchange
within two to five years after this filing.
We intend to pursue these objectives by continuing to acquire community retail
centers and office and office/warehouse properties for long-term ownership and
for the purpose of producing income.
Our policy is to continue to acquire properties in the Houston, Texas
metropolitan area, where we believe opportunities exist for acceptable
investment returns. We primarily acquire assets for income rather than capital
gain. We anticipate that we will continue to focus on properties in the
$1,000,000 to $10,000,000 value range. We typically
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lease our properties to a wide variety of tenants on a "triple-net" basis, which
means that the tenant is responsible for paying the cost of all maintenance and
minor repairs, property taxes and insurance relating to its leased space. Our
management believes that its extensive experience, market knowledge and network
of industry contacts in the Houston metropolitan area and focusing our
investments to this area gives us a competitive advantage and enhances our
ability to identify and capitalize on acquisitions. Although we anticipate that
we will continue to focus primarily on acquisition opportunities in Houston,
Texas, we are also exploring specific investment opportunities in San Antonio
and Dallas, Texas. Further, we are exploring the feasibility of acquiring
properties outside of Texas.
Although we have historically invested in properties that have been
constructed and have operating histories, we may invest in raw land or in
properties that are under development or construction. We consider the potential
for growth in value as a factor in the valuation of income-producing properties
and we anticipate that some properties we acquire will both provide cash
distributions to shareholders and have the potential for growth in value. To the
extent feasible, we will strive to invest in a diversified portfolio of
properties, in terms of type of property and industry group of tenants, which
will satisfy our investment objectives. We are not specifically limited in the
number or size of properties we may acquire or the percentage of capital that we
may invest in a single property. The number and mix of properties we acquire
will depend on real estate and market conditions existing at the time we acquire
properties and our capital resources.
Although, we currently intend to invest in or develop community retail
centers, office/warehouse and office properties, our future investment
activities are not limited to any specified property use. We may invest in other
commercial properties such as manufacturing facilities, and warehouse and
distribution facilities. Neither our governance documents nor our management
policies contain any limitations on the percentage of assets which may be
invested in any specific property.
Although we are not limited as to the form our investments may take, all
of our properties are owned by the Operating Partnership or a wholly-owned
subsidiary of the Operating Partnership in fee simple title. We expect to
continue to pursue our investment objectives through the direct ownership of
properties. However, in the future, we may also participate with other entities
(including non-affiliated entities) in property ownership, through joint
ventures or other types of common ownership. We presently have no plans to own
any properties jointly with another entity or entities.
The Management Company identifies particular properties as potential
acquisitions and manages our day-to-day operations, including all leasing
functions. In making investment decisions for us, the Management Company will
consider relevant real estate property and financial factors, including:
. the location of the property;
. the property's condition, suitability for the current or
proposed use and any refurbishment needs;
. the property's historical operation and any potential
liabilities associated therewith;
. information learned from surveys, environmental reports, title
reports and policies and similar materials;
. the property's income-producing history and capacity;
. the property's prospects for long-term appreciation;
. the potential liquidity of the property; and
. income tax considerations.
We have acquired 28 of our 32 of our properties from entities controlled
by Mr. Hartman. We anticipate that we will acquire additional properties in the
future from entities controlled by, or otherwise affiliated with, Mr. Hartman.
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We will conduct all such transactions in accordance with the related party
transactions policies summarized below. We will obtain a third party appraisal
or valuation of any property we acquire from an affiliated or related party.
By conducting such transactions in accordance with this policy, we hope to be
able to avoid any material disadvantages associated with related party
transactions (primarily valuation issues) and achieve advantages, such as
avoiding third party broker fees and acquiring properties of which the
Management Company has a thorough knowledge.
Investment Limitations
Our declaration of trust places numerous limitations on us with respect
to the manner in which we may invest our funds. These limitations cannot be
changed unless our declaration of trust is amended, which requires approval of
our shareholders. Unless our declaration of trust is amended, we will not:
. borrow in excess of 75% of the aggregate value of all properties
owned by us, provided that we may borrow in excess of 50% of the
value of an individual property;
. invest in commodities or commodity futures contracts, except for
futures contracts when used solely for the purpose of hedging in
connection with our ordinary business of investing in real
estate assets and mortgages;
. invest in real estate contracts of sale, otherwise known as land
sale contracts, unless the contract is in recordable form and is
appropriately recorded in the chain of title;
. make or invest in mortgage loans unless an appraisal is obtained
concerning the underlying property except for those mortgage
loans insured or guaranteed by a government or government
agency. Mortgage debt on any property shall not exceed such
property's appraised value. In cases where our board of trust
managers determines, and in all cases in which the transaction
is with any of our trust managers or Hartman and its affiliates,
such appraisal shall be obtained from an independent appraiser.
We will maintain such appraisal in our records for at least five
years and it will be available for inspection and duplication.
We will also obtain a mortgagee's or owner's title insurance
policy as to the priority of the mortgage;
. make or invest in mortgage loans, including construction loans,
on any one property if the aggregate amount of all mortgage
loans on such property would exceed an amount equal to 85% of
the appraised value of such property as determined by appraisal
unless substantial justification exists for exceeding such limit
because of the presence of other underwriting criteria;
. make or invest in mortgage loans that are subordinate to any
mortgage or equity interest of any of our trust managers, Mr.
Hartman or his affiliates;
. invest in junior debt secured by a mortgage on real property
which is subordinate to the lien or other senior debt except
where the amount of such junior debt plus any senior debt
exceeds 90% of the appraised value of such property, if after
giving effect thereto, the value of all such mortgage loans
would not then exceed 25% of our net assets, which means our
total assets less our total liabilities;
. engage in any short sale or borrow on an unsecured basis, if the
borrowing will result in asset coverage of less than 300%.
"Asset coverage," for the purpose of this clause, means the
ratio which the value of our total assets, less all liabilities
and indebtedness for unsecured borrowings, bears to the
aggregate amount of all of our unsecured borrowings;
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. make investments in unimproved property or indebtedness secured
by a deed of trust or mortgage loans on unimproved property in
excess of 10% of our total assets;
. issue equity securities on a deferred payment basis or other
similar arrangement;
. issue debt securities in the absence of adequate cash flow to
cover debt service;
. issue equity securities which are non-voting or assessable;
. issue "redeemable securities," solely at the option of the
holder;
. grant warrants or options to purchase shares to Mr. Hartman or
his affiliates or to officers or trust managers affiliated with
the Management Company except on the same terms as the options
or warrants are sold to the general public and the amount of the
options or warrants does not exceed an amount equal to 10% of
the outstanding shares on the date of grant of the warrants and
options;
. engage in trading, as compared with investment activities, or
engage in the business of underwriting or the agency
distribution of securities issued by other persons; or
. lend money to our trust managers, or to Mr. Hartman or his
affiliates, unless approved by a majority of our independent
trust managers.
We will continually review our investment activity to attempt to ensure that we
do not come within the definition of an "investment company" under the Act. If
at any time the character of our investments could cause us to be deemed an
investment company for purposes of the Investment Company Act of 1940, we will
take the necessary action to attempt to ensure that we are not deemed to be an
"investment company."
Investments in Real Estate Mortgages
While we intend to emphasize equity real estate investments, we may
invest in first or second mortgages or other real estate interests consistent
with our REIT status. Such mortgages may or may not be insured or guaranteed by
the Federal Housing Administration, the Veterans Administration or another third
party. We may also invest in participating or convertible mortgages if our trust
managers conclude that we and our shareholders may benefit from the cash flow or
any appreciation in the value of the subject property. Such mortgages are
similar to equity participation. Except as stated herein, our governance
documents do not place any limit or restriction on:
. the percentage of our assets that may be invested in any type of
mortgage or in any single mortgage; or
. the types of properties subject to mortgages in which we may
invest.
The governance documents of the Operating Partnership also do not contain any
such restrictions.
Presently, we have no intention of investing in real estate mortgages.
We also have no present intention of originating, servicing or warehousing
mortgages.
Securities of or Interests in Persons Primarily Engaged in Real Estate
Activities and Other Issuers
We may acquire securities of entities engaged in real estate activities
or securities of other issuers, including for the purpose of exercising control
over such entities. However, all acquisitions of securities of such entities
will be subject to the percentage ownership limitations and gross income tests
necessary for REIT qualification. We refer you to the discussion of "Federal
Income Tax Considerations--Requirements for Qualification as a REIT" in this
section below for a discussion of these tests. We may acquire all or
substantially all of the securities or assets of REITs or similar entities where
such investments would be consistent with our investment policies. We anticipate
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that we will only acquire securities or other interests in issuers engaged in
commercial real estate activities involving retail, office or office/warehouse
properties. We may also invest in entities owning undeveloped acreage. Our
governance documents do not contain any limitations or restrictions on the
percentage of our assets that may be invested in securities of or interests in
other issuers. The governance documents of the Operating Partnership also do not
contain any such restrictions.
Other than our interest in the Operating Partnership, we currently do
not own any securities of other entities. We do not presently intend to acquire
securities of any non-affiliated entities.
Periodic Review of Assets
We may dispose any of our properties or any property that may be
acquired in the future if our management determines that the disposition of such
property is appropriate or necessary. We will consider many relevant economic,
tax, strategic and operational factors when determining whether a particular
property should be sold.
Change in Investment Objectives and Limitations
Our declaration of trust requires that the independent trust managers
review our investment policies at least annually to determine that the policies
we are following are in the best interests of our shareholders. Each
determination and the basis therefore is required to be set forth in the
applicable meeting minutes. The methods of implementing our investment policies
also may vary as new investment techniques are developed. The methods of
implementing our investment objectives and policies, except as otherwise
provided in the organizational documents, may be altered by a majority of our
trust managers, including a majority of the independent trust managers, without
the approval of the shareholders. Those of our investment objectives set forth
in our declaration of trust, however, may only be amended by a vote of the
shareholders holding a majority of our outstanding shares.
FINANCING POLICIES
As of the date of this registration statement, 20 of our 32 properties
are subject to mortgages. If we acquire a property for cash in the future, we
will most likely fund a portion of the purchase price with debt. By acquiring
and operating on a leveraged basis, we will have more funds available for
investment in properties. This will allow us to make more investments than would
otherwise be possible, resulting in a more diversified portfolio of assets.
However, this also subjects us to risks associated with borrowing. See "Risk
Factors--Our use of borrowings to fund acquisitions and improvements on
properties could result in foreclosures and unexpected debt service expenses
upon refinancing" below.
We do not have a policy limiting the amount of mortgages which may be
placed on any one piece of property. As of December 31, 2002, we had an
aggregate debt to book value ratio of approximately 36%. As a general policy, we
intend to maintain a ratio of total indebtedness to market value that is less
than 50%. However, we may not be able to continue to achieve this objective.
We may reevaluate and change our debt policy in the future without a
shareholder vote. Factors that we would consider when reevaluating or changing
our debt policy include then-current economic conditions, the relative cost of
debt and equity capital, any acquisition opportunities, the ability of our
properties to generate sufficient cash flow to cover debt service requirements
and other similar factors. Further, we may increase or decrease our ratio of
debt to book value in connection with any change of policy.
We may incur indebtedness in the form of bank borrowings, purchase money
obligations to the sellers of properties, publicly or privately-placed debt
instruments or financing from institutional investors or other lenders. This
indebtedness may be unsecured or may be secured by mortgages or other interests
in our properties, or may be limited to the particular property to which the
indebtedness relates. We may use borrowing proceeds to finance acquisitions of
new properties, to refinance existing indebtedness, for the payment of
distributions, or for working capital.
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EQUITY CAPITAL POLICIES
In the event that our trust managers determine to raise additional
equity capital, they have the authority, without shareholder approval, to issue
additional common shares or preferred shares of beneficial interest.
Additionally, our trust managers could cause the Operating Partnership to issue
OP Units which are convertible into our common shares. Subject to limitations
contained in HCP's and the Operating Partnership's governance documents, the
trust managers could issue, or cause to be issued, such securities in any manner
(and on such terms and for such consideration) they deem appropriate, including
in exchange for real estate. We have issued securities in exchange for real
estate and we expect to continue to do so in the future. Existing shareholders
have no preemptive right to purchase such shares in any offering, and any such
offering might cause a dilution of a shareholder's initial investment.
AFFILIATE TRANSACTION POLICY
Our bylaws provide that no contract or transaction between:
. us and one or more of our trust managers or officers; or
. us and any other real estate investment trust, corporation,
partnership, association or other organization in which one or
more of our trust managers or officers are trust managers,
directors or officers, or have a financial interest;
will be void or voidable solely because the trust manager or officer is a party
to the transaction and/or is present at or participates in the meeting of the
trust managers or committee thereof which authorizes the contract or
transaction, or solely because his, her, or their votes are counted for such
purpose, if:
. the material facts as to his or her relationship or interest and
as to the contract or transaction are disclosed or are known to
the trust managers or the committee, and the trust managers or
committee in good faith authorizes the contract or transaction
by the affirmative vote of a majority of the disinterested trust
managers, even though the disinterested trust managers
constitute less than a quorum;
. the material facts as to his or her relationship or interest and
as to the contract or transaction are disclosed or are known to
the shareholders entitled to vote thereon, and the contract or
transaction is specifically approved in good faith by vote of
the shareholders; or
. the contract or transaction is fair to us at the time it is
authorized, approved or ratified by the trust managers, a
committee thereof, or the shareholders.
Our bylaws also provide that any of our trust managers or officers may
have business interests and engage in business activities similar (and even
competitive) to or in addition to those relating to our business as long as they
act in a capacity other than that of our trust manager or officer. Further, each
of our trust managers and officers is not required to present any investment
opportunity to us which comes to him or her in any capacity other than acting
solely as our trust manager, officer or agent, even if we could exploit such
opportunity if presented to us. We may place contractual restrictions with any
trust manager or officer's business interests or activities, but we currently
have no such contracts in place with any trust manager or officer.
Our board of trust managers has established a conflicts committee which
will review and approve all matters the board believes may involve a conflict of
interest. This committee will be composed solely of independent trust managers.
Please see "Item 5. Directors and Executive Officers--Committees of the Board of
Trust Managers--Conflicts Committee" and "--Certain Conflict Resolution
Procedures" below.
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JOINT VENTURE INVESTMENTS
We may enter into joint ventures with affiliated entities for the
acquisition, development or improvement of properties for the purpose of
diversifying our portfolio of assets. We may also enter into joint ventures,
partnerships, co-tenancies and other co-ownership arrangements or participations
with real estate developers, owners and other affiliated third-parties for the
purpose of developing, owning and operating real properties. In determining
whether to invest in a particular joint venture, we will evaluate the real
property that such joint venture owns or is being formed to own under the same
criteria described elsewhere in this registration statement for the selection of
our real estate property investments.
We may only enter into joint ventures with other Hartman programs for
the acquisition of properties if:
. a majority of our trust managers, including a majority of the
independent trust managers, approve the transaction as being
fair and reasonable to us;
. the investment by us and such affiliate are on substantially the
same terms and conditions; and
. we will have a right of first refusal to buy if such co-venturer
elects to sell its interest in the property held by the joint
venture.
In the event that the co-venturer were to elect to sell property held in any
such joint venture, however, we may not have sufficient funds to exercise our
right of first refusal to buy the other co-venturer's interest in the property
held by the joint venture. In the event that any joint venture with an
affiliated entity holds interests in more than one property, the interest in
each such property may be specially allocated based upon the respective
proportion of funds invested by each co-venturer in each such property. Our
entering into joint ventures with other Hartman programs will result in certain
conflicts of interest.
CERTAIN OTHER POLICIES
We intend to operate in such a manner that we will not be subject to
regulation under the Investment Company Act of 1940. We do not intend to:
. invest in the securities of other issuers for the purpose of
exercising control over such issuer (except as described above);
. underwrite securities of other issuers; or
. actively trade in loans or other investments.
Subject to restrictions we are subject to in order to qualify to be
taxed as a REIT, we may make investments other than as previously described,
although we do not currently intend to do so. We have authority to purchase or
otherwise reacquire our common shares or any of our other securities. We have no
present intention of repurchasing any of our common shares, and we would only
take such action in conformity with applicable federal and state laws and the
requirements for qualifying as a REIT under the Internal Revenue Code.
RISK FACTORS
We encourage investors to carefully consider the risks described below,
together with all other information in this registration statement. We encourage
investors to keep these risks in mind when they read this registration
statement. If any of the following risks actually occurs, our results of
operations and ability to pay distributions would likely suffer materially. As a
result, the value and trading price of our common shares may decline, and
shareholders could lose all or part of the money they paid to buy our common
shares.
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BUSINESS RISKS
Because our portfolio of properties is not geographically diversified, an
economic downturn in the metropolitan Houston, Texas area could adversely impact
our operations and ability to make distributions to our shareholders.
All of our assets and revenues are currently derived from properties
located in the metropolitan Houston, Texas area. Our results of operations are
directly contingent on our ability to attract financially sound commercial
tenants. If Houston experiences a significant economic downturn, our ability to
locate and/or retain financially sound tenants may decrease. Likewise, we may be
required to lower our rental rates to attract desirable tenants in such an
environment. Consequently, because our assets are not diversified
geographically, if Houston experiences an economic downturn, our operations and
ability to make distributions to our shareholders could be adversely impacted.
We may need to incur borrowings to meet REIT minimum distribution requirements.
In order to maintain our qualification as a REIT, we are required to
distribute to our shareholders at least 90% of our annual net taxable income
(excluding any net capital gain). In addition, the Internal Revenue Code will
subject us to a 4% nondeductible excise tax on the amount, if any, by which
certain distributions paid by us with respect to any calendar year are less than
the sum of (i) 85% of our ordinary income for that year, (ii) 95% of our capital
gain net income for that year and (iii) 100% of our undistributed taxable income
from prior years. Although we intend to make distributions to our shareholders
in a manner that allows us to meet the foregoing distribution requirement and
avoid this 4% excise tax, we cannot assure shareholders that we will always be
able to do so.
Our income consists almost solely of our share of the Operating
Partnership's income, and the cash available for distribution by us to our
shareholders consists of our share of cash distributions made by the Operating
Partnership. Because we are the sole general partner of the Operating
Partnership, our trust managers will determine the amount of any distributions
made by the Operating Partnership. The trust managers may consider a number of
factors in making such distributions, including:
. the amount of the cash available for distribution;
. the Operating Partnership's financial condition;
. the Operating Partnership's capital expenditure requirements;
and
. the annual distribution requirements in the Internal Revenue
Code necessary to maintain our qualification as a REIT.
Differences in timing between the actual receipt of income and actual
payment of deductible expenses and the inclusion of such income and deduction of
such expenses when determining our taxable income, as well as the effect of
nondeductible capital expenditures and the creation of reserves or required debt
amortization payments, could require us to borrow funds on a short-term or
long-term basis to meet the REIT distribution requirements and to avoid the 4%
excise tax described above. In such circumstances, we might need to borrow funds
to avoid adverse tax consequences even if our management believes that the then
prevailing market conditions generally are not favorable for such borrowings or
that such borrowings would not be advisable in the absence of such tax
consideration.
We rely on Allen R. Hartman and the Management Company, and the loss of either
could adversely impact our operations.
We are dependent on the efforts of Mr. Hartman. Mr. Hartman has over 30
years of experience in owning, operating, managing, acquiring, developing and
redeveloping commercial real estate. Although Mr. Hartman has a significant
ownership interest in the Company, he does not have an employment agreement with
us and is not obligated to devote his full-time to the Company.
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We are not self-managed. Rather, the Management Company advises us on
our day-to-day operations and manages all of our properties. The Management
Company is owned and operated by Mr. Hartman and has assembled a team of
professionals who have broad experience in the real estate industry in general,
and in the management of our properties in particular. The Management Company is
also dependent on Mr. Hartman. Further, competition for commercial real estate
personnel is intense and we are dependent on the Management Company's ability to
attract and retain skilled personnel to operate our business. We have no right
or ability to vote on the election of the Management Company's officers and, as
a result, we do not have the ability to control the Management Company's
operations.
The loss of Mr. Hartman or the Management Company, or the inability of
the Management Company to retain skilled personnel, would adversely impact our
operations and our ability to make distributions to our shareholders.
Our inability to retain earnings for acquisitions could limit our ability to
acquire new properties.
In order to maintain our qualification as a REIT, we are required to
distribute to our shareholders at least 90% of our net taxable income (excluding
any net capital gain). This requirement limits our ability to retain income or
cash flow from operations to finance the acquisition of new properties. We
anticipate that we will use debt and equity financing to acquire new properties
from time to time. Consequently, if we cannot obtain debt or equity financing on
acceptable terms, our ability to acquire new properties and expand our
operations will be adversely affected.
We expect to acquire or develop properties in the near future which, if
unsuccessful, could adversely impact our ability to make distributions to our
shareholders.
We expect to acquire or develop new properties in the near future. The
acquisition of additional properties will subject us to risks associated with
managing new properties, including tenant retention and tenant defaults of lease
obligations. A larger portfolio of properties will also generate additional
operating expenses. Specific examples of risks that could relate to acquisitions
include:
. risks that investments will fail to perform in accordance with
expectations;
. risks that judgments with respect to the costs of necessary
improvements will prove inaccurate; and
. general investment risks associated with any new real estate
investment.
To the extent that we pursue a property which needs substantial renovation or
repositioning, we will bear certain risks including:
. the risks of construction delays or cost overruns that may
increase project costs and could make such project uneconomical;
. the risk that occupancy or rental rates at the completed project
will not be sufficient to enable us to pay operating expenses or
earn the targeted rate of return on our investment; and
. the risk of incurrence of redevelopment costs in connection with
projects that are not completed.
In the case of an unsuccessful acquisition or redevelopment project, our loss
could exceed our investment in such project, which could adversely impact our
ability to make distributions to our shareholders.
Our use of borrowings to fund acquisitions and improvements on properties could
result in foreclosures and unexpected debt service expenses upon refinancing.
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We have relied on borrowings to fund acquisitions and we expect to
continue to rely on borrowings and other external sources of financing to fund
the costs of new property acquisitions, capital expenditures and other items. As
of December 31, 2002, we had aggregate outstanding debt of $37,718,000 secured
by our assets. Accordingly, we are subject to the risk that our cash flow will
not be sufficient to cover required debt service payments.
If we cannot meet our required mortgage payment obligations, the
property or properties subject to such mortgage indebtedness could be foreclosed
upon by or otherwise transferred to our lender, with a consequent loss of income
and asset value to the Company. Additionally, we may be required to refinance
our debt subject to "lump sum" or "balloon" payment maturities on terms less
favorable than the original loan or at a time we would otherwise prefer to not
refinance such debt. A refinancing on such terms or at such times could increase
our debt service payments, which could adversely impact the cash we would have
available for distribution to our shareholders.
We could become more highly leveraged, resulting in an increased risk of
default and an increase in debt service requirements, which could also adversely
affect our financial condition and results of our operations and, consequently,
our ability to make distributions to our shareholders.
We operate in a competitive business and many of our competitors have greater
resources and operating flexibility than we do.
Numerous real estate companies that operate in the metropolitan Houston,
Texas area compete with us in developing and acquiring retail, office/warehouse
and office properties and seeking tenants to occupy such properties. Such
competition could adversely affect our business. There are numerous commercial
developers, real estate companies, real estate investment trusts and major
retailers that compete with us in seeking properties for acquisition and tenants
for properties. Many of these entities have greater financial and other
resources, and more operating experience, than us or the Management Company.
Approximately 41.69% of our gross leasable area is subject to leases that expire
prior to December 31, 2004.
As of December 31, 2002, 41.69% of the aggregate gross leasable area of
our properties is subject to leases that expire in either 2003 or 2004. These
leases accounted for 44.39% of our total rental income in 2002. We are subject
to the risk that:
. tenants will not renew such leases;
. we will not be able to re-lease the space subject to such
leases; and
. that the terms of any renewal or re-lease will not be as
favorable as current leases.
If any of these risks materialize, our cash flow and ability to make
distributions to our shareholders could be adversely affected.
We depend on tenants for our revenue and on anchor tenants to attract non-anchor
tenants.
As rental income from real property derives substantially all of our
income, the inability of a single major tenant or a number of smaller tenants to
meet their obligations would adversely affect our income. Tenants may have the
right to terminate their leases upon the occurrence of certain customary events
of default or, in some cases, if the lease held by an anchor tenant or other
principal tenant of the property expires, is terminated or the property subject
to the lease is vacated, even if rent continues to be paid under the lease. The
weakening of a significant tenant's financial condition or the loss of an anchor
tenant may adversely affect our cash flow and amounts available for
distribution.
The bankruptcy or insolvency of major tenants would adversely impact our
operations.
As of December 31, 2002, the five largest tenants of our properties
generated approximately 7.3% of the combined rent of our properties. The
bankruptcy or insolvency of a major tenant or a number of small tenants would
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have an adverse impact on our income and our ability to make distributions to
our shareholders. Generally, under bankruptcy law, a tenant has the option of
continuing or terminating any unexpired lease. If the tenant continues its
current lease, the tenant must cure all defaults under the lease and provide
adequate assurance of its future performance under the lease. If the tenant
terminates the lease, our claim for breach of the lease (absent collateral
securing the claim) will be treated as a general unsecured claim. General
unsecured claims are the last claims paid in a bankruptcy and therefore funds
may not be available to pay all or part of such claims. During the first quarter
of 2003, one of our five largest tenants, Fleming Foods Corporation, filed for
bankruptcy protection. Our lease with Fleming expires in June 2003 and rents
from this lease represented 1.3% of our total revenues during 2002.
We may be subject to risks as the result of joint ownership of real estate with
third parties.
We may invest in properties and assets jointly with other persons or
entities. Joint ownership of properties, under certain circumstances, may
involve risks not otherwise present, including:
. the possibility that our partners or co-investors might become
insolvent or bankrupt;
. the risk that such partners or co-investors might have economic
or other business interests or goals that are inconsistent with
our business interests or goals;
. the possibility that we may incur liabilities as the result of
the action taken by our partner or co-investor; or
. the risk that such partners or co-investors may be in a position
to take action contrary to our instructions or requests or
contrary to our policies or objectives, including our policy
with respect to maintaining our qualification as a REIT.
Our business will be directly affected by general economic and regulatory
factors that we cannot control or predict.
We only own commercial real estate. Investments in real estate typically
involve a high level of risk as the result of factors that we cannot control or
predict. One of the risks of investing in real estate is the possibility that
our properties will not generate income sufficient to meet operating expenses or
will generate income and capital appreciation, if any, at rates lower than those
anticipated or available through investments in comparable real estate or other
investments. The following factors may affect income from properties and yields
from investments in properties and are generally outside of our control:
. conditions in financial markets;
. over-building;
. a reduction in rental income as the result of the inability to
maintain occupancy levels;
. adverse changes in applicable tax or environmental laws;
. changes in general economic conditions;
. a taking of any of our properties by eminent domain;
. adverse local conditions (such as changes in real estate zoning
laws that may reduce the desirability of real estate in the
area); and
. acts of God, such as earthquakes or floods and other uninsured
losses.
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Some or all of the foregoing factors may affect our properties, which could
adversely affect our operations and our ability to pay distributions to our
shareholders.
We may have difficulty selling real estate investments.
Equity real estate investments are relatively illiquid. We have a
limited ability to vary our portfolio in response to changes in economic or
other conditions. We are especially sensitive to this risk considering that all
of our properties are located in one metropolitan location. In addition,
mortgage payments and, to the extent a property is not subject to triple net
leases, certain significant expenditures such as real estate taxes and
maintenance costs generally are not reduced when circumstances cause a reduction
in revenue from the investment. The occurrence of such events would adversely
affect our income.
Potential liability as the result of environmental matters could adversely
affect our operations.
Under various federal, state and local laws, ordinances and regulations,
an owner of real estate is liable for the costs of removal or remediation of
certain hazardous or toxic substances on or in such property. Such laws often
impose this liability without regard to whether the owner knew of, or was
responsible for, the presence of such hazardous or toxic substances. The costs
of any required remediation or removal of such substances may be substantial.
Furthermore, laws, ordinances and regulations generally do not limit the owner's
liability for such costs of remediation or removal, which could exceed the value
of the property. The presence of such substances, or the failure to properly
remediate such substances, may adversely affect the owner's ability to sell the
property or to borrow using real estate as collateral.
Some of our tenants operate businesses on our properties that may result
in contamination of a property by hazardous or toxic materials. In particular,
environmental evaluations of one property concluded that the property, at some
time, had been slightly impacted by a tenant who conducted a dry cleaning
business on the property. However, samples evidencing an impact showed minimal
traces of contamination and the contaminant levels were below regulatory limits.
Further, environmental evaluations of another property showed potential lead
contamination due to a previous use of the facility as a skeet range and
potential hydrocarbon contamination from oil/gas exploration activities
previously conducted at the site several decades ago. The evaluator determined
that the contamination was minimal and not hazardous.
The cost of defending against claims of liability, of compliance with
environmental laws and regulations or of remediating any contaminated property
could adversely affect our operations and our ability to pay distributions to
our shareholders.
The ownership limit in our Declaration of Trust may discourage a takeover
attempt.
Our declaration of trust provides that no holder of capital shares,
other than any person to whom our board of trust managers grants an exemption,
may directly or indirectly own more than 9.8% of the number or value of the
outstanding shares of any class or series of our outstanding shares of
beneficial interest. This ownership limit may deter tender offers for our common
shares, which offers may be attractive to our shareholders. This deterrence may
limit the opportunity for shareholders to receive a premium for their common
shares that might otherwise exist if an investor attempted to assemble a block
of common shares in excess of 9.8% in number or value of the outstanding common
shares or otherwise to effect a change of control of HCP. Please read the "Item
11. Description of Registrant's Securities to be Registered--Restrictions on
Transfer" section of this registration statement for additional information
regarding the restrictions on transfer of our common shares.
CONFLICTS OF INTEREST RISKS
The Management Company may face conflicts of interest when allocating personnel
and resources between our operations and the operations of other entities it
manages.
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Mr. Hartman strategically directs our day-to-day operations through the
Management Company, which he owns and controls, pursuant to the terms of a
management agreement. Mr. Hartman also controls other entities which own
properties managed by the Management Company. Management Company personnel will
not devote their efforts full-time to the property management of our portfolio
of properties, but will devote a material amount of their time to the management
of the business of these other property-owning entities controlled by Mr.
Hartman but otherwise unaffiliated with us. From time to time, the Management
Company may have conflicts of interest in allocating its personnel between our
operations and the operations of other entities controlled by Mr. Hartman. The
failure of the Management Company to adequately perform services for, or
allocate resources to, us because of its obligations to these other entities
could adversely affect our business and the returns we receive from our
investments.
Certain of our officers and trust managers face conflicts of interests relating
to the positions they hold with other entities.
Certain of our officers and trust managers are also officers and
directors of the Management Company and other entities controlled by Mr.
Hartman. These personnel owe fiduciary duties to these other entities and their
security holders and these duties may from time to time conflict with the
fiduciary duties such individuals owe to us and to our shareholders.
Allen R. Hartman controls other entities that compete with us for his time as
well as for tenants and acquisition opportunities.
Mr. Hartman is not restricted from acquiring, operating, managing or
developing real estate through entities other than us. We expect that Mr.
Hartman will continue to develop, own or operate real estate in or through other
entities. Mr. Hartman currently controls and/or operates three other entities
which collectively own eight properties in the Houston metropolitan area. Mr.
Hartman spends a material amount of time on managing these properties and other
assets unrelated to our business. To varying degrees, we compete with these
entities for tenants. Mr. Hartman may have conflicts of interest when seeking to
allocate tenant and acquisition opportunities between us and other entities he
controls. Where an investment opportunity is consistent with the investment
strategy of several of the entities under his control, Mr. Hartman will present
such opportunity to whichever entity has not been presented with an investment
opportunity for the longest period of time.
Our UPREIT structure may result in potential conflicts of interest.
Persons holding OP Units have the right to vote on certain amendments to
the Agreement of Limited Partnership of the Operating Partnership, as well as on
certain other matters. Persons holding such voting rights may exercise them in a
manner that conflicts with the interests of our shareholders. HCP, as the
general partner of the Operating Partnership, has fiduciary duties to the
limited partners of the Operating Partnership, the discharge of which may
conflict with the interests of our shareholders.
We have acquired a majority of our properties from entities controlled by Mr.
Hartman and we will bear the risk of any deficiencies of such properties.
We have acquired 28 of the 32 properties we owned as of December 31,
2002 from entities controlled by Mr. Hartman. We acquired these properties by
either paying cash or issuing common shares or OP Units. No third parties were
retained to represent or advise these selling entities against us, or vice
versa, and the transactions were not conducted on an "arms'-length" basis.
Mr. Hartman received certain benefits from the acquisitions described
above. Mr. Hartman had interests that differed from, and may in certain cases
have conflicted with, both the interests of persons acquiring partnership units
or common shares in the acquisitions and the interests of our then current
shareholders. The benefits Mr. Hartman received might have been different if he
had not participated in structuring or valuing the acquisitions. These benefits
include the following:
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. the receipt of 627,982.66 OP Units in consideration of Mr.
Hartman's general partner interest in the selling entities;
. the ability to limit his future exposure to general partner
liability as a result of Mr. Hartman no longer serving as the
general partner to certain of the selling entities; and
. the repayment of debt encumbering various of our properties
which was personally guaranteed by Mr. Hartman.
Further, Mr. Hartman (either personally or in his capacity as a general
partner) made no representations or warranties in regard to the properties or
the selling entities in the operative documents executed in order to consummate
the consolidations. Consequently, we essentially acquired the properties on an
"as is" basis. Therefore, we will bear the risk associated with any
characteristics or deficiencies of our properties unknown at the closing of the
acquisitions that may affect the valuation or revenue potential of the
properties.
TAX RISKS
If we failed to qualify as a REIT, our operations and distributions to our
shareholders would be adversely impacted.
We intend to continue to operate so as to qualify as a REIT under the
Internal Revenue Code. A REIT generally is not taxed at the corporate level on
income it currently distributes to its shareholders. Qualification as a REIT
involves the application of highly technical and complex rules for which there
are only limited judicial or administrative interpretations. The determination
of various factual matters and circumstances not entirely within our control may
affect our ability to continue to qualify as a REIT. In addition, new
legislation, regulations, administrative interpretations or court decisions
could significantly change the tax laws with respect to qualification as a REIT
or the federal income tax consequences of such qualification.
If we were to fail to qualify as a REIT in any taxable year:
. we would not be allowed to deduct our distributions to our
shareholders when computing our taxable income;
. we would be subject to federal income tax (including any
applicable alternative minimum tax) on our taxable income at
regular corporate rates;
. we would be disqualified from being taxed as a REIT for the four
taxable years following the year during which qualification was
lost, unless entitled to relief under certain statutory
provisions;
. our cash available for distribution would be reduced and we
would have less cash to distribute to our shareholders; and
. we may be required to borrow additional funds or sell some of
our assets in order to pay corporate tax obligations we may
incur as a result of our disqualification.
We encourage you to read the "Federal Income Tax Considerations" below.
If the Operating Partnership were classified as a "publicly-traded partnership"
under the Internal Revenue Code, our operations and distributions to our
shareholders could be adversely affected.
We structured the Operating Partnership so that it would be classified
as a partnership for federal income tax purposes. In this regard, the Internal
Revenue Code generally classifies "publicly traded partnerships" (as defined in
Section 7704 of the Internal Revenue Code) as associations taxable as
corporations (rather than as partnerships),
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unless substantially all of their taxable income consists of specified types of
passive income. In order to minimize the risk that the Internal Revenue Code
would classify the Operating Partnership as a "publicly traded partnership" for
tax purposes, we placed certain restrictions on the transfer and/or redemption
of OP units. If the Internal Revenue Service were to assert successfully that
the Operating Partnership is a "publicly traded partnership," and substantially
all of the Operating Partnership's gross income did not consist of the specified
types of passive income, the Internal Revenue Code would treat the Operating
Partnership as an association taxable as a corporation.
These topics are discussed in greater detail in "Federal Income Tax
Considerations--Tax Aspects of the Operating Partnership" below. In such event,
the character of our assets and items of gross income would change and would
prevent us from continuing to qualify as a REIT. In addition, the imposition of
a corporate tax on the Operating Partnership would reduce our amount of cash
available for distribution by HCP to our shareholders.
Distributions to tax-exempt investors may be classified as unrelated business
tax income.
Neither dividend distributions nor income from the sale of common shares
should generally constitute unrelated business taxable income to a tax-exempt
investor, provided that our stock is not predominately held by qualified
employee pension trusts. However, the Internal Revenue Code may classify our
distributions to a tax-exempt investor as unrelated business tax income in the
event such investor incurs debt in order to acquire common shares. We encourage
you to read "Federal Income Tax Considerations--Taxation of Tax Exempt Entities"
below for further discussion of this issue if you are a tax-exempt investor.
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The following summary of material federal income tax considerations that
may be relevant to a holder of common shares is based on current law and is not
intended to be tax advice. The following discussion does not cover all possible
tax considerations and does not include a detailed discussion of any state,
local or foreign tax considerations. Nor does it discuss all aspects of federal
income taxation that may be relevant to a shareholder in light of his or her
particular circumstances or to certain types of shareholders (including
insurance companies, tax-exempt entities, financial institutions or
broker-dealers, foreign corporations and persons who are not citizens or
residents of the United States) who are subject to special treatment under the
federal income tax laws. For the purposes of this section, we call the Internal
Revenue Code the "Code".
The Code provisions governing the federal tax treatment of REITs are
highly technical and complex. This summary is based on, and qualified in its
entirety by, the following:
. current provisions of the Code;
. existing, temporary and currently proposed Treasury Regulations
promulgated under the Code;
. the legislative history of the Code;
. existing administrative rulings; and
. judicial interpretations of the foregoing.
No assurance can be given that legislative, judicial or administrative changes
will not affect the accuracy of any statements in this registration statement
with respect to transactions entered into or contemplated prior to the effective
date of such changes.
This discussion is not intended to be a substitute for careful tax
planning. We urge each shareholder to consult with his or her own tax advisor
regarding the specific tax consequences applicable to him or her
-19-
relating to the ownership and disposition of our common shares of beneficial
interest, including the federal, state, local, foreign and other tax
consequences of such ownership, sale and disposition.
We elected to be treated as a REIT under Section 856 through Section 860
of the Code for federal income tax purposes commencing with our taxable year
ended December 31, 1999. You should note, however, that we cannot assure you
that the Internal Revenue Service will not successfully challenge our status as
a REIT.
Moreover, our qualification for taxation as a REIT depends on our
ability to meet the various qualification tests imposed by the Code discussed
below. The rules governing REITs are highly technical and require ongoing
compliance with a variety of tests that depend, among other things, on future
operating results. While we expect to satisfy these tests, and will use our best
efforts to do so, we can't assure you that the continued actual results of our
operations for any particular year will satisfy these requirements. We also
can't assure you that the applicable law will not change and adversely affect us
and our shareholders. The consequences of failing to be taxed as a REIT are
summarized in the "--Failure to Qualify as a REIT" section below.
The following is a summary of the material federal income tax
considerations affecting us as a REIT and our shareholders.
REQUIREMENTS FOR QUALIFICATION AS A REIT
Organizational Requirements
In order to maintain our REIT qualification, we must meet the following
criteria:
. we must be organized as a domestic entity that would, if we did
not maintain our REIT status, be taxable as a regular
corporation;
. we can't be a financial institution or an insurance company;
. we must be managed by one or more trustees or directors;
. our taxable year must be a calendar year;
. our beneficial ownership must be evidenced by transferable
shares;
. our capital stock must be held by at least 100 persons during at
least 335 days of a taxable year of 12 months or during a
proportionate part of a taxable year of less than 12 months;
. not more than 50% of the value of our shares of capital stock
may be held, directly or indirectly, applying certain
constructive ownership rules, by five or fewer individuals at
any time during the last half of each of our taxable years; and
. we must elect to be taxed as a REIT and satisfy certain filing
and other administrative requirements.
To protect against violations of these requirements, our declaration of
trust contains restrictions on transfers of our capital stock, as well as
provisions that automatically convert shares of stock into Excess Securities to
the extent that the ownership otherwise might jeopardize our REIT status. See
"Item 11. Description of Registrant's Securities to be Registered--Restrictions
on Transfer." There is no assurance, however, that these restrictions will in
all cases prevent us from failing to satisfy the share ownership requirements
described above.
We are required to maintain records disclosing the actual ownership of
common shares in order to monitor our compliance with the share ownership
requirements. To do so, we may demand written statements each year from the
record holders of certain percentages of shares in which the record holders must
disclose the actual owners of the shares (i.e., the persons required to include
our dividends in their gross income). A list of those persons failing or
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refusing to comply with this demand will be maintained as part of our records.
Shareholders who fail or refuse to comply with the demand must submit a
statement with their tax returns disclosing the actual ownership of the shares
and certain other information.
We believe we currently satisfy, and we expect to continue to satisfy,
each of the requirements discussed above. We also believe we currently satisfy,
and we expect to continue to satisfy, the requirements that are separately
described below concerning the nature and amounts of our income and assets and
the levels of required annual distributions.
Operational Requirements--Gross Income Tests
In order to qualify as a REIT for a particular year, we also must meet
two tests governing the sources of our income. These tests are designed to
ensure that a REIT derives its income principally from passive real estate
investments. In evaluating a REIT's income, the REIT will be treated as
receiving its proportionate share (based on its interest in partnership capital)
of the income produced by any partnership in which the REIT holds an interest as
a partner. Any such income will retain the character that it has in the hands of
the partnership. The Code allows us to own and operate a number of our
properties through wholly-owned subsidiaries that are "qualified REIT
subsidiaries." The Code provides that a qualified REIT subsidiary is not treated
as a separate corporation, and all of its assets, liabilities and items of
income, deduction and credit are treated as assets, liabilities and such items
of the REIT.
75% Gross Income Test. At least 75% of our gross income for each taxable
year must be derived from specified classes of income that are related to real
estate or income earned by our cash or cash equivalents. The permitted
categories of income currently relevant to us are:
. "rents from real property" (as described below);
. gains from the sale of real property (excluding gain from the
sale of property held primarily for sale to customers in the
ordinary course of the Company's trade or business, referred to
below as "dealer property");
. abatements and refunds of real property taxes; and
. "qualified temporary investment income" (which generally means
income that is attributable to stock or debt instruments, is
attributable to the temporary investment of capital received
from our issuance of capital stock or debt securities that have
a maturity of at least five years, and is received or accrued by
us within one year from the date we receive such capital).
In evaluating our compliance with the 75% gross income test, as well as
the 95% gross income test described below, gross income does not include gross
income from "prohibited transactions." In general, a prohibited transaction is
one involving a sale of dealer property, not including certain dealer property
held by us for at least four years. In other words, we are generally required to
acquire and hold properties for investment rather than be in the business of
buying and selling properties.
We expect that substantially all of our operating gross income will be
considered "rent from real property." "Rent from real property" is qualifying
income for purposes of the gross income tests in accordance with the rules
summarized below.
. "Rent from real property" can include rent attributable to
personal property we lease in connection with the real property
so long as the personal property rent is less than 15% of the
total rent attributable to the lease. We do not expect to earn
material amounts in these categories.
. "Rent from real property" generally does not include rent based
on the income or profits of the tenant leasing the property. We
do not currently, nor do we intend to, lease property and
receive rentals based on the tenant's net income or profit.
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. "Rent from real property" can include rent based on a percentage
of a tenant's gross sales or gross receipts. We may have some
leases, from time to time, where rent is based on a percentage
of gross income.
. "Rent from real property" can not include rent we receive from a
person or corporation (or subtenant of such person of
corporation) in which we (or any of our 10% or greater owners)
directly or constructively own a 10% or greater interest.
. "Rent from real property" can include amounts we receive with
respect to services we provide for tenants only if such services
are "usually and customarily rendered" in connection with the
rental of space for occupancy only and are not considered
"rendered to the occupant." If the services we provide do not
meet this standard and are impermissible tenant services, the
income derived therefrom will not qualify as "rent from real
property," unless such income does not exceed one percent of all
amounts received from the property, such services are provided
to our tenants through an "independent contractor" from whom we
do not derive any income, or such are provided to our tenants
through a taxable REIT subsidiary.
Upon the ultimate sale of any of our properties, any gains realized also
are expected to constitute qualifying income, as gain from the sale of real
property (not involving a prohibited transaction).
We have invested proceeds we obtained from our private placement in
government securities or certificates of deposit. Income derived from these
investments is qualifying income under the 75% gross income test for the first
year after receipt of such proceeds. Accordingly, to the extent that proceeds
from our private placement are not invested in properties prior to the
expiration of this one year period, we may invest such proceeds in less liquid
investments such as mortgage-backed securities or shares in other entities taxed
as REITs. This would allow us to continue to include the income from such
invested proceeds as qualified income for our REIT qualification.
95% Gross Income Test. In addition to earning 75% of our gross income
from the sources listed above, at least an additional 20% of our gross income
for each taxable year must come either from those sources, or from dividends,
interest or gains from the sale or other disposition of stock or other
securities that do not constitute dealer property. This test permits a REIT to
earn a significant portion of its income from traditional "passive" investment
sources that are not necessarily real estate related. The term "interest" (under
both the 75% and 95% tests) does not include amounts that are based on the
income or profits of any person, unless the computation is based only on a fixed
percentage of receipts or sales.
Failing the 75% or the 95% Gross Income Tests; Reasonable Cause. As a
result of the 75% and 95% gross income tests, REITs generally are not permitted
to earn more than 5% of their gross income from active sources (such as
brokerage commissions or other fees for services rendered). We may receive
certain types of such income. This type of income will not qualify for the 75%
gross income test or the 95% gross income test. But we do not expect our
non-qualifying income to be significant and we expect such income will always be
less than 5% of our annual gross income. While we do not anticipate we will earn
substantial amounts of non-qualifying income, if non-qualifying income exceeds
5% of our gross income, we could lose our REIT status.
If we fail to meet either the 75% or 95% gross income tests during a
taxable year, we may still qualify as a REIT for that year if:
. we report the source and nature of each item of our gross income
in our federal income tax return for that year;
. the inclusion of any incorrect information in our return is not
due to fraud with intent to evade tax; and
. our failure to meet the tests is due to reasonable cause and not
to willful neglect.
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However, in that case we would be subject to a 100% tax based on the
greater of the amount by which we fail either the 75% or 95% gross income tests
for such year, multiplied by a fraction intended to reflect our profitability,
as described in the "Taxation as a REIT" section below.
Operational Requirements--Asset Tests
On the last day of each calendar quarter, we also must meet two tests
concerning the nature of our investments.
First, at least 75% of the value of our total assets generally must
consist of real estate assets, cash, cash items (including receivables) and
government securities. For this purpose, "real estate assets" include interests
in real property, interests in loans secured by mortgages on real property or by
certain interests in real property, shares in other REITs and certain options,
but do not include mineral, oil or gas royalty interests. The temporary
investment of new capital in debt instruments also qualifies under this 75%
asset test, but only for the one-year period beginning on the date we receive
the new capital.
Second, although the balance of our assets generally may be invested
without restriction, we will not be permitted to own (1) securities of any one
non-governmental issuer (other than securities of a taxable REIT subsidiary)
that represent more than 5% of the value of our total assets, (2) more than 10%
of the outstanding voting securities of any single issuer (other than securities
of a taxable REIT subsidiary), (3) securities of any single issuer (other than
securities of a taxable REIT subsidiary) which have a value of more than 10% of
the total value of all the outstanding securities of such issuer, or (4)
securities of one or more taxable REIT subsidiaries that represent more than 20%
of the value of our total assets. A REIT, however, may own 100% of the stock of
a qualified REIT subsidiary, in which case the subsidiary will be ignored for
tax purposes and the assets, liabilities and items of income, deduction and
credit of the subsidiary are treated as those of the REIT. In evaluating a
REIT's assets, if the REIT invests in a partnership (such as the Operating
Partnership), it is deemed to own its proportionate share of the assets of the
partnership. We currently comply with, and expect to continue to satisfy, these
asset tests.
Operational Requirements--Annual Distribution Requirement
To maintain our REIT status, we generally must distribute to our
shareholders in each taxable year at least 90% of our net ordinary income
(capital gain is not required to be distributed). More precisely, we must
distribute an amount equal to (1) 90% of the sum of (a) our "REIT taxable
income" before deduction of dividends paid and excluding any net capital gain
and (b) any net income from property we foreclose on less the tax on such
income, minus (2) limited categories of "excess noncash income" (including,
cancellation of indebtedness and original issue discount income). In order to
meet this distribution requirement, the distributions on any particular class of
shares must be pro rata, with no preference to any share of stock as compared
with other shares of the same class, and with no preference to one class of
stock as compared with another class except to the extent that the former is
entitled to such preference.
REIT taxable income is defined to be the taxable income of the REIT,
computed as if it were a corporation, with certain modifications. For example,
the deduction for dividends paid is allowed, but neither net income from
foreclosure property nor net income from prohibited transactions, is included.
In addition, the REIT may carry over, but not carry back, a net operating loss
for 20 years following the year in which it was incurred.
A REIT may satisfy the 90% distribution test with dividends paid during
the taxable year and with dividends paid after the end of the taxable year if
the dividends fall within one of the following categories:
. Dividends declared by us in October, November, or December of a
particular year and payable to shareholders of record on a date
during such month of such year will be deemed to have been paid
during such year so long as such dividends are actually paid by
us by January 31 of the following year.
. Dividends declared after the end of, but before the due date
(including extensions) of our tax return for, a particular
taxable year will be deemed to have been paid during such
taxable year if such dividends are
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actually paid by us (1) within 12 months of the end of such
taxable year and (2) no later than the date of our next regular
dividend payment made after such declaration.
Dividends that are paid after the close of a taxable year that do not
qualify under the rule governing payments made in January (described above) will
be taxable to the shareholders in the year paid, even though we may take them
into account for a prior year. A nondeductible excise tax equal to 4% will be
imposed on us for each calendar year to the extent that dividends declared and
distributed or deemed distributed before December 31 are less than the sum of
(1) 85% of our "ordinary income" plus (2) 95% of our capital gain net income
plus (3) any undistributed income from prior periods. We will also be taxed at
regular corporate rates to the extent we retain any portion of our taxable
income.
It is possible that we may not have sufficient cash or other liquid
assets to meet the distribution requirements discussed above. This could arise
because of competing demands for our funds, or because of timing differences
between taxable income recognition and cash receipts and disbursements. Although
we do not anticipate any difficulty in meeting the REIT distribution
requirements, we can't assure investors that necessary funds will be available.
In the event this occurs, we may arrange for short-term, or possibly long-term,
borrowings to allow us to pay the required dividends and meet the 90%
distribution requirement.
If we fail to meet the 90% distribution requirement because of an
adjustment to our taxable income by the Internal Revenue Service, we may be able
to retroactively cure the failure by paying a "deficiency dividend," as well as
applicable interest and penalties, within a specified period.
In computing our REIT taxable income, we will use the accrual method of
accounting. We are required to file an annual federal income tax return, which,
like other corporate returns, is subject to examination by the Internal Revenue
Service. Because the tax law requires us to make many judgments regarding the
proper treatment of a transaction or an item of income or deduction, it is
possible that the Internal Revenue Service will challenge positions we take in
computing our REIT taxable income and our distributions. Issues could arise, for
example, with respect to the allocation of the purchase price of properties
between depreciable or amortizable assets and nondepreciable or non-amortizable
assets such as land, and the current deductibility of fees paid to the
Management Company or its affiliates. If the Internal Revenue Service
successfully challenges our characterization of a transaction or determination
of our taxable income, we could be found to have failed to satisfy a requirement
required to maintain our taxable status as a REIT. If, as a result of a
challenge, we are determined to have failed to satisfy the distribution
requirements for a taxable year, we would be disqualified as a REIT, unless we
were permitted to pay a deficiency distribution to our shareholders, as well as
any required interest thereon to the Internal Revenue Service. A deficiency
distribution can't be used to satisfy the distribution requirement, however, if
the failure to meet the requirement is not due to a later adjustment to our
income by the Internal Revenue Service.
Operational Requirements--Recordkeeping
In order to continue to qualify as a REIT, we must maintain certain
records as set forth in the Treasury Regulations. Further, as we discussed
above, we must request, on an annual basis, certain information designed to
disclose the ownership of our outstanding shares. We intend to comply with these
requirements.
TAXATION AS A REIT
As a REIT, we generally will not be subject to corporate income tax to
the extent we distribute our REIT taxable income to our shareholders. This
treatment effectively eliminates the "double taxation" (i.e., taxation at both
the corporate and shareholder levels) imposed on investments in most
corporations. We generally will be taxed only on the portion of our taxable
income that we retain, including any undistributed net capital gain, because we
will be entitled to a deduction for dividends paid to shareholders during the
taxable year. A "dividends paid" deduction is not available for dividends that
are considered preferential within any given class of shares or as between
classes except to the extent such class is entitled to such preference. We do
not anticipate we will pay any such preferential dividends.
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Even as a REIT, we will be subject to tax in the following
circumstances:
. we will be taxed at regular corporate rates on our undistributed
taxable income, including undistributed net capital gains;
. a tax of 100% applies to any net income we receive from
prohibited transactions, (as previously described, these
transactions are usually sales or other dispositions of property
held primarily for sale to customers in the ordinary course of
business);
. if we fail to meet either the 75% or 95% gross income test
previously described, but still qualify for REIT status under
the reasonable cause exception to those tests, we will be
subject to a 100% tax on the amount obtained by multiplying (1)
the greater of the amount, if any, by which we failed either the
75% gross income test or the 95% gross income test, times (2)
the ratio of our REIT taxable income to our gross income
(excluding capital gain and certain other items);
. under some circumstances, we will be subject to the alternative
minimum tax;
. we will be subject to the 4% excise tax discussed earlier if we
fail, in any calendar year, to distribute to shareholders an
amount equal to the sum of (1) 85% of our REIT ordinary income
for such year, (2) 95% of our REIT capital gain net income for
such year, and (3) any undistributed taxable income from prior
years;
. if we acquire any asset from a C-corporation (i.e., a
corporation generally subject to corporate level tax) in a
carry-over basis transaction and then recognize gain on the
disposition of the asset within ten years after we acquired the
asset, then a portion of our gain may by subject to tax at the
highest regular corporate rate;
. any income or gain we receive from foreclosure property will be
taxed at the highest corporate rate (currently 35%); and
. a tax of 100% applies in certain cases to the extent that income
is shifted away from, or deductions are shifted to, any taxable
REIT subsidiary through the use of certain non-arm's length
pricing arrangements between the REIT and such taxable REIT
subsidiary.
FAILURE TO QUALIFY AS A REIT
If we fail to qualify as a REIT and are not successful in obtaining
relief, we will be taxed at regular corporate rates on all of our taxable
income. Distributions to our shareholders would not be deductible in computing
our taxable income and we would no longer be required to make distributions. Any
corporate level taxes generally would reduce the amount of cash available for
distribution to our shareholders and, because our shareholders would continue to
be taxed on any distributions they receive, the net after tax yield to our
shareholders likely would be substantially reduced.
As a result, our failure to qualify as a REIT during any taxable year
could have a material adverse effect us and our shareholders. If we lose our
REIT status, unless we are able to obtain relief, we will not be eligible to
elect REIT status again until the fifth taxable year that begins after the
taxable year during which our election was terminated.
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TAXATION OF SHAREHOLDERS
DISTRIBUTIONS
In general, distributions will be taxable to shareholders (who are not
"Non-U.S. Shareholders, as defined below in "Taxation of Foreign Investors") as
ordinary income to the extent of our earnings and profits. Specifically,
dividends and distributions will be treated as follows:
. Dividends declared during the last quarter of a calendar year
and actually paid during January of the immediately following
calendar year are generally treated as if received by the
shareholders on December 31 of the calendar year during which
they were declared.
. If we declare a dividend after the end of, but before the due
date (including applicable extensions) of our tax return for, a
particular taxable year, and we distribute such dividend to our
shareholders not later than the date of our first regular
dividend payment made after such declaration (or, if earlier,
within 12 months of the end of such taxable year), we may elect
to treat the dividend as having been paid during the taxable
year for purposes of satisfying our distribution requirements.
However, any such dividend described in the preceding sentence
will be treated as received by shareholders in the taxable year
in which the distribution is actually made by us.
. Distributions paid to shareholders will not constitute passive
activity income, and as a result generally can't be offset by
losses from passive activities of a shareholder subject to the
passive activity rules.
. Distributions we designate as capital gains dividends generally
will be taxed as capital gains to shareholders to the extent
that the distributions do not exceed our actual net capital gain
for the taxable year. Corporate shareholders may be required to
treat up to 20% of any such capital gains dividends as ordinary
income.
. If we elect to retain and pay income tax on any net long-term
capital gain, our shareholders would include in their income as
long-term capital gain their proportionate share of such net
long-term capital gain. Each of our shareholders would receive a
credit for such shareholder's proportionate share of the tax
paid by us on such retained capital gains and an increase in tax
basis in their shares in an amount equal to the difference
between the undistributed long-term capital gains and the amount
of tax we paid.
. Any distributions we make, whether characterized as ordinary
income or as capital gains, are not eligible for the "dividends
received" deduction for corporations.
. Shareholders are not permitted to deduct our losses or loss
carry-forwards.
Future regulations may require that the shareholders take into account,
for purposes of computing their individual alternative minimum tax liability,
certain of our tax preference items.
We may generate cash in excess of our net earnings. If we distribute
cash to our shareholders in excess of our current and accumulated earnings and
profits, other than as a capital gain dividend, the excess cash will be deemed
to be a non-taxable return of capital to each shareholder to the extent of the
adjusted tax basis of the shareholder's shares. Distributions in excess of the
adjusted tax basis will be treated as gain from the sale or exchange of the
shares. A shareholder who has received a distribution in excess of our current
and accumulated earnings and profits may, upon the sale of the shares, realize a
higher taxable gain or a smaller loss because the basis of the shares as reduced
will be used for purposes of computing the amount of the gain or loss.
DISPOSITIONS OF SHARES
Generally, gain or loss realized by a shareholder upon the sale of
common shares will be reportable as capital gain or loss. Such gain or loss will
be treated as long-term capital gain or loss if the shares have been held for
more
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than 12 months and as short-term capital gain or loss if the shares have been
held for 12 months or less. If a shareholder receives a long-term capital gain
dividend and has held the shares for six months or less, any loss incurred on
the sale or exchange of the shares is treated as a long-term capital loss to the
extent of the corresponding long-term capital gain dividend received.
OUR FAILURE TO QUALIFY AS A REIT
In any year in which we fail to qualify as a REIT, our shareholders
generally will continue to be treated in the same fashion described above,
except that:
. none of our dividends will be eligible for treatment as capital
gains dividends;
. corporate shareholders will qualify for the "dividends received"
deduction; and
. shareholders will not be required to report any share of the
Company's tax preference items.
BACKUP WITHHOLDING
We will report to our shareholders and the Internal Revenue Service the
amount of dividends paid during each calendar year and the amount of tax
withheld, if any. If a shareholder is subject to backup withholding, we will be
required to deduct and withhold from any dividends payable to that shareholder a
tax of 30%. (This 30% rate is scheduled to be reduced to 29% for payments
received in 2004 and 2005 and to 28% for payments received after 2005). These
rules may apply in the following circumstances:
. when a shareholder fails to supply a correct and properly
certified taxpayer identification number (which, for an
individual, is his or her Social Security Number);
. when the Internal Revenue Service notifies us that the
shareholder is subject to the backup withholding rules;
. when a shareholder furnishes an incorrect taxpayer
identification number; or
. in the case of corporations or others within certain exempt
categories, when they fail to demonstrate that fact when
required.
A shareholder that does not provide a correct taxpayer identification
number may also be subject to penalties imposed by the Internal Revenue Service.
Backup withholding is not an additional tax. Rather, any amount withheld as
backup withholding will be credited against the shareholder's actual federal
income tax liability. We also may be required to withhold a portion of capital
gain distributions made to shareholders that fail to certify their non-foreign
status.
TAXATION OF TAX EXEMPT ENTITIES
Income earned by tax-exempt entities (such as employee pension benefit
trusts, individual retirement accounts, charitable remainder trusts, etc.) is
generally exempt from federal income taxation, unless such income consists of
"unrelated business taxable income" ("UBTI") as such term is defined in the
Code.
In general, dividends received or gain realized on our shares by a
tax-exempt entity will not constitute UBTI. However, if a tax-exempt entity has
financed the acquisition of its shares with "acquisition indebtedness" within
the meaning of the Code part or all of such income or gain would constitute
taxable UBTI.
In the event that we were deemed to be "predominately held" by qualified
employee pension benefit trusts that each hold more than 10% (in value) of our
shares, such trusts would be required to treat a certain percentage of the
dividend distributions paid to them as UBTI. We would be deemed to be
"predominately held" by such trusts if
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either (1) one employee pension benefit trust owns more than 25% in value of our
shares, or (2) any group of such trusts, each owning more than 10% in value of
our shares, holds in the aggregate more than 50% in value our shares. If either
of these ownership thresholds were ever exceeded, any qualified employee pension
benefit trust holding more than 10% in value of our shares would be subject to
tax on that portion of our dividend distributions made to it which is equal to
the percentage of our income which would be UBTI if we were a qualified trust,
rather than a REIT. We will attempt to monitor the concentration of ownership of
employee pension benefit trusts of our shares, and we do not expect our shares
to be "predominately held" by qualified employee pension benefit trusts for
purposes of the foregoing rules (although there is no assurance in this regard).
For social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts and qualified group legal services plans exempt from
federal income taxation under Sections 501(c)(7), (c)(9), (c)(17) and (c)(20) of
the Code, respectively, income from an investment in our securities will
constitute UBTI unless the organization is able to deduct an amount properly set
aside or placed in reserve for certain purposes so as to offset the unrelated
business taxable income generated by the investment in our securities. These
prospective investors should consult their own tax advisors concerning the "set
aside" and reserve requirements.
TAXATION OF FOREIGN INVESTORS
The rules governing federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships and other foreign
shareholders (collectively, "Non-U.S. Shareholders") are complex and no attempt
will be made herein to provide more than a summary of such rules. Non-U.S.
investors should consult with their own tax advisors to determine the impact
that federal, state and local income tax or similar laws will have on them as a
result of an investment in the Company.
Distributions Generally.
Distributions paid by us that are not attributable to gain from our
sales or exchanges of United States real property interests and not designated
by us as capital gain dividends will be treated as dividends of ordinary income
to the extent that they are made out of our current or accumulated earnings and
profits. Such dividends to Non-U.S. Shareholders ordinarily will be subject to a
withholding tax equal to 30% of the gross amount of the dividend unless an
applicable tax treaty reduces or eliminates that tax. However, if income from
the investment in the common shares is treated as effectively connected with the
Non-U.S. Shareholder's conduct of a United States trade or business, the
Non-U.S. Shareholder generally will be subject to a tax at the graduated rates
applicable to ordinary income, in the same manner as U.S. shareholders are taxed
with respect to such dividends (and may also be subject to the 30% branch
profits tax in the case of a shareholder that is a foreign corporation).
Dividends in excess of our current and accumulated earnings and profits will not
be taxable to a shareholder to the extent they do not exceed the adjusted basis
of the shareholder's shares. Instead, they will reduce the adjusted basis of
such shares. To the extent that such dividends exceed the adjusted basis of a
Non-U.S. Shareholder's shares, they will give rise to tax liability if the
Non-U.S. Shareholder would otherwise be subject to tax on any gain from the sale
or disposition of his shares, as described below.
Distributions Attributable to Sale or Exchange of Real Property.
Distributions that are attributable to gain from our sales or exchanges
of United States real property interests will be taxed to a Non-U.S. Shareholder
as if such gain were effectively connected with a United States trade or
business. Non-U.S. Shareholders would thus be taxed at the normal capital gain
rates applicable to U.S. shareholders, and would be subject to applicable
alternative minimum tax and a special alternative minimum tax in the case of
nonresident alien individuals. Also, such dividends may be subject to a 30%
branch profits tax in the hands of a corporate Non-U.S. Shareholder not entitled
to any treaty exemption.
Tax Withholding on Distributions.
For withholding tax purposes, we will generally withhold tax at the rate
of 30% on the amount of any distribution (other than distributions designated as
capital gain dividends) made to a Non-U.S. Shareholder, unless the
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Non-U.S. Shareholder provides us with a properly completed Internal Revenue
Service (1) Form W-8BEN (in which case we will withhold at the lower treaty
rate) or (2) Form W-8ECI claiming that the dividend is effectively connected
with the Non-U.S. Shareholder's conduct of a trade or business within the United
States (in which case we will not withhold tax). We are also generally required
to withhold tax at the rate of 35% on the portion of any dividend to a Non-U.S.
Shareholder that is or could be designated by us as a capital gain dividend.
Such withheld amounts of tax do not represent actual tax liabilities but,
rather, represent payments in respect of those tax liabilities described in the
preceding two paragraphs. Thus, such withheld amounts are creditable by the
Non-U.S. Shareholder against its actual U.S. federal income tax liabilities,
including those described in the preceding two paragraphs. The Non-U.S.
Shareholder would be entitled to a refund of any amounts withheld in excess of
such Non-U.S. Shareholder's actual U.S. federal income tax liabilities, provided
that the Non-U.S. Shareholder files applicable returns or refund claims with the
Internal Revenue Service.
Sales of Shares.
Gain recognized by a Non-U.S. Shareholder upon a sale of shares
generally will not be subject to U.S. federal income taxation, provided that:
. such gain is not effectively connected with the conduct by such
Non-U.S. Shareholder of a trade or business within the United
States;
. the Non-U.S. Shareholder is not present in the United States for
183 days or more during the taxable year and certain other
conditions apply; and
. we are a "domestically controlled REIT", which generally means
that less than 50% in value of our shares continues to be held
at all times during a specified testing period directly or
indirectly by foreign persons (as is currently the case).
If we were not a domestically controlled REIT, the determination of
whether a Non-U.S. Shareholder's sale of common shares would be subject to tax
would depend on whether or not the common shares were regularly traded on an
established securities market and on the size of selling Non-U.S. Shareholder's
interest in our securities. If the gain on the sale of shares were to be subject
to taxation, the Non-U.S. Shareholder will be subject to the same treatment as
U.S. shareholders with respect to such gain and the purchaser of such common
shares may be required to withhold 10% of the gross purchase price.
STATE AND LOCAL TAXES
We may be subject to state or local taxation. In addition, our
shareholders may also be subject to state or local taxation. Consequently, you
should consult your own tax advisors regarding the effect of state and local tax
laws on your investment in our securities.
TAX ASPECTS OF THE OPERATING PARTNERSHIP
The following discussion summarizes the material United States federal
income tax considerations applicable to our investment in the Operating
Partnership. This summary does not address tax consequences under state, local,
or foreign tax laws and does not discuss all aspects of federal law that may
affect the tax consequences of the ownership and disposition of an interest in
the Operating Partnership.
TAX TREATMENT OF THE OPERATING PARTNERSHIP
The Operating Partnership will be treated as a pass-through entity that
does not incur any federal income tax liability, provided that the Operating
Partnership is classified for federal income tax purposes as a partnership
rather than as a corporation or an association taxable as a corporation. The
Operating Partnership has been formed as a Delaware limited partnership under
the Delaware Revised Uniform Limited Partnership Act. An organization formed
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as a partnership under applicable state partnership law will be treated as a
partnership, rather than as a corporation, for federal income tax purposes if:
. it is not expressly classified as a corporation under Section
301.7701-2(b)(1) through (8) of the Treasury Regulations;
. it does not elect to be classified as an association taxable as
a corporation; and
. either (A) it is not classified as a "publicly traded
partnership" under Section 7704 of the Code or (B) 90% or more
of it's gross income consists of specified types of "qualifying
income" within the meaning of Section 7704(c)(2) of the Code
(including interest, dividends, "real property rents" and gains
from the disposition of real property). A partnership is deemed
to be a "publicly traded partnership" if its interests are
either (i) traded on an established securities market or (ii)
readily tradable on a secondary market (or the substantial
equivalent thereof).
Pursuant to the Treasury Regulations under Section 7704, the
determination of whether a partnership is publicly traded is generally based on
a facts and circumstances analysis. However, the regulations provide limited
"safe harbors" which preclude publicly traded partnership status. The
Partnership Agreement of the Operating Partnership contains a number of
limitations on transfers and redemptions of partnership interests which are
intended to cause the Operating Partnership to qualify for an exemption from
publicly traded partnership status under one or more of the safe harbors of
contain in the applicable regulations. Moreover, the Operating Partnership is
not expressly classified as, and will not elect to be classified as, a
corporation under the Treasury Regulations. Accordingly, we believe that the
Operating Partnership will be treated as a partnership for federal income tax
purposes.
If for any reason the Operating Partnership were taxable as a
corporation, rather than as a partnership for federal income tax purposes, we
would not be able to satisfy the income and asset requirements for REIT status.
Further, the Operating Partnership would be required to pay income tax at
corporate tax rates on its net income, and distributions to its partners would
constitute dividends that would not be deductible in computing the Operating
Partnership's taxable income and would be taxable to us. Any change in the
Operating Partnership's status for tax purposes could also, in certain cases, be
treated as a taxable event, in which case we might incur a tax liability without
any related cash distribution.
The following discussion assumes that the Operating Partnership will be
treated as a partnership for federal income tax purposes.
TAX TREATMENT OF PARTNERS
Income and Loss Pass-Through.
No federal income tax will be paid by the Operating Partnership.
Instead, each partner, including us, is required to report on its income tax
return its allocable share of income, gains, losses, deductions and credits of
the Operating Partnership, regardless of whether the Operating Partnership makes
any distributions. Our allocable shares of income, gains, losses, deductions and
credits of the Operating Partnership are generally determined by the terms of
the Partnership Agreement.
Pursuant to Section 704(c) of the Code, income, gain, loss and deduction
attributable to property that is contributed to a partnership in exchange for an
interest in such partnership must be allocated in a manner that takes into
account the unrealized tax gain or loss associated with the property at the time
of the contribution. The amount of such unrealized tax gain or loss is generally
equal to the difference between the fair market value of the contributed
property at the time of contribution and the adjusted tax basis of such property
at the time of contribution (a "book/tax difference"). Such allocations are
solely for federal income tax purposes and do not affect the book capital
accounts or other economic or legal arrangements among the partners. The
Operating Partnership was formed by way of contributions of property which have
a book/tax difference. Consequently, under the Partnership Agreement, the
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partners will be allocated tax items in a manner designed to eliminate the
effects of these differences in manner that is consistent with Section 704(c) of
the Code. As a result, (1) certain partners that contributed property with a
book/tax difference may be allocated depreciation deductions for tax purposes
which are lower than such deductions would be if determined on a pro rata basis
and (2) in the event of a disposition of any contributed asset which has a
book/tax difference, all income attributable to such book/tax difference will
generally be allocated to the partner that contributed such asset to the
Operating Partnership and the other partners will generally be allocated only
their share of capital gains attributable to the appreciation in the value of
such asset, if any, since the date of such contribution.
Although the special allocation rules of Section 704(c) are generally
intended to cause the amount of tax allocations with respect to contributed
property which are made to partners other than the contributing partner to equal
the amount of book allocations to such other partners, the rules do not always
have this result. Thus, in certain cases we may be allocated, with respect to
property which has a book/tax difference and has been contributed by other
partners, tax depreciation and other tax deductions that are less than, and
possibly an amount of taxable income or gain on the sale of such property which
is greater than, the amount of book depreciation, deductions, income or gain
which is allocated to us. This may cause us to recognize taxable income in
excess of cash proceeds, which might adversely affect our ability to comply with
the REIT distribution requirements.
The foregoing principles also apply in determining our earnings and
profits for purposes of determining the portion of distributions taxable as
dividend income. The application of these rules over time may result in a higher
portion of distributions being taxed as dividends than would have occurred had
we purchased the contributed assets entirely for cash.
The characterization of any item of profit or loss (for example, as
capital gain or loss rather than ordinary income or loss) which is allocated to
us will be the same for us as it was for the Operating Partnership.
Treatment of Distributions and Constructive Distributions.
Distributions we receive from the Operating Partnership will generally
be nontaxable to us. However, we would have taxable income in the event the
amount of distributions we receive from the Operating Partnership, or the amount
of any decrease in our share of the Operating Partnership's indebtedness (any
such decrease being considered a constructive cash distribution to us), exceeds
our adjusted tax basis in our interest in the Operating Partnership. Such
taxable income would normally be characterized as a capital gain, and if our
interest in the Operating Partnership has been held for longer than one year,
any such gain would constitute long-term capital gain.
Tax Basis in Our Operating Partnership Interest.
Our adjusted tax basis in our interest in the Operating Partnership
generally:
. will be equal to the amount of cash and the basis of any other
property contributed to the Operating Partnership by us and our
proportionate share of the Operating Partnership's indebtedness;
. will be increased by our share of the Operating Partnership's
taxable and non-taxable income and any increase in our share of
Operating Partnership indebtedness; and
. will be decreased (but not below zero) by the distributions we
receive, our share of deductible and non-deductible losses and
expenses of the Operating Partnership and any decrease in our
share of Operating Partnership indebtedness.
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ITEM 2. FINANCIAL INFORMATION.
SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial
information for the Company from the commencement of our operations. You should
read this information in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and our audited consolidated
financial statements and the notes thereto, both of which appear elsewhere in
this registration statement.
(in thousands except per share data)
------------------------------------------------------------
Year Ended December 31,
------------------------------------------------------------
2002 2001 2000 1999
------------ ------------ ------------ ------------
INCOME STATEMENT DATA:
Revenues.................................... $ 20,755 $ 11,704 $ 9,626 $ 5,009
Operations expenses......................... 8,243 5,068 3,925 2,017
Interest.................................... 1,573 812 1,271 732
Depreciation and amortization............... 4,041 2,151 1,786 850
------------ ------------ ------------ ------------
Total expenses.......................... 13,857 8,031 6,982 3,599
------------ ------------ ------------ ------------
Income before minority interests............ 6,898 3,673 2,644 1,410
Minority interest in income................. (3,193) (1,932) (1,770) (1,396)
------------ ------------ ------------ ------------
Net income.................................. $ 3,705 $ 1,741 $ 874 $ 14
============ ============ ============ ============
Net income per common share................. $ 0.755 0.573 $ 0.475 $ 0.037
Weighted average shares outstanding......... 4,905 3,036 1,841 375
BALANCE SHEET DATA:
Real estate................................. $ 109,294 $ 66,269 $ 62,781 $ 29,518
Other assets................................ 17,305 4,170 3,017 3,209
------------ ------------ ------------ ------------
Total assets............................ $ 126,599 $ 70,439 $ 65,798 $ 32,727
============ ============ ============ ============
Liabilities............................. $ 45,252 $ 16,072 $ 17,439 $ 13,038
Minority interests in Operating Partnership 38,598 27,264 27,278 15,866
Shareholders' equity.................... 42,749 27,103 21,081 3,823
------------ ------------ ------------ ------------
Total liabilities and equity............ $ 126,599 $ 70,439 $ 65,798 $ 32,727
============ ============ ============ ============
CASH FLOW DATA:
Proceeds from issuance of common shares..... $ 155 $ 6,748 $ 11,660 $ 3,978
Additions to real estate.................... 1,983 5,027 6,089 6,368
OTHER FINANCIAL DATA:
Dividends per share......................... $ 0.9625 $ 0.8125 $ 0.9550 $ 0.9250
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
You should read the following discussion of our financial condition and
results of operations in conjunction with our audited consolidated financial
statements and the notes thereto included in this registration statement. For
more detailed information regarding the basis of presentation for the following
information, you should read the notes to the audited consolidated financial
statements included in this registration statement.
OVERVIEW
We owned 32 commercial properties at December 31, 2002, consisting of 17
rental centers, 12 office/warehouse properties and three office buildings. All
of our properties are located in the Houston, Texas
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metropolitan area. As of December 31, 2002, we had 636 total tenants. No
individual lease or tenant is material to our business. Revenues from our
largest lease constituted 2.32% of our total revenues during 2002. Leases for
our properties range from one year for our smaller spaces to over ten years for
larger tenants. Our leases generally include minimum monthly lease payments and
tenant reimbursements for payment of taxes, insurance and maintenance.
We have no employees and we do not manage our properties. Our properties
and day-to-day operations are managed by the Management Company under a
management agreement. Under this agreement, we pay the Management Company the
following amounts:
. a management fee of 5% of our gross effective revenues to manage
our properties;
. a leasing fee of 6% of the gross effective revenues from leases
originated by the Management Company and a fee of 4% of the
gross effective revenues from expansions or renewals of existing
leases;
. an administrative fee of 1% of our gross effective revenues for
day-to-day supervisory and general administration services; and
. the reimbursement of certain expenses and costs incurred on our
behalf.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements. We prepared these
financial statements in conformity with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
required us to make estimates and assumptions that affect the reported amounts
of assets and liabilities at the dates of the financial statements and the
reported amounts of revenues and expenses during the reporting periods. We based
our estimates on historical experience and on various other assumptions we
believe to be reasonable under the circumstances. Our results may differ from
these estimates. Currently, we believe that our accounting policies do not
require us to make estimates using assumptions about matters that are highly
uncertain. You should read Note 1, Summary of Significant Accounting Policies,
to our financial statements in conjunction with this Management's Discussion and
Analysis of Financial Condition and Results of Operations.
We have described below the critical accounting policies that we believe
could impact our consolidated financial statements most significantly.
Basis of Consolidation. We are the sole general partner of the Operating
Partnership and possess full legal control and authority over its operations. As
of December 31, 2002, we owned a majority of the partnership interests in the
Operating Partnership. Consequently, our consolidated financial statements
include the accounts of the Operating Partnership. All significant intercompany
balances have been eliminated. Minority interest in the accompanying
consolidated financial statements represents the share of equity and earnings of
the Operating Partnership allocable to holders of partnership interests other
than us. Net income is allocated to minority interests based on the
weighted-average percentage ownership of the Operating Partnership during the
year. Issuance of additional common shares and OP Units changes our ownership
interests as well as those of minority interests.
Real Estate. We record real estate properties at cost, net of
accumulated depreciation. We capitalize improvements, major renovations and
certain costs directly related to the acquisition, improvement and leasing of
real estate. We charge expenditures for repairs and maintenance to operations as
they are incurred. We calculate depreciation using the straight-line method over
the estimated useful lives of 5 to 39 years of our buildings and improvements.
We depreciate tenant improvements using the straight-line method over the life
of the lease.
We review our properties for impairment whenever events or changes in
circumstances indicate that the carrying amount of the assets, including accrued
rental income, may not be recoverable through our operations. We determine
whether an impairment in value has occurred by comparing the estimated future
cash flows (undiscounted
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and without interest charges), including the estimated residual value of the
property, with the carrying cost of the property. If impairment is indicated, we
record a loss for the amount by which the carrying value of the property exceeds
its fair value. We have determined that there has been no impairment in the
carrying value of our real estate assets as of December 31, 2002.
Revenue Recognition. All leases on properties we hold are classified as
operating leases, and we recognize the related rental income on a straight-line
basis over the terms of the related leases. We capitalize or charge to accrued
rent receivable, as applicable, differences between rental income earned and
amounts due per the respective lease agreements. Percentage rents are recognized
as rental income when the thresholds upon which they are based have been met.
Recoveries from tenants for taxes, insurance, and other operating expenses are
recognized as revenues in the period the corresponding costs are incurred. We
provide an allowance for doubtful accounts against the portion of tenant
accounts receivable which we estimate to be uncollectible.
Liquidity and Capital Resources
General. During the year ended December 31, 2002, our properties
generated sufficient cash flow to cover our operating expenses and to allow us
to pay quarterly dividends. We generally lease our properties on a triple-net
basis, which means that tenants are required to pay for all repairs and
maintenance, property taxes, insurance and utilities. We anticipate that cash
flows from operating activities and our borrowing capacity will continue to
provide adequate capital for our working capital requirements, anticipated
capital expenditures and scheduled debt payments during the next 12 months. We
also believe that cash flows from operating activities and our borrowing
capacity will allow us to make all dividend payments required for us to continue
to qualify to be taxed as a REIT. We also believe that our properties are
adequately covered by insurance.
Cash and Cash Equivalents. We had cash and cash equivalents of
$6,091,699 on December 31, 2002 as compared to $203,418 on December 31, 2001.
This increase resulted primarily from excess loan proceeds from refinancing our
debt. We place all cash in short-term, highly liquid investments that we believe
provide appropriate safety of principal. We expect our overall holdings of cash
and cash equivalents to eventually decrease as we acquire additional properties
with such proceeds.
Our Debt for Borrowed Money.
In December 2002, we refinanced most of our debt with a new credit
facility from GMAC Commercial Mortgage Corporation. The loan is secured by,
among other things, 18 of our properties, which are held by a wholly-owned
subsidiary formed for the purpose of this credit facility, and the improvements,
personal property and fixtures on the properties, as well as certain accounts
and intangible assets and an assignment of rents related to such properties. We
may prepay the loan after July 1, 2005 without penalty. We must pay a prepayment
fee equal to one percent of the outstanding principal balance under the facility
if we prepay the note prior to July 1, 2005.
We are required to make monthly interest payments under this credit
facility. During the initial term of the note, indebtedness under the credit
facility will bear interest at LIBOR plus 2.5%, adjusted monthly. The interest
rate was 3.92% as of December 31, 2002. The credit facility will mature on
January 1, 2006, though we have the option, subject to certain conditions, of
extending the facility for an additional two-year period. In no event shall the
interest rate be lower than 3.82% during the initial term or lower than 4.32%
during the extension term.
In addition, the borrower entered into certain covenants pursuant to the
credit facility which, among other things, require it to maintain specified
levels of insurance and use the properties securing the note only for retail,
light industrial, office, warehouse and commercial office uses. The facility
also limits, without the approval of the lender, the borrower's ability to:
. acquire additional material assets;
. merge or consolidate with any other entity;
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. engage in any other business or activity other than the
ownership, operation and maintenance of the properties securing
the note;
. make certain investments;
. incur, assume or guarantee additional indebtedness;
. grant certain liens; and
. loan money to others. The note and the security documents
related thereto also contain customary events of default,
including, without limitation, payment defaults,
bankruptcy-related defaults and breach of covenant defaults.
Upon the closing of this financing, we repaid approximately $24,800,000
of existing debt, placed approximately $2,800,000 in escrows established at the
closing for taxes, insurance, agreed capital improvement and other uses required
by the lender and paid fees and expenses of approximately $600,000 incurred in
connection with the credit facility. The remaining proceeds, approximately
$6,200,000, were available for general working capital purposes.
In August 2002, we entered into $2,000,000 line of credit with First
Bank & Trust. We may only use this line of credit in connection with
acquisitions to purchase interests held by investors who do not qualify as
"accredited investors" under the Securities Act of 1933 and the rules and
regulations promulgated thereunder. As of December 31, 2002, there were no
amounts outstanding under this line of credit. This line of credit is secured by
our Bellnot Square property. In the event we borrow amounts under this line of
credit, such amounts will accrue interest at a rate equal to the lender's prime
rate. This line of credit terminates on July 31, 2004, unless the lender elects
to extend the term of the line for additional one year periods. This line of
credit contains customary covenants and events of default.
In November 2002, we borrowed $3,278,000 from Houston R.E. Income
Properties XVI, L.P. This debt is evidenced by a promissory note and accrues
interest at a rate of 4.25%. The note is secured by our Corporate Park Northwest
property and is payable at any time upon the demand of Houston XVI. We used
these borrowed funds to repay existing debt. Mr. Hartman controls the general
partner of Houston XVI. We are only required to make monthly interest payments
under the note.
Our Private Placement.
We sold common shares between May, 1999 and December, 2000 in a private
placement. As a result of this private placement, we received subscriptions to
purchase 2,481,745 common shares at a price of $10 per share, resulting in
aggregate proceeds of $24,817,451. Although we closed this offering in December
2000, we received approximately $7,454,000 in gross proceeds in 2001 and
approximately $169,000 in gross proceeds in 2002 in accordance with subscription
agreements executed prior to December 2000.
After accounting for volume discounts offered to investors, we paid
$476,175 in selling commissions to broker-dealers and $438,027 to the Management
Company for advisory and management services provided in connection with the
private placement and for the reimbursement of offering and organizational fees
and expenses paid by the Management Company on our behalf. We transferred
$23,546,034 of net proceeds to the Operating Partnership as capital
contributions and received an aggregate of 2,354,603.4 OP Units therefor.
We used proceeds of the private placement to pay down amounts owed under
our then-existing line of credit, to acquire four properties and for general
working capital purposes. In addition to the amount we paid to the Management
Company for its services in connection with the private placement, we also paid
$992,698 to the Management Company for services the Management Company provided,
and to reimburse the Management Company for expenses incurred, in connection
with locating, evaluating and completing property acquisitions.
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Capital Expenditures. We currently do not expect to make significant
capital expenditures or any significant improvements to any of our properties
during the next 12 months. However, we may have unexpected capital expenditures
or improvements on our existing assets. Additionally, we may incur significant
capital expenditures or make significant improvements in connection with any
properties we may acquire.
Total Contractual Cash Obligations. A summary of our contractual cash
obligations, as of December 31, 2002, is as follows:
PAYMENT DUE BY PERIOD
LESS THAN 1 MORE THAN 5
CONTRACTUAL OBLIGATIONS TOTAL YEAR 1-3 YEARS 3-5 YEARS YEARS
Long-Term Debt Obligations $ 37,718,000 $ 3,278,000 $ 34,440,000 -- --
Capital Lease Obligations -- -- -- -- --
Operating Lease Obligations -- -- -- -- --
Purchase Obligations -- -- -- -- --
Other Long-Term Liabilities
Reflected on the Registrant's
Balance Sheet under GAAP -- -- -- -- --
Total $ 37,718,000 $ 3,278,000 $ 34,440,000 -- --
We have no commercial commitments such as lines of credit or guarantees
that might result from a contingent event that would require our performance
pursuant to a funding commitment.
Property Acquisitions. We acquired ten properties from five entities
controlled by Mr. Hartman during 2002. We acquired four of these properties by
merging the selling entities with and into either HCP or the Operating
Partnership. In these mergers we issued common shares or OP Units, as
applicable, to equity holders in the selling entities who were accredited
investors and paid cash for equity interests held by non-accredited investors.
For all ten properties, we issued 1,650,891 common shares, 2,851,066 OP Units
(including 1,067,657 issued to HCP), assumed mortgage debt and other liabilities
aggregating $15,053,870 and paid approximately $1,811,398 to purchase interests
held by non-accredited investors in connection with these mergers.
Common Share Distributions. We declared the following distributions to
our shareholders during 2001, 2002 and 2003:
TOTAL AMOUNT OF DISTRIBUTIONS
MONTH PAID DISTRIBUTIONS PAID PER SHARE
--------------------- ------------------ -------------
February 2001 $ 559,440 $ 0.2425
May 2001 541,380 0.2000
August 2001 602,138 0.2000
November 2001 635,778 0.2000
February 2002 687,544 0.2125
May 2002 1,102,340 0.2250
August 2002 1,166,709 0.2375
November 2002 1,226,777 0.2500
February 2003 1,226,777 0.2500
Average Per Quarter $ 0.2242
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OP Unit Distributions. The Operating Partnership declared the following
distributions to holders of its OP Units, including HCP, during 2001, 2002 and
2003:
TOTAL AMOUNT OF DISTRIBUTIONS
MONTH PAID DISTRIBUTIONS PAID PER SHARE
--------------------- ------------------ -------------
February 2001 $ 1,196,357 $ 0.2425
May 2001 1,070,594 0.2000
August 2001 1,126,845 0.2000
November 2001 1,158,818 0.2000
February 2002 1,242,869 0.2125
May 2002 1,942,412 0.2250
August 2002 2,053,866 0.2375
November 2002 2,161,143 0.2500
February 2003 2,179,976 0.2500
Average Per Quarter $ 0.2242
Please see "Item 9. Market Price of and Dividends on the Registrant's
Common Equity and Related Stockholder Matters" for an expanded discussion of our
distribution history and policies.
RESULTS OF OPERATIONS
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
General.
The following table provides a general comparison of our results of
operations for the years ended December 31, 2001 and December 31, 2002:
DECEMBER 31, 2001 DECEMBER 31, 2002
----------------- -----------------
Number of properties owned and operated 23 32
Aggregate gross leasable area (sq. ft.) 1,461,454 2,348,862
Aggregated occupancy rate 88% 92%
Total Revenues $ 11,703,737 $ 20,755,026
Total Operating Expenses $ 8,031,063 $ 13,857,303
Income before Minority Interest $ 3,672,674 $ 6,897,723
Minority Interest in the Operating Partnership $ (1,931,962) $ (3,192,605)
Net Income $ 1,740,712 $ 3,705,118
Revenues.
We had rental income and tenant reimbursements of $20,423,485 for the
year December 31, 2002, as compared to revenues of $11,606,031 for the year
ended December 31, 2001, an increase of $8,817,454, or 76%. Substantially all of
our revenues are derived from rents received from the use of our properties. The
increase in our revenues during 2002 as compared to 2001 was due primarily to
nine additional properties we acquired in 2002, as well as an increase in
occupancy levels and an increase in the amount of rent charged at some
locations. Our average occupancy rate in 2002 was 90%, as compared to 85% in
2001, and our average lease rate was $8.84 per square foot in 2002, as compared
to an average rate of $8.26 per square foot in 2001.
We had interest and other income of $331,541 for the year ended December
31, 2002, as compared to $97,706 for the year ended December 31, 2001, an
increase of $233,835, or 239%. We hold all revenues and proceeds we receive from
offerings in money market accounts and other short-term, highly liquid
investments. In 2001, we had proceeds from the private placement we completed in
December, 2000 that earned interest prior to being invested. The increase in
interest and other income during 2002 as compared to 2001 resulted primarily
from
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the fact that we had more properties producing non-rent income such as late fees
and deposit forfeitures. This increase was offset somewhat by the lower interest
rates we earned on our investments in 2002 as compared to 2001. We expect the
percentage of our total revenues from interest income from investments in money
market accounts or other short term, highly liquid investments to return to 2001
levels or decrease as we invest cash holdings in properties.
Expenses.
Our total operating expenses, including interest expense and
depreciation and amortization expense, were $13,857,303 for the year ended
December 31, 2002, as compared to $8,031,063 for the year ended December 31,
2001, an increase of $5,826,240, or 73%. We expect that the dollar amount of
operating expenses will increase as we acquire additional properties and expand
our operations. However, we expect that general and administrative expenses as a
percentage of total revenues will decline as we acquire additional properties.
The increase in our operating expenses during 2002 was primarily the
result of increased expenses associated with the nine properties we acquired in
2002. Consequently, we had higher expenses directly related to these acquired
properties, such as increased maintenance, real estate taxes, utilities and
depreciation and amortization expenses.
The amount we pay the Management Company under our management agreement
is based on our revenues and the number of leases the Management Company
originates. As a result of our increased revenues in 2002, management fees were
$1,231,212 in 2002, as compared to $674,529 in 2001, an increase of $556,683, or
83%. Our interest expense increased by $761,241, or 94%, in 2002 as compared to
2001. Although our average outstanding debt increased from $11,887,723 in 2001
to $29,263,144 in 2002, the average interest rate associated with this debt
decreased from 6.83% in 2001 to 5.38% in 2002. Finally, general and
administrative expenses increased $312,804, or 60%, in 2002 as compared to 2001
primarily as the result of an increase in professional fees.
Net Income.
Income provided by operating activities before minority interest was
$6,897,723 for the year ended December 31, 2002, as compared to $3,672,674 for
the year ended December 31, 2001, an increase of $3,225,049, or 88%. Net income
provided by operating activities for the year ended December 31, 2002 was
$3,705,118, as compared to $1,740,712 for the year ended December 31, 2001, an
increase of $1,964,406, or 113%.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
General.
The following table provides a general comparison of our results of
operations for the years ended December 31, 2000 and December 31, 2001:
DECEMBER 31, 2000 DECEMBER 31, 2001
----------------- -----------------
Number of properties owned and operated 22 23
Aggregate gross leasable area (sq. ft.) 1,371,127 1,461,454
Aggregated occupancy rate 82% 88%
Total Revenues $ 9,625,758 $ 11,703,737
Total Operating Expenses $ 6,981,984 $ 8,031,063
Income before Minority Interest $ 2,643,774 $ 3,672,674
Minority Interest in the Operating Partnership $ (1,770,078) $ (1,931,962)
Net Income $ 873,696 $ 1,740,712
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Revenues.
We had rental income and tenant reimbursements of $11,606,031 for the
year December 31, 2001, as compared to revenues of $9,564,686 for the year ended
December 31, 2000, an increase of $2,041,345, or 21%. Substantially all of our
revenues are derived from rents received from the use of our properties. The
increase in our revenues during 2001 as compared to 2000 was due primarily to
the addition of one property to our portfolio in 2001, as well as higher
occupancy and lease rates. Our average occupancy rate in 2001 was 85% as
compared to 82% in 2000 and our average lease rate was $8.26 per square foot in
2001 as compared to an average rate of $7.02 per square foot in 2000.
We had interest and other income of $97,706 for the year ended December
31, 2001, as compared to $61,072 for the year ended December 31, 2000, an
increase of $36,634, or 60%. We hold all revenues and proceeds we receive from
offerings in money market accounts and other short-term, highly liquid
investments. In 2001, we had proceeds from the private placement we completed in
December 2000 that earned interest prior to being invested. The increase in
interest and other income during 2001 as compared to 2000 was primarily the
result of the fact that we had more proceeds from our private placement invested
during 2001 and we therefore earned more interest in 2001.
Expenses.
Our total operating expenses, including interest expense and
depreciation and amortization expense, were $8,031,063 for the year ended
December 31, 2001, as compared to $6,981,984 for the year ended December 31,
2000, an increase of $1,049,079, or 15%.
The increase in our operating expenses during 2001 was primarily the
result of increased expenses associated with the property we acquired in 2001,
as well as an overall increase in repair and maintenance expenses and property
taxes. Consequently, we had higher expenses directly related to this acquired
property, such as increased maintenance, real estate taxes, insurance, utilities
and depreciation and amortization expenses.
As a result of our increased revenues in 2001, our management fees
increased from $574,216 in 2000 to $674,529 in 2001, an increase of $100,313, or
17%. The increase in our operating expenses was partially offset by decreases in
our interest expense. Our interest expense decreased $459,165, or 36%, in 2001
as compared to 2000. Our average outstanding debt was $11,887,723 in 2001, as
compared to $13,502,948 in 2000, a decrease of $1,615,225, or 12%. Although our
average outstanding debt remained relatively constant during both 2001 and 2000,
the average interest rate associated with this debt decreased from 9.41% in 2000
to 6.83% in 2001. Our general and administrative expenses decreased slightly by
$15,796, or 3%.
Net Income.
Income provided by operating activities before minority interest was
$3,672,674 for the year ended December 31, 2001, as compared to $2,643,774 for
the year ended December 31, 2000, an increase of $1,028,900, or 39%. Net income
provided by operating activities for the year ended December 31, 2001 was
$1,740,712, as compared to $873,696 for the year ended December 31, 2000, an
increase of $867,016, or 99%.
TAXES
We elected to be taxed as a REIT under the Internal Revenue Code
beginning with our taxable year ended December 31, 1999. As a REIT, we generally
are not subject to federal income tax on income that we distribute to our
shareholders. If we fail to qualify as a REIT in any taxable year, we will be
subject to federal income tax on our taxable income at regular corporate rates.
We believe that we are organized and operate in such a manner as to qualify to
be taxed as a REIT, and we intend to operate so as to remain qualified as a REIT
for federal income tax purposes.
INFLATION
We anticipate that our leases will continue to be triple-net leases and
will contain provisions that we believe will mitigate the effect of inflation.
In addition, many of our leases are for terms of less than five years, which
allows
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us to adjust rental rates to reflect inflation and other changing market
conditions when the leases expire. Consequently, increases due to inflation, as
well as ad valorem tax rate increases, generally do not have a significant
adverse effect upon our operating results.
Environmental Matters
Our properties are subject to environmental laws and regulations adopted
by various governmental authorities in the jurisdictions in which our operations
are conducted. From our inception, we have incurred no significant environmental
costs, accrued liabilities or expenditures to mitigate or eliminate future
environmental contamination.
Recent Accounting Pronouncements
In June 1998, Statement of Financial Accounting Standards ("SFAS") No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended,
was issued. This statement requires that an entity recognize all derivatives as
either assets or liabilities and measure the instruments at fair value. The
accounting for change in fair value of a derivative depends upon its intended
use. We adopted the provisions of this statement effective January 1, 2001, and
we believe that this statement did not have any material impact on our financial
statements.
SFAS No. 141, "Business Combinations," which became effective on July 1,
2001, prohibits pooling-of-interests accounting for acquisitions. The adoption
of SFAS 141 did not have a material impact on our financial statements.
SFAS No. 142, "Goodwill and Other Intangible Assets," which became
effective on January 1, 2002, specifies that goodwill and some intangible assets
will no longer be amortized but instead will be subject to periodic impairment
testing. The effect of adopting SFAS No. 142 did not have a material impact on
our financial statements.
On January 1, 2003, we adopted SFAS No. 143, "Accounting for Asset
Retirement Obligations," which was issued in June 2001 and is effective for
years beginning after June 15, 2002. This statement addresses financial
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. The
adoption of SFAS No. 143 will not have a material impact on our financial
statements.
On January 1, 2002, we adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which was issued in August 2001.
This Statement supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and the
accounting and reporting provisions of Accounting Principles Board ("APB")
Opinion No. 30, "Reporting the Results of Operations Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" for the disposal of a segment of a business
(as previously defined in that Opinion). This Statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
The adoption of SFAS No. 144 did not have a material impact on our financial
statements.
On April 30, 2002, we adopted SFAS No. 145, "Rescission of SFAS
Statements No. 4, 44 and 64, Amendment of SFAS No. 13, Technical Corrections,"
which was issued in April 2002. The purpose of this statement is to update,
clarify and simplify existing accounting standards. The effect of adopting SFAS
No. 145 did not have a material impact on our financial statements.
SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and
Disclosure--an amendment of FASB Statement No. 123," which was issued in
December 2002, is effective for fiscal years beginning after December 15, 2002.
This statement provides alternative methods of transition for an entity that
voluntarily changes to the fair value-based method of accounting for stock-based
employee compensation. It also amends the disclosure requirements of SFAS No.
123 to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. We adopted this statement
effective January 1, 2003 using the prospective method, and we do not expect the
adoption of this statement to have a material impact on our financial position,
results of operations or cash flows.
-40-
In November 2002, FASB issued Interpretation No.("FIN") 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 establishes new disclosure and
liability-recognition requirements for direct and indirect debt guarantees with
specified characteristics. The initial measurement and recognition requirements
of FIN 45 are effective prospectively for guarantees issued or modified after
December 31, 2002. However, the disclosure requirements are effective for
interim and annual financial statement periods ending after December 15, 2002.
We have adopted the disclosure provisions, and we do not expect the full
adoption of FIN 45 to have a material impact on our financial statements.
Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss arising from adverse changes in market
rates and prices. The principal market risk to which we are exposed is the risk
related to interest rate fluctuations. We will be exposed to changes in interest
rates as a result of our credit facility which has a floating interest rate. As
of December 31, 2002, we had $34,440,000 of indebtedness outstanding under this
facility. The impact of a 1% increase in interest rates on our debt would result
in an increase in interest expense and a decrease in income of approximately
$344,400 annually.
ITEM 3. PROPERTIES.
On December 31, 2002, we owned 32 properties. All of our properties are
located in the metropolitan Houston, Texas area. Our properties consist of 17
retail centers, 12 office/warehouse properties and three office properties. Set
forth below is additional information relating to our properties.
GENERAL PHYSICAL ATTRIBUTES
The following table lists, for all properties we owned on December 31,
2002, the year each property was developed or significantly renovated, the
applicable segment, the purchase price we paid for such property and the anchor
or largest tenant at such property.
YEAR
DEVELOPED/
PROPERTY RENOVATED SEGMENT/USE PURCHASE PRICE ANCHOR OR LARGEST TENANT
- ------------------------ ---------- ---------------- -------------- ---------------------------------
Bissonnet/Beltway 1978 Retail $ 2,339,771 Cash America International
Webster Point 1984 Retail 1,700,000 Houston Learning Academy
Centre South 1974 Retail 1,900,000 Carlos Alvarez
Torrey Square 1983 Retail 4,500,000 Fleming Foods
Providence 1980 Retail 4,604,656 Kroger Food Stores, Inc.
Holly Knight 1984 Retail 1,603,138 Quick Wash Laundry
Plaza Park 1982 Office/Warehouse 4,250,000 American Medical Response
Northwest Place II 1984 Office/Warehouse 1,100,000 Terra Mar, Inc.
Lion Square 1980 Retail 5,900,000 Kroger Food Stores, Inc.
Zeta Building 1982 Office 2,500,000 Astrium North America
Royal Crest 1984 Office 1,900,000 Dringle, Jenkins & Associates, PC
Featherwood 1983 Office 3,000,000 Transwestern Publishing
Interstate 10 1980 Office/Warehouse 3,740,000 River Oaks, L-M, Inc.
Westbelt Plaza 1978 Office/Warehouse 2,620,000 National Oilwell
Greens Road 1979 Retail 1,593,058 Juan Gailegos
Town Park 1978 Retail 3,585,000 Omar's Meat Market
Northeast Square 1984 Retail 2,595,751 99 Cent Store
Main Park 1982 Office/Warehouse 3,780,000 Corum Healthcare
Dairy Ashford 1981 Office/Warehouse 1,428,492 Kainus Community Church
South Richey 1980 Retail 3,305,220 Kroger Food Stores, Inc.
-41-
YEAR
DEVELOPED/
PROPERTY RENOVATED SEGMENT/USE PURCHASE PRICE ANCHOR OR LARGEST TENANT
- ------------------------ ---------- ---------------- -------------- ---------------------------------
Corporate Park Woodlands 2000 Office/Warehouse 6,012,052 Interceramic
South Shaver 1978 Retail 801,092 EZ Pawn
Kempwood Plaza 1974 Retail 2,948,952 Brookshire Brothers
Bellnot Square 1982 Retail 5,789,879 Kroger Food Stores, Inc.
Corporate Park Northwest 1981 Office/Warehouse 7,694,654 Region IV Education
Westgate 1984 Office/Warehouse 3,372,360 Polymeric Process
Garden Oaks 1954 Retail 6,446,067 Bally Total Fitness
Westchase 1978 Retail 2,120,777 Jesus Corral
Sunridge 1979 Retail 1,382,145 Carlos Morales
Holly Hall 1980 Office/Warehouse 2,828,747 Texas Medical Management
Brookhill 1979 Office/Warehouse 931,706 T.S. Moly-Lubricants
Corporate Park West 1999 Office/Warehouse 12,817,830 Urethane Products International
==============
Total -- -- $ 111,091,347 --
GENERAL ECONOMIC ATTRIBUTES
The following table lists certain information that relates to the rents
generated by each property. All of the information listed in this table is as of
December 31, 2002.
TOTAL
ANNUALIZED EFFECTIVE NET ANNUAL
TOTAL LEASABLE RENTS BASED ON RENT Per Sq. PERCENTAGE
PROPERTY PERCENT LEASED AREA (Sq. Ft.) OCCUPANCY ($) Ft. ($) RENT
- ------------------------ -------------- -------------- -------------- ------------- ----------
Bissonnet/Beltway 93.2 29,205 452,270 15.49 0
Webster Point 82.8 26,060 300,616 11.54 0
Centre South 88.2 44,593 344,743 7.73 0
Torrey Square 96.4 105,766 968,867 9.16 0
Providence 97.6 90,327 957,845 10.60 0
Holly Knight 90.5 20,015 321,855 16.08 0
Plaza Park 93.1 105,530 895,603 8.49 0
Northwest Place II 51.9 27,974 119,560 4.27 0
Lion Square 98.3 119,621 1,136,559 9.50 0
Zeta Building 93.6 39,106 530,133 13.56 0
Royal Crest 87.7 24,825 288,001 11.60 0
Featherwood 96.3 49,670 823,545 16.58 0
Interstate 10 95.5 151,000 756,706 5.01 0
Westbelt Plaza 92.5 65,619 566,126 8.63 0
Greens Road 100.0 20,507 365,156 17.81 0
Town Park 100.0 43,526 749,734 17.22 0
Northeast Square 90.4 40,525 444,612 10.97 0
Main Park 87.1 113,410 608,378 5.36 0
Dairy Ashford 100.0 42,902 255,137 5.95 0
South Richey 100.0 69,928 610,106 8.72 0
Corporate Park Woodlands 75.7 99,937 698,049 6.98 0
South Shaver 96.8 21,926 230,969 10.53 0
Kempwood Plaza 92.8 112,359 836,506 7.44 $ 9,491
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TOTAL
ANNUALIZED EFFECTIVE NET ANNUAL
TOTAL LEASABLE RENTS BASED ON RENT Per Sq. PERCENTAGE
PROPERTY PERCENT LEASED AREA (Sq. Ft.) OCCUPANCY ($) Ft. ($) RENT
- ------------------------ -------------- -------------- -------------- ------------- ----------
Bellnot Square 98.1 73,930 749,366 10.14 0
Corporate Park Northwest 90.2 185,625 1,564,923 8.43 0
Westgate 95.8 97,225 643,340 6.62 0
Garden Oaks 86.2 95,046 1,026,069 10.80 0
Westchase 66.4 42,924 304,022 7.08 0
Sunridge 95.9 49,359 481,256 9.75 0
Holly Hall 100.0 90,000 485,756 5.40 0
Brookhill 88.5 74,757 277,685 3.71 0
Corporate Park West 94.8 175,665 1,688,665 9.61 0
Total/Average 92.2 2,348,862 $ 20,482,158 $ 8.72 $ 9,491
The following table lists the five properties that generated the most
rents during the year 2002.
PERCENTAGE OF OUR
TOTAL RENTS TOTAL RENTS RECEIVED
PROPERTY RECEIVED IN 2002 IN 2002
------------------------ ---------------- --------------------
Corporate Park West $ 1,720,050 8.30%
Corporate Park Northwest 1,622,470 7.83%
Lion Square 1,185,588 5.72%
Providence 1,148,480 5.54%
Torrey Square 1,038,646 5.01%
================ ============
Total $ 6,715,234 32.40%
The following table lists for each property, as of December 31 of each
of the last five years or as for long as we have owned the property, both the
occupancy of each property and the average rental and other income per square
foot of gross leasable area.
1998 1999 2000 2001 2002
AVE. AVE. AVE. AVE. AVE.
INCOME INCOME INCOME INCOME INCOME
PERCENT PER SQ. PERCENT per Sq. PERCENT per Sq. PERCENT PER SQ. PERCENT per Sq.
PROPERTY LEASED Ft. ($) LEASED Ft. ($) LEASED Ft. ($) LEASED Ft. ($) LEASED Ft. ($)
- ------------------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Bissonnet/Beltway 100 12.86 100 13.95 100 14.42 100 17.02 93 16.50
Webster Point 92 9.65 79 10.19 86 10.92 93 10.57 83 11.83
Centre South 80 5.90 73 5.55 71 6.31 88 7.96 88 7.40
Torrey Square 97 6.63 96 8.02 96 7.69 99 9.71 96 9.82
Providence -- -- -- -- -- -- 100 8.81 98 12.71
Holly Knight 93 13.61 88 13.09 93 14.02 100 17.58 91 16.46
Plaza Park 78 5.51 88 6.32 85 6.26 83 7.60 93 7.89
Northwest Place II 90 6.51 71 6.84 80 5.76 52 5.31 52 4.40
Lion Square 95 7.38 99 8.28 97 8.84 100 9.59 98 9.91
Zeta Building 84 12.10 92 12.50 86 12.96 91 13.36 94 13.72
Royal Crest 87 13.08 83 12.43 73 10.34 73 7.38 88 10.24
Featherwood 100 14.34 -- 10.74 77 2.01 96 12.86 96 15.46
Interstate 10 96 3.79 91 4.30 82 3.97 97 4.36 96 4.78
-43-
1998 1999 2000 2001 2002
AVE. AVE. AVE. AVE. AVE.
INCOME INCOME INCOME INCOME INCOME
PERCENT PER SQ. PERCENT PER SQ. PERCENT PER SQ. PERCENT PER SQ. PERCENT PER SQ.
PROPERTY LEASED FT. ($) LEASED FT. ($) LEASED FT. ($) LEASED FT. ($) LEASED FT. ($)
- ------------------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Westbelt Plaza 84 6.00 90 6.38 93 6.92 85 7.21 92 8.88
Greens Road 82 14.12 78 14.50 78 15.83 100 16.54 100 18.60
Town Park 100 14.72 100 14.93 100 16.09 100 19.01 100 17.88
Northeast Square 100 12.31 68 11.39 81 9.91 84 9.14 90 11.81
Main Park 93 5.59 93 6.01 81 5.41 89 4.89 87 5.53
Dairy Ashford 96 3.64 100 5.90 80 5.94 100 6.11 100 5.83
South Richey -- -- 88 2.60 100 8.72 94 9.45 100 9.63
Corporate Park
Woodlands -- -- -- -- 4 0.06 19 1.75 76 4.70
South Shaver -- -- -- -- 57 5.11 83 7.29 97 9.82
Kempwood Plaza 84 4.68 94 5.29 95 5.79 91 5.72 93 6.73
Bellnot Square 94 10.17 96 10.55 96 10.70 98 11.71 98 11.53
Corporate Park
Northwest 97 7.23 93 7.38 92 7.38 91 8.28 90 8.74
Westgate 85 4.69 59 4.14 83 4.26 96 5.54 96 6.78
Garden Oaks 78 8.28 82 9.02 86 9.44 82 10.32 86 10.69
Westchase 62 6.76 57 8.68 50 2.51 75 7.16 66 8.15
Sunridge 96 9.97 96 10.49 71 4.33 77 9.39 96 10.71
Holly Hall 67 0.67 91 4.09 91 4.56 100 5.12 100 4.63
Brookhill 53 0.33 100 1.98 52 1.59 75 3.43 89 3.45
Corporate Park West -- -- 31 0.41 71 3.88 92 8.47 95 9.79
MAJOR TENANTS
The next table sets forth certain information that relates to the major
tenants at each property. This information is as of December 31, 2002. The
information summarizes information relating to each anchor or largest tenant at
each property. No single lease accounted for more than 5% of our total revenues
during 2002.
TOTAL LEASED TOTAL EFFECTIVE LEASE
AREA (SQ. ANNUAL NET RENT PER EXPIRATION
PROPERTY NAME OF TENANT FT.) RENT ($) SQ. FT. ($) DATE
- ------------------------ -------------------------- ------------ -------- ------------ -----------
Bissonnet/Beltway Cash America International 5,300 80,068 15.11 4/30/05
Webster Point Houston Learning Academy 3,976 58,627 14.75 12/31/06
Centre South Carlos Alvarez 10,407 71,252 6.85 3/31/06
Torrey Square Fleming Foods 35,350 267,368 7.56 6/29/03
Providence Kroger 45,528 368,772 8.10 5/31/04
Holly Knight Qwick Wash Laundry 2,460 44,229 17.98 9/30/09
Plaza Park American Medical Response 14,765 122,452 8.29 5/31/06
Northwest Place II Terra Mar, Inc. 11,167 93,834 10.99 7/31/03
Lion Square Kroger 42,205 253,440 6.00 10/31/05
Zeta Building Astrium North America 3,690 63,099 17.10 6/30/04
Royal Crest Dringle, Jenkins & Associates, 2,450 36,362 14.84 11/30/06
PC
Featherwood Transwestern Publishing 9,543 159,270 16.69 11/30/07
-44-
TOTAL LEASED TOTAL EFFECTIVE LEASE
AREA (SQ. ANNUAL NET RENT PER EXPIRATION
PROPERTY NAME OF TENANT FT.) RENT ($) SQ. FT. ($) DATE
- ------------------------ -------------------------- ------------ -------- ------------ -----------
Interstate 10 River Oaks L-M Inc. 38,050 182,640 4.80 12/31/03
Westbelt Plaza National Oilwell 14,997 190,590 12.71 3/31/05
Greens Road Juan Gailegos 3,985 23,904 6.00 12/31/11
Town Park Omar's Meat Market 6,450 110,592 17.15 12/31/07
Northeast Square 99 Cent Store 4,573 40,968 8.96 11/30/05
Main Park Transport Sales 23,882 94,573 3.96 8/31/05
Dairy Ashford Praise Tabernacle Church 19,127 84,000 4.39 10/31/05
South Richey Kroger 42,130 265,416 6.30 2/28/06
Corporate Park Woodlands Interceramic 13,500 74,520 5.52 6/30/07
South Shaver EZ Pawn 4,547 50,525 11.11 11/30/07
Kempwood Plaza Brookshire Bros. 30,558 168,032 5.50 5/19/04
Bellnot Square Kroger 42,130 337,044 8.00 7/31/07
Corporate Park Northwest Region XIV Education 8,388 80,525 9.60 2/28/04
Westgate Polymeric Processes 11,878 59,355 5.00 10/31/06
Garden Oaks Bally Total Fitness 25,722 256,728 9.98 6/30/05
Westchase Jesus Corral 5,396 46,729 8.66 2/28/07
Sunridge Carlos Morales 9,416 84,744 9.00 1/31/05
Holly Hall Texas Medical Mgmt. 30,000 168,168 5.61 12/31/07
Brookhill T.S. Molly Lubricants 10,187 37,590 3.69 9/30/07
Corporate Park West Urethane Products
International 14,730 95,874 6.51 mo.-to-mo.
LEASE EXPIRATIONS
The following table lists, on an aggregate basis, all of our scheduled
lease expirations over the next 10 years.
GROSS LEASABLE AREA ANNUAL RENTAL INCOME
PERCENT OF OUR PERCENT OF OUR
APPROXIMATE TOTAL LEASABLE TOTAL RENTAL
YEAR NUMBER OF LEASES SQUARE FEET AREA AMOUNT ($) INCOME
----- ---------------- ----------- -------------- ---------- ---------------
2003 148 548,552 23.35% 4,827,049 23.57%
2004 142 430,716 18.34% 4,263,638 20.82%
2005 113 406,214 17.29% 3,669,678 17.92%
2006 82 310,881 13.24% 2,885,179 14.09%
2007 72 266,801 11.36% 2,425,141 11.84%
2008 30 66,114 2.81% 752,036 3.67%
2009 15 44,214 1.88% 447,960 2.19%
2010 12 19,427 0.83% 324,372 1.58%
2011 13 46,269 1.97% 590,087 2.88%
2012 5 17,312 0.74% 200,919 0.98%
Total 632 2,156,500 91.81% 20,386,059 99.53%
-45-
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following shows the number and percentage of our outstanding common
shares that were owned as of December 31, 2002 by:
. persons known to us to beneficially own more than 5% of our
common shares;
. each trust manager and executive officer; and
. all trust managers and executive officers as a group.
The table also shows this ownership information assuming all outstanding OP
Units are converted into common shares.
As of December 31, 2002, we had 4,907,107.16 common shares outstanding.
As of December 31, 2002, there were 8,719,905.55 OP Units outstanding (of which
4,654,066 were owned by HCP). Each OP Unit is convertible into common shares on
a one-for-one basis.
NUMBER OF SHARES OWNED OWNERSHIP PERCENTAGE
ASSUMING ASSUMING
CONVERSION CONVERSION
NAME OF OF OF
SHAREHOLDER/(1)/ ACTUAL ALL OP UNITS ACTUAL ALL OP UNITS
- -------------------------------- ------------ -------------- ---------- -------------
Allen R. Hartman 165,224.27/(2)/ 1,763,937.33/(3)/ 3.37% 19.66%
Robert W. Engel -- -- -- --
Samuel C. Hathorn 37,578.29 80,380.88 * *
Jack L. Mahaffey 47,949.70 70,309.60 * *
Chris A. Minton 28,949.75 50,111.32 * *
Chand Vyas 100,000.00 100,000.00 2.04% 1.11%
Allen Cecil -- -- -- --
All trust managers and executive 379,702.01 2,064,739.13 7.74% 15.15%
officers as a group
- ----------
* = less than 1%.
(1) Each person listed has an address in care of Hartman Commercial
Properties REIT, 1450 West Sam Houston Parkway North, Suite 100,
Houston, Texas 77043.
(2) Includes 118,855 shares owned by Hartman Partnership, Inc., a company
wholly-owned by Mr. Hartman.
(3) Includes 861,976.37 OP Units owned by Houston R.E. Income Properties
XIV, LP, 342,429.52 OP Units held by Hartman Partnership, Inc.,
49,418.39 OP Units held by Hartman Partnership XII, L.P. and 39 OP Units
held by Hartman Partnership XV, LLC. Mr. Hartman and his affiliates own
Hartman Partnership XII, L.P. and Hartman Partnership XV, LLC. Mr.
Hartman does not own any limited partner interests in Houston R.E.
Income Properties XIV, L.P. However, Mr. Hartman owns 100% of the equity
of the general partner of this partnership. As a result, Mr. Hartman may
be deemed to be the beneficial owner of the securities held by Houston
R.E. Income Properties XIV, L.P. Consequently, for purposes of this
table, Mr. Hartman is deemed to beneficially own the 861,976.37 common
shares into which these OP Units are convertible. Mr. Hartman disclaims
beneficial ownership of these OP Units and all common shares into which
such OP Units are convertible.
-46-
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS.
GENERAL
We operate under the direction of our board of trust managers. The board
is ultimately responsible for the management and control of our business and
operations. We have no employees. We have retained the Management Company to
manage our day-to-day operations. The Management Company also manages the
acquisition, development and operation of our properties, subject to the board's
supervision.
Our declaration of trust and bylaws provide that the number of trust
managers that serve on our board of trust managers may be established by a
majority of the entire board of trust managers. However, the board of trust
managers must always have at least three members and no more than ten members.
We currently have a total of seven members on our board. Of our current seven
board members, five members are independent trust managers. Our declaration of
trust requires that a majority of the members of our board of trust managers be
independent trust managers. An "independent trust manager" is a person who is
not an officer or employee of HCP or the Operating Partnership, is not an
officer, director or employee of the Management Company or its affiliates, has
not otherwise been affiliated with such entities for the previous two years and
does not have a material business or professional relationship with the
Management Company or its affiliates.
Each trust manager serves on the board until the next annual meeting of
shareholders or until his or her successor has been duly elected and qualified.
Although the number of trust managers may be increased or decreased, a decrease
may not have the effect of shortening the term of any incumbent trust managers.
Any trust manager may resign at any time and may be removed with or without
cause by the shareholders upon the affirmative vote of least two-thirds of all
votes entitled to be cast at a meeting called for the purpose of the proposed
removal. A vacancy created by either an increase in the number of trust managers
or the death, removal, resignation, incompetence or other incapacity of a trust
manager may be filled by a vote of the remaining trust managers, unless the
vacancy is filled by a vote of shareholders as permitted by the Texas Real
Estate Investment Trust Act.
Our trust managers are accountable to us and our shareholders as
fiduciaries. Generally speaking, this means that our trust managers must perform
their duties in good faith and in a manner each trust manager believes to be in
our best interest as well as the best interest of our shareholders. Further,
trust managers must act with such care as a prudent person in a similar position
would use under similar circumstances, including exercising reasonable inquiry,
when taking actions.
However, the trust managers are not required to devote all or any
specific amount of their time to our business. The trust managers are only
required to devote the time to our business as their duties require. We
anticipate that our trust managers will meet at least quarterly, or more
frequently if necessary. We do not expect that our trust managers will be
required to devote a substantial portion of their time to discharge their duties
as trust managers. In the exercise of their fiduciary responsibilities, the
trust managers will be relying heavily on the Management Company. Although we
currently do not have any employees and we do not pay our officers a salary, the
board is empowered to fix the compensation of all officers that it selects and
it may choose to compensate officers for their service.
Our general policies governing investments and acquisitions,
development, borrowing and transactions with affiliates are set forth in this
registration statement. The board may establish additional written policies or
amend our current policies at any time. The board will monitor our
administrative procedures, investment operations and performance to ensure that
our policies are being followed and continue to be in the best interest of our
shareholders. We will follow the policies outlined in this registration
statement unless and until such policies are modified by the board of trust
managers and, when required, our shareholders.
As described below, the conflicts committee of our board of trust
managers is also responsible for reviewing our fees and expenses with sufficient
frequency to determine that the expenses incurred are in the best interest of
our shareholders. Our management agreement with the Management Company was
signed when Mr. Hartman was our sole trust manager. However, all amendments to
the Management Agreement and all other agreements or transactions
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between the Management Company and the Company must be approved by the conflicts
committee, which is composed of independent trust managers. Additionally, the
conflicts committee must approve all transactions between the Company and any
entities affiliated with Mr. Hartman.
TRUST MANAGERS AND EXECUTIVE OFFICERS
Following is certain information about our trust managers and executive
officers. Our trust managers and officers are elected for one-year terms.
NAME AGE POSITION(s)
----------------- ------ -----------------------------------------
Allen R. Hartman 51 President, Secretary and Trust Manager
Robert W. Engel 48 Chief Financial Officer and Trust Manager
Samuel C. Hathorn 59 Trust Manager
Jack L. Mahaffey 71 Trust Manager
Chris A. Minton 66 Trust Manager
Chand Vyas 59 Trust Manager
Allen Cecil 59 Trust Manager
Allen R. Hartman is the President, Secretary and a trust manager of HCP.
He is also the President, Secretary, sole director and sole shareholder of the
general partner of the Management Company and the sole limited partner of the
Management Company. Since 1984 to the present, Mr. Hartman, as an individual
general partner, has been the sponsor of 15 private limited and general
partnerships that have invested in commercial real estate in Houston, Texas. Mr.
Hartman has over 30 years of experience in the commercial real estate industry.
From 1978 to 1983, Mr. Hartman owned and operated residential rental properties.
From 1972 to 1978, Mr. Hartman worked as an independent contractor in the real
estate construction industry. In 1978, Mr. Hartman formed Hartman Investment
Properties, a Texas sole proprietorship, to develop, acquire, manage, and lease
commercial real estate ventures.
In 1986, Mr. Hartman established Hartman Securities, Inc., a Texas
corporation, to underwrite private placements sponsored by Hartman. Mr. Hartman
was the sole shareholder, officer and director of Hartman Securities. On August
26, 1998, Mr. Hartman, Hartman Securities and the Texas State Securities Board
(the "TSSB") entered into a Disciplinary Order Reprimanding and Suspending a
Dealer and an Agent. The TSSB alleged that (1) Hartman Securities had offered
for sale and sold securities at a time when neither was properly registered with
the Texas Securities Commissioner as required by the Texas Securities Act and
(2) Hartman Securities had offered for sale and sold securities through agents
who were not properly registered with the Texas Securities Commission as
required by the Texas Securities Act. Without admitting or denying these
allegations, Hartman Securities and Mr. Hartman agreed to the disciplinary order
which contained a reprimand and provided for a $8,500 fine. Additionally,
pursuant to the order, Hartman Securities and Mr. Hartman temporarily engaged
third parties to perform certain monitoring and audit reviews of the operational
activities of Mr. Hartman and Hartman Securities. These third parties provided
the TSSB with certain reports and recommendations as a results of their
activities. Mr. Hartman believes that both he and Hartman Securities have fully
complied with the disciplinary order. Simultaneous with the reprimand and
suspension, the TSSB granted the dealer registration of Hartman Securities and
the registration of Mr. Hartman as an agent of Hartman Securities, provided that
both Hartman Securities and Mr. Hartman were suspended from soliciting new
clients for a period of 30 days from the date of the disciplinary order. Hartman
Securities is currently dormant.
On April 12, 1997, the NASD rendered a decision on an appeal made by Mr.
Hartman and Hartman Securities from a decision of the NASD dated June 6, 1996 in
which Mr. Hartman and Hartman Securities were found to have violated certain
rules of NASD in connection with the conduct of their business during the period
from June 1989 through July 1993. The decision resulted from a complaint filed
by NASD against Mr. Hartman and Hartman Securities in July 1995. The decision
found violations of certain rules relating to the creation and proper
maintenance of an escrow account created for an offering by Hartman Securities
in 1992 (thereby inadvertently triggering additional net capital requirements
for Hartman Securities) and that Hartman Securities had conducted securities
transactions while a member of the NASD at a time when the NASD believed that
the firm was inactive. Mr. Hartman and Hartman Securities appealed the decision
because they believed the sanctions were excessive under the
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circumstances and no harm had resulted to any customer of Hartman Securities as
a result of the violations. The NASD found in favor of Mr. Hartman and Hartman
Securities on two counts and against them on the remaining two counts. As a
result of the appeal, the NASD affirmed a two-week suspension of the memberships
of Mr. Hartman and Hartman Securities and reduced the fine to $20,000.
Robert W. Engel is the Chief Financial Officer and a trust manager of
HCP, and the Controller of the Management Company. Mr. Engel is a graduate from
the University of Texas with a BBA with highest honors with a major in
Accounting. Mr. Engel is a CPA and holds memberships in the American Institute
of Certified Public Accountants, and the Texas Society of Certified Public
Accountants. Mr. Engel is also a CPM, with membership in the Institute of Real
Estate Management, and a CCIM as a member of the CCIM Institute. He is a
licensed real estate broker in the State of Texas. From 1991 to 1999, Mr. Engel
served as Vice President and Controller for Reignquest/Fred Rizk Construction
Company.
Chand Vyas has been a trust manager since 2002. Mr. Vyas is the Chairman
and Chief Executive Officer of EPS Technology, a global information technology
and business process outsourcing company founded by Mr. Vyas in 2000. From 1982
to 1998, Mr. Vyas served as a senior executive including the Chief Executive
Officer of Ziegler Coal Holding Co. Prior to working for Ziegler, Mr. Vyas held
various management positions with Consolidated Coal and International Harvester.
Allen Cecil has been a trust manager since 2002. Mr. Cecil was employed
by Exxon Mobil for 31 years. Prior to his retirement in 1999, he held a number
of senior management positions in both operations and engineering in the United
States and overseas. Mr. Cecil attended the University of Houston and graduated
with honors. He holds a Bachelor of Science and a Masters Degree in Petroleum
Engineering.
Jack L. Mahaffey has been a trust manager since 2001. Mr. Mahaffey was
employed by Shell Oil Company for 32 years. Prior to his retirement in 1991, Mr.
Mahaffey was the President of Shell Mining Co. Mr. Mahaffey graduated from Ohio
State University with a B.S. and M.S. in Petroleum Engineering and served in the
U.S. Air Force. He is a former board member of the National Coal Association and
the National Coal Council.
Samuel C. Hathorn has been a trust manager since 2001. Mr. Hathorn has
been in the home building and land development business for over thirty years.
He has held both divisional and senior management positions with three different
large publicly-held home builders/developers during his real estate career. For
the last 21 years, Mr. Hathorn has been a senior executive with Weyerhaeuser
Real Estate Company, a wholly owner subsidiary of Weyerhaeuser Company (NYSE).
Since 1984, Mr. Hathorn has been President and Chief Executive Officer of
Trendmaker Homes, the Houston, Texas based home building and land development
subsidiary of Weyerhaeuser Real Estate Company. Mr. Hathorn is a licensed CPA in
the State of California and holds a Bachelor of Science degree in accounting. He
currently serves as a director of National Beverage Corp. (AMEX).
Chris A. Minton has been a trust manager since 2001. Mr. Minton was
employed by Lockheed Martin for 35 years and was a Vice-President for Business
Operations of Lockheed's Technology Services Group. Mr. Minton retired from
Lockheed in 1995. Mr. Minton graduated from Villanova University with a
Bachelors Degree, and he is a licensed CPA (retired status) in the State of
Texas. He has been awarded the Gold Knight of Management for achievements as a
professional manager by the National Management Association.
COMMITTEES OF THE BOARD OF TRUST MANAGERS
Our entire board of trust managers considers all major decisions
concerning our business. However, the board has established an audit committee
and a conflicts committee so that these important areas can be addressed in more
depth than may be possible at a full board meeting, and to also ensure that that
these areas are addressed by non-interested members of the board.
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AUDIT COMMITTEE
The audit committee will meet on a regular basis at least once a year.
The current audit committee members are Messrs. Minton, Cecil and Hathorn. The
audit committee's primary function is to assist the board of trust managers in
fulfilling its oversight responsibilities by reviewing the financial information
to be provided to the shareholders and others, the system of internal controls
which management has established, and the audit and financial reporting process.
CONFLICTS COMMITTEE
At least three trust managers will serve on a conflicts committee to
review specific matters that the board believes may involve conflicts of
interest. The conflicts committee will determine if the resolution of the
conflict of interest is fair and reasonable to us. The members of the conflicts
committee may not be officers or employees of the Company, officers, or
employees of its affiliates (including the Management Company) and must
otherwise be independent trust managers. Any matters approved by the conflicts
committee will be conclusively deemed to be fair and reasonable to us. The
current members of our conflicts committee are Messrs. Cecil, Vyas and Mahaffey.
COMPENSATION OF TRUST MANAGERS
We pay our independent trust managers an annual fee of $5,000, $1,000
for each board meeting attended and $1,000 per quarter for attendance at board
committee meetings, payable in either cash or by issuing such trust managers
common shares. Although we have not granted any awards under our Incentive Share
Plan to any of our trust managers, we may also grant stock options or other
incentive awards to members of the board. All trust managers are reimbursed for
reasonable out-of-pocket expenses incurred in connection with attendance at
meetings of the board of trust managers. If a trust manager is also an officer
of the Management Company, we do not pay separate compensation for services
rendered as a trust manager.
LIMITED LIABILITY AND INDEMNIFICATION OF TRUST MANAGERS, OFFICERS, EMPLOYEES AND
OTHER AGENTS
Our declaration of trust provides that none of our trust managers or
officers will be liable to us for any act, omission, loss, damage or expense
arising from the performance of his or her duties as a trust manager and/or
officer, except for his or her own willful misfeasance, willful malfeasance or
gross negligence. We also maintain a directors and officers liability insurance
policy.
Subject to limited exceptions, our declaration of trust and bylaws
provide that we will indemnify each of our trust managers, officers, employees
and agents to the fullest extent allowed by the Texas Real Estate Investment
Trust Act. The Texas Real Estate Investment Trust Act generally allows trust
managers and officers to be indemnified against all judgments, penalties
(including taxes), fines, amounts paid in settlement and reasonable expenses
incurred in connection with any proceeding unless:
. the trust manager or officer is found liable to us on the basis
that such trust manager or officer improperly received a
personal benefit; or
. the trust manager or officer is found liable for willful or
intentional misconduct in the performance of his or her duty to
us.
In spite of the above provisions of Texas law, our declaration of trust provides
that our trust managers and officers will be indemnified by us for losses
arising from our operation only if all of the following conditions are met:
. the indemnified person determined, in good faith, that the
course of conduct which caused the loss or liability was in our
best interests;
. the indemnified person was acting on our behalf or performing
services for us;
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. in the case of affiliated trust managers and officers, the
liability or loss was not the result of negligence or misconduct
by the party seeking indemnification; and
. in the case of independent trust managers, the liability or loss
was not the result of gross negligence or willful misconduct by
the party seeking indemnification.
Any indemnification is recoverable only out of our assets and not from
our shareholders. Indemnification could reduce the legal remedies available to
us and our shareholders against the indemnified individuals. These rights do not
limit a shareholder's ability to obtain injunctive relief or other equitable
remedies for a violation of a trust manager's or an officer's duties to us,
although the equitable remedies may not be an effective remedy in some
circumstances. The general effect to investors of any arrangement under which
any of our trust managers, officers, employees or agents are indemnified against
liability is a potential reduction in distributions resulting from such
obligations or from our payment of premiums associated with any insurance we may
obtain in relation to these obligations.
The Securities and Exchange Commission takes the position that
indemnification against liabilities arising under the Securities Act of 1933 is
against public policy and unenforceable. Indemnification of trust managers or
officers will not be allowed for liabilities arising from or out of a violation
of state or federal securities laws, unless one or more of the following
conditions are met:
. there has been a successful adjudication on the merits of each
count involving alleged securities law violations;
. such claims have been dismissed with prejudice on the merits by
a court of competent jurisdiction; or
. a court of competent jurisdiction approves a settlement of the
claims against the indemnitee and finds that indemnification of
the settlement and the related costs should be made, and the
court considering the request for indemnification has been
advised of the position of the Securities and Exchange
Commission and of the published position of any state securities
regulatory authority in which the securities were offered as to
indemnification for violations of securities laws.
Indemnification will be allowed for settlements and related expenses of lawsuits
alleging securities laws violations and for expenses incurred in successfully
defending any lawsuits, provided that a court either:
. approves the settlement and finds that indemnification of the
settlement and related costs should be made; or
. dismisses with prejudice or there is a successful adjudication
on the merits of each count involving alleged securities law
violations as to the particular indemnitee and a court approves
the indemnification.
THE MANAGEMENT COMPANY
All of our day-to-day operations are managed and performed by the
Management Company. Some of our trust managers and officers are also directors
and officers of the Management Company. The directors and executive officers of
the Management Company are as follows:
NAME AGE POSITION
------------------ ------ ------------------------------------
Allen R. Hartman 51 President, Secretary and Director
Terry L. Henderson 51 Chief Financial Officer
Robert W. Engel 48 Controller
John Crossin 63 Director of Leasing and Acquisitions
Valarie L. King 42 Director of Property Management
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The backgrounds of Messrs. Hartman and Engel are described above. Below
is a brief description of the other executive officers of the Management
Company:
Terry L. Henderson is the Chief Financial Officer of the Management
Company. Mr. Henderson joined the Management Company in 2002. His
responsibilities include the various financial and administrative functions, as
well as the construction and renovations activities, of the Management Company.
Mr. Henderson is a Certified Public Accountant and a member of various
professional CPA organizations. He holds a Bachelor of Business Administration
in Accounting from Texas Tech University. Prior to joining the Management
Company, Mr. Henderson was the Chief Financial Officer for Senterra Real Estate
Group in Houston, Texas from 1990 to 2002.
John Crossin is the Director of Leasing for the Management Company. In
this capacity, he is responsible for leasing retail, office and warehouse space
through the prospecting and closing of individual tenants and by directing a
staff of agents and lead generators. Mr. Crossin has a degree in finance from
Scranton Jesuit University and did graduate work in business management at
Temple University in Philadelphia. Mr. Crossin joined the Management Company in
2001. Mr. Crossin has more than 25 years of experience in the leasing, sale and
marketing of commercial real estate including office, retail and industrial
properties with C.B. Richard Ellis, Grubb & Ellis and Crossin & Company.
Valarie L. King is the Senior Property Manager. In this capacity, she is
responsible for all property management activities. Mrs. King has 15 years of
property management experience in Houston, Texas. Prior to joining the
Management Company in 2000, she was Property Manager at Helmsley Spear National
Realty from 1986 to 1990, where she was responsible for running the Houston
office, including property management, leasing and construction.
THE MANAGEMENT AGREEMENT
We entered into a Property and Partnership Management Agreement with the
Management Company in January 1999. Pursuant to this agreement, we appointed the
Management Company to manage, operate, direct and supervise all of the
properties we own from time to time. We do not have any employees. Therefore,
the Management Company also agreed to perform various administrative services
for us.
The compensation we pay the Management Company under this agreement is
summarized in the "Item 7. Certain Relationships and Related
Transactions--Management of our Properties and the Operating Partnership"
section of this registration statement.
The agreement automatically renews for successive one-year terms, unless
it is terminated by either party in writing at least 30 days prior to the
expiration of a previous term. We can terminate the agreement if the Management
Company fails to perform its duties thereunder and such failure continues for 30
days after we provide the Management Company written notice of the failure. We
may also terminate the agreement upon 30 days advance notice in the event we
sell our properties to an unaffiliated third party in a bona fide transaction.
Finally, in accordance with our declaration of trust, a majority of our
independent trust managers may terminate the Management Agreement upon 60 days
written notice at any time.
The Management Company has agreed to deal at all times with third
parties, including affiliates of the Management Company, on an arms' length and
in our interest. The Management Company may not enter into any contract with any
party affiliated with the Management Company in relation to the services it
provides under the agreement without our consent, which we can withhold in our
sole discretion. The Management Company is responsible for the supervision,
employment and discharge of all employees managing, maintaining or otherwise
operating our properties. We have the right to reasonably request that a
Management Company employee be removed from the management of any of our
properties if we reasonably deem such employee to be incompetent, careless,
subordinate or otherwise objectionable.
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Each year we will agree on an operating budget with the Management
Company for the operation of our properties. The Management Company must use
diligence and employ all reasonable efforts to ensure that actual costs do not
exceed the applicable approved budget items. Otherwise, we will reimburse the
Management Company for all costs, expenses and disbursements reasonably and
properly incurred by the Management Company in accordance with the agreement,
including the employment costs, or a pro rata portion thereof, of all personnel
managing our properties.
Each year, we will also agree on leasing and marketing guidelines with
the Management Company. Although the Management Company must use diligent
efforts to collect rents, the Management Company is not authorized to terminate
any lease, lock out a tenant or institute any proceedings in relation to a lease
without our prior written approval. Additionally, the Management Company does
not have signatory authority to execute any lease or related document and we
must approve all significant capital improvements.
The Management Company is not liable to us for any act or omission of
any agent or employee of the Management Company except for liabilities resulting
from:
. the gross negligence or willful misconduct of the Management
Company, or any of its officers, agents or employees; or
. any breach of the agreement.
The Management Company must indemnify us from and against any and all causes of
action, claims, losses, costs, expenses, liabilities, damages or injuries that
result from:
. the gross negligence or willful misconduct of the Management
Company and/or its officers, agents or employees, acting within
the scope of their office, agency or employment; or
. any breach of the agreement by the Management Company.
All amendments to the agreement must be approved by us and the
Management Company. However, the agreement will not be amended without the
approval of the conflicts committee of our board of trust managers.
The Management Company must reimburse us at least annually for amounts
paid to the Management Company in any year to the extent that such payments
cause our operating expenses to exceed the greater of (1) 2% of our average
invested assets, which consists of the average book value of our real estate
properties, both equity interests in and loans secured by real estate, before
reserves for depreciation or bad debts or other similar non-cash reserves, or
(2) 25% of our net income, which is defined as our total revenues less total
operating expenses for any given period. Operating expenses includes all
expenses paid or incurred by us as determined by generally accepted accounting
principles, such as:
. real estate operating costs, net of reimbursements,
. management and leasing fees,
. general and administrative expenses, including legal and
accounting expenses,
but excluding
. expenses of raising capital such as organizational and offering
expenses,
. interest payments, taxes, and non-cash expenditures such as
depreciation, amortization and bad debt reserves, and
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. amounts payable out of capital contributions which are not
treated as operating expenses under generally accepted
accounting principles such as the acquisition and advisory fees
payable to the Management Company.
To the extent that operating expenses payable or reimbursable by us exceed this
limit and the independent trust managers determine that the excess expenses were
justified based on unusual and nonrecurring factors which they deem sufficient,
the Management Company may be reimbursed in future years for the full amount of
the excess expenses, or any portion thereof, but only to the extent the
reimbursement would not cause our operating expenses to exceed the limitation in
any year. Within 60 days after the end of any of our fiscal quarters for which
total operating expenses for the 12 months then ended exceed the limitation, we
will send to our shareholders a written disclosure, together with an explanation
of the factors the independent trust managers considered in arriving at the
conclusion that the excess expenses were justified.
CERTAIN CONFLICT RESOLUTION PROCEDURES
In order to reduce or eliminate certain potential conflicts of interest,
our declaration of trust contains a number of restrictions relating to (1)
transactions we enter into with Mr. Hartman and his affiliates, (2) certain
future offerings, and (3) allocation of properties among affiliated entities.
These restrictions include, among others, the following:
. Except as otherwise described in this registration statement, we
will not accept goods or services from Mr. Hartman or his
affiliates unless a majority of our trust managers, including a
majority of the independent trust managers, not otherwise
interested in the transactions, approve such transactions as
fair and reasonable to us and on terms and conditions not less
favorable to us than those available from unaffiliated third
parties.
. We will not purchase or lease properties in which Mr. Hartman or
his affiliates has an interest without a determination by a
majority of our trust managers, including a majority of the
independent trust managers, not otherwise interested in such
transaction, that such transaction is competitive and
commercially reasonable to us and at a price no greater than the
cost of the property to Mr. Hartman or his affiliates, unless
there is substantial justification for any amount that exceeds
such cost and such excess amount is determined to be reasonable.
In no event will we acquire any such property at an amount in
excess of its appraised value. We will not sell or lease
properties to Mr. Hartman or his affiliates or to our trust
managers unless a majority of our trust managers, including a
majority of the independent trust managers, not otherwise
interested in the transaction, determine the transaction is fair
and reasonable to us.
. Except as disclosed in this registration statement, we will not
make any loans to Mr. Hartman or his affiliates or to our trust
managers. In addition, Mr. Hartman and his affiliates will not
make loans to us or to joint ventures in which we are a joint
venture partner for the purpose of acquiring properties. Any
loans made to us by Mr. Hartman or his affiliates or our trust
managers for other purposes must be approved by a majority of
our trust managers, including a majority of the independent
trust managers, not otherwise interested in the transaction, as
fair, competitive and commercially reasonable, and no less
favorable to us than comparable loans between unaffiliated
parties. Mr. Hartman and his affiliates shall be entitled to
reimbursement, at cost, for actual expenses incurred by them on
our behalf or joint ventures in which we are a joint venture
partner, subject to the limitation on reimbursement of operating
expenses to the extent that they exceed the greater of 2% of our
average invested assets or 25% of our net income, as described
in the "--The Management Agreement" above.
. In the event that an investment opportunity becomes available
which is suitable for us and one or more entities affiliated
with Mr. Hartman and his affiliates, then the entity which has
had the longest period of time elapse since it was offered an
investment opportunity will first be offered such investment
opportunity. In determining whether or not an investment
opportunity is suitable for more than one
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program, the Management Company, subject to approval by our
board of trust managers, shall examine, among others, the
following factors:
. the cash requirements of each program;
. the effect of the acquisition both on
diversification of each program's investments by
type of commercial property and geographic area,
and on diversification of the tenants of its
properties;
. the policy of each program relating to leverage
of properties;
. the anticipated cash flow of each program;
. the income tax effects of the purchase of each
program;
. the size of the investment; and
. the amount of funds available to each program
and the length of time such funds have been
available for investment.
If a subsequent event or development, such as a delay in the closing of a
property or a delay in the construction of a property, that the Management
Company determines causes any such investment to be more appropriate for a
program other than the program that committed to make the investment, the
Management Company may determine that another program affiliated with Mr.
Hartman or his affiliates will make the investment. Our board of trust managers
has a duty to ensure that the method used by the Management Company for the
allocation of the acquisition of properties by two or more affiliated programs
seeking to acquire similar types of properties shall be reasonable.
ITEM 6. EXECUTIVE COMPENSATION.
We have no employees. Our operations are conducted by the Management
Company pursuant to the Management Agreement which is described above. The
compensation we pay the Management Company under this agreement is summarized in
"Item 7. Certain Relationships and Related Transactions--Management of our
Properties and the Operating Partnership" section of this registration
statement.
We adopted an Incentive Share Plan to:
. furnish incentives to individuals chosen to receive share-based
awards because they are considered capable of improving
operations and increasing profits;
. encourage selected persons to accept or continue employment with
the Management Company; and
. increase the interest of our trust managers in our welfare
through their participation in the growth in the value of our
common shares.
The total number of common shares that may be issued under the Incentive
Share Plan is currently 5,000,000 common shares. As of the date hereof, no
options or awards to purchase common shares have been granted under the
Incentive Share Plan.
The Incentive Share Plan provides for the award to our full-time
employees and trust managers, and certain of our consultants, of a broad variety
of equity-based compensation alternatives such as nonqualified share options,
incentive share options, restricted shares appreciation rights, and dividend
equivalent rights. All awards under the Incentive Share Plan are subject to the
ownership limits contained in our declaration of trust.
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Options entitle the holder to purchase common shares for a specified
exercise price during a specified period. Under the Incentive Share Plan, we may
grant options that are intended to be incentive stock options within the meaning
of Section 422 of the Internal Revenue Code ("incentive stock options") or
options that are not incentive stock options ("nonqualified stock options").
Incentive stock options and nonqualified stock options generally may not have an
exercise price less than 100% of the fair market value of the common shares on
the date of grant and will expire, with certain exceptions, 10 years after such
date. Under the Incentive Share Plan, any option or portion thereof that has not
vested on or before the termination of employment of an optionee expires on the
date of such termination.
Restricted share awards entitle the recipient to purchase common shares
from us in consideration of a specified exercise price under terms that provide
for vesting over a specified period of time. Such awards would typically be
forfeited with respect to the unvested shares upon the termination of the
recipient's employment or other relationship with us. Restricted shares may not
be issued to non-employee trust managers. Restricted shares may not, in general,
be sold or otherwise transferred until restrictions are removed and the shares
have vested. Holders of restricted shares may receive distributions prior to the
time when the restrictions lapse.
Share appreciation rights entitle the recipient to receive from us (at
the time of exercise) a per share amount equal to the excess of the fair market
value at the date of exercise of a common share over a price specified at the
time of grant, which cannot be less than the fair market value of the common
shares on the grant date. Share appreciation rights may not be issued to
non-employee trust managers.
Dividend equivalent rights entitle the recipient to receive, for a
specified period, a payment equal to the quarterly dividend declared and paid by
us on one common share. Dividend equivalent rights may not be granted to
non-employee trust managers and are forfeited to us upon the termination of the
recipient's employment or other relationship with us.
The Incentive Share Plan will be administered by the board of trust
managers. This board will determine:
. the eligible persons to whom awards will be granted;
. the time or times at which awards will be granted;
. the number of shares to be subject to such awards and the terms
and conditions thereof; and
. administrative and interpretive rules and regulations relating
to the plan and any modifications and revisions of such rules
and regulations.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
GENERAL
Mr. Hartman and entities controlled by Mr. Hartman owned, as of December
31, 2002, approximately 3.4% of our issued and outstanding common shares, and
approximately 19.7% of our issued and outstanding common shares assuming all
outstanding OP Units are converted in common shares on a one-for-one basis. Mr.
Hartman is also on our board of trust managers and is our chief executive
officer. Mr. Hartman owns 100% of the Management Company.
Potential conflicts of interest may exist among us, Mr. Hartman, the
Management Company and other affiliates of Mr. Hartman, in relation to how we
have operated and will operate. Currently, five of our seven trust managers are
independent trust managers. The trust managers have an obligation to function on
our behalf in all situations in which a conflict of interest may arise and have
a statutory obligation to act in the best interests of the shareholders. All
conflict of interest transactions must be approved by a majority of our
independent trust managers in the manner set forth in our declaration of trust
and bylaws.
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PAYMENTS TO AFFILIATES OF MR. HARTMAN
The following table summarizes the compensation we will pay the
Management Company and other fees or compensation we have paid to Mr. Hartman or
his affiliates in the past. Other than the fees described below, we currently
pay no salary or other fees to Mr. Hartman, the Management Company or any of
their affiliates. Such fees were not determined on an arm's-length basis:
FORMATION STAGE
Initial Investment...................... At our formation, Mr. Hartman
received 126,000 common shares for
services he provided in connection
with our formation and initial
capitalization.
Property Acquisitions................... We have acquired 28 of our 32
properties to date by consolidating
entities controlled by Mr. Hartman.
These acquisitions are described
below in the section entitled
"--Property Acquisitions from
Entities Controlled by Mr. Hartman."
SECURITIES OFFERINGS
Private Placement....................... In connection with our $25,000,000
private placement of common shares
we closed in December 2000, we paid
the Management Company $438,027 for
advisory and management services
provided, and for the reimbursement
of expenses incurred, in connection
with the private placement.
OPERATIONAL STAGE
Acquisition Advisory Fees............... We paid the Management Company 4% of
the gross proceeds we received from
the private placement we closed in
December 2000 for acquisition
advisory fees, resulting in
aggregate payments of $992,698.
Property Management and Leasing Fees.... We pay the Management Company 5% of
our effective gross revenues for the
management of our properties. We
will also pay the Management Company
6% of the effective gross revenues
of leases originated by the
Management Company and 4% of
effective gross revenues from
expansions and renewals of current
or existing leases by the Management
Company. Because the amount we pay
the Management Company for these
services is dependent on future
revenues, we are unable to determine
the amount we may pay the Management
Company in the future for these
services.
Partnership Management.................. We pay the Management Company 1% of
our effective gross revenues for the
day-to-day operations of the
Operating Partnership and for
providing general administrative
services for us. Because the amount
we pay the Management Company for
these services is dependent on
future revenues, we are unable to
determine the amount we may pay the
Management Company in the future for
these services.
Reimbursement of Expenses............... We reimburse the Management Company
for all reasonable and necessary
expenses incurred or funds advanced
in connection with the management
and operation of our properties. We
will not reimburse the Management
Company for its overhead expenses,
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including salaries and expenses of
centralized employees other than
salaries of certain maintenance and
construction employees.
Distributions........................... We will pay distributions on common
shares owned by Mr. Hartman and his
affiliates on the same basis as the
distributions paid to other
shareholders.
These fees are described more fully, and amounts actually paid to the Management
Company are set forth, below in the section entitled "--Management of Our
Properties and the Operating Partnership."
PROPERTY ACQUISITIONS FROM ENTITIES CONTROLLED BY MR. HARTMAN
The following table compares the price we paid for all properties we
acquired from affiliates of Mr. Hartman and the original purchase price paid by
the applicable seller.
YEAR PRIOR
OWNER YEAR WE PURCHASE PRICE PURCHASE
ACQUIRED ACQUIRED PAID BY THE PRICE PAID BY
PROPERTY NAME OF PRIOR OWNER PROPERTY PROPERTY COMPANY(1) PRIOR OWNER
- ------------------ ------------------------------------ ---------- --------- -------------- --------------
Holly Knight Holly Knight Plaza, Ltd. 1984 2000 $ 1,603,138/(2)/ $ 1,399,141
Bissonnet/Beltway Bissonnet/Beltway Plaza, Ltd. 1987 1999 $ 2,339,771 $ 1,694,502
Interstate 10 Interstate 10 Office/Warehouse, Ltd. 1986 1999 $ 3,740,000 $ 2,315,000
Kempwood Plaza Kempwood Plaza, Ltd. 1986 1999 $ 2,948,952 $ 2,900,000
Westbelt Plaza Westbelt Plaza, Ltd. 1988 1999 $ 2,620,000 $ 1,025,000
Greens Road Houston R.E. Income Properties, Ltd. 1990 1999 $ 1,593,058 $ 703,950
Town Park Houston R.E. Income Properties, Ltd. 1990 1999 $ 3,585,000 $ 905,100
Bellnot Square Houston R.E. Income Properties VIII,
Ltd. 1990 2002 $ 5,789,879 $ 4,100,000
Corporate Park
Northwest Houston R.E. Income Property IX, Ltd. 1992 2002 $ 7,694,654 $ 4,100,000
Webster Point Houston R.E. Income Properties X, Ltd. 1992 2000 $ 1,700,000 $ 800,000
Centre South Houston R.E. Income Properties X, Ltd. 1993 2000 $ 1,900,000 $ 600,000
Torrey Square Houston R.E. Income Properties X, Ltd. 1994 2000 $ 4,500,000 $ 3,000,000
Main Park Houston R.E. Income Properties XI, Ltd. 1994 1999 $ 3,780,000 $ 1,950,000
Dairy Ashford Houston R.E. Income Properties XI, Ltd. 1994 1999 $ 1,428,492 $ 700,000
Westgate Houston R.E. Income Properties XI, Ltd. 1994 2002 $ 3,372,360 $ 1,450,000
Northeast Square Houston R.E. Income Properties XI, Ltd. 1995 1999 $ 2,595,751 $ 1,450,000
Plaza Park Houston R.E. Income Properties XII, L.P. 1995 2000 $ 4,250,000 $ 1,550,000
Northwest Place II Houston R.E. Income Properties XII, L.P. 1996 2000 $ 1,100,000 $ 850,000
Lion Square Houston R.E. Income Properties XII, L.P. 1997 2000 $ 5,900,000 $ 4,250,000
Zeta Building Houston R.E. Income Properties XII, L.P. 1997 2000 $ 2,500,000 /(3)/
Royal Crest Houston R.E. Income Properties XII, L.P. 1997 2000 $ 1,900,000 /(3)/
Featherwood Houston R.E. Income Properties XII, L.P. 1997 2000 $ 3,000,000 /(3)/
Garden Oaks Houston R.E. Income Properties XIV, L.P. 1997 2002 $ 6,446,067 $ 4,150,000
Westchase Houston R.E. Income Properties XIV, L.P. 1998 2002 $ 2,120,777 $ 1,400,000
Sunridge Houston R.E. Income Properties XIV, L.P. 1998 2002 $ 1,382,145 $ 2,228,750
Holly Hall Houston R.E. Income Properties XIV, L.P. 1998 2002 $ 2,828,747 $ 1,590,000
Brookhill Houston R.E. Income Properties XIV, L.P. 1998 2002 $ 931,706 $ 970,000
Corporate Park West Houston R.E. Income Properties XV, L.P. 1998 2002 $ 12,817,830 $ 10,858,517/(4)/
- ----------
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(1) We paid for these properties using common shares or OP Units unless
otherwise noted, valued at $10 per share or unit as applicable.
(2) Purchased with cash.
(3) Houston R.E. Income Properties XII, L.P. purchased the Featherwood, Zeta
and Royal Crest office buildings from a single seller for an aggregate
purchase price of $6,950,000.
(4) This property was developed by Houston R.E. Income Properties XV, Inc.
Total construction costs were $8,889,544, plus $1,966,973 in
organizational and offering costs.
We use several steps when valuing properties acquired from affiliated
entities. Projections of future income and capital requirements are made for the
properties. Then a market capitalization rate is selected based on various risk
factors of the properties, including age, location, quality of construction and
the quality of tenants. The projected income is capitalized at this rate for a
preliminary value. Then the projected cost of capital improvements and leasing
commissions necessary to achieve the projected income are subtracted from the
preliminary value to arrive at the final value. The assumptions used in the
income projections, selection of capitalization rate, and projections of capital
costs developed by the Management Company are then reviewed by outside real
estate and accounting consultants, the board of trust managers and real estate
appraisers.
We acquired the properties listed above as the result of consolidating
several individual programs managed by the Management Company into us. Many of
these properties were acquired as the result of mergers or the contribution of
properties to us. Mr. Hartman received certain benefits from these transactions.
Mr. Hartman had interests that differed from, and may in certain cases have
conflicted with, the interests of persons acquiring partnership units or common
shares in the transactions. The benefits Mr. Hartman received might have been
different if he had not participated in structuring the transactions. These
benefits include the following:
. the receipt of 627,982.66 OP Units in consideration of Mr.
Hartman's general partner interest in the selling entities;
. the ability to limit his future exposure to general partner
liability as a result of Mr. Hartman no longer serving as the
general partner to certain of the entities; and
. the repayment of debt encumbering various of our properties
which was personally guaranteed by Mr. Hartman.
Further, Mr. Hartman (neither personally nor in his capacity as a general
partner when applicable) made no representations or warranties in regard to the
properties or the merged entities in the operative documents executed in order
to consummate the consolidations. Consequently, the Operating Partnership
essentially acquired the properties on an "as is" basis.
MANAGEMENT OF OUR PROPERTIES AND THE OPERATING PARTNERSHIP
In January 1999, we entered into a management agreement with the
Management Company. Pursuant to this management agreement, our properties are
under the supervision and control of the Management Company. In addition to
supervising and controlling our properties, the Management Company further
provides us with investment advisory services and day-to-day administrative
services. Subject to a budget approved by us on an annual basis, the Management
Company has discretion in all matters relating to the management and operation
of our properties and determines such operational policies as rent, supplies and
services, and the extent and expense of advertising, promotional activities and
publicity.
Moreover, the Management Company determines the assignments of key
personnel and the allocation of management and staff time to our properties and
other day-to-day operations. In the course of its management of our properties,
the Management Company manages the marketing of other properties for which they
have management responsibilities. In allocating employees and services among,
and in soliciting business for, such properties, the Management Company also may
be in a conflict of interest position upon a potential sale of our properties.
The
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Management Company may only be terminated by us as to a particular property upon
the sale of such property or upon the failure by the Management Company to
perform its duties under the management agreement.
We pay the Management Company a management fee for performing the duties
and obligations set forth in the management agreement. The management fee is 5%
of "Effective Gross Revenues" from our properties. The management agreement
defines "Effective Gross Revenues" as all payments actually collected from
tenants and occupants of our properties, exclusive of:
. security payments and deposits (unless and until such deposits
have been applied to the payment of current or past due rent);
and
. payments received from tenants in reimbursement of expenses of
repairing damage caused by tenants.
Further, we pay the Management Company a leasing fee in the amount of:
. 6% of the Effective Gross Revenues from leases originated by the
Management Company; and
. 4% of the Effective Gross Revenues from expansions and renewals
of leases by the Management Company.
We must reimburse the Management Company for all reasonable and necessary
expenses incurred or funds advanced in connection with the management and
operation of our properties; provided, however, that we will not reimburse the
Management Company for its overhead, including salaries and expenses of
centralized employees other than salaries of certain maintenance and
construction personnel.
We also retained the Management Company to perform various general
supervisory and administrative services on our behalf in our capacity as general
partner of the Operating Partnership. We pay the Management Company a
partnership management fee of 1% of the Effective Gross Revenues from our
properties for managing the day-to-day affairs of the Operating Partnership and
for providing other general administrative services described in the Management
Agreement.
In connection with our $25,000,000 private placement we completed in
December 2000, we also paid the Management Company:
. approximately 1.8% of gross proceeds for advisory and management
services provided by the Management Company in connection with
the private placement, and the reimbursement of offering and
organizational fees and expenses paid by the Management Company
on our behalf; and
. 4% of the proceeds contributed to the Operating Partnership for
advisory services it provided in connection with locating and
acquiring properties and to reimburse the Management Company for
expenses incurred in connection with these services.
The following table summarizes all payments made to the Management
Company during 2000, 2001 and 2002:
TOTAL AMOUNT PAID IN
TOTAL AMOUNT PAID UNDER THE CONNECTION WITH OUR PRIVATE
YEAR MANAGEMENT AGREEMENT PLACEMENT TOTAL
------- --------------------------- --------------------------- --------------
2000 $ 1,123,454 $ 726,612 $ 1,850,066
2001 $ 1,399,640 $ 426,210 $ 1,825,850
2002 $ 2,122,065 $ 10,024 $ 2,132,089
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COMPETITIVE ACTIVITIES OF MR. HARTMAN AND HIS AFFILIATES
Mr. Hartman and his affiliates have engaged in and will continue to
engage in the operation, management and ownership of other properties in
Houston, Texas. The facilities and clientele of such properties will, in many
instances, be similar to those of our properties. Mr. Hartman has economic
interests in commercial properties that we do not own. Mr. Hartman has not
included these properties in our portfolio because the asset profile or
condition of such properties is inconsistent with our investment or operating
policies.
As of the date of this registration statement, Mr. Hartman controls
and/or has economic interests in three entities that own commercial properties
in the Houston, Texas metropolitan area. These entities own, in the aggregate,
eight commercial properties and have investment objectives similar to ours. The
Management Company manages and operates these entities and their properties. Mr.
Hartman is not prohibited from developing, acquiring or managing additional
properties that may compete directly with our properties. We expect that Mr.
Hartman will organize similar entities in the future. The Management Company is
also free to manage and otherwise operate additional properties that may
directly or indirectly compete with our properties.
Mr. Hartman is not employed by us. Mr. Hartman is required to devote
only such time to the operation of our properties as in his judgment is
reasonably required. The Management Company is required to devote only such time
as to the management or operation of our properties as is necessary to fulfill
its obligations under our management agreement.
COMPETITIVE ACTIVITIES OF THE MANAGEMENT COMPANY
The Management Company personnel will not devote their efforts full-time
to the property management of our properties, but will devote a material amount
of their time to the management of the business of other property-owning
entities controlled by Mr. Hartman, but otherwise unaffiliated with us. Often,
these properties directly compete with our properties. In allocating employees
and services among, and in soliciting business for, such properties, the
Management Company or its affiliates may face conflicts of interest. The
Management Company also may be in a conflict of interest position upon a
potential sale of our properties as well as locating new tenants for available
space and/or negotiating with current tenants to renew expiring leases.
FEES AND OTHER COMPENSATION PAYABLE TO MR. HARTMAN AND HIS AFFILIATES
Transactions involving the purchase, financing, leasing, and sale of our
properties may involve substantial commissions, fees, compensation, and other
income to Mr. Hartman, the Management Company or their affiliates. The
Management Company and Mr. Hartman have considerable discretion with respect to
these transactions, subject to the express provisions of our governance
documents, our policies governing related party transactions and the management
agreement.
We may purchase properties in which Mr. Hartman or his affiliates
directly or indirectly may have an interest. Any such acquisitions shall be
consummated in accordance with the conflict of interest policies set forth in
this registration statement and will be approved by the Conflicts Committee of
the board of trust managers. Please see "Item 1. Business--Investment Policies
and Policies with Respect to Certain Activities--Affiliate Transaction Policy."
LACK OF SEPARATE REPRESENTATION
The Operating Partnership, the Management Company, Mr. Hartman, HCP and
their affiliates may be represented by the same legal counsel and may retain the
same accountants and other experts. Should a dispute arise which involves
conflicts of interest between or among these parties, we anticipate that, as
appropriate, separate counsel will be retained for such matters.
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NO ARM'S-LENGTH AGREEMENTS
All agreements, contracts or arrangements between or among Mr. Hartman
and his affiliates, including the Management Company, and us were not be
negotiated at arm's-length. Such agreements include our management agreement,
our declaration of trust, the Operating Partnership's partnership agreement, and
various agreements involved in our acquisition of properties acquired from Mr.
Hartman or his affiliates. The policies with respect to conflicts of interest
described herein were designed to lessen the potential conflicts which arise
from such relationships. All conflict of interest transactions must also be
approved by the Conflicts Committee of our board of trust managers in the
future. Please see "Item 1. Business--Investment Policies and Policies with
Respect to Certain Activities--Affiliate Transaction Policy."
INDEBTEDNESS OF MANAGEMENT
The following is a list of the entities affiliated with the Company that
have been indebted to the Company in excess of $60,000 at any time since January
1, 2002, as well as a brief description of the loans made by the Company to each
person listed below.
PAYER DESCRIPTION
- --------------------------------------- ------------------------------------
Houston R.E. Income Properties XI, Ltd. Houston R.E. XI owed the Company
approximately $195,000 on December
31, 2001. This loan evidenced cash
advances made to the Company in 1999
in connection with the acquisition
by the Company of properties owned
by Houston R.E. XI. The loan was
repaid in connection with the merger
of Houston R.E. XI with and into the
Operating Partnership which was
effective as of January 1, 2002. An
affiliate of Mr. Hartman was the
general partner of Houston R.E. XI.
Houston R.E. Income Properties XVI, Ltd. In December 2001, the Company loaned
Houston R.E. XVI $780,000 to allow
Houston R.E. XVI to complete an
acquisition. The loan was made in
the form of a demand note and
accrued interest at a rate of 8%.
The note was repaid, together with
accrued interest, in January 2002.
An affiliate of Mr. Hartman is the
general partner of Houston R.E. XVI.
Houston R.E. Income Properties XIV, L.P. Effective January 2002, Houston R.E.
XIV contributed five properties to
the Operating Partnership in
exchange for OP Units. Houston R.E.
XIV continued to own two additional
properties, one of which was
contributed to the Operating
Partnership in October 2002 in
exchange for OP Units. All of these
properties secured a single loan,
which was repaid by the Company in
December 2002. Houston R.E. XIV
agreed to pay the Company the
portion of the loan repaid by the
Company that was attributable to the
last property held by Houston R.E.
XIV. As of December 31, 2002,
Houston R.E. XIV owed the Company
$2,626,269. The loan accrues
interest at a rate of 2.5% over
LIBOR and payable upon demand. An
affiliate of Mr. Hartman is the
general partner of Houston R.E. XIV.
ADDITIONAL CONFLICTS OF INTEREST
We have a loan with a an entity controlled by Mr. Hartman. See "Item 1.
Our Business - Financing -- Houston R.E. XVI Note" for a discussion of this
note. The Management Company leases office space from the Company on a
month-to-month basis. The Management Company pays us approximately $8,000 a
month for this
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space which is calculated based on previaling market rates. Either party can
terminate this lease at any time upon 30 days written notice.
Mr. Hartman, the Management Company and we will potentially be in
conflict of interest positions as to various other matters in our day-to-day
operations, including matters related to the:
. computation of fees and/or reimbursements under the Operating
Partnership's partnership agreement and the management
agreement;
. enforcement of the management agreement;
. termination of the management agreement;
. order and priority in which we pay the obligations of the
Operating Partnership, including amounts guaranteed by or due to
Mr. Hartman or his affiliates;
. order and priority in which we pay amounts owed to third parties
as opposed to amounts owed to the Management Company;
. timing, amount and manner in which we refinance any
indebtedness; and
. extent to which we repay or refinance the indebtedness which is
recourse to Mr. Hartman prior to non-recourse indebtedness and
the terms of any such refinancing.
ITEM 8. LEGAL PROCEEDINGS.
We are not presently involved in any litigation nor, to our knowledge,
is any litigation threatened against us or any of our properties, except for
routine litigation arising in the ordinary course of business which, in the
opinion of our executive officers, would not have a material adverse effect on
us.
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.
Our common shares are not currently traded on any exchange, and there is
no established public trading market for our stock. We currently have no
outstanding options or warrants to purchase common shares. OP Units are
convertible into common shares on a one-for-one basis. As of December 31, 2002,
there were 8,719,905.55 OP Units outstanding. We have not agreed to register any
common shares or OP Units under the Securities Act of 1933 for sale by security
holders and, currently, no common shares or OP Units could be sold pursuant to
Rule 144 under the Securities Act of 1933. As of March 31, 2003, we had 621
shareholders and the Operating Partnership had 417 partners.
We have paid and intend to continue to pay regular distributions to our
shareholders. Because all of our operations are performed through the Operating
Partnership, our ability to pay distributions depends on the Operating
Partnership's ability to make distributions to us and its other partners. Prior
to April 2003, we paid quarterly distributions in February, May, August and
September of each year. Beginning April 2003, we began paying distributions
monthly whereby the distribution attributable to a calendar quarter would be
paid in three equal monthly payments during the next quarter.
The following table shows the distributions we have paid (including the
total amount paid and the amount paid on a per share basis) since we commenced
operations:
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TOTAL AMOUNT OF DISTRIBUTION
MONTH PAID DISTRIBUTIONS PAID PER SHARE
------------------- ------------------ ------------
November 1999 $ 59,365 0.2300
February 2000 109,294 0.2325
May 2000 320,276 0.2350
August 2000 402,124 0.2375
November 2000 478,206 0.2400
February 2001 559,940 0.2425
May 2001 541,380 0.2000
August 2001 602,138 0.2000
November 2001 635,778 0.2000
February 2002 687,544 0.2125
May 2002 1,102,340 0.2250
August 2002 1,166,709 0.2375
November 2002 1,226,777 0.2500
February 2003 1,226,777 0.2500
===========
Average Per Quarter 0.2242
We expect to maintain the distribution rate paid in February 2003,
unless our results of operations, our general financial condition, general
economic conditions or other factors prohibit us from doing so. The funds we
receive from operations that are available for distribution may be affected by a
number of factors, including:
. our operating and interest expenses;
. the ability of tenants to meet their obligations under the
leases associated with our properties;
. our ability to keep our properties occupied;
. our ability to maintain or increase rental rates when renewing
or replacing current leases; and
. unanticipated capital expenditures.
We may not be able to maintain our historical or expected level of
distributions in the future. Our ability to pay dividends will be impacted by
our investing and financing strategies. In particular, we expect to continue to
finance certain acquisitions and redevelopments partially through borrowings. As
a result, our need to repay and/or refinance such indebtedness may adversely
affect our ability to make future distributions. We must distribute to our
shareholders at least 90% of our taxable income in order to meet the
requirements for being treated as a REIT under the Internal Revenue Code. This
requirement is described in greater detail in "Item 1. Business--Federal Income
Tax Consequences--Requirements For Qualification as a REIT" section of this
registration statement. Our trust managers may increase this percentage as they
deem appropriate. Since the Internal Revenue Code's distribution requirements
are calculated after inclusion of certain non-cash income items and deduction of
certain non-cash charges, we expect normal distributions of our funds from
operations will exceed any such distribution requirements. However, on occasion,
we may have to distribute more than our funds generated from operations in order
to maintain our qualification as a REIT. On such occasions, we may have to
borrow the excess funds required from third parties.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES.
HCP and the Operating Partnership issued securities in the following
transactions, each of which was exempt from the registration requirements of the
Securities Act of 1933, as amended, under Section 4(2) of the Securities Act as
transactions by an issuer not involving any public offering, or under Rule 506
of Regulation D promulgated under the Securities Act. All of the securities
referenced below are restricted securities for the purposes of the Securities
Act of 1933. With respect to the sale of these securities, we required each
purchaser to represent in writing that he or she was purchasing the securities
for long-term investment purposes, and to agree not to offer, sell or transfer
any of the common shares unless a registration statement with respect to such
securities had been declared effective, or an exemption from registration was
available. Further, each purchaser was required to represent to us that such
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purchaser was an "accredited investor" under the Securities Act of 1933. No
underwriters were involved in any of the issuances listed below.
Effective January 2000, we issued an aggregate of 648,482 common shares
to shareholders of Houston R.E. Income Properties X, Inc., the sole limited
partner of Houston R.E. Income Properties X, Ltd., in connection with the merger
of such corporation with and into HCP. Only shareholders we reasonably believed
were accredited investors received common shares. All non-accredited
shareholders received cash for their shares in the merged entity. Our shares
were issued based on a $10 per share value.
Effective January 2000, the Operating Partnership issued an aggregate of
1,115,987 OP Units to Houston R.E. Income Properties XII, L.P. in connection
with the contribution of properties owned by Houston R.E. Income Properties XII,
L.P. to the Operating Partnership. The OP Units were issued based on a $10 per
unit value.
Effective January 2000, the Operating Partnership issued 118,196 OP
Units to Mr. Hartman in exchange for the cancellation of amounts and other
certain rights owed to him by Houston R.E. Income Properties X, Ltd. and Houston
R.E. Income Properties XII, L.P. Our shares and OP Units were issued based on a
$10 per unit value.
We conducted a private placement of common shares from May 1999 until
December 2000. Shares were only sold to investors we reasonably believed were
accredited investors. We issued an aggregate of 2,481,745.10 common shares at a
purchase price of $10 per share (subject to certain volume discounts) in
connection with a private placement. We received $24,817,451 in gross proceeds
from this offering. We paid a total of $476,175 in commissions to broker dealers
in connection with this offering.
Effective January 2002, we issued an aggregate of 1,650,891 common
shares to shareholders in connection with the mergers of Houston R.E. Income
Properties XI REIT, Inc. and Houston R.E. Income Properties XV REIT, Inc. with
and into HCP. Only shareholders we reasonably believed were accredited investors
received common shares. All non-accredited shareholders received cash for their
shares in the merged entity. Our shares were issued based on a $10 per share
value.
Effective January 2002, the Operating Partnership issued an aggregate of
844,596 OP Units to limited partners in connection with the mergers of Houston
R.E. Income Properties VIII, Ltd. and Houston R.E. Income Properties IX, Ltd.
with and into the Operating Partnership. OP Units were issued to limited
partners we reasonably believed were accredited investors. All non-accredited
investors received cash for their interests. The Operating Partnership also
issued 826,925 OP Units to Houston R.E. Income Properties XIV, L.P. in
consideration of five properties contributed by Houston R.E. Income Properties
XIV, L.P. to the Operating Partnership. The OP Units were issued based on a $10
per unit value.
ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED.
Our declaration of trust authorizes us to issue up to 100,000,000 common
shares of beneficial interest at $0.001 par value per share and 10,000,000
preferred shares of beneficial interest at $0.001 par value per share. As of
December 31, 2002, we had 4,907,107.16 common shares and no preferred shares
issued and outstanding.
COMMON SHARES OF BENEFICIAL INTEREST
Each outstanding common share entitles the holder to one vote on all
matters submitted to a vote of shareholders, including the election of trust
managers. Our common shares have no cumulative voting in the election of trust
managers or for any other matter. Holders of common shares are entitled to such
distributions as may be declared from time to time by the trust managers out of
funds legally available.
Holders of common shares have no conversion, redemption or preemptive
rights to subscribe for any of our securities. All outstanding common shares are
fully paid and non-assessable.
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In the event of any liquidation, dissolution or winding-up of our
affairs, holders of common shares will be entitled to share ratably in our
assets remaining after provision for payment of liabilities to creditors and
payment of liquidation preferences to holders of outstanding preferred shares,
if any.
PREFERRED SHARES
Our declaration of trust authorizes our trust managers (without any
further action by the shareholders) to issue preferred shares in one or more
series, and to fix the voting rights, liquidation preferences, dividend rates,
conversion rights, redemption rights and terms, including sinking fund
provisions, and certain other rights and preferences with respect to such
preferred shares. If we ever created and issued preferred shares with a dividend
preference over common shares, payment of any dividend preferences of
outstanding preferred shares would reduce the amount of funds available for the
payment of dividends on the common shares. Further, holders of preferred shares
are normally entitled to receive a preference payment in the event we liquidate,
dissolve or wind up before any payment is made to the common shareholders,
likely reducing the amount common shareholders would otherwise receive upon such
an occurrence. In addition, under certain circumstances, the issuance of
preferred shares may render more difficult or tend to discourage:
. a merger, offer or proxy contest;
. the assumption of control by a holder of a large block of our
securities; or the removal of incumbent management.
Also, the trust managers, without shareholder approval, may issue preferred
shares with voting and conversion rights which could adversely affect the
holders of common shares.
We have no present intention to issue any preferred shares or any other
new class of securities.
RESTRICTIONS ON TRANSFER
To maintain our REIT qualification under the Internal Revenue Code:
. five or fewer individuals (as defined in the Internal Revenue
Code to include certain tax exempt organizations and trusts) may
not own, directly or indirectly, more than 50% in value of our
outstanding shares during the last half of a taxable year; and
. 100 or more persons must beneficially own our shares during at
least 335 days of a taxable year of 12 months or during a
proportionate part of a shorter taxable year.
Because we believe it is essential for us to continue to qualify as a REIT, our
declaration of trust provides (subject to certain exceptions) that no holder may
own, or be deemed to own by virtue of the attribution provisions of the Internal
Revenue Code, more than 9.8% of the number or value (in either case as
determined in good faith by the trust managers) of any class or series of our
outstanding shares. Our trust managers may waive this ownership limit if
evidence satisfactory to our trust managers and our tax counsel is presented
that such ownership will not then or in the future jeopardize our status as a
REIT. Also, these restrictions on transferability and ownership will not apply
if our trust managers determine that it is no longer in our best interests to
continue to qualify as a REIT.
Additionally, the transfer or issuance of our shares or any security
convertible into our shares will be null and void, and the intended transferee
will acquire no rights to our shares, if such transfer or issuance:
. creates a direct or indirect ownership of our shares in excess
of the 9.8% ownership limit described above;
. with respect to transfers only, results in the our shares being
owned by fewer than 100 persons;
-66-
. results in us being "closely held" within the meaning of Section
856(h) of the Internal Revenue Code;
. results in us owning, directly or indirectly, 10% or more of the
ownership interests in any tenant or subtenant; or
. results in our disqualification as a REIT.
Our declaration of trust provides that any shares proposed to be
transferred pursuant to a transfer which, if consummated, would violate these
restrictions on transfer, will be deemed to be transferred to a trust to be held
for the exclusive benefit of a charitable beneficiary. To avoid confusion, these
shares will be referred to in this registration statement as the "Excess
Securities." The trustee of the beneficial trust, as record holder of the Excess
Securities, will be entitled to receive all dividends and distributions declared
by the trust managers on such securities for the benefit of the charitable
beneficiary. Our declaration of trust further entitles the trustee of the
beneficial trust to vote all Excess Securities.
The trustee of the beneficial trust may select a transferee to whom the
securities may be sold as long as such sale does not violate the 9.8% ownership
limit or the other restrictions on transfer. The intended transferee (the
transferee of the Excess Securities whose ownership would violate the 9.8%
ownership limit or the other restrictions on transfer) will receive from the
trustee of the beneficial trust the lesser of such sale proceeds, or the price
per share the intended transferee paid for the Excess Securities (or, in the
case of a gift or devise to the intended transferee, the price per share equal
to the market value per share on the date of the transfer to the intended
transferee). The trustee of the beneficial trust will distribute to the
charitable beneficiary any amount the trustee receives in excess of the amount
to be paid to the intended transferee.
In addition, we have the right to purchase any Excess Securities for a
period of ninety days after the transfer that created such Excess Securities. We
will pay the trustee of the beneficial trust (for the benefit of the beneficial
trust) the amount of any dividend or distribution we pay to an intended
transferee on Excess Securities prior to our discovery that such Excess
Securities have been transferred in violation of the provisions of the
declaration of trust. If any legal decision, statute, rule or regulation deems
or declares the transfer restrictions described in this section of the
registration statement to be void or invalid, then we may, at our option, deem
the intended transferee of any Excess Securities to have acted as an agent on
our behalf in acquiring such Excess Securities and to hold such Excess
Securities on our behalf.
SHARE DISTRIBUTIONS
Our declaration of trust allows us to make common share distributions in
common shares, cash or property, affording us greater flexibility in the means
by which we pay distributions to our shareholders. When making a determination
of whether to declare a distribution, the trust managers will make the
determination consistent with their fiduciary duties as trust managers. Our
distribution policy is summarized in "Item 9. Market Price of and Dividends on
the Registrant's Common Equity and Related Stockholder Matters." We will not
make or pay a distribution, however, when we are unable to pay our debts as they
become due in the usual course of its business, or when the payment of such
distribution would result in us being unable to pay our debts as they become due
in the usual course of business.
REDEMPTION OF COMPANY SHARES
We may purchase or redeem our own shares, subject to the limitations of
the Texas Real Estate Investment Trust Act. The Texas Real Estate Investment
Trust Act allows real estate investment trusts to redeem or repurchase shares,
unless after giving effect to such a redemption or repurchase, we would be
insolvent or the amount paid for such shares would exceed the our surplus. This
provision allows us to distribute assets by acquiring shares and redeem shares
in transactions in which such a redemption may be beneficial to us and our
shareholders.
-67-
VOTING RIGHTS
Each shareholder is entitled at each meeting of shareholders to one vote
on all matters submitted to a vote of shareholders. When a quorum is present at
any meeting, the votes of a majority of the common shares entitled to vote,
present in person or by proxy, will decide any matter submitted to such meeting,
unless our declaration of trust, our bylaws or the law requires a greater
number, in which case the vote of such greater number will govern and control.
In determining the number of common shares entitled to vote, shares abstaining
from voting or not voted on a matter will not be treated as entitled to vote.
Shareholders are entitled to receive a copy of our shareholder list upon
request. This list will include each shareholder's name, address and telephone
number, if available, and the number of shares owned by such shareholder. The
requesting shareholder will need to represent to us that the list will not be
used for commercial interests. We will send this list within 10 days after we
receive the applicable request. A shareholder requesting a list will be required
to pay reasonable costs of postage and duplication.
In addition to the foregoing, shareholders have rights under Rule 14a-7
under the Securities Exchange Act which provides that, upon the request of
investors and the payment of expenses of distribution, we are required to
distribute specific materials to shareholders in the context of the solicitation
of proxies for voting on matters presented to shareholders or at our option,
provide requesting shareholders with a copy of the list of shareholders so that
the requesting shareholders may make the distribution of proxies themselves.
SHAREHOLDER LIABILITY
Both the Texas Real Estate Investment Trust Act, our declaration of
trust and our bylaws provide that our shareholders:
. are not liable personally or individually in any manner
whatsoever for any debt, act, omission or obligation incurred by
us or the trust managers; and
. are under no obligation to us or our creditors with respect to
their shares other than the obligation to pay to us the full
amount of the consideration for which their shares were issued.
TRUST MANAGER LIABILITY
In accordance with the Texas Real Estate Investment Trust Act, our
declaration of trust provides that we will indemnify each trust manager against
all judgments, penalties, fines, amounts paid in settlement and reasonable
expenses actually incurred by the trust manager in connection with any
threatened, pending or completed action, suit or proceeding, in which he or she
is involved by reason of his or her serving as a trust manager, to the fullest
extent Texas law permits indemnification. See "Item 12. Indemnification of
Directors and Officers." This indemnification will not preclude any other rights
to which those seeking indemnification may at any time be entitled under our
bylaws, any law, agreement or vote of shareholders or disinterested trust
managers, or otherwise.
Pursuant to our bylaws, no trust manager or officer will be liable to us
for any act, omission, loss, damage, or expense arising from the performance of
his or her duties, unless such trust manager is willful or grossly negligent. In
discharging their duties, our trust managers and officers will be entitled to
rely on expert and other matters as provided in the Texas Real Estate Investment
Trust Act and in our bylaws.
BOARD OF TRUST MANAGERS
Our declaration of trust and bylaws together provide that our board of
trust managers must consist of no fewer than three individuals nor more than 10
individuals. Our board of trust managers currently consists of seven persons.
The term of office for each board member is one year. Our bylaws also provide
that nominations of persons for election as trust managers may be made at any
annual meeting of shareholders:
. by or at the direction of the trust managers; or
-68-
. by any shareholder who is a shareholder of record on the date of
the giving of notice provided for in the bylaws and on the
record date for the determination of shareholders entitled to
vote at such annual meeting and who complies with the notice
procedures set forth in the bylaws.
RESTRICTIONS ON ROLL-UP TRANSACTIONS
In connection with any proposed transaction considered a "Roll-up
Transaction" involving us and the issuance of securities of an entity (a
"Roll-up Entity") that would be created or would survive after the successful
completion of the Roll-up Transaction, an appraisal of all properties shall be
obtained from a competent independent appraiser. The properties shall be
appraised on a consistent basis, and the appraisal shall be based on the
evaluation of all relevant information and shall indicate the value of the
properties as of a date immediately prior to the announcement of the proposed
Roll-up Transaction. The appraisal shall assume an orderly liquidation of
properties over a 12-month period. The terms of the engagement of the
independent appraiser shall clearly state that the engagement is for our benefit
and the shareholders. A summary of the appraisal, indicating all material
assumptions underlying the appraisal, shall be included in a report to
shareholders in connection with any proposed Roll-up Transaction.
A "Roll-up Transaction" is a transaction involving the acquisition,
merger, conversion or consolidation, directly or indirectly, of us and the
issuance of securities of a Roll-up Entity. This term does not include:
. a transaction involving our securities that have been for at
least 12 months listed on a national securities exchange or
included for quotation on NASDAQ; or
. a transaction involving our conversion to corporate, trust, or
association form if, as a consequence of the transaction, there
will be no significant adverse change in any of the following:
shareholder voting rights; the term of our existence;
compensation to the Management Company; or our investment
objectives.
In connection with a proposed Roll-up Transaction, the person sponsoring
the Roll-up Transaction must offer to shareholders who vote "no" on the proposal
the choice of:
. accepting the securities of a Roll-up Entity offered in the
proposed Roll-up Transaction; or
. one of the following:
. remaining as shareholders of HCP and preserving their
interests therein on the same terms and conditions as
existed previously, or
. receiving cash in an amount equal to the shareholder's
pro rata share of the appraised value of our net assets.
We are prohibited from participating in any proposed Roll-up
Transaction:
. that would result in the shareholders having democracy rights in
a Roll-up Entity that are less than those provided in our
declaration of trust and bylaws, including rights with respect
to the election and removal of trust managers, annual reports,
annual and special meetings, amendment of our declaration of
trust, and our dissolution;
. that includes provisions that would operate to materially impede
or frustrate the accumulation of shares by any purchaser of the
securities of the Roll-up Entity, except to the minimum extent
necessary to preserve the tax status of the Roll-up Entity, or
which would limit the ability of an investor to exercise the
voting rights of its securities of the Roll-up Entity on the
basis of the number of shares held by that investor;
-69-
. in which investor's rights to access of records of the Roll-up
Entity will be less than those provided in the our governance
documents; or
. in which any of the costs of the Roll-up Transaction would be
borne by us if the Roll-up Transaction is not approved by the
shareholders.
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Subsection (B) of Section 9.20 of the Texas Real Estate Investment Trust
Act authorizes a Texas real estate investment trust to indemnify any person who
was, is, or is threatened to be made a named defendant or respondent in any
threatened, pending, or completed action, suit or proceeding, whether civil,
criminal, administrative, arbitrative or investigative, any appeal in such an
action, suit or proceeding, or any inquiry or investigation that can lead to
such an action, suit or proceeding because the person is or was a trust manager,
officer, employee or agent of the trust or is or was serving at the request of
the trust as a trust manager, director, officer, partner, venturer, proprietor,
trustee, employee, agent, or similar functionary of another real estate
investment trust, corporation, partnership, joint venture, sole proprietorship,
trust, employee benefit plan or other enterprise against reasonable expenses
(including court costs and attorney's fees), judgments, penalties (including
excise and similar taxes), fines and settlements if he conducted himself in good
faith and reasonably believed his conduct was in or not opposed to the best
interests of the trust and, in the case of any criminal proceeding, had no
reasonable cause to believe that his conduct was unlawful.
The Texas Real Estate Investment Trust Act further provides that, except
to the extent otherwise permitted by the Texas Real Estate Investment Trust Act,
indemnification in respect of a proceeding in which the person is found liable
on the basis that personal benefit was improperly received by him or in which
the person is found liable to the trust is limited to reasonable expenses
actually incurred by such person. Indemnification pursuant to Subsection (B) of
Section 9.20 of the Texas Real Estate Investment Trust Act may not be made in
respect of any proceeding in which the person has been found liable for willful
or intentional misconduct in the performance of his duty to the trust.
Subsection (C) of Section 15.10 of the Texas Real Estate Investment
Trust Act provides that a trust manager shall not be liable for any claims or
damages that may result from his acts in the discharge of any duty imposed or
power conferred upon him by the trust if, in the exercise of ordinary care, he
acted in good faith and in reliance upon information, opinions, reports or
statements, including financial statements and other financial data, concerning
the trust or another person, that were prepared or presented by officers or
employees of the trust, legal counsel, public accountants, investment bankers or
certain other professionals or a committee of trust managers of which the trust
manager is not a member. In addition, no trust manager shall be liable to the
trust for any act, omission, loss, damage or expense arising from the
performance of his duty to the trust, save only for his own willful misfeasance,
willful malfeasance or gross negligence.
Our declaration of trust requires us to indemnify our trust managers and
officers to the fullest extent permitted by the Texas Real Estate Investment
Trust Act, subject to limited exceptions. See "Item 5. Directors and Executive
Officers -- Limited Liability and Indemnification of Trust Managers, Officers,
Employees and Other Agents."
We intend to maintain director and officer liability insurance.
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See the Financial Statements beginning on page F-1 of this registration
statement.
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The Company engaged Deloitte & Touche LLP to audit its 1999 and 2000
financial statements. Deloitte & Touche issued an Independent Auditors' Report
for such financial statements which did not contain an adverse opinion, or a
disclaimer of opinion, and which was not qualified or modified as to
uncertainty, audit scope or accounting principle. Deloitte & Touche was not
engaged to audit any of the Company's subsequent financial
-70-
statements. Deloitte & Touche terminated the client-auditor relationship between
it and the Company by a letter dated January 21, 2002.
The Company engaged Pannell Kerr Forster of Texas, P.C. on July 24, 2002
as the Company's independent auditors. Our board of trust managers approved this
appointment. Pannell Kerr Forster of Texas, P.C. audited the Company's 2000,
2001 and 2002 financial statements included with this registration statement.
There were no "reportable events" or disagreements between the Company
and Deloitte & Touche on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure during any period
preceding Deloitte & Touche's termination of its relationship with the Company.
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements
The following financial statements are included in this registration
statement.
PAGE
DESCRIPTION OF FINANCIAL STATEMENTS NUMBER
-------------------------------------------------------------------------- ------
HCP Consolidated Financial Statements
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-3
Consolidated Statements of Income for each of the years ended F-5
December 31, 2002, 2001 and 2000
Consolidated Statements of Changes in Shareholders' Equity for each of F-6
the years ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for each of the years ended F-7
December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements F-8
2002 Acquisition Properties
Independent Auditors' Report F-23
Statement of Revenue and Certain Expenses for each of the years ended F-24
December 31, 2001 and 2000
Notes to the Statement of Revenue and Certain Expenses for each of the F-25
years ended December 31, 2001 and 2000
(b) The following documents are filed as exhibits hereto:
EXHIBIT NO. DESCRIPTION
----------- -----------------------------------------------------------
3.1 Amended and Restated Declaration of Trust of Hartman
Commercial Properties REIT
3.2 Bylaws of Hartman Commercial Properties REIT
4.1 Specimen certificate for the common shares of beneficial
interest, par value $.001, of Hartman Commercial Properties
REIT
10.1 Agreement of Limited Partnership of Hartman REIT Operating
Partnership, L.P.
10.2 Property and Partnership Management Agreement, dated as of
January 28, 1999, by
-71-
EXHIBIT NO. DESCRIPTION
----------- -----------------------------------------------------------
and between Hartman REIT Operating Partnership, L.P. and
Hartman Management, L.P. (f/k/a Hartman Management, Inc.)
10.3 Certificate of Formation of Hartman REIT Operating
Partnership II GP, LLC.
10.4 Limited Liability Agreement of Hartman REIT Operating
Partnership II GP, LLC
10.5 Certificate of Limited Partnership of Hartman REIT
Operating Partnership II, L.P.
10.6 Agreement of Limited Partnership of Hartman REIT Operating
Partnership II, L.P.
10.7 Promissory Note, dated December 20, 2002, between Hartman
REIT Operating Partnership II, L.P. and GMAC Commercial
Mortgage Corporation.
10.8 Deed of Trust and Security Agreement, dated December 20,
2002, between Hartman REIT Operating Partnership II, L.P.
and GMAC Commercial Mortgage Corporation.
10.9 Employee and Trust Manager Incentive Plan
16.1 Letter from Deloitte & Touche LLP regarding its concurrence
or disagreement with the statements made by the Company in
the registration statement concerning the resignation as
the Company's principal accountant
21.1 List of Subsidiaries of Hartman Commercial Properties REIT
23.1 Consent of Pannell Kerr Forster of Texas, P.C.
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant has duly caused this registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized.
Hartman Commercial Properties REIT
Dated: April 30, 2003
By: /s/ Allen R. Hartman
---------------------
Name: Allen R. Hartman
Title: President
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INDEX TO FINANCIAL STATEMENTS
PAGE
----
HCP Consolidated Financial Statements
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-3
Consolidated Statements of Income for each of the years ended
December 31, 2002, 2001 and 2000 F-5
Consolidated Statements of Changes in Shareholders' Equity for each of
the years ended December 31, 2002, 2001 and 2000 F-6
Consolidated Statements of Cash Flows for each of the years ended
December 31, 2002, 2001 and 2000 F-7
Notes to Consolidated Financial Statements F-8
2002 Acquisition Properties
Independent Auditors' Report F-23
Statement of Revenue and Certain Expenses for each of the years ended
December 31, 2001 and 2000 F-24
Notes to the Statement of Revenue and Certain Expenses for each of the
years ended December 31, 2001 and 2000 F-25
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Trust Managers and Shareholders of
Hartman Commercial Properties REIT
We have audited the accompanying consolidated balance sheets of Hartman
Commercial Properties REIT and subsidiary (the "Company") as of December 31,
2002 and 2001, and the related consolidated statements of income, shareholders'
equity and cash flows, for each of the three years in the period ended December
31, 2002. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Hartman Commercial
Properties REIT and subsidiary as of December 31, 2002 and 2001, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2002 in conformity with accounting
principles generally accepted in the United States of America.
/s/ PANNELL KERR FORSTER OF TEXAS, P.C.
Houston, Texas
March 28, 2003
F-2
Hartman Commercial Properties REIT and Subsidiary
Consolidated Balance Sheets
December 31,
--------------------------------
2002 2001
-------------- --------------
ASSETS
Real estate
Land $ 24,044,499 $ 15,323,934
Buildings and improvements 92,984,637 55,130,010
-------------- --------------
117,029,136 70,453,944
Less accumulated depreciation (7,735,355) (4,185,030)
-------------- --------------
Real estate, net 109,293,781 66,268,914
Cash and cash equivalents 6,091,699 203,418
Escrows and acquisition deposits 2,891,300 -
Note receivable 421,890 -
Receivables
Accounts receivable, net of allowance for doubtful
accounts of $391,500 and $225,800 in 2002
and 2001, respectively 339,044 436,819
Accrued rent receivable 1,700,076 972,469
Due from affiliates 2,847,600 1,052,789
-------------- --------------
Receivables, net 4,886,720 2,462,077
-------------- --------------
Deferred costs, net 2,918,210 1,490,058
Prepaid expenses and other assets 95,583 14,463
-------------- --------------
Total assets $ 126,599,183 $ 70,438,930
-------------- --------------
See notes to consolidated financial statements.
F-3
December 31,
--------------------------------
2002 2001
-------------- --------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Notes payable $ 37,718,000 $ 11,997,058
Accounts payable and accrued expenses 3,308,345 1,173,345
Due to affiliates 864,487 712,281
Tenants' security deposits 1,117,705 638,652
Dividends payable 1,226,777 941,749
Other liabilities 1,016,460 608,951
-------------- --------------
Total liabilities 45,251,774 16,072,036
-------------- --------------
Minority interests of unit holders in Operating Partnership; 4,065,840 and
2,865,654 units at December 31, 2002 and 2001, respectively 38,598,491 27,264,090
Commitments and Contingencies - -
Shareholders' equity
Preferred shares, $0.001 par value per share; 10,000,000
shares authorized; none issued and outstanding
at December 31, 2002 and 2001 - -
Common shares, $0.001 par value per share; 100,000,000
shares authorized; 4,907,107 and 3,239,316 issued and
outstanding at December 31, 2002 and 2001, respectively 4,907 3,239
Additional paid-in capital 45,529,255 28,867,324
Accumulated deficit (2,785,244) (1,767,759)
-------------- --------------
Total shareholders' equity 42,748,918 27,102,804
-------------- --------------
Total liabilities and shareholders' equity $ 126,599,183 $ 70,438,930
-------------- --------------
See notes to consolidated financial statements.
F-4
Hartman Commercial Properties REIT and Subsidiary
Consolidated Statements of Income
Year Ended December 31,
-----------------------------------------------
2002 2001 2000
------------- ------------- -------------
Revenues
Rental income $ 16,794,963 $ 9,352,910 $ 7,853,568
Tenants' reimbursements 3,628,522 2,253,121 1,711,118
Interest and other income 331,541 97,706 61,072
------------- ------------- -------------
Total revenues 20,755,026 11,703,737 9,625,758
------------- ------------- -------------
Expenses
Operation and maintenance 2,299,377 1,417,820 998,166
Interest expense 1,573,270 812,029 1,271,194
Real estate taxes 2,629,122 1,529,350 1,160,019
Insurance 381,155 175,442 114,573
Electricity, water and gas utilities 795,431 700,976 508,775
Management and partnership
management fees 1,231,212 674,529 574,216
General and administrative 831,675 518,871 534,667
Depreciation 3,550,325 1,922,247 1,593,779
Amortization 491,536 229,499 192,095
Bad debt expense 74,200 50,300 34,500
------------- ------------- -------------
Total operating expenses 13,857,303 8,031,063 6,981,984
------------- ------------- -------------
Income before minority interests 6,897,723 3,672,674 2,643,774
Minority interests in Operating Partnership (3,192,605) (1,931,962) (1,770,078)
------------- ------------- -------------
Net income $ 3,705,118 $ 1,740,712 $ 873,696
------------- ------------- -------------
Net income per common share $ 0.755 $ 0.573 $ 0.475
------------- ------------- -------------
Weighted-average shares outstanding 4,905,022 3,035,521 1,840,700
------------- ------------- -------------
See notes to consolidated financial statements.
F-5
Hartman Commercial Properties REIT and Subsidiary
Consolidated Statements of Changes in Shareholders' Equity
Common Stock
-----------------------------
Additional
Paid-in Accumulated
Shares Amount Capital Deficit Total
------------- ------------- ------------- ------------- -------------
Balance, December 31, 1999 572,466 $ 572 $ 3,977,332 $ (154,781) $ 3,823,123
Issuance of common stock for cash,
net of offering costs 1,273,007 1,273 11,658,960 - 11,660,233
Issuance of common stock to acquire
Operating Partnership units 648,482 649 6,484,176 - 6,484,825
Net income - - - 873,696 873,696
Dividends - - - (1,760,546) (1,760,546)
------------- ------------- ------------- ------------- -------------
Balance, December 31, 2000 2,493,955 2,494 22,120,468 (1,041,631) 21,081,331
Issuance of common stock for cash,
net of offering costs 745,361 745 6,746,856 - 6,747,601
Net income - - - 1,740,712 1,740,712
Dividends - - - (2,466,840) (2,466,840)
------------- ------------- ------------- ------------- -------------
Balance, December 31, 2001 3,239,316 3,239 28,867,324 (1,767,759) 27,102,804
Issuance of common stock for cash,
net of offering costs 16,912 17 154,792 - 154,809
Issuance of common stock to acquire
Operating Partnership units 1,067,646 1,068 10,675,392 - 10,676,460
Issuance of common stock in exchange for
Operating Partnership units 583,233 583 5,831,747 - 5,832,330
Net income - - - 3,705,118 3,705,118
Dividends - - - (4,722,603) (4,722,603)
------------- ------------- ------------- ------------- -------------
Balance, December 31, 2002 4,907,107 $ 4,907 $ 45,529,255 $ (2,785,244) $ 42,748,918
------------- ------------- ------------- ------------- -------------
See notes to consolidated financial statements.
F-6
Hartman Commercial Properties REIT and Subsidiary
Consolidated Statements of Cash Flows
Years Ended December 31,
--------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
Cash flows from operating activities:
Net income $ 3,705,118 $ 1,740,712 $ 873,696
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Depreciation 3,550,325 1,922,247 1,593,779
Amortization 491,536 229,499 192,095
Minority interests in Operating Partnership 3,192,605 1,931,962 1,770,078
Bad debt expense 74,200 50,300 34,500
Changes in operating assets and liabilities:
Due from affiliates 847,608 (1,557,318) 262,375
Escrows and acquisition deposits (956,051) 727,264 (24,579)
Receivables (557,277) (403,321) (529,364)
Deferred costs (894,076) (725,107) (322,064)
Prepaid expenses and other assets 77,130 33,002 34,941
Accounts payable and accrued expenses 987,052 (972,043) 747,858
Tenants' security deposits 67,876 141,526 82,666
-------------- -------------- --------------
Net cash provided by operating activities 10,586,046 3,118,723 4,715,981
-------------- -------------- --------------
Cash flows used in investing activities:
Additions to real estate (1,982,508) (5,027,727) (6,089,034)
Proceeds from sale of property 60,000 - -
-------------- -------------- --------------
Net cash used in investing activities (1,922,508) (5,027,727) (6,089,034)
-------------- -------------- --------------
Cash flows from financing activities:
Dividends paid (4,437,575) (2,233,080) (1,190,831)
Distributions paid to OP unit holders (3,998,069) (2,405,038) (2,681,327)
Purchase of nonaccredited investors' shares (1,452,960) - (339,791)
Proceeds from issuance of common shares 154,809 6,747,601 11,660,233
Proceeds from notes payable 22,020,991 9,230,000 3,211,000
Repayments of notes payable (14,639,488) (9,233,753) (10,502,281)
Payments of loan origination costs (422,965) (304,000) -
-------------- -------------- --------------
Net cash provided by financing activities (2,775,257) 1,801,730 157,003
-------------- -------------- --------------
Net increase (decrease) in cash and cash equivalents 5,888,281 (107,274) (1,216,050)
Cash and cash equivalents at beginning of year 203,418 310,692 1,526,742
-------------- -------------- --------------
Cash and cash equivalents at end of year $ 6,091,699 $ 203,418 $ 310,692
-------------- -------------- --------------
Supplemental disclosure of cash flow information:
Debt assumed in connection with acquisition
of properties $ 13,595,156 $ - $ 8,676,104
-------------- -------------- --------------
OP units issued in connection
with acquisition of properties $ 28,510,660 $ 382,521 $ 18,853,165
-------------- -------------- --------------
Shares issued in connection with
acquisition of properties $ 10,676,460 $ - $ 6,484,825
-------------- -------------- --------------
See notes to consolidated financial statements.
F-7
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business and nature of operations
Hartman Commercial Properties REIT ("HCP") was formed as a real estate
investment trust, pursuant to the Texas Real Estate Investment Trust
Act on August 20, 1998 to consolidate and expand the real estate
investment strategy of Allen R. Hartman ("Hartman") in acquiring and
managing office and retail properties. Hartman, HCP's Chairman of the
Board of Trust Managers, has been engaged in the ownership,
acquisition, and management of commercial properties in the Houston,
Texas, metropolitan area for over 20 years. HCP serves as the general
partner of Hartman REIT Operating Partnership, L.P. (the "Operating
Partnership" or "HROP") which was formed on December 31, 1998 as a
Delaware limited partnership. HCP and the Operating Partnership are
collectively referred to herein as the "Company". HCP currently
conducts substantially all of its operations and activities through
the Operating Partnership. As the general partner of the Operating
Partnership, HCP has the exclusive power to manage and conduct the
business of the Operating Partnership, subject to certain customary
exceptions. Hartman Management, L.P. (the "Management Company"), a
company wholly-owned by Hartman, provides a full range of real estate
services including leasing and property management, accounting, asset
management and investor relations for the Company.
In January 1999, the Company acquired nine commercial properties (the
"First Consolidation") pursuant to (i) a merger at fair values of four
privately-held limited partnerships (Houston R.E. Income Properties
IV, V, VI and VII Ltd.) controlled and operated by Hartman, with and
into the Operating Partnership; (ii) a contribution by Houston R.E.
Income Properties XI, Ltd. of certain of its properties to the
Operating Partnership in exchange for Operating Units ("OP Units") of
the Operating Partnership, and (iii) a purchase of one property from a
limited partnership for cash. During 1999, the Company bought an
additional three properties from unrelated parties.
Effective January 2000, the Company acquired nine additional
commercial properties (the "Second Consolidation"). Three of these
commercial properties were acquired by merging at fair values a
Hartman controlled entity (Houston R.E. Income Properties X REIT,
Inc.) into HCP. Further, a separate Hartman controlled limited
partnership (Houston R.E. Income Properties XII, L.P.), contributed
six commercial properties to the Operating Partnership in exchange for
OP Units. On August 31, 2000, the Company bought another property
controlled by Hartman. During 2001, the Company acquired another
property from an unrelated party.
Effective January 2002, the Company acquired nine additional
commercial properties. Five of these properties were contributed at
fair values by Houston R.E. Income Properties XIV, L.P., a limited
partnership controlled by Hartman, to the Operating Partnership in
exchange for OP Units. Further, two properties were acquired when
Hartman controlled limited partnerships Houston R.E. Income Properties
VIII, Ltd. and Houston R.E. Income Properties IX, Ltd. were merged at
fair value with and into the Operating Partnership in exchange for OP
units. Two additional properties were acquired when Hartman controlled
entities Houston R.E. Income Properties XI REIT, Inc. and Houston R.E.
Income Properties XV REIT, Inc. were merged at fair value into the
Company in exchange for HCP common shares. In addition, another
property was acquired during 2002 and subsequently sold to an
unrelated party (see Note 2). As of December 31, 2002, 2001 and 2000,
the Company owned and operated 32, 23 and 22 office and retail
properties, respectively, located in and around Houston, Texas.
F-8
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Basis of consolidation
HCP is the sole general partner of the Operating Partnership and
possesses full legal control and authority over the operations of the
Operating Partnership. As of December 31, 2002, HCP owned a majority
of the partnership interests in the Operating Partnership.
Consequently, the accompanying consolidated financial statements of
the Company include the accounts of the Operating Partnership. All
significant intercompany balances have been eliminated. Minority
interest in the accompanying consolidated financial statements
represents the share of equity and earnings of the Operating
Partnership allocable to holders of partnership interests other than
the Company. Net income is allocated to minority interests based on
the weighted-average percentage ownership of the Operating Partnership
during the year. Issuance of additional common shares and OP Units
changes the ownership interests of both the minority interests and the
Company.
Basis of accounting
The financial records of the Company are maintained on the accrual
basis of accounting whereby revenues are recognized when earned and
expenses are recorded when incurred.
Cash and cash equivalents
The Company considers all highly liquid debt instruments purchased
with an original maturity of three months or less to be cash
equivalents. Cash and cash equivalents at December 31, 2002 and 2001
consist of demand deposits at commercial banks and money market funds.
Due from affiliates
Due from affiliates include amounts owed to the Company from Hartman
controlled limited partnerships and other entities.
Escrows and acquisition deposits
Escrow deposits include escrows established pursuant to certain
mortgage financing arrangements for real estate taxes, insurance,
maintenance and capital expenditures. Acquisition deposits include
earnest money deposits on future acquisitions.
Real estate
Real estate properties are recorded at cost, net of accumulated
depreciation. Improvements, major renovations, and certain costs
directly related to the acquisition, improvement, and leasing of real
estate are capitalized. Expenditures for repairs and maintenance are
charged to operations as incurred. Depreciation is computed using the
straight-line method over the estimated useful lives of 5 to 39 years
for the buildings and improvements. Tenant improvements are
depreciated using the straight-line method over the life of the lease.
F-9
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Real estate (continued)
Management reviews its properties for impairment whenever events or
changes in circumstances indicate that the carrying amount of the
assets, including accrued rental income, may not be recoverable
through operations. Management determines whether an impairment in
value has occurred by comparing the estimated future cash flows
(undiscounted and without interest charges), including the estimated
residual value of the property, with the carrying cost of the
property. If impairment is indicated, a loss will be recorded for the
amount by which the carrying value of the property exceeds its fair
value. Management has determined that there has been no impairment in
the carrying value of the Company's real estate assets as of December
31, 2002.
Deferred costs
Deferred costs consist primarily of leasing commissions and deferred
financing costs. Leasing commissions are amortized on the
straight-line method over the terms of the related lease agreements.
Deferred financing costs are amortized on the straight-line method
over the terms of the loans, which approximates the interest method.
Offering costs
Offering costs include selling commissions, issuance costs, investor
relations fees and unit purchase discounts. These costs were incurred
in the raising of capital through the sale of common shares and are
treated as a reduction of shareholders' equity.
Revenue recognition
All leases on properties held by the Company are classified as
operating leases, and the related rental income is recognized on a
straight-line basis over the terms of the related leases. Differences
between rental income earned and amounts due per the respective lease
agreements are capitalized or charged, as applicable, to accrued rent
receivable. Percentage rents are recognized as rental income when the
thresholds upon which they are based have been met. Recoveries from
tenants for taxes, insurance, and other operating expenses are
recognized as revenues in the period the corresponding costs are
incurred. The Company provides an allowance for doubtful accounts
against the portion of tenant accounts receivable which is estimated
to be uncollectible.
Federal income taxes
The Company is qualified as a real estate investment trust ("REIT")
under the Internal Revenue Code of 1986 and is therefore not subject
to Federal income taxes provided it meets all conditions specified by
the Internal Revenue Code for retaining its REIT status. The Company
believes it has continuously met these conditions since reaching 100
shareholders in 1999 (see Note 7).
F-10
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Use of estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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.
Significant estimates used by the Company include the estimated useful
lives for depreciable and amortizable assets and costs, and the
estimated allowance for doubtful accounts receivable. Actual results
could differ from those estimates.
Fair value of financial instruments
The Company's financial instruments consist primarily of cash, cash
equivalents, accounts receivable and accounts and notes payable. The
carrying value of cash, cash equivalents, accounts receivable and
accounts payable are representative of their respective fair values
due to the short-term nature of these instruments. The fair value of
the Company's debt obligations is representative of its carrying value
based upon current rates offered for similar types of borrowing
arrangements.
Concentration of risk
Substantially all of the Company's revenues are obtained from office,
industrial and retail locations in the Houston, Texas, metropolitan
area.
The Company maintains cash accounts in major U.S. financial
institutions. The terms of these deposits are on demand to minimize
risk. The balances of these accounts occasionally exceed the federally
insured limits, although no losses have been incurred in connection
with such cash balances.
Comprehensive income
The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income" in 1999. For the
years presented, the Company did not have significant amounts of
comprehensive income.
New accounting pronouncements
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended, was issued. This statement requires
that an entity recognize all derivatives as either assets or
liabilities and measure the instruments at fair value. The accounting
for change in fair value of a derivative depends upon its intended
use. The Company adopted the provisions of this statement effective
January 1, 2001 and believes that this statement did not have any
material impact on the Company's consolidated financial statements.
F-11
Hartman Commercial Properties REIT and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
New accounting pronouncements (continued)
SFAS No. 141, "Business Combinations" was effective July 1, 2001 and
prohibits pooling-of-interests accounting for acquisitions. The effect
of adopting SFAS 141 did not have a material impact on the Company's
financial statements.
SFAS No. 142, "Goodwill and Other Intangible Assets" is effective
January 1, 2002 and specifies that goodwill and some intangible assets
will no longer be amortized but instead will be subject to periodic
impairment testing. The effect of adopting SFAS No. 142 did not have a
material impact on the Company's financial statements.
SFAS No. 143, "Accounting for Asset Retirement Obligations" was issued
in June 2001, is effective for years beginning after June 15, 2002,
and will be adopted by the Company on January 1, 2003. This Statement
addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The adoption of SFAS No. 143 will
not have a material impact on the Company's financial statements.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" was issued in August 2001, and was adopted by the Company on
January 1, 2002. This Statement supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", and the accounting and reporting provisions of
Accounting Principles Board ("APB") Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions", for the disposal of a segment of a business
(as previously defined in that Opinion). This Statement addresses
financial accounting and reporting for the impairment or disposal of
long-lived assets. The effect of adopting SFAS No. 144 did not have a
material impact on the Company's financial statements.
SFAS No. 145, "Rescission of SFAS Statements No. 4, 44 and 64,
Amendment of SFAS No. 13, Technical Corrections" was issued in April
2002 and adopted by the Company on April 30, 2002. The purpose of this
statement is to update, clarify and simplify existing accounting
standards. The effect of adopting SFAS No. 145 did not have a material
impact on the Company's financial statements.
F-12
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
New accounting pronouncements (continued)
SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure - an amendment of FASB Statement No. 123," was issued in
December 2002 and is effective for fiscal years beginning after
December 15, 2002. This statement provides alternative methods of
transition for an entity that voluntarily changes to the fair
value-based method of accounting for stock-based employee
compensation. It also amends the disclosure requirements of SFAS No.
123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported
results. The Company will adopt this statement effective January 1,
2003 using the prospective method, and does not expect the adoption of
this statement to have a material impact on its financial position,
results of operations or cash flows.
In November 2002, FASB issued Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others". FIN 45
establishes new disclosure and liability-recognition requirements for
direct and indirect debt guarantees with specified characteristics.
The initial measurement and recognition requirements of FIN 45 are
effective prospectively for guarantees issued or modified after
December 31, 2002. However, the disclosure requirements are effective
for interim and annual financial-statement periods ending after
December 15, 2002. The Company has adopted the disclosure provisions,
and does not expect the full adoption of FIN 45 to have a material
impact on the Company's financial statements.
NOTE 2 - REAL ESTATE
During 2001, the Company acquired from an unrelated party one
grocery-anchored shopping center comprising approximately 90,327
square feet of gross leaseable area ("GLA"). The property was acquired
for cash consideration of approximately $4,600,000.
During 2002, the Company completed a series of transactions to acquire
ten commercial real estate properties from affiliated partnerships.
Approximately 883,494 square feet of GLA was acquired for the
following consideration:
2,851,066 HCP shares of beneficial interest and
HROP partnership units convertible one for one into
HCP shares $ 28,510,660
Assumption of mortgage debt 13,595,156
Cash 1,811,398
Other liabilities assumed, net of other assets acquired 1,458,714
------------
$ 45,375,928
------------
F-13
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 2 - REAL ESTATE (Continued)
Effective November 19, 2002, the Company sold one of the properties
acquired during 2002 to an unrelated third party. The sales price of
the property equaled its carrying value and no gain or loss from
disposition was recorded. Revenues and operating expenses of the
property were minimal and are recorded in the consolidated statements
of income for the year ended December 31, 2002. Consideration from the
sale included a note receivable from the purchaser maturing December
4, 2004. Interest is payable monthly at 6% per annum with the unpaid
principal due on maturity.
At December 31, 2002, the Company owned 32 commercial properties in
the Houston, Texas area comprising approximately 2,349,000 square feet
of GLA.
NOTE 3 - DEFERRED COSTS
Deferred costs consist of the following:
December 31,
------------------------------
2002 2001
------------- -------------
Leasing commissions $ 2,402,151 $ 1,507,826
Deferred financing costs 1,271,043 510,705
------------- -------------
3,673,194 2,018,531
Less: accumulated amortization (754,984) (528,473)
------------- -------------
$ 2,918,210 $ 1,490,058
------------- -------------
NOTE 4 - FUTURE MINIMUM LEASE INCOME
The Company leases the majority of its office and retail properties
under noncancelable operating leases which provide for minimum base
rentals plus, in some instances, contingent rentals based upon a
percentage of the tenants' gross receipts.
A summary of minimum future rentals to be received (exclusive of
renewals, tenant reimbursements, and contingent rentals) under
noncancelable operating leases in existence at December 31, 2002, is
as follows:
Years Ended December 31,
---------------------------------
2003 $ 14,528,666
2004 12,246,666
2005 9,165,830
2006 6,823,664
2007 3,819,685
Thereafter 6,864,712
--------------
$ 53,449,223
--------------
F-14
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 5 - NOTES PAYABLE
Mortgages and other notes payable consist of the following:
December 31,
---------------------------
2002 2001
------------ ------------
Mortgages and other notes payable $ 34,440,000 $ 6,422,058
Demand note, Houston R.E. Income
Properties XVI, Ltd. 3,278,000 -
Revolving loan secured by properties - 5,575,000
------------ ------------
Total $ 37,718,000 $ 11,997,058
------------ ------------
Upon completion of the First Consolidation in January 1999, the
Company entered into a credit facility with Coastal Banc ssb which
provided the Company with a $9,000,000 line of credit (the
"Financing") to refinance all debt associated with the acquired
properties, to purchase certain limited partnership interests in
connection with the merger of four privately-held limited
partnerships, to facilitate the acquisition of one property for cash,
to pay other expenses associated with the consolidation, and to cover
general working capital needs. The interest rate is indexed to the
30-day London Interbank Offered Rate ("LIBOR") plus 2.15% to 2.75%
based on the average balance of compensating deposits held by Coastal
Banc ssb. Borrowings under the Financing are secured by the properties
with recourse to the Company.
In May 2000, the Financing was modified in connection with the Second
Consolidation and extended until April 1, 2002. Additionally, in
connection with the Second Consolidation, the Company assumed three
notes payable to Coastal Banc ssb with an aggregate balance of
$6,449,238. The interest rate on these three notes is indexed to the
30-day LIBOR plus 2.40%, and the maturity date of these notes was also
extended to April 1, 2002. The interest rate on outstanding borrowings
was 4.5% at December 31, 2001.
In December 2002, the Company refinanced substantially all of its
mortgage debt with a three-year floating rate mortgage loan
collateralized by 18 of the Company's properties and a maturity date
of January 1, 2006. The loan bears interest at 2.5% over a LIBOR rate
(3.92% at December 31, 2002) and has a two-year extension option.
Interest only payments are due monthly for the first 30 month period
after the origination date, after which, the loan may be repaid in
full or in $100,000 increments, with a final balloon payment due upon
maturity. The Company capitalized loan costs of $1,271,043 financed
from the proceeds of the refinancing.
In August 1999, the Company assumed a non-recourse note in the amount
of $1,905,000 in connection with the acquisition of South Richey
Shopping Center. The note's interest rate is fixed at 10% with
payments of principal and interest aggregating $87,809 due monthly.
The note was collateralized by a final mortgage lien on the South
Richey Shopping Center and was paid in full on August 31, 2001.
The Company also assumed an unsecured, demand note payable to Hartman
Management, Inc., a related party, in connection with the acquisition
of Holly Knight Plaza in August 2000 in the amount of $129,583. The
interest rate is fixed at 8% and the note was payable on demand. The
note was paid in January 2001.
F-15
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 5 - NOTES PAYABLE (Continued)
In November 2002, the Company issued a $3,278,000 note payable bearing
interest at 4.25% per annum to Houston R.E. Income Properties XVI,
Ltd., a related party controlled by Hartman. The note is secured by
property and due upon demand with interest only payments due monthly.
The Company also has available a $2,000,000 revolving line of credit
maturing in July 2004 from a bank. The revolver note bears interest at
the bank's prime rate and is secured by property. No amounts were
outstanding on the line of credit at December 31, 2002.
The Company made cash payments for interest on debt of $1,636,904,
$812,029 and $1,150,960 for the years ended December 31, 2002, 2001
and 2000, respectively.
NOTE 6 - EARNINGS PER SHARE
Basic earnings per share is computed using net income to common
shareholders and the weighted average number of common shares
outstanding. Diluted earnings per share reflects common shares
issuable from the assumed conversion of OP units convertible into
common shares. Only those items that have a dilutive impact on basic
earnings per share are included in the diluted earnings per share.
Accordingly, because all OP units are convertible into common shares
on a one-for-one basis, no OP units were included in the diluted
earnings per share calculations.
Years Ended December 31,
---------------------------------------
2002 2001 2000
----------- ----------- -----------
Basic and diluted earnings per share
Weighted average common shares outstanding 4,905,022 3,035,521 1,840,700
Basic and diluted earnings per share $ 0.755 $ 0.573 $ 0.475
Net income $ 3,705,118 $ 1,740,712 $ 873,696
NOTE 7 - FEDERAL INCOME TAXES
Federal income taxes are not provided because the Company intends to
and believes it qualifies as a REIT under the provisions of the
Internal Revenue Code. Shareholders of the Company include their
proportionate taxable income in their individual tax returns. As a
REIT, the Company must distribute at least 90% (95% in 2000) of its
ordinary taxable income to its shareholders and meet certain income
sources and investment restriction requirements. In addition, 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 (including any
applicable alternative minimum tax) on its taxable income at regular
corporate tax rates.
Taxable income differs from net income for financial reporting
purposes principally due to differences in the timing of recognition
of interest, real estate taxes, depreciation and rental revenue.
F-16
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 7 - FEDERAL INCOME TAXES (Continued)
For Federal income tax purposes, the cash dividends distributed to
shareholders are characterized as follows for the years ended December
31:
2002 2001 2000
------ ------ ------
Ordinary income (unaudited) 85.1% 70.5% 75.9%
Return of capital (unaudited) 14.9% 29.5% 24.1%
Capital gain distributions (unaudited) 0% 0% 0%
------ ------ ------
Total 100% 100% 100%
------ ------ ------
NOTE 8 - RELATED-PARTY TRANSACTIONS
In January 1999, the Company entered into a property management
agreement with the Management Company. In consideration for
supervising the management and performing various day-to-day affairs,
the Company pays the Management Company a management fee of 5% and a
partnership management fee of 1% based on Effective Gross Revenues
from the properties, as defined. The Company incurred total management
and partnership fees of $1,231,212, $674,529 and $574,216 for the
years ended December 31, 2002, 2001 and 2000, respectively, of which
$81,094 and $89,244 were payable at December 31, 2002 and 2001,
respectively.
Under the provisions of the property management agreement, costs
incurred by the Management Company for the management and maintenance
of the properties are reimbursable to the Management Company. At
December 31, 2002 and 2001, $382,231 and $249,810, respectively, was
payable to the Management Company related to these reimbursable costs.
In consideration of managing and leasing the properties, the Company
also pays the Management Company leasing commissions of 6% for leases
originated by the Management Company and 4% for expansions and
renewals of existing leases based on Effective Gross Revenues from the
properties. The Company incurred total leasing commissions to the
Management Company of $890,852, $725,109 and $549,238 for the years
ended December 31, 2002, 2001 and 2000, respectively, of which
$200,747 and $187,474 were payable at December 31, 2002 and 2001,
respectively.
Also, we paid the Management Company a fee of up to 2% of the gross
selling price of all common shares sold in consideration of offering
services performed by the Management Company. The Company incurred
total fees of $3,259, $128,066 and $217,410 for the years ended
December 31, 2002, 2001 and 2000, respectively. Such fees have been
treated as offering costs and netted against the proceeds from the
sale of common shares.
The Management Company also receives acquisition fees equal to 4% of
the gross selling price of all common shares sold as a reimbursement
of expenses incurred in identifying reviewing, and acquiring
properties for the Company. The Company incurred total fees of $6,766,
$298,144 and $509,202 for the years ended December 31, 2002, 2001 and
2000, respectively. Such fees have been treated as offering costs and
netted against the proceeds from the sale of common shares.
F-17
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 8 - RELATED-PARTY TRANSACTIONS (Continued)
In conjunction with the acquisition of certain properties, the Company
assumed liabilities payable to the Management Company. At December 31,
2002 and 2001, $200,415 and $185,753, respectively, was payable to the
Management Company related to these liabilities.
The Company's day-to-day operations are strategically directed by the
Board of Trust Managers and implemented through the Management
Company. Hartman is the Company's Board Chairman and sole owner of the
Management Company. Hartman was owed $31,500 and $280,980 in dividends
payable on his common shares at December 31, 2002 and 2001,
respectively. Hartman owned 3.4%, 4.5% and 5.7% of the issued and
outstanding common shares of the Company as of December 31, 2002, 2001
and 2000, respectively.
The Company was a party to various other transactions with related
parties which are reflected in due to/from affiliates in the
accompanying consolidated balance sheets and also disclosed in Notes
2, 5 and 9.
NOTE 9 - SHAREHOLDERS' EQUITY
The Charter and Bylaws of the Company authorize the Company to issue
up to 100,000,000 common shares at $.001 par value per share, and
10,000,000 Preferred Shares at $.001 par value per share. The Company
commenced a private offering (the "Offering") in May 1999 to sell
2,500,000 common shares, par value $.001 per share, at a price of $10
per common share for a total Offering of $25,000,000. The Company
intended that the Offering be exempt from the registration
requirements of the Securities Act of 1933 and Regulation D
promulgated there under. The common shares are "restricted securities"
and are not transferable unless they subsequently are registered under
the 1933 Act and applicable state securities laws or an exemption from
such registration is available. The Offering was directed solely to
"accredited investors" as such term is defined in Regulation D.
Pursuant to the Offering, the Company sold for cash or issued in
exchange for property or OP Units, 4,907,107, 3,239,316 and 2,493,955
shares as of December 31, 2002, 2001 and 2000, respectively. HCP
conducts substantially all of its operations through the Operating
Partnership. All net proceeds of the Offering were contributed by HCP
to the Operating Partnership in exchange for OP Units. The Operating
Partnership used the proceeds to acquire additional commercial
properties and for general working capital purposes. HCP received one
OP Unit for each $10 contributed to the Operating Partnership, which
was the OP Unit valuation used in the Consolidations.
Operating partnership units
In January 1999, in connection with the First Consolidation, the
Company acquired its first properties by merging four privately held
limited partnerships (the "Merged Partnerships") into the Operating
Partnership. The Operating Partnership also purchased a property from
a limited partnership controlled by Hartman and received three
properties from Houston R.E. Income Properties XI, Ltd. ("HREIP XI,
Ltd.") in exchange for OP Units. In connection with these
transactions, the Operating Partnership issued, in the aggregate,
1,593,218 OP Units to either (i) limited partners of the Merged
Partnerships who were accredited investors in exchange for their
limited partner interests in the Merged Partnerships, or (ii) to HREIP
XI, Ltd. in consideration for its contribution of real estate
properties.
F-18
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 9 - SHAREHOLDERS' EQUITY (Continued)
Operating partnership units (continued)
In January 2000, in connection with the Second Consolidation, the
Company acquired nine additional commercial properties from two
limited partnerships controlled by Hartman. The Company acquired three
commercial properties from Houston R.E. Income Properties X, Ltd.
pursuant to a series of transactions. As a result of these
transactions, HCP received 648,482 OP Units and Hartman received
68,488 OP Units.
The Company also acquired six commercial properties from Houston R.E.
Income Properties XII, L.P. ("HREIP XII, L.P."). HREIP XII, L.P.
contributed these properties to the Operating Partnership in exchange
for 1,165,696 OP Units. As a result of this transaction, Hartman
received 49,709 OP Units in exchange for the cancellation of certain
rights owed to him by HREIP XII, L.P.
During 2002, the Company acquired ten properties from various Hartman
controlled limited partnerships in exchange for 2,851,066 OP Units.
Limited partners in the Operating Partnership holding OP Units have
the right to convert their OP Units into common shares at a ratio of
one OP Unit for one common share. Subject to certain restrictions, OP
Units are not convertible into common shares until the later of one
year after acquisition or an initial public offering of the common
shares. As of December 31, 2002 and 2001, there were 8,719,906 and
5,852,661 OP Units outstanding, respectively. HCP owned 4,654,066 and
2,987,007 Units as of December 31, 2002 and 2001, respectively. HCP's
weighted-average share ownership in the Operating Partnership was
approximately 53.71%, 49.59% and 36.99% during the years ended
December 31, 2002, 2001 and 2000, respectively.
Dividends and distributions
The following tables summarize the cash dividends/distributions
payable to holders of common shares and holders of OP Units related to
the years ended December 31, 2002, 2001 and 2000.
HCP Shareholders
-----------------------------------------------------------------
Dividend/Distribution per Date Dividend Total Amount
Common Share Payable Payable
------------------------- ------------- ------------
0.2350 5/15/00 $ 320,276
0.2375 8/15/00 402,124
0.2400 11/15/00 478,206
0.2425 2/15/01 559,940
0.2000 5/15/01 541,380
0.2000 8/15/01 602,138
0.2000 11/15/01 635,778
0.2125 2/15/02 687,544
0.2250 5/15/02 1,102,340
0.2375 8/15/02 1,166,709
0.2500 11/15/02 1,226,777
0.2500 2/15/03 1,226,777
F-19
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 9 - SHAREHOLDERS' EQUITY (Continued)
Dividends and distributions (continued)
OP Unit Holders Including Minority Unit Holders
-----------------------------------------------------------------
Dividend/Distribution per Date Dividend Total Amount
OP Unit Payable Payable
------------------------- ------------- ------------
0.2350 5/15/00 $ 946,842
0.2375 8/15/00 1,032,482
0.2400 11/15/00 1,111,729
0.2425 2/15/01 1,196,357
0.2000 5/15/01 1,070,594
0.2000 8/15/01 1,126,845
0.2000 11/15/1 1,158,818
0.2125 2/15/02 1,242,869
0.2250 5/15/02 1,942,412
0.2375 8/15/02 2,053,866
0.2500 11/15/02 2,161,143
0.2500 2/15/03 2,179,976
NOTE 10- INCENTIVE SHARE PLAN
The Company has adopted an Employee and Trust Manager Incentive Share
Plan (the "Incentive Share Plan") to (i) furnish incentives to
individuals chosen to receive share-based awards because they are
considered capable of improving operations and increasing profits;
(ii) encourage selected persons to accept or continue employment with
the Company; and (iii) increase the interest of employees and Trust
Managers in the Company's welfare through their participation and
influence on the growth in value of the common shares. The total
number of common shares that may be issued under the Incentive Share
Plan is an amount of shares equal to 5% of the outstanding shares on a
fully diluted basis. As of December 31, 2002, no options or awards to
purchase common shares have been granted under the Incentive Share
Plan.
NOTE 11- COMMITMENTS AND CONTINGENCIES
The Company is a participant in various legal proceedings and claims
that arise in the ordinary course of business. These matters are
generally covered by insurance. While the resolution of these matters
cannot be predicted with certainty, the Company believes that the
final outcome of such matters will not have a material effect on the
financial position, results of operations, or cash flows of the
Company.
NOTE 12- SEGMENT INFORMATION
The operating segments presented are the segments of the Company for
which separate financial information is available, and operating
performance is evaluated regularly by senior management in deciding
how to allocate resources and in assessing performance. The Company
evaluated the performance of its operating segments based on net
operating income that is defined as total revenues less operating
expenses and ad valorem taxes. Management does not consider gains or
losses from the sale of property in evaluating ongoing operating
performance.
F-20
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 12- SEGMENT INFORMATION (Continued)
The retail segment is engaged in the acquisition, development and
management of real estate, primarily anchored neighborhood and
community shopping centers located in Houston, Texas. The customer
base includes supermarkets and other retailers who generally sell
basic necessity-type commodities. The office/warehouse segment is
engaged in the acquisition, development and management of office and
warehouse centers located in Houston, Texas and has a diverse customer
base. The office segment is engaged in the acquisition, development
and management of commercial office space. Included in "Other" are
corporate related items, insignificant operations and costs that are
not allocated to the reportable segments.
Information concerning the Company's reportable segments for the years
ended December 31 is as follows:
Office
Retail Warehouse Office Other Total
------------- ------------- ------------- ------------- -------------
2002
Revenues $ 10,851,942 $ 8,282,170 $ 1,558,335 $ 62,579 $ 20,755,026
Net operating income 7,200,296 5,361,944 759,761 22,528 13,344,529
Total assets 53,936,120 50,685,602 7,628,230 14,349,231 126,599,183
Capital expenditures 17,005,552 29,411,594 158,046 - 46,575,1912
2001
Revenues $ 7,284,444 $ 3,099,998 $ 1,289,893 $ 29,402 $ 11,703,737
Net operating income 4,849,565 1,752,006 539,004 14,745 7,155,320
Total assets 38,015,144 22,534,392 7,746,679 2,142,715 70,438,930
Capital expenditures 4,872,237 282,228 255,784 - 5,410,249
2000
Revenues $ 5,997,889 $ 2,727,976 $ 925,051 $ (25,158) $ 9,625,758
Net operating income 4,019,324 1,717,804 386,259 112,122 6,235,509
Total assets 34,080,691 23,062,130 7,516,715 1,138,006 65,797,542
Capital expenditures 15,460,642 11,927,147 7,469,215 - 34,857,004
Net operating income reconciles to income before minority interests
shown on the consolidated statements of income for the years ended
December 31 as follows:
2002 2001 2000
------------- ------------- -------------
Total segment operating income $ 13,344,529 $ 7,155,320 $ 6,235,509
Less:
Depreciation and amortization 4,041,861 2,151,746 1,785,874
Interest 1,573,270 812,029 1,271,194
General and administrative 831,675 518,871 534,667
------------- ------------- -------------
Income before minority interests 6,897,723 3,672,674 2,643,774
Minority interests in Operating Partnership (3,192,605) (1,931,962) (1,770,078)
------------- ------------- -------------
Net income $ 3,705,118 $ 1,740,712 $ 873,696
------------- ------------- -------------
F-21
Hartman Commercial Properties REIT and Subsidiary
Notes to Consolidated Financial Statements
December 31, 2002
NOTE 13- PRO FORMA FINANCIAL INFORMATION (Unaudited)
During the year ended December 31, 2002 the Company acquired four
retail centers and five office/warehouse centers totaling $44,595,928
million. The pro forma financial information for the years ended
December 31, 2001 and 2000 is based on the historical statements of
the Company after giving effect to the acquisitions as if such
acquisitions took place on January 1, 2000.
The pro forma financial information shown below is presented for
information purposes only and may not be indicative of results that
would have actually occurred if the acquisitions had been in effect at
the date indicated, nor does it purport to be indicative of the
results that may be achieved in the future.
2001 2000
------------ ------------
Pro forma revenues $ 18,612,639 $ 14,940,066
------------ ------------
Pro forma net income available to
common shareholders $ 3,085,173 $ 1,538,641
------------ ------------
Pro forma basic and diluted earnings per
common share $ 0.658 $ 0.441
------------ ------------
F-22
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Hartman Commercial Properties REIT
We have audited the accompanying Statement of Revenue and Certain Expenses, for
the properties known as 2002 Acquisition Properties, as more fully described in
Note 1, for the years ended December 31, 2001 and 2000. The financial statement
is the responsibility of the properties' management. Our responsibility is to
express an opinion on this financial statement based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statement is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statement. An audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
The accompanying Statement of Revenue and Certain Expenses was prepared as
described in Note 2, for the purpose of complying with the rules and regulations
of the Securities and Exchange Commission (for inclusion in the Form 10 of
Hartman Commercial Properties REIT) and is not intended to be a complete
presentation of 2002 Acquisition Properties revenue and expenses.
In our opinion, the financial statement referred to above presents fairly, in
all material respects, the revenue and certain expenses of 2002 Acquisition
Properties for the years ended December 31, 2001 and 2000 in conformity with
accounting principles generally accepted in the United States of America.
/s/ PANNELL KERR FORSTER OF TEXAS, P.C.
Houston, Texas
March 28, 2003
F-23
Hartman Commercial Properties REIT
2002 Acquisition Properties
Statement of Revenue and Certain Expenses
Year Ended December 31,
---------------------------
2001 2000
------------ ------------
Revenue
Rent $ 5,914,917 $ 4,526,906
Recoveries from tenants 942,934 699,350
Other 51,051 88,052
------------ ------------
Total revenue 6,908,902 5,314,308
------------ ------------
Certain expenses
Operation and maintenance 635,903 503,906
Interest 979,196 1,071,963
Real estate taxes 984,105 950,015
Insurance 95,835 96,073
Electricity, water and gas utilities 218,286 210,061
Management fees 404,605 346,618
General and administrative 130,647 117,288
Bad debts 46,473 55,500
Tenant-in-common interest 22,858 25,285
------------ ------------
3,517,908 3,376,709
------------ ------------
Revenue in excess of certain expenses $ 3,390,994 $ 1,937,599
------------ ------------
The accompanying notes are an integral part of this
Statement of Revenue and Certain Expenses.
F-24
Hartman Commercial Properties REIT
2002 Acquisition Properties
Notes to Statement of Revenue and Certain Expenses
Years Ended December 31, 2001 and 2000
NOTE 1 - ORGANIZATION AND OPERATION OF PROPERTIES
Effective January 2, 2002, Hartman REIT Operating Partnership, L.P.
("HROP") acquired nine commercial real estate properties (the
"Properties"). HROP is a Delaware limited partnership formed to
acquire, own, lease, operate, and manage real properties on behalf of
Hartman Commercial Properties REIT ("HCP"), a Texas real estate
investment trust. As the sole general partner of HROP, HCP possesses
full legal control and authority over the operations of HROP.
The Properties comprise approximately 884,000 square feet of gross
leaseable area ("GLA"). Three of the Properties are classified as
anchored shopping centers and have an aggregate GLA of approximately
266,000 square feet; two of the Properties are classified as
unanchored shopping centers with an aggregate GLA of approximately
92,000 square feet; and four of the Properties are classified as
office/warehouse centers with an aggregate GLA of approximately
525,000 square feet. The Properties are leased to multiple tenants
(see Note 4).
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying statements of revenue and certain expenses are
presented in conformity with accounting principles generally accepted
in the United States of America and in accordance with the applicable
rules and regulations of the Securities and Exchange Commission for
real estate properties acquired. Accordingly, these statements exclude
certain historical expenses that are not comparable to the proposed
future operations of the property such as depreciation and
amortization. Therefore, these statements are not comparable to the
statement of operations of the Properties after their acquisition by
HROP.
Rental income is recognized on a straight-line basis over the terms of
the respective leases. Percentage rents are recognized as rental
income when the thresholds upon which they are based have been met.
Recoveries from tenants for taxes, insurance, and other operating
expenses are recognized as revenue in the period the corresponding
costs are incurred.
The preparation of the financial statement in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
NOTE 3 - MORTGAGE NOTES PAYABLE
HROP acquired the Properties subject to certain mortgage loans with an
aggregate outstanding balance of approximately $13,300,000. All of the
loans were repaid in November 2002 with proceeds from a new loan for
which the Properties served as collateral.
F-25
Hartman Commercial Properties REIT
2002 Acquisition Properties
Notes to Statement of Revenue and Certain Expenses
Year Ended December 31, 2001 and 2000
NOTE 4 - FUTURE MINIMUM RENTAL COMMITMENTS
As of January 2, 2002, the Properties had approximately 240 tenants
with remaining lease terms ranging from 1 month to 10 years. Future
minimum rental commitments (exclusive of renewals, tenant
reimbursements, and contingent rentals) under noncancelable operating
leases in existence at December 31, 2001 are as follows:
Year Ending December 31,
------------------------
2002 $ 5,373,539
2003 4,104,974
2004 3,067,560
2005 2,001,313
2006 1,240,169
Thereafter 1,407,781
------------
Total $ 17,195,336
------------
F-26