American Realty Investors(ARL) - 2018 Q4 - Annual Report

PART I Item 1. Business ARL is a real estate investment company focused on acquiring, developing, and owning income-producing properties - ARL is a Nevada corporation, formed in 1999, headquartered in Dallas, Texas, and its common stock trades on the NYSE under the symbol 'ARL'[5] - ARL and a subsidiary own approximately 77.68% of Transcontinental Realty Investors, Inc. (TCI), whose financial results are consolidated with ARL[6][7] - Pillar Income Asset Management, Inc. (Pillar) serves as ARL's external Advisor and Cash Manager, responsible for identifying investment opportunities and arranging financing[8][9] - ARL's primary business involves the acquisition, development, and ownership of income-producing residential and commercial real estate, as well as opportunistic land acquisition[16] - On November 19, 2018, TCI formed a joint venture, Victory Abode Apartments, LLC (VAA), with Macquarie Group, contributing 49 apartment complexes and 3 development projects, receiving $236.8 million cash and recognizing a gain of approximately $154.1 million[14][26] Income-Producing Properties at December 31, 2018 | Property Type | Details | | :------------ | :------ | | Commercial | 7 properties (5 office, 2 retail), ~1.7 million sq ft | | Residential | 9 apartment communities, 1,489 units (company-owned) | | Joint Venture | 49 residential apartment communities, 9,192 units (50% owned VAA) | Apartment Projects in Development (December 31, 2018) | Property | Location | No. of Units | Costs to Date ($ thousands) | Total Projected Costs ($ thousands) | | :------- | :------- | :----------- | :-------------------------- | :---------------------------------- | | Sugar Mill III | Addis, LA | 72 | 787 | 11,862 | | Parc at Denham Springs Phase II | Denham Springs, LA | 144 | 6,532 | 18,768 | | Overlook at Allensville Phase II | Sevierville, TN | 144 | 12,646 | 20,244 | | Total | | 360 | 19,965 | 50,874 | Undeveloped and Partially Developed Land Holdings (December 31, 2018) | Location | Acquired | Acres | Cost ($ thousands) | Intended Use | | :------- | :------- | :---- | :----------------- | :----------- | | Dallas, TX | 1996-2013 | 20.59 | 1,008 | Mixed use | | Farmers Branch, TX | 2008 | 153.44 | 25,892 | Mixed use | | Kaufman County, TX | 2008 | 16.79 | 1,597 | Multi-family residential | | Kaufman County, TX | 2006 | 1,963.68 | 50,913 | Mixed use | | Various | 1990-2008 | 191.87 | 9,027 | Various | | Total | | 2,346.37 | 88,437 | | Item 1A. Risk Factors The company faces risks from tenant health, competition, operating costs, development, and high financial leverage - Cash flow depends on leasing space on favorable terms, with risks including lack of demand, tenant defaults, and oversupply[50][51][52] - Competition is high in attracting tenants and acquiring land/properties, with other landlords potentially offering more attractive financial terms[53][54] - Increased operating costs (insurance, utilities, maintenance) may not be offset by rent increases, adversely affecting cash flow and debt service ability[57] - Development risks include construction delays, cost overruns, failure to obtain permits, and projects not meeting profitability expectations[58] - Acquisition risks involve high competition, properties failing to perform as expected, and challenges in new markets[59][60] - The company is highly leveraged with approximately $445 million in total indebtedness at December 31, 2018, increasing vulnerability to economic downturns[64] - Inability to access financial markets for capital or refinance maturing debt on favorable terms could adversely affect liquidity and operations[65][68] - An increase in interest rates would raise interest costs on variable-rate debt and could hinder refinancing efforts[71][72] - Real estate investments are illiquid, limiting the company's ability to quickly dispose of properties in response to changing economic conditions[75][84] Item 1B. Unresolved Staff Comments The company reported no unresolved staff comments from the SEC - There are no unresolved staff comments[86] Item 2. Properties The company's portfolio includes directly owned properties, land for development, and a 50% interest in a large joint venture - As of December 31, 2018, the portfolio consisted of 16 income-producing properties: 9 apartment communities (1,489 units) and 7 commercial properties (5 office buildings, 2 retail centers)[87] - The company also owns or controls 2,346 acres of improved and unimproved land for future development or sale[87] - Through the VAA joint venture, ARL has a 50% ownership interest in 49 income-producing properties totaling 9,192 units[87] Average Annual Rental and Other Property Revenue per Square Foot (December 31, 2018) | Property Type | Revenue per Square Foot | | :------------ | :---------------------- | | Residential Apartment Portfolio | $6.53 | | Commercial Portfolio | $19.80 | | VAA Joint Venture (Residential) | $12.83 | Commercial Lease Expirations (December 31, 2018) | Year of Lease Expiration | Rentable Square Feet Subject to Expiring Leases | Percentage of Total Square Feet | | :----------------------- | :---------------------------------------------- | :------------------------------ | | 2019 | 250,228 | 14.7% | | 2020 | 132,376 | 7.8% | | 2021 | 135,017 | 8.0% | | 2022 | 237,489 | 14.0% | | 2023 | 339,701 | 20.0% | | 2024 | 237,549 | 14.0% | | 2025 | 113,829 | 6.7% | | 2026 | 23,432 | 1.4% | | Thereafter | 56,926 | 3.4% | | Total | 1,526,547 | 90% | Item 3. Legal Proceedings ARL is involved in several legal proceedings, including long-standing litigation and a new breach of fiduciary duty lawsuit - A formerly owned entity has been in litigation since 1999, resulting in a recalculated judgment of approximately $59 million against it[94][95][375][376] - ART filed a suit against a national law firm in 2005, which was dismissed on procedural grounds, and ART has filed an appeal[96][377] - A Final Judgment was entered against Dynex Commercial, Inc., awarding Basic $0.448 million, ART $24.8 million, and TCI $19.5 million[99][380] - In February 2019, the Berger Litigation was filed against TCI, ARL, Pillar, and certain officers/directors, alleging breach of fiduciary duty[102][383] Item 4. Mine Safety Disclosures The company states that this item is not applicable - This item is not applicable[104] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities ARL's common stock trades on the NYSE American, no dividends were paid in 2018, and a share repurchase program is in place - ARL's common stock is listed and traded on the NYSE American under the symbol 'ARL'[106] - As of March 29, 2019, there were 15,997,076 shares of common stock outstanding, held by approximately 2,900 stockholders[3][106] - No dividends were paid on common stock in 2018, 2017, or 2016, in accordance with the Board's annual dividend policy[107] - At December 31, 2018, 614 shares of Series A Preferred Stock were outstanding after significant share purchases and conversions[109][110] - A share repurchase program authorizes the repurchase of up to 1,250,000 shares of common stock, but no shares were repurchased in 2018 or 2017[114] ARL Common Stock High and Low Sales Prices (2018 vs. 2017) | Quarter | 2018 High ($) | 2018 Low ($) | 2017 High ($) | 2017 Low ($) | | :------ | :------------ | :----------- | :------------ | :----------- | | First | 21.57 | 11.70 | 9.85 | 5.17 | | Second | 20.63 | 12.26 | 9.99 | 7.00 | | Third | 19.00 | 14.50 | 8.95 | 8.00 | | Fourth | 17.48 | 12.04 | 14.50 | 8.67 | Item 6. Selected Financial Data This section provides a five-year summary of key consolidated financial data, highlighting a significant increase in 2018 net income Selected Consolidated Financial Data (2014-2018, in thousands) | Metric | 2018 | 2017 | 2016 | 2015 | 2014 | | :-------------------------------------------------- | :----- | :----- | :----- | :----- | :----- | | EARNINGS DATA | | | | | | | Rental and other property revenues | $120,956 | $126,221 | $119,663 | $104,188 | $79,412 | | Total operating expenses | 107,071 | 108,793 | 105,029 | 97,880 | 82,611 | | Operating income (loss) | 13,885 | 17,428 | 14,634 | 6,308 | (3,199) | | Gain on disposition of 50% interest in VAA | 154,126 | — | — | — | — | | Gain on income producing properties | — | 16,698 | 16,207 | — | — | | Gain on land sales | 17,404 | 4,884 | 3,121 | 21,648 | 561 | | Net income (loss) attributable to American Realty Investors, Inc. | 173,699 | (8,431) | (2,732) | (1,960) | 30,885 | | Net income (loss) applicable to common shares | $172,798 | $(9,536) | $(3,833) | $(3,176) | $28,842 | | PER SHARE DATA | | | | | | | Earnings per share - basic (Net income (loss) applicable to common shares) | $10.81 | $(0.61) | $(0.25) | $(0.21) | $2.28 | | Weighted average common shares used in computing earnings per share | 15,982,528 | 15,514,360 | 15,514,360 | 15,111,107 | 12,683,956 | | BALANCE SHEET DATA | | | | | | | Real estate, net | $381,043 | $988,117 | $901,006 | $853,507 | $699,763 | | Total assets | 826,149 | 1,296,720 | 1,174,909 | 1,117,368 | 965,498 | | Notes and interest payable | 286,968 | 901,083 | 851,095 | 804,760 | 659,059 | | Bonds and interest payable | 158,574 | 113,049 | — | — | — | | Shareholders' equity | 321,127 | 165,883 | 176,131 | 176,889 | 179,588 | | Book value per share | 20.09 | 10.69 | 11.35 | 11.71 | 14.16 | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial performance, investment strategy, accounting policies, and the impact of the VAA joint venture - ARL is an externally advised and managed real estate investment company with a diverse portfolio of properties and land[123] - The company's investment strategy includes acquiring existing properties, developing new ones, and opportunistically acquiring land[123] - Acquisitions are primarily financed through operating cash flow, property sales, and debt financing[124] - Related party transactions are a historical part of the business but are not presumed to be arm's length[125] Item 7A. Quantitative and Qualitative Disclosures About Market Risk ARL's primary market risk is exposure to interest rate changes on its variable-rate and maturing debt - ARL's primary market risk exposure is to changes in interest rates on variable-rate debt and maturing debt that needs refinancing[201] - The overall weighted average interest rate at December 31, 2018, was 7.29%, compared to 4.91% in 2017[202] - A hypothetical 100 basis point increase in market interest rates would decrease net income by approximately $0.4 million[204] Debt Structure (December 31, 2018, in millions) | Debt Type | Amount | | :---------- | :----- | | Fixed-rate debt | $253.6 | | Variable-rate debt | $41.9 | | Total outstanding notes payable | $295.5 | Item 8. Consolidated Financial Statements and Supplementary Data This section presents the audited consolidated financial statements and supplementary data for the years 2016 through 2018 - The consolidated financial statements present fairly the financial position, results of operations, and cash flows in conformity with U.S. GAAP[209] - The report emphasizes liquidity, noting management's intent to sell properties and refinance or extend debt to meet liquidity needs[213] Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reported no changes in or disagreements with its accountants - There were no changes in or disagreements with accountants on accounting and financial disclosure[401] Item 9A. Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective - Disclosure controls and procedures were evaluated and deemed effective as of December 31, 2018[402] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2018, based on the COSO (2013) framework[404] - No changes in internal controls over financial reporting occurred during the fourth quarter of 2018 that materially affected internal controls[406] Item 9B. Other Information The company reported no other information for this item - This item is not applicable[407] PART III Item 10. Directors, Executive Officers and Corporate Governance This section details the company's board, executive officers, and the external advisory agreement with Pillar - ARL's Board of Directors manages the company's affairs and sets strategic policies, with a goal for a majority of independent directors[409][410] - The Board has standing Audit, Compensation, and Governance and Nominating Committees, all with independent members[419][420][422][423] - Executive officers are employed by Pillar and receive no direct remuneration from ARL[431][432][433][461] - Pillar serves as ARL's external Advisor and Cash Manager, responsible for day-to-day operations and investment opportunities[438] - Pillar's compensation includes a monthly gross asset fee, an annual net income fee, an annual incentive sales fee, and other commissions[443][445] - Regis Realty Prime, LLC manages commercial properties for a fee of 3.0% or less of monthly gross rents and leasing commissions of 6.0% or less[457][458] Item 11. Executive Compensation ARL does not directly compensate its executive officers; only non-affiliated directors receive remuneration from the company - ARL has no employees, payroll, or benefit plans and pays no compensation to its executive officers, who are compensated by Pillar[461] - Non-affiliated directors receive an annual retainer of $20,000, with the Audit Committee Chairman receiving an additional $500 annual fee[463] Non-Employee Director Fees Paid in 2018 | Director Name | Fees Paid ($) | | :------------ | :------------ | | Robert A. Jakuszewski | 20,000 | | Ted R. Munselle | 20,500 | | Raymond D. Roberts, Sr. | 20,000 | | Total | 60,500 | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters This section outlines the beneficial ownership of ARL's common stock, showing significant control by related parties - Percentages are based on 15,997,076 shares outstanding as of March 31, 2019[467][470] Security Ownership of Certain Beneficial Owners (March 31, 2019) | Name and Address of Beneficial Owner | Amount and Nature of Beneficial Ownership | Approximate Percent of Class | | :----------------------------------- | :---------------------------------------- | :--------------------------- | | May Realty Holdings, Inc. | 13,929,271 | 87.07% | | RA Stock Holdings, Inc. | 1,459,828 | 9.13% | | Realty Advisors, Inc. | 13,929,271 | 87.07% | | Realty Advisors LLC | 3,929,828 | 24.57% | Security Ownership of Management (March 31, 2019) | Name of Beneficial Owner | Amount and Nature of Beneficial Ownership | Approximate Percent of Class | | :----------------------- | :---------------------------------------- | :--------------------------- | | Gene S. Bertcher | 13,521,251 | 87.07% | | Henry A. Butler | 140,000 | 0.94% | | Louis J. Corna | 13,521,251 | 87.07% | | Robert A. Jakuszewski | 140,000 | 0.94% | | Daniel J. Moos | 13,526,251 | 87.07% | | Ted R. Munselle | 140,000 | 0.94% | | Raymond D. Roberts, Sr. | 140,000 | 0.94% | | All Directors and Executive Officers as a group (7 persons) | 13,526,251 | 87.09% | Item 13. Certain Relationships and Related Transactions, and Director Independence ARL has extensive business relationships with related parties, including its advisor, property manager, and affiliated companies - ARL's Articles of Incorporation require disclosure and approval by independent directors for transactions with related parties to ensure fairness[472][473] - Pillar serves as ARL's Advisor and Cash Manager, and also advises related entities TCI and IOR[477] - All ARL directors and executive officers also serve in the same capacities for TCI and IOR, creating overlapping fiduciary duties[479] - Regis Realty Prime, LLC manages commercial properties and provides brokerage services to ARL for fees and commissions[480] - ARL owned approximately 77.68% of TCI's common stock and, through TCI, approximately 81.25% of IOR's common stock as of December 31, 2018[482] - TCI has a development agreement with Unified Housing Foundation, Inc. (UHF), a related party, and is a primary guarantor on a $39.1 million mezzanine loan[483][484] Related Party Transactions and Fees (2018, in millions) | Transaction Type | Amount ($) | | :--------------- | :--------- | | Advisory fees paid to Pillar | 11.5 | | Net income fees paid to Pillar | 0.6 | | Mortgage brokerage and equity refinancing fees paid to Pillar | 2.9 | | Cost reimbursements paid to Pillar | 4.4 | | Interest received from Pillar | 3.4 | | Property management, construction management, and leasing commissions paid to Regis | 0.5 | | Rental revenue received from Pillar and related parties | 1.2 | | Notes and interest receivables (net of allowances) from related parties | 97.5 (notes), 8.2 (interest) | | Pillar owes ARL | 70.6 | | Land subject to sales contract with related parties | 86 acres | | TCI received cash from VAA joint venture for transferred properties | 7.4 (as of Feb 6, 2019) | Item 14. Principal Accounting Fees and Services This section details the audit and tax fees paid to the company's principal accounting firms for 2018 and 2017 - Audit fees cover professional services for audits and reviews of consolidated financial statements and statutory/regulatory filings[494] - Tax fees cover professional services for federal and state tax compliance, planning, consultation, and return preparation/review[496] - All services rendered by the principal auditors were pre-approved by the Board of Directors or the Audit Committee[497] Aggregate Fees for Professional Services (2018 vs. 2017, in thousands) | Type of Fee | Farmer, Fuqua & Huff (2018) | Swalm & Associates (2018) | Farmer, Fuqua & Huff (2017) | Swalm & Associates (2017) | | :---------- | :-------------------------- | :------------------------ | :-------------------------- | :------------------------ | | Audit Fees | $821,200 | $72,210 | $881,183 | $72,136 | | Tax Fees | 54,600 | — | 39,760 | — | | Total | $875,800 | $72,210 | $920,943 | $72,136 | PART IV Item 15. Exhibits, Financial Statement Schedules This section lists all documents filed as part of the report, including financial statements, schedules, and various exhibits - The report includes consolidated financial statements, financial statement schedules, and incorporated financial statements of related entities[501][502] - Exhibits include corporate governance documents, preferred stock designations, the Advisory Agreement with Pillar, and required certifications[503][508][512][513][514]