American Realty Investors(ARL) - 2022 Q4 - Annual Report

Part I Business ARL, an externally managed real estate company operating through TCI, focuses on multifamily, commercial, and land investments, with 2022 marked by major property sales and acquisitions - The company is an externally managed real estate firm operating through its majority-owned subsidiary, Transcontinental Realty Investors, Inc. (TCI), managed by Pillar Income Asset Management, Inc., with ARL itself having no employees[6][7][11] Portfolio Composition as of December 31, 2022 | Property Type | Details | | :--- | :--- | | Commercial Properties | 4 office buildings, ~1,056,793 sq ft | | Multifamily Properties | 14 properties, 2,328 units | | Land | ~1,858 acres (developed and undeveloped) | - A major 2022 event was the VAA joint venture's sale of 45 properties for $1.8 billion, resulting in ARL receiving an initial cash distribution of $182.8 million, a subsequent distribution of $204.0 million, and full operational control of the seven remaining VAA properties[17][18] - The company's business strategy is to maximize long-term value by acquiring, developing, and owning income-producing multifamily properties in the secondary markets of the Southern United States, while also opportunistically investing in commercial properties and land[19] Risk Factors This section outlines significant risks to the company's business, categorized by factors affecting its assets and the broader real estate industry Factors Affecting Our Assets Risks directly impacting the company's assets include potential future disease outbreaks, tenant financial instability, intense competition, development activity risks, high leverage of approximately $317.2 million, and geographic concentration - The company's operating results are highly dependent on tenants' ability to pay rent, which can be adversely affected by economic challenges, such as those created by the COVID-19 pandemic, and potential shifts in residents' views on their rent obligations[35] - As of December 31, 2022, the company had total indebtedness of approximately $317.2 million, with substantially all real estate assets pledged as collateral, increasing risk of loss and vulnerability to economic declines[48] - The company's properties are concentrated in the southwestern, southeastern, and mid-western United States, making its performance heavily dependent on the economic conditions in these regions[47] Factors Affecting the Industry The company is subject to industry-wide risks including real estate illiquidity, economic downturns, interest rate changes, competition, increased operating costs, and regulatory changes like rent control laws - Real estate investments are generally illiquid, meaning properties cannot be sold quickly, which may limit the company's ability to respond to changing economic conditions or realize full asset value[55][63] - Adverse economic conditions, such as a recession or pandemic effects, could lead to reduced rental rates, lower occupancy, decreased property valuations, and difficulty in obtaining financing[62][68] - The company faces risks from competition, changes in rent control or stabilization laws, and shifts in tenant demand, particularly with the increase in 'work from home' arrangements[64][66] Unresolved Staff Comments The company reports that it has no unresolved staff comments from the Securities and Exchange Commission - None[69] Properties As of December 31, 2022, the company's portfolio includes 14 residential properties with 2,328 units, four commercial properties totaling approximately 1.06 million square feet, and significant land investments of approximately 1,858 acres Residential Property Portfolio Summary (Dec 31, 2022) | Location | No. of Properties | Units | | :--- | :--- | :--- | | Alabama | 1 | 200 | | Colorado | 2 | 260 | | Louisiana | 3 | 608 | | Mississippi | 1 | 160 | | Texas | 7 | 1,100 | | Total | 14 | 2,328 | Commercial Property Portfolio Summary (Dec 31, 2022) | Property | Location | Square Feet | Occupancy | | :--- | :--- | :--- | :--- | | 770 South Post Oak | Houston, TX | 95,450 | 55.2% | | Browning Place | Dallas, TX | 625,297 | 71.7% | | Senlac | Dallas, TX | 2,812 | 100.0% | | Stanford Center | Dallas, TX | 333,234 | 61.6% | | Total | | 1,056,793 | | - A significant portion of commercial leases are set to expire in the near term, with 36% of total leased square footage expiring in 2023[75] - The company holds 1,710 acres of land for development and an additional 148 acres held subject to sales contracts, with the largest project being Windmill Farms in Kaufman County, TX[77] Legal Proceedings The company reports on three key legal matters: a favorable jury verdict in the 'Nixdorf' case, an ongoing appeal in the 'Clapper' case, and the dismissal of the 'Berger' suit - In the 'Nixdorf' property sale litigation, a jury returned a "Plaintiff take nothing" verdict in the company's favor on March 18, 2023[78] - In the 'Clapper' litigation, a jury found the defendants owed nothing, and the court issued a take-nothing judgment, with the case currently under appeal to the US Fifth Circuit Court of Appeals[78] - The 'Berger' suit, which alleged improper property sales, was voluntarily dismissed by the plaintiff and formally dismissed with prejudice by the court on January 4, 2023[78] Mine Safety Disclosures This item is not applicable to the company's operations - Not applicable[79] Part II Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities The company's common stock (NYSE: ARL) showed significant volatility in 2022, with no dividends paid for 2020-2022, and no shares repurchased in 2022 under its program Quarterly Common Stock Price Range (NYSE: ARL) | Quarter | 2022 High | 2022 Low | 2021 High | 2021 Low | | :--- | :--- | :--- | :--- | :--- | | First | $15.70 | $11.90 | $11.50 | $8.50 | | Second | $23.02 | $13.75 | $13.31 | $7.71 | | Third | $16.74 | $13.35 | $20.38 | $9.20 | | Fourth | $27.76 | $15.26 | $13.67 | $11.04 | - The Board of Directors determined not to pay any dividends on common stock in 2022, 2021, or 2020[82] - Under its stock repurchase program, the company did not repurchase any shares in 2022, with 19,465 shares remaining authorized for repurchase as of December 31, 2022[82] Selected Financial Data This section is optional and has not been included in the report - Optional and not included[83] Management's Discussion and Analysis of Financial Condition and Results of Operations This section details the company's financial performance and condition, highlighting the significant impact of the VAA Sale Portfolio on 2022 net income and discussing liquidity, critical accounting policies, and FFO reconciliation Management's Overview The company, an externally managed real estate firm, saw its 2022 activities dominated by the $1.8 billion VAA Sale Portfolio transaction, generating a $738.4 million gain for the JV and significant cash distributions to ARL - On September 16, 2022, the VAA joint venture completed the sale of the VAA Sale Portfolio for $1.8 billion, generating a gain of $738.4 million for the JV[92] - Following the VAA sale, the company received cash distributions totaling $386.8 million and acquired full operational control of the seven-property VAA Holdback Portfolio[92][93] - Financing activities in 2022 included paying off mortgage loans on Toulon ($14.7 million), Sugar Mill Phase III ($9.6 million), and Stanford Center ($38.5 million), and assuming $70.3 million in mortgages on the acquired VAA Holdback Portfolio[90] Critical Accounting Policies Management identifies critical accounting policies requiring significant estimates and judgments, including fair value measurements using a three-level hierarchy, related party transactions, and environmental liabilities - The company applies ASC Topic 820 for fair value measurements, using a three-level hierarchy to prioritize inputs, where Level 1 uses quoted prices in active markets and Level 3 uses unobservable data requiring the most judgment[97] - The company is not aware of any environmental liabilities that would have a material adverse effect on its business, assets, or results of operations[99] Results of Operations Net income for 2022 dramatically increased by $468.9 million year-over-year, primarily driven by a $454.6 million increase in joint venture income from the VAA Sale Portfolio and a $62.5 million gain on remeasurement of assets Comparison of Results of Operations (Years Ended Dec 31, in thousands) | (In thousands) | 2022 | 2021 | Variance | | :--- | :--- | :--- | :--- | | Total Revenue | $37,544 | $42,039 | ($4,495) | | Segment Operating Income | $15,741 | $16,948 | ($1,207) | | Income from Joint Ventures | $469,268 | $14,634 | $454,634 | | Gain on sale/remeasurement | $87,132 | $24,647 | $62,485 | | Net Income | $475,317 | $6,445 | $468,872 | - The $468.9 million increase in net income was primarily due to the company's share of the gain on the sale of the VAA Sale Portfolio and a $73.2 million gain on the remeasurement of the VAA Holdback Portfolio[105] Liquidity and Capital Resources The company's cash sources include operations, asset sales, and financing, with 2022 seeing increased net cash used in operating activities due to tax payments and substantially higher net cash from investing activities due to VAA distributions - Principal sources of cash include property operations, proceeds from property sales, collection of notes receivable, and debt/equity financing[107] Cash Flow Summary (Years Ended Dec 31, in thousands) | Activity | 2022 | 2021 | Variance | | :--- | :--- | :--- | :--- | | Net cash used in operating activities | $(45,386) | $(11,523) | $(33,863) | | Net cash provided by investing activities | $307,357 | $100,822 | $206,535 | | Net cash used in financing activities | $(112,377) | $(103,585) | $(8,792) | - The increase in cash from investing activities was primarily due to a $376.9 million increase in distributions from the VAA joint venture following the sale of the VAA Sale Portfolio[111] Funds From Operations (FFO) The company uses FFO, a non-GAAP measure defined by Nareit, as a supplemental financial metric, with FFO-adjusted increasing to $41.3 million in 2022 from $26.4 million in 2021 - FFO is used as a supplemental measure to GAAP net income to provide a meaningful comparison of operating results, as it excludes items like real estate depreciation and gains from property sales[113][114] Reconciliation of Net Income to FFO-adjusted (in thousands) | | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Net income attributable to the Company | $373,349 | $3,347 | $9,030 | | Adjustments for depreciation, gains on sale, etc. | ... | ... | ... | | FFO-Basic and Diluted | $43,275 | $18,819 | $23,350 | | Adjustments for debt extinguishment, currency | ... | ... | ... | | FFO-adjusted | $41,267 | $26,445 | $36,730 | Quantitative and Qualitative Disclosures About Market Risk This section is optional and has not been included in the report - Optional and not included[118] Consolidated Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for 2020-2022, including the independent auditor's report highlighting critical audit matters, and detailed notes on key events, accounting policies, debt, and related party transactions Report of Independent Registered Public Accounting Firm The independent auditor issued an unqualified opinion on the consolidated financial statements, identifying real estate impairment, notes receivable collectability, and straight-line revenue recognition as critical audit matters - The auditor expressed an unqualified opinion on the consolidated financial statements for the three-year period ended December 31, 2022[125] - Critical Audit Matters identified were: Impairment of investment in real estate, Collectability of Notes Receivable, and Revenue Recognition (straight-line) for commercial tenants[129] Consolidated Financial Statements The consolidated financial statements show total assets increased to $1.2 billion in 2022, total liabilities decreased, and total equity grew substantially to $812.2 million, with net income surging to $475.3 million and EPS to $23.11 due to the VAA transaction Consolidated Balance Sheet Highlights (in thousands) | | Dec 31, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | Total Assets | $1,197,479 | $770,569 | | Total Liabilities | $385,311 | $433,718 | | Total Equity | $812,168 | $336,851 | Consolidated Statement of Operations Highlights (in thousands, except per share) | | Year Ended Dec 31, 2022 | Year Ended Dec 31, 2021 | | :--- | :--- | :--- | | Total Revenue | $37,544 | $42,039 | | Net Income | $475,317 | $6,445 | | EPS (Basic and Diluted) | $23.11 | $0.21 | Notes to Consolidated Financial Statements The notes detail the VAA joint venture transaction, including the $1.81 billion sale of 45 properties and the $73.2 million remeasurement gain on the acquired VAA Holdback Portfolio, alongside disclosures on $188.0 million in mortgages, $129.2 million in bonds payable, and significant related party transactions - Note 10: On September 16, 2022, the VAA joint venture sold 45 properties for $1.81 billion, resulting in a gain of $738.4 million to the JV, with the company receiving substantial cash distributions and the remaining seven properties[206] - Note 11: On November 1, 2022, the company acquired the VAA Holdback Portfolio, resulting in a gain on remeasurement of assets of $73.2 million[196][215] Debt Summary (as of Dec 31, 2022, in thousands) | Debt Type | Carrying Value | | :--- | :--- | | Mortgages and other notes payable | $188,004 | | Bonds payable | $129,218 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on any matter of accounting principles or practices, or financial statement disclosure - None[267] Controls and Procedures Management concluded that the company's disclosure controls and procedures and internal control over financial reporting were effective as of December 31, 2022, with no material changes identified during the fourth quarter - Management concluded that the company's disclosure controls and procedures were effective as of the end of the period covered by the report[268] - Based on an assessment using the COSO framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2022[270] - No changes in internal control over financial reporting occurred during the fourth quarter of 2022 that materially affected, or are reasonably likely to materially affect, these controls[271] Other Information This item is not applicable - Not applicable[272] Part III Directors, Executive Officers and Corporate Governance This section details the company's governance structure, including its six-member Board with five independent directors, and describes the extensive Advisory Agreement with Pillar, which employs all executive officers and receives various fees - The Board of Directors has six members, with five deemed independent: Henry A. Butler, William J. Hogan, Robert A. Jakuszewski, Ted R. Munselle, and Raymond D. Roberts, Sr[277][279][281][291] - All executive officers, including the CEO and CFO, are employed by Pillar Income Asset Management, Inc. (Pillar), the company's external advisor, and the company has no direct employees[292][299] - Pillar's compensation includes a monthly gross asset fee (0.75% annually), a 7.5% net income fee, a 10% incentive sales fee, up to 1% acquisition commission, and a 6% construction fee on hard costs[301][302][304] Executive Compensation The company has no employees and does not directly compensate its executive officers, who are paid by the advisor Pillar; only independent directors receive remuneration, totaling $90,238 in 2022 - The company has no employees or payroll and pays no compensation to its executive officers, who are compensated by the external advisor, Pillar[317] - Non-affiliated Directors are entitled to an annual retainer of $12,000, with the Chairman of the Audit Committee receiving an additional annual fee of $500[318] - Total director fees paid to non-employee directors for the year ended December 31, 2022, was $90,238[319] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters As of March 23, 2023, The May Trust, through its affiliates, beneficially owned approximately 90.8% of the company's common stock, while ownership by directors and executive officers remains minimal - The May Trust, along with its affiliates May Realty Holdings, Inc. and Realty Advisors, Inc., is the largest beneficial owner, holding 14,669,820 shares, which represents 90.8% of the outstanding common stock[322] - Security ownership by management is very low, with only one of nine listed directors and executive officers, Bradford A. Phillips, holding shares (4,315 shares, or 0.02%), owned indirectly[324] Certain Relationships and Related Transactions, and Director Independence The company details extensive related party relationships, primarily with its advisor Pillar and property manager Regis, requiring independent director approval for all such transactions, and reported a $108.2 million receivable from related parties at year-end 2022 - The company's policy requires that any transaction with a related party must be determined to be fair and be authorized or ratified by a majority of independent directors[327] - In 2022, the company paid its advisor, Pillar, $8.8 million in advisory fees and $3.6 million in cost reimbursements, and paid Regis $0.4 million in property management and other fees[335][336] - As of December 31, 2022, the company had a receivable from related parties of $108.2 million, which accrues interest at the prime rate plus 1.0%[337] Principal Accounting Fees and Services This section details fees billed by the independent auditor, Farmer, Fuqua and Huff, L.P., with audit fees totaling $104,042 in 2022, and confirms the Audit Committee's policy for pre-approval of all audit and permissible non-audit services Auditor Fees Billed | Fee Category | 2022 | 2021 | | :--- | :--- | :--- | | Audit Fees | $104,042 | $183,333 | | Audit-Related Fees | $0 | $0 | | All Other Fees | $0 | $0 | - The Audit Committee has established policies and procedures for the pre-approval of all audit and permitted non-audit services performed by the independent auditor[343] Part IV Exhibits, Financial Statement Schedules This section lists all documents filed as part of the Form 10-K report, including consolidated financial statements, specific schedules for real estate and mortgage loans, and various exhibits such as the Advisory Agreement and officer certifications - The filing includes financial statements and two key schedules: Schedule III—Real Estate and Accumulated Depreciation, and Schedule IV—Mortgage Loan Receivables on Real Estate[346] - Key exhibits filed with the report include the Advisory Agreement with Pillar Income Asset Management (Exhibit 10.1) and certifications by the Principal Executive Officer and Principal Financial Officer as required by the Sarbanes-Oxley Act[348] Form 10-K Summary This section is optional and has not been included in the report - Optional and not included herein[349]