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TRADE STREET RESIDENTIAL, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS.(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion analyzes the financial condition and results of operations of Trade Street Residential, Inc. ("TSRE") and Trade Street Operating Partnership, LP ("TSOP"). A wholly owned subsidiary of TSRE, Trade Street OP GP, LLC is the sole general partner of TSOP. As of September 30, 2014, TSRE owned a 94.0% limited partner interest in TSOP. TSRE conducts all of its business and owns all of its properties through TSOP and TSOP's various subsidiaries. Except as otherwise required by the context, the "Company," "Trade Street," "we," "us" and "our" refer to TSRE and TSOP together, as well as TSOP's subsidiaries.FORWARD-LOOKING STATEMENTS Certain information presented in this Quarterly Report on Form 10-Q constitutes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 as amended (the "Securities Act"), and Section 21E of the Exchange Act of 1934, as amended (the "Exchange Act"). Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, our business, financial condition, liquidity, results of operations, funds from operations and prospects could differ materially from those set forth in the forward-looking statements. Certain factors that might cause such a material difference include the following: changes in general economic conditions, changes in real estate market conditions in general and within our specific submarkets, continued availability of debt or equity capital to finance acquisitions, our ability to locate suitable tenants for our properties, the ability of tenants to make payments under their respective leases, the timing of acquisitions, and sales of properties, the ability to meet development schedules and other risks, uncertainties and assumptions. Any forward-looking statement speaks only as of the date of this Quarterly Report on Form 10-Q, and we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. We caution investors not to place undue reliance on these forward-looking statements and urge investors to carefully review the disclosures we make concerning risks and uncertainties in the section entitled "Risk Factors" within our Annual Report on Form 10-K for the year ended December 31, 2013, which is accessible on the Securities and Exchange Commission (the "SEC") website at www.sec.gov, as well as risks, uncertainties and other factors discussed in this Quarterly Report on Form 10-Q and identified in other documents filed by us with the SEC. Overview of Our Company We are a vertically integrated and self-managed real estate investment trust ("REIT"), focused on acquiring, owning, operating and managing high-quality, conveniently-located apartment communities in mid-sized cities and suburban submarkets of larger cities primarily in the southeastern United States and Texas. We currently have approximately 150 full-time employees who provide property management, maintenance, landscaping, administrative and accounting services for the properties we own. We elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December31, 2004. We seek to own and operate apartment communities in cities that have: • a stable work force comprised of a large number of "echo boomers" augmented by positive net population migration; • well-paying jobs provided by a diverse mix of employers across the education, government, healthcare, insurance, manufacturing and tourist sectors; • a favorable cost of living; • reduced competition from larger multifamily REITs and large institutional real estate investors who tend to focus on select coastal and gateway markets; and • a limited supply of new housing and new apartment construction. We recognize that economic conditions could deteriorate and that the current economic recovery may not be sustainable. However, with the growth in multi-family supply expected to continue below historical averages for the next few years and with employment in our markets steady or increasing, we do not anticipate any significant slowdown in the multi-family sector. One of our core focuses during 2014 has been to strengthen our balance sheet and simplify our capital structure to (i) allow financial and operational flexibility and (ii) recycle capital through strategic acquisitions and dispositions of undeveloped land and older operating properties within our portfolio. In that regard, on July 11, 2014, we completed the sale of Post Oak, a 126-unit apartment community located in Louisville, Kentucky. Net cash proceeds from this sale were $7.8 million and we recognized a gain within continuing operations of approximately $0.4 million. On October 17, 2014, we executed and closed on an agreement with the holders of the Class A preferred stock to redeem 100% of the outstanding 309,130 shares of our Class A preferred stock in exchange for: 29 · Assignment of all interests in the following Land Investments: o The Estates at Maitland ("Maitland"), with a current indicated value of $9.4 million; o Millenia Phase II ("Millenia II"), with a current indicated value of $6.25 million; and o Venetian, with a current indicated value of $4.0 million. · Assignment of all interests in the Sunnyside land parcel, with a current indicated value of $1.5 million; · Cash payment of $5.0 million. On October 7, 2014, we entered into a non-binding agreement with a third party to purchase our undivided interest in the Midlothian Town Center East ("Midlothian") land parcel for $3.6 million. This agreement is subject to customary conditions terms for similar transactions, including a period of examination during which the agreement could be cancelled by us or the purchaser, and is expected to close during the second half of 2015. Emerging Growth Company We are an "emerging growth company" under the federal securities laws and, as such, we have elected to provide reduced public company reporting requirements in this and in future filings. In addition, Section 107 of the JOBS Act also provides that an "emerging growth company" can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with accounting standards newly issued or revised after April 5, 2012. In other words, an "emerging growth company" can delay the adoption of accounting standards until those standards would otherwise apply to privatecompanies. Our Properties As of September 30, 2014, our portfolio primarily consisted of an aggregate of 5,129 apartment units located in 20 operating properties, of which 19 were wholly-owned and one was owned through an unconsolidated joint venture in which we have a 50% interest as detailed in the following table: Average Average Year Built Date Number of Unit Size Physical Property Name Location Renovated (1) Acquired Units (Sq. Ft.) Occupancy (2) The Pointe at Canyon Ridge Sandy Springs, GA 1986/2007 09/18/08 494 920 94.8 % Arbors River Oaks Memphis, TN 1990/2010 06/09/10 191 1,136 96.6 % The Estates at Perimeter (3) Augusta, GA 2007 09/01/10 240 1,109 95.4 % Lakeshore on the Hill Chattanooga, TN 1969/2005 12/14/10 123 1,168 95.6 % The Trails of Signal Mountain Chattanooga, TN 1975 05/26/11 172 1,185 97.9 % Mercé Apartments Addison, TX 1991/2007 10/31/11 114 653 95.1 % Fox Trails Plano, TX 1981 12/06/11 286 960 96.3 % Millenia 700 Orlando, FL 2012 12/03/12 297 952 96.2 %Westmont Commons Asheville, NC 2003/2008 12/12/12 252 1,009 97.3 % Bridge Pointe Huntsville, AL 2002 03/04/13 178 1,047 97.9 % St. James at Goose Creek Goose Creek, SC 2009 05/16/13 244 976 95.7 % Creekstone at RTP Durham, NC 2013 05/17/13 256 1,043 96.3 % Talison Row at Daniel Island Charleston, SC 2013 08/26/13 274 989 92.4 % Fountains Southend Charlotte, NC 2013 09/24/13 208 844 96.9 % The Estates at Wake Forest Wake Forest, NC 2013 01/21/14 288 1,047 85.3 % Miller Creek at Germantown Memphis, TN 2012/2013 01/21/14 330 1,049 97.4 % The Aventine Greenville Greenville, SC 2013 02/06/14 346 961 93.3 % Waterstone at Brier Creek Raleigh, NC 2013/2014 03/10/14 232 1,137 85.7 % Avenues at Craig Ranch McKinney, TX 2013 03/18/14 334 1,006 93.9 % Waterstone at Big Creek Alpharetta, GA 2013 04/07/14 270 1,131 98.4 % Total / Weighted Average 5,129 1,013 94.8 % 30 (1) The extent of the renovations included within the term "renovated" depends on the individual apartment community, but "renovated" generally refers to the replacement of siding, roof, wood, windows or boilers, updating of gutter systems, renovation of leasing centers and interior rehabilitation, including updated appliances, countertops, vinyl plank flooring, fixtures, fans and lighting, or some combination thereof. (2) Average physical occupancy for the three months ended September 30, 2014 represents the average occupancy of the total number of units occupied at each apartment community during the period divided by the total number of units at each apartment community. (3) We own a 50% interest in this apartment community through an unconsolidated joint venture. Our interest in this joint venture was classified as held for sale at September 30, 2014, as a result of executing a contract for sale on that date that is anticipated to close prior to the end of 2014. While we do have a definitive agreement to sell our 50% interest of this joint venture investment, closing is subject to certain conditions and, as such, we can provide no assurance that this closing will occur on the terms we anticipate or at all. For the three months ended September 30, 2014, the weighted average monthly rent and monthly effective rent per occupied unit for operating properties was $1,007 and $994, respectively. Average monthly rent is market rent after "loss to lease" and concessions but before vacancy, discounted employee units, model units, and bad debt during the period. Effective rent per occupied unit is equal to the average of gross monthly rent minus any leasing discounts offered for each month during the period divided by the total number of occupied units each month during the period. Discounts include concessions, discounted employee units and model units. Operating properties acquired during the period are not included in these per unit results. Our Land Investments consist of the parcels described in the table below. Property Name Location Potential Use Acreage Venetian (1) Fort Myers, FL Apartments 23.0 Midlothian (2) Midlothian, VA Apartments 8.4 Maitland (3) Maitland, FL Apartments 6.1 Millenia II (4) Orlando, FL Apartments 7.0 Sunnyside (5) Panama City, FL Apartments 22.0 (1) Venetian was acquired from an insolvent developer after construction began. The site currently has improvements, including a partially completed clubhouse, building pads, roads and utilities. The net book value of this property as of September 30, 2014 was approximately $4.0 million. In February 2014, we reclassified Venetian as real estate assets held for sale. (2) Midlothian is currently approved for 246 apartment units and 10,800 square feet of retail space, including a parking deck structure. The project is currently going through a site plan modification process in Chesterfield County, Virginia that will allow the development of 238 apartment units, 10,800 square feet of retail space and the elimination of the parking deck structure. The net book value of this property as of September 30, 2014 was approximately $3.5 million. In February 2014, we reclassified Midlothian to real estate assets held for sale. On October 7, 2014, we entered into a non-binding agreement with a third party to purchase our undivided interest in the Midlothian land parcel for $3.6 million. This agreement is subject to customary terms for similar transactions, including a period of examination during which the agreement could be cancelled by either party and is expected to close during the second half of 2015. (3) Maitland is currently approved for a maximum of 330 apartment units and 20,000 square feet of retail space. The City of Maitland, Florida changed its zoning code allowing a higher density in May 2012. The municipal development agreement is currently being modified to include 416 units and 10,000 square feet of retail space. The net book value of this property as of September 30, 2014 was approximately $9.0 million. In February 2014, we reclassified Maitland to real estate assets held for sale. (4) Millenia II is currently approved for 403 apartment units and 10,000 square feet of retail space. The net book value of this property as of September 30, 2014 was approximately $6.2 million. In September 2014, we reclassified Millenia II to real estate held for sale. (5) Sunnyside is currently undeveloped land permitted for 212 apartment units and 20,000 square feet of retail space. The net book value of this property as of September 30, 2014 was approximately $1.5 million. On March 10, 2014, we completed foreclosure proceedings, obtained title to the Sunnyside asset and reclassified Sunnyside to real estate assets held for sale. During the three and nine months ended September 30, 2014, we recorded an approximate $8.0 million charge for impairment of the values of four of the five Land Investments classified as held for sale as of September 30, 2014. This non-cash impairment charge was based upon fair value estimates determined from unobservable market inputs, such as (i) opinions of value from independent commercial brokers and (ii) purchase offers or bids from unrelated third parties, that we believe provides the best indication of the current liquidation value of the Land Investments given our intent to dispose of these Land Investments in connection with the transaction to redeem all of our outstanding shares of Class A preferred stock. Approximately $0.7 million of this impairment charge was associated with the Midlothian Land Investment, on which we executed a non-binding contract for sale with an unrelated third party for $3.6 million on October 7, 2014. Summary Results of Operations The following discussion of results of operations for the three and nine months ended September 30, 2014 and 2013 should be read in conjunction with the Condensed Consolidated Statements of Operations of the Company and the related notes thereto included in Item 1 of this Form 10-Q. 31 Throughout this section, we have provided certain information on a "same store" property basis. We define "same store" properties as properties that were owned and stabilized since January 1, 2013 through September 30, 2014. For newly constructed or lease-up properties or properties undergoing significant redevelopment, we consider a property stabilized at the earlier of (i) attainment of 90% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment. For comparison of the three and nine months ended September 30, 2014 and 2013, the same store properties included operating properties owned since January 1, 2013, excluding operating properties disposed of during the three and nine months ended September 30, 2014 and 2013 (see below). No operating properties owned since January 1, 2013 were under construction or undergoing redevelopment and, as a result, no operating properties owned since January 1, 2013 were excluded from the same store portfolio. For the three months ended September 30, 2014, we reported net loss attributable to common stockholders of ($9.1) million, compared with net income attributable to common stockholders of $1.4 million for the prior year period. For the nine months ended September 30, 2014, we reported net loss attributable to common stockholders of ($28.3) million, compared with net income attributable to common stockholders of $4.1 million in the prior year period. The principal factors that impacted our results from continuing operations for the three months ended September 30, 2014 as compared to the same period ofthe prior year were: · Increases in same-store revenues of $0.2 million, or 3.6%, and net operating income of $0.1 million, or 2.2%; · Increases in revenue and net operating income of $7.3 million and $4.3 million, respectively, from eight operating properties acquired since August 2013; · a $1.2 million decrease in general and administrative expenses associated with reductions in long-term incentive compensation and travel expenses; · a $1.2 million increase in interest expense associated with increased indebtedness used to partially fund the acquisition of the eight operating properties acquired since August 2013; · a $1.6 million increase in depreciation and amortization expense due to the additional eight operating properties acquired since August 2013; · an $8.0 million charge for impairment of the values of four of the five Land Investments owned by the Company which have been classified as held for sale due to the closing of our the transaction to redeem all of our outstanding shares of Class A preferred stock on October 17, 2014; and · The prior year period also included a $6.9 million bargain purchase gain from the acquisition of an operating property. There was no similar gain recognized in the current year. In addition to the factors described above, the principal factors that impacted our results from continuing operations for the nine months ended September30, 2014 were: · Increases in same-store revenues of $0.8 million, or 5.0%, and net operating income of $0.3 million, or 3.7%; · Increases in revenue and net operating income of $21.1 million and $12.0 million, respectively, from eleven operating properties acquired since March 2013; · The $9.3 million management transition expenses related to the resignation of certain executive officers and other members of management during the first half of 2014; · a $3.5 million increase in interest expense associated with increased indebtedness used to partially fund the acquisition of eleven operating properties acquired since March 2013; · a $6.9 million increase in depreciation and amortization expense due to the eleven operating properties acquired since March 2013; · a $0.7 million increase in the costs to acquire operating properties; and · a $0.5 million increase in loss from early extinguishment of debt associated with refinancing of certain of the operating properties. RESULTS OF OPERATIONS Comparison of three and nine months ended September 30, 2014 to the three and nine months ended September 30, 2013 Below are the results of operations for the three and nine months ended September 30 2014 and 2013. In the comparative tables presented below, increases in revenues/income or decreases in expenses (favorable variances) are shown without parentheses while decreases in revenues/income or increases in expenses (unfavorable variances) are shown with parentheses. For purposes of comparing our results of operations for the periods presented below, all of our properties in the "same store" reporting group were wholly owned from January 1, 2013 through September 30, 2014. Property Revenues include rental revenue and other property revenues. Property Expenses include property operations, real estate taxes and insurance. 32 Three Months Ended Nine Months Ended Apartment September 30, Change September 30, Change(dollars in thousands) Units 2014 2013 $ % 2014 2013 $ % Property Revenues Same Store (8 properties) 1,929 $ 5,410 $ 5,221 $ 189 3.6 % $ 15,939 $ 15,184 $ 755 5.0 % Non Same Store (11 properties) 2,960 9,845 2,523 7,322 290.2 % 24,785 3,694 21,091 571.0 % Other (1 property) - 51 283 (232 ) (82.0 )% 645 871 (226 ) (25.9 )% Total property revenues 4,889 $ 15,306 $ 8,027 $ 7,279 90.7 % $ 41,369 $ 19,749 $ 21,620 109.5 % Property Expenses Same Store (8 properties) 1,929 $ 2,475 $ 2,348 $ (127 ) (5.4 )% $ 7,305 $ 6,860 $ (445 ) (6.5 )% Non Same Store (11 properties) 2,960 3,949 1,046 (2,903 ) (277.5 )% 10,675 1,616 (9,059 ) (560.6 )% Other (1 property) - 27 164 137 83.5 % 361 452 91 20.1 % Total property expenses 4,889 $ 6,451 $ 3,558 $ (2,893 ) (81.3 )% $ 18,341 $ 8,928 $ (9,413 ) (105.4 )% Same Store Properties-Property Revenues and Property Expenses Same store property revenues increased approximately $0.2 million, or 3.6%, for the three months ended September 30, 2014 as compared to the same period in 2013 primarily due to a 4.0% increase in average rental rates. Same store property revenues increased approximately $0.8 million, or 5.0%, for the nine months ended September 30, 2014 as compared to the same period in 2013 primarily due to an increase of $0.5 million as a result of a 3.2% increase in average rental rates, an increase of $0.2 million as the result of a 90 basis point increase in average occupancy and an increase of $0.1 million in other property revenues. Same store property expenses increased approximately $0.1 million, or 5.4%, for the three months ended September 30, 2014 as compared to the same period in 2013 primarily a result of $0.1 million increase in property taxes. Same store property expenses increased approximately $0.3 million, or 4.9%, for the nine months ended September 30, 2014 as compared to the same period in 2013 after adjusting for the benefit of a $0.1 million 2012 property tax settlement received in the prior year period. This increase was primarily a result of a $0.1 million increase in property taxes, $0.1 million in weather-related expenses, and increased utilities and make ready/turnover expenses during the nine months ended September 30, 2014. Non-Same Store Properties-Property Revenues and Property Expenses Property revenues and expenses for our non-same store properties increased significantly due to the acquisition of five operating properties during 2013 and the acquisition of six operating properties in 2014. The results of operations for these properties have been included in our consolidated statements of operations from the date of acquisition. Property revenues and expense classified as other for the periods presented are primarily associated with the Post Oak community that we sold during the quarter ended September 30, 2014. Other Expenses Three Months Ended Nine Months Ended September 30, Change September 30, Change(dollars in thousands) 2014 2013 $ % 2014 2013 $ % General and administrative $ 1,943 $ 3,099 $ 1,156 37.3 % $ 6,356 $ 6,482 $ 126 1.9 % Management transition expenses $ - $ - $ - - $ 9,291 $ - $ (9,291 ) * Interest expense $ 3,381 $ 2,210 $ (1,171 ) (53.0 )% $ 9,572 $ 6,110 $ (3,462 ) (56.7 )% Depreciation and amortization $ 4,922 $ 3,312 $ (1,610 ) (48.6 )% $ 15,389 $ 8,479 $ (6,910 ) (81.5 )% Development and pursuit costs $ 217 $ 52 $ (165 ) (317.3 )% $ 356 $ 67 $ (289 ) (431.3 )% Acquisition costs $ - $ 472 $ 472 100.0 % $ 1,641 $ 916 $ (725 ) (79.1 )% Amortization of deferred financing costs $ 236 $ 275 $ 39 14.2 % $ 788 $ 994 $ 206 20.7 % Loss on early extinguishment of debt $ - $ - $ - - $ 1,629 $ 1,146 $ (483 ) (42.1 )% * Not a meaningful percentage. 33 General and administrative expense decreased approximately $1.2 million, or 37.3%, for the three months ended September 30, 2014 as compared to the same period of 2013 primarily due to a $1.0 million decrease in short- and long-term incentive compensation and a $0.2 million decrease in travel expenses. For the nine months ended September 30, 2014, general and administrative expense decreased $0.1 million, or 1.9%, primarily due the net impact of decreases in short- and long-term incentive compensation ($0.4 million) and travel expenses ($0.4 million), which were partially offset by increases in legal and contract staff costs incurred during the transition of management ($0.2 million), information technology and software licensing costs ($0.2 million), costs associated with operating as a public company ($0.2 million) and franchise taxes due to property acquisitions in Texas and Tennessee ($0.1 million). Management transition expenses for the nine months ended September 30, 2014 of approximately $9.3 million are associated with the restructuring of our management team of which approximately $3.5 million was paid in cash, $3.3 million was paid in shares of our common stock, and $2.5 million was charged relating to the conversion of Class B contingent units into common operating partnership units. Interest expense increased approximately $1.2 million, or 53.0%, for the three months ended September 30, 2014, substantially due to the increase in debt as a result of the aforementioned acquisition of five operating properties during 2013 and the acquisition of six properties completed during 2014. Interest expense increased approximately $3.5 million, or 56.7%, for the nine months ended September 30, 2014, substantially due to the increase in debt as a result of the aforementioned eleven acquisitions completed since March 2013. Depreciation and amortization expense for the three months ended September 30, 2014 increased approximately $1.6 million, or 48.6%, as compared to the same period in 2013. This increase was primarily due to the aforementioned ten acquisitions completed since May 2013. Depreciation and amortization expense for the nine months ended September 30, 2014 increased approximately $6.9 million, or 81.5%, as compared to the same period in 2013. This increase was primarily due to the aforementioned eleven acquisitions completed since March 2013. Acquisition expenses are charged to expense in the period incurred. Our acquisition expenses include direct costs to acquire apartment communities, including broker fees, certain transfer taxes, legal, accounting, valuation, and other professional and consulting fees. For the three months ended September 30, 2013, acquisition expenses were approximately $0.5 million, primarily due to costs incurred in the acquisition of Talison Row at Daniel Island and Fountains Southend. No acquisition expenses were recorded in the three months ended September 30, 2014. For the nine months ended September 30, 2014, acquisition expenses were approximately $1.7 million, primarily due to costs incurred in the acquisition of Miller Creek, Wake Forrest, Aventine, Brier Creek, Craig Ranch and Big Creek. For the nine months ended September 30, 2013, acquisition expenses were approximately $0.9 million, primarily due to costs incurred in the acquisition of Bridge Pointe, Creekstone, St. James, Talison Row at Daniel Island and Fountains Southend. Amortization of deferred financing costs decreased approximately $0.2 million for the nine months ended September 30, 2014 as compared to the same periods in 2013. The decrease was primarily due to the refinancing of debt on Millenia 700 and The Pointe at Canyon Ridge, which are amortized over a longer period than the previous debt. Loss on early extinguishment of debt for the nine months ended September 30, 2014 includes prepayment penalties and write-off of unamortized deferred loan costs related to the refinancing of a bridge loan for Southend, refinancing of the mortgage note payable for Millenia 700 and the pay down in full of indebtedness on Fox Trails, Mercé Apartments and our former Post Oak Property. Loss on extinguishment of debt for the nine months ended September 30, 2013 includes the early prepayment penalties related to the refinancing of the bridge loan for The Point at Canyon Ridge as well as the refinancing of debt on Arbor River Oaks. Other Income and Expenses Three Months Ended Nine Months Ended September 30, Change September 30, Change(dollars in thousands) 2014 2013 $ % 2014 2013 $ % Other income $ 1 $ 26 $ (25 ) * $ 45 $ 70 $ (25 ) 35.7 % Impairment associated with land holdings $ (7,962 ) $ - $ (7,962 ) * $ (7,962 ) $ (613 ) $ (7,349 ) * Gain on sales of real estate assets $ 353 $ - $ 353 * $ 353 $ - $ 353 * Gain on bargain purchase $ - $ 6,900 $ (6,900 ) * $ - $ 6,900 $ (6,900 ) * Income from operation of discontinued rental property including gains/losses on disposals $ - $ (80 ) $ 80 * $ - $ 1,696 $ (1,696 ) * (Income) loss allocated to noncontrolling interest holders $ 566 $ (258 ) $ (824 ) 319.4 % $ 1,907 $ 911 $ (996 ) (109.3 )% * Not a meaningful percentage. 34 During the three and nine months ended September 30, 2014, we recorded an approximate $8.0 million charge for impairment of the values of four of the five Land Investments classified as held for sale as of September 30, 2014. This non-cash impairment charge was based upon fair value estimates determined from unobservable market inputs, such as (i) opinions of value from independent commercial brokers and (ii) purchase offers or bids from unrelated third parties, that we believe provides the best indication of the current liquidation value of the Land Investments given our intent to dispose of these Land Investments in connection with the transaction to redeem all of our outstanding shares of Class A preferred stock. Approximately $0.7 million of this impairment charge was associated with the Midlothian Land Investment, on which we executed a non-binding contract for sale with an unrelated third party for $3.6 million on October 7, 2014. Approximately $0.6 million of impairment associated with land holdings was recorded during the nine months ended September 30, 2013 to write down the carrying value of the Maitland Land Investment. Maitland is classified as real estate assets held for sale in the accompanying condensed consolidated balance sheet. The impairment charge was based on an appraisal of the land which was determined to be the best indication of fair market value. Gain on sales of real estate assets for the both the three and nine months ended September 30, 2013 represents a gain recorded on the Post Oak community that we sold during the quarter ended September 30, 2014. There was no comparable gain recorded in the three and nine months ended September 30, 2013. Gain on bargain purchase for the both the three and nine months ended September 30, 2013 represents a gain recorded on the acquisition of Fountains Southend. We placed the property under contract for a purchase price of $34.0 million in December 2012 while the property was early in the construction period. As a result of the strong leasing market in the Charlotte, North Carolina market and the compression in multi-family capitalization rates during construction and lease-up, the property appraised for $40.9 million at closing on September 24, 2013 resulting in the bargain purchase gain. There was no comparable gain recorded in the three and nine months ended September 30, 2014. Income from operations of discontinued rental property for the three months ended September 30, 2013 includes primarily the operating results for discontinued rental properties. Income from operations of discontinued rental property including gains/losses on disposals for the nine months ended September 30, 2013 includes primarily the sale of Fontaine Woods on March 1, 2013 (approximately $1.6 million) and the sale of Oak Reserve on June 12, 2013 (approximately $0.5 million). The 2013 gain was offset by $0.1 million for payments from escrow during the nine months ended September 30, 2013 related to the sale of Mill Creek property in the fourth quarter of 2012. The properties included in discontinued operations were all sold during 2013. (Income) loss allocated to noncontrolling interests for the above periods primarily represents the noncontrolling interest in our Operating Partnership. The proportionate allocation of loss to noncontrolling interest as a percentage decreased during the nine months ended September 30, 2014 as compared to the same period in 2013 due to the conversion of 210,915 Class B contingent units into 2,343,500 OP units. Funds from Operations and Core FFO Funds from operations ("FFO") is defined by the National Association of Real Estate Investment Trusts ("NAREIT"), as net income (computed in accordance with GAAP), excluding gains (losses) from sales of property and bargain purchase gains, plus real estate-related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. Our calculation of FFO is in accordance with the NAREIT definition. Management considers FFO to be useful in evaluating potential property acquisitions and measuring operating performance. FFO does not represent net income or cash flows from operations as defined by GAAP. You should not consider FFO to be an alternative to net income as a reliable measure of our operating performance; nor should you consider FFO to be an alternative to cash flows from operating, investing or financing activities (as defined by GAAP) as measures of liquidity. Further, FFO as disclosed by other REITs might not be comparableto our calculation of FFO. Management believes that the computation of FFO in accordance with NAREIT's definition includes certain items, such as gains and losses on extinguishment of debt, transaction costs related to acquisitions, management transition costs and certain other non-cash items that are not indicative of the results provided by our operating portfolio and affect the comparability of our period-over-period performance with other multifamily REITs. Accordingly, management believes that it is helpful to investors to add back non-comparable and non-cash items to arrive at Core FFO. The following table sets forth a reconciliation of FFO and Core FFO for the periods presented to net income (loss) attributable to common stockholders, as computed in accordance with GAAP: 35 Three Months Ended Nine Months Ended September 30, September 30,in thousands, except per share amounts 2014 2013 2014 2013 Net income (loss) attributable to common stockholders $ (9,086 ) $ 1,360 $ (28,279 ) $ 4,121 Adjustments related to earnings per share computation (1) (14 ) 1 (44 ) (9,224 ) Impairment associated with land holdings 7,484 - 7,448 507 Real estate depreciation and amortization - continuing operations 4,709 2,858 14,642 7,015 Real estate depreciation and amortization - discontinued operations - - - 364 Real estate depreciation and amortization - unconsolidated joint venture 96 80 283 239 Gain on bargain purchase - (5,954 ) - (5,709 ) Gains on sales of real estate assets (332 ) - (330 ) (1,610 ) Funds from operations attributable to common stockholders (2) $ 2,857 $ (1,655 ) $ (6,280 ) $ (4,297 ) Management transition expenses - - 8,691 - Acquisition costs - 407 1,535 758 Loss on early extinguishment of debt - - 1,524 955 Non-cash straight-line adjustment for ground lease expenses - 89 - 256 Non-cash stock awards 122 1,076 292 1,191 Non-cash accretion of preferred stock and units 156 156 462 495 Core funds from operations attributable to common stockholders (2) $ 3,135 $ 73 $ 6,224 $ (642 ) Per share data Funds from operations - diluted $ 0.08 $ (0.15 ) $ (0.18 ) $ (0.53 ) Core funds from operations - diluted $ 0.09 $ 0.01 $ 0.18 $ (0.08 ) Weighted average common shares outstanding - diluted(3)(4) 36,723 11,394 35,133 8,082 (1) See Notes B and G to the accompanying Condensed Consolidated Financial Statements. (2) Individual line items included in the computations are net of noncontrolling interests and include results from discontinued operations where applicable. (3) Includes non-vested portion of restricted stock awards. (4) The calculations of funds from operations and core funds from operations are reflected net of noncontrolling interests. Accordingly, noncontrolling interests represented by 2,344 Operating Partnership common units during the three and nine months ended September 30, 2014 and 2013 are not included in the determination of diluted weighted-average common shares outstanding. If these calculations had considered noncontrolling interests and the 2,344 common units had been included as part of diluted weighted-average shares outstanding, there would have been no impact on the per share amounts of funds from operations or core funds from operations. 36 Net Operating Income We believe that net operating income ("NOI") is a useful measure of our operating performance. We define NOI as total property revenues less total property operating expenses, excluding depreciation and amortization. Other REITs may use different methodologies for calculating NOI, and accordingly, our NOI may not be comparable to other REITs. We believe that this measure provides an operating perspective not immediately apparent from GAAP operating income or net income. We use NOI to evaluate our performance on a same store and non-same store basis because NOI allows us to evaluate the operating performance of our properties as it measures the core operations of property performance by excluding corporate level expenses and other items not related to property operating performance and captures trends in rental housing and property operating expenses. In addition, results for three and nine months ended September 30, 2014 and 2013 represent continuing operations and; therefore, exclude NOI from discontinued operations (Oak Reserve at Winter Park, The Beckanna on Glenwood, Fontaine Woods, Terrace at River Oaks and Estates of Mill Creek). Three Months Ended Nine Months Ended September 30, September 30, in thousands 2014 2013 2014 2013 Net Operating Income (1) Same Store (8 properties) $ 2,935 $ 2,873 $ 8,634 $ 8,324Non Same Store (11 properties) 5,896 1,477 14,110 2,078 Other (1 property) 24 119 284 419 Total property net operating income $ 8,855 $ 4,469 $ 23,028 $ 10,821 Reconciliation of NOI to GAAP Net Income (Loss) Total property net operating income $ 8,855 $ 4,469 $ 23,028 $ 10,821 Other income 1 26 45 70 Gains on sales of real estate assets 353 - 353 - Gain on bargain purchase - 6,900 - 6,900 Depreciation and amortization (4,922 ) (3,312 ) (15,389 ) (8,479 ) Development and pursuit costs (217 ) (52 ) (356 ) (67 ) Interest expense (3,381 ) (2,210 ) (9,572 ) (6,110 ) Amortization of deferred financing costs (236 ) (275 ) (788 ) (994 ) Loss on early extinguishment of debt - - (1,629 ) (1,146 ) General and administrative (1,943 ) (3,099 ) (6,356 ) (6,482 ) Management transition expenses - - (9,291 ) - Impairment associated with land holdings (7,962 ) - (7,962 ) (613 ) Acquisition costs - (472 ) (1,641 ) (916 ) Income (loss) from unconsolidated joint venture 20 (13 ) 21 42 Income (loss) from continuing operations (9,432 ) 1,962 (29,537 ) (6,974 ) Discontinued operations - (80 ) - 1,696 Net income (loss) (9,432 ) 1,882 (29,537 ) (5,278 ) (Income) loss allocated to noncontrolling interests 566 (258 ) 1,907 911 Adjustments related to earnings per share computation (1) (220 ) (264 ) (649 ) 8,488 Income (loss) attributable to common stockholders $ (9,086 ) $ 1,360 $ (28,279 ) $ 4,121 (1) See Notes B and G to the accompanying Condensed Consolidated Financial Statements. 37 Liquidity and Capital Resources As of September 30, 2014, our outstanding indebtedness was $344.9 million, which is comprised of $297.9 million of mortgage indebtedness secured by our properties and $47.0 million of borrowings under our Revolver. Factors which could increase or decrease our future liquidity include, but are not limited to, access to and volatility in capital and credit markets; sources of financing; our ability to complete asset purchases, sales or developments; and the effect our debt level and changes in credit ratings could have on our cost of funds. Financial Condition and Sources of Liquidity Our primary sources of liquidity are cash on hand, availability under our Revolver, proceeds from refinancing of existing mortgaged apartment communities, proceeds from new mortgage loans on newly stabilized apartment communities, net cash from the operation of our apartment communities, net proceeds from the sale of certain properties, and net proceeds from offerings of our securities. As of September 30, 2014, we had $16.7 million of available cash on hand, and $11.1 million available for future borrowings under the Revolver that can be usedfor general corporate purposes. As of the date of this Quarterly Report, we had approximately $11.6 million of available cash on hand and approximately $11.1 million available for future borrowings under the Revolver that can be used for acquisition and general corporate purposes. Shares Issuances On January 16, 2014, we received net cash proceeds from the sale of 24,881,517 shares of our common stock offered in our Rights Offering and the related transactions of approximately $147.2 million after deducting offering expenses of approximately $2.8 million payable by us. We contributed the net proceeds we received from the Rights Offering and the related transactions to our Operating Partnership in exchange for common units of our Operating Partnership. The Operating Partnership used approximately (i) $94.6 million, which include approximately $1.5 million for acquisition costs, to acquire five communities, (ii) $26.0 million to repay short-term borrowings under our Revolver, which were repaid within five business days after initially being borrowed, (iii) $16.7 million to pay down, in part, certain indebtedness secured by two communities in conjunction with their refinancing, and (iv) $4.2 million to pay down certain indebtedness secured by land held for development, leaving approximately $5.7 million for working capital and general corporate purposes. Secured Revolving Credit Facility On January 31, 2014, we and the Operating Partnership entered into a Revolver with Regions Bank as Lead Arranger and U.S. Bank National Association as a participant. The Revolver is comprised of an initial $75.0 million commitment with an accordion feature allowing us to increase borrowing capacity to $250.0 million subject to certain approvals and meeting certain criteria. The Revolver has an initial three-year term that can be extended at our option for up to two, one-year periods and has a variable interest rate of LIBOR, as defined in the agreement, plus a margin of 175 basis points to 275 basis points, depending on our consolidated leverage ratio. As of September 30, 2014, the weighted average interest rate was approximately 2.69%. The Revolver is guaranteed by us and certain of our subsidiaries and is secured by first priority mortgages on designated properties that make up the borrowing base ("Borrowing Base") as defined in the loan documents. Availability under the Revolver is permitted up to sixty-five percent (65%) of the value of the Borrowing Base subject to the limitations set forth in the loan documents. The loan documents contain customary affirmative and negative covenants with respect to, among other things, insurance, maintaining at least one class of exchange listed common shares, the guaranty in connection with the Revolver, liens, intercompany transfers, transactions with affiliates, mergers, consolidation and asset sales, ERISA plan assets, modification of organizational documents and material contracts, derivative contracts, environmental matters, and management agreements and fees. In addition, the loan documents require us to satisfy certain financial covenants, including the following: · minimum tangible net worth of at least $158.0 million plus 75.0% of the net proceeds of any equity issuances effected at any time after September 30, 2013 by the Operating Partnership or any of its subsidiaries; · maintaining a ratio of funded indebtedness to total asset value of no greater than 0.65 to 1.0; · maintaining a ratio of adjusted EBITDA to fixed charges of no less than (i)1.3 to 1.0 from the effective date of the loan documents to and including March 31, 2014, (ii) 1.4 to 1.0 from April 1, 2014 to and including June 30, 2014, and (iii) 1.5 to 1.0 from July 1, 2014 and at all times thereafter; · limits on investments in unimproved land, mortgage receivables, interests in unconsolidated affiliates, construction-in-progress on development properties, and marketable securities and non-affiliated entities, in each case, based on the value of such investments relative to total asset value, as set forth in the loan documents; and · restrictions on certain dividend and cash distributions. We were in compliance with all applicable covenants, including these financial covenants, at September 30, 2014. 38 On January 31, 2014, in conjunction with the closing of the Revolver, we borrowed approximately $27.0 million to pay down, in full, indebtedness secured by Fox Trails of $14.9 million, Mercé Apartments of $5.5 million and Post Oak Property of $5.3 million as these properties served as collateral on the Revolver and to pay fees associated therewith. The remainder of the amount borrowed of approximately $0.9 million was used for closing costs and other expenses related to the Revolver and approximately $0.4 million for working capital purposes. On February 24, 2014, we entered into an amendment to our Revolver to, among other things: · Exclude from the definition of "EBITDA" non-comparable cash costs in an amount not to exceed $4.0 million incurred during the fiscal quarter ending March 31, 2014, in connection with the severance of various officers (discussed below) during such fiscal quarter; and · Exclude transactions in connection with the severance of various officers from the application of certain covenants relating to restricted payments and transactions with affiliates. On April 7, 2014, we entered into a second amendment to our Revolver and an Accession Agreement with the participating banks in the Revolver to modify certain terms and conditions of the Revolver related to the additions of new borrowing base properties. Also, on April 7, 2014, we drew $37.0 million from the Revolver to complete the purchase of Big Creek. During the nine months ended September 30, 2014, we repaid $17.0 million under the Revolver. On August 5, 2014, the Company and the Operating Partnership executed a Third Amendment to the Credit Agreement to modify certain terms and conditions of the Revolver related to cash dividends paid by us for any fiscal year ending after December 31, 2014shall not exceed the greater of (i) the amount required to be distributed for us to remain in compliance with REIT status or (ii) 95.0% of our Funds From Operations for such period. On October 16, 2014, we and the Operating Partnership executed a Fourth Amendment to the Credit Agreement to modify certain terms and conditions in the Revolver related to the weighting of the borrowing base properties value with any one geographic area and to reduce the required minimum tangible net worth to $123.0 million, plus 75.0% of the net proceeds of any equity issuances by the Operating Partnership or any of its subsidiaries. Short-Term Liquidity Requirements Our short-term liquidity requirements will primarily be to fund operating expenses, recurring capital expenditures, property taxes and insurance, interest and scheduled debt principal payments, general and administrative expenses and distributions to stockholders and unitholders, as well as the acquisition and financing activity described below. We expect to meet these requirements using our cash on hand, the net cash provided by operations, the net cash proceeds from the sale of certain properties and, to the extent available, by accessing our Revolver and the capital markets. Dividend Declared On August 12, 2014, the Board approved a dividend in the amount of $0.095 per share, payable to holders of record of shares of common stock as of September 30, 2014. The dividend was subsequently paid on October 15, 2014, and we paid equivalent amounts per unit to holders of the common units in the operating partnership. The total amount distributed was approximately $3.7 million. As a REIT, we are required to distribute at least 90% of our REIT taxable income, excluding net capital gains, to stockholders on an annual basis. We expect that these needs will be met from cash generated from operations and other sources, including proceeds from secured mortgage and unsecured indebtedness, proceeds from additional equity issuances, cash generated from the sale of property and the formation of joint ventures Redemption of Class A Preferred Stock On October 17, 2014, we executed and closed on an agreement with the holders of the Class A preferred stock to redeem 100% of the outstanding 309,130 shares of our Class A preferred stock in exchange for: · Assignment of all interests in the following Land Investments: o Maitland, with a current indicated value of $9.4 million; o Millenia II, with a current indicated value of $6.25 million; and o Venetian, with a current indicated value of $4.0 million. · Assignment of all interests in the Sunnyside land parcel, with a current indicated value of $1.5 million; and · Cash payment of $5.0 million. 39 Acquisition of Big Creek Phase II As of September 30, 2014, we are party to an agreement to purchase an additional 100 units adjacent to our Waterstone at Big Creek community for $15.0 million for which a $0.2 million nonrefundable deposit has been paid by us. The closing of this acquisition is expected during the first quarter of 2015. Long-Term Liquidity Requirements Our principal long-term liquidity requirements will primarily be to fund additional property acquisitions, major renovation and upgrading projects and debt payments and retirements at maturities. We do not expect that net cash provided by operations will be sufficient to meet all of these long-term liquidity needs. We anticipate meeting our long-term liquidity requirements by using cash, short-term credit facilities and net proceeds from the sale of certain properties as an interim measure, to be replaced by funds from borrowing under public and private equity and debt offerings, long-term secured and unsecured indebtedness, or joint venture investments. In addition, we may use Operating Partnership units issued by our Operating Partnership to acquire properties from existing owners seeking a tax-deferred transaction. Cash Flows Summary Below is a summary of our recent cash flow activity: Nine Months Ended September 30, (In thousands) 2014 2013 Sources (uses) of cash and cash equivalents: Operating activities $ 11,567 $ (927 ) Investing activities (129,747 ) (59,443 ) Financing activities 125,856 62,266 Net change in cash and cash equivalents $ 7,676 $ 1,896 Cash Flows for the Nine Months Ended September 30, 2014 Compared to the Nine Months Ended September 30, 2013 Operating Activities Net cash provided by operating activities increased $12.5 million to $11.6 million for the nine months ended September 30, 2014 compared to approximately $0.9 million net cash used in operating activities for the nine months ended September 30, 2013. This increase was primarily the result of a $12.5 million increase in net operating income primarily associated with our operating communities, a $7.3 million reduction in from prepaid expenses and other assets, primarily from applying deposits to acquisitions and deferred offering costs, a $1.1 million reduction in restricted cash, a $1.4 million increase in accounts payable and other accrued expenses, and a $0.2 million increase in security deposits. Partially offsetting these cash flow benefits is $3.5 million in cash expenditures associated with the restructuring of management, a $0.7 million increase in net cash paid for acquisition costs, a $3.8 million increase in net interest payments, a $0.9 million increase in general and administrative expenses, a $0.3 million increase in development and pursuit costs and $0.7 million reduction in net cash provided by discontinued operations. Investing Activities Net cash used in investing activities was approximately $129.7 million during the nine months ended September 30, 2014 compared to approximately $59.4 million net cash used in investing activities during the nine months ended September 30, 2013. The increase in net cash used in investing activities was primarily the result of the use of approximately $135.1 million during the nine months ended September 30, 2014 for the acquisition of six properties compared to the use of approximately $62.2 million during the nine months ended September 30, 2013 for the acquisition of five properties. Additions from property capital expenditures during the nine months ended September 30, 2014 totaled $2.5 million as compared to $1.8 million in the comparable prior year period and $1.5 million of cash paid was for the acquisition of a mortgage loan receivable during the nine months ended September 30, 2013. Partially offsetting the cash used in investing activities during the nine months ended September 30, 2014 is approximately $7.8 million of net proceeds from the sale of an operating property included in continued operations and $5.7 million from the sale of two operating properties included in discontinued operations during the comparable prior year period. Financing Activities Net cash provided by financing activities was approximately $125.9 million during the nine months ended September 30, 2014 compared to approximately $62.3 million net cash provided by financing activities during the nine months ended September 30, 2013. The increase in net cash provided by financing activities was primarily due to $92.7 million of additional net proceeds from the issuance of our common stock, net of offering costs, a $85.8 million increase in proceeds from indebtedness, a $0.7 million reduction in related parties receivable, a $0.3 million reduction in prepayment fees for early extinguishment of debt, a $3.7 million reduction in payments for redemption of noncontrolling interest, and a $4.1 million reduction in net cash used in discontinued operations. Partially offsetting the cash provided by financing activities is $103.0 million increase in debt repayment, a $1.2 million increase in payment of deferred loan costs, a $5.5 million increase in distributions to stockholders and unit holders, and cash payments of $1.0 million to cover withholding taxes related to restricted shares vested during the nine months ended September 30, 2014. 40 Off-Balance Sheet Arrangements As of September 30, 2014, we had no off-balance sheet arrangements that have had or are reasonably likely to have a material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital resources or capital expenditures. On September 30, 2014, we entered into an agreement to sell our 50% joint venture interest in one operating property, which we account for under the equity method as we exercise significant influence over, butdo not control, the investee. Income Taxes No provision has been made for income taxes since all of our operations are held in pass-through entities and accordingly the income or loss of the company is included in the individual income tax returns of the partners or members. We elected to be taxed as a REIT under the Code beginning with our taxable year ended December 31, 2004. As a REIT, we generally are not subject to federal income tax on income that we distribute to our stockholders. 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 tax rates. We believe that we are organized and operate in a manner to qualify and be taxed as a REIT and we intend to operate so as to remain qualified as a REIT for federal income tax purposes. Inflation Inflation in the United States has been relatively low in recent years and did not have a significant impact on the results of operations for the company's business for the periods shown in the consolidated historical financial statements. We do not believe that inflation poses a material risk to the company. The leases at our apartment properties are short term in nature. None are longer than two years, and most are one year or less. Although the impact of inflation has been relatively insignificant in recent years, it does remain a factor in the United States economy and could increase the cost of acquiring or replacing properties in the future. Critical Accounting Policies Our 2013 Annual Report on Form 10-K contains a description of our critical accounting policies, including purchase price allocation and related depreciation and amortization, capital expenditures, impairment of real estate assets, revenue recognition, property expenses, accounting for recapitalization and accounting for the variable interest entity. For the nine months ended September 30, 2014, there were no material changes to these policies, except for the presentation change related to our adoption of ASU 2014-08. We evaluate our estimates, assumptions and judgments on an ongoing basis, based on information that is then available to us, our experience and various matters that we believe are reasonable and appropriate for consideration under the circumstances. Our critical accounting policies have not changed materially from information reported in our Annual Report on Form 10-K for the year ended December 31, 2013 which was filed with the SEC on March 26, 2014, except for the early adoption of ASU 2014-08. See Note A to the Condensed Consolidated Financial Statements. |