Amendment No. 1 to Form 10-K
Table of Contents
Index to Financial Statements

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-K/A

(Amendment No. 1)

 

x ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Year Ended December 31, 2004

 

¨ TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 001-15663

 


 

American Realty Investors, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Nevada

(State or Other Jurisdiction of
Incorporation or Organization)

 

75-2847135

(I.R.S. Employer
Identification No.)

 

1800 Valley View Lane, Suite 300,

Dallas, Texas

(Address of Principal Executive Offices)

 

75234

(Zip Code)

 

(469) 522-4200

(Registrant’s Telephone Number, Including Area Code)

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of each class

Common Stock, $.01 par value

 

Name of each exchange on which registered

New York Stock Exchange

 

Securities Registered Pursuant to Section 12(g) of the Act:

 

NONE

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

 

The aggregate market value of the shares of voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the closing sales price of the Common Stock on the New York Stock Exchange as of June 30, 2004 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $19,911,105 based upon a total of 2,204,995 shares held as of June 30, 2004 by persons believed to be non-affiliates of the Registrant. The basis of the calculation does not constitute a determination by the Registrant as defined in Rule 405 of the Securities Act of 1933, as amended, such calculation, if made as of a date within sixty days of this filing would yield a different value. As of March 24, 2005, there were 10,895,972 shares of common stock outstanding, including 746,972 shares issued to and owned by Transcontinental Realty Investors, Inc.

 

Documents Incorporated by Reference:

 

Consolidated Financial Statements of Income Opportunity Realty Investors, Inc.; Commission File No. 001-14784

 



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AMENDMENT #1 FOR ANNUAL REPORT ON 10-K FOR

AMERICAN REALTY INVESTORS, INC.

 

The undersigned registrant hereby amends the following items, exhibits, or other portions of its Annual Report on Form 10-K for the fiscal year ended 12/31/2004 as set forth below and as reflected in the substituted pages attached hereto, which replace the same numbered pages in the original filing:

 

*Page 39, 3rd paragraph from the bottom, 1st line, changed “translation” to “transaction” and 3rd line, changed “TCI” to “ARI.”

 

*Page 44, 1st full paragraph, 3rd line, changed “TCI” to “ARI.”“

 

*Page 71, 1st line, removed “Related Party.”

 

*Page 85, 1st line below table, changed “ARI owed $1.4” to “ARI owed $1.1.”

 

*Page 115, ITEM 9, last paragraph, 1st line, changed “March 30” to “April 15.”

 

*Page 131, ITEM 14 table, far right column “(1)” was changed to superscript.

 

*Page 133, ITEM 15(a) 1. 1st line, “Report of Independent Certified Public Accountants” changed to “Reports of Independent Registered Public Accounting Firms” and the last line of the page changed “2003” to “2004.”

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Amendment to be signed on its behalf by the undersigned, thereunto duly authorized.

 

       

American Realty Investors, Inc.

   

Dated: April 6, 2005

      By:  

/S/ SCOTT T. LEWIS


               

Scott T. Lewis

Executive Vice President and

Chief Financial Officer

(Principal Financial and Accounting

Officer and Acting Principal

Executive Officer)


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Index to Financial Statements

INDEX TO

ANNUAL REPORT ON FORM 10-K

 

          Page

     PART I     
Item 1.   

Business

   3
Item 2.   

Properties

   13
Item 3.   

Legal Proceedings

   28
Item 4.   

Submission of Matters to a Vote of Security Holders

   31
     PART II     
Item 5.   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   32
Item 6.   

Selected Financial Data

   34
Item 7.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   35
Item 7A.   

Quantitative and Qualitative Disclosures About Market Risk

   49
Item 8.   

Consolidated Financial Statements and Supplementary Data

   50
Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   115
Item 9A.   

Controls and Procedures

   115
Item 9B.   

Other Information

   115
     PART III     
Item 10.   

Directors, Executive Officers and Advisor of the Registrant

   116
Item 11.   

Executive Compensation

   123
Item 12.   

Security Ownership of Certain Beneficial Owners and Management

   125
Item 13.   

Certain Relationships and Related Transactions

   126
Item 14.   

Principal Accountant Fees and Services

   131
     PART IV     
Item 15.   

Exhibits and Financial Statement Schedules

   133

Signature Page

   135

 

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FORWARD LOOKING STATEMENTS

 

Certain Statements in this Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. The words “estimate,” “plan,” “intend,” “expect,” “anticipate,” “believe,” and similar expressions are intended to identify forward-looking statements. The forward-looking statements are found at various places throughout this Report and in the documents incorporated herein by reference. The Company disclaims any intention or obligations to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that our expectations are based upon reasonable assumptions, we can give no assurance that our goals will be achieved. Important factors that could cause our actual results to differ from estimates or projections contained in any forward-looking statements are described under “Risk Factors Related to ARI’s Business” beginning on page 5.

 

PART I

 

ITEM 1. BUSINESS

 

The predecessor to American Realty Investors, Inc. (“ARI” or the “Company” or “we” or “us”) was organized in 1961 to provide investors with a professionally managed, diversified portfolio of equity real estate and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income.

 

On October 23, 2001, ARI, Transcontinental Realty Investors, Inc. (“TCI”), and Income Opportunity Realty Investors, Inc. (“IORI”) jointly announced a preliminary agreement with the plaintiff’s legal counsel of the derivative action entitled Olive et al. V. National Income Realty Trust, et al. for a complete settlement of all disputes in the lawsuit (the “Olive Litigation”). In February 2002, the court granted final approval of the proposed settlement (the “Olive Settlement”). Under the Olive Settlement, ARI agreed to either (i) acquire all of the outstanding shares of IORI and TCI not currently owned by ARI for a cash payment or shares of ARI preferred stock or (ii) make a tender offer for all of the outstanding shares of IORI and TCI not currently owned by ARI. On November 15, 2002, ARI commenced the tender offers for the IORI and TCI shares. The tender offers were completed on March 19, 2003. ARI paid $19.00 cash per IORI share and $17.50 cash per TCI share for the stock held by unaffiliated stockholders. Pursuant to the tender offers, ARI subsidiaries acquired 265,036 IORI shares and 1,213,226 TCI shares. The completion of the tender offer fulfilled the obligations under the Olive Settlement, and the Olive Litigation originally filed in February 1990 was dismissed with prejudice.

 

After the tender offer, ARI subsidiaries owned 64.8% of the outstanding shares of TCI and 62.5% of the outstanding shares of IORI (46.9% owned directly by ARI subsidiaries and 15.6% through TCI’s ownership of IORI shares). ARI began consolidation of TCI’s and IORI’s accounts and operations effective March 31, 2003. The effect of consolidating TCI’s and IORI’s operations from the completion of the tender offer through March 31, 2003 was determined to be immaterial. Through June 30, 2003, ARI had the same advisor as TCI and IORI, and TCI and IORI had the same board of directors. At December 31, 2004, ARI and TCI have the same Board of Directors, and one director of ARI (Ted Stokely) serves as a director of IORI. Effective July 1, 2003, ARI and TCI have the same advisor.

 

On June 2, 2003, ARI subsidiaries exchanged all of their 674,971 IORI shares with Basic Capital Management, Inc. (“BCM”), receiving 650,000 TCI shares from BCM. After the exchange, ARI subsidiaries owned 72.9% of the outstanding shares of TCI. On June 30, 2003, ARI sold a participating interest in $5.8 million of its $15.5 million line of credit receivable from One Realco Corporation (“One Realco”) to BCM, receiving 314,141 TCI shares from BCM (See NOTE 3. “NOTES AND INTEREST RECEIVABLE”). After the transaction, ARI subsidiaries owned 76.8% of the outstanding shares of TCI. In December 2003, ARI subsidiaries purchased 88,600 TCI shares in open market transactions and 204,633 TCI shares in transactions with related parties for a total of $1.4 million. At December 31, 2004, ARI subsidiaries owned 82.2% of the outstanding shares of TCI. ARI no longer directly owns any IORI shares. At December 31, 2004, TCI owned 24.0% of IORI shares. ARI ceased consolidation of IORI’s accounts and operations effective June 2, 2003.

 

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Effective July 1, 2003, Prime Asset Management, Inc. (“PAMI”) became the advisor to ARI and TCI. PAMI is owned by Realty Advisors, Inc. (80%) and Syntek West, Inc. (“Syntek West”) (20%), related parties. Syntek West is owned by Gene Phillips. Effective August 18, 2003, PAMI changed its name to Prime Income Asset Management, Inc. (“PIAMI”). On October 1, 2003, Prime Income Asset Management, LLC (“Prime”), which is 100% owned by PIAMI, replaced PIAMI as the advisor to ARI and TCI.

 

Business Plan and Investment Policy

 

ARI’s primary business is investing in equity interests in real estate (including equity securities of real estate-related entities), leases, joint venture development projects, and partnerships and, to a lesser extent, financing real estate and real estate activities through investments in mortgage loans, including first, wraparound and junior mortgage loans. Information regarding the real estate and mortgage notes receivable portfolios of ARI is set forth in ITEM 2. “PROPERTIES,” NOTE 3. “NOTES AND INTEREST RECEIVABLE” and in Schedules III and IV to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” ARI has six operating segments: apartments, commercial properties, hotels, land ownership, quick-service restaurants, and notes receivables. See NOTE 18 “OPERATING SEGMENTS” to the Consolidated Financial Statements.

 

ARI’s business objective is to maximize long-term profitability for its stockholders by investing in commercial real estate through the ownership, management, development, and acquisition of apartments, commercial properties, hotels, and land. ARI intends to achieve this objective through offering properties in multiple markets and operating as a leading landlord within the industry. ARI believes that this objective will provide the benefits of enhanced investment opportunities, economies of scale, risk diversification, both in terms of geographic market and real estate product type, and access to capital. In pursuing its business objective, ARI seeks to achieve a combination of internal and external growth, maintain a strong balance sheet, and pursue a strategy of financial flexibility. When ARI’s marketing efforts identify opportunities, ARI will in appropriate instances, pursue those opportunities. ARI seeks to maximize the profitability of its apartments and commercial properties by endeavoring to maintain high occupancy levels while obtaining competitive rental rates, controlling costs and focusing on customer service efforts.

 

Current general economic conditions have resulted in downward pressure on rental rates, and market rental rates have declined on a year-to-year basis. ARI seeks to generate increased cash flow from apartments and commercial properties in operation through annual contractual increases in rental rates under leases. ARI also seeks to identify the best practices across operating platforms in order to enhance cost savings and other efficiencies. ARI and its subsidiaries employ an annual capital improvement and preventive maintenance program designed to reduce the operating costs of the apartments and commercial properties and maintain the long-term value of those real estate assets.

 

ARI also pursues attractive development opportunities, focusing primarily upon new construction or development, either directly or in concert with unaffiliated parties or affiliates. A summary of the properties under construction is set forth under ITEM 2. “PROPERTIES” below.

 

ARI also seeks to acquire properties consistent with its business objectives and strategies. ARI executes its acquisition strategy by purchasing properties which management believes will create stockholder value over the long-term. During the year ended December 31, 2004, ARI, through its subsidiaries, acquired 19 properties and disposed of 31 properties. ARI’s subsidiaries dispose of properties and land held for development, which no longer fit within ARI’s business plan or with respect to which management believes it can optimize cash proceeds.

 

Although ARI seeks to maximize long-term profitability for its stockholders through the development, acquisition and disposition of properties, ARI intends to continue to pursue its development, acquisition and disposition strategies. ARI at all times, and currently, is in various stages of discussions and negotiations with

 

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respect to development, acquisition and disposition projects. The consummation of any current or future development, acquisition or disposition, if any, and the pace at which any may be completed cannot be assured or predicted.

 

Substantially all properties are owned by separate subsidiaries of ARI, many of which are single-asset entities. This structure permits greater access to financing for individual properties and permits flexibility in the type of transaction available for future disposition of each property by permitting a sale of either the asset or the equity ownership in the entity owning the asset. From time-to-time, subsidiaries have invested in joint ventures with others, which creates the possibility of risks that do not exist with properties solely owned by an ARI subsidiary. In those instances where other participants are involved, those other participants may, at any time, have business, economic or other objectives that are inconsistent with ARI’s objectives, which may require a different action for the operation or ultimate disposition of the asset in question.

 

Real estate generally cannot be sold quickly. ARI and its subsidiaries may not be able to dispose of properties promptly in response to economic or other conditions. To offset this challenge, selective dispositions have been a part of ARI’s strategy to create an efficient portfolio and provide additional sources of capital for future use. See the discussion under “LIQUIDITY AND CAPITAL RESOURCES” in MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for information concerning sales of properties during the past three years. Similarly, ARI and its subsidiaries finance acquisitions at times through non-recourse mortgages, internally generated funds, and to a lesser extent, property sales. Those sources provide the bulk of funds for future acquisitions. ARI, from time-to-time, acquires properties subject to existing indebtedness by a subsidiary assuming such indebtedness. When properties are acquired in such manner, ARI and its subsidiaries customarily seek to refinance the asset in order to properly leverage the asset for future operation.

 

ARI, through its subsidiary, Milano Restaurants International Corporation (“MRI”), operates and franchises several quick-service restaurant concepts including pizzerias featuring pizza delivery, carryout and dine-in under the trademarks “Me-N-Ed’s Pizzerias,” “Me-N-Ed’s Slices,” and “Angelo & Vito’s Pizzerias.” The first Me-N-Ed’s Pizzeria opened in 1958. At December 31, 2004, there were 60 restaurants in operation, consisting of 41 owned and 19 franchised. Two of the restaurants were located in Texas and the remainder were in California. In addition to the Pizzerias, MRI has developed two new concepts: Pizzeria del Pane, a bakery/café concept and Zia Mia’s Cucina Italiana, a full service Italian restaurant. The initial locations for each of the concepts opened in 2004.

 

ARI’s businesses are not seasonal. With regard to real estate investments, ARI is seeking both current income and capital appreciation. ARI’s plan of operation is to continue, to the extent its liquidity permits, to make equity investments in income producing real estate such as hotels, apartments, or commercial properties, or equity securities of real estate-related entities. ARI also intends to continue to pursue higher risk, higher reward investments, such as improved and unimproved land where it can obtain financing of substantially all of a property’s purchase price. ARI intends to seek selected dispositions of certain of its assets, in particular, selected income producing properties in stabilized markets and certain of its land holdings where the prices obtainable for such assets justify their disposition. ARI has determined that it will no longer actively seek to fund or purchase mortgage loans. However, it may, in selected instances, originate mortgage loans or it may provide purchase money financing in conjunction with a property sale. See ITEM 2. “PROPERTIES,” NOTE 3. “NOTES AND INTEREST RECEIVABLE” and Schedules III and IV to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.”

 

ARI’s Board of Directors has broad authority under ARI’s governing documents to make all types of investments, and may devote available assets to particular investments or types of investments, without restriction on the amount or percentage of assets that may be allocated to a single investment or to any particular type of investment, and without limit on the percentage of securities of any one issuer that may be acquired. Investment objectives and policies may be changed at any time by the Board without stockholder approval.

 

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The specific composition from time-to-time of ARI’s real estate portfolio owned through subsidiaries depends largely on the judgment of management as to changing investment opportunities and the level of risk associated with specific investments or types of investments. Management intends to attempt to maintain a real estate portfolio diversified by location and type of property.

 

In addition to its equity investments in real estate, ARI and/or its subsidiaries have also invested in private and open market purchases of the equity securities of IORI and TCI, both affiliates of ARI. See ITEM 2. “PROPERTIES—Investments in Real Estate Companies.”

 

Risk Factors Related to ARI’s Business

 

Adverse events concerning existing tenants, or negative market conditions that may affect existing tenants could have an adverse impact on ARI’s ability to attract new tenants, relet space, collect rent or renew leases, and thus could adversely affect cash flow from operations and inhibit growth. Cash flow from operations depends on the ability to lease space to tenants on economically favorable terms. ARI could be adversely affected by various facts and events over which there is limited control, such as:

 

    lack of demand for space in areas where the properties are located;

 

    inability to retain existing tenants and attract new tenants;

 

    oversupply of or reduced demand for space and changes in market rental rates;

 

    defaults by tenants or failure to pay rent on a timely basis;

 

    the need to periodically renovate and repair marketable space;

 

    physical damage to properties;

 

    economic or physical decline of the areas where properties are located;

 

    potential risk of functional obsolescence of properties over time.

 

At any time, any tenant may experience a downturn in its business that may weaken its financial condition. As a result, a tenant may delay a lease commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent or declare bankruptcy. Any tenant bankruptcy or insolvency, leasing delay or failure to make rental payments when due could result in the termination of the tenant’s lease and material losses to the Company.

 

If tenants do not renew their leases as they expire, ARI may not be able to rent the space. Furthermore, leases that are renewed, and some new leases for space that is relet, may have terms that are less economically favorable than current lease terms, or may require ARI to incur significant costs, such as renovations, tenant improvements, or lease transaction costs.

 

Any of these events could adversely affect cash flow from operations and ARI’s ability to make expected distributions to shareholders and service indebtedness.

 

A significant portion of the costs, such as real estate taxes, insurance costs, and debt service payments, generally are not reduced when circumstances cause a decrease in cash flow from the properties.

 

ARI may not be able to compete successfully with other entities that operate in our industry. ARI experiences a great deal of competition in attracting tenants for the properties and in locating land to develop and properties to acquire.

 

In ARI’s effort to lease these properties, ARI competes for tenants with a broad spectrum of other landlords in each of the markets. These competitors include, among others, publicly-held REITs, privately-held entities, individual property owners and tenants who wish to sublease their space. Some of these competitors may be able to offer prospective tenants more attractive financial terms than ARI is able to offer.

 

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If the availability of land or high quality properties in ARI’s markets diminishes, operating results could be adversely affected.

 

ARI may experience increased operating costs, which could adversely affect our operations. ARI’s properties are subject to increases in operating expenses such as insurance, cleaning, electricity, heating, ventilation and air conditioning, administrative costs and other costs associated with security, landscaping, repairs, and maintenance of the properties. While current tenants generally are obligated to pay a significant portion of these costs, there is no assurance that these tenants will make such payments or agree to pay these costs upon renewal or new tenants will agree to pay these costs. If operating expenses increase in ARI’s markets, ARI may not be able to increase rents or reimbursements in all of these markets to meet increased expenses, without at the same time decreasing occupancy rates. If this occurs, ARI’s ability to make distributions to shareholders and service indebtedness could be adversely affected.

 

ARI’s ability to achieve growth in operating income depends in part on the ability to develop properties, which may suffer under certain circumstances. ARI intends to continue to develop properties where warranted by market conditions. The decline in demand for real estate has reduced the amount of development ARI is undertaking. ARI has a number of ongoing development and land projects being readied for development.

 

Additionally, general construction and development activities include the following risks:

 

    construction and leasing of a property may not be completed on schedule, which could result in increased expenses and construction costs, and would result in reduced profitability for that property;

 

    construction costs may exceed original estimates due to increases in interest rates and increased materials, labor or other costs, possibly making the property unprofitable because of inability to increase rents to compensate for the increase in construction costs;

 

    some developments may fail to achieve expectations, possibly making them unprofitable;

 

    ARI may be unable to obtain, or face delays in obtaining, required zoning, land-use, building, occupancy, and other governmental permits and authorizations, which could result in increased costs and could require ARI to abandon their activities entirely with respect to a project;

 

    ARI may abandon development opportunities after the initial exploration, which may result in failure to recover costs already incurred. If ARI determines to alter or discontinue its development efforts, future costs of the investment may be expensed as incurred rather than capitalized and ARI may determine the investment is impaired resulting in a loss;

 

    ARI may expend funds on and devote management’s time to projects which we do not complete;

 

    occupancy rates and rents at newly-completed properties may fluctuate depending on a number of factors, including market and economic conditions, which may result in lower than projected rental rates with the result that the investment is not profitable.

 

ARI faces risks associated with property acquisitions.    ARI acquires individual properties and portfolios of properties, and intends to continue to do so. The acquisition activities and their success are subject to the following risks:

 

    when ARI is able to locate a desired property, competition from other real estate investors may significantly increase the purchase price;

 

    acquired properties may fail to perform as expected;

 

    the actual costs of repositioning or redeveloping acquired properties may be higher than the estimates;

 

    acquired properties may be located in new markets where ARI faces risks associated with an incomplete knowledge or understanding of the local market, a limited number of established business relationships in the area and a relative unfamiliarity with local governmental and permitting procedures;

 

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    ARI may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into existing operations, and results of operations and financial condition could be adversely affected.

 

ARI may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities. As a result, if a liability were asserted against ARI based upon ownership of those properties, ARI might have to pay substantial sums to settle it, which could adversely affect cash flow.

 

Many of ARI’s properties are concentrated in our primary markets, and may suffer economic harm as a result of adverse conditions in those markets.    ARI’s properties are located principally in specific geographic areas in the Southwestern, Southeastern, and Midwestern United States. Due to the concentration of properties in these areas, performance is dependent on economic conditions. These areas have experienced periods of economic decline.

 

ARI is highly leveraged and may not be able to meet our debt service obligations.    ARI had total indebtedness at December 31, 2004 of approximately $958.6 million. Substantially all assets have been pledged to secure debt. These borrowings increase the risk of loss because they represent a prior claim on assets and require fixed payments regardless of profitability. ARI’s highly leveraged position makes it vulnerable to changes in economic conditions and may limit the ability to capitalize on significant business opportunities in the future.

 

The Company may not be able to access financial markets to obtain capital on a timely basis, or on acceptable terms.    ARI relies on proceeds from property dispositions and third party capital sources for a portion of its capital needs, including capital for acquisitions and development. The public debt and equity markets are among the sources relied on. There is no guarantee ARI will be able to access these markets, or any other source of capital. The ability to access the public debt and equity markets depends on a variety of factors, including:

 

    general economic conditions affecting these markets;

 

    ARI’s own financial structure and performance;

 

    the market’s opinion of REITs and real estate companies in general;

 

    the market’s opinion of REITs and real estate companies that own properties like ARI.

 

ARI may suffer adverse effects as a result of terms of and covenants relating to the Company’s indebtedness.    Required payments on ARI’s indebtedness generally are not reduced if the economic performance of the portfolio declines. If the economic performance declines, net income, cash flow from operations and cash available for distribution to stockholders will be reduced. If payments on debt cannot be made, ARI could sustain a loss, or in the case of mortgages, suffer foreclosures by mortgagees or suffer judgments. Further, some obligations contain cross-default and/or cross-acceleration provisions, which means that a default on one obligation may constitute a default on other obligations.

 

ARI anticipates only a small portion of the principal of our debt will be repaid prior to maturity. Therefore, ARI is likely to need to refinance at least a portion of its outstanding debt as it matures. There is a risk that ARI may not be able to refinance existing debt or the terms of any refinancing will not be as favorable as the terms of the existing debt. If principal payments due at maturity cannot be refinanced, extended or repaid with proceeds from other sources, such as the proceeds of sales of assets or new equity securities, cash flow will not be sufficient to repay all maturing debt in years when significant “balloon” payments come due.

 

ARI’s credit facilities and unsecured debt securities contain customary restrictions, requirements and other limitations on the ability to incur indebtedness, including total debt to asset ratios, secured debt to total asset ratios, debt service coverage ratios, and minimum ratios of unencumbered assets to unsecured debt, which ARI must maintain. ARI’s continued ability to borrow is subject to compliance with financial and other covenants. In

 

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addition, failure to comply with such covenants could cause a default under credit facilities, and ARI may then be required to repay such debt with capital from other sources. Under those circumstances, other sources of capital may not be available, or be available only on unattractive terms.

 

The degree of leverage could affect ARI’s ability to obtain additional financing for working capital, capital expenditures, acquisitions, development, or other general corporate purposes. The degree of leverage could also make ARI more vulnerable to a downturn in business or the economy or could affect the market price the common stock.

 

An increase in interest rates would increase interest costs on variable rate debt and could adversely impact the ability to refinance existing debt.    ARI currently has, and may incur more, indebtedness that bears interest at variable rates. Accordingly, if interest rates increase, so will the interest costs, which would adversely affect cash flow and the ability to pay principal and interest on ARI’s debt and the ability to make distributions to shareholders. Further, rising interest rates could limit ARI’s ability to refinance existing debt when it matures.

 

Unbudgeted capital expenditures or cost overruns could adversely affect business operations and cash flow.    If capital expenditures on ongoing or planned development projects, renovations, or condominium conversions exceed our expectations, the additional cost of these expenditures could have an adverse effect on business operations and cash flow. In addition, ARI might not have access to funds on a timely basis to meet the unexpected expenditures.

 

Construction costs are funded in large part through construction financing, which the Company often guarantees, and the Company’s obligation to pay interest on this financing continues until the rental project is completed, leased up, and permanent financing is obtained, or the for sale project is sold out. Unexpected delays in completion of one or more ongoing projects could also have a significant adverse impact on business operations and cash flow.

 

ARI may need to sell properties from time-to-time for cash flow purposes.    Because of the lack of liquidity of real estate investments generally, ARI’s ability to respond to changing circumstances may be impaired. Real estate investments generally cannot be sold quickly. In the event that ARI must sell assets to generate cash flow, ARI cannot predict whether there will be a market for those assets in the time period desired or need to sell them, or whether ARI will be able to sell them at a price that will allow the Company to fully recoup the investment. ARI may not be able to realize the full potential value of the assets, and may incur costs related to the early pay-off of the debt secured by such assets.

 

The Company intends to devote increasing resources to the development of new projects.    ARI plans to continue developing new projects as opportunities arise in the future. Development and construction activities entail a number of risks, including but not limited to the following:

 

    ARI may abandon a project after spending non-recoverable time and money determining its feasibility;

 

    Construction costs may materially exceed original estimates;

 

    The revenue from a new project may not be enough to make it profitable or generate a positive cash flow;

 

    ARI may not be able to obtain financing on favorable terms for development of a property, if at all;

 

    The Company may not complete construction and lease-ups on schedule, resulting in increased development or carrying costs;

 

    ARI may not be able to obtain, or may be delayed in obtaining, necessary governmental permits.

 

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The overall business is subject to all of the risks associated with the real estate industry.    ARI is subject to all risks incident to investment in real estate, many of which relate to the general lack of liquidity of real estate investments, including, but not limited to:

 

    changes in general or local economic conditions: because ARI’s real estate assets are concentrated in the Southwest, Southeast, and Midwest any deterioration in the general economic conditions in any of those states could have an adverse effect on business and assets in that state;

 

    changes in interest rates may make the ability to satisfy debt service requirements materially more burdensome;

 

    lack of availability of financing may render the purchase, sale or refinancing of a property more difficult or unattractive;

 

    changes in real estate and zoning laws;

 

    increases in real estate taxes and insurance costs;

 

    federal or local economic or rent control, and

 

    floods, earthquakes and other similar natural disasters.

 

Risks Related to the Real Estate Industry

 

Real estate investments are illiquid, and the Company may not be able to sell our properties if and when we determine it is appropriate to do so.    Real estate generally cannot be sold quickly. ARI may not be able to dispose of properties promptly in response to economic or other conditions. In addition, provisions of the Internal Revenue Code limit ARI’s ability to sell properties in some situations when it may be economically advantageous to do so, thereby adversely affecting returns to stockholders and adversely impacting the ability to meet ARI’s obligations to the holders of other securities.

 

Management of the Company

 

Although the Board of Directors is directly responsible for managing the affairs of ARI and for setting the policies, which guide it, its day-to-day operations are performed by Prime, a contractual advisor under the supervision of the Board. The duties of Prime include, among other things, locating, investigating, evaluating, and recommending real estate and mortgage note investments and sales opportunities, as well as financing and refinancing sources. Prime also serves as a consultant in connection with ARI’s business plan and investment policy decisions made by the Board. Prime is indirectly owned by Gene E. Phillips (20%) and by a trust for the children of Gene E. Phillips (80%). Mr. Phillips is not an officer or director of Prime, but serves as a representative of the trust, is involved in daily consultation with the officers of Prime, and has significant influence over the conduct of Prime’s business, including the rendering of advisory services and the making of investment decisions for itself and ARI. As of March 24, 2005, PIAMI, Prime’s parent, owned 1,437,208 shares of ARI’s Common Stock, approximately 13.2% of the shares then outstanding. Prime is more fully described in ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT—The Advisor.”

 

Prime has been providing advisory services to ARI since October 1, 2003. Prime also serves as advisor to TCI. The officers of ARI are also officers of IORI, TCI, and Prime. The directors of ARI also serve as directors of TCI. The Chairman of the Board of Directors of ARI also serves as the Chairman of the Board of Directors of TCI and IORI. Affiliates of Prime have provided property management services to ARI. Currently, Triad Realty Services, Ltd. (“Triad”), an affiliate, and Carmel Realty, Inc. (“Carmel”) provide such property management services. Triad and Carmel subcontract with other entities for property-level management services. The general partner of Triad is BCM. The limited partner of Triad is Highland Realty Services, Inc. (“Highland”). Triad subcontracts the property-level management and leasing of 30 of ARI’s commercial properties (shopping centers, office buildings and industrial warehouses) to Regis Realty I, LLC (“Regis I”) which is owned by Highland.

 

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Index to Financial Statements

Regis I receives property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Triad. Since January 1, 2003, Regis Hotel I, LLC, has managed ARI’s 11 hotels. The sole member of Regis I and Regis Hotel I, LLC is Highland. Carmel is a company previously owned by First Equity Properties, Inc., which is a company affiliated with Prime. On May 1, 2004, Regis I acquired the ownership of Carmel.

 

Regis I is also entitled to receive real estate brokerage commissions in accordance with the terms of the Advisory Agreement as discussed in ITEM 10. “DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT—The Advisor.”

 

ARI has no employees itself, but MRI has 843 employees. Employees of Prime render services to ARI.

 

Competition

 

Real Estate.    The real estate business is highly competitive, and ARI competes with numerous entities engaged in real estate activities (including certain entities described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Related Party Transactions”), some of which have greater financial resources than ARI. Management believes that success against such competition is dependent upon the geographic location of the property, the performance of property-level managers in areas such as marketing, collections and control of operating expenses, the amount of new construction in the area, and the maintenance and appearance of the property. Additional competitive factors with respect to commercial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rent levels. With respect to apartments, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the tenants. With respect to hotels, competition is also based upon the market served, i.e., transient, commercial or group users. Management believes that beyond general economic circumstances and trends, the rate at which properties are renovated or the rate new properties are developed in the vicinity of each of ARI’s properties, in particular its improved and unimproved land, are also competitive factors. See also “Risk Factors Related to ARI’s Business.”

 

To the extent that ARI seeks to sell any of its properties, the sales prices for the properties may be affected by competition from other real estate entities and financial institutions, also attempting to sell properties in areas where ARI’s properties are located, as well as aggressive buyers attempting to dominate or penetrate a particular market.

 

As described above and in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS—Related Party Transactions,” the officers of ARI also serve as officers of IORI (with the exception of the CFO) and TCI, both of which have business objectives similar to ARI’s. ARI’s officers and advisor owe fiduciary duties to both IORI and TCI as well as to ARI under applicable law. In determining whether a particular investment opportunity will be allocated to ARI, IORI, or TCI, management and the advisor consider the respective investment objectives of each and the appropriateness of a particular investment in light of the existing real estate and mortgage notes receivable portfolios of each. To the extent that any particular investment opportunity is appropriate to more than one of the entities, the investment opportunity will be allocated to the entity, which has had funds available for investment for the longest period of time, or, if appropriate, the investment may be shared among all or some of the entities.

 

In addition, also as described in ITEM 13. “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,” ARI competes with entities, which are affiliates of Prime having similar investment objectives in the purchasing, selling, leasing, and financing of real estate and real estate-related investments. In resolving any potential conflicts of interest which may arise, Prime has informed ARI that it intends to continue to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.

 

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ARI is subject to all the risks incident to ownership and financing of real estate and interests therein, many of which relate to the general illiquidity of real estate investments. These risks include, but are not limited to, changes in general or local economic conditions, changes in interest rates and availability of permanent mortgage financing which may render the purchase, sale, or refinancing of a property difficult or unattractive, and which may make debt service burdensome, changes in real estate and zoning laws, increases in real estate taxes, federal or local economic or rent controls, floods, earthquakes, hurricanes and other acts of God and other factors beyond the control of management or the advisor. The illiquidity of real estate investments may also impair the ability of management to respond promptly to changing circumstances. Management believes that such risks are partially mitigated by the diversification by geographic region and property type of ARI’s real estate and mortgage notes receivable portfolios. However, to the extent that property sales, new property investments, in particular improved and unimproved land, or mortgage lending are concentrated in any particular region, the advantages of geographic diversification are mitigated.

 

Virtually all of ARI’s real estate, equity security holdings in IORI and TCI and its portfolio of equity securities are held subject to secured indebtedness. Such borrowings increase the risk of loss because they represent a prior claim on ARI’s assets and require fixed payments regardless of profitability. In the event of default, the lender may foreclose on the assets securing such indebtedness, and ARI could lose its investment in the pledged assets.

 

Pizza Parlors.    The pizza parlor business is highly competitive and is affected by changes in consumer tastes and eating habits, as well as national, regional, and local economic conditions, and demographic trends. The performance of an individual pizza parlor can be affected by changes in traffic patterns, demographics, and the type, number and location of competing restaurants.

 

The quick-service restaurant industry is extremely competitive with respect to price, service, location, and food quality. MRI and its franchisees compete with a variety of other restaurants in the quick-service restaurant industry; including those that offer dine-in, carryout, and delivery services. These competitors include national and regional chains, franchisees of other restaurant chains, and local owner-operated restaurants. Some of these competitors have been in existence longer and have an established market presence in certain geographic regions, and some have substantially greater financial, marketing, and other resources than MRI and its franchisees. MRI competes for qualified franchisees with many other restaurant concepts, including national and regional restaurant chains.

 

MRI’s success is largely dependent upon the efforts of its management and other key personnel. The loss of the service of one or more members of management could have an adverse effect on MRI’s operations. Significant transitions in management involve important risks, including potential loss of key personnel, difficulties in implementing changes to operational strategies and maintaining relationships with franchisees.

 

At December 31, 2004, MRI owned and operated 41 and franchised 19 pizza parlors. The results achieved by MRI’s relatively small pizza parlor base may not be indicative of the results of a larger number of pizza parlors in a more geographically dispersed area. Because of MRI’s relatively small pizza parlor base, an unsuccessful pizza parlor has a more significant effect on MRI’s results of operations than would be the case in a company owning more pizza parlors.

 

MRI’s existing pizza parlors, both owned and franchised, are located in California or Texas. At December 31, 2004, there were 58 pizza parlors in California and two in Texas. Accordingly, MRI’s results of operations may be affected by economic or other conditions in those regions. Also, given MRI’s present geographic concentration, publicity relating to MRI’s pizza parlors could have a more pronounced effect on MRI’s overall sales than might be the case if MRI’s pizza parlors were geographically dispersed.

 

All of MRI’s owned pizza parlors are operated on premises leased from third parties. Most of the pizza parlor leases provide for a minimum annual rent. There can be no assurance that MRI will be able to renew leases

 

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Index to Financial Statements

upon expiration or that the lease terms on renewal will be as favorable as the current lease terms. In 2004, MRI closed one company-owned store, opened two new franchise stores, reopened a remodeled franchised store, with two franchise stores leaving the system. In 2005, three new franchise stores are scheduled to open.

 

In July 2003, ARI sold its interest in MRI to Gruppa Florentina, LLC (“Gruppa”), for $18.5 million, receiving $7.4 million in cash after debt assumption and providing purchase money financing of $2.3 million. ARI owns 20.0% of Gruppa, thereby retaining a 20.0% interest in MRI. ARI remains as the guarantor of $8.7 million of assumed debt and is one of the guarantors of $7.5 million in new debt obtained by Gruppa. Due to the debt guarantees and ARI’s continuing ownership interest in MRI, management has determined that this should be accounted for as a financing transaction. In September 2003, ARI sold the note to Syntek West for $2.3 million, plus accrued and unpaid interest, to reduce affiliate debt.

 

Available Information

 

ARI maintains an internet site at http://www.amrealtytrust.com. Available through the website, free of charge, are Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, reports filed pursuant to Section 16, and amendments to those reports as soon as reasonably practicable after they are electronically filed or furnished to the Securities and Exchange Commission. In addition, ARI has posted the charters for the Audit Committee, Compensation Committee, and Governance and Nominating Committee, as well as the Code of Business Conduct and Ethics, Corporate Governance Guidelines on Director Independence, and other information on the website. These charters and principles are not incorporated in this Report by reference. ARI will also provide a copy of these documents free of charge to stockholders upon written request. ARI issues Annual Reports containing audited financial statements to its common stockholders.

 

ITEM 2. PROPERTIES

 

ARI’s principal offices are located at 1800 Valley View Lane, Suite 300, Dallas, Texas 75234 and are, in the opinion of management, suitable and adequate for ARI’s present operations.

 

Details of ARI’s and its subsidiaries’ real estate and mortgage notes receivable portfolios at December 31, 2004, are set forth in SCHEDULES III and IV, respectively, to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” The discussions set forth below under the headings “Real Estate” and “Mortgage Loans” provide certain summary information concerning ARI’s real estate and mortgage notes receivable portfolios.

 

At December 31, 2004, no single asset accounted for 10.0% or more of total assets. At December 31, 2004, 82.6% of ARI’s assets consisted of real estate, and 6.1% consisted of notes and interest receivable. The remaining 11.3% of ARI’s assets were cash, cash equivalents, marketable equity securities, pizza parlor equipment, investments in equity investees, goodwill and other intangibles, and other assets. The percentage of assets invested in any one category is subject to change and no assurance can be given that the composition of ARI’s assets in the future will approximate the percentages listed above.

 

ARI’s real estate is geographically diverse, with concentrations in the Southwest, Southeast, and Midwest regions. At December 31, 2004, ARI’s real estate was located in all geographic regions of the continental United States, other than the Northeast region, as shown more specifically in the table under “Real Estate” below. ARI also holds mortgage notes receivable secured by real estate located in the Southwest, Southeast, Pacific and Midwest regions of the continental United States. See SCHEDULE IV to the Consolidated Financial Statements included in ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for a detailed description of ARI’s notes receivable portfolio.

 

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Index to Financial Statements

Geographic Regions

 

LOGO

 

Excluded from above are 78 parcels of improved and unimproved land, and a single-family residence, as described below.

 

Real Estate

 

At December 31, 2004, 83.1% of ARI’s assets were invested in real estate and the equity securities of IORI. ARI invests in real estate located throughout the continental United States, either on a leveraged or non-leveraged basis. ARI’s real estate portfolio consists of properties held for investment, properties held for sale, investments in partnerships, and investments in equity securities of IORI.

 

Types of Real Estate Investments.    ARI’s real estate consists of apartments, commercial properties (office buildings, industrial warehouses, shopping centers, and a merchandise mart), hotels, and improved and unimproved land. In selecting real estate for investment, the location, age and type of property, gross rents, lease terms, financial and business standing of tenants, operating expenses, fixed charges, land values, and physical condition are among the factors considered. Properties may be purchased subject to debt, or existing debt may be assumed and properties may be mortgaged, pledged or otherwise collateralized to obtain financing. The Board of Directors may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of stockholders.

 

Although ARI has typically invested in developed real estate, it may also invest in new construction or development either directly or in partnership with unaffiliated parties or affiliates (subject to approval by the Board of Directors). To the extent that it invests in construction and development projects, such as the apartments described below, ARI is subject to business risks, which include cost overruns and construction delays, associated with higher risk projects.

 

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At December 31, 2004, ARI had the following properties under construction:

 

Property


   Location

   Units

   Amount
Expended


   Additional
Amount
to Expend


   Construction
Loan
Funding


Apartments

                              

Blue Lake Villas II

   Waxahachie, TX    76 Units    $ 4,454    $ 217    $ 4,234

Bluffs at Vista Ridge

   Lewisville, TX    272 Units      17,239      3,347      15,500

Bridges on Kinsey

   Tyler, TX    232 Units      11,572      4,509      14,477

Dakota Arms

   Lubbock, TX    208 Units      12,611      1,326      12,549

Kingsland Ranch

   Houston, TX    398 Units      24,573      1,081      23,000

Laguna Vista

   Farmers Branch, TX    206 Units      3,432      17,673      17,741

Lake Forest

   Houston, TX    240 Units      13,919      519      12,815

Parc at Maumelle

   Maumelle, AR    240 Units      4,502      14,196      16,829

Stonebridge at City Park (formerly 288 City Park)

   Houston, TX    240 Units      15,486      1,201      15,005

Vistas of Vance Jackson

   San Antonio, TX    240 Units      13,393      4,708      16,056

Wildflower Villas

   Temple, TX    220 Units      9,377      6,220      14,073

 

In 2004, ARI completed the 248 unit DeSoto Ranch Apartments in DeSoto, Texas, the 314 unit Verandas at Cityview Apartments in Fort Worth, Texas, the 216 unit Mariposa Villas (Echo Valley) in Dallas, Texas, the 176 unit Breakwater Bay Apartments in Beaumont, Texas, the 156 unit Capitol Hill Apartments in Little Rock, Arkansas and the 332 unit Vistas of Pinnacle Park Apartments in Dallas, Texas.

 

In the opinion of management, the properties owned by ARI are adequately covered by insurance.

 

The following table sets forth the percentages, by property type and geographic region, of owned real estate (excluding 78 parcels of improved and unimproved land, a hotel in Wroclaw, Poland and a single-family residence, described below) at December 31, 2004.

 

Region


   Apartments

    Commercial
Properties


    Hotels

 

Midwest

   5 %   15 %   11 %

Mountain

   —       19     11  

Pacific

   —       1     49  

Southeast

   10     10     29  

Southwest

   85     55     —    
    

 

 

     100 %   100 %   100 %
    

 

 

 

The foregoing table is based solely on the number of apartment units, amount of commercial square footage, and number of hotel rooms owned, and does not reflect the value of ARI’s investment in each region. See SCHEDULE III to the Consolidated Financial Statements included in ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for a detailed description of owned real estate.

 

Excluded from the table above are a 165 room hotel in Wroclaw, Poland, a single family residence in Dallas, Texas, and 78 parcels of improved and unimproved land consisting of: four parcels in Austin, Texas, totaling 484.2 acres; a 7.6 acre parcel in Carrollton, Texas; two parcels in Collin County, Texas, totaling 53.1 acres; seven parcels in Dallas County, Texas, totaling 392.4 acres; six parcels in Dallas, Texas, totaling 61.1 acres; a 13.9 acre parcel in Denton, Texas; a 105.4 acre parcel in Denton County, Texas; a 202.0 acre parcel in Desoto, Texas; 18 parcels in Farmers Branch, Texas, totaling 494.8 acres; a 18.9 acre parcel in Fort Wayne, Indiana; a 4.7 acre parcel in Fruitland Park, Florida; four parcels in Ft. Worth, Texas, totaling 86.3 acres; a 13.9 acre parcel in Grand Prairie, Texas; a 130.6 acre parcel in Harris County, Texas; two parcels in Houston, Texas,

 

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Index to Financial Statements

totaling 38.2 acres; a 16.9 acre parcel in Humble, Texas; four parcels in Irving, Texas, totaling 39.9 acres; a 52.9 acre parcel in Kent, Ohio; six parcels in Las Colinas, Texas, totaling 351.2 acres; a 79.0 acre parcel in Lewisville, Texas; a 2.9 acre parcel in Lubbock, Texas; a 10.8 acre parcel in Maumelle, Arkansas; a 127.4 acre parcel in Nashville, Tennessee; a 0.4 acre parcel in New Orleans, Louisiana; a 110.05 acre parcel in Palm Desert, California; a 11.8 acre parcel in Plano, Texas; a 21.9 acre parcel in Pulaski County, Arkansas; a 20.1 acre parcel in Rogers, Arkansas; a 0.7 acre parcel in San Angelo, Texas; a 20.7 acre parcel in Siskiyou County, California; a 4.0 acre parcel in Springfield, Virginia; two parcels in Tarrant County, Texas, totaling 31.3 acres; and a 63.3 acre parcel in Travis County, Texas. See SCHEDULE III to the Consolidated Financial Statements included in ITEM 8. “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for a detailed description of ARI’s real estate portfolio.

 

A summary of the activity in the owned real estate portfolio during 2004 is as follows:

 

Owned properties at January 1, 2004

   216  

Properties purchased (excluding additions to existing land parcels)

   19  

Properties sold (excluding partial sales)

   (31 )
    

Owned properties at December 31, 2004

   204  
    

 

Operating Properties.    Set forth below are ARI’s operating properties and the monthly rental rate for apartments, the average annual rental rate for commercial properties, the average daily room rate and room revenue divided by total available rooms for hotels, and occupancy at December 31, 2004, 2003 and 2002 for apartments and commercial properties and average occupancy during 2004, 2003 and 2002 for hotels. The 2002 information for the properties added through the consolidation of TCI, as identified with “(T)”, is provided for comparative purposes only.

 

               Rent Per
Square Foot


   Occupancy %

Property


  

Location


   Units/Square Footage

   2004

   2003

   2002

   2004

   2003

   2002

Apartments

                                             

4400 (T)

   Midland, TX    92 Units/94,472 Sq. Ft.    $ .51    $ .49    $ .49    97    86    86

Apple Lane (T)

   Lawrence, KS    75 Units/30,000 Sq. Ft.      1.08      1.05      1.04    100    100    93

Arbor Point (T)

   Odessa, TX    195 Units/178,920 Sq. Ft.      .47      .45      .43    90    95    87

Arlington Place

   Pasadena, TX    230 Units/205,476 Sq. Ft.      .76      .76      .75    97    97    94

Ashton Way (T)

   Midland, TX    178 Units/138,964 Sq. Ft.      .45      .43      .43    95    87    82

Autumn Chase (T)

   Midland, TX    64 Units/58,652 Sq. Ft.      .57      .55      .54    98    98    98

Bay Walk (T)

   Galveston, TX    192 Units/153,120 Sq. Ft.      .75      .75      .74    90    95    95

Blue Lake Villas (T)

   Waxahachie, TX    186 Units/169,746 Sq. Ft.      .91      .91      *    90    92    *

Bluffs at Vista Ridge (T)

   Lewisville, TX    272 Units/257,432 Sq. Ft.      **      **      **    **    **    **

Breakwater Bay (T)

   Beaumont, TX    176 Units/145.688 Sq. Ft.      .93      *      *    87    *    *

Bridgestone

   Friendswood, TX    76 Units/65,519 Sq. Ft.      .74      .74      .74    96    96    92

By the Sea (T)

   Corpus Christi, TX    153 Units/123,945 Sq. Ft.      .88      .88      .86    96    91    88

Capitol Hill (T)

   Little Rock, AR    156 Units/151,116 Sq. Ft.      .88      *      *    70    *    *

Château

   Bellevue, NE    115 Units/99,220 Sq. Ft.      .73      .73      .71    86    86    96

Château Bayou

   Ocean Springs, MS    122 Units/105,536 Sq. Ft.      .67      .67      .67    94    94    94

Courtyard (T)

   Midland, TX    133 Units/111,576 Sq. Ft.      .47      .46      .45    94    99    93

Coventry (T)

   Midland, TX    120 Units/105,608 Sq. Ft.      .45      .44      .43    96    84    91

DeSoto Ranch (T)

   DeSoto, TX    248 Units/240,718 Sq. Ft.      .95      .94      *    98    98    *

El Chapparal (T)

   San Antonio, TX    190 Units/174,220 Sq. Ft.      .95      .73      .72    94    96    79

Fairway View Estates (T)

   El Paso, TX    264 Units/204,000 Sq. Ft.      .65      .64      .63    90    96    92

Fairways (T)

   Longview, TX    152 Units/134,176 Sq. Ft.      .59      .58      .56    96    93    92

Falcon Lakes (T)

   Arlington, TX    284 Units/207,960 Sq. Ft.      .96      .96      .97    94    94    11

Fountain Lake (T)

   Texas City, TX    166 Units/161,220 Sq. Ft.      .62      .62      .62    86    96    89

Fountains of Waterford (T)

   Midland, TX    172 Units/129,200 Sq. Ft.      .55      .53      .53    96    99    85

Foxwood

   Memphis, TN    220 Units/212,000 Sq. Ft.      .61      .61      .61    83    83    85

Governor’s Square

   Tallahassee, FL    169 Units/146,550 Sq. Ft.      .73      .73      .66    95    95    95

Harper’s Ferry (T)

   Lafayette, LA    122 Units/112,500 Sq. Ft.      .61      .60      .59    95    90    83

 

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               Rent Per
Square Foot


   Occupancy %

Property


  

Location


   Units/Square Footage

   2004

   2003

   2002

   2004

   2003

   2002

Heather Creek (T)

   Mesquite, TX    200 Units/170,212 Sq. Ft.    $ .94    $ *    $ *    93    *    *

Hunters Glen (T)

   Midland, TX    260 Units/174,180 Sq. Ft.      .42      .39      .38    93    94    81

Island Bay (T)

   Galveston, TX    458 Units/374,784 Sq. Ft.      .83      .83      .81    93    91    90

Kingsland Ranch (T)

   Houston, TX    398 Units/350,574 Sq. Ft.      **      **      **    **    **    **

Limestone Canyon (T)

   Austin, TX    260 Units/216,000 Sq. Ft.      1.06      1.06      1.06    96    91    88

Limestone Ranch (T)

   Lewisville, TX    252 Units/219,600 Sq. Ft.      .95      .94      .94    95    91    91

Longwood

   Long Beach, MS    200 Units/187,048 Sq. Ft.      .58      .58      *    90    90    *

Marina Landing (T)

   Galveston, TX    256 Units/205,504 Sq. Ft.      .83      .83      .82    92    95    96

Mariposa Villas (T)

   Dallas, TX    216 Units/199,656 Sq. Ft.      .89      .89      *    95    97    *

Mediterranean Villas

   San Antonio, TX    140 Units/158,960 Sq. Ft.      .56      .56      .55    92    92    84

Mountain Plaza (T)

   El Paso, TX    188 Units/220,710 Sq. Ft.      .52      .52      .51    90    94    97

Oak Park IV (T)

   Clute, TX    108 Units/78,708 Sq. Ft.      .56      .56      .56    93    91    95

Oak Tree

   Grandview, MO    189 Units/160,591 Sq. Ft.      .66      .66      .65    93    93    89

Paramount Terrace (T)

   Amarillo, TX    181 Units/123,840 Sq. Ft.      .61      .60      .59    91    93    91

Plantation (T)

   Tulsa, OK    138 Units/103,500 Sq. Ft.      .61      .61      .61    90    92    0

Quail Oaks (T)

   Balch Springs, TX    131 Units/72,848 Sq. Ft.      .83      .83      .83    95    95    85

Quail Pointe

   Huntsville, AL    184 Units/202,602 Sq. Ft.      .46      .46      .47    91    91    90

River Oaks (T)

   Wylie, TX    180 Units/164,604 Sq. Ft.      .86      .86      *    95    98    *

Sendero Ridge (T)

   San Antonio, TX    384 Units/340,880 Sq. Ft.      1.02      1.01      *    94    80    *

Somerset (T)

   Texas City, TX    200 Units/163,368 Sq. Ft.      .68      .68      .68    85    88    87

Southgate (T)

   Odessa, TX    180 Units/151,656 Sq. Ft.      .46      .43      .43    98    93    90

Spy Glass (T)

   Mansfield, TX    256 Units/239,264 Sq. Ft.      .96      .95      *    92    97    *

Sunchase (T)

   Odessa, TX    300 Units/223,048 Sq. Ft.      .51      .49      .49    97    96    91

Sun Hollow

   El Paso, TX    216 Units/156,000 Sq. Ft.      .74      .74      .72    92    92    91

Sunset

   Odessa, TX    240 Units/160,400 Sq. Ft.      .50      .50      .47    100    100    89

Terrace Hills (T)

   El Paso, TX    310 Units/233,192 Sq. Ft.      .70      .70      .69    94    96    93

Timbers (T)

   Tyler, TX    180 Units/101,666 Sq. Ft.      .60      .60      .59    96    92    93

Tivoli (T)

   Dallas, TX    190 Units/168,862 Sq. Ft.      .95      .95      .96    92    92    27

Treehouse (T)

   Irving, TX    160 Unite/153,072 Sq. Ft.      .80      ***      .80    96    ***    94

Verandas at City View (T)

   Fort Worth, TX    314 Units/295,170 Sq. Ft.      .92      .60      *    93    92    *

Villa Del Mar

   Wichita, KS    162 Units/128,004 Sq. Ft.      .62      .62      .62    89    89    86

Villager

   Ft. Walton, FL    33 Units/22,840 Sq. Ft.      .79      .79      .77    100    100    88

Vistas of Pinnacle Park (T)

   Dallas, TX    332 Units/276,928 Sq. Ft.      .91      *      *    96    *    *

Waters Edge III

   Gulfport, MS    238 Units/212,216 Sq. Ft.      .64      .64      .63    91    91    90

Waters Edge IV

   Gulfport, MS    80 Units/76,400 Sq. Ft.      .76      .76      .76    94    94    74

Westwood

   Mary Ester, FL    120 Units/93,000 Sq. Ft.      .74      .74      .72    100    100    98

Westwood (T)

   Odessa, TX    79 Units/49,001 Sq. Ft.      .46      .44      .49    91    100    80

Whispering Pines

   Topeka, KS    320 Units/299,264 Sq. Ft.      .55      .55      .54    91    91    91

Willow Creek (T)

   El Paso, TX    112 Units/103,140 Sq. Ft.      .58      .57      .55    97    96    94

Willo-Wick Gardens (T)

   Pensacola, FL    152 Units/153,360 Sq. Ft.      .55      .55      .54    95    91    84

Windsong (T)

   Ft. Worth, TX    188 Units/169,464 Sq. Ft.      .89      *      *    91    *    *

Windsor Tower

   Ocala, FL    64 Units/66,000 Sq. Ft.      .56      .56      .55    98    98    97

Woodhollow

   San Antonio, TX    546 Units/348,692 Sq. Ft.      .71      .71      .68    79    79    84

Woodlake

   Carrollton, TX    256 Units/210,208 Sq. Ft.      .87      .87      .85    92    92    89

Woodview (T)

   Odessa, TX    232 Units/165,840 Sq. Ft.      .53      .52      .51    93    94    85

Office Buildings

                                             

1010 Common (T)

   New Orleans, LA    494,579 Sq. Ft.      14.08      13.63      12.77    84    82    74

225 Baronne (T)

   New Orleans, LA    416,834 Sq. Ft.      10.70      10.63      9.89    69    65    76

9033 Wilshire (T)

   Los Angeles, CA    44,253 Sq. Ft.      33.75      30.16      29.24    70    70    63

Amoco (T)

   New Orleans, LA    378,244 Sq. Ft.      13.66      13.37      12.73    69    78    79

Bay Plaza (T)

   Tampa, FL    75,780 Sq. Ft.      13.96      14.98      15.85    54    80    86

Bay Plaza II (T)

   Tampa, FL    78,882 Sq.Ft.      12.79      13.23      13.01    77    78    72

Cooley Building

   Farmers Branch, TX    27,000 Sq. Ft.      12.63      12.63      11.49    100    100    100

Durham Center

   Durham, NC    207,171 Sq. Ft.      17.73      17.73      17.79    83    83    98

Eton Square (T)

   Tulsa, OK    222,654 Sq. Ft.      11.09      11.60      11.35    75    38    42

Executive Court

   Memphis, TN    41,840 Sq. Ft.      8.00      8.00      11.24    —      —      —  

Forum (T)

   Richmond, VA    79,791 Sq. Ft.      13.68      14.23      15.32    76    61    60

Four Hickory Centre

   Farmers Branch, TX    226,911 Sq. Ft.      18.70      18.70      *    4    4    *

Institute Place (T)

   Chicago, IL    144,915 Sq. Ft.      16.67      17.21      17.13    69    83    88

 

17


Table of Contents
Index to Financial Statements
               Rent Per
Square Foot


   Occupancy %

Property


  

Location


   Units/Square Footage

   2004

   2003

   2002

   2004

   2003

   2002

Lexington Center (T)

   Colorado Springs, CO    74,603 Sq. Ft.    $ 10.56    $ 12.33    $ 13.41    58    70    84

One Hickory Centre

   Farmers Branch, TX    102,615 Sq. Ft.      20.34      20.34      20.42    74    74    74

Parkway North (T)

   Dallas, TX    71,041 Sq. Ft.      16.58      18.08      17.41    60    64    72

Signature Athletic Club (T)

   Dallas, TX    56,532 Sq. Ft.      10.00      ****      ****    100    ****    ****

Two Hickory Centre

   Farmers Branch, TX    96,127 Sq. Ft.      21.47      21.47      21.23    100    100    93

University Square

   Anchorage, AK    22,260 Sq. Ft.      14.64      14.64      15.54    100    100    100

Westgrove Air Plaza (T)

   Addison, TX    78,326 Sq. Ft.      12.68      13.26      13.96    74    94    66

Industrial Warehouses

                                             

5360 Tulane (T)

   Atlanta, GA    30,000 Sq. Ft.      2.85      2.80      2.75    100    65    100

5700 Tulane (T)

   Atlanta, GA    67,850 Sq. Ft.      1.88      2.14      2.45    65    65    12

Addison Hanger (T)

   Addison, TX    23,650 Sq. Ft.      7.54      7.94      8.12    67    100    98

Addison Hanger II (T)

   Addison, TX    29,000 Sq. Ft.      9.24      9.64      9.33    92    92    97

Encon (T)

   Fort Worth, TX    256,410 Sq. Ft.      3.12      3.17      3.17    100    100    100

Space Center (T)

   San Antonio, TX    101,500 Sq. Ft.      3.41      3.43      3.46    61    84    84

Shopping Centers

                                             

Bridgeview Plaza (T)

   LaCrosse, WI    116,008 Sq. Ft.      6.97      7.25      *    89    90    *

Cross County Mall

   Mattoon, IL    304,575 Sq. Ft.      5.44      5.44      5.34    88    88    87

Cullman (T)

   Cullman, AL    92,466 Sq. Ft.      3.55      3.53      3.39    27    95    91

Dunes Plaza (T)

   Michigan City, IN    223,869 Sq. Ft.      5.91      5.51      5.83    64    61    69

Promenade (T)

   Highland Ranch, CO    133,558 Sq. Ft.      10.45      10.94      12.41    85    79    81

Merchandise Mart

                                             

Denver Mart

   Denver, CO    509,508 Sq. Ft.      11.75      11.75      11.48    92    92    92

Single Family Residence

                                             

Tavel Circle

   Dallas, TX    2,271 Sq. Ft.                                    

 

            Average Room Rate

  Occupancy %

  Total Room Revenues
Divided By
Total Available Rooms


Property


 

Location


 

Rooms


  2004

  2003

  2002

  2004

  2003

  2002

  2004

  2003

  2002

Hotels

                                                       

Akademia (T)

  Wroclaw, Poland   165 Rooms   $ 55.33   $ 47.78   $ 48.92   65   51   33   $ 35.98   $ 46.86   $ 15.97

Best Western

  Virginia Beach, VA   110 Rooms     108.92     108.92     105.78   65   65   69     70.56     70.56     72.79

Château Inn

  Fresno, CA   78 Rooms     63.42     63.42     61.89   58   58   53     36.52     36.52     32.56

City Suites (T)

  Chicago, IL   45 Rooms     126.29     120.16     131.46   58   58   56     71.60     76.78     73.38

Majestic Inn (T)

  San Francisco, CA   57 Rooms     129.43     107.67     141.62   50   52   37     64.10     66.68     52.25

Picadilly Airport

  Fresno, CA   185 Rooms     79.25     79.25     75.18   63   63   61     50.04     50.04     45.83

Picadilly Shaw

  Fresno, CA   194 Rooms     81.19     81.19     78.24   69   69   69     55.70     55.70     53.87

Picadilly University

  Fresno, CA   190 Rooms     68.21     68.21     69.58   63   63   59     43.03     43.03     40.93

Quality Inn

  Denver, CO   161 Rooms     56.10     56.10     53.62   55   55   60     30.80     30.80     32.13

The Majestic (T)

  Chicago, IL   55 Rooms     129.64     124.47     133.79   52   48   52     65.91     57.86     64.31

Williamsburg Hospitality House

  Williamsburg, VA   296 Rooms     93.97     93.97     99.79   53   53   49     49.98     49.98     48.86

Willows (T)

  Chicago, IL   52 Rooms     119.84     121.24     129.76   57   53   49     67.62     69.54     63.35

* Property was purchased or constructed in 2003 or 2004.
** Property was under construction at December 31, 2004.
*** Property was sold in 2003 and repurchased in 2004.
**** No applicable data for Signature Athletic Club. ARI sold the Athletic Club in November 2004, but retained the Signature office building.

 

Occupancy presented above and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.

 

18


Table of Contents
Index to Financial Statements

In 2004, ARI purchased the following properties:

 

Property


  

Location


  

Units/Acres


   Purchase
Price


   Net Cash
Paid/
(Received)


    Debt
Incurred


    Interest
Rate


    Maturity
Date


Apartments

                                           

288 City Park(1)

   Houston, TX    240 Units    $ 3,056    $ 612     $ 2,444     5.95 %   04/45

Blue Lake Villas II(1)

   Waxahachie, TX    70 Units      729      (164 )     729     5.80     04/45

Bridges on Kinsey(1)

   Tyler, TX    232 Units      2,291      596       1,687     5.74     08/45

Dakota Arms(1)

   Lubbock, TX    208 Units      2,472      681       1,791     5.85     06/45

Laguna Vista(1)

   Farmers Branch, TX    206 Units      2,424      902       1,522     5.50     09/46

Lake Forest(1)

   Houston, TX    240 Units      2,316      (470 )     2,316     5.60     03/45

Parc at Maumelle(1)

   Maumelle, AR    240 Units      3,120      916       2,204     5.37     07/46

Treehouse(3)

   Irving, TX    160 Units      7,519      (498 )     5,027 (4)   5.00     08/13

Vistas of Vance Jackson(1)

   San Antonio, TX    240 Units      3,550      771       2,779     5.78     06/45

Wildflower Villas(1)

   Temple, TX    220 Units      2,045      79       1,996     5.99     10/45

Land

                                           

Cooks Lane

   Ft. Worth, TX    21.9 Acres      1,000      1,034       —       —       —  

Denton-Coonrod

   Denton, TX    13.9 Acres      1,644      1,046       840     6.25     11/06

DeSoto

   DeSoto, TX    202.0 Acres      2,516      1,364       1,265     6.25     11/06

Granbury Station

   Ft. Worth, TX    15.7 Acres      923      236       738     7.00     09/07

Ladue

   Farmers Branch, TX    8.0 Acres      1,743      659       1,206     6.65 (2)   06/06

Las Colinas

   Irving, TX    45.5 Acres      4,802      1,674       3,121     7.00     12/06

Las Colinas(5)

   Irving, TX    268.0 Acres      4,687      159       —       —       —  

Lubbock

   Lubbock, TX    2.9 Acres      224      224       —       —       —  

Meloy Road

   Kent, OH    54.2 Acres      4,900      343       4,900     5.00 (2)   01/06

Railroad

   Dallas, TX    0.3 Acres      708      704       —       —       —  

Rogers

   Rogers, AR    20.1 Acres      1,390      619       1,130     10.50     04/05

West End

   Dallas, TX    0.2 Acres      71      71       —       —       —  

(1) Initial construction loan funding to purchase land and begin apartment construction. Does not represent actual units purchased.
(2) Variable interest rate.
(3) Purchased from IORI, a related party, for assumption of debt and a note receivable, less $498 in cash received.
(4) Assumed debt of seller.
(5) Obtained in exchange for 13.0 acres of Las Colinas land.

 

In 2004, ARI sold the following properties:

 

Property


  

Location


  

Units/Sq.Ft./
Acres


   Sales
Price


   Net Cash
Received/
(Paid)


   Debt
Discharged


    Gain/
(Loss)
on Sale


 

Apartments

                                        

Cliffs of El Dorado(5)

   McKinney, TX    208 Units    $ 13,442    $ 10    $ 10,323 (1)   $ —    

Falcon House

   Ft. Walton, FL    82 Units      3,330      1,178      1,950 (1)     1,209  

In the Pines

   Gainesville, FL    242 Units      11,300      3,247      5,201       5,517  

La Mirada

   Jacksonville, FL    320 Units      10,500      2,576      7,098       7,576  

Park Avenue

   Tallahassee, FL    121 Units      6,225      926      4,320 (1)     3,922  

Sandstone

   Mesa, AZ    238 Units      8,650      2,920      5,531       1,688  

Tiberon Trails

   Merrillville, IN    376 Units      10,325      2,869      6,189 (1)     49  

Industrial Warehouses

                                        

Kelly (Cash Road)

   Dallas, TX    97,150 Sq. Ft.      1,500      1,077      422       454  

Kelly (Pinewood)

   Dallas, TX    100,000 Sq. Ft.      1,650      65      65       153  

Ogden Industrial

   Ogden, UT    107,112 Sq. Ft.      2,600      668      668       1,474  

Texstar Warehouse

   Arlington, TX    97,846 Sq. Ft.      2,400      —        —         —   (3)

Land

                                        

Allen

   Collin County, TX    492.5 Acres      19,962      7,956      4,088     $ 7,915 (2)

Marine Creek

   Ft. Worth, TX    10.7 Acres      1,488      1,198      991       —   (7)

Mason Goodrich

   Houston, TX    5.7 Acres      686      45      588       379  

 

19


Table of Contents
Index to Financial Statements

Property


  

Location


  

Units/Sq.Ft./
Acres


   Sales
Price


   Net Cash
Received/
(Paid)


    Debt
Discharged


    Gain/
(Loss)
on Sale


 

Mason Goodrich

   Houston, TX    8.0 Acres    $ 1,045    $ 251     $ 200     $ 617  

Mason Goodrich

   Houston, TX    4.0 Acres      523      33       436       306  

Mason Goodrich

   Houston, TX    2.4 Acres      250      15       200       115  

Mason Goodrich

   Houston, TX    5.0 Acres      515      466       —         254  

Mason Goodrich

   Houston, TX    12.0 Acres      1,492      1,338       —         854  

Meloy Road

   Kent, OH    1.3 Acres      135      —         135       11  

Rasor

   Plano, TX    24.5 Acres      2,600      2,600       1,260       220  

Red Cross

   Dallas, TX    2.9 Acres      8,500      2,842       4,450       —    

Vineyards

   Tarrant County, TX    1.6 Acres      1,307      (275 )     548       677  

Vineyards II

   Tarrant County, TX    1.5 Acres      1,239      (261 )     200       551  

Vista Ridge

   Lewisville, TX    1.3 Acres      310      259       —         131  

Office Buildings

                                         

4135 Beltline

   Addison, TX    90,000 Sq. Ft.      4,900      2,472       2,009       337  

Ambulatory Surgery Center

   Sterling, VA    33,832 Sq. Ft.      8,675      5,448       2,899       784  

Atrium

   Palm Beach, FL    74,603 Sq. Ft.      5,775      1,842       3,772       708  

Brandeis(6)

   Omaha, NE    319,234 Sq. Ft.      —        —         —         (92 )

Centura Tower(4)

   Farmers Branch, TX    410,901 Sq. Ft.      84,075      36,350       49,878       38,154  

Corporate Pointe

   Chantilly, VA    65,918 Sq. Ft.      9,000      5,025       3,585       5,533  

Countryside Harmon

   Sterling, VA    72,062 Sq. Ft.      9,150      4,608       3,865       1,931  

Countryside Mimado

   Sterling, VA    35,127 Sq. Ft.      4,000      102       941       72  

Countryside Retail

   Sterling, VA    133,422 Sq. Ft.      27,100      3,408       3,408       6,807  

One Steeplechase

   Sterling, VA    103,376 Sq. Ft.      11,900      3,743       7,654       6,786  

Venture Center

   Atlanta, GA    38,272 Sq. Ft.      4,000      997       2,550       1,381  

Shopping Centers

                                         

Collection

   Denver, CO    267,812 Sq. Ft.      21,200      6,703       13,153       3,314  

K-Mart

   Cary, NC    92,033 Sq. Ft.      3,200      —         1,677 (1)     —   (3)

Plaza on Bachman Creek

   Dallas, TX    80,278 Sq. Ft.      7,850      1,808       5,358       4,073  

Sadler Square

   Amelia Island, FL    70,295 Sq. Ft.      4,500      1,876       2,680       1,897  

Other

                                         

Signature Athletic Club(2)

   Dallas, TX    N/A      120      (154 )     88       (47 )

(1) Debt assumed by purchaser.
(2) Signature Athletic Club was sold for the assumption of capital leases by purchaser. Net cash paid is from prepaid dues and unearned revenues due purchaser.
(3) Sold to BCM, a related party, for assumption of debt and a secured note receivable. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.” Gain of $1,157 (Texstar) and $521 (K-Mart) deferred until sale to unrelated party.
(4) ARI sold a 95% limited partnership interest, retaining a 1% general partner and 4% limited partner interest.
(5) Sold to Unified Housing Foundation, Inc. (“UHF”), a related party, in 2003. See NOTE 9. “RELATED PARTY TRANSACTIONS.” Gain of $2,542 deferred until sale to unrelated party.
(6) Returned to lender. See NOTE 7. “NOTES AND INTEREST PAYABLE.”
(7) Sold to UHF. Gain of $581 deferred until sale to unrelated party.

 

20


Table of Contents
Index to Financial Statements

In 2004, ARI financed/refinanced or obtained second mortgage financing on the following:

 

Property


 

Location


 

Units/Sq. Ft.
Rooms/Acres


  Debt
Incurred


    Debt
Discharged


    Net Cash
Received/
(Paid)


    Interest
Rate


    Maturity
Date


 

Apartments

                                           

Mountain Plaza

  El Paso, TX   188 Units   $ 5,184     $ 4,257     $ 370     5.16 %   12/34  

Treehouse

  Irving, TX   160 Units     5,780       5,027       138     5.06     07/34  

Villager

  Fort Walton, FL   33 Units     804       507       129     5.15     06/34  

Waters Edge III

  Gulfport, MS   238 Units     3,250       —         —   (5)   12.50     12/04 (9)

Hotels

                                           

City Suites

  Chicago, IL   45 Rooms     3,640       —         3,548     6.75 (1)   09/09  

Majestic Inn

  San Francisco, CA   57 Rooms     2,000 (8)     5,138       (1,238 )   5.75 (1)   10/05  

Williamsburg Hospitality House

  Williamsburg, VA   296 Rooms     11,500       12,332       (13,689 )(3)   7.00 (1)   03/05 (10)

Willows

  Chicago, IL   52 Rooms     3,500       —         3,411     6.75 (1)   09/09  

Land

                                           

Bonneau

  Dallas County, TX   8.4 Acres     9,661 (6)     10,283 (7)     76     6.75 (1)   09/05  

Centura

  Farmers Branch, TX   8.8 Acres     4,485       4,000       (183 )   7.00 (1)   02/05 (11)

Chase Oaks

  Plano, TX   5.8 Acres     —   (6)     —         —       —       —    

Cooks Lane

  Ft. Worth, TX   23.2 Acres     550       —         —       6.75     11/06  

Dalho

  Farmers Branch, TX   2.9 Acres     —   (6)     —         —       —       —    

Dominion/Hollywood

  Farmers Branch, TX   66.1 Acres     6,985       6,222       (67 )   7.00 (1)   02/05 (12)

HSM

  Farmers Branch, TX   6.2 Acres     —   (6)     —         —       —       —    

JHL Connell

  Carrollton, TX   7.6 Acres     —   (6)     —         —       —       —    

Katy

  Harris County, TX   130.6 Acres     7,500       —         (75 )(4)   6.00 (1)   02/07  

Lacy Longhorn

  Farmers Branch, TX   17.1 Acres     1,965       1,800       78     4.03 (1)   07/07  

Las Colinas

  Las Colinas, TX   1.5 Acres     —   (6)     —         —       —       —    

Marine Creek

  Ft. Worth, TX   28.4 Acres     1,785       —         1,746     4.03 (1)   07/07  

Mason/Goodrich

  Houston, TX   39.4 Acres     2,133       714       1,345     6.00 (1)   08/05  

Stagliano

  Farmers Branch, TX   3.2 Acres     —   (6)     —         —       —       —    

Vista Ridge

  Lewisville, TX   64.9 Acres     —   (6)     —         —       —       —    

Walker

  Dallas County, TX   132.6 Acres     8,750       7,950       264     5.90 (1)   06/06  

Office Buildings

                                           

225 Baronne

  New Orleans, LA   416,834 Sq. Ft.     500 (8)     —         —       5.75 (1)   10/05  

1010 Common

  New Orleans, LA   494,579 Sq. Ft.     16,250       8,000       7,829     4.03 (1)   07/07  

Amoco

  New Orleans, LA   378,244 Sq. Ft.     1,500 (8)     —         —       5.75 (1)   10/05  

Centura Tower

  Farmers Branch, TX   410,901 Sq. Ft.     34,000 (2)     36,889       (4,588 )   5.50 (1)   04/06  

Centura Tower

  Farmers Branch, TX   410,901 Sq. Ft.     3,800 (2)     —         3,737     5.75 (1)   04/06  

Centura Tower

  Farmers Branch, TX   410,901 Sq. Ft.     50,000       37,594       2,989     4.94     10/09  

Cooley

  Farmers Branch, TX   27,000 Sq. Ft.     2,600       1,726       811     5.50 (1)   09/06  

Two Hickory Centre

  Farmers Branch, TX   96,127 Sq. Ft.     7,500       7,500       (164 )   3.60 (1)   05/06  

Warehouses

                                           

Addison Hangers I & II

  Addison, TX   52,650 Sq. Ft.     4,500       2,592       1,635     10.00     09/14  

(1) Variable interest rate.
(2) Repaid with proceeds of subsequent $50,000 loan.
(3) Cash of $10,961 was received by an affiliate, increasing ARI’s affiliate receivable.
(4) Cash of $7,400 was received by an affiliate, increasing ARI’s affiliate receivable.
(5) Cash of $3,250 was received by an affiliate, increasing ARI’s affiliate receivable.
(6) Single note, with all properties as collateral.
(7) Debt forgiveness of $2,268 recognized.
(8) The Majestic Inn, 225 Baronne Office Building and Amoco Office Building are cross collateralized. The debt incurred on 225 Baronne and Amoco are 2nd lien loans.
(9) Repaid in December 2004.
(10) Maturity date extended to September 2005.
(11) Repaid in February 2005.
(12) Maturity date extended to February 2006.
(13) The Addison Hangers were sold in September 2004 to a third party but were then leased back for 10 years on a triple net lease basis. This transaction has been recorded as a financing transaction for accounting purposes.

 

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Land Properties.    Set forth below are ARI’s land properties, consisting of both improved and unimproved land:

 

Property


  

Location


   Acres

1013 Common

   New Orleans, LA    0.4

2301 Valley Branch

   Farmers Branch, TX    23.8

2524 Valley View

   Farmers Branch, TX    0.5

Alamo Springs

   Dallas, TX    0.7

Backlick

   Springfield, VA    4.0

Bee Street

   Farmers Branch, TX    0.5

Bonneau

   Dallas County, TX    8.4

Centura

   Farmers Branch, TX    8.8

Chase Oaks

   Plano, TX    11.8

Cooks Lane

   Ft. Worth, TX    23.2

Croslin

   Dallas County, TX    0.8

Dalho

   Farmers Branch, TX    3.4

Denton-Coonrod

   Denton, TX    82.2

DeSoto

   DeSoto, TX    21.9

Dominion

   Dallas, TX    14.4

Elm Fork

   Denton County, TX    105.4

Fiesta

   San Angelo, TX    0.7

Folsom

   Dallas, TX    36.8

Fort Wayne

   Fort Wayne, IN    23.2

Fruitland

   Fruitland Park, FL    4.7

FRWM Cummings

   Farmers Branch, TX    6.5

Granbury Station

   Ft. Worth, TX    15.7

Hollywood Casino

   Farmers Branch, TX    42.8

HSM

   Farmers Branch, TX    6.2

JHL Connell

   Carrollton, TX    7.6

Katrina

   Palm Desert, CA    110.5

Katy Road

   Harris County, TX    130.6

Kelly

   Dallas County, TX    0.8

Lacy Longhorn

   Farmers Branch, TX    17.1

LaDue

   Farmers Branch, TX    8.0

Lakeshore Villas

   Humble, TX    16.9

Lamar/Parmer

   Austin, TX    17.1

Las Colinas

   Las Colinas, TX    1.6

Las Colinas

   Las Colinas, TX    4.7

LCLLP

   Las Colinas, TX    45.5

Lemmon Carlisle

   Dallas, TX    2.1

Leone

   Irving, TX    8.2

Limestone Canyon II

   Austin, TX    10.0

Lubbock

   Lubbock, TX    2.9

Manhattan

   Farmers Branch, TX    108.9

Marine Creek

   Ft. Worth, TX    43.3

Mason Park

   Houston, TX    18.0

Mason/Goodrich

   Houston, TX    20.2

Maumelle

   Maumelle, AR    10.8

McKinney 36

   Collin County, TX    34.6

McKinney Corners II

   Collin County, TX    18.5

Meloy

   Kent, OH    52.9

Mendoza

   Dallas County, TX    0.4

 

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Index to Financial Statements

Property


  

Location


   Acres

Mira Lago

   Farmers Branch, TX    8.9

Nashville

   Nashville, TN    127.4

Pac Trust

   Farmers Branch, TX    7.1

Payne

   Las Colinas, TX    268.0

Pioneer Crossing

   Austin, TX    439.1

Pulaski

   Pulaski County, AR    21.9

Railroad

   Dallas, TX    3

Rochelle I

   Las Colinas, TX    10.1

Rochelle II

   Las Colinas, TX    21.3

Rogers

   Rogers, AR    20.1

Round Mountain

   Austin, TX    18.0

Seminary West

   Ft. Worth, TX    5.4

Sheffield Village

   Grand Prairie, TX    13.9

Siskiyou

   Siskiyou County, CA    20.7

Sladek

   Travis County, TX    63.3

Stagliano

   Farmers Branch, TX    3.2

Thompson

   Farmers Branch, TX    4.0

Thompson II

   Dallas County, TX    3.3

Tomlin

   Farmers Branch, TX    9.2

Travelers

   Farmers Branch, TX    202.0

Valley Ranch

   Irving, TX    6.8

Valley Ranch III

   Irving, TX    12.5

Valley Ranch IV

   Irving, TX    12.4

Valley View 34

   Farmers Branch, TX    33.9

Valwood

   Dallas County, TX    246.1

Vineyards

   Tarrant County, TX    14.2

Vineyards II

   Tarrant County, TX    17.1

Vista Ridge

   Lewisville, TX    79.0

Walker

   Dallas County, TX    132.6

West End

   Dallas, TX    6.8

 

Partnership Properties.    ARI accounts for partnership properties using the equity method. ARI had no property information for properties owned by partnerships.

 

ARI is a 30% general partner in Sacramento Nine (“SAC 9”), which owned the Prospect Park #29 Office Building. In December 2004, SAC 9 sold the Prospect Park #29 office building for $3.7 million, of which ARI received $1.1 million after closing costs and fees. ARI recognized a gain on the sale of investment in SAC 9 of $882,000 relating to this transaction.

 

In December 2004, ARI sold a 95% interest in Garden Centura, L.P. that owns the 410,901 sq. ft. Centura Tower office building located in Farmers Branch, Texas. ARI retained a non-controlling 1% general partner and 4% limited partner interest in Garden Centura, L.P. ARI will account for its investment in this partnership on the cost basis.

 

Mortgage Loans

 

In addition to real estate, a portion of ARI’s assets are invested in mortgage notes receivable, secured by income-producing real estate, unimproved land and partnership interests. Management expects that the percentage of ARI’s assets invested in mortgage loans will decline, as ARI will no longer seek to fund or acquire new mortgage loans. However, ARI may, in selected instances, originate mortgage loans or it may provide purchase money financing in conjunction with a property sale. Management intends to service and hold for investment the mortgage notes currently in the portfolio. Mortgage notes receivable consist primarily of first mortgage loans.

 

Types of Properties Subject to Mortgages.    The types of properties securing mortgage notes receivable at December 31, 2004, consisted of one apartment, four commercial buildings, unimproved land and partnership

 

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Index to Financial Statements

interests. The type of properties subject to mortgages in which ARI invests may be altered without a vote of stockholders.

 

As of December 31, 2004, the obligors on $43.3 million or 59.0% of the mortgage notes receivable portfolio were affiliates of ARI. Also at that date, $6.6 million or 8.9% of the mortgage notes receivable portfolio was non-performing.

 

The following table sets forth the percentages (based on the outstanding mortgage loan balance at December 31, 2004), by property type and geographic region, of the income producing properties that serve as collateral for ARI’s mortgage notes receivable. Excluded are $55.5 million of mortgage notes that are secured by unimproved land and other security, or are unsecured. See SCHEDULE IV to the Consolidated Financial Statements included in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” for additional details of ARI’s mortgage notes receivable portfolio.

 

Region


   Commercial
Properties


 

Midwest

   5 %

Southwest

   95  
    

     100 %
    

 

A summary of the activity in the mortgage notes receivable portfolio during 2004 is as follows:

 

Mortgage notes receivable at January 1, 2004

   25  

Loans funded

   38  

Loans collected in full

   (5 )

Loans sold

   (1 )
    

Mortgage notes receivable at December 31, 2004

   57  
    

 

During 2004, $5.9 million in interest and $11.6 million in principal were collected on mortgage notes receivable.

 

First Mortgage Loans.    These loans generally provide for level periodic payments of principal and interest sufficient to substantially repay the loan at or prior to maturity, but may involve interest-only payments, moderate or negative amortization of principal, or all interest and a “balloon” principal payment at maturity. With respect to first mortgage loans, it is ARI’s general policy to require that the borrower provide a title policy or an acceptable legal opinion of title as to the validity and the priority of ARI’s mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders. ARI may grant participations in first mortgage loans that it originates to other lenders.

 

The following discussion briefly describes first mortgage loans funded in 2004, as well as events during 2004 that affected previously funded first mortgage loans.

 

In March 2004, ARI sold an 8.0 acre tract of its Mason Goodrich land parcel for $1.0 million, receiving $251,000 after payment of closing costs and providing purchase money financing of $523,000. The secured loan bears interest at 10.0% per annum, requires monthly payments of accrued interest and matures in March 2006. All principal and accrued but unpaid interest is due at maturity.

 

In March 2004, ARI sold 492.5 acres in Collin County, Texas for $20.0 million, receiving $8.0 million after payment of debt and closing costs, and providing purchase money financing of $7.2 million for a portion of the land on a contingent basis. The secured note bore interest at 7.0% per annum and matured in September 2004.

 

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The purchaser extended the note to December 2004 with a $1.1 million extension payment in September 2004. In December 2004, the note was collected in full, including accrued but unpaid interest.

 

In October 2004, ARI sold the In The Pines apartments to a third party and provided $1.0 million of the purchase price as seller financing in the form of two notes. The first note bears interest at 7.0% per annum, requires monthly interest payments and matured in January 2005. The Purchaser extended this note to March 2005 by paying 1.0% of the outstanding principal balance as an extension fee and then extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance. In the event of a default, the note is also secured by membership rights in the purchaser’s entity. The second note is unsecured; bears interest at 8.5% per annum, requires monthly interest payments and matured in January 2005. The Purchaser extended this note to March 2005 by paying 1.0% of the outstanding principal balance as an extension fee and then extended the note an additional 30 days to April 2005 by paying an extension fee of 0.5% of the outstanding principal balance.

 

In November 2004, ARI sold a 1.6 acre tract of its Vineyards II land parcel for $2.5 million, paying $536,000 after mortgage paydowns, closing costs, and providing purchase money financing of $2.0 million. In November 2004, the note was sold to an unrelated party for $2.0 million plus accrued and unpaid interest.

 

In March 2002, ARI sold the 174,513 sq. ft. Hartford Office Building in Dallas, Texas, for $4.0 million and provided the $4.0 million purchase price as seller financing and an additional $1.4 million line of credit for leasehold improvements in the form of a first lien mortgage note. The note bears interest at a variable interest rate, currently 7.0% per annum, requires monthly payments of accrued interest and matures in March 2007. As of March 2005, ARI has funded $788,000 of the additional line of credit.

 

In October 2002, ARI sold its Varner Road land parcel for $3.7 million, receiving $0.7 million after payment of closing costs and providing purchase money financing of $2.8 million. The loan bore interest at 9.0% per annum, matured in October 2004 and required quarterly interest payments. All principal and accrued but unpaid interest were due at maturity. In October 2004, the note was collected in full, including accrued but unpaid interest.

 

In February 2003, ARI sold an 89.3 acre tract of its Katrina land parcel for $8.5 million, paying $410,000 after payment of closing costs and debt pay down and providing purchase money financing of $5.6 million. The note bears interest at 8.0% per annum and matures three years after the recording of the Deed of Trust. Interest will begin accruing after improvements to the site have been completed by ARI. At April 2004, the improvements were begun. The future costs to ARI to complete the improvements, estimated to be $2.5 million, were accrued in 2002. A principal payment of $450,000 is due within ten days after a Tentative Parcel Map (the “Map”) is recorded. At March 2005, negotiations with the buyer to settle any further obligations are under way. Interest payments will be due on the first day of each calendar quarter, beginning with the first quarter following the completion of the site improvements.

 

Junior participations.    In August 2001, ARI agreed to fund up to $5.6 million secured by a second lien on an office building in Dallas, Texas. The note receivable bore interest at a variable rate, required monthly payments of accrued interest and matured in January 2003. As of March 2005, ARI has funded a total of $4.3 million and the note is classified as non-performing. The collateral used to secure ARI’s second lien was seized by the first lien holder. In March 2004, ARI agreed to accept an assignment of claims in litigation as security for the note. In December 2004, ARI agreed to a Modification Agreement with the borrower, which was effective November 1, 2003. As of the modified effective date, accrued interest of $582,000 was applied to the principal balance of the note, the interest rate was set to a fixed rate of 9.0% per annum and all principal and interest is due November 2005. ARI also received Pledge and Security Agreements in various partnership interests belonging to the borrower and received various Assignments of Proceeds from sales in certain entities owned by the borrower. ARI also agreed to reduce accrued interest and principal by $1.5 million from the receipt of notes receivable assigned to ARI by borrower and by $605,000 from cash received. ARI also received $1.4 million in January

 

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Index to Financial Statements

2005 that was applied to accrued interest and principal effective December 30, 2004. As a result of this modification, ARI has released $1.4 million of allowance for loan losses to expense. The following notes were assigned to ARI as payment on the note:

 

    $678,000 from a partnership that owns an apartment building. This note is unsecured, bears no interest and has no maturity date. Distributions made from the partnership operations will be used to pay the principal on the note.

 

    $264,000 secured by a second lien on 13 acres of unimproved land. This note bears interest at 9.0% and matured in February 2003.

 

    $341,000 secured by a second lien on 23.3 acres of unimproved land. This note bears interest at 4.0% and is payable upon demand.

 

    $125,000 secured by a 100% interest in an affiliated company that owns an apartment building. This note bears interest at 12.0%, only requires payments if surplus cash is available and matures in April 2009.

 

In June 2003, ARI sold the 104 unit Willow Wick Apartments in North Augusta, South Carolina, for $2.7 million and provided $42,000 of the purchaser’s closing costs as seller financing. The note bore interest at 5.0% per annum and required all interest and principal payments be paid at maturity in December 2003. This loan was extended until February 2004 and $10,000 was received in March 2004. The note, including accrued and unpaid interest, was paid in June 2004. ARI discounted the note $2,000 and recognized a loss of $2,000.

 

In September 2003, ARI sold a 367.4 acre tract of its Pioneer Crossing land parcel for $22.5 million, receiving $4.9 million after payment of closing costs and providing purchase money financing of $16.9 million. The note bears interest at 8.0% per annum, matures in September 2006 and requires quarterly payments of accrued interest beginning in January 2004. All principal and accrued but unpaid interest are due at maturity. In November 2003, ARI sold an interest in $8.0 million of the note for $7.5 million, receiving $7.2 million in cash after payment of closing costs and debt paydown. In February 2004, ARI sold an additional interest in $6.6 million of the note for $6.3 million, receiving $6.3 million in cash after payment of closing costs.

 

In December 2003, ARI sold a tract of Marine Creek land to a subsidiary of United Housing Foundation, Inc. (“UHF”) for $1.5 million, receiving cash and a note receivable. This sale was not recognized as a sale at that time because UHF is a related party and ARI has continuing involvement and control. In February 2004, Marine Creek was refinanced by UHF, which paid in full ARI’s note payable on the land. ARI recorded the sale of the land and received a note receivable of $270,000, which was the difference between the sales price and the amount of ARI’s note payable. The note bears interest at 6.0%, requires quarterly payments from available surplus cash and matures in December 2007. See Note 9. “RELATED PARTY TRANSACTIONS.”

 

Other.    In July 2002, ARI entered into an agreement to fund up to $300,000 under a revolving line of credit secured by 100% interest in a partnership of the borrower. The line of credit bears interest at 12.0% per annum, requires monthly payments of accrued interest, and matures in June 2005. ARI has funded the entire $300,000.

 

In September 1999, in conjunction with the sale of two apartments in Austin, Texas, $2.1 million in purchase money financing was provided, secured by limited partnership interests in two limited partnerships owned by the buyer. The financing bore interest at 16.0% per annum, required monthly payments of interest only at 6.0%, beginning in February 2000 and required a $200,000 principal paydown in December 1999, which was not received, and matured in August 2000. ARI had the option of obtaining the buyer’s general and limited partnership interests in the collateral partnerships in full satisfaction of the financing. In March 2000, ARI agreed to forbear foreclosing on the collateral securing the note and released one of the partnership interests, in exchange for a payment of $250,000 and executed deeds of trusts on certain properties owned by the buyer. In March 2000, the borrower made a $1.1 million payment, upon receipt of which ARI returned the deeds of trust. The borrower executed a replacement promissory note for the remaining note balance of $1.0 million, which was unsecured, non-interest bearing and matured in April 2003. In April 2004, a demand letter was sent to the debtor. ARI initiated legal action in June 2004.

 

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Related Parties.    In March 2004, ARI sold a K-Mart in Cary, North Carolina to BCM for $3.2 million, including the assumption of debt. ARI also provided $1.5 million of the purchase price as seller financing. The secured note bears interest at 2.0% over the prime rate, currently 7.75%, and matures in April 2005.

 

In March 2004, ARI sold the Texstar Warehouse in Arlington, Texas to BCM for $2.4 million, including the assumption of debt. ARI also provided $1.3 million of the purchase price as seller financing. The secured note bears interest at 2.0% over the prime rate, currently 7.75%, and matures in April 2005.

 

In October 2004, ARI contemplated the sale of the common stock of TCI Lexington Corporation, which owns the Lexington Center office building in Colorado Springs, Colorado, to One Realco Office Investors, Inc., a related party, for the assumption of debt of $5.1 million, which was subject to lender approval, and a seller note of $237,000. The assumption of debt by One Realco Office Investors, Inc. was not approved by the lender; therefore, the Board of Directors rescinded their approval of the transaction. ARI extended the loan on the Lexington Center with the lender in December 2004.

 

In October 2004, ARI advanced $3.3 million to the Class A Limited Partners of Edina Park Plaza Associates, Limited Partnership, of which ARI is the general partner. The loans bear interest at 10.0% per annum and mature in September 2017. Interest due to ARI will be deducted from the quarterly return owed by ARI to the Class A Limited Partners, eliminating the quarterly payments. The outstanding principal is due at maturity.

 

In October 1999, ARI funded a $4.7 million loan to Realty Advisors. The loan, to provide funds for acquisitions or working capital needs, was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore interest at 10.25% per annum and matured in November 2001. In January 2000, $100,000 was collected. In November 2001, the maturity date was extended to November 2004. The collateral was changed to a pledge of 850,000 shares of ARI Common Stock owned by BCM. The interest rate was changed to 2.0% over the prime rate, currently 7.75% per annum, and the accrued but unpaid interest of $1.0 million was added to the principal. The new principal balance is $5.6 million. In September 2003, $673,000 in accrued interest was collected. In August 2004, $342,000 in accrued interest was collected. In November 2004, the maturity date was extended to November 2006. All principal and accrued interest are due at maturity.

 

In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco. A wholly-owned subsidiary of One Realco owns approximately 2.2% of the outstanding shares of ARI’s Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bore interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $810,000 in principal and interest was collected. In December 2001, $825,000 in principal and interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal, and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. In June 2003, ARI sold a participating interest in $5.8 million of the $15.5 million balance to BCM, receiving 314,141 TCI shares from BCM (see NOTE 1. “BASIS OF PRESENTATION.”) In February 2004, $2.3 million in interest was collected, accrued but unpaid interest of $161,000 was added to the principal, the maturity date was extended to February 2007, and the interest rate was changed to 3.0% over the prime rate, currently at 8.75%. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI until May 31, 2004, was a 10.0% shareholder of One Realco until July 31, 2004. Mr. Kimbrough did not participate in the day-to-day operations or management of One Realco.

 

Investments in Real Estate Companies

 

Real estate entities.    ARI’s investment in real estate entities includes the equity securities of a publicly traded real estate company, IORI, and interests in real estate joint venture partnerships.

 

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Index to Financial Statements

The Board of Directors authorized the expenditure of up to an aggregate of $50.0 million to acquire, in open market purchases, shares of IORI, excluding private purchase transactions which were separately authorized. Through December 31, 2004, ARI had expended an aggregate of $10.0 million to acquire shares of IORI, in open market purchases, in accordance with these authorizations. As of December 31, 2004, ARI and its subsidiaries, other than TCI, owned no shares of common stock of IORI but TCI continued to own 345,728 IORI shares (approximately 24.0% of the outstanding IORI shares). ARI may make additional investments in the equity securities of IORI to the extent its liquidity permits.

 

The following summary description of IORI is based on information publicly reported by IORI in its Form 10-K Annual Report to the Commission for the fiscal year ended December 31, 2004.

 

Pertinent information regarding ARI’s investment in the equity securities of the IORI at December 31, 2004, is summarized below (dollars in thousands):

 

Investee


   Percentage
of ARI’s
Ownership at
December 31, 2004


    Carrying Value
of Investment at
December 31, 2004


   Equivalent
Investee Book
Value at
December 31, 2004


   Market Value of
Investment at
December 31, 2004


IORI

   19.73 %   $ 5,765    $ 10,545    $ 5,532

 

IORI owns real estate, some of which has been held for many years. Because of depreciation, IORI may earn substantial amounts in periods in which it sells real estate and will probably incur losses in periods in which it does not. ARI’s reported income or loss attributable to IORI will differ materially from its cash flow attributable to it.

 

IORI is a Nevada corporation, which was originally organized on December 14, 1984, as a California business trust and commenced operations on April 10, 1985. IORI’s business is investing in real estate through direct equity investments and partnerships. At December 31, 2004, IORI had total assets of $91.2 million and owned six apartments, one office building, one shopping center, one industrial warehouse, and one parcel of unimproved land, all within the State of Texas. In 2004, IORI sold two apartments, two office buildings and a parcel of unimproved land for a total of $24.5 million, receiving net cash of $4.8 million after paying off $15.8 million in mortgage debt and the payment of various closing costs. IORI recognized gains of $5.6 million on the sales, of which ARI’s equity share was $1.1 million. In 2003, IORI sold three office buildings and a parcel of unimproved land for a total of $55.7 million, receiving net cash of $10.1 million after paying off $9.5 million in mortgage debt and the payment of various closing costs. IORI recognized gains of $3.0 million on the sales, of which ARI’s equity share was $715,000.

 

ARI received no dividends from IORI in 2004.

 

ITEM 3. LEGAL PROCEEDINGS

 

Innovo Realty, Inc.    On August 10, 2004, American Realty Investors, Inc. (“ARI”), Investors, Inc. (“TCI”) and Income Opportunity Realty Investors, Inc. (“IOT”) instituted an action in Texas State District Court as Cause No. 2004-60231-393 styled American Realty Investors, Inc., Transcontinental Realty Investors, Inc. and Income Opportunity Realty Investors, Inc., Plaintiffs v. Innovo Realty, Inc. and Innovo Group, Inc., Involuntary Plaintiffs v. Innovo Realty, Inc., Metra Capital LLC, Innovo Group, Inc., Joseph Mizrachi, Simon Mizrachi, Hubert Guez, Third Millennium Partners LLC, Third Millennium Partners, Inc., Third Millennium Group LLC and Sunridge Management Group, Inc., Defendants. Plaintiffs’ Complaint alleges that Joseph Mizrachi, a former director of ARI and others, offered a plan to the Plaintiffs to create one or more joint venture arrangements with one or more of the Plaintiffs to pursue alternative forms of financing or refinancing portions of Plaintiffs’ real estate portfolios, which entailed the creation of 22 separate limited partnerships to acquire 28 separate apartment complexes in three states (Texas, Florida and Louisiana), the general partners of which are affiliates of, or controlled by, Joseph Mizrachi. Plaintiffs’ Complaint alleges that the overall transaction required the establishment of a sinking fund by

 

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Index to Financial Statements

the Defendants and the 22 limited partnerships as a trust for the benefit of certain preferred shareholders of Innovo Group, Inc. and the payment of certain proceeds to the Plaintiffs. Plaintiffs assert that payments have not been made pursuant to the agreement of the parties. Plaintiffs allege that Defendants’ conduct constituted a common business enterprise, alleges breach of contract and derivative claims on behalf of Innovo Group, Inc. against Joseph Mizrachi and others, and requests declaratory relief involving the Plaintiffs’ rights in the partnerships, an accounting of proceeds, and the creation of a constructive trust. Plaintiffs’ Complaint also alleges that Joseph Mizrachi engaged in fraud, negligent misrepresentation and/or breach of fiduciary duty and seeks unspecified damages, attorneys’ fees, the establishment of a constructive trust and other relief.

 

Sunset Management, LLC.    On October 5, 2004, Sunset Management LLC (“Sunset”) filed a Complaint as a purported stockholder’s derivative action on behalf of Transcontinental Realty Investors, Inc. (“TCI”) in the United States District Court for the Northern District of Texas, Dallas Division, against American Realty Investors, Inc. (“ARI”), Basic Capital Management, Inc. (“BCM”), Prime Income Asset Management, Inc. (“PIAMI”), Prime Income Asset Management LLC (“Prime”), Income Opportunity Realty Investors, Inc. (“IOT”), United Housing Foundation, Inc. (“United”), Regis Realty, Inc. (“Regis”), TCI, TCI’s current directors and officers and others. Sunset’s Complaint was instituted as Case No. 3:04-CV-02162-B styled Sunset Management LLC, Derivatively on Behalf of Transcontinental Realty Investors, Inc. v. American Realty Investors, Inc., et al. Sunset’s Complaint alleges (i) Sunset is the owner of 10 shares of Common Stock of TCI and Sunset is the pledgee and beneficial owner of 3,673,115 shares of Common Stock of TCI, (ii) Sunset is a single-member limited liability company, (iii) all of the Defendants have in their various capacities breached fiduciary duties to TCI, and (iv) unjust enrichment of the various Defendants. Sunset’s Complaint seeks an injunction prohibiting TCI from entering into any related-party transactions that are not fair to TCI and approved by disinterested directors and/or the stockholders of TCI with full knowledge of the common interest of the directors and/or officers, unspecified damages, attorneys’ fees and costs. Individual directors and officers of TCI do not believe their interests are adverse to TCI in this matter. All Defendants believe the action is not properly brought as a derivative action on behalf of TCI, as Sunset’s interests are adverse to the interests of TCI. The current action brought by Sunset contains many of the same allegations raised by Sunset in four other cases which, as rulings have occurred, have resulted in a denial of Sunset’s requested relief. The Defendants intend to vigorously defend the action, and on November 8, 2004, filed a Motion to Dismiss the case pursuant to Rules 12 and 23.1 of the Federal Rules of Civil Procedure on the basis that Sunset’s allegations are insufficient to evade the stringent demand requirement under the futility exception for stockholder derivative actions, and that Sunset cannot fairly and adequately represent the interests of other stockholders. On January 4, 2005, the Defendants also filed a Motion to Stay Discovery and For Protective Order based on the concept that the Motion to Dismiss should dispose of the matter. No hearing has been held or order issued by the Court on either Motion through March 30, 2005. Separately, one of the individual Defendants filed on January 4, 2005 a Motion to Disqualify Sunset’s Counsel.

 

On December 23, 2004, Sunset filed another Complaint in the United States District Court for the Northern District of Texas, Dallas Division, against ARI, BCM, EQK Holdings, Inc. (“EQK”) and American Realty Trust, Inc. (“ART”). EQK and ART are subsidiaries of ARI. Sunset’s Complaint was instituted as Case No. 3:04-CV-2710-K styled Sunset Management LLC, Plaintiff v. American Realty Investors, Inc., Basic Capital Management, Inc., EQK Holdings, Inc. and American Realty Trust, Inc., alleging (i) that on September 17, 2001, Sunset lent BCM, EQK, ART and ART Williamsburg, Inc. $30,000,000, and in connection with such loan, BCM, EQK and ART pledged 3,673,115 shares of TCI stock to Sunset; 2,129,701 TCI shares pledged to Sunset by EQK; 920,507 TCI shares pledged to Sunset by BCM, and 622,907 shares pledged to Sunset by ART, (ii) that each of the stock pledge agreements specifically provides that the borrower will not “without the written consent of Sunset, sell, dispose of, transfer directly or indirectly, or further encumber the Pledged Securities,” (iii) some or all of the shares pledged by BCM and ART had been transferred to one or more subsidiaries of ARI in violation of the stock pledge agreements, (iv) BCM and ART have allegedly breached the stock pledge agreements by transferring certain shares of TCI, (v) that ARI and EQK have allegedly tortuously interfered with existing contractual relationships among BCM, ART and Sunset. Sunset’s Complaint seeks specific performance under the stock pledge agreements, and that the Court enter an Order (a) requiring ART to reacquire at least 534,307

 

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Index to Financial Statements

pledged shares it allegedly transferred to EQK, (b) requiring BCM to reacquire at least 920,507 pledged shares it allegedly transferred to EQK, (c) requiring EQK to transfer 534,307 pledged shares back to ART, and (d) requiring EQK 920,507 pledged shares back to BCM. On February 2, 2005, the Defendants in this case filed a Motion to Dismiss or in the Alternative to Stay Action Pending the Resolution of Prior Proceedings in a sister federal court based upon dependency of an adversary proceeding in the United States Bankruptcy Court for the Eastern District of Texas, Sherman Division (Plano, Texas), styled American Realty Trust, Inc. v. Sunset Management LLC, Adversary Proceeding No. 03-4256 (E.D. Texas), which is described in the following paragraphs as the “Texas Litigation.” No hearing has been held or Order issued by the Court on such Motion through March 30, 2005.

 

The current Sunset Complaint is the fifth in a continuing series of actions involving Sunset, certain subsidiaries of ARI and ARI resulting from a loan in September 2001 to BCM and three subsidiaries of ARI in the original amount of $30 million ($19.5 million of which bore interest at 24% per annum, while the remaining $10.5 million of which bore interest at 20%). In September 2002, $15 million in principal was repaid leaving a $15 million aggregate balance, which Sunset orally agreed to extend the maturity date and accept substitute collateral, an arrangement which Sunset did not honor, resulting in the original litigation filed in Texas State Court during October 2002 as Cause No. 02-09433-I in the 162nd Judicial District Court of Dallas County, Texas styled American Realty Trust, Inc., ART Williamsburg, Inc., Basic Capital Management, Inc. and EQK Holdings, Inc. v. Sunset Management LLC (the “Texas Litigation”). The Texas Litigation alleged breach of contract, misrepresentation, breach of duty of good faith and fair dealing and slander of title by Sunset and sought certain declaratory relief against Sunset, as well as temporary and permanent anti-suit injunction against Sunset.

 

During January 2003, without notice to the Plaintiffs in the Texas Litigation, Sunset institute an action in Federal District Court in Las Vegas, Nevada against Commonwealth Land Title (“Commonwealth”) seeking disposition of certain shares of Common Stock of TCI held by Commonwealth as Pledge Holder. On January 31, 2003, after a Temporary Restraining Order was issued in the Texas Litigation against Sunset, Sunset instituted a separate lawsuit in Nevada State Court styled Sunset Management LLC v. American Realty Trust, Inc., et al., Cause No. A462587 pending in District Court of Clark County, Nevada (the “Nevada Litigation”). On February 12, 2003, the Nevada State Court held a hearing on Sunset’s request for emergency relief and denied all of Sunset’s requested relief and indicated that a stay of the Nevada Litigation may be appropriate, which stay of litigation (including claims against TCI) was granted on May 2, 2003. Notwithstanding the stay of the Nevada Litigation, Sunset has attempted to re-litigate the underlying issues already determined in the Texas Litigation and the Nevada Litigation through cross-claims and counterclaims in the Texas Litigation and renewed motions for injunctions and the appointment of a receiver in the Nevada Litigation. During September 2003, the Texas Litigation was removed to Bankruptcy Court for the Northern District of Texas and subsequently transferred to the Eastern District of Texas. Sunset and the Plaintiffs have filed cross-motions for partial summary judgment in the Bankruptcy Court which had been briefed but remain pending at this time. The parties have also filed an Agreed Motion to Withdraw the reference and have the case transferred to a United States District Judge for trial, which has been denied without prejudice pending resolution of pre-trial motions, including the motions for summary judgment.

 

On February 10, 2004, Sunset filed yet another lawsuit in Nevada styled Sunset Management LLC v. Transcontinental Realty Investors, Inc., Case No. CV04-00345 in the Superior Court of Washoe County, seeking to compel a new election of directors, alleging that Sunset was improperly denied voting rights with respect to certain pledged shares at the 2003 stockholders meeting of TCI. TCI responded to that action by informing the Nevada Court that the issue of the validity and effectiveness of proxies purportedly held by Sunset in connection with the loan was already pending before the Bankruptcy Court. On May 12, 2004, the Nevada District Court denied Sunset’s motion to compel and election of corporate directors because of the dispute pending in the Texas Bankruptcy Court concerning the status of the loan. Subsequently, the Nevada District Court denied two motions for reconsideration filed by Sunset. Sunset is currently appealing the rulings of the Washoe County District Court.

 

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The ownership of property and provision of services to the public as tenants entails an inherent risk of liability. Although the Company and its subsidiaries are involved in various items of litigation incidental to and in the ordinary course of its business, in the opinion of management, the outcome of such litigation will not have a material adverse impact upon the Company’s financial condition, results of operations or liquidity.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

Not applicable.

 

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Index to Financial Statements

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

ARI’s Common Stock is traded on the New York Stock Exchange using the symbol “ARL.” The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the New York Stock Exchange.

 

Quarter Ended


   High

   Low

March 31, 2005 (through March 24, 2005)

   $ 9.99    $ 8.90

March 31, 2004

     11.25      7.58

June 30, 2004

     9.80      6.99

September 30, 2004

     9.17      8.20

December 31, 2004

     11.60      7.54

March 31, 2003

     10.65      7.50

June 30, 2003

     13.10      8.30

September 30, 2003

     12.25      10.00

December 31, 2003

     12.55      8.95

 

As of March 24, 2005, the closing market price of ARI’s Common Stock on the New York Stock Exchange was $9.35 per share.

 

As of March 24, 2005, ARI’s Common Stock was held by approximately 2,900 stockholders of record.

 

During the second quarter of 1999, the Board of Directors established the policy that dividend declarations on ARI’s Common Stock would be determined on an annual basis following the end of each year. In accordance with that policy, the Board determined not to pay any dividends in 2004. Future distributions to Common stockholders will be dependent upon ARI’s realized income, financial condition, capital requirements and other factors deemed relevant by the Board.

 

15,000,000 shares of Series A 10.0% Cumulative Convertible Preferred Stock are authorized under ARI’s Amended Articles of Incorporation, with a par value of $2.00 per share and a liquidation preference of $10.00 per share plus accrued and unpaid dividends. Dividends are payable at the annual rate of $1.00 per share, or $.25 per share quarterly, to stockholders of record on the last day of each March, June, September, and December, when and as declared by the Board of Directors. The Series A Preferred Stock may be converted into Common Stock at 90.0% of the average daily closing price of ARI’s Common Stock for the prior 20 trading days. At December 31, 2004, 3,469,350 shares of Series A Preferred Stock were outstanding and 869,808 shares were reserved for issuance as future consideration in various business transactions. Of the outstanding shares, 300,000 shares are owned by ART Edina, Inc., and 600,000 shares are owned by ART Hotel Equities, Inc., wholly-owned subsidiaries of ARI. Dividends are not paid on the shares owned by ARI subsidiaries.

 

231,750 shares of Series C Cumulative Convertible Preferred Stock are authorized under ARI’s Amended Articles of Incorporation, with a par value of $2.00 per share and liquidation preference of $100.00 per share plus accrued and unpaid dividends. The Series C Preferred Stock bears a quarterly dividend of $2.50 per share to stockholders of record on the last day of March, June, September and December when and as declared by the Board of Directors. The Series C Preferred Stock is reserved for conversion of the Class A limited partner units of ART Palm, L.P. (“Art Palm”). At December 31, 2003, 10,188,750 Class A units were outstanding. The Class A units may be exchanged for Series C Preferred Stock at the rate of 100 Class A units for each share of Series C Preferred Stock. At June 30, 2003, shares of Series C Preferred Stock could be converted into 57,500 shares of ARI Common Stock. On or after December 31, 2005, additional shares of Series C Preferred Stock may be converted into 16,250 shares of ARI Common Stock. On or after December 31, 2006, all remaining outstanding

 

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Index to Financial Statements

shares of Series C Preferred Stock may be converted into ARI Common Stock. All conversions of Series C Preferred Stock into ARI Common Stock will be at 90.0% of the average daily closing price of ARI’s Common Stock for the prior 20 trading days. In January 2001, 2.5 million Class A limited partner units of ART Palm were redeemed for $2.5 million in cash. In December 2001, 7.2 million Class A limited partner units of ART Palm were redeemed for $5.8 million, including $2.5 million in cash. ARI gave a note payable for the remaining $3.3 million. The note was paid in full in January 2003, including accrued but unpaid interest. In July 2002, 1.6 million Class A limited partner units of ART Palm were redeemed for $1.6 million in cash. In August 2003, 1.6 million Class A limited partner units of ART Palm were redeemed for $1.6 million in cash. In June 2004, 2.6 million Class A limited partner units were redeemed for $2.6 million in cash. In December 2004, 750,000 Class A limited partner units were redeemed for $750,000 in cash. At December 31, 2004, no Series C Preferred Stock was outstanding.

 

91,000 shares of Series D 9.50% Cumulative Preferred Stock are authorized under ARI’s Amended Articles of Incorporation, with a par value of $2.00 per share, and a liquidation preference of $20.00 per share. Dividends are payable at the annual rate of $1.90 per year or $.475 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. The Series D Preferred Stock is reserved for the conversion of the Class A limited partner units of Ocean Beach Partners, L.P. The Class A units may be exchanged for Series D Preferred Stock at the rate of 20 Class A units for each share of Series D Preferred Stock. No more than one-third of the Class A units could be exchanged prior to May 31, 2001. Between June 1, 2001 and May 31, 2006, all unexchanged Class A units are exchangeable. At December 31, 2004, no Series D Preferred Stock was outstanding.

 

500,000 shares of Series E 6.0% Cumulative Preferred Stock are authorized under ARI’s Amended Articles of Incorporation, with a par value $2.00 per share and a liquidation preference of $10.00 per share. Dividends are payable at the annual rate of $.60 per share or $.15 per quarter to stockholders of record on the last day of each March, June, September and December when and as declared by the Board of Directors. At December 31, 2004, 50,000 shares of Series E Preferred Stock were outstanding.

 

The following table sets forth information regarding purchases made by ARI of shares of ARI Common Stock on a monthly basis during the fourth quarter of 2004:

 

Period


   (a)
Total Number of
Shares Purchased


   (b)
Average Price
Paid per Share


   (c)
Total Number of Shares
Purchased as Part of Publicly
Announced Plans or Programs(1)


   (d)
Maximum Number of Shares
that May Yet Be Purchased
Under the Plans or Programs(1)


October 2004

   —      $ —      —      465,393

November 2004

   —        —      —      465,393

December 2004

   335,900      11.25    335,900    129,493
    
  

  
    

Total

   335,900    $ 11.25    335,900     
    
  

  
    

(1) The repurchase program was announced in September 2000. 1,000,000 shares may be repurchased through the program. The program has no expiration date.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

     For the Years Ended December 31,

 
     2004

    2003

    2002

    2001

    2000

 
           Restated(1)                    
     (dollars in thousands, except per share)  

EARNINGS DATA

                                        

Operating income

   $ 42,746     $ 34,772     $ 11,922     $ 14,081     $ 29,620  

Gain on land sales

     11,781       43,831       16,727       7,883       29,001  

Pizza parlor gross margin

     7,812       7,006       6,750       6,278       5,784  
    


 


 


 


 


Income from operations

     62,339       85,609       35,399       28,242       64,405  

Equity in loss of investees

     (41 )     (4,441 )     (20,914 )     (13,352 )     (4,581 )

Loss on sale of investments in equity investees

     —         —         (286 )     (387 )     (8,744 )

Equity in gain on sale of real estate by equity investees

     —         —         —         22,542       18,571  

Other income

     22,526       24,640       8,590       2,448       2,039  

Other expenses

     143,115       123,354       78,897       91,806       126,255  

Gain on sale of real estate

     —         —         —         77,816       67,727  
    


 


 


 


 


Net income (loss) from continuing operations

     (58,291 )     (17,546 )     (56,108 )     25,503       13,162  

Net income (loss) from discontinued operations

     91,485       29,409       47,644       (8,149 )     (10,483 )

Net income (loss)

     33,194       11,863       (8,464 )     17,354       2,679  

Preferred dividend requirement

     (2,601 )     (2,351 )     (2,401 )     (2,485 )     (2,327 )
    


 


 


 


 


Income (loss) applicable to Common shares

   $ 30,593     $ 9,512     $ (10,865 )   $ 14,869     $ 352  
    


 


 


 


 


PER SHARE DATA

                                        

Net income (loss) from continuing operations

   $ (5.76 )   $ (1.85 )   $ (5.15 )   $ 1.96     $ 1.04  

Net income (loss) from discontinued operations

     8.66       2.73       4.19       (.69 )     (1.01 )
    


 


 


 


 


Net income (loss) applicable to Common shares

   $ 2.90     $ .88     $ (.96 )   $ 1.27     $ .03  
    


 


 


 


 


Weighted average shares outstanding

     10,559,571       10,789,352       11,375,127       11,714,374       10,399,890  

BALANCE SHEET DATA

                                        

Real estate, net

   $ 983,422     $ 1,054,735     $ 466,042     $ 590,488     $ 653,744  

Notes and interest receivable, net

     72,661       70,595       82,133       30,382       13,831  

Total assets

     1,190,843       1,240,880       711,330       761,048       787,015  

Notes and interest payable

     939,921       986,769       475,433       564,298       616,331  

Margin borrowings

     18,663       21,194       8,558       28,040       13,485  

Stockholders’ equity

     103,009       76,871       79,527       88,169       73,402  

Book value per share

   $ 9.04     $ 6.75     $ 6.99     $ 7.75     $ 6.21  

(1) The 2004 Restatement adjustments affecting 2003 are set forth in the following table:

 

     2003

     As Previously
Reported


   As
Restated


     (dollars in thousands)

Net income (loss)

   $ 8,321    $ 9,512

Net income (loss) per Common Share

   $ .77    $ .88

Financial Position Data (at December 31):

             

Total Assets

   $ 1,240,181    $ 1,240,880

Stockholders’ Equity

   $ 75,680    $ 76,871

 

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The 2004 Restatement adjustments affecting 2003 are adjustments with respect to net income (loss), as described in ITEM 8. “CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.” —NOTE 24. “RESTATEMENT OF 2003 FINANCIAL STATEMENTS.”

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Introduction

 

ARI was organized in 1999. In August 2000, ARI acquired American Realty Trust, Inc. (“ART”) and National Realty, L.P. (“NRLP”), ART was organized in 1961 to provide investors with a professionally managed, diversified portfolio of real estate and mortgage loan investments selected to provide opportunities for capital appreciation as well as current income. ART owns a portfolio of real estate and mortgage loan investments. NRLP was organized in 1987, and subsequently acquired all of the assets and assumed all of the liabilities of 35 public and private limited partnerships. NRLP also owns a portfolio of real estate and mortgage loan investments.

 

Critical Accounting Policies

 

Critical accounting policies are those that are both important to the presentation of ARI’s financial condition and results of operations and require management’s most difficult, complex or subjective judgments. ARI’s critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.

 

If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value, less costs to sell and an impairment loss is recognized within income from continuing operations. ARI’s estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. ARI’s estimates are subject to revision as market conditions and ARI’s assessments of them change. In the third quarter of 2004, ARI recognized asset impairments of $3.4 million. In the fourth quarter of 2004, ARI recognized asset impairments of $7.1 million.

 

ARI’s allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and ARI’s assessment of its ability to meet its lease or interest obligations. ARI’s estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions.

 

ARI’s management periodically discusses criteria for estimates and disclosures of its estimates with the Audit Committee of its Board of Directors.

 

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Obligations and Commitments

 

ARI has contractual obligations and commitments primarily with regards to the payment of mortgages.

 

The following table aggregates ARI’s expected contractual obligations and commitments subsequent to December 31, 2004. (dollars in thousands)

 

     Payments Due by Period

Contractual Obligations


   Total

   Less than
1 year


   1-3 years

   3-5 years

   More than
5 years


Long-Term Debt Obligations(1)

   $ 931,663    $ 236,274    $ 246,100    $ 103,204    $ 346,085

Capital Lease Obligations

     —        —        —        —        —  

Operating Lease Obligations

     11,015      2,234      3,673      2,621      2,487

Purchase Obligations

     —        —        —        —        —  

Other Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under GAAP

     2,171      2,171      —        —        —  

Total

   $ 944,849    $ 240,679    $ 249,773    $ 105,925    $ 348,572

(1) ARI’s long-term debt may contain financial covenants that, if certain thresholds are not met, could allow the lender to accelerate principal payments or cause the note to become due immediately.

 

Other long-term liabilities represent ARI’s intentions to purchase the interests of general and limited purchases of partnerships formed to construct residential properties.

 

Liquidity and Capital Resources

 

General.    Cash and cash equivalents at December 31, 2004 totaled $22.4 million, compared with $9.5 million at December 31, 2003. ARI’s principal sources of cash have been and will continue to be from property operations, proceeds from property sales, and the collection of mortgage notes receivable, borrowings and, to a lesser extent, distributions from partnerships. Management anticipates that ARI’s cash at December 31, 2004, along with cash that will be generated in 2005 from property operations, will not be sufficient to meet all of ARI’s cash requirements. Management intends to selectively sell income producing real estate or land, refinance or extend real estate debt and seek additional borrowings against real estate to meet its cash requirements. Historically, management has been successful at extending its current maturity obligations. Management also anticipates funding ongoing real estate construction projects and the acquisition of new real estate from cash generated by property sales, debt refinancings or extensions, and additional borrowings.

 

Notes payable totaling $236.3 million are scheduled to mature during 2005. During the first quarter of 2005, ARI either extended, refinanced, paid down, paid off or received commitments from lenders to extend or refinance $108.9 million of the debt scheduled to mature in 2005. See NOTE 2. “REAL ESTATE,” NOTE 8. “NOTES AND INTEREST PAYABLE” and NOTE 23. “SUBSEQUENT EVENTS.”

 

ARI reported net income of $33.2 million for 2004, which included the following non-cash charges and credits: gain on sale of real estate of $111.0 million, depreciation and amortization of real estate held for investment and intangible assets of $30.4 million, amortization of deferred borrowing costs of $10.5 million, provision for asset impairment of $10.5 million, gain on settlement of debt of $10.6 million, provision for loan losses of $2.8 million, discount on sale of notes receivable of $389,000 and gain on foreign currency transactions of $3.8 million. Net cash used in operating activities was $40.7 million. Interest receivable decreased by $1.3 million due to a collection of notes receivable, other assets increased by $3.5 million primarily due to increased affiliate receivables, interest payable increased by $2.6 million primarily due to unpaid interest on disputed notes payable, and a decrease in minority interest primarily due to allocation of loss to minority owners.

 

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Index to Financial Statements

Net cash provided by investing activities of $54.3 million was primarily due to proceeds from sale of real estate of $273.4 million, proceeds from the sale of notes receivable of $8.3 million, and collection of notes receivable of $11.6 million. These inflows were offset by real estate improvements of $165.2 million, investments in real estate entities of $3.9 million, acquisition of real estate of $57.8 million, earnest money deposits of $4.8 million, and funding of notes receivable of $6.8 million.

 

Net cash used in financing activities of $659,000 was primarily comprised of proceeds for the funding or refinancing of notes payable of $382.3 million and net advances from affiliates of $14.2 million; offset by payouts of $380.6 million to paydown existing notes payable, $9.0 million for financing costs, $5.2 million to repurchase common stock, $1.6 million in dividends paid, and net margin payments of $736,000.

 

If ARI continues to dispose of operating properties, a further decline in cash from property operations would be expected.

 

In 2004, ARI purchased a total of 408.7 acres of land in Denton, Ft. Worth, Farmers Branch, Irving, Lubbock, and Dallas, Texas and Kent, Ohio, in separate transactions for a total of $19.7 million. ARI paid $5.1 million in cash, including closing costs. ARI acquired three apartments and land for ten apartments for a total of $34.4 million. ARI paid $6.4 million in cash, including closing costs.

 

In 2004, ARI sold a total of 573.4 acres of land in Collin County, Ft Worth, Houston, Plano, Dallas, Tarrant County, and Lewisville, Texas and Kent, Ohio in 14 separate transactions for a total of $40.1 million. ARI received net cash of $16.5 million, after paying off or paying down $11.8 million in mortgage debt secured by such land parcels. ARI also sold seven apartments, four industrial warehouses, four shopping centers, 11 office buildings, and an athletic club for a total of $277.4 million. ARI received net cash of $89.8 million, after the payoff or assumption by the purchaser of mortgage debt totaling $145.2 million and after providing purchase money financing of $34.4 million.

 

ARI expects that funds from existing cash resources, aggressive sales of land and selected income producing property sales, refinancing of real estate, and borrowings against its real estate will be sufficient to meet the cash requirements associated with ARI’s current and anticipated level of operations, maturing debt obligations and existing commitments. To the extent that ARI’s liquidity permits or financing sources are available, ARI will make investments in real estate, primarily in improved and unimproved land, will continue making investments in real estate entities and marketable equity securities, and will develop and construct income-producing properties.

 

ARI expects that it will be necessary for it to sell $47.7 million, $52.6 million and $8.1 million of its land holdings during each of the next three years to satisfy the debt on the land as it matures. If ARI is unable to sell at least the minimum amount of land to satisfy the land debt obligations as they mature, ARI intends to extend such debt or sell other of its assets, specifically income producing properties, to pay the debt.

 

Stock Loans Payable.    ARI has margin arrangements with various brokerage firms and financial institutions, which provide for borrowings of up to 50.0% of the market value of marketable equity securities. The borrowings under the margin arrangements are secured by the equity securities and bear interest rates ranging from 6.75% to 24.0%. Margin borrowings totaled $18.7 million (approximately 20.8% of market value) at December 31, 2004, compared to $21.2 million at December 31, 2003. See NOTE 8. “MARGIN BORROWINGS.”

 

Equity Investments.    During the fourth quarter of 1988, ARI began purchasing shares of IORI and TCI, both of which had the same advisor as ARI until June 30, 2003. It is anticipated that additional equity securities of IORI and TCI may be acquired in the future through open market and negotiated transactions to the extent ARI’s liquidity permits. See ITEM 1. “BUSINESS” for discussion of the tender offer for shares of TCI and IORI common stock by ARI and the current ownership of TCI and IORI by ARI.

 

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Equity securities of IORI and TCI held by ARI may be deemed “restricted securities” under Rule 144 of the Securities Act of 1933 (“Securities Act”). Accordingly, ARI may be unable to sell such equity securities other than in a registered public offering or pursuant to an exemption under the Securities Act for a one-year period after they are acquired. Such restrictions may reduce ARI’s ability to realize the full fair market value of such investments if ARI attempted to dispose of such securities in a short period of time.

 

ARI’s cash flow from these investments is dependent on the ability of IORI to make distributions. In December 2000, the Board of IORI suspended the payment of quarterly dividends. ARI received no distributions from IORI in 2004, and ARI anticipates receiving no distributions from IORI in 2005.

 

In 2004, ARI paid dividends to its Preferred stockholders totaling $1.6 million.

 

Management reviews the carrying values of ARI’s properties and mortgage notes receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable, impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. If impairment is found to exist, a provision for loss is recorded by a charge against earnings to the extent that the investment in the note exceeds management’s estimate of the fair value of the collateral securing such note. The mortgage note receivable review includes an evaluation of the collateral property securing each note. The property review generally includes: (1) selective property inspections, (2) a review of the property’s current rents compared to market rents, (3) a review of the property’s expenses, (4) a review of maintenance requirements, (5) a review of the property’s cash flow, (6) discussions with the manager of the property, and (7) a review of properties in the surrounding area.

 

Commitments

 

ARI will rely on externally generated funds, including aggressive land sales, selected sales of income producing properties, refinancing of properties and, to the extent necessary, borrowings to meet these commitments.

 

Results of Operations

 

2004 Compared to 2003.    ARI reported net income of $33.2 million in 2004 compared to net income of $11.9 million in 2003. ARI’s net income in 2004 included gains on the sales of real estate of $108.8 million compared to gains on the sales of real estate of $92.6 million in 2003. The primary factors contributing to ARI’s net income are discussed in the following paragraphs.

 

ARI began consolidating TCI’s operations effective March 31, 2003. (See ITEM 1. “BUSINESS.”) The consolidation is the principal factor for the increase during 2004 in the following areas: rents, property operations expense, interest expense, depreciation and amortization, general and administrative expense, advisory fees, and gain on sale of real estate. For these items, 2004 results are also presented without the effect of the consolidation of TCI’s operations for the first three months of 2004.

 

     2004

   2003

     With TCI

   Without 1Q TCI

  

Rents (dollars in thousands)

                    

Commercial

   $ 49,931    $ 43,000    $ 42,928

Apartments

     76,186      62,957      54,733

Hotels

     38,303      36,824      35,725

Land

     610      468      615

Other

     342      342      1,841
    

  

  

     $ 165,372    $ 143,591    $ 135,842
    

  

  

 

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The increase in apartment rents, without the effect of the consolidation of TCI’s operations, was primarily attributable to completed construction. The increase in hotel rents was primarily attributable to increased occupancy. The decrease in other rents was primarily attributable to the sale of ARI’s interest in Realty Advisors Korea, Ltd. as of June 30, 2003. Total rents are expected to increase in 2005, as a result of completed apartment construction.

 

     2004

   2003

     With TCI

   Without 1Q TCI

  

Property Operations Expenses (dollars in thousands)

                    

Commercial

   $ 35,372    $ 31,128    $ 28,002

Apartments

     50,519      42,433      39,809

Hotels

     28,857      27,449      27,198

Land

     7,115      6,722      5,671

Other

     763      763      390
    

  

  

     $ 122,626    $ 108,495    $ 101,070
    

  

  

 

The increase in commercial operations expense was primarily attributable to increased management fees. The increase in apartment operations expense was primarily attributable to property replacements and completed apartment construction. The increase in hotel operations expense was primarily attributable to increased personnel costs and an increase in repairs and replacement expenses. Property operations expenses are expected to increase in 2005, as a result of completed apartment construction.

 

Pizza parlor sales and cost of sales increased to $34.5 million and $26.7 million in 2004 from $33.1 million and $26.1 million in 2003. The increases were primarily attributable to same-store sales increases of 6.4% in 2004 from 2003 levels.

 

Interest income decreased to $5.3 million in 2004 from $9.2 million income in 2003. The decrease was primarily attributable to the collection of $41.2 million of notes receivable in 2003 and 2004.

 

Equity in loss of investees improved to $(41,000) in 2004, from $(4.4) million in 2003. Prior to March 31, 2003, ARI’s equity in loss of investees included equity in TCI’s operations. See NOTE 5. “INVESTMENTS IN EQUITY INVESTEES.”

 

Gain on foreign currency transaction was $3.8 million in 2004. Gain or loss on foreign currency transaction is the result of Hotel Akademia converting long-term debt, which is denominated in Euros, into the functional currency, the Polish Zloty. The Euro weakened against the Zloty during 2004, which has resulted in ARI recognizing this gain.

 

Gain on settlement of debt was $10.6 million in 2004, compared to $7.2 million in 2003. The 2004 gain resulted from negotiated settlements regarding mortgage loans on an office building in Farmers Branch, Texas ($8.4 million) and land properties in Texas ($2.2 million). The 2003 gain resulted from a favorable ruling in a lender dispute regarding the mortgage loans on three office buildings in New Orleans, Louisiana ($4.4 million) and from the sale through foreclosure of a hotel in Kansas City, Missouri ($2.8 million).

 

Gain on condemnation award was $4.8 million in 2003, resulting from the settlement of a dispute regarding a land parcel in Dallas, Texas.

 

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Other income was $2.7 million in 2004 compared to $3.4 million in 2003. In 2004, ARI recognized $2.3 million from the sale of leasehold interests in California.

 

     2004

   2003

     With TCI

   Without 1Q TCI

  

Interest Expense (dollars in thousands)

                    

Commercial

   $ 13,665    $ 11,491    $ 12,249

Apartments

     26,050      21,268      16,150

Hotels

     5,916      5,881      5,072

Land

     12,966      12,345      17,479

MRI

     1,488      1,488      1,127

Other

     7,554      7,554      6,523
    

  

  

     $ 67,639    $ 60,027    $ 58,600
    

  

  

 

The increase in apartment interest expense was primarily attributable to increased loan balances due to completed apartment construction. The decrease in land interest expense was primarily attributable to reduced principal balances payable and reduced interest rates on land mortgages.

 

     2004

   2003

     With TCI

   Without 1Q TCI

  
               As Restated

Depreciation and Amortization (dollars in thousands)

                    

Commercial

   $ 11,700    $ 9,150    $ 8,407

Apartments

     8,631      7,070      4,213

Hotels

     3,995      3,658      4,976

MRI

     950      950      1,484

Other

     56      45      34
    

  

  

     $ 25,332    $ 20,873    $ 19,114
    

  

  

 

The increase in apartment depreciation and amortization was primarily attributable to completed construction. The decrease in hotel depreciation and amortization was primarily attributable to the recognition, in 2003, of depreciation from the date of purchase for improvements at one hotel that had been place in service in 1997.

 

Discount on sale of notes receivable was $389,000 in 2004, compared to $2.2 million in 2003. This represents the discount from the face amount given by ARI to purchasers of notes receivable. See NOTE 3. “NOTES AND INTEREST RECEIVABLE.”

 

General and administrative expenses decreased to $18.7 million in 2004 from $22.1 million in 2003. The expenses in 2003 include $3.1 million of one-time reimbursements to BCM for legal fees.

 

Advisory fees increased to $10.7 million in 2004 from $9.3 million in 2003. In 2003, ARI received an operating expense refund of $1.3 million.

 

Provision for asset impairment increased to $8.0 million in 2004, from $7.7 million in 2003. In 2004, an office building in Farmers Branch, Texas, an office building in New Orleans, Louisiana, and 1.0 acre of land in Farmers Branch, Texas (exchanged for additional land in the first quarter of 2005) were reduced to their net realizable value.

 

Minority interest increased to $7.3 million in 2004 from $771,000 in 2003. Minority interest is the earnings attributable to owners, other than ARI, of certain controlled entities. Minority interest in 2004 and 2003 was

 

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attributable, in part, to the preferred return for limited partner units of Ocean Beach Partners, L.P., Edina Park Plaza Associates, L.P., Hawthorne Lakes Associates, L.P., and ART Palm, L.P. The increase is primarily attributable to reduced minority participation in ARI partnerships and to the increase in minority interest expense related to TCI’s operations.

 

In 2004 and 2003 gains on sale of real estate totaling $108.8 million and $92.6 million were recognized. See Note 2. “REAL ESTATE.”

 

Net income from discontinued operations was $91.5 million in 2004 compared to $29.4 million in 2003. The net income relates to 23 properties and leasehold interests in oil and gas properties that ARI sold in 2002, 32 properties that ARI sold in 2003, and 27 properties that ARI sold in 2004, and three properties ARI sold in 2005. The following table summarizes revenue and expense information for the properties sold.

 

     2004

    2003

 

Revenue

                

Rental

   $ 30,414     $ 51,810  

Property operations

     18,161       30,757  
    


 


       12,253       21,053  

Expenses

                

Interest

     12,368       21,025  

Depreciation

     5,108       8,105  
    


 


       17,476       29,130  

Net loss from discontinued operations

     (5,223 )     (8,077 )

Gain on sale of real estate

     96,994       48,806  

Write-down of assets held for sale

     (2,498 )     (12,036 )

Equity in gain on sale of real estate by equity investees

     2,212       716  
    


 


Net income from discontinued operations

   $ 91,485     $ 29,409  
    


 


 

2003 Compared to 2002.    ARI reported net income of $11.9 million in 2003 compared to a net loss of $8.5 million in 2002. ARI’s net income in 2003 included gains on the sale of real estate of $92.6 million compared to gains on the sale of real estate of $48.4 million in 2002. The primary factors contributing to ARI’s net income are discussed in the following paragraphs.

 

ARI began consolidating TCI’s operations effective March 31, 2003. (See ITEM 1. “BUSINESS.”) The consolidation is the principal factor for the increase during 2003 in the following areas: rents, property operations expense, interest expense, depreciation and amortization, general and administrative expense, advisory fees, and gain on sale of real estate. For these items, 2003 results are also presented without the effect of the consolidation of TCI’s operations.

 

     2003

   2002

     With TCI

   Without TCI

  

Rents (dollars in thousands)

                    

Commercial

   $ 42,928    $ 16,370    $ 16,106

Apartments

     54,733      20,678      20,129

Hotels

     35,725      28,666      27,675

Land

     615      46      575

Other

     1,841      1,841      246
    

  

  

     $ 135,842    $ 67,601    $ 64,731
    

  

  

 

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The increase in hotel rents was primarily attributable to increased occupancy.

 

     2003

   2002

     With TCI

   Without TCI

  

Property Operations Expenses (dollars in thousands)

                    

Commercial

   $ 28,002    $ 12,027    $ 12,076

Apartments

     39,809      15,657      13,226

Hotels

     27,198      22,115      20,977

Land

     5,671      4,041      6,002

Other

     390      390      528
    

  

  

     $ 101,070    $ 54,230    $ 52,809
    

  

  

 

The increase in apartment operations expense, without the effect of the consolidation of TCI’s operations, was primarily attributable to the acquisition of one apartment complex and the construction of one apartment complex in 2002 and one apartment complex in 2003. The increase in hotel operations expense was primarily attributable to increased personnel costs and an increase in repairs and replacement expenses. The decrease in land operations expense was primarily attributable to lower property taxes due to land sales.

 

Pizza parlor sales and cost of sales increased to $33.1 million and $26.1 million in 2003 from $32.0 million and $25.3 million in 2002. The increases were primarily attributable to same-store sales increases of 4.6% in 2003 from 2002 levels.

 

Interest income increased to $9.2 million in 2003 from $3.1 million income in 2002. The increase was primarily attributable to interest earned by RAK during ARI’s ownership, interest received by ARI upon the sale of RAK to Realty Advisors, and notes receivable from property sales late in 2002 and early in 2003.

 

Equity in loss of investees improved to $(4.4) million in 2003, from $(20.9) million in 2002. The improvement was primarily attributable to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50.0% of TCI’s common stock. Prior to March 31, 2003, and in 2002, ARI’s equity in loss of investees included equity in TCI’s operations. See NOTE 5. “INVESTMENTS IN EQUITY INVESTEES.”

 

Loss on sale of investments in equity investees was $(286,000) in 2002, recognizing the loss on the sale of Villas Continental Apartments.

 

Gain on settlement of debt was $7.2 million in 2003. The gain resulted from a favorable ruling in a lender dispute regarding the mortgage loans on three office buildings in New Orleans, Louisiana ($4.4 million) and from the sale through foreclosure of a hotel in Kansas City, Missouri ($2.8 million).

 

Gain on condemnation award was $4.8 million in 2003, resulting from the settlement of a dispute regarding a land parcel in Dallas, Texas.

 

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Other income decreased to $3.4 million in 2003 from $5.4 million in 2002. The decrease was primarily due to $2.2 million received in 2002 in settlement of a lawsuit against a brokerage firm for improper sales in 2000 of TCI common stock owned by ARI and held by the brokerage firm, and $1.4 million received in 2002 as partial settlement of a lawsuit against a lender for improperly attempting to seize, in 1996, a mortgage note receivable due to ARI. ARI sold the note to BCM in 1999, with the provision that any settlement received in excess of the amount paid by BCM, plus accrued interest, would be returned to ARI.

 

     2003

   2002

     With TCI

   Without TCI

  

Interest Expense (dollars in thousands)

                    

Commercial

   $ 12,249    $ 5,566    $ 5,031

Apartments

     16,150      6,636      7,212

Hotels

     5,072      3,455      3,822

Land

     17,479      14,397      19,763

MRI

     1,127      1,127      840

Other

     6,523      6,523      11,351
    

  

  

     $ 58,600    $ 37,704    $ 48,019
    

  

  

 

The decrease in land and other interest expense, without the effect of the consolidation of TCI’s operations, was primarily attributable to reduced balances payable on stock loans and land mortgages. In 2002, ARI recognized a $912,000 loss on an interest rate swap contract. See NOTE 21. “DERIVATIVE FINANCIAL INSTRUMENTS.”

 

     2003 (as restated)

   2002

     With TCI

   Without TCI

  

Depreciation and Amortization (dollars in thousands)

                    

Commercial

   $ 8,407    $ 1,820    $ 1,870

Apartments

     4,213      1,447      1,449

Hotels

     4,976      3,590      1,920

MRI

     1,484      1,484      1,268

Other

     34      —        39
    

  

  

     $ 19,114    $ 8,341    $ 6,546
    

  

  

 

The increase in hotel depreciation and amortization, without the effect of the consolidation of TCI’s operations, was primarily attributable to the recognition of depreciation from the date of purchase for improvements at one hotel that had been placed in service in 1997.

 

Discount on sale of notes receivable was $2.2 million in 2003. This represents the discount from the face amount given by ARI to purchasers of notes receivable. See NOTE 3. “NOTES RECEIVABLE.”

 

General and administrative expenses increased to $22.1 million in 2003 from $12.5 million in 2002. The expenses in 2003 include $3.1 million of one-time reimbursements to BCM for legal fees. Without the effect of the consolidation, general and administrative expenses increased to $14.6 million, which included $1.4 million of the legal fee reimbursement to BCM.

 

Advisory fees increased to $9.3 million in 2003 from $5.9 million in 2002. Without the effect of the consolidation, advisory fees increased to $6.0 million.

 

Provision for asset impairment increased to $7.7 million in 2003, from $3.7 million in 2002. In 2003, the carrying value of an office building in Farmers Branch, Texas, was reduced to its net realizable value. In 2002,

 

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the carrying value of an 89.3 acre tract of land in Palm Desert, California (sold in the first quarter of 2003) was reduced to its net realizable value.

 

Loss on foreign currency transaction was $3.3 million in 2003. Loss on foreign currency transaction is the result of Hotel Akademia converting long-term debt, which is denominated in Euros, into the functional currency, the Polish Zloty. The Euro strengthened against the Zloty during 2003, which has resulted in ARI recognizing this charge.

 

Minority interest decreased to $771,000 in 2003 from $1.3 million in 2002. Minority interest is the earnings attributable to owners, other than ARI, of certain controlled entities. Minority interest in 2003 and 2002 was attributable, in part, to the preferred return for limited partner units of Ocean Beach Partners, L.P., Valley Ranch, L.P., Edina Park Plaza Associates, L.P., Hawthorne Lakes Associates, L.P., ART Florida Portfolio I, ART Florida Portfolio II, ART Florida Portfolio III and ART Palm, L.P. The decrease is primarily attributable to reduced minority participation in ARI partnerships and to the consolidation of TCI’s operations by ARI effective March 31, 2003, following ARI’s acquisition of more than 50.0% of TCI’s common shares.

 

In 2003 and 2002, gains on sale of real estate totaling $92.6 million and $48.4 million were recognized.

 

Net income from discontinued operations was $29.4 million in 2003 compared to $47.6 million in 2002. The net income relates to 23 properties and leasehold interests in oil and gas properties that ARI sold during 2002, 32 properties that ARI sold in 2003, 27 properties that ARI sold in 2004, and three properties ARI sold in 2005. The following table summarizes revenue and expense information for the properties sold.

 

     2003

    2002

 

Revenue

                

Rental

   $ 51,810     $ 46,158  

Property operations

     30,757       28,297  
    


 


       21,053       17,861  

Expenses

                

Interest

     21,025       17,814  

Depreciation

     8,105       7,699  
    


 


       29,130       25,513  

Net loss from discontinued operations

     (8,077 )     (7,652 )

Gain on sale of real estate

     48,806       31,706  

Write-down of assets held for sale

     (12,036 )     (479 )

Equity in gain on sale of real estate by equity investees

     716       24,069  
    


 


Net income from discontinued operations

   $ 29,409     $ 47,644  
    


 


 

Related Party Transactions

 

Historically, ARI, TCI, IORI, BCM and Prime have each engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. Management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to ARI as could have been obtained from unrelated parties.

 

Operating Relationships

 

In October 2003, ARI entered into a lease with Prime for space at the One Hickory Centre Office Building. The lease was for 59,115 sq. ft. (approximately 59.0% of the building), has a term of three years, and provided for annual base rent of $1.3 million, or $21.50 per sq. ft. Effective May 1, 2004, the lease was amended to 54,404 sq. ft. (approximately 56.0% of the building), with an annual base rent of $1.2 million, or $21.50 per sq. ft.

 

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ARI received rents of $69,000 in 2004 from BCM for BCM’s lease at Addison Hanger. BCM owns a corporate jet that is housed at the hanger and ARI has available space at the hanger.

 

In 2004, ARI paid BCM, Prime, their affiliates and a related party $10.7 million in advisory fees, $1.9 million in net income fees, $1.9 million in loan arrangement fees, $578,000 in property acquisition fees, $8.4 million in real estate brokerage commissions, $5.6 million in construction supervision fees and $6.7 million in property and construction management fees and leasing commissions, net of property management fees paid to subcontractors, other than affiliates of BCM. In addition, as provided in the Advisory Agreement, BCM and Prime received cost reimbursements of $4.6 million.

 

Partnership Transactions

 

BCM has entered into put agreements with certain holders of the Class A limited partner units of Ocean Beach Partners, L.P. The Class A units are convertible into Series D Cumulative Preferred Stock of ARI. The put price of the Series D Preferred Stock is $20.00 per share plus accrued but unpaid dividends.

 

BCM has entered into put agreements with the holders of the Class A units of ART Palm, L.P. Such Class A units are convertible into Series C Cumulative Convertible Preferred Stock of ARI. The put price for the Class A units is $1.00 per unit and the put price for either the Series C Preferred Stock or ARI’s Common Stock is 90.0% of the average daily closing price of ARI’s Common Stock for the prior 20 trading days. The put agreement calls for ARI to repurchase the outstanding Class A units as follows: December 31, 2005—875,000 units; and December 31, 2006—5,938,750 units.

 

Advances and Loans

 

From time-to-time, ARI and its affiliates have made advances to each other, which have not had specific repayment terms, do not bear interest, are unsecured and have been reflected in ARI’s financial statements as other assets or other liabilities. At December 31, 2004, after accounting for affiliate purchases and sales, amounts still owed by ARI were $260,000 and $1.2 million to IORI and Regis I, respectively. Also at December 31, 2004, ARI was owed $13.6 million and $1.4 million by BCM, Prime and Regis I, respectively.

 

Activity in 2004 included:

 

In January 2004, ARI issued 200,000 shares of Series A 10.0% Cumulative Convertible Preferred Stock to Prime, ARI’s advisor. In February 2004, 50,000 additional shares were issued to Prime. ARI’s affiliate receivable was increased by $2.5 million.

 

In February 2004, ARI obtained an unsecured loan of $5.0 million. The proceeds of $5.0 million were received by an affiliate of ARI, increasing ARI’s affiliate receivable.

 

In February 2004, ARI obtained financing of $7.5 million on the Katy land tract. The funds, along with additional cash of $6.3 million, were sent to an affiliate. Subsequently, the affiliate paid off the existing loan balance on an ARI property.

 

In March 2001, ARI funded $13.6 million of a $15.0 million unsecured line of credit to One Realco. A wholly-owned subsidiary of One Realco owns approximately 2.2% of the outstanding shares of ARI’s Common Stock. One Realco periodically borrows money to meet its cash obligations. The line of credit bore interest at 12.0% per annum. All principal and interest were due at maturity in February 2002. The line of credit is guaranteed by BCM. In June 2001, $810,000 in principal and interest was collected. In December 2001, $825,000 in principal and interest was collected. In February 2002, the line of credit was increased to $18.0 million, accrued but unpaid interest of $217,000 was added to the principal, and the maturity date was extended to February 2004. In March 2002, ARI funded an additional $1.8 million, increasing the outstanding principal

 

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balance to $15.5 million. In October 2002, $856,900 in interest was collected, by the return of 85,690 shares of ARI Series A Preferred Stock. In June 2003, ARI sold a participating interest in $5.8 million of the $15.5 million balance to BCM; receiving 314,141 TCI shares from BCM (see NOTE 1. “BASIS OF PRESENTATION.”) In February 2004, $2.3 million in interest was collected, accrued but unpaid interest of $161,000 was added to the principal, the maturity date was extended to February 2007, and the interest rate was changed to 3.0% over the prime rate, currently at 8.75%. All principal and interest are due at maturity. Ronald E. Kimbrough, Acting Principal Executive Officer, Executive Vice President and Chief Financial Officer of ARI until May 31, 2004, was a 10.0% shareholder of One Realco until July 31, 2004. Mr. Kimbrough did not participate in the day-to-day operations or management of One Realco.

 

In March 2004, ARI obtained financing of $11.5 million on a hotel property. The proceeds of $11.0 million were received by an affiliate, increasing ARI’s affiliate receivable.

 

In April 2004, $825,000 was advanced under a security loan arrangement with a financial institution. The proceeds were paid to an affiliate, increasing ARI’s affiliate receivable.

 

In July 2004, ARI obtained a loan of $3.2 million secured by a contract for sale of the Waters Edge III Apartments. The proceeds of $3.2 million were received by an affiliate, increasing ARI’s affiliate receivable.

 

In October 2004, ARI advanced $3.3 million to the Class A Limited Partners of Edina Park Plaza Associates, Limited Partnership, of which ARI is the general partner. The loans bear interest at 10.0% per annum and mature in September 2017. Interest due to ARI will be deducted from the quarterly return owed by ARI to the Class A Limited Partners, eliminating the quarterly payments. The outstanding principal is due at maturity.

 

In October 1999, ARI funded a $4.7 million loan to Realty Advisors. The loan, to provide funds for acquisitions or working capital needs, was secured by all of the outstanding shares of common stock of American Reserve Life Insurance Company. The loan bore interest at 10.25% per annum, and matured in November 2001. In January 2000, $100,000 was collected. In November 2001, the maturity date was extended to November 2004. The collateral was changed to a pledge of 850,000 shares of ARI Common Stock owned by BCM. The interest rate was changed to 2.0% over the prime rate, currently 7.75% per annum, and the accrued but unpaid interest of $1.0 million was added to the principal. The new principal balance is $5.6 million. In September 2003, $0.7 million in accrued interest was collected. In August 2004, $0.3 million in accrued interest was collected. In November 2004, the maturity date was extended to November 2006. All principal and accrued interest are due at maturity.

 

Property Transactions

 

Activity in 2004 included:

 

In December 2003, ARI sold seven properties to subsidiaries of Unified Housing Foundation, Inc. (“UHF”), a Texas Non-Profit 501(c)3 Corporation. ARI sold 39.3 acres of Pioneer Crossing land for $3.9 million, 10.7 acres of Marine Creek land for $1.5 million, the Limestone at Vista Ridge Apartments for $19.0 million, the Cliffs of El Dorado Apartments for $13.4 million, the Limestone Canyon Apartments for $18.0 million, the Sendero Ridge Apartments for $29.4 million, and Tivoli Apartments for $16.1 million. All of the transactions included the assumption of debt and notes receivable to ARI for the remainder of the purchase price. Ted Stokely, Chairman of the Board of ARI, is the General Manager of UHF. Richard Humphrey, who is employed by Regis Realty I, LLC, an affiliate, is President of UHF. Due to UHF being considered a related party to ARI and ARI having continued involvement and control of these entities, these transactions have not been recorded as sales. Instead, these transactions will be accounted for on the deposit method, and the properties and corresponding debt will continue to be consolidated by ARI. All of these transactions were approved by ARI’s Board of Directors. Mr. Stokely abstained from voting on all of these transactions. The loans on Limestone Canyon apartments and Limestone at Vista Ridge apartments were approved by their prospective lenders for

 

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transfer to the purchasing entities. ARI has guaranteed the loans on both of these transfers. Also, Marine Creek land and the Cliffs of El Dorado apartments were recognized as sales during 2004. See NOTE 2. “REAL ESTATE.” Management is currently seeking lender approval on the transfer of the notes associated with the Tivoli apartments and Sendero Ridge apartments.

 

In December 2003, ARI sold a tract of Marine Creek land to a subsidiary of United Housing Foundation, Inc. (“UHF”) for $1.5 million, receiving cash and a note receivable. This sale was not recognized as a sale at that time because UHF is a related party and ARI has continuing involvement and control. In February 2004, Marine Creek was refinanced by UHF, which paid in full ARI’s note payable on the land. ARI recorded the sale of the land and received a note receivable of $270,000, which was the difference between the sales price and the amount of ARI’s note payable. The note bears interest at 6.0%, requires quarterly payments from available surplus cash and matures in December 2007. See Note 9. “RELATED PARTY TRANSACTIONS.”

 

In May 2004, ARI purchased the Treehouse Apartments from an affiliate, with a net purchase price of $7.5 million after assumption of debt and a note receivable, less cash received of $0.5 million. The note receivable was from the sale of the Cliffs of El Dorado Apartments to a related party in 2003. At that time, the sale of the Cliffs of El Dorado was not recorded as a sale for accounting purposes. ARI recorded the sale of the Cliffs of El Dorado in May 2004, due to payment received for the Cliffs of El Dorado note receivable.

 

In September 2004, ARI sold Limestone Canyon II land to a subsidiary of UHF for $720,000 in the form of a seller note receivable. Due to no cash received and common control, ARI has elected to continue consolidating this tract of land until the requirements for a sale have been met. No sale was recognized and no note receivable has been recorded.

 

In April 2002, ARI and TCI sold 21 apartment properties to partnerships controlled by Metra Capital, LLC (“Metra”). Innovo Group, Inc. (“Innovo”) is a limited partner in the partnerships that purchased the properties. Joseph Mizrachi, then a director of ARI, controlled approximately 11.67% of the outstanding common stock of Innovo. Management determined to treat the sales as financing transactions, and ARI and TCI continue to report the assets and the new debt incurred by Metra on their financial statements. The partnership agreements for each of these partnerships state that the Metra Partners, as defined, receive cash flow distributions at least quarterly in an amount sufficient to provide them with a 15.0% cumulative compounded annual rate of return on their invested capital, as well as a cumulative compounded annual amount of 0.50% of the average outstanding balance of the mortgage indebtedness secured by any of these properties. These distributions to the Metra Partners have priority over distributions to any other partners. At December 31, 2004, 16 of the properties remained on ARI’s balance sheet, and ARI’s other liabilities included $1.4 million owed to the Metra Partners related to cash received by ARI upon the sale of these apartments in April 2002.

 

Environmental Matters

 

Under various federal, state and local environmental laws, ordinances and regulations, ARI may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials.

 

Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on ARI’s business, assets or results of operations.

 

Inflation

 

The effects of inflation on ARI’s operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of

 

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inflation also affect the sales values of properties and the ultimate gains to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new financings as well as the cost of variable interest rate debt will be affected.

 

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ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

ARI’s future operations, cash flow and fair values of financial instruments are partially dependent upon the then existing market interest rates and market equity prices. Market risk is the changes in the market rates and prices and the affect of the changes on the future operations. Market risk is managed by matching a property’s anticipated net operating income to an appropriate financing.

 

The following table contains only those exposures that existed at December 31, 2004. Anticipation of exposures of risk on positions that could possibly arise was not considered. ARI’s ultimate interest rate risk and its effect on operations will depend on future capital market exposures, which cannot be anticipated with a probable assurance level. Dollars in thousands.

 

     2005

    2006

    2007

    2008

    2009

    Thereafter

   Total

Assets

                                                     

Trading Instruments—Equity Price Risk

                                                     

Marketable securities at market value

                                                  $ 6,670

Notes receivable

                                                     

Variable interest rate—fair value

                                                  $ 23,408

Instrument’s maturities

   $ 2,776     $ 5,633     $ 14,717     $ —       $ —       $ —      $ 23,126

Instrument’s amortization

     —         —         —         —         —         —        —  

Interest

     1,672       1,395       182       —         —         —        3,249

Average rate

     7.3 %     8.3 %     2.0 %     —         —         —         

Fixed interest rate—fair value

                                                  $ 52,075

Instrument’s maturities

   $ 27,849     $ 7,740     $ 2,570     $ 2,626     $ 125     $ 9,098    $ 50,008

Instrument’s amortization

     51       60       67       47       —         —        225

Interest

     3,599       1,940       1,347       1,045       1,021       5,293      14,245

Average rate

     8.5 %     11.3 %     11.3 %     11.3 %     11.3 %             

Liabilities

                                                     

Notes payable

                                                     

Variable interest rate—fair value

                                                  $ 135,256

Instrument’s maturities

   $ 96,009     $ 44,258     $ 30,454     $ —       $ 6,637     $ 17,936    $ 195,294

Instrument’s amortization

     3,864       3,830       1,427       630       575       9,804      20,130

Interest

     9,494       5,866       3,134       2,080       1,739       14,046      36,359

Average rate

     5.1 %     4.4 %     4.7 %     7.0 %     7.0 %             

Fixed interest rate—fair value

                                                  $ 690,115

Instrument’s maturities

   $ 126,960     $ 75,576     $ 72,880     $ 54,239     $ 26,162     $ 88,852    $ 444,669

Instrument’s amortization

     9,441       9,048       8,627       7,809       7,152       229,493      271,570

Interest

     42,503       40,218       33,351       27,825       24,813       343,130      511,840

Average rate

     7.2 %     7.9 %     8.2 %     8.5 %     8.9 %             

 

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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Financial Statements

    

Reports of Independent Registered Public Accounting Firms

   51

Consolidated Balance Sheets—December 31, 2004 and 2003

   53

Consolidated Statements of Operations—Years Ended December 31, 2004, 2003 and 2002

   54

Consolidated Statements of Stockholders’ Equity—Years Ended December 31, 2004, 2003 and 2002

   55

Consolidated Statements of Cash Flows—Years Ended December 31, 2004, 2003 and 2002

   56

Notes to Consolidated Financial Statements

   58

Financial Statement Schedules

    

Schedule III—Real Estate and Accumulated Depreciation

   100

Schedule IV—Mortgage Loans on Real Estate

   109

 

All other schedules are omitted because they are not required, are not applicable or the information required is included in the Consolidated Financial Statements or the notes thereto.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors of

American Realty Investors, Inc.

Dallas, Texas

 

We have audited the accompanying consolidated balance sheet of American Realty Investors, Inc. and Subsidiaries as of December 31, 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As described in Note 22, American Realty Investors, Inc.’s management has indicated its intent to both sell income producing properties and refinance or extend debt secured by real estate to meet its liquidity needs.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Realty Investors, Inc. as of December 31, 2004, and the results of its operations and its cash flows for the year ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

 

Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. Schedules III and IV are presented for the purpose of complying with the Securities and Exchange Commission’s rules and is not a required part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states, in all material respects, the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.

 

Farmer, Fuqua & Huff, PC

 

Plano, Texas

March 30, 2005

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors of

American Realty Investors, Inc.

 

We have audited the accompanying consolidated balance sheets of American Realty Investors, Inc. and Subsidiaries as of December 31, 2003 and the related consolidated statements of operations, stockholders’ equity, other comprehensive income (loss) and cash flows for each of the two years in the period ended December 31, 2003. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe our audits provide a reasonable basis for our opinion.

 

As described in Note 22, American Realty Investors, Inc.’s management has indicated its intent to sell both land and operating properties and refinance or extend debt coming due, to meet its liquidity needs.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Realty Investors, Inc. and Subsidiaries as of December 31, 2003 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

 

Also, in our opinion, the schedules present fairly, in all material respects, the information set forth therein.

 

BDO SEIDMAN, LLP

 

Dallas, Texas

April 15, 2004

 

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AMERICAN REALTY INVESTORS, INC.

 

CONSOLIDATED BALANCE SHEETS

 

     December 31,

 
     2004

    2003

 
           As Restated  
     (dollars in thousands,
except per share)
 
Assets                 

Real estate held for investment

   $ 877,677     $ 931,014  

Less—accumulated depreciation

     (157,138 )     (168,069 )
    


 


       720,539       762,945  

Real estate held for sale, net of depreciation

     192,533       211,942  

Real estate subject to sales contract (Note 8)

     70,350       79,848  

Notes and interest receivable

                

Performing ($43,605 in 2004 and $37,697 in 2003 from affiliates)

     67,894       64,296  

Non-performing

     6,632       10,932  
    


 


       74,526       75,228  

Less—allowance for estimated losses

     (1,865 )     (4,633 )
    


 


       72,661       70,595  

Pizza parlor equipment

     13,747       12,237  

Less—accumulated depreciation

     (6,608 )     (5,385 )
    


 


       7,139       6,852  

Marketable equity securities, at market value

     6,670       5,020  

Cash and cash equivalents

     22,401       9,543  

Investments in equity investees<