ITEM 1. BUSINESS (Continued)
Business Plan (Continued)
The Company's Board of Directors currently intends to continue its policy of prohibiting the Company from incurring aggregate secured and unsecured indebtedness in excess of 300% of the Company's net asset value (defined as the book value of all assets of the Company minus all of its liabilities); however, the Board of Directors may alter such policy at any time.
Management of the Company
Although the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by Basic Capital Management, Inc. ("BCM" or the "Advisor"), a contractual advisor under the supervision of the Company's Board of Directors. The duties of the Advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities, as well as financing and refinancing sources for the Company. The Advisor also serves as a consultant in connection with the Company's business plan and investment decisions made by the Company's Board of Directors.
BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Trustee of the Trust until December 31, 1992. Mr. Phillips also served as a director of BCM until December 22, 1989, and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company. BCM is more fully described in ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor."
BCM has been providing advisory services to the Company since March 28, 1989. Renewal of BCM's advisory agreement with the Company was approved by the Company's stockholders at the Company's annual meeting of stockholders held on May 8, 1997. BCM also serves as advisor to Continental Mortgage and Equity Trust ("CMET") and Transcontinental Realty Investors, Inc. ("TCI"). The Directors of the Company are also trustees of CMET and directors of TCI and the officers of the Company are also officers of CMET and TCI. Mr. Phillips is a general partner of Syntek Asset Management, L.P. ("SAMLP"), the general partner of National Realty, L.P. ("NRLP") and National Operating, L.P. ("NOLP"), the operating partnership of NRLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to American Realty Trust, Inc. ("ART"). Mr. Phillips served as a director and Chairman of the Board of ART until November 16, 1992. Randall M. Paulson, President of the Company, also serves as President of CMET, TCI and BCM, Executive Vice President of ART, and as the President and sole director of Syntek Asset Management, Inc. ("SAMI"), the managing general partner of SAMLP. The officers of the Company are also officers of ART and SAMI. As of March 6, 1998, ART and
ITEM 1. BUSINESS (Continued)
Management of the Company (Continued)
TCI each owned approximately 29.7% and 22.5% of the Company's outstanding shares of Common Stock and BCM owned approximately 39.0% of ART's outstanding shares of common stock.
Since February 1, 1990, affiliates of BCM have provided property management services to the Company. Currently Carmel Realty Services, Ltd. ("Carmel, Ltd.") provides such property management services. Carmel, Ltd. subcontracts with other entities for the provision of property-level management services to the Company. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) First Equity Properties, Inc. ("First Equity"), which is 50% owned by BCM, (ii) Gene E. Phillips, and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of nine of the Company's office buildings and the commercial properties owned by a real estate partnership in which the Company and TCI are partners to Carmel Realty, Inc. ("Carmel Realty"), which is a company owned by First Equity. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.
Carmel Realty is also entitled to receive real estate brokerage commissions in accordance with the terms of a nonexclusive brokerage agreement as discussed in ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR TO THE REGISTRANT - The Advisor."
The Company has no employees. Employees of the Advisor render services to the Company.
Competition
The real estate business is highly competitive and the Company 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 may have greater financial resources than those of the Company. The Company's management believes that success against such competition is dependent upon the geographic location of the property, the performance of the property managers in areas such as marketing, collection and the ability to control 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. The Company's management believes that general economic circumstances and trends and new or renovated properties in the vicinity of each of the Company's properties are also competitive factors.
ITEM 1. BUSINESS (Continued)
Competition (Continued)
To the extent that the Company seeks to sell any of its properties, the sales prices for such properties may be affected by competition from other real estate entities and financial institutions also attempting to sell their properties located in areas in which the Company's properties are located.
As described above and in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" - Related Party Transactions," the officers and Directors of the Company also serve as officers, directors or trustees of certain other entities, each of which is also advised by BCM, and each of which has business objectives similar to those of the Company. The Company's Directors, officers and Advisor owe fiduciary duties to such other entities as well as to the Company under applicable law. In determining to which entity a particular investment opportunity will be allocated, the officers, trustees or directors and the Advisor consider the respective investment objectives of each such entity and the appropriateness of a particular investment in light of each such entity's existing real estate and mortgage notes receivable portfolios. To the extent that any particular investment opportunity is appropriate to more than one of such entities, such 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 such entities.
In addition, also as described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships," the Company also competes with other entities which are affiliates of the Advisor and which may have investment objectives similar to the Company's and that may compete with the Company in the acquisition, sale, leasing and financing of real estate. In resolving any potential conflicts of interest which may arise, the Advisor has informed the Company 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.
Certain Factors Associated with Real Estate and Related Investments
The Company 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 the availability of permanent mortgage financing which may render the acquisition, 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 the Company's management or Advisor. Also, the illiquidity of real estate investments may impair the ability of the Company to respond promptly to changing circumstances. The Company's management believes that such risks are partially mitigated by the
ITEM 1. BUSINESS (Continued)
Certain Factors Associated with Real Estate and Related Investments (Continued)
diversification by geographic region and property type of the Company's real estate portfolio. However, to the extent property acquisitions are concentrated in any particular geographic region or property type, the advantages of diversification may be mitigated.
ITEM 2.
ITEM 2. "PROPERTIES - REAL ESTATE" and ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA."
Shares and per share data have been restated for the two for one forward Common Stock split effected June 14, 1996.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
Income Opportunity Realty Investors, Inc. (the "Company") invests in equity interests in real estate through acquisitions, leases and partnerships and in mortgage loans on real estate, including first, wraparound and junior mortgage loans. The Company is the successor to a California business trust organized on December 14, 1984 which commenced operations on April 10, 1985.
Liquidity and Capital Resources
Cash and cash equivalents at December 31, 1997 aggregated $1.1 million compared with $3.2 million at December 31, 1996. The Company's principal sources of cash have been and will continue to be property operations, proceeds from property sales and refinancings, collection of its mortgage note receivable and partnership distributions. The Company anticipates that it will have sufficient cash in 1998 to meet its various cash requirements including the payment of dividends, debt service obligations and property development, renovation and/or improvement costs.
The Company's cash flow from property operations (rents collected less payments for property operating expenses) increased from $3.5 million in 1996 to $6.5 million in 1997. This increase is the result of the acquisition of eight income producing properties in 1997 and two income producing properties in 1996 and also to increased occupancy and rental rates, primarily at the Company's commercial properties, and the control of operating expenses. These increases are partially offset by a decrease of $1.2 million due to properties sold in 1997. The Company's management believes that this trend will continue, particularly in the Company's apartments, if the economy remains stable or improves.
Interest collected on mortgage notes receivable decreased from $327,000 in 1996 to $253,000 in 1997. This decrease is primarily due to a decrease in short term investment income. Interest is expected to continue to decrease as a source of cash to the Company due to the expected payoff of its one mortgage note receivable in August 1998. The Company has determined that generally, it will not actively seek to originate new mortgage loans, other than those resulting from the Company's providing purchase money financing in connection with a property sale.
Interest paid on the Company's notes payable increased from $2.3 million in 1996 to $3.9 million in 1997. This increase is primarily attributable to interest paid on mortgages secured by two income producing properties purchased by the Company in 1996 and eight income producing properties purchased by the Company in 1997 and interest paid on two financings in 1996 secured by previously unencumbered commercial properties and the refinancing of a commercial property in 1997. The Company believes that interest paid on notes payable will continue to increase as the Company continues to acquire properties on a leveraged basis and/or obtain financing on its one unencumbered property.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
The Company was involved in significant investing activities during 1997. The Company purchased two apartment complexes and six commercial properties during 1997, for which the Company paid a total of $46.6 million. The Company paid $14.2 million in cash, with the remaining $34.8 million financed through new or assumed mortgage debt. The Company also made improvements to its properties totaling $901,000. The Company sold three apartment complexes during 1997 for $24.8 million. The Company received net cash of $8.4 million after the payoff of existing mortgage debt and the payment of various closing costs associated with the sales.
During 1997, the Company refinanced the mortgage debt secured by an office building. The Company received net cash of $3.3 million after the payoff of $3.7 million in existing mortgage debt and the payment of various closing costs associated with the refinancing. Also during 1997, the Company made scheduled mortgage principal payments totaling $736,000. Scheduled principal payments on notes payable of $3.5 million are due in 1998.
The Company owns a 36.3% general partner interest and Transcontinental Realty Investors, Inc. ("TCI") owns a 63.7% combined general and limited partner interest in the Tri-City Limited Partnership ("Tri-City"). In 1997, the Company received $218,000 in distributions from Tri-City's operating cash flow, $627,000 from its financing cash flow and made advances of $218,000 to Tri-City. In 1997, the Company received no distributions from and made $7,000 in contributions to Nakash Income Associates ("NIA"). The Company owns a 40% general partner interest and TCI owns a 60% general partner interest in NIA. See NOTE 5. "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."
The Company has paid quarterly dividends since the first quarter of 1993. In 1997 and 1996, the Company paid dividends to its stockholders totaling $567,000 ($.40 per share) and $621,000 ($.40 per share), respectively.
The Company's management reviews the carrying values of the Company's properties and mortgage note 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. In those instances where impairment is found to exist, a provision for loss is recorded by a charge against earnings. The Company's mortgage note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of maintenance
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
requirements, a review of the property's cash flow, discussions with the manager of the property and a review of properties in the surrounding area.
Results of Operations
1997 COMPARED TO 1996. For the year 1997, the Company reported net income of $3.3 million as compared with a net loss of $568,000 in 1996. The Company's 1997 net income includes gains on sale of real estate of $4.0 million, where as its 1996 net loss includes no such gains. The primary factors contributing to the Company's 1997 net income are discussed in the following paragraphs.
Rents in 1997, were $12.2 million compared to $8.7 million in 1996. Of this increase, $5.4 million is attributable to the ten properties purchased in 1997 and late 1996 and $355,000 is attributable to increased occupancy and rental rates at two of the Company's commercial properties and two of its apartment complexes. This increase is partially offset by a decrease of $2.2 million due to three apartment complexes being sold in 1997. Rents are expected to increase in 1998 due to a full year of operations of the commercial properties acquired in 1997.
Property operations expense for 1997 was $5.9 million, compared to $4.4 million for 1996. Of the increase, $2.5 million is attributable to the ten properties purchased in 1997 and late 1996 and $87,000 is due to increased repairs and maintenance at one of the Company's commercial properties. This increase is partially offset by a decrease of $1.0 million due to three apartment complexes being sold in 1997.
Equity in income of partnerships was $52,000 in 1997 compared to $85,000 in 1996. The decrease is due to expenses relating to the refinancing of one of the partnership's mortgage debt.
Interest income of $266,000 in 1997 decreased from the $339,000 earned in 1996. This decrease is primarily due to a decrease in short term investment income. Interest income is expected to decrease in 1998, as the Company's only mortgage note receivable is scheduled to mature in August 1998.
Interest expense increased to $4.1 million in 1997 compared to $2.6 million in 1996. Of this increase $2.1 million is attributable to the purchase of ten properties in 1997 and late 1996 and $191,000 is due to the financing of two previously unencumbered commercial properties in late 1996 and the refinancing of a commercial property in 1997. This increase is partially offset by a decrease of $848,000 due to three apartment complexes being sold in 1997. Interest expense will increase in 1998 due to a full year's affect of the 1997 transactions, described above.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Depreciation expense increased to $1.6 million in 1997 compared to $1.1 million in 1996. Of this increase, $734,000 is due to ten properties purchased in 1997 and late 1996 partially offset by a decrease of $294,000 due to three apartment complexes being sold in 1997. Depreciation expense will increase in 1998 due to a full year's affect of the eight properties acquired by the Company in 1997.
Advisory fee expense increased to $343,000 in 1997 compared to $227,000 in 1996. Such increase is attributable to an increase in the Company's gross assets, the basis for such fee. Such fee is expected to continue to increase as the Company's assets increase.
Net income and incentive sales fees totaling $275,000 were earned by the Company's advisor in 1997. Such fees are the result of the Company recognizing gains totaling $4.0 million from the sale of three apartment complexes in 1997. No such fees were earned by the Company's advisor in 1996.
General and administrative expenses for 1997 decreased to $1.0 million as compared to $1.3 million in 1996. Of this decrease, $189,000 is attributable to a decrease in legal fees related to the Olive litigation (see NOTE 14. "COMMITMENTS AND CONTINGENCIES") and $248,000 is attributable to the 1996 preparation of proxy material and registration statement relating to the Company's incorporation, which is nonrecurring in nature. These decreases are partially offset by an increase of $73,000 in advisor cost reimbursements and $90,000 in professional fees relating to the selection of new directors.
1996 COMPARED TO 1995. For the year 1996, the Company incurred a net loss of $568,000 as compared with a net loss of $906,000 in 1996. The primary factor contributing to the Company's decreased net loss in 1996 was an improvement in equity in income (loss) of partnerships of $829,000.
Rents in 1996, were $8.7 million compared to $7.7 million in 1995. Of this increase, $466,000 is attributable to the two commercial properties purchased in 1996, $170,000 is attributable to a full year of operations of an apartment complex foreclosed in 1995 and $302,000 is attributable to increased occupancy and rental rates at one of the Company's commercial properties and two of its apartment complexes.
Property operations expense for 1996 was $4.4 million, compared to $4.0 million for 1995. Of the increase, $141,000 is attributable to the two commercial properties purchased in 1996, $27,000 is attributable to a full year of operations of an apartment complex foreclosed in 1995, and $164,000 is due to increased repairs and maintenance at two of the Company's apartment complexes.
Equity in income (loss) of partnerships was income of $85,000 in 1996 as compared to a loss of $744,000 in 1995. The 1995 equity loss is primarily due to the modification of a wraparound note receivable and
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
underlying note payable by Nakash Income Associates ("NIA"), a partnership in which the Company has a 40% general partner interest and to the writedown of a wraparound mortgage note receivable to the balance of the underlying mortgage payable also by NIA. The Company's equity share of the loss on the note modification was $85,000 and its equity share of the note writedown was $601,000. See NOTE 5. "INVESTMENT IN EQUITY METHOD PARTNERSHIPS." Excluding the effect of the NIA transactions, equity earnings would have been comparable in each year.
Interest income increased to $339,000 in 1996 from $231,000 in 1995 due to an increase in short-term investment income.
Interest expense increased to $2.6 million in 1996 compared to $2.0 million in 1995. Of this increase, $537,000 is attributable to the refinancing of two previously unencumbered commercial properties in March 1996 and in September 1996 and $100,000 is due to the purchase of two commercial properties in 1996.
Depreciation expense of $1.1 million in 1996 was comparable to the $1.1 million in 1995.
Advisory fee expense decreased to $227,000 in 1996 compared to $316,000 in 1995. Such decrease is attributable to the operating expense limitation in the Company's Advisory Agreement. See NOTE 9. "ADVISORY AGREEMENT."
General and administrative expenses for 1996 increased to $1.3 million as compared to $699,000 in 1995. Of this increase, $399,000 is attributable to an increase in legal fees related to the Olive litigation (See NOTE 14. "COMMITMENTS AND CONTINGENCIES."), $101,000 is attributable to consulting and engineering fees related to potential property acquisitions and financings and $96,000 is attributable to the preparation of proxy material and registration statement relating to the Company's incorporation, which is nonrecurring in nature.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and regulations, the Company 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 from the Company for personal injury associated with such materials.
The Company's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Company's business, assets or results of operations.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Inflation
The effects of inflation on the Company's operations are not quantifiable. Revenues from property operations fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sale values of properties and, correspondingly, the ultimate realizable value of the Company's real estate and notes receivable portfolios. Inflation also has an effect on the Company's earnings from short-term investments.
Taxes
For the years 1995, 1996 and 1997, the Company elected and in the opinion of the Company's management qualified, to be taxed as a Real Estate Investment Trust ("REIT") as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"). To continue to qualify for federal taxation as a REIT under the Code, the Company is required to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year. The Code also requires a REIT to distribute at least 95% of its REIT taxable income plus 95% of its net income from foreclosure property, all as defined in Section 857 of the Code, on an annual basis to stockholders.
Year 2000
The Company's advisor has advised the Company that its current computer software has been certified by the Information Technology Association of America ("ITAA") as year 2000 compliant. The Company's advisor has also advised the Company that it has recently received and plans to install in 1998 the ITAA certified year 2000 compliant operating system for its computer hardware.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE --------
Report of Independent Certified Public Accountants.............. 26
Consolidated Balance Sheets - December 31, 1997 and 1996.................................. 27
Consolidated Statements of Operations - Years Ended December 31, 1997, 1996 and 1995................ 28
Consolidated Statements of Stockholders' Equity - Years Ended December 31, 1997, 1996 and 1995................ 29
Consolidated Statements of Cash Flows - Years Ended December 31, 1997, 1996 and 1995................ 30
Notes to Consolidated Financial Statements...................... 32
Schedule III - Real Estate and Accumulated Depreciation......... 46
Schedule IV - Mortgage Loans on Real Estate.................... 48
All other schedules are omitted because they are not required, are not applicable or the information required is included in the Financial Statements or the notes thereto.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors of Income Opportunity Realty Investors, Inc.
We have audited the accompanying consolidated balance sheets of Income Opportunity Realty Investors, Inc. and Subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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 generally accepted auditing standards. 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.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Income Opportunity Realty Investors, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
Also, in our opinion, the schedules referred to above present fairly, in all material respects, the information set forth therein.
BDO SEIDMAN, LLP
Dallas, Texas March 6, 1998
INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these Consolidated Financial Statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these Consolidated Financial Statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these Consolidated Financial Statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these Consolidated Financial Statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements of Income Opportunity Realty Investors, Inc. and consolidated entities (the "Company") have been prepared in conformity with generally accepted accounting principles, the most significant of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES." These, along with the remainder of the Notes to Consolidated Financial Statements, are an integral part of these Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.
Certain balances for 1996 and 1995 have been reclassified to conform to the 1997 presentation. Shares and per share data have been restated for the two for one forward Common Stock split effected June 14, 1996.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Company Business. Income Opportunity Realty Investors, Inc. ("IORI"), is the successor to a California business trust organized on December 14, 1984, which commenced operations on April 10, 1985. The Company may hold interests in real estate through direct ownership, leases and partnerships and it may also invest in mortgage loans on real estate, including first, wraparound and junior mortgage loans.
Basis of consolidation. The Consolidated Financial Statements include the accounts of IORI and subsidiaries and partnerships which it controls. All intercompany transactions and balances have been eliminated.
Accounting estimates. In the preparation of the Company's Consolidated Financial Statements in conformity with generally accepted accounting principles it was necessary for the Company's management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses for the year then ended. Actual results could differ from these estimates.
Interest recognition on notes receivable. It is the Company's policy to cease recognizing interest income on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.
Allowance for estimated losses. Valuation allowances are provided for estimated losses on notes receivable considered to be impaired. Impairment is considered to exist when it is probable that all amounts due under the terms of the note will not be collected. Valuation allowances are provided for estimated losses on notes receivable to the
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
extent that the Company's investment in the note exceeds the Company's estimate of fair value of the collateral securing such note.
Real Estate Held for Investment and Depreciation. Real estate held for investment is carried at cost. Statement of Financial Accounting Standards No. 121 ("SFAS No. 121") requires that a property be considered impaired, if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property. If impairment exists, an impairment loss is recognized, by a charge against earnings, equal to the amount by which the carrying amount of the property exceeds the fair value of the property. If impairment of a property is recognized, the carrying amount of the property is reduced by the amount of the impairment, and a new cost for the property is established. Such new cost is depreciated over the property's remaining useful life. Depreciation is provided by the straight-line method over estimated useful lives, which range from 3 to 40 years.
Real Estate Held for Sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated costs of sale. SFAS No. 121 also requires that properties held for sale be reported at the lower of carrying amount or fair value less costs of sale. If a reduction in a held for sale property's carrying amount to fair value less costs of sale is required, a provision for loss shall be recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale property's estimated fair value less costs of sale is recorded as an adjustment to the property's carrying amount, but not in excess of the property's carrying amount when originally classified as held for sale. A corresponding charge against or credit to earnings is recognized. Properties held for sale are not to be depreciated.
Present value discounts. The Company provides for present value discounts on notes receivable that have interest rates that differ substantially from prevailing market rates and amortizes such discounts by the interest method over the lives of the related notes. The factors considered in determining a market rate for notes receivable include the borrower's credit standing, nature of the collateral and payment terms of the note.
Revenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, "Accounting for Sales of Real Estate" ("SFAS No. 66"). Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using either the deposit, the installment sale, the cost recovery or the financing method, whichever is appropriate.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Investment in noncontrolled partnerships. The Company uses the equity method to account for investments in partnerships which it does not control. Under the equity method, the Company's initial investment, recorded at cost, is increased by the Company's proportionate share of the partnership's operating income and additional advances and decreased by the Company's proportionate share of the partnership's operating losses and distributions received.
Fair value of financial instruments. The Company used the following assumptions in estimating the fair value of its note receivable and notes payable. For its note receivable, which is performing, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. The estimated fair value presented does not purport to represent the amount to be ultimately realized by the Company. The amount ultimately realized may vary significantly from the estimated fair value presented. For notes payable the fair value was estimated using year end interest rates for mortgages with similar terms and maturities.
Cash equivalents. For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Earnings per share. Income (loss) per share is computed based upon the weighted average number of shares of Common Stock outstanding during each year, adjusted for the two for one stock split effective June 14, 1996.
NOTE 2. NOTES AND INTEREST RECEIVABLE
Notes and interest receivable consisted of the following:
The Company does not recognize interest income on nonperforming notes receivable. For the year 1995, unrecognized interest income on nonperforming notes receivable totaled $121,000. The Company's single note receivable was performing throughout 1997, bears interest at 10.0% per annum and matures in 1998.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. REAL ESTATE AND DEPRECIATION
In January 1997, the Company purchased the Chuck Yeager Building, a 60,060 square foot industrial/office building in Chantilly, Virginia, for $5.1 million. The Company paid $2.0 million in cash and obtained new mortgage financing of $3.1 million.
In March 1997, the Company completed the sale of the Plumtree Apartments, a 116 unit apartment complex in Martinez, California, that was under contract for sale at December 31, 1996, for $7.8 million in cash. The Company received net cash of $1.6 million after the payoff of $5.7 million in existing mortgage debt and the payment of various closing costs associated with the sale. The Company recognized a gain of $1.8 million on the sale.
In May 1997, the Company purchased the La Mesa Village Plaza, a 92,611 square foot office building in La Mesa, California, for $8.1 million. The Company paid $2.1 million in cash and obtained new mortgage financing of $6.0 million.
In June 1997, the Company sold the Porticos Apartments, a 256 unit apartment complex in Milwaukee, Wisconsin, for $15.2 million in cash. The Company received net cash of $5.2 million after the payoff of $9.6 in existing mortgage debt and the payment of various closing costs associated with the sale. The Company recognized a gain of $1.5 million on the sale.
Also in June 1997, the Company purchased Renaissance Parc Apartments, a 294 unit apartment complex in Dallas, Texas, for $15.7 million. The Company paid $3.2 million in cash and obtained new mortgage financing of $12.5 million.
Further in June 1997, the Company purchased LaMonte Park Apartments, a 128 unit apartment complex in Houston, Texas, for $3.7 million. The Company paid $200,000 cash and assumed the existing mortgage of $3.5 million.
In September 1997, the Company purchased Valley View Center, a partially complete four story office building in Farmers Branch, Texas, for $565,000 in cash.
In November 1997, the Company purchased Westlake Village, a 45,500 square foot office building in Westlake Village, California, for $3.9 million. The Company paid $1.0 million in cash and obtained new mortgage financing of $2.9 million.
In December 1997, the Company purchased Akard Plaza, a 42,895 square foot office building in Dallas, Texas, for $3.5 million. The Company paid $1.0 million in cash with the seller providing purchase money financing of the remaining $2.5 million of the purchase price.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. REAL ESTATE AND DEPRECIATION
Also in December 1997, the Company purchased Fireside Thrift, a 56,120 square foot office building in Newark, California, for $6.0 million. The Company paid $1.7 million in cash and assumed the existing mortgage of $4.3 million.
Further in December 1997, the Company sold the Spanish Trace Apartments, a 136 unit apartment complex in Irving, Texas, for $1.8 million in cash. The Company had obtained the property through foreclosure in 1994. The Company received net cash of $1.7 million after the payment of various closing costs associated with the sale. The Company recognized a gain of $631,000 on the sale.
In 1996, the Company purchased two office buildings: Daley Plaza Corporate Center, a three building, 122,795 square foot office facility in San Diego, California, and the Olympic Building, a 57,000 square foot office building in Los Angeles, California. The Company paid $5.1 million in cash and either obtained new mortgage or seller financing of $8.0 million.
NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES
Activity in the allowance for estimated losses was as follows:
NOTE 5. INVESTMENT IN EQUITY METHOD PARTNERSHIPS
The Company's investments in equity method partnerships consist of the following:
The Company uses the equity method to account for its 36.3% general partner interest in Tri-City, which owns five properties in Texas. Transcontinental Realty Investors, Inc. ("TCI") owns a combined 63.7% general and limited partner interest in Tri-City. In September 1997, Tri-City obtained first mortgage financing of $1.9 million secured by the previously unencumbered Oaks of Inwood and Inwood Green Apartments. The Company received $627,000 of the net financing proceeds. As of March 6, 1998, TCI owned approximately 22.5% of the Company's outstanding shares of Common Stock.
In July 1995, Tri-City obtained first mortgage financing of $1.4 million, secured by a previously unencumbered office building in Dallas, Texas. The Company received $486,000 of the net financing proceeds.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)
The Company also uses the equity method to account for its 40% general partner interest in NIA. TCI owns the remaining 60% general partner interest in NIA.
At December 31, 1995, NIA owned two wraparound mortgage notes receivable, one of which was secured by a shopping center in Onandaga, New York. In July 1995, the owner of the shopping center informed NIA that it had determined that further investment in the shopping center was not justified and further that it had offered to deed the property back to the first lien holder in lieu of foreclosure making the wraparound note receivable held by NIA uncollectible. NIA recorded a provision for loss of $1.5 million to write its wraparound note receivable down to the balance of the first lien mortgage. The Company's equity portion of the loss was $601,000. The property was returned to the lender in March 1996. In September 1995, the Company received notice from NIA that the other of its wraparound notes receivable secured by a shopping center in Maulden, Missouri had been modified in conjunction with the modification of the underlying note payable. NIA recorded a provision for loss of $212,000 on such modification of which the Company's equity share was $85,000. In August 1997, the owner of the shopping center refinanced the matured mortgage secured by the shopping center in the amount of $850,000.
Set forth below are summarized financial data for the partnerships the Company accounts for using the equity method:
The Company's equity share of the above net income (loss) for 1997, 1996 and 1995 was $56,000, $89,000 and $(552,000), respectively, before amortization of property acquisition costs discussed below.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)
The Company's share of the above partnerships' capital was $2.5 million in 1997 and $3.0 million in 1996.
The excess of the Company's investment over its respective share of the equity in the underlying net assets of Tri-City relates principally to the remaining unamortized property acquisition costs of $172,000 in 1997 and $176,000 in 1996. These amounts are being amortized over the remaining estimated useful lives of the properties.
NOTE 6. NOTES AND INTEREST PAYABLE
Notes and interest payable consist of the following:
Scheduled notes payable principal payments are due as follows:
Mortgage notes payable at December 31, 1997, bear interest at rates ranging from 7.75% to 11.0% and mature between 1998 and 2007. These notes are collateralized by deeds of trust on real estate with a net carrying value of $81.2 million.
In 1997, the Company purchased two apartment complexes and six office buildings for a total of $46.6 million. In conjunction with the purchases, the Company either assumed existing mortgage debt or obtained new mortgage financing totaling $34.8 million. The mortgages bear interest at rates ranging from 8.375% to 11.0% per annum, require monthly payments of principal and interest, currently totaling $310,939, and mature from June 1998 to July 2007.
In October 1997, the Company refinanced the matured mortgage debt secured by Daley Plaza Corporate Center in San Diego, California in the amount of $7.0 million. The Company received net cash of $3.3 million after the payoff of $3.7 million in existing mortgage debt and the payment of various closing costs associated with the refinancing. The
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6. NOTES AND INTEREST PAYABLE (Continued)
new mortgage bears interest at a variable rate, currently 9.75% per annum, requires monthly payments of principal and interest of $62,380 and matures in October 2002.
In 1996, the Company obtained mortgage financing totaling $8.5 million on the previously unencumbered Saratoga and Town Center Plaza Office Buildings in Saratoga, California and Boca Raton, Florida, respectively. The Company received net cash of $7.6 million after funding required escrows and the payment of various closing costs associated with the financings. The mortgages bear interest at 9.0% and 9.16% per annum, respectively, mature in April and October 2006 and both require principal and interest payments totaling $71,557.
NOTE 7. DIVIDENDS
The Company has paid quarterly dividends to its stockholders since the first quarter of 1993. The Company paid dividends of $.40 per share in 1997 and 1996 and $.30 per share in 1995 totaling $567,000, $621,000 and $475,000, respectively.
The Company reported to the Internal Revenue Service that 100% of the dividends paid in 1997 represented capital gains and 100% of the dividends paid in 1996 and 1995 represented a return on capital.
NOTE 8. RENTS UNDER OPERATING LEASES
The Company's operations include the leasing of office buildings. The leases thereon expire at various dates through 2007. The following is a schedule of minimum future rents on non-cancelable operating leases as of December 31, 1997:
NOTE 9. ADVISORY AGREEMENT
Basic Capital Management, Inc. ("BCM" or the "Advisor") has served as advisor to the Company since March 28, 1989. BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Director of the Company until December 31, 1992, and as a director of BCM until December 22, 1989, and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. ADVISORY AGREEMENT (Continued)
At the Company's annual meeting of stockholders held on May 8, 1997, the renewal of the Company's Advisory Agreement with BCM through the next annual meeting of the Company's stockholders was approved. Subsequent renewals of the Company's Advisory Agreement with BCM do not require the approval of the Company's stockholders, but do require approval of the Company's Board of Directors.
Under the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Company's Board of Directors a budget and business plan for the Company containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and acquisitions, lending foreclosure and borrowing activity and other investments. The Advisor is required to report quarterly to the Company's Board of Directors on the Company's performance against the business plan. In addition, all transactions by the Company shall require prior approval by the Company's Board of Directors, unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Company's Board of Directors.
The Advisory Agreement also requires prior approval of the Company's Board of Directors for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that the Advisor shall be deemed to be in a fiduciary relationship to the Company's stockholders and contains a broad standard governing the Advisor's liability for losses by the Company.
The Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Company and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Company (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Company's net income.
The Advisory Agreement also provides for BCM to receive an annual incentive sales fee. BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Company. BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Company. BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Company or refinancing on the Company's properties and BCM is to receive reimbursement of certain expenses incurred by it, in the performance of advisory services to the Company.
The Advisory Agreement requires BCM or any affiliate of BCM to pay to the Company one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Company.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. ADVISORY AGREEMENT (Continued)
Under the Advisory Agreement all or a portion of the annual advisory fee must be refunded by the Advisor to the Company if the Operating Expenses of the Company (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement. The effect of this limitation was to require that BCM refund $201,000, $191,000 and $44,000, of the 1997, 1996 and 1995 annual advisory fee, respectively.
Additionally, if the Company were to request that BCM render services to the Company other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed in NOTE 10. "PROPERTY MANAGEMENT," the Company has hired Carmel Realty Services, Ltd. ("Carmel, Ltd."), an affiliate of BCM, to provide property management for the Company's properties and, as discussed in NOTE 11. "REAL ESTATE BROKERAGE," the Company has engaged Carmel Realty, Inc. ("Carmel Realty"), also an affiliate of BCM, on a non-exclusive basis, to provide brokerage services for the Company.
BCM may only assign the Advisory Agreement with the prior consent of the Company.
NOTE 10. PROPERTY MANAGEMENT
Carmel, Ltd. provides property management services to the Company for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Company at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) First Equity Properties, Inc. ("First Equity"), which is 50% owned by BCM, (ii) Gene E. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of nine of the Company's office buildings and the commercial properties owned by Tri-City in which the Company and TCI are partners to Carmel Realty which is a company owned by First Equity. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.
NOTE 11. REAL ESTATE BROKERAGE
Carmel Realty, also provides brokerage services to the Company on a non-exclusive basis. Carmel Realty is entitled to receive a commission for property purchases and sales in accordance with a sliding scale of total fees to be paid by the Company.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.
Fees and cost reimbursements to BCM and its affiliates:
- - ----------------------
* Net of property management fees paid to subcontractors, other than Carmel Realty.
NOTE 13. INCOME TAXES
For the years 1997, 1996 and 1995, the Company has elected and qualified to be treated as a Real Estate Investment Trust ("REIT"), as defined in Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"), and as such, will not be taxed for federal income tax purposes on that portion of its taxable income which is distributed to stockholders, provided that at least 95% of its REIT taxable income, plus 95% of its taxable income from foreclosure property as defined in Section 857 of the Code, is distributed.
The Company had net income for federal income tax purposes before the application of operating loss carryforwards in 1997 and net losses in 1996 and 1995 for federal income tax purposes; therefore, the Company recorded no provision for income taxes. The Company's tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties and investments in joint venture partnerships. At December 31, 1997, the Company's tax basis in its net assets exceeded its basis for financial statement purposes by $3.0 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes and the Company would be able to maintain its REIT status without distributing 95% of its financial statement income. Additionally, at December 31, 1997, the Company had tax net operating loss carryforwards of $15.2 million expiring through the year 2011.
As a result of the Company's election to be treated as a REIT for income tax purposes and of its intention to distribute its taxable income, if any, in future years, no deferred tax asset, liability or valuation allowance was recorded.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. COMMITMENTS AND CONTINGENCIES
Olive Litigation. In February 1990, the Company, together with Continental Mortgage and Equity Trust ("CMET"), National Income Realty Trust and TCI, three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Company, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., relating to the operation and management of each of the entities. On April 23, 1990, the Court granted final approval of the terms of the settlement.
On May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the "Olive Modification") which settled subsequent claims of breaches of the settlement that were asserted by the plaintiffs and that modified certain provisions of April 1990 settlement. The Olive Modification was preliminarily approved by the Court July 1, 1994 and final Court approval was entered on December 12, 1994. The effective date of the Olive Modification was January 11, 1995.
The Court retained jurisdiction to enforce the Olive Modification, and during August and September 1996, the Court held evidentiary hearings to assess compliance with the terms of the Olive Modification by various parties. The Court issued no ruling or order with respect to the matters addressed at the hearings.
Separately, in 1996, legal counsel for the plaintiffs notified the Company's Board of Directors that he intended to assert that certain actions taken by the Board of Directors breached the terms of the Olive Modification. On January 27, 1997, the parties entered into an Amendment to the Olive Modification effective January 9, 1997 (the "Olive Amendment"), which was submitted to the Court for approval on January 29, 1997. The Olive Amendment provides for the settlement of all matters raised at the evidentiary hearings and by plaintiffs' counsel in his notices to the Company's Board of Directors. On May 2, 1997, a hearing was held for the Court to consider approval of the Olive Amendment. As a result of the hearing, the parties entered into a revised Olive Amendment. The Court issued an order approving the Olive Amendment on July 3,1997.
The Olive Amendment provides for the addition of four new unaffiliated members to the Company's Board of Directors and sets forth new requirements for the approval of any transactions with certain affiliates until April 28, 1999. In addition, the Company, CMET, TCI and their stockholders released the defendants from any claims relating to the plaintiffs' allegations and matters which were the subject of the evidentiary hearings. The plaintiffs' allegations of any breaches of the Olive Modification shall be settled by mutual agreement of the parties or, lacking such agreement, by an arbitration proceeding.
INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 14. COMMITMENTS AND CONTINGENCIES (Continued)
Under the Olive Amendment, all shares of the Company owned by Gene E. Phillips or any of his affiliates shall be voted at all stockholder meetings of the Company held until April 28, 1999 in favor of all new members of the Company's Board of Directors added under the Olive Amendment. The Olive Amendment also requires that, until April 28, 1999, all shares of the Company owned by Mr. Phillips or his affiliates in excess of forty percent (40%) of the Company's outstanding shares shall be voted in proportion to the votes cast by all non-affiliated stockholders of the Company.
In accordance with the Olive Amendment, Richard W. Douglas, Larry E. Harley and R. Douglas Leonhard were added to the Company's Board of Directors in January 1998 and Murray Shaw was added to the Company's Board of Directors in February 1998.
Other Litigation. The Company is also involved in various other lawsuits arising in the ordinary course of business. The Company's management is of the opinion that the outcome of these lawsuits will have no material impact on the Company's financial condition, results of operations or liquidity.
NOTE 15. QUARTERLY DATA
The following is a tabulation of the Company's quarterly results of operations for the years 1997 and 1996 (unaudited).
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INCOME OPPORTUNITY REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. QUARTERLY DATA (Continued)
SCHEDULE III INCOME OPPORTUNITY REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1997
(1) The aggregate cost for Federal income tax purposes is $88.9 million. (2) Under construction at December 31, 1997.
SCHEDULE III (Continued)
INCOME OPPORTUNITY REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION
SCHEDULE IV
INCOME OPPORTUNITY REALTY INVESTORS, INC. MORTGAGE LOANS ON REAL ESTATE December 31, 1997
- - -------------------- (1) The aggregate cost for Federal income tax purposes is $2.0 million.
SCHEDULE IV (Continued)
INCOME OPPORTUNITY REALTY INVESTORS, INC. MORTGAGE LOANS ON REAL ESTATE
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
__________________________
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
Directors
The affairs of Income Opportunity Realty Investors, Inc. (the "Company" or the "Registrant") are managed by a Board of Directors. The Directors are elected at the annual meeting of stockholders or appointed by the incumbent Board of Directors and serve until the next annual meeting of stockholders or until a successor has been elected or approved.
The Directors of the Company are listed below, together with their ages, terms of service, all positions and offices with the Company or its advisor, Basic Capital Management, Inc. ("BCM" or the "Advisor"), their principal occupations, business experience and directorships with other companies during the last five years or more. The designation "Affiliated", when used below with respect to a Director, means that the Director is an officer, director or employee of the Advisor or an officer of the Company. The designation "Independent" when used below with respect to a Director, means that the Director is neither an officer of the Company nor a director, officer or employee of the Advisor, although the Company may have certain business or professional relationships with such Director as discussed in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -Certain Business Relationships."
TED P. STOKELY: Age 64, Director (Independent) (since April 1990) and Chairman of the Board (since January 1995).
General Manager (since January 1995) of ECF Senior Housing Corporation, a nonprofit corporation; General Manager (since January 1993) of Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid Consultant (since January 1993) and paid Consultant (April 1992 to December 1992) of Eldercare Housing Foundation ("Eldercare"), a nonprofit corporation; President (April 1992 to April 1994) of PSA Group; Executive Vice President (1987 to 1991) of Key Companies Inc.; Trustee (since April 1990) and Chairman of the Board (since January 1995) of Continental Mortgage and Equity Trust ("CMET"); Director (since April 1990) and Chairman of the Board (since January 1995) of Transcontinental Realty Investors, Inc. ("TCI"); and Trustee (April 1990 to August 1994) of National Income Realty Trust ("NIRT").
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Directors (Continued)
RICHARD W. DOUGLAS: Age 50, Trustee (Independent) (since January 1998).
President (since 1991) of Dallas Chamber of Commerce; President (1988 to 1991) of North Texas Commission; President (1978 to 1981) of Las Colinas Corporation and Southland Investment Properties, both affiliates of Southland Financial Corporation; Trustee (since January 1998) of CMET; and Director (since January 1998) of TCI.
LARRY E. HARLEY: Age 57, Trustee (Independent) (since January 1998).
President (1993 to 1997) and Executive Vice President (1992 to 1993) of U.S. Operations, Executive Vice President (1989 to 1992) and Senior Vice President (1986 to 1989) of Distribution Operations, Director of Marketing (1984 to 1986), and Manager of North Central Distribution Center (1974 to 1984) of Mary Kay Cosmetics; Trustee (since January 1998) of CMET; and Director (since January 1998) of TCI.
R. DOUGLAS LEONHARD: Age 61, Trustee (Independent) (since January 1998).
Senior Vice President (1986 to 1997) of LaCantera Development Company, a wholly-owned subsidiary of USAA; Senior Vice President (1980 to 1985) of The Woodlands Development Corporation; Vice President and Houston Projects Manager (1973 to 1979) of Friendswood Development Company; Manager in various capacities (1960 to 1973) of Exxon Corp.; Trustee (since January 1998) of CMET; and Director (since January 1998) of TCI.
MURRAY SHAW: Age 66, Trustee (Independent) (since February 1998).
Chairman of the Board of Regents (since 1997) of Stephen F. Austin University; Vice President (1967 to 1996) of Tracor, Inc.; Trustee (since February 1998) of CMET; and Director (since February 1998) of TCI.
MARTIN L. WHITE: Age 58, Director (Independent) (since January 1995).
Chief Executive Officer (since 1995) of Builders Emporium, Inc.; Chairman and Chief Executive Officer (since 1993) of North American Trading Company Ltd.; President and Chief Operating Officer (since 1992) of Community Based Developers, Inc.; Development Officer and Loan Manager (1986 to 1992) of the City of San Jose, California; Vice President and Director of Programs (1967 to 1986) of Arpact, Inc., a government contractor for small business development and trade; Trustee (since January 1995) of CMET; and Director (since January 1995) of TCI.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Directors (Continued)
EDWARD G. ZAMPA: Age 63, Director (Independent) (since January 1995).
General Partner (since 1976) of Edward G. Zampa and Company; Trustee (since January 1995) of CMET; and Director (since January 1995) of TCI.
Board Committees
The Company's Board of Directors held seven meetings during 1997. For such year, no incumbent Director attended fewer than 75% of the aggregate of (i) the total number of meetings held by the Company's Board of Directors during the period for which he had been a Director and (ii) the total number of meetings held by all committees of the Board of Directors on which he served during the period that he served, except Mr. White, who attended only one of the two audit committee meetings held in 1997.
The Company's Board of Directors has an Audit Committee, the function of which is to review the Company's operating and accounting procedures. The current members of the Audit Committee, all of whom are Independent Directors, are Messrs. Stokely, Leonhard and White. The Audit Committee met twice during 1997.
The Company's Board of Directors has a Relationship with Advisor Committee and a Board Development Committee. The current members of the Relationship with Advisor Committee are Messrs. Stokely and Zampa. The Relationship with Advisor Committee reviews and reports to the Company's Board of Directors on the services provided to the Company by the Advisor and its affiliates and the terms of any engagement or compensation of the Advisor or its affiliates. The Relationship with Advisor Committee did not meet in 1997. The Board Development Committee reviews and reports to the Company's Board of Directors on the membership, compensation and functions of the Board of Directors. The current member of the Board Development Committee is Mr. White. The Board Development Committee did not meet in 1997.
The Company's Board of Directors does not have Nominating or Compensation Committees.
Executive Officers
The following persons currently serve as executive officers of the Company: Randall M. Paulson, President; Karl L. Blaha, Executive Vice President - Commercial Asset Management; Bruce A. Endendyk, Executive Vice President; and Thomas A. Holland, Executive Vice President and Chief Financial Officer. Their positions with the Company are not subject to a vote of stockholders. Their ages, terms of service, all
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Executive Officers (Continued)
positions and offices with the Company or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.
RANDALL M. PAULSON: Age 51, President (since August 1995) and Executive Vice President (January 1995 to August 1995).
President (since August 1995) and Executive Vice President (January 1995 to August 1995) of CMET, TCI and Syntek Asset Management, Inc. ("SAMI"), the managing general partner of Syntek Asset Management, L.P. ("SAMLP"), which is the general partner of National Realty, L.P. ("NRLP") and National Operating, L.P. ("NOLP"), and (October 1994 to August 1995) of BCM; Director (since August 1995) of SAMI; Executive Vice President (since January 1995) of American Realty Trust, Inc. ("ART"); Vice President (1993 to 1994) of GSSW, LP, a joint venture of Great Southern Life and Southwestern Life; Vice President (1990 to 1993) of Property Company of America Realty, Inc.; President (1990) of Paulson Realty Group; President (1983 to 1989) of Johnstown Management Company; and Vice President (1979 to 1982) of Lexton-Ancira.
KARL L. BLAHA: Age 50, Executive Vice President - Commercial Asset Management (since July 1997).
Executive Vice President- Commercial Asset Management (since July 1997) and Executive Vice President and Director of Commercial Management (April 1992 to August 1995) of BCM, CMET, TCI, and SAMI; Director (since June 1996), President (since October 1993) and Executive Vice President and Director of Commercial Management (April 1992 to October 1993) of ART; Executive Vice President (October 1992 to July 1997) of Carmel Realty, Inc. ("Carmel Realty"), a company owned by First Equity Properties, Inc. ("First Equity"), which is 50% owned by BCM; President and Director (since 1996) of First Equity; Executive Vice President and Director of Commercial Management (April 1992 to February 1994) of NIRT and Vinland Property Trust ("VPT"); Partner - Director of National Real Estate Operations (August 1988 to March 1992) of First Winthrop Corporation; Corporate Vice President (April 1984 to August 1988) of Southmark Corporation ("Southmark"); and President (March 1986 to August 1988) of Southmark Commercial Management.
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Executive Officers (Continued)
BRUCE A. ENDENDYK: Age 49, Executive Vice President (since January 1995).
President (since January 1995) of Carmel Realty; Executive Vice President (since January 1995) of BCM, SAMI, ART, CMET and TCI; Management Consultant (November 1990 to December 1994); Executive Vice President (January 1989 to November 1990) of Southmark; President and Chief Executive Officer (March 1988 to January 1989) of Southmark Equities Corporation; and Vice President/Resident Manager (December 1975 to March 1988) of Coldwell Banker Commercial/Real Estate Services in Houston, Texas.
THOMAS A. HOLLAND: Age 55, Executive Vice President and Chief Financial Officer (since August 1995); Secretary (since February 1997) and Senior Vice President and Chief Accounting Officer (July 1990 to August 1995).
Executive Vice President and Chief Financial Officer (since August 1995) and Senior Vice President and Chief Accounting Officer (July 1990 to August 1995) of BCM, SAMI, ART, CMET and TCI; Secretary (since February 1997) of CMET and TCI; Senior Vice President and Chief Accounting Officer (July 1990 to February 1994) of NIRT and VPT; Vice President and Controller (December 1986 to June 1990) of Southmark; Vice President-Finance (January 1986 to December 1986) of Diamond Shamrock Chemical Company; Assistant Controller (May 1976 to January 1986) of Maxus Energy Corporation (formerly Diamond Shamrock Corporation); Trustee (August 1989 to June 1990) of Arlington Realty Investors; and Certified Public Accountant (since 1970).
Officers
Although not executive officers of the Company, the following persons currently serve as officers of the Company: Robert A. Waldman, Senior Vice President and General Counsel; and Drew D. Potera, Vice President and Treasurer. Their positions with the Company are not subject to a vote of stockholders. Their ages, terms of service, all
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Officers (Continued)
positions and offices with the Company or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.
ROBERT A. WALDMAN: Age 45, Senior Vice President and General Counsel (since January 1995); Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997).
Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997) of CMET and TCI; Senior Vice President and General Counsel (since January 1995), Vice President (January 1993 to January 1995) and Secretary (since December 1989) of ART; Senior Vice President and General Counsel (since November 1994), Vice President and Corporate Counsel (November 1989 to November 1994), and Secretary (since November 1989) of BCM; Senior Vice President and General Counsel (since January 1995), Vice President (April 1990 to January 1995) and Secretary (since December 1990) of SAMI; Vice President (December 1990 to February 1994) and Secretary (December 1993 to February 1994) of NIRT and VPT; and Director (February 1987 to October 1989) and General Counsel and Secretary (1985 to October 1989) of Red Eagle Resources Corporation.
DREW D. POTERA: Age 38, Vice President (since December 1996) and Treasurer (since December 1990).
Vice President (since December 1996) and Treasurer (since December 1990) of CMET and TCI; Vice President (since December 1996) and Treasurer (since August 1991) and Assistant Treasurer (December 1990 to August 1991) of ART; Vice President, Treasurer and Securities Manager (since July 1990) of BCM; Vice President and Treasurer (since February 1992) of SAMI; Treasurer (December 1990 to February 1994) of NIRT and VPT; and Financial Consultant with Merrill Lynch, Pierce, Fenner & Smith Incorporated (June 1985 to June 1990).
In addition to the foregoing officers, the Company has several vice presidents and assistant secretaries who are not listed herein.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Under the securities laws of the United States, the Company's Directors, executive officers, and any persons holding more than ten percent of the Company's shares of Common Stock are required to report their ownership of the Company's shares and any changes in that ownership to the Securities and Exchange Commission (the "Commission"). Specific due dates for these reports have been established and the Company is required to report any failure to file by these dates during 1997. All
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Compliance with Section 16(a) of the Securities Exchange Act of 1934 (Continued)
of these filing requirements were satisfied by its Directors and executive officers and ten percent holders. In making these statements, the Company has relied on the written representations of its incumbent Directors and executive officers and its ten percent holders and copies of the reports that they have filed with the Commission.
The Advisor
Although the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by a contractual advisor under the supervision of the Company's Board of Directors. The duties of the advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities as well as financing and refinancing sources for the Company. The advisor also serves as a consultant to the Company's Board of Directors in connection with the business plan and investment policy decisions.
BCM has served as the Company's advisor since March 1989. BCM is a company of which Messrs. Paulson, Blaha, Endendyk and Holland serve as executive officers. BCM is owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a director of BCM until December 22, 1989, and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company.
At the Company's annual meeting of stockholders held on May 8, 1997, the Company's stockholders approved the renewal of the Company's Advisory Agreement with BCM through the next annual meeting of the Company's stockholders. Subsequent renewals of the Company's Advisory Agreement with BCM do not require the approval of the Company's stockholders, but do require approval of the Company's Board of Directors.
Under the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Company's Board of Directors a budget and business plan for the Company containing a twelve month forecast of operations and cash flow, a general plan for asset sales and acquisitions, lending foreclosure and borrowing activity, and other investments. The Advisor is required to report quarterly to the Company's Board of Directors on the Company's performance against the business plan. In addition, all transactions by the Company shall require prior approval by the Company's Board of Directors, unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Company's Board of Directors.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
The Advisor (Continued)
The Advisory Agreement also requires prior approval of the Company's Board of Directors for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that the Advisor shall be deemed to be in a fiduciary relationship to the Company's stockholders; contains a broad standard governing the Advisor's liability for losses by the Company; and contains guidelines for the Advisor's allocation of investment opportunities as among itself, the Company and other entities it advises.
The Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Company and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Company (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Company's net income.
The Advisory Agreement also provides for BCM to receive an annual incentive sales fee equal to 10% of the amount, if any, by which the aggregate sales consideration for all real estate sold by the Company during such fiscal year exceeds the sum of: (i) the cost of each such property as originally recorded in the Company's books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (ii) capital improvements made to such assets during the period owned by the Company, and (iii) all closing costs, (including real estate commissions) incurred in the sale of such real estate; provided, however, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8% simple annual return on the Company's net investment including capital improvements, calculated over the Company's holding period before depreciation and inclusive of operating income and sales consideration and (b) the aggregate net operating income from all real estate owned by the Company for each of the prior and current fiscal years shall be at least 5% higher in the current fiscal year than in the prior fiscal year.
Additionally, pursuant to the Advisory Agreement BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Company equal to the lesser of (i) up to 1% of the cost of acquisition, inclusive of commissions, if any, paid to nonaffiliated brokers or (ii) the compensation customarily charged in arm's-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property, provided that the aggregate purchase price of each property (including acquisition fees and real estate brokerage commissions) may not exceed such property's appraised value at acquisition.
The Advisory Agreement requires BCM or any affiliate of BCM to pay to the Company, one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
The Advisor (Continued)
by the Company; provided, however, that the compensation retained by BCM or any affiliate of BCM shall not exceed the lesser of (i) 2% of the amount of the loan committed by the Company or (ii) a loan brokerage and commitment fee which is reasonable and fair under the circumstances.
The Advisory Agreement also provides that BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Company equal to the lesser of (i) 1% of the amount of the loan purchased or (ii) a brokerage or commitment fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding by the Company of any mortgage loan.
Under the Advisory Agreement, BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Company or refinancing on Company properties equal to the lesser of (i) 1% of the amount of the loan or the amount refinanced or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from BCM or an affiliate of BCM without the approval of the Company's Board of Directors. No fee shall be paid on loan extensions.
Under the Advisory Agreement, BCM is to receive reimbursement of certain expenses incurred by it, in the performance of advisory services to the Company.
Under the Advisory Agreement all or a portion of the annual advisory fee must be refunded by the Advisor to the Company if the Operating Expenses of the Company (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement based on the book value, net asset value and net income of the Company during such fiscal year. The effect of this limitation was to require that BCM refund $201,000, of the 1997 annual advisory fee.
Additionally, if the Company were to request that BCM render services to the Company other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed below, under "Property Management", the Company has hired Carmel Realty Services, Ltd. ("Carmel, Ltd."), an affiliate of BCM, to provide management for the Company's properties and, as discussed below, under "Real Estate Brokerage" the Company has engaged Carmel Realty, also an affiliate of BCM, on a non-exclusive basis to provide brokerage services for the Company.
BCM may only assign the Advisory Agreement with the prior consent of the Company.
The directors and principal officers of BCM are set forth below.
MICKEY N. PHILLIPS: Director
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Mickey N. Phillips is Gene E. Phillips' brother and Ryan T. Phillips is Gene E. Phillips' son. Gene E. Phillips serves as a representative of the trust established for the benefit of his children which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company.
Property Management
Since February 1, 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel, Ltd. provides such property management services for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Company at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) First Equity, which is 50% owned by BCM, (ii) Gene E. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of nine of the Company's office buildings and the commercial properties owned by a real estate partnership in which the Company and TCI are partners to Carmel Realty which is a company owned by First Equity. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with its property-level management agreement with Carmel, Ltd.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Real Estate Brokerage
Since December 1, 1992, Carmel Realty has been engaged, on a non-exclusive basis, to provide brokerage services for the Company. Carmel Realty is entitled to receive a real estate brokerage commission for property acquisitions and sales by the Company in accordance with the following sliding scale of total fees to be paid by the Company: (i) maximum fee of 5% on the first $2.0 million of any purchase or sale transaction of which no more than 4% would be paid to Carmel Realty or affiliates; (ii) maximum fee of 4% on transaction amounts between $2.0 million - $5.0 million of which no more than 3% would be paid to Carmel Realty or affiliates; (iii) maximum fee of 3% on transaction amounts between $5.0 million - $10.0 million of which no more than 2% would be paid to Carmel Realty or affiliates; and, (iv) maximum fee of 2% on transaction amounts in excess of $10.0 million of which no more than 1 1/2% would be paid to Carmel Realty or affiliates.
ITEM 11. EXECUTIVE COMPENSATION
The Company has no employees, payroll or benefit plans and pays no compensation to the executive officers of the Company. The executive officers of the Company who are also officers or employees of BCM, the Company's Advisor, are compensated by the Advisor. Such executive officers of the Company perform a variety of services for the Advisor and the amount of their compensation is determined solely by the Advisor. BCM does not allocate the cash compensation of its officers among the various entities for which it serves as advisor. See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor" for a more detailed discussion of the compensation payable to BCM by the Company.
The only remuneration paid by the Company is to the Directors who are not officers or directors of BCM or its affiliated companies. The Independent Directors (i) review the business plan of the Company to determine that it is in the best interest of the Company's stockholders, (ii) review the Company's contract with the advisor, (iii) supervise the performance of the Company's advisor and review the reasonableness of the compensation which the Company pays to its advisor in terms of the nature and quality of services performed, (iv) review the reasonableness of the total fees and expenses of the Company and (v) select, when necessary, a qualified independent real estate appraiser to appraise properties acquired by the Company. Each Independent Director receives compensation in the amount of $15,000 per year, plus reimbursement for expenses, and the Chairman of the Board receives an additional fee of $1,500 per year for serving in such position. In addition, each Independent Director receives an additional fee of $1,000 per day for any special services rendered by him to the Company outside of his ordinary duties as Director, plus reimbursement of expenses.
During 1997, $65,500 was paid to the Independent Directors in total Directors' fees for all services including the annual fee for service during the period January 1, 1997 through December 31, 1997, and 1997 special service fees, as follows: Ted P. Stokely, $16,500 ; Edward L. Tixier, $15,000; Martin L. White, $15,000; and Edward G. Zampa, $19,000.
ITEM 11. EXECUTIVE COMPENSATION (Continued)
Performance Graph
The following performance graph compares the cumulative total stockholder return on the Company's shares of Common Stock with the Standard & Poor's 500 Stock Index ("S&P 500 Index") and the National Association of Real Estate Investment Trusts, Inc. Hybrid REIT Total Return Index ("REIT Index"). The comparison assumes that $100 was invested on December 31, 1992 in the Company's shares of Common Stock and in each of the indices and further assumes the reinvestment of all distributions. Past performance is not necessarily an indicator of future performance.
COMPARISON OF FIVE YEAR
CUMULATIVE TOTAL RETURN
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Certain Beneficial Owners. The following table sets forth the ownership of the Company's shares of Common Stock, both beneficially and of record, both individually and in the aggregate for those persons or entities known by the Company to be beneficial owners of more than 5% of its shares of Common Stock as of the close of business on March 6, 1998.
(1) Percentages are based upon 1,519,888 shares of Common Stock outstanding at March 6, 1998.
Security Ownership of Management. The following table sets forth the ownership of the Company's shares of Common Stock, both beneficially and of record, both individually and in the aggregate for the Directors and executive officers of the Company as of the close of business on March 6, 1998.
___________________________
(1) Percentage is based upon 1,519,888 shares of Common Stock outstanding at March 6, 1998.
(2) Includes 341,500 shares owned by TCI of which the Directors may be deemed to be beneficial owners by virtue of their positions as directors of TCI and 452,102 shares owned by ART and 102,450 owned by BCM, of which the executive officers of the Company may be deemed to be beneficial owners by virtue of their positions as executive officers of ART and BCM. The Company's Directors and executive officers disclaim beneficial ownership of such shares. Each of the directors of ART may be deemed to be beneficial owners
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued)
of the shares owned by ART by virtue of their positions as directors of ART. Each of the directors of BCM may be deemed to be beneficial owners of the shares owned by BCM by virtue of their positions as directors of BCM. The directors of ART and BCM disclaim such beneficial ownership.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain Business Relationships
In February 1989, the Company's Board of Directors voted to retain BCM as the Company's advisor. See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor." BCM is a company of which Messrs. Paulson, Blaha, Endendyk and Holland serve as executive officers. Gene E. Phillips served as a director of BCM until December 22, 1989, and as Chief Executive Officer of BCM until September 1, 1992. BCM is owned by a trust for the benefit of the children of Mr. Phillips. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company.
Since February 1, 1991, affiliates of BCM have provided property management services to the Company. Currently, Carmel, Ltd. provides such property management services. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) First Equity, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of nine of the Company's office buildings and the commercial properties owned by a real estate partnership in which the Company and TCI are partners to Carmel Realty, which is a company owned by First Equity.
Prior to December 1, 1992, affiliates of BCM provided brokerage services to the Company and received brokerage commissions in accordance with the advisory agreement. Since December 1, 1992, the Company has engaged, on a non- exclusive basis, Carmel Realty to perform brokerage services for the Company. Carmel Realty is a company owned by First Equity.
The Directors and officers of the Company also serve as trustees or directors and officers of CMET and TCI. The Directors owe fiduciary duties to such entities as well as to the Company under applicable law. CMET and TCI have the same relationship with BCM as the Company. Mr. Phillips is a general partner of SAMLP, the general partner of NRLP and NOLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to ART. Mr. Phillips served as Chairman of the Board and as a director of ART until November 16, 1992. Messrs. Blaha, Paulson, Endendyk and Holland serve as executive officers of ART.
From April 1992 to December 31, 1992, Mr. Stokely was employed as a paid Real Estate Consultant and since January 1993 as a part-time unpaid Consultant for Eldercare, a nonprofit corporation engaged in the
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)
Certain Business Relationships (Continued)
acquisition of low income and elderly housing. Eldercare has revolving loan committment from Syntek West, Inc. of which Mr. Phillips is the sole shareholder. Eldercare filed for bankruptcy protection in July 1993 and was dismissed from bankruptcy in October 1994. Eldercare again filed for bankruptcy protection in May 1995 and was reorganized in bankruptcy in February 1996, and has since paid all debts as directed by the Court.
Related Party Transactions
Historically, the Company has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. The Company's management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to the Company as could have been obtained from unrelated third parties.
As more fully described in ITEM 2. "PROPERTIES - Real Estate," the Company is a partner with TCI in the Tri-City Limited Partnership and Nakash Income Associates.
In 1997, the Company paid BCM and its affiliates $612,000 in advisory and net income fees, $6,000 in incentive sales fees, $2.5 million in real estate brokerage commissions, $70,000 in mortgage brokerage and equity refinancing fees, and $503,000 in property management and construction supervision fees (net of property management fees paid to subcontractors, other than Carmel Realty). In addition, as provided in the Advisory Agreement, BCM received cost reimbursements from the Company of $248,000 in 1997.
Restrictions on Related Party Transactions
Article FOURTEENTH of the Company's Articles of Incorporation provides that the Company shall not, directly or indirectly, contract or engage in any transaction with (i) any director, officer or employee of the Company, (ii) any director, officer or employee of the advisor, (iii) the advisor or (iv) any affiliate or associate (as such terms are defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) of any of the aforementioned persons, unless (a) the material facts as to the relationship among or financial interest of the relevant individuals or persons and as to the contract or transaction are disclosed to or are known by the Company's Board of Directors or the appropriate committee thereof and (b) the Company's Board of Directors or committee thereof determines that such contract or transaction is fair to the Company and simultaneously authorizes or ratifies such contract or transaction by the affirmative vote of a majority of independent directors of the Company entitled to vote thereon.
Article FOURTEENTH defines an "Independent Director" as one who is neither an officer or employee of the Company nor a director, officer or employee of the Company's advisor.
Pursuant to the terms of the Modification of Stipulation of Settlement (the "Olive Modification") in the Olive Litigation, as more fully
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)
Restrictions on Related Party Transactions (Continued)
discussed in ITEM 3.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Consolidated Financial Statements
Report of Independent Certified Public Accountants
Consolidated Balance Sheets - December 31, 1997 and 1996
Consolidated Statements of Operations - Years Ended December 31, 1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity - Years Ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows - Years Ended December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Schedule III - Real Estate and Accumulated Depreciation
Schedule IV - Mortgage Loans on Real Estate
All other schedules are omitted because they are not applicable or because the required information is shown in the Financial Statements or the Notes thereto.
3. Exhibits
The following documents are filed as Exhibits to this Report:
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)
(b) Reports on Form 8-K:
A Current Report on Form 8-K, dated November 19, 1997, was filed with respect to Item 2. "Acquisition or Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the acquisition of the Westlake Village Office Building, filed December 3, 1997 and was amended on Form 8-K/A, filed January 14, 1998.
A Current Report on Form 8-K, dated December 30, 1997, was filed with respect to Item 2. "Acquisition or Disposition of Assets," and Item 7. "Financial Statements and Exhibits," which reports the acquisition of the Akard Plaza and the Fireside Thrift Building, filed January 9, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INCOME OPPORTUNITY REALTY INVESTORS, INC.
Dated: March 20, 1998 By: /s/ Randall M. Paulson --------------------- ----------------------------------- Randall M. Paulson President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
INCOME OPPORTUNITY REALTY INVESTORS, INC.
EXHIBITS TO ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 1997