ITEM 1. BUSINESS
Certain of the statements contained in this Annual Report on Form 10-K constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements include, without limitation, statements regarding future plans with respect to the sale of the properties and future capital expenditures relating to renovation and development activities. These forward-looking statements are included in this Annual Report on Form 10-K based on the intent, belief or current expectations of the Partnership (as hereinafter defined). However, such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those projected in the forward-looking statements as a result of various factors. Although the Partnership believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved. Factors that could cause actual results to differ materially from the Partnership's current expectations include general local market conditions, the investment climate for particular property types, individual property issues, construction delays due to unavailability of materials, leasing activities, weather conditions or other causes, and the other risks detailed from time to time in the Partnership's reports filed with the Securities and Exchange Commission (the "SEC").
General. The registrant, ML/EQ Real Estate Portfolio, L.P. (the "Partnership"), is a limited partnership formed on December 22, 1986 under the Revised Uniform Limited Partnership Act of the State of Delaware. The Partnership operates pursuant to the Amended and Restated Agreement of Limited Partnership dated as of April 23, 1987 as amended as of February 9, 1988 (the "Partnership Agreement"), which is included as an exhibit to this annual report. Capitalized terms used in this annual report that are not defined herein have the same meaning as in the Partnership Agreement.
The Partnership's two general partners are EREIM Managers Corp., a Delaware corporation (the "Managing General Partner"), and MLH Real Estate Associates Limited Partnership, a Delaware limited partnership (the "Associate General Partner" and, together with the Managing General Partner the "General Partners"). The Managing General Partner is an indirect, wholly-owned subsidiary of The Equitable Life Assurance Society of the United States ("Equitable") and the general partner of the Associate General Partner is an affiliate of Merrill Lynch & Co., Inc. ("Merrill Lynch").
The Managing General Partner was a wholly-owned subsidiary of Equitable Real Estate Investment Management, Inc. ("Equitable Real Estate"), which was a wholly owned subsidiary of Equitable. On June 10, 1997, Equitable sold Equitable Real Estate to a subsidiary of Lend Lease Corporation Limited ("Lend Lease"). The shares of the Managing General Partner were not included in the sale and the Managing General Partner continues to be a wholly-owned indirect subsidiary of Equitable. Lend Lease merged its existing U.S. real estate investment advisor, The Yarmouth Group, Inc., into Equitable Real Estate and changed the name of Equitable Real Estate to ERE Yarmouth, Inc. ("ERE Yarmouth"). ERE Yarmouth was retained by the Managing General Partner, at the Managing General Partner's expense, to continue providing the same services with respect to the Partnership, EML Associates (the "Venture"), a joint venture with EREIM LP Associates, a New York general partnership between Equitable and EREIM LP Corp., a wholly-owned subsidiary of Equitable, and the properties that Equitable Real Estate has historically provided to the Managing General Partner. See "Advisory Agreement."
The Partnership offered to the public $150,000,000 of Beneficial Assignee Certificates (the "BACs"), which evidence the economic rights attributable to limited partnership interests in the Partnership (the "Interests"), in an offering (the "Offering") which commenced in 1987. The Offering was made pursuant to a Prospectus dated April 23, 1987, as supplemented by Supplements dated December 29, 1987 (the "December Supplement"), March 3, 1988 (the "March 3 Supplement") and March 17, 1988 (the "March 17 Supplement"), filed with the SEC in connection with a Registration Statement on Form S-11 (No. 33-11064). The Prospectus as supplemented is hereinafter referred to as the "Prospectus." The Offering terminated on March 29, 1988. On March 10, 1988, the Partnership's initial investor closing occurred at which
time the Partnership received $92,190,120, representing the proceeds from the sale of 4,609,506 BACs. On May 3, 1988, the Partnership's final investor closing occurred at which time the Partnership received $16,294,380, representing the proceeds from the sale of an additional 814,719 BACs. In total, the Partnership realized gross proceeds of $108,484,500 from the Offering, representing the sale of 5,424,225 BACs.
Following its investor closings, the Partnership contributed the net proceeds of the Offering to the Venture. The Venture was formed in March 1988. The capital of the Venture was provided approximately 80% by the Partnership and approximately 20% by EREIM LP Associates.
Effective as of January 1, 1997, the Partnership entered into an amendment to the Joint Venture Agreement of the Venture between the Partnership and EREIM LP Associates pursuant to which EREIM LP Associates agreed to defer, without interest, its rights to receive 20% of the Venture's distributions of sale or financing proceeds until the Partnership has received aggregate distributions from the Venture in an amount equal to the capital contributions made to the Partnership by the BAC holders plus a noncompounded cumulative return computed at the rate of 9.75% per annum on contributions outstanding from time to time. Prior to the amendment, EREIM LP Associates had a right to receive 20% of all of the Venture's distributions of sale or financing proceeds on a pari passu basis with the Partnership. The amendment has the effect of accelerating the return of original contributions to BAC holders to the extent that sale or financing proceeds are realized prior to the dissolution of the Partnership.
Business of the Partnership. The Partnership was formed to invest in a diversified portfolio of properties and mortgage loans. The Partnership considers its business to represent one industry segment, investment in real property. The Partnership has, however, a concentration of retail real estate investments with the inclusion of the Venture's interest in Northland Center, which was transferred to the Venture and Equitable on July 22, 1994. The Venture's interest in Northland Center represented approximately 37%, 32% and 31% of the real estate investments owned by the Venture as of December 31, 1997, 1996 and 1995, respectively, and approximately 42%, 46% and 54% of total revenues of the Venture for the years ended December 31, 1997, 1996 and 1995, respectively. The Venture's interest in Brookdale Center, which was sold in November 1997, represented approximately 12% of the real estate investments owned by the Venture as of December 31, 1996 and approximately 20% and 15% of total revenues of the Venture in the years ended December 31, 1997 and 1996, respectively. Combined retail real estate investments represented approximately 50%, 53% and 55% of real estate investments owned by the Venture as of December 31, 1997, 1996 and 1995, respectively, and approximately 68%, 67% and 66% of total revenues of the Venture for the years ended December 31, 1997, 1996 and 1995, respectively.
Following the Offering, the Venture acquired a diversified portfolio of real properties and mortgage loans secured by real properties. Based on original acquisition prices, approximately 52% of the Venture's original contributed capital was invested in existing income-producing real properties acquired without permanent mortgage indebtedness, approximately 25% of such capital was invested in zero coupon or similar mortgage notes (the "Zero Notes"), and the balance was invested in fixed-rate first mortgage loans. The Properties and the properties that secured the mortgage loans included commercial, industrial, residential, retail and warehouse/distribution properties.
At December 31, 1997, the Venture owned six properties (one of which consists of two adjacent office buildings) and an undivided interest in one property, (Northland Center) (collectively, the "Properties") as a tenant in common with Equitable. All references herein to the Venture's ownership of Northland Center shall be deemed to refer to the Venture's undivided interest as a tenant in common with Equitable unless otherwise indicated. Five of the Properties were purchased at an aggregate cost of approximately $61.5 million. Two of the Properties, Northland Center and 300 Delaware (originally properties that secured a Zero Note and a fixed rate first mortgage loan), respectively, were transferred to the Venture during 1994 in separate deed in lieu of foreclosure transactions. The estimated fair market value of the Venture's undivided interest in the Northland Center Zero Coupon Mortgage Note Receivable immediately preceding the transfer was approximately $32.2 million and the estimated fair market value of the 300 Delaware Mortgage Loan immediately preceding the transfer was approximately $8.5 million. In addition, at December 31, 1997, the Venture owned one remaining Mortgage Loan in the principal amount of $6.0 million (the "Mortgage Loan"). (Amounts
identified are exclusive of closing costs.) Reference is made to Item 2.
ITEM 2. PROPERTIES
At December 31, 1997, approximately 78% of the aggregate rentable square feet of the Venture's Properties was leased. Leases covering approximately 1.8%, 10.1% and 14.6% of the Properties rentable square feet are scheduled to expire in 1998, 1999 and 2000, respectively.
In November 1997, the Venture sold Brookdale Center to Talisman Brookdale L.L.C. for approximately $24.8 million, of which the Partnership's portion was approximately $17.8 million. The Venture, in which the Partnership holds an 80% interest, held a 71.66% participation interest in Brookdale Center. The sale generated approximately $17.7 million in net sales proceeds. The Partnership made a special distribution of the net proceeds in December 1997. See Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
In December 1997, the Venture sold the warehouse/office Properties located at 701 Maple Lane, 733 Maple Lane, 7550 Plaza Court and 800 Hollywood, all in Chicago (the "Chicago Industrial Properties") to SSP Real Estate O'Hare, Inc. for approximately $7.9 million. The sale generated approximately $7.6 million in net sales proceeds. The Partnership made a distribution of the net proceeds from the sale and from previous sale and financing events in February 1998. See Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Set forth below is a brief description of each of the Venture's investments at December 31, 1997. Reference is made to Notes 3, 4, 5 and 9 of the Notes to Consolidated Financial Statements in Item 8. FINANCIAL STATEMENTS. The Venture has fee ownership of the land and improvements relating to each of the Properties.
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(1) Excludes square feet of properties owned by certain anchor stores.
PROJECTED ANNUAL AGGREGATE LEASE PAYMENTS TO BE RECEIVED (IN DOLLARS)(1)
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(1) Lease payments to be received under noncancelable operating leases in effect as of December 31, 1997. (2) Montgomery Ward filed for Chapter 11 Bankruptcy during 1997. The store closed in January 1998, yet will continue to pay ground rent through March 31,1998. This ground rent has been included in the schedule of projected annual aggregate lease payments to be received.
RANGE OF LEASE EXPIRATIONS
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(1) Vacant as of December 31, 1997.
MAJOR TENANTS
The following list sets forth major tenants for the Properties together with percentage of space used by such tenants as of December 31, 1997:
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(1) At December 31, 1997, 1850 Westfork Drive was 100% vacant. (2) Hudson's Department Store, J.C. Penney, Montgomery Ward, and Target independently constructed and operate their stores at Northland Center and each contributes common area maintenance payments for operating expenses and real estate taxes under separate agreements. These stores covering 511,509 square feet, 283,534 square feet, 117,750 square feet, and 116,222 square feet, respectively, are not included in the gross leasable area of the mall. In addition, J.C. Penney and Montgomery Ward pay ground rent.
DESCRIPTION OF PROPERTIES
1200 Whipple Road is a one-story warehouse/distribution property located in the Hayward-Union City market area, approximately 25 miles southeast of San Francisco. At December 31, 1997, the property was 100% leased to Broadway Stores, Inc. under a lease that runs through August 2003. The lease was assigned to Broadway Stores, Inc. by Permer Control in February 1996. The lease is guaranteed by Broadway Stores, Inc. and management expects all obligations under the lease to be fulfilled.
Richland Mall is located in Richland Township, Pennsylvania. It was converted to a community shopping center in 1997. The primary tenants include Bon Ton Department Store, Redner's Market Grocery Store, CVS, and Radio Shack. At December 31, 1997, the Mall was approximately 86% leased with 26,308 square
feet vacant. Excluding the two anchor stores, the Mall was 44% leased. Leases covering approximately 0.6% and 1.4% of the space are scheduled to expire in 1999 and 2000, respectively.
In an effort to strengthen Richland Mall's position in this market, management embarked on a plan in 1997 to (i) address the physical drawbacks of the center and (ii) enhance tenant mix. The redevelopment of the property from an enclosed mall to a community shopping center was near completion at December 31, 1997. Redner's Market, Radio Shack and CVS have taken occupancy in their new locations and opened for business in November 1997, September 1997 and July 1997, respectively. Currently, the vacant space is being actively marketed by management.
Wal-Mart, which has been attempting to enter this market for the past few years, has received zoning approval and has already begun construction of a Wal-Mart store, which is expected to open in June 1998. The Wal-Mart Shopping Center (including the Wal-Mart store) is likely to compete with Richland Mall.
16/18 Sentry Park West are two four-story office buildings located approximately 15 miles northwest of the Philadelphia central business district. Tenants include Liberty Mutual Insurance Company and J&B Software. At December 31, 1997, the property was 99% leased. Leases covering approximately 2.1%, 23.0% and 45.2% of the space are scheduled to expire in 1998, 1999 and 2000, respectively.
1850 Westfork Drive is a one-story warehouse/distribution facility located approximately 15 miles west of the Atlanta central business district. On August 30, 1997, the lease with Treadway Exports Limited ("Treadway") expired and Treadway vacated the property. At December 31, 1997 the property was 100% vacant. Management is actively marketing the space for lease.
1345 Doolittle Drive is a one-story warehouse/distribution property located in San Leandro, California approximately one mile south of Oakland International Airport. At December 31, 1997, the property was 100% leased. Major tenants include Treasure Chest Advertising and Publishing, National Distribution Agency and Jay-N Company. Leases covering approximately 25.5% and 44.1% of the space are scheduled to expire in 1999 and 2000, respectively.
Northland Center, which was transferred to the Venture and Equitable (collectively, the "Owners") by a deed in lieu of foreclosure on July 22, 1994, is a regional enclosed mall located in Southfield, Michigan. Major tenants include Hudson's Department Store, J.C. Penney, Montgomery Ward and Target. As of December 31, 1997, the Center was approximately 67% leased (excluding the anchor stores). Leases covering approximately 5.7%, 12.3% and 5.8% of the space (excluding the anchor stores) are scheduled to expire in 1998, 1999 and 2000, respectively.
Montgomery Ward filed for bankruptcy protection in July 1997. At December 31, 1997, the Northland Center store was still open for business. On January 4, 1998, the store closed, although Montgomery Ward continues to pay ground rent. Under Federal Bankruptcy Law, Montgomery Ward had the option to reject, assume, or assign its lease. In order to control the use of the space, the Owners agreed to pay Montgomery Ward's assignee $100,000 in exchange for a rejection of the lease, which is expected to be effective March 31, 1998.
The space vacated by the Montgomery Ward store and the vacant Kohl's Department Store's ("Kohl's") space containing 60,806 square feet (which has been vacant since March 1995) represent challenges for the Owners. While conditions in the retail industry have seen some improvement, the Montgomery Ward and Kohl's vacancies and the age of the mall place the property at a competitive disadvantage.
300 Delaware, which was transferred to the Venture by deed in lieu of foreclosure on November 15, 1994, is a seventeen story office building in Wilmington, Delaware. PNC Bank, a major tenant, occupies 102,808 square feet, or 32.7% of the building. PNC's lease expires in May 2005 and contains an option to renew. PNC's rent is substantially below market rates. As of December 31, 1997, the building was approximately 61% leased. Over the past year, management has removed asbestos from a number of the vacant floors in the building. Currently, approximately 46,492 square feet of the 121,871 square feet of vacant space still contain asbestos, removal of which is scheduled for 1998 and 1999. The majority of deferred maintenance has been corrected, and thus contemplated capital expenditures in 1998 will generally be for asbestos abatement, tenant
improvements and leasing commissions in connection with actual leasing. Leases covering approximately 1.0%, 0.2% and 3.7% are scheduled to expire in 1998, 1999 and 2000 respectively.
Management has established an enhancement/stabilization and renovation program for 300 Delaware. See Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for further information regarding this renovation program.
OUTSTANDING MORTGAGE LOAN
Jericho Village Loan is a first mortgage loan to the Wilcon Company secured by an apartment complex in Weston, Massachusetts. Interest-only payments on the loan in the amount of $51,250 are due monthly in arrears during the term of the loan, with the full principal amount of the loan due upon maturity of the loan on February 1, 1999. The borrower may prepay the loan in full subject to a prepayment penalty based on a yield maintenance formula, but not less than 2% of the principal balance of the loan. The property that secures the loan consists of 22 free-standing one and two-story apartment buildings, containing a total of 99 apartment units. At December 31, 1997, the property was approximately 99% leased.
BROOKDALE CENTER
Brookdale Zero Note was a first mortgage note secured by Brookdale Center, a regional shopping mall located approximately five miles northwest of the central business district of Minneapolis, Minnesota. The Venture acquired its 71.66% participation interest in 1988 from Equitable which held the remaining 28.34% interest. The Venture's participation interest had a fair value (including accrued interest) at the time of acquisition of approximately $12.3 million. The borrower was Midwest Real Estate Shopping Center, L.P. ("Midwest"), formerly Equitable Real Estate Shopping Center, L.P. The note had an implicit interest rate of 10.2% compounded semiannually, with the Venture's portion of the principal and accrued interest totaling approximately $25.3 million due June 30, 1995.
Management discontinued the accrual of interest relating to the Brookdale note beginning with the second quarter of 1995 as the accreted value of the mortgage approximated the estimated fair market value of Brookdale Center. The Venture's share of the note plus accrued interest at the time was approximately $24.7 million.
An internal review of the property, performed for the Venture as of September 30, 1995, estimated the fair market value of Brookdale Center to be approximately $30.0 million. The Venture recorded a valuation allowance of approximately $3.2 million to value its interest in the Brookdale Zero Note at an amount equal to the Venture's participation interest in the note multiplied by the estimated fair market value of the Center, or approximately $21.5 million. This valuation allowance was presented on the consolidated balance sheets as a decrease in assets and partners' capital and on the consolidated statements of operations as a provision for impairment on zero coupon mortgage. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
On December 16, 1996, Brookdale Center was transferred to the Venture and Equitable, as tenants in common pursuant to a Chapter 11 bankruptcy plan for Midwest that was approved by the Bankruptcy Court on November 25, 1996. The consideration for this transfer was (i) release of Midwest from its obligations under the Brookdale zero coupon note and (ii) payment to Midwest of $500,000, of which the Venture's portion was approximately $358,000. An internal review of the property, performed for the Venture as of the date of transfer, estimated the fair market value of Brookdale Center to be approximately $21.7 million, of which the Venture's portion was approximately $15.6 million. Following the transfer, Brookdale Center was reclassified from zero coupon mortgage note receivable to rental properties and income and expenses were recorded from that date. The Venture recognized a loss of approximately $6.2 million to record Brookdale
Center at its estimated fair market value. The Venture recorded its proportionate share of the assets, liabilities, revenues, and expenses of the undivided interest in Brookdale Center in accordance with the Participation Agreement dated March 3, 1988 between the Venture and Equitable, as amended on March 10, 1988, which is included as an exhibit to this annual report.
In November 1997, the Venture sold Brookdale Center to Talisman Brookdale L.L.C. for approximately $24.8 million, of which the Partnership's portion was approximately $17.8 million. The Partnership made a special distribution of the net proceeds in December 1997.
Midwest is subject to the informational requirements under the Exchange Act, and in accordance therewith files reports and other information, including financial statements, with the Securities Exchange Commission under Commission File No. 1-9331. Such reports and other information filed by Midwest can be inspected and copied at the public reference facilities maintained by the SEC in Washington, D.C. and at certain of its Regional Offices, and copies may be obtained from the Public Reference Section of the SEC, Washington, D.C. 20549, at prescribed rates.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Partnership is a defendant in a consolidated action brought in the Court of Chancery of the State of Delaware entitled IN RE: ML/EQ Real Estate Partnership Litigation. The consolidated action results from two related cases. Scher v. ML/EQ Real Estate Portfolio, L.P., et al., was served on the Partnership on July 14, 1997. On September 8, 1997, the Partnership was named as a defendant in Folette v. ML/EQ Real Estate Portfolio, L.P., et al., a substantially similar complaint, also brought in the Court of Chancery of the State of Delaware. The cases were consolidated pursuant to a stipulation between the parties by order of the court on October 3, 1997. In addition to the Partnership, the complaint names as defendants the Managing General Partner, Equitable, Equitable Real Estate, EREIM L.P. Corp. and EREIM LP Associates.
The Plaintiffs purport to sue on behalf of a class of all limited partners of the Partnership who purportedly have been or will be adversely affected by the conduct of the defendants. The complaint alleges that the defendants have caused the Venture to accumulate excessive cash rather than distribute it to the limited partners, and that defendants' motive in so doing was (i) to manipulate the Partnership's cash flow so as to limit certain defendants' exposure under the guarantee agreement and (ii) to secure for certain defendants additional fees. The complaint also alleges that defendants have utilized the Venture to provide liquidity for illiquid assets and to acquire and continue to hold under-performing properties. The complaint purports to state claims for breach of fiduciary duties, breach of contract, and aiding and abetting breach of fiduciary duties. The complaint requests, among other things, money damages in an unspecified amount and orders that defendants distribute to the purported class the cash which defendants have allegedly wrongfully failed to distribute and disgorge all earnings, profits, interests and other benefits which they have realized on account of their allegedly wrongful conduct. The Partnership intends to defend vigorously against these claims. On November 6, 1997, defendants answered the complaint, denying any wrongdoing. Additionally, defendants have noticed a motion to dismiss a portion of the case on the pleadings in the Delaware Court of Chancery. Although the outcome of any litigation cannot be predicted with certainty, particularly in the early stages of an action, the Partnership's management believes that the ultimate resolution of the litigation will not have a material adverse effect on the financial condition of the Partnership. Due to the early stage of such litigation, the Partnership's management cannot make an estimate of loss, if any, or predict whether or not such litigation will have a material adverse effect on the Partnership's results of operations in any particular period.
Several class action suits have been filed against Midwest, the general partner of Midwest, certain officers of such general partner, Lehman Brothers, Inc., Equitable and Equitable Real Estate. The complaints allege, among other things, that defendants breached their fiduciary duties and violated federal securities laws in connection with the initial sale of BACs, the operation of Midwest and Midwest's sale of Northland Center to the Venture and Equitable. Neither the Venture nor the Partnership has been named as a party to the lawsuits. A settlement of these class actions was approved by the District Court on February 20, 1998.
On October 30, 1996, the plaintiffs in one of the class action suits previously filed against Midwest, Equitable and others filed a claim for equitable subordination against Equitable in the Midwest bankruptcy
proceeding. The claim alleges, among other things, that Equitable breached a fiduciary duty to Midwest's investors and violated federal securities laws in connection with the initial sale of interests in Midwest and, as such, that Equitable should not be entitled to preferential treatment in bankruptcy court. On December 16, 1996, Brookdale Center was transferred to the Venture and Equitable in a bankruptcy court proceeding free and clear of any claims that Midwest or any other creditors may have. Ultimate resolution of this claim is expected to have no effect on Brookdale Center or the Venture. On October 31, 1997, this proceeding was dismissed, subject to the District Court's approval of the class action settlement.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matter was submitted during the fourth quarter of the fiscal year to a vote of BAC Holders.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
No public trading market for BACs or Interests exists nor is it expected that one will develop. Accordingly, accurate information as to the market value of a BAC at any given date is not available. Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S") has generally offered a limited partnership secondary service through the Merrill Lynch Limited Partnership Secondary Transaction Department ("LPSTD").
BACs are transferable as provided in Article Seven of the Partnership Agreement. Subject to certain restrictions, the General Partners are authorized to impose restrictions on the transfer of BACs or Interests (or take such other action as they deem necessary or appropriate) so that the Partnership is not treated as a "publicly-traded partnership" as defined in Section 7704(b) of the Internal Revenue Code of 1986 (or any similar provision of succeeding law) which could result in adverse tax consequences. See "AMENDMENTS TO PARTNERSHIP AGREEMENT -- TRANSFER OF INTERESTS" in the March 3 Supplement.
The number of BAC Holders at February 28, 1998 was 11,118.
The Partnership is a limited partnership and, accordingly, does not pay dividends. It does, however, make distributions of cash to its BAC Holders and General Partners. BAC Holders are entitled to receive cash distributions, allocations of taxable income and tax loss and guaranty proceeds as provided in Article Four of the Partnership Agreement. For information regarding the Guaranty Agreement, see Item 1. BUSINESS. Since inception, the Partnership has made the following distributions:
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(1) The distribution made on August 31, 1992 to holders of record on June 30, 1992 includes a $0.162 distribution of sale or financing proceeds associated with the termination of the lease with Saab-Scania of America, Inc. ("Saab") at 1850 Westfork Drive. (2) All of the distributions made from 1994 through February 28, 1997 constitute distributions of sale or financing proceeds derived from a portion of the proceeds from the pay-off of the Mortgage Loan to the Second Merritt Seven Joint Venture on November 22, 1993. (3) The August 29, 1997 distribution represents a distribution of distributable cash from operations. The Partnership made a decision to distribute a major portion of the monies previously held following its decision to sell Brookdale Center. (4) The December 23, 1997 distribution constitutes distributions of sale or financing proceeds derived from the sale of Brookdale Center. (5) The February 27, 1998 distribution constitutes distributions of sale or financing proceeds derived from the sale of the Chicago Industrial Properties during 1997, remaining proceeds from both the sale of Brookdale Center and the pay-off of the mortgage loan to the Second Merritt Seven Joint Venture and early lease termination payments.
See Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for further information regarding cash distributions.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following sets forth the selected financial data for the Partnership on a consolidated basis for the years ended December 31, 1993, 1994, 1995, 1996 and 1997:
The above selected financial data for the years 1993 through 1997 should be read in conjunction with the financial statements and the related notes appearing elsewhere in this annual report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Partnership had cash and cash equivalents of approximately $2.0 million. Such cash and cash equivalents are expected to be utilized for general working capital requirements including, to the extent that scheduled lease expirations occur, shortfalls associated with such lease expirations on the Properties until such time as such leases can be replaced and for capital needs at the Venture's Properties. In addition, to the extent that cash distributions from the Partnership's interest in the Venture are insufficient, the payment or reimbursement of fees and expenses to the General Partners and their affiliates will be paid out of such cash and short-term investments. Amounts which the Managing General Partner determines are not needed for general working capital requirements will be available for distribution.
The Partnership's policy is to maintain adequate cash reserves (taking into consideration reserves of the Venture) to enable it to meet short and long-term requirements. The Partnership's working capital reserves
may be increased or decreased, from time to time, depending on the Managing General Partner's determination as to their adequacy.
The Partnership owns an 80% interest in the Venture. At December 31, 1997, the Venture owned six real properties, an undivided interest in one real property as a tenant in common with Equitable and one Mortgage Loan on a real property. Five of the Properties were purchased at an aggregate cost of approximately $61.5 million. Two of the properties, Northland Center and 300 Delaware (originally properties that secured a Zero Note and a Fixed-Rate Mortgage Loan, respectively), were transferred to the Venture during 1994 in separate deed in lieu of foreclosure transactions. The estimated fair market value of the Venture's undivided interest in the Northland Center Zero Coupon Mortgage Note Receivable immediately preceding the transfer was approximately $32.2 million and the estimated fair market value of the 300 Delaware Mortgage Note immediately preceding the transfer was approximately $8.5 million. Brookdale Center (originally a property that secured a Zero Note) was transferred to the Venture during December 1996 pursuant to a Chapter 11 bankruptcy plan for Midwest. The estimated fair market value of the Venture's undivided interest in the Zero Note immediately preceding the transfer was approximately $15.6 million. Brookdale Center was sold by the Venture in November 1997. At December 31, 1997 the Venture also had approximately $19.3 million in cash and cash equivalents. $15.6 million was distributed to the Partnership in February 1998, of which $14.9 million was distributed to BAC Holders in February 1998. The remaining $700,000 was used to pay various semi- annual fees incurred by the Partnership. An additional $320,000 was distributed to EREIM LP Associates, representing its 20% interest in amounts distributed to cover fees. The remaining cash and cash equivalents of approximately $3.4 million is intended to be utilized primarily to fund the renovation work on 300 Delaware, to fund possible costs incurred to increase tenancy at Richland Mall and Northland Mall, to fund capital improvements at the Venture's other Properties, and to cover general working capital requirements. For 1997, 1996 and 1995, the Partnership received distributions from the Venture totaling approximately $34.5 million, $2.4 million and $3.1 million, respectively.
All of the Venture's Properties and the Mortgage Loan were acquired without mortgage indebtedness, and neither the Venture nor the Partnership has incurred any borrowings. In aggregate, the Venture's Properties and its Mortgage Loan are currently producing operating cash flow to the Venture which, net of expenses of the Venture and the establishment or increase of reserves, is distributable 80% to the Partnership and 20% to EREIM LP Associates as provided in the Joint Venture Agreement.
The Partnership continues to evaluate appropriate strategies for the ownership of each of the assets in its portfolio in order to achieve maximum value. In this regard, the Partnership considers improving capital markets and investment markets for most types of real estate; local market conditions; future capital needs, including potential lease exposure for specific properties; and other issues that impact property performance. Among other things, this analysis will provide the basis for hold/sell recommendations for the properties.
On December 16, 1996, Brookdale Center was transferred to the Venture and Equitable, as tenants in common (collectively, the "Owners"), following default by the borrower on the mortgage note securing the property. The Owners considered alternative strategies for Brookdale Center and ultimately determined that the best course of action was to sell the property. In July 1997, the Owners received an offer to purchase Brookdale Center and subsequently executed a binding purchase and sale agreement in October whereby Talisman Brookdale L.L.C. agreed to purchase Brookdale Center for approximately $24.8 million, of which the Venture's portion was approximately $17.8 million. In November 1997, the Partnership sold Brookdale Center to Talisman Brookdale L.L.C. and made a special distribution of the net proceeds in December 1997. Based on the amendment to the Joint Venture Agreement effective as of January 1, 1997, EREIM LP Associates agreed to defer, without interest, its right to receive 20% of the Venture's distribution of sale and financing proceeds, thereby entitling the Partnership to receive currently 100% of the sale and financing proceeds attributable to the sale.
Management has established an enhancement, stabilization and renovation program for 300 Delaware which was transferred to the Venture by deed in lieu of foreclosure on November 15, 1994. Estimated costs for this program total $4.4 million, of which $1.6 million was incurred in 1995, $1.2 million was incurred in 1996, $398,000 was incurred in 1997, and the remaining balance is expected to be expended through 1999. As of
December 31, 1997, approximately $3.1 million of these costs have been expended. Approximately $98,000 in capital costs at 300 Delaware have been accrued but not paid as of December 31, 1997.
Included in the estimated $4.4 million of renovation expenditures is approximately $2.3 million for asbestos abatement of which approximately $1.4 million has been expended. Also included in the $4.4 million is $400,000 for sprinkler installation, $400,000 for exterior deferred maintenance and $600,000 for interior and exterior common area cosmetic upgrades. Management expects the cosmetic upgrades to give the building a fresher, more inviting look. Additional costs not included in the above figures are estimated tenant improvements of $3.0 million. The tenant improvement costs are directly associated with actual leasing and will only be expended as leasing transactions occur in the building. As of December 31, 1997, approximately $946,000 had been expended for tenant improvements. The remaining tenant improvement costs of approximately $2.1 million are expected to be expended over the next few years to lease the currently vacant space.
As of December 31, 1997, the Venture has incurred costs of approximately $3.7 million to increase tenancy at Richland Mall and, in 1998, expects to incur an additional $100,000 to finish the project.
Cash provided by operating activities decreased approximately $5.2 million, or 41%, from $12.7 million in 1996 to $7.5 million in 1997. This decrease is due to (i) a decrease of approximately $3.3 million in interest received, (ii) an increase of approximately $2.4 million in cash paid for operating activities and (iii) an increase of approximately $3.2 million in cash distributions to minority interest, offset by an increase of approximately $3.7 million in tenant rentals received. The decrease in interest received is due primarily to the reclassification of Brookdale Center from a zero coupon mortgage note receivable to a rental property in December 1996, compared to the receipt of approximately $4.9 million of interest in 1996, of which the Venture's portion was approximately $3.5 million, that was remitted under the terms of the receivership for the Brookdale Zero Note. The increase in cash paid for operating activities and tenant rentals received is also due to the reclassification of Brookdale Center from a zero coupon mortgage note receivable to a rental property in December 1996. Tenant rentals received at Brookdale Center are offset by a decrease in the receipt of tenant rentals at Richland Mall during 1997 in connection with the enhancement program and the timing of receipts at the various other properties. Net cash flows received from Brookdale Center during 1997 were approximately $3.2 million, of which the Venture's portion was approximately $2.3 million.
Cash provided by operating activities increased approximately $2.5 million, or 25%, from $10.2 million in 1995 to $12.7 million in 1996. This increase is primarily due to the receipt of approximately $4.9 million (consisting of cash remitted under the terms of the receivership and cash remitted under the terms of the cash collateral order), of which the Venture's portion was approximately $3.5 million, which was remitted in connection with the Brookdale Zero Note during 1996, as compared to $700,000, of which the Venture's portion was approximately $502,000, which was remitted in connection with the Brookdale Zero Note during 1995.
Distributable Cash from operations is distributed in accordance with the terms of the Partnership Agreement, which provides that such amounts will be distributed 95% to the BAC Holders and Limited Partners and 5% to the General Partners with the BAC Holders and Limited Partners entitled to a non-cumulative preferred 6% simple return on their Adjusted Capital Contribution during each period. Since inception, the Partnership has made the following distributions:
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(1) The distribution made on August 31, 1992 to holders of record on June 30, 1992 includes a $0.162 distribution of sale or financing proceeds associated with the termination of the lease with Saab at 1850 Westfork Drive. (2) All of the distributions made from 1994 through February 28, 1997 constitute distributions of sale or financing proceeds derived from a portion of the proceeds from the pay-off of the Mortgage Loan to the Second Merritt Seven Joint Venture on November 22, 1993. (3) The August 29, 1997 distribution represents a distribution of distributable cash from operations. The Partnership made a decision to distribute a major portion of the monies previously held following its decision to sell Brookdale Center. (4) The December 23, 1997 distribution constitutes distributions of sale or financing proceeds derived from the sale of Brookdale Center. (5) The February 27, 1998 distribution constitutes distributions of sale or financing proceeds derived from the sale of the Chicago Industrial Properties during 1997, remaining proceeds from both the sale of Brookdale Center and the pay-off of the mortgage loan to the second Merritt Seven Joint Venture and early lease termination payments.
The determination to withhold the 1995 distributions of distributable cash was based on the uncertainty regarding the level and timing of expenditures relating to Brookdale Center as well as the likelihood of significant capital expenditures for the renovation of 300 Delaware. The determination to withhold the 1996 distributions of distributable cash was based on uncertainty regarding Brookdale Center expenditures, the needs of the Venture to fund significant capital expenditures for the renovation of 300 Delaware and costs incurred at Richland Mall to increase tenancy. The levels of future cash distributions principally will be dependent on the distributions to the Partnership by the Venture, which in turn will be dependent on returns from the Venture's investments and future reserve requirements for capital expenditures at the Venture's Properties.
During 1995, 1996 and 1997, the Venture received approximately $1.5 million, $179,000 and $133,000, respectively, for early lease termination payments, of which the Partnership's share was approximately $1.2 million, $143,000 and $133,000, respectively. These early lease termination payments were classified as sale or financing proceeds and were distributed in 1998. See Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The amount and timing of distributions from sale or financing proceeds depend upon payments of the Mortgage Loan and maturity schedule, the timing of disposition of Properties as well as the need to allocate such funds to increase reserves.
The Partnership is intended to be self-liquidating in nature, meaning that proceeds from the sale of properties or principal repayments of loans will not be reinvested but instead will be distributed to BAC Holders and partners, subject to certain limitations. Under the terms of the Guaranty Agreement which has been assigned to the Partnership, following the earlier of the sale or other disposition of all of the Properties and Mortgage Loans or the liquidation of the Partnership, EREIM LP Associates has guaranteed to pay an amount which, when added to all distributions from the Partnership to the BAC Holders, will enable the Partnership to provide the BAC Holders with a minimum return equal to their original capital contributions plus a simple annual return equal to 9.75% simple interest per annum multiplied by their adjusted capital contributions calculated from the investor closing at which an investor acquired his BACs, subject to certain
limitations. Capital contributions by the BAC Holders totaled $108,484,500. As of December 31, 1997, the cumulative 9.75% simple annual return was $102,048,149. As of December 31, 1997, cumulative distributions by the Partnership to the BAC Holders totaled $49,479,767, or $9.12 per BAC, of which $26,307,492 is attributable to income from operations and $23,172,275 is attributable to sales of Venture assets, principal payments on Mortgage Loans and other capital events. Another $14,916,619 in capital proceeds was distributed to the BAC Holders in February 1998.
FINANCIAL CONDITION
The Partnership's financial statements include the consolidated statements of the Partnership and the Venture, through which the Partnership conducts its business of investment in real property. Although the Partnership was formed in 1986, it did not commence operations until March 1988, following receipt of the first proceeds of its offering of BACs. Thereafter, utilizing the net proceeds of the Offering, the Partnership (through the Venture) began its acquisition of real estate investments. The Partnership substantially completed its acquisition phase in 1989.
Total real estate investments decreased approximately $20.1 million, or 14.8%, from $135.4 million in 1996 to $115.3 million in 1997. This decrease is due to the sale of Brookdale Center and the Chicago Industrial properties in 1997 with a combined net book value of approximately $23.1 million and is offset by capital additions in 1997 of approximately $3.2 million at Richland Mall to increase tenancy and $1.4 million at 300 Delaware for the enhancement, stabilization and renovation project.
Other assets decreased approximately $6.2 million, or 16.8%, from $36.6 million in 1996 to $30.5 million in 1997 primarily due to a decrease in cash and cash equivalents. Cash and cash equivalents decreased approximately $6.1 million as a result of the Partnership distributing excess cash reserves of approximately $14.6 million during 1997 previously held to fund capital improvements at Brookdale Center. This decrease is partially offset by approximately $7.6 million in net proceeds received on December 31, 1997 from the sale of the Chicago Industrial properties.
Total liabilities increased approximately $14.3 million, or 268.5%, from $5.3 million in 1996 to $19.6 million in 1997. This increase is primarily due to the distribution declared as of December 31, 1997, which was approximately $14.1 million greater than the distribution declared as of December 31, 1996.
RESULTS OF OPERATIONS
Rental income increased approximately $3.8 million, or 18.1%, from $20.7 million in 1996 to $24.5 million in 1997. This increase is due primarily to an increase in rental income from Brookdale Center of approximately $6.5 million, of which the Venture's portion was approximately $4.7 million. This increase is partially offset by a decrease in rental income during 1997 at Northland Mall of approximately $1.1 million, of which the Venture's portion is approximately $806,000, and a decrease in rental income during 1997 at Richland Mall of approximately $558,000. Rental income remained fairly constant from 1995 to 1996.
Lease termination rental income decreased approximately $46,000, or 25.8%, from $179,000 in 1996 to $133,000 in 1997. This decrease is due to approximately $133,000 of lease termination rental income recognized during 1997 at Richland Mall compared to approximately $179,000 of lease termination rental income recognized during 1996 at Northland Mall and 16/18 Sentry Park West. Lease termination income decreased approximately $1.3 million, or 88.1%, from $1.5 million in 1995 to $179,000 in 1996, primarily due to the receipt of approximately $1.8 million in 1995, of which the Venture's portion was approximately $1.3 million, pursuant to the agreement between Kohl's and the Venture regarding the termination of Kohl's lease at Northland Center.
Interest on loans receivable decreased approximately $3.5 million, or 85.0%, from $4.1 million in 1996 to $615,000 in 1997 due to the reclassification of Brookdale Center from a zero coupon mortgage note receivable to a rental property in December 1996. Interest on loans receivable increased approximately $2.4 million, or 136.4%, from $1.7 million in 1995 to $4.1 million in 1996. This increase is primarily due to the receipt of cash in connection with the Brookdale Zero Note during 1996 of approximately $4.9 million, of which the
Venture's portion was approximately $3.5 million. The Venture recorded cash received under the terms of receivership and the cash collateral order as interest income. The Venture recognized interest income of approximately $1.1 million on the Brookdale Zero Note in 1995.
Operating expenses increased approximately $2.4 million, or 15.8%, from $15.2 million in 1996 to $17.6 million in 1997. This increase is primarily due to the reclassification of Brookdale Center from a zero coupon mortgage note receivable to a rental property in December 1996, as well as an increase in real estate operating expenses at Brookdale Center of approximately $4.0 million, of which the Venture's portion was approximately $2.9 million. This increase is partially offset by a decrease in real estate operating expenses of approximately $814,000 at Northland Mall, of which the Venture's portion is approximately $583,000. This decrease at Northland Mall is primarily due to a decrease in utility and HVAC expense associated with a new contract with the local electric company, the initiation of an energy conservation program and additional HVAC repairs and maintenance expense incurred in 1996 and the successful tax appeal lowering the property's real estate taxes. Operating expenses increased approximately $872,000, or 6.1%, from $14.3 million in 1995 to $15.2 million in 1996. This increase is primarily due to an increase in depreciation and amortization of approximately $866,000 at Northland Center, 16/18 Sentry Park West and 300 Delaware. The Venture recorded depreciation on approximately $11.4 million and $3.6 million of capital expenditures, of which the Venture's portion was approximately $8.2 million and $2.6 million, respectively, at Northland Center which were capitalized in the second half of 1995 and during 1996, respectively. The Venture also recorded depreciation on approximately $1.0 million which was capitalized at 16/18 Sentry Park West during 1996. Additionally, the Venture recorded depreciation on approximately $2.6 million which has been capitalized by the Venture in connection with the enhancement, stabilization, and renovation program which was established at the end of the second quarter of 1995 for 300 Delaware.
Total other income (expense), net increased approximately $9.5 million, or 144.0%, from expense of $6.6 million in 1996 to income of $2.9 million in 1997. This increase is primarily due to the $3.3 million gain recorded by the Venture on the sale of Brookdale Center and the Chicago Industrial properties during 1997 and the loss on write down of zero coupon mortgage of $6.2 million in 1996. Total other income (expense), net decreased approximately $2.9 million, or 77.9%, from expense of $3.7 million in 1995 to expense of $6.6 million in 1996, primarily due to an increase in loss on write down of zero coupon mortgage offset by a slight increase in interest on short term investments and a slight decrease in general and administrative expense in 1996 as compared to 1995.
YEAR 2000
The inability of computers, software and other equipment to recognize and properly process data fields containing a 2 digit year is commonly referred to as the Year 2000 compliance issue. As the year 2000 approaches, such systems may be unable to accurately process certain date-based information.
The Partnership and the Venture rely on the services of third-party providers, including Merrill Lynch and ERE Yarmouth, for all its computing needs. The Partnership and the Venture are in the process of communicating with such third-party providers to obtain assurance that such providers will be Year 2000 compliant. There can be no assurance that the systems of such providers will be Year 2000 compliant or that any third party's failure to have Year 2000 compliant systems would not have a material adverse effect on the Partnership and the Venture.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are included in Item 14 of this annual report:
Independent Auditors' Report.
Consolidated Balance Sheets, December 31, 1997 and 1996.
Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Partners' Capital for the years ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Partnership is a limited partnership and has no directors or officers.
For informational purposes only, certain information regarding the General Partners and their respective directors and officers is set forth below.
MANAGING GENERAL PARTNER
The Managing General Partner is a wholly-owned subsidiary of Equitable Investment Corporation, which is a wholly owned subsidiary of Equitable. On June 10, 1997, Equitable sold Equitable Real Estate to a subsidiary of Lend Lease. The shares of the Managing General Partner were not included in the sale and the Managing General Partner continues to be a wholly owned indirect subsidiary of Equitable. Lend Lease merged its existing U.S. real estate investment advisor, The Yarmouth Group, Inc., into Equitable Real Estate and changed the name of Equitable Real Estate to ERE Yarmouth, Inc. ("ERE Yarmouth"). ERE Yarmouth was retained by the Managing General Partner, at the Managing General Partner's expense, to continue providing the same services with respect to the Partnership, the Venture and the properties that Equitable Real Estate has historically provided to the Managing General Partner. The sale did not affect the ownership of EREIM LP Associates, the guarantor under the Guaranty Agreement. The obligations of EREIM LP Associates under the Guaranty Agreement and of Equitable under the Keep Well Agreement were not affected by the sale.
The names and titles of the directors and officers of the Managing General Partner as of March 15, 1998 are as follows:
The business experience of the directors and executive officers of the Managing General Partner is set forth below.
Peter D. Noris has been Executive Vice President and Chief Investment Officer of Equitable, since May 1995. In this position, he manages Equitable's General Account investment portfolio backing the company's traditional life insurance and annuity business, and oversees certain accounts managed for third parties by Equitable's investment subsidiary, Alliance Capital Management. Mr. Noris joined Equitable in 1995. Prior thereto, he was Vice President and Manager at Salomon Brothers Inc. from November 1992 to May 1995, where he provided investment and asset/liability expertise to insurance companies. Before joining
Salomon in 1992, Mr. Noris was Principal of Morgan Stanley & Co., Inc. where he worked since 1984 in its Insurance Group and its Synthetic Equity Group.
Anthony C. Pasquale has been Senior Vice President of Equitable, since June 1991. He has held numerous managerial positions within Pension and Investment Organizations of Equitable since joining the Equitable in 1965. Mr. Pasquale has been working in the Chief Investment Office for the last eight years where he brings professional expertise along with experience and knowledge of each business segment, investment subsidiaries and Equitable's General Account. He is responsible for all investment financial reporting to the Investment Committee of Equitable's Board which includes forecasting investment income, capital gains and losses and assets under management and he is Chairman of the Investments Under Surveillance Committee.
John H. Kirst has been Senior Vice President of Equitable since September 1997. In this position he oversees the investment strategy and management of Equitable's $10 billion real estate and mortgage portfolio. Mr. Kirst joined Equitable in 1997. Prior thereto, he was Managing Director of Landauer Associates, Inc. from 1996 through August 1997 and Managing Director of Sutton Advisors throughout 1995, in both capacities, providing advisory and transaction counseling services to institutional investors. Mr. Kirst was previously affiliated with NLI Properties, Inc., the U.S. real estate subsidiary of Nippon Life Insurance Company, where as Vice President and Director of Asset Management from 1992 through 1994, he managed a $2.5 billion portfolio of office, retail and hotel investments. Mr. Kirst worked for ten years at IBM where he was responsible for joint venture development projects across the country and for overseeing the planning, leasing, design and construction of IBM facilities.
Patricia C. Snedeker has been Vice President, Controller and Treasurer of the Managing General Partner since January 1995 and Chief Financial Officer from June 1994 to June 1997. Mrs. Snedeker is also a Senior Vice President of ERE Yarmouth responsible for overseeing the Investor Reporting Department which handles the accounting and financial reporting for all of the organization's real estate portfolios. Mrs. Snedeker has been with Equitable since October 1982.
J. Mark Hillis has been Vice President of the Managing General Partner since 1997. Mr. Hillis is a Vice President of ERE Yarmouth, where he is the assistant portfolio manager for several limited partnerships. Mr. Hillis joined ERE Yarmouth in August 1994 as Director of Appraisal, where he was responsible for preparing annual valuations of properties owned by Equitable. Before he joined ERE Yarmouth, he was employed by Price Waterhouse in their Real Estate Valuation Group since 1991, where he was responsible for audit valuation compliance, general real estate appraisal and due diligence services.
Michael L. Jacobson has been Vice President of the Managing General Partner since 1997. Mr. Jacobson has been a Senior Vice President of ERE Yarmouth since 1989, where he is responsible for overseeing fund and joint venture investments for certain Japanese accounts and Equitable's general account. Mr. Jacobson joined Equitable in 1976 in the accounting area and has held various management positions.
Douglas L. Brown has been Secretary of the Managing General Partner since March 1996. He has been a Senior Vice President and Secretary of ERE Yarmouth since April 1993.
ASSOCIATE GENERAL PARTNER
The Associate General Partner is a limited partnership and has no directors or officers. The general partner of the Associate General Partner is MLH Real Estate Inc., a wholly-owned subsidiary of MLH Group Inc., which is a wholly-owned subsidiary of Merrill Lynch, Hubbard Inc. ("MLH"). MLH is a wholly-owned subsidiary of Merrill Lynch Group, Inc., which is a wholly-owned subsidiary of Merrill Lynch.
The names and dates of election of the directors and executive officers of the general partner of the Associate General Partner as of March 31, 1998 are as follows:
The business experience of the directors and executive officers of the general partner of the Associate General Partner is set forth below.
Allen N. Jones has been Chairman, Chief Executive Officer and Director of the Associate General Partner since January 1997. Mr. Jones joined Merrill Lynch in 1973. From June 1992 through February 1994, Mr. Jones was the President and Chief Executive Officer of Merrill Lynch Insurance Group, Inc., and he currently serves on its Board of Directors. Since June 1992, Mr. Jones has held the position of Senior Vice President of Merrill Lynch, Pierce, Fenner & Smith ("MLPF&S") where he has held various senior executive responsibilities.
James V. Caruso has been President, Chief Operating Officer and Director of the Associate General Partner since January 1997. Mr. Caruso joined Merrill Lynch in 1975 and is a Director in its Investment Banking Group ("IBK"). Since September 1992, he has been responsible for managing the IBK Finance Department and the Controller's area of the Partnership Analysis & Finance Group. Mr. Caruso also serves as the Chief Financial Officer for certain Merrill Lynch limited partnerships for which Merrill Lynch subsidiaries serve as general partner.
Robert F. Aufenanger has been Executive Vice President and Director of the Associate General Partner since January 1997. Mr. Aufenanger joined Merrill Lynch in 1980. He is a Vice President of its Corporate Credit Department and a Director of the Partnership Management Department where he is responsible for the ongoing management of the operations of certain Merrill Lynch limited partnerships for which Merrill Lynch subsidiaries serve as general partner.
Rosalie Y. Goldberg has been Vice President since January 1997 and a Director of the Associate General Partner since February 1997. Ms. Goldberg joined Merrill Lynch in 1975 and is a Director in its Private Client Group. Since February 1995, she has served as Manager of the Special Investments Group. Ms. Goldberg is also a Director of certain other Merrill Lynch subsidiaries which serve as general partners to certain Merrill Lynch limited partnerships.
Michael E. Lurie has been Vice President since January 1997 and a Director of the Associate General Partner since February 1997. Mr. Lurie joined Merrill Lynch in 1970 and is a First Vice President of its Corporate Credit Department and the Director of the Asset Recovery Management Group. Prior to his present position, Mr. Lurie held several senior positions at Merrill Lynch.
Audrey Bommer has been Vice President and Treasurer of the Associate General Partner since January 1997. Mr. Bommer joined the IBK Partnership Analysis and Management Group at MLPF&S in April 1994 where she also serves as Treasurer for certain other Merrill Lynch limited partnerships for which Merrill Lynch subsidiaries serve as general partner. Prior to joining Merrill Lynch, Ms. Bommer worked in senior accounting positions at Metallgesellschaft Corp., a Commodities firm, and Grant Thornton, LLP, a public accounting firm.
There is no family relationship among any of the above-listed directors and officers of the Managing General Partner and the general partner of the Associate General Partner. All of the directors have been elected to serve until the next annual meeting of the shareholder of the Managing General Partner or general
partner of the Associate General Partner, respectively, or until their successors are elected and qualify. All of the officers have been elected to serve until their successors are elected and qualify.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The General Partners are entitled to receive a share of cash distributions and a share of taxable income or tax loss as provided in Article Four of the Partnership Agreement which is incorporated herein by reference.
The General Partner and their affiliates may be paid certain fees and commissions and reimbursed for certain out-of-pocket expenses. Information concerning such fees, commissions and reimbursements is set forth under "Compensation and Fees" in the Prospectus and Note 7 to notes to Consolidated Financial Statements in Item 8. FINANCIAL STATEMENTS, which is incorporated herein by reference.
All of the directors and officers of the Managing General Partner are employees of Equitable or ERE Yarmouth and are not separately compensated for services provided to the Managing General Partner or, on behalf of the Managing General Partner, to the Partnership. All of the directors and officers of the general partner of the Associate General Partner are employees of Merrill Lynch or its subsidiaries and are not separately compensated for services provided to the Associate General Partner or, on behalf of the Associate General Partner, to the Partnership.
The Partnership Agreement indemnifies the General Partners and the Initial Limited Partner against liability for losses resulting from errors in judgment or other action or inaction, whether or not disclosed, if such course of conduct did not constitute negligence or misconduct (see Section 5.7 of the Partnership Agreement). As a result of such indemnification provisions, a purchaser of BACs may have a more limited right of legal action than he would have if such provision were not included in the Partnership Agreement. In the opinion of the Securities and Exchange Commission, indemnification for liabilities arising under the Federal Securities laws is against public policy and therefore unenforceable. Indemnification of general partners involves a developing and changing area of the law and since the law relating to the rights of assignees of limited partnership interests, such as BAC Holders, is largely undeveloped, investors who have questions concerning the duties of the General Partners should consult their own counsel.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Initial Limited Partner, an affiliate of the Associate General Partner, is the record owner of substantially all of the Interests in the Partnership, although it has assigned such Interests to BAC Holders. In its capacity as record owner of the Interests, the Initial Limited Partner has no authority to transact business for, or to participate in the activities and decisions of, the Partnership. As of February 28, 1998, MLPF&S was the record owner of approximately 72% of the BACs, holding such BACs in a nominee capacity and having no beneficial interest in the BACs. Otherwise, there is no person known to the Partnership who owns beneficially or of record more than five percent of the BACs of the Partnership. Neither of the General Partners owns any BACs of the Partnership. The directors and officers of the Managing General Partner and the general partner of the Associate General Partner, as a group, own no BACs.
There are no arrangements known to the Partnership, the operation of which may, at a subsequent date, result in a change in control of the Partnership.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. The following financial statements are filed with this report on the pages indicated:
2. The following audited financial statement schedules are filed with this report on the pages indicated:
All schedules except those indicated above have been omitted as the required information is not applicable or the information is shown in the financial statements or notes thereto.
3. Exhibits
See Item 14(c) below.
(b) The Partnership filed a Current Report on Form 8-K on December 9, 1997.
(c) Exhibits.
4. (a) Amended and Restated Agreement of Limited Partnership dated April 23, 1987. Included as an Exhibit to the Prospectus (see Exhibit 99(a)).
(b) Amendment to Amended and Restated Agreement of Limited Partnership dated February 9, 1988 (incorporated by reference to Exhibit 4(b) to the Partnership's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1987 (File No. 33-11064) (the "1987 10-K")).
10. Material Contracts.
(a) Real Estate Investment Advisory Agreement by and between EREIM Managers Corp. and Equitable Real Estate Investment Management, Inc. (currently ERE Yarmouth, Inc.) dated as of June 10, 1997.
(b) Purchase and Sale Agreement by and between The Equitable Life Assurance Society of the United States and Talisman Brookdale L.L.C., dated September 2, 1997.
(c) Purchase and Sale Agreement by and between EML Associates and SPP Real Estate (O'Hare), Inc., dated December 31, 1997.
(d) Form of Beneficial Assignee Certificate (incorporated by reference to Exhibit 10(a) to Pre-Effective Amendment No. 1 to the Registration Statement of the Partnership (File No. 33-11064)).
(e) Agreement Between General Partners (incorporated by reference to Exhibit 10(c) to the 1987 10-K).
(f) Joint Venture Agreement of EML Associates (incorporated by reference to Exhibit 10(d) to the 1987 10-K).
(g) Investment Guaranty Agreement between the Venture and EREIM LP Associates (incorporated by reference to Exhibit 10(e) to the 1987 10-K).
(h) Assignment Agreement between Registrant and Venture (incorporated by reference to Exhibit 10(f) to the 1987 10-K).
(i) Keep Well Agreement between The Equitable Life Assurance Society of the United States and EREIM LP Corp. (incorporated by reference to Exhibit 10(g) to the 1987 10-K).
(j) Amended and Restated Agreement of General Partnership of EREIM LP Associates (incorporated by reference to Exhibit 10(h) to the 1987 10-K).
(k) Form of Participation Agreement between The Equitable Life Assurance Society of The United States and EML Associates dated September 27, 1988 (incorporated by reference to Exhibit No. 2 to Form 8-K dated September 27, 1988 of ML/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).
(l) Note and Mortgage and Security Agreement dated January 31, 1989 relating to loan by EML to The Wilcon Company (incorporated by reference to Exhibit No. 4 to Form 8-K dated December 27, 1988 of ML/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).
27. Financial Data Schedule, which is submitted electronically to the Securities and Exchange Commission for information only and not filed.
99. Additional Exhibits.
(a) Prospectus dated April 23, 1987, as supplemented by supplements dated December 29, 1987, March 3, 1988 and March 17, 1988 (incorporated by reference to Exhibit 28 to the 1987 10-K).
(b) Amendment to Joint Venture Agreement dated as of January 1, 1997 between ML/EQ Real Estate Portfolio, L.P. and EREIM LP Associates (incorporated by reference to Exhibit 99(i) of the Form 10-K of the Partnership for the year ended December 31, 1996).
ML/EQ REAL ESTATE PORTFOLIO, L.P.
INDEPENDENT AUDITORS' REPORT
ML/EQ Real Estate Portfolio, L.P.:
We have audited the accompanying consolidated balance sheets of ML/EQ Real Estate Portfolio L.P. (the "Partnership") as of December 31, 1997 and 1996 and the related consolidated statements of operations, partners' capital, and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedules listed in the table of contents as consolidated supplemental schedules. These financial statements and the supplemental schedules discussed below are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and supplemental 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 are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of ML/EQ Real Estate Portfolio, L.P. at December 31, 1997 and 1996 and the results of its operations and its 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, such consolidated supplemental schedules, when considered in relation to the basic consolidated financial statements, present fairly in all material respects the information shown therein.
DELOITTE & TOUCHE LLP
Atlanta, Georgia February 6, 1998
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997 AND 1996
See notes to consolidated financial statements.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
See notes to consolidated financial statements.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
See notes to consolidated financial statements.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
SUPPLEMENTAL INFORMATION REGARDING NONCASH INVESTING ACTIVITIES:
The Venture accrued $1,566,226 and $1,120,796 in capital expenditures that were not paid before December 31, 1997 and 1996, respectively.
The Venture reclassified $15,550,364 relating to Brookdale Center from zero coupon mortgage note receivable to rental properties as a result of Brookdale Center being conveyed to the Venture and Equitable on December 16, 1996.
See notes to consolidated financial statements.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
1. ORGANIZATION
ML/EQ Real Estate Portfolio, L.P., a Delaware limited partnership (the "Partnership"), was formed on December 22, 1986. The Partnership was formed to invest in existing income-producing real properties, zero coupon or similar mortgage notes, and fixed-rate mortgage loans through a joint venture, EML Associates (the "Venture"). The Venture was formed on March 10, 1988 with EREIM LP Associates, an affiliate of The Equitable Life Assurance Society of the United States ("Equitable"). The Partnership owns an 80% interest in the Venture.
The Managing General Partner of the Partnership is EREIM Managers Corp. (the "Managing General Partner"), an affiliate of Equitable, and the Associate General Partner is MLH Real Estate Associates Limited Partnership (the "Associate General Partner"), an affiliate of Merrill Lynch, Hubbard Inc. The initial limited partner is MLH Real Estate Assignor, Inc., an affiliate of Merrill Lynch, Hubbard Inc.
The Partnership's Amended and Restated Agreement of Limited Partnership (the "Partnership Agreement") authorized the sale of up to 7,500,000 Beneficial Assignee Certificates ("BACs") at $20 per BAC. The BACs evidence the economic rights attributable to limited partnership interests in the Partnership. On March 10, 1988, the Partnership's initial investor closing occurred, at which time the Partnership received $92,190,120 representing the proceeds from the sale of 4,609,506 BACs. On May 3, 1988, the Partnership had its second and final investor closing. The Partnership received $16,294,380 representing the proceeds from the sale of an additional 814,719 BACs.
Total capital contributions to the Partnership are summarized as follows:
The Managing General Partner was a wholly-owned subsidiary of Equitable Real Estate Investment Management, Inc. ("ERE"), which was a wholly-owned subsidiary of Equitable. On June 10, 1997, Equitable sold ERE to a subsidiary of Lend Lease Corporation Limited ("Lend Lease"). The shares of the Managing General Partner were not included in the sale and the Managing General Partner continues to be a wholly owned indirect subsidiary of Equitable. Lend Lease merged its existing U.S. real estate investment advisor, The Yarmouth Group, Inc. into ERE and changed the name of ERE to ERE Yarmouth, Inc. ("ERE Yarmouth"). ERE Yarmouth was retained by the Managing General Partner, at the Managing General Partner's expense, to continue providing the same services with respect to the Partnership, the Venture, and the properties that ERE has historically provided to the Managing General Partner. The sale did not affect the ownership of EREIM LP Associates, the guarantor under the Guaranty Agreement, as ERE has no interest therein. The obligations of EREIM LP Associates under the Guaranty Agreement and of Equitable under the Keep Well Agreement were not affected by the sale.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with generally accepted accounting principles requires 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Principles of Consolidation -- The consolidated financial statements include the accounts of the Partnership and the Venture. EREIM LP Associates' 20% ownership in the Venture is reflected as a minority interest in the Partnership's consolidated financial statements. All significant intercompany accounts are eliminated in consolidation.
The Venture records its proportionate share of the assets, liabilities, revenues, and expenses of the undivided interests in Northland Center and Brookdale Center.
Allocation of Partnership Income -- Partnership net income was allocated 99% to the limited partners as a group and 1% to the general partners until 1990 at which time the Partnership paid the final portion of the acquisition/syndication fees to the general partners. Since 1990, partnership net income has been allocated 95% to the limited partners as a group and 5% to the general partners, consistent with the provisions in the limited partnership agreement for the allocation of distributable cash (see Note 8).
Rental Properties -- Rental properties are stated at cost. Cost is allocated between land and buildings based upon preacquisition appraisals of each property. Impairment is determined by calculating the sum of the estimated undiscounted future cash flows including the projected undiscounted future net proceeds from sale of property. In the event such sum is less than the depreciated cost of the property, the property will be written down to estimated fair market value.
Depreciation -- Depreciation of buildings and building improvements is provided using the straight-line method over estimated useful lives of five to forty years. Tenant improvements and leasing commissions are amortized using the straight-line method over the life of the related lease.
Rental Income -- Rental income is recognized on a straight-line basis over the terms of the leases.
Zero Coupon Mortgage Note Receivable -- The Venture measures impairment of the zero coupon mortgage note receivable based upon the estimated fair market value of the underlying collateral. If the Venture's portion of the estimated fair market value of the collateral declines below the recorded investment in the loans, impairment will be recognized through the creation of a valuation allowance. The Venture records interest received on the cash method (see Note 4).
Mortgage Loan Receivable -- The mortgage loan receivable is stated at cost (see Note 5).
Offering Costs -- Offering costs, including the acquisition/syndication fee payable to the general partners and other offering and issuance costs of the BACs totaling $11,037,537, were charged against the limited partners' capital in accordance with the provisions of the Partnership Agreement, following the investor closings in 1988.
Guaranty Fees -- Guaranty fees are being recognized as expense over the estimated life of the Partnership through a combination of the amortization of the nonrecurring portion of the fees incurred during the first three years of the Partnership and the expense of the recurring portion of the fees as incurred (Note 7).
Cash and Cash Equivalents -- Cash equivalents include cash, demand deposits, money market accounts, and highly liquid short-term investments purchased with original maturities of three months or less.
Income Taxes -- No provisions for income taxes have been made since all income and losses are allocated to the partners for inclusion in their respective tax returns.
Fair Value of Financial Instruments -- Management has reviewed the various assets and liabilities of the Partnership and has concluded that the estimated fair market value of the Partnership's financial instruments, including the mortgage loan receivable, have terms such that the carrying value approximates the estimated fair market value.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reclassifications -- Certain prior year amounts have been reclassified to conform with the 1997 presentation.
3. RENTAL PROPERTIES
As of December 31, 1997, the Partnership's rental properties consisted of the following:
The costs related to the rental properties are summarized below:
During 1997, the Venture consummated the sale of Brookdale Center and the Chicago Industrial properties. Brookdale Center was sold for a cash price of $24,830,000, of which the Venture's portion was $17,793,352. Prior to the sale, the Venture held a 71.66% interest in Brookdale Center.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. ZERO COUPON MORTGAGE NOTES RECEIVABLE
Brookdale Center
The Venture held a 71.66% participation interest in a zero coupon mortgage note. The property which secured this first mortgage note is Brookdale Center which is located outside of Minneapolis, Minnesota. The Venture acquired its participation interest in 1988 from Equitable which held the remaining 28.34% interest. The Venture's participation interest had an estimated fair market value (including accrued interest) at the time of acquisition of $12,278,885. The borrower was Midwest Real Estate Shopping Center L.P. ("Midwest"), a publicly traded limited partnership, (formerly Equitable Real Estate Shopping Centers, L.P.). The note had an implicit interest rate of 10.2% compounded semiannually with the Venture's portion of the entire amount of principal and accrued interest totaling $25,345,353 due on June 30, 1995.
Midwest defaulted on its obligation to repay the Brookdale zero note in full on the maturity date. Notice of default was given to Midwest. For book purposes, beginning with the second quarter of 1995, Management discontinued the accrual of interest on the Brookdale zero note as the accreted value of the mortgage approximated the estimated fair market value of Brookdale Center. Under the terms of the mortgage agreement, however, the Venture continued to accrue interest off the books at the effective implicit rate of 10.2% until June 30, 1995. On July 1, 1995, the Venture began to accrue interest off the books on the Brookdale zero note at the default rate of 19.0%. Equitable and the Venture (collectively referred to as "Lender") commenced foreclosure by advertisement proceedings and a court appointed receiver was named. The receiver was responsible for collecting rent proceeds from the tenants at Brookdale Center and applying the proceeds to payments of operating costs at Brookdale Center. Any remaining funds were paid to Lender on account of the Brookdale zero note. The Venture recorded cash received from the operation of Brookdale Center on a cash basis as interest income. During 1996 and 1995, approximately $1,975,000 and $700,000, respectively, was remitted under the terms of the receivership. The Venture's portion of these payments was approximately $1,415,000 and $502,000, respectively.
As of September 30, 1995, an internal review of the Brookdale Center was performed for the Venture. Based on this review, the estimated fair market value of Brookdale Center was $30,000,000. The Venture recorded a valuation allowance of $3,232,210 to value the note at an amount equal to the Venture's participation interest in the note multiplied by the estimated fair market value of Brookdale Center, or $21,498,199.
In April 1996, the Lender agreed in principle to a workout arrangement with Midwest on the Brookdale zero note under which Midwest would file for Chapter 11 bankruptcy protection and, with the support of the Lender, submit a plan of reorganization to Bankruptcy Court for approval. The workout arrangement was memorialized in a nonbinding letter agreement dated April 11, 1996 (the "Letter Agreement") between Midwest and Equitable and approved by the Board of Directors of EREIM Managers Corp., the general partner of the Partnership, on behalf of the Venture.
On June 20, 1996 Midwest filed a voluntary petition for Chapter 11 bankruptcy protection, as contemplated by the Letter Agreement, staying the Brookdale foreclosure proceeding and terminating the receivership arrangement. As further contemplated by the Letter Agreement, Midwest subsequently obtained Bankruptcy Court approval to retain the management company that had served as receiver prior to the bankruptcy filing as Brookdale's property manager.
In addition, the Bankruptcy Court, with the agreement of Midwest and Lender, entered a cash collateral order as contemplated by the Letter Agreement, pursuant to which all positive cash flow generated by the property in excess of property-related expenses and certain administrative costs of the bankruptcy, not to exceed $25,000, was paid to the Lender during the bankruptcy. The Venture recorded cash received from the operation of Brookdale Center as interest income. During 1996, approximately $2,890,000 was remitted under the terms of the cash collateral order. The Venture's portion of these payments was approximately $2,071,000.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On December 16, 1996, Brookdale Center was transferred to the Venture and Equitable, as tenants in common, pursuant to a Chapter 11 bankruptcy plan for Midwest that was approved by the Bankruptcy Court on November 25, 1996. The consideration for this transfer was (i) release of Midwest from its obligations under the Brookdale Zero Note and (ii) payment to Midwest of $500,000, of which the Venture's portion was $358,303. An internal review of the property, performed for the Venture as of the date of transfer, estimated the fair market value of the Brookdale Center to be $21,700,000, of which the Venture's portion was $15,550,364. Following the transfer, Brookdale Center was reclassified from zero coupon mortgage note receivable to rental properties and income and expenses were recorded from that date. In connection with the December 1996 transfer the Venture recognized a loss of $6,211,644 to record Brookdale Center at its fair market value. In November 1997, the Venture sold Brookdale Center to Talisman Brookdale L.L.C. for $24,830,000, of which the Venture's portion was approximately $17,793,000.
Northland Center
Until July 22, 1994, the Venture also held a 71.66% participation interest in a zero coupon mortgage note and the first mortgage on Northland Center which is located outside of Detroit, Michigan. The Venture acquired its participation interest in 1988 from Equitable which held the remaining 28.34% interest. The Venture's participation interest had an estimated fair market value (including accrued interest) at the time of acquisition of $20,774,985. The borrower was Midwest. The note had an implicit interest rate of 10.2% compounded semiannually with the Venture's portion of the entire amount of principal and accrued interest totaling $42,882,504 due on June 30, 1995. The note provided that the borrower could elect to pay interest currently; however, no interest was paid through July 22, 1994.
On July 22, 1994, Midwest transferred Northland Center to the Venture and Equitable in proportion to their respective undivided interests in the Northland Center mortgage. Following the transfer, which was retroactive as of January 1, 1994, Northland Center was reclassified from other real estate assets to rental properties and income and expenses were adjusted as of that date. The Venture records its proportionate share of the assets, liabilities, revenues, and expenses of the undivided interests in Northland Center in accordance with the tenancy in common arrangements in the Participation Agreement between the Venture and Equitable. The Venture and Equitable paid the owner $6.6 million at the time of transfer (an amount which was determined to approximate the net present value of the anticipated cash flow from Northland Center, subject to closing adjustments, for the period from January 1, 1994 through June 30, 1995, the date the Northland Center mortgage would have matured).
In connection with the transfer of Northland Center, the Venture and Equitable modified the agreement with Dayton Hudson, which operates one of the anchor stores at Northland Center, and entered into an agreement to add Montgomery Ward as an additional anchor. The Venture and Equitable also commenced a renovation program at Northland Center. The renovations were completed during the second quarter of 1995 at a total cost of approximately $11.0 million, of which the Venture's share was approximately $7.9 million.
5. MORTGAGE LOANS RECEIVABLE
In 1989, the Venture made a $6,000,000 nonrecourse first mortgage loan to the Wilcon Company. The loan is collateralized by an apartment complex in Weston, Massachusetts. The loan bears interest at 10.25% per annum with interest only of $51,250 due monthly to the maturity date of February 1999.
6. GUARANTY AGREEMENT
EREIM LP Associates has entered into a guaranty agreement with the Venture to provide a minimum return to the Partnership's limited partners on their contributions. The Venture has assigned its rights under the guaranty agreement to the Partnership. Payments on the guaranty are due 90 days following the earlier of the sale or other disposition of all the properties and mortgage loans and notes or the liquidation of the ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Partnership. The minimum return will be an amount which, when added to the cumulative distributions to the limited partners, will enable the Partnership to provide the limited partners with a minimum return equal to their capital contributions plus a simple annual return of 9.75% on their adjusted capital contributions calculated from the dates of the investor closings. Adjusted capital contributions are the limited partners' original cash contributions reduced by distributions of sale or financing proceeds and by distributions of certain funds in reserves, as more particularly described in the Partnership Agreement. The limited partners' original cash contributions have been adjusted by that portion of distributions paid through December 31, 1997, resulting from cash available to the Partnership as a result of sale or financing proceeds paid to the Venture. The minimum return is subject to reduction in the event that certain taxes, other than local property taxes, are imposed on the Partnership or the Venture, and is also subject to certain other limitations set forth in the prospectus. Based upon the assumption that the last property is sold on December 31, 2002, upon expiration of the term of the Partnership, the maximum liability of EREIM LP Associates to the Venture under the guaranty agreement as of December 31, 1997 is limited to $202,642,593, plus the value of EREIM LP Associates' interest in the Venture less any amounts contributed by EREIM LP Associates to the Venture to fund cash deficits.
Capital contributions by the BAC holders totaled $108,484,500. As of December 31, 1997, the cumulative 9.75% simple annual return was $102,048,149. As of December 31, 1997, cumulative distributions by the Partnership to the BAC holders totaled $49,479,767, of which $26,307,492 is attributable to income from operations and $23,172,275 is attributable to sales of Venture assets, principal payments on mortgage loans and other capital events. Another $14,916,619 in sale or financing proceeds was distributed to the BAC holders in February 1998. To the extent that future cash distributions to the limited partners are insufficient to provide the specified minimum return, any shortfall will be funded by the guarantor, up to the above described maximum.
Effective as of January 1, 1997, the Partnership entered into an amendment to the Joint Venture Agreement of the Venture between the Partnership and EREIM LP Associates pursuant to which EREIM LP Associates agreed to defer, without interest, its rights to receive 20% of the Venture's distributions of sale or financing proceeds until the Partnership has received aggregate distributions from the Venture in an amount equal to the capital contributions made to the Partnership by the BAC holders plus a noncompounded cumulative return computed at the rate of 9.75% per annum on contributions outstanding from time to time. Prior to the amendment, EREIM LP Associates had a right to receive 20% of all the Venture's distributions of sale or financing proceeds on a pari passu basis with the Partnership. The amendment has the effect of accelerating the return of original contributions to BAC holders to the extent that sale or financing proceeds are realized prior to the dissolution of the Partnership.
7. COMPENSATION AND FEES
Acquisition/Syndication Fee -- The acquisition/syndication fee was paid to the general partners for initial acquisition, management, and administrative services to the Partnership. The fee was 8.7% of the proceeds from the offering of BACs, which amounted to $9,438,152 based upon the total number of BACs sold and has been included in the offering costs charged to limited partners' capital. The outstanding balance of this fee was paid to the general partners in August 1990.
Asset Management Fees:
Venture Supervisory Fee -- The Venture supervisory fee is payable to the Managing General Partner for supervising the Partnership's investment in the Venture. The fee is payable semiannually in an amount equal to .75% per annum of the Partnership's allocable share of the acquisition price of properties owned by the Venture. For each of the years ended December 31, 1997, 1996, and 1995, the total expense for this fee was $737,702, $658,271, and $654,192, respectively.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Mortgage Loan Servicing Fee -- The mortgage loan servicing fee is payable to the Managing General Partner for servicing mortgage loans owned by the Venture. The fee is payable semiannually in an amount equal to .20% per annum of the outstanding principal amount of the Partnership's allocable share of fixed-rate first mortgage loans and .20% per annum of the Partnership's allocable share of the accreted amount of zero coupon mortgage notes at the time of acquisition or contribution to the Venture. For each of the years ended December 31, 1997, 1996, and 1995, the total expense for this fee was $9,600, $28,387, and $29,246, respectively.
Partnership Administration Fee -- The Partnership administration fee is payable to the Associate General Partner as compensation for providing investor services limited to processing investor information and disseminating Partnership reports and tax information. The fee is payable on a semiannual basis at an annual rate of .15% per annum of the average annual adjusted capital contributions of the offering of BACs. For the years ended December 31, 1997, 1996, and 1995, the total expense for this fee was $154,109, $156,389, and $158,350, respectively.
Property Management Fees -- Properties are managed and leased by third-party managing and leasing agents, including Compass Management and Leasing, Inc. ("Compass") and ERE Yarmouth Retail, Inc. ("Retail"), affiliates of ERE Yarmouth. As discussed in Note 1, until June 10, 1997, ERE, the predecessor company to ERE Yarmouth, was an affiliate of Equitable. Property management fees are generally established at specified percentages of 1% to 5% of the gross receipts of the properties as defined in the management agreements. Property management fees for properties managed by Compass and Retail were $396,440, $406,995, and $442,906, in 1997, 1996, and 1995, respectively.
Leasing commissions are based on a percentage of the rent payable during the term of the lease as specified in each lease agreement. Leasing commissions paid by the Venture to Compass and Retail were $276,314, $123,611, and $93,519, in 1997, 1996, and 1995, respectively. Leasing commissions are capitalized in deferred leasing costs on the balance sheet or expensed in real estate operating expenses on the statement of operations in accordance with the Venture's capitalization policy. The Venture has reimbursed Compass and Retail for payroll incurred of $1,785,133, $1,678,348, and $1,974,425 in 1997, 1996, and 1995, respectively. Payroll reimbursements are included in real estate operating expenses on the statement of operations. Additionally, the Venture has paid construction management fees to Compass and Retail of $11,829, $92,024, and $167,861 in 1997, 1996, and 1995, respectively. The construction management fees have been capitalized as a portion of the construction projects to which they relate.
Retail performed certain due diligence work with regard to the workout arrangement with Midwest on the Brookdale zero note. Consulting fees paid to Retail during 1996 for due diligence work were $72,047, of which the Venture's portion was $51,630. The consulting fees are included in the statements of operations as a component of real estate operating expenses.
Guaranty Fee -- The guaranty fee is payable to the Venture in consideration of the assignment of the guaranty agreement. The fee was initially paid in six semiannual installments, which commenced on June 30, 1988 and ended on December 31, 1990, at an annual rate of 1.15% of gross proceeds plus .35% of average annual adjusted capital contributions. Subsequent to December 31, 1990, the fee is payable on a semiannual basis at an annual rate of .35% of the average annual adjusted capital contributions of the offering of BACs. The guaranty fee is assigned to EREIM LP Associates. The total of the recurring portion of the guaranty fee which is included in general and administrative expense on the statement of operations was $359,587, $365,426, and $369,484, for the years ended December 31, 1997, 1996, and 1995, respectively. The amortization expense on the nonrecurring portion of the fee was $268,251 in each of the years ended December 1997, 1996, and 1995.
Disposition Fee -- The disposition fee is payable to the Managing General Partner in the case of a sale of a property. Upon distribution of the proceeds of the sale to the limited partners, the fee is payable in the
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amount of 1.50% of the aggregate gross proceeds received by the Partnership. The Managing General Partner will not receive any portion of the disposition fee which, when combined with amounts paid to all other entities as real estate brokerage commissions in connection with the sale, exceeds 6% of the aggregate gross sale proceeds. Such amounts shall not be payable until such time as the BAC Holders and Limited Partners as a class have received distributions of sale or financing proceeds in a cumulative amount equal to their capital contributions. The disposition fee related to the sale of Brookdale Center and the Chicago Industrial properties during 1997, has been deferred, without interest, until such time the required distributions to BAC Holders and Limited Partners are met, and therefore, has not been accrued.
8. PARTNERSHIP AGREEMENT
The general partners are liable for all general obligations of the Partnership to the extent not paid by the Partnership. The limited partners are not liable for the obligations of the Partnership beyond the amount of their contributed capital.
After payment of the acquisition/syndication fee to the general partners, which has been charged to the limited partners' capital, distributable cash from operations, less any amounts set aside for reserves, will be distributed semiannually on the basis of 95% to the BAC holders and limited partners as a group and 5% to the general partners. Distributions to the general partners for any semiannual period will be deferred until the limited partners have received a 6% per annum simple return on their adjusted capital contribution during the period.
Taxable income and loss will generally be allocated 1% to the general partners and 99% to the limited partners. Distributions from sale or financing proceeds, if applicable during a period, will be distributed on a semiannual basis with priority return given to the limited partners. An exception in the agreement provides that the distribution of sale or financing proceeds may be delayed if the purpose for withholding such a distribution is to supplement cash reserves. Subsequent to a complete return of the limited partners' capital contributions and the receipt of the minimum return by the limited partners, as defined in the Partnership Agreement, sales proceeds will be allocated to the general partners to the extent of any distributable cash that has been deferred, net of disposition fees paid to the Managing General Partner. The balance will be allocated 85% to the limited partners and 15% to the general partners.
9. LEASES
Future minimum rentals to be received for the properties under noncancellable operating leases in effect as of December 31, 1997 are as follows:
In addition to the minimum lease amounts, certain leases provide for escalation charges to tenants for common area maintenance and real estate taxes. The amount of escalation charges included in rental income totaled $9,172,055, $7,686,606, and $7,792,848, for the years ended December 31, 1997, 1996, and 1995, respectively.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the case of retail tenants, certain leases provide for percentage rents. Contingent rentals which include percentage rents included in rental income for the years ended December 31, 1997, 1996, and 1995 totaled $621,290, $615,400, and $601,316, respectively.
Information with respect to significant individual leases is as follows:
- Treasure Chest Advertising, formerly Gruner & Jahr Printing, occupies approximately 44.1% (143,852 square feet) of Doolittle Drive at an annual base rent of $518,956 under a lease which expires in August 2000.
- Hudson's Department Store, J.C. Penney, Montgomery Ward, and Target operate stores at Northland Center and each contributes common area maintenance payments for operating expenses and real estate taxes under separate agreements. These stores, covering 511,509 square feet, 283,534 square feet, 117,750 square feet, and 116,222 square feet, respectively, are not included in the gross leasable area of the mall. In addition, Montgomery Ward filed Chapter 11 Bankruptcy during 1997. The store was open for business as of December 31, 1997, but subsequently closed during January 1998. In order to control the use of the space, the Partnership agreed to pay HK/MW, LLC $100,000 in exchange for a rejection of the lease, which is anticipated to take effect on March 31, 1998.
- Pursuant to an agreement with Kohl's Department Stores, Inc. ("Kohl's") finalized on February 17, 1995, Equitable agreed to accept $1,750,000 in connection with the termination of Kohl's lease at Northland Center on behalf of the tenancy in common arrangement between the Venture and Equitable. The Venture's portion of the termination payment was $1,254,062. Upon termination of the lease, Kohl's was released from any remaining lease obligation under the original lease agreement.
- PNC Bank occupies approximately 32.7% of The Bank of Delaware Building at an annual rent of $359,471. The majority of the lease commitment expires in May 2005.
- Broadway Stores, Inc. occupies the entire Whipple Road property (257,500 square feet) at an annual rent of $1,098,200 under a lease which expires in August 2003.
- Bon-Ton and Redner's Market occupies approximately 45.4% and 29.3%, (84,405 and 54,471 square feet), respectively, of Richland Mall. Bon-Ton and Redner's Market pay an annual base rent of $295,579 and $435,768 under leases which expire December 2006 and November 2017, respectively.
10. TAXABLE NET INCOME AND TAX NET WORTH
The following is a reconciliation of the Partnership's financial net income to taxable net income and a reconciliation of partners' capital for financial reporting purposes to net worth on a tax basis:
ML/EQ REAL ESTATE PORTFOLIO, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. LEGAL PROCEEDINGS
The Partnership is a defendant in a consolidated action brought in the Court of Chancery of the State of Delaware entitled IN RE: ML/EQ Real Estate Partnership Litigation. The consolidated action results from two related cases. Scher v. ML/EQ Real Estate Portfolio, L.P., et al., was served on the Partnership on July 14, 1997. On September 8, 1997, the Partnership was named as a defendant in Folette v. ML/EQ Real Estate Portfolio, L.P., et al., a substantially similar complaint, also brought in the Court of Chancery of the State of Delaware. The cases were consolidated pursuant to a stipulation between the parties by order of the court on October 3, 1997. In addition to the Partnership, the complaint names as defendants EREIM Managers Corp., Equitable, ERE, EREIM L.P. Corp., and EREIM LP Associates.
The Plaintiffs purport to sue on behalf of a class of all limited partners of the Partnership who purportedly have been or will be adversely affected by the conduct of the defendants. The complaint alleges that the defendants have caused the Venture to accumulate excessive cash rather than distribute it to the limited partners, and that defendants' motive in so doing was (i) to manipulate the Partnership's cash flow so as to limit certain defendants' exposure under the guarantee agreement and (ii) to secure for certain defendants additional fees. The complaint also alleges that defendants have utilized the Venture to provide liquidity for illiquid assets and to acquire and continue to hold under-performing properties. The complaint purports to state claims for breach of fiduciary duties, breach of contract, and aiding and abetting breach of fiduciary duties. The complaint requests, among other things, money damages in an unspecified amount and orders that defendants distribute to the purported class the cash which defendants have allegedly wrongfully failed to distribute and disgorge all earnings, profits, interests, and other benefits, which they have realized on account of their allegedly wrongful conduct. The Partnership intends to defend vigorously against these claims. On November 6, 1997, defendants answered the complaint, denying any wrongdoing. Additionally, defendants have noticed a motion to dismiss the case on the pleadings in the Delaware Court of Chancery. Although the outcome of any litigation cannot be predicted with certainty, particularly in the early stages of an action, the Partnership's management believes that the ultimate resolution of the litigation will not have a material adverse effect on the financial condition of the Partnership. Due to the early stage of such litigation, the Partnership's management cannot make an estimate of loss, if any, or predict whether or not such litigation will have a material adverse effect on the Partnership's results of operations in any particular period.
CONSOLIDATED SUPPLEMENTAL SCHEDULES (SEE INDEPENDENT AUDITORS' REPORT)
SCHEDULE III
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 1997 AND FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
CONSOLIDATED SUPPLEMENTAL SCHEDULES (SEE INDEPENDENT AUDITORS' REPORT)
SCHEDULE IV
ML/EQ REAL ESTATE PORTFOLIO, L.P.
CONSOLIDATED SCHEDULE OF MORTGAGE LOANS ON REAL ESTATE AS OF DECEMBER 31, 1997 AND FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
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Notes: (a) This loan is not subject to any delinquencies. (b) The Venture recorded a valuation allowance of $3,232,210 at September 30, 1995 to value the note at an amount equal to the Venture's participation interest in the note multiplied by the estimated fair market value of the underlying collateral. On December 16, 1996, upon acquiring its undivided interest in the shopping mall securing the zero coupon mortgage, the Venture recorded a loss of $6,211,644 and recorded the property on its balance sheet at an amount equal to the Venture's participation interest in the property multiplied by the estimated fair market value of the property. (c) The aggregate tax basis is $6,000,000. (d) Payments of interest only of $51,250 are due monthly until the maturity date of February 1999.
SIGNATURES
Pursuant to requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 30th day of March, 1998.
ML/EQ REAL ESTATE PORTFOLIO, L.P.
By: EREIM MANAGERS CORP. ------------------------------------ (Managing General Partner)
By: /s/ JOHN H. KIRST ------------------------------------ John H. Kirst President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on March 30, 1998.
/s/ JOHN H. KIRST -------------------------------------- John H. Kirst President, Chief Executive Officer and Director of EREIM Managers Corp. (principal executive officer)
/s/ PATRICIA C. SNEDEKER -------------------------------------- Patricia C. Snedeker Vice President, Controller and Treasurer of EREIM Managers Corp. (principal financial officer)
/s/ PETER D. NORIS -------------------------------------- Peter D. Noris Director of EREIM Managers Corp.
/s/ ANTHONY C. PASQUALE -------------------------------------- Anthony C. Pasquale Director of EREIM Managers Corp.
EXHIBIT INDEX