Item 1. Business
PaineWebber Equity Partners Two Limited Partnership (the "Partnership") is a limited partnership formed on May 16, 1986, under the Uniform Limited Partnership Act of the State of Virginia to invest in a diversified portfolio of existing, newly-constructed or to-be-built income-producing real properties such as apartments, shopping centers, hotels, office buildings and industrial buildings. The Partnership had authorized the issuance of a maximum of 150,000,000 Partnership Units (the "Units") at $1 per Unit, pursuant to a Registration Statement on Form S-11 filed under the Securities Act of 1933 (Registration No. 33-5929). On June 2, 1988, the offering of Units in the Partnership was completed and gross proceeds of $134,425,741 had been received by the Partnership. Limited Partners will not be required to make any additional capital contributions.
As of March 31, 1998 the Partnership owned, through joint venture partnership, interests in the operating properties set forth in the following table:
(1) See Notes to the Financial Statements of the Registrant filed with this Annual Report for a description of the agreements through which the Partnership has acquired these real estate investments.
Originally, the Partnership had interests in ten joint venture partnerships, four of which have since been liquidated following the sales of their operating investment properties. On November 2, 1995, the joint venture which owned the Richmond Park Apartments and Richland Terrace Apartments sold the properties to a third party for $11 million. The Partnership received net proceeds of approximately $8 million after deducting closing costs, the co-venturer's share of the proceeds and repayment of a $2 million loan which encumbered the property. In addition, on December 29, 1995 the joint venture which owned the Treat Commons II Apartments sold the property to a third party for approximately $12.1 million. The Partnership received net proceeds of approximately $4.1 million after deducting closing costs and the repayment of the existing mortgage note of approximately $7.3 million. On May 31, 1990, the joint venture that owned the Highland Village Apartments sold the property at a gross sales price of $8.5 million. Net proceeds from the sale were split between the Partnership and its co-venture partner, with the Partnership receiving approximately $7.7 million. Also, on November 29, 1989, the Partnership entered into an agreement with Awbrey's Road II Associates Limited Partnership (ARA) to sell the rights to its interest in Ballston Place - Phase II Associates which was to own and operate Ballston Place - Phase II, an apartment complex in Arlington, Virginia. The Partnership received the $9 million which had been funded into escrow during the construction phase of the project. In addition, the Partnership received certain other compensation in connection with this transaction. As a result of these sale transactions, the Partnership no longer owns any interest in the Richmond Park Apartments, Richland Terrace Apartments, Treat Commons II Apartments, Highland Village Apartments or Ballston Place - Phase II Apartments.
The Partnership's investment objectives are to invest the proceeds raised from the offering of limited partnership units in a diversified portfolio of income-producing properties in order to:
(1) preserve and protect Limited Partners' capital; (2) provide the Limited Partners with quarterly cash distributions, a portion of which will be sheltered from current federal income tax liability; and (3) achieve long-term capital appreciation in the value of the Partnership's investment properties.
Through March 31, 1998, the Limited Partners had received cumulative cash distributions totalling approximately $84,752,000, or $660 per original $1,000 investment for the Partnership's earliest investors. This return includes a distribution of $38 per original $1,000 investment from the sale of the Richland Terrace Apartments and Richmond Park Apartments in November 1995, $23 per original $1,000 investment from the sale of the Treat Commons II Apartments in December 1995 and $57 per original $1,000 investment from the sale of the Highland Village Apartments in May 1990. The proceeds of the Ballston Place transaction described above were retained by the Partnership to pay down debt and to bolster reserves in light of expected future capital needs. The remaining cash distributions have been from net rental income, and a substantial portion of such distributions has been sheltered from current federal income tax liability. As a result of the reduction in Partnership cash flow resulting from the fiscal 1996 sale transactions described above, the Partnership reduced the annualized distribution rate from 2% to 1% effective with the payment made on February 15, 1996 for the quarter ended December 31, 1995. As of March 31, 1998, the Partnership was paying regular quarterly distributions at a rate of 1% per annum on remaining invested capital of $882 per original $1,000 investment. In addition, the Partnership retains its ownership interest in six of its ten original investment properties.
The Partnership's success in meeting its capital appreciation objective will depend upon the proceeds received from the final liquidation of the remaining investments, which comprise 73% of the Partnership's original investment portfolio. The amount of such proceeds will ultimately depend upon the value of the underlying investment properties at the time of their liquidation, which cannot presently be determined. As of March 31, 1998, the Partnership's portfolio of real estate investments consists of two retail shopping centers, two office/R&D properties and two multi-family apartment complexes. While market values for commercial office buildings continued to recover during fiscal 1998 after several years of depressed conditions, such values, for the most part, remain below the levels which existed in the mid-1980's, which is when the Partnership's properties were acquired. Such conditions are due, in part, to the residual effects of the overbuilding which occurred in the late 1980's and the trend toward corporate downsizing and restructurings which occurred in the wake of the last national recession. In addition, at the present time real estate values for retail shopping centers in certain markets are being adversely impacted by the effects of overbuilding and consolidations among retailers which have resulted in an oversupply of space and by the generally flat rate of growth in retail sales. The market for multi-family residential properties in most markets throughout the country remained strong during fiscal 1998 although estimated market values in some markets appear to have plateaued as a result of the increase in development activity referred to below. Management is currently focusing on potential disposition strategies for the remaining investments in its portfolio. Although no assurances can be given, it is currently contemplated that sales of the Partnership's remaining assets could be completed within the next 2- to- 3 years.
All of the Partnership's investment properties are located in real estate markets in which they face significant competition for the revenues they generate. The apartment complexes compete with numerous projects of similar type generally on the basis of price and amenities. Apartment properties in all markets also compete with the local single family home market for prospective tenants. The continued availability of low interest rates on home mortgage loans has increased the level of this competition over the past few years. However, the impact of the competition from the single-family home market has generally been offset by a significant increase in the funds available in the capital markets for investment in real estate and by the lack of significant new construction activity in the multi-family apartment market over most of this period. Over the past two years, development activity for multi-family properties in many markets has escalated significantly. The Partnership's shopping centers and office/R&D buildings also compete for long-term commercial tenants with numerous projects of similar type generally on the basis of price, location and tenant improvement allowances.
The Partnership has no real property investments located outside the United States. The Partnership is engaged solely in the business of real estate investment, therefore presentation of information about industry segments is not applicable.
The Partnership has no employees; it has, however, entered into an Advisory Contract with PaineWebber Properties Incorporated (the "Adviser"), which is responsible for the day-to-day operations of the Partnership. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated ("PWI"), a wholly-owned subsidiary of PaineWebber Group Inc. ("PaineWebber").
The general partners of the Partnership (the "General Partners") are Second Equity Partners, Inc., and Properties Associates 1986, L.P. Second Equity Partners, Inc. (the "Managing General Partner"), a wholly-owned subsidiary of PaineWebber Group Inc. is the managing general partner of the Partnership. Properties Associates 1986, L.P. (the "Associate General Partner"), a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner and the Adviser, is the associate general partner of the Partnership.
The terms of transactions between the Partnership and affiliates of the Managing General Partner of the Partnership are set forth in Items 11 and 13 below to which reference is hereby made for a description of such terms and transactions.
Item 2.
Item 2. Properties
As of March 31, 1998, the Partnership had interests in six operating properties through joint venture partnerships. These joint venture partnerships and the related properties are referred to under Item 1 above to which reference is made for the name, location and description of each property.
Occupancy figures for each fiscal quarter during 1998, along with an average for the year, are presented below for each property:
Percent Occupied At ---------------------------------------------- Fiscal 6/30/97 9/30/97 12/31/97 3/31/98 Average ------- ------- -------- ------- -------
625 North Michigan Avenue 87% 89% 89% 88% 88%
The Gables at Erin Shades 96% 96% 95% 93% 95%
Gateway Plaza Shopping Center 89% 89% 89% 89% 89%
Saratoga Center & EG&G Plaza 100% 100% 100% 94% 99%
West Ashley Shoppes 64% 94% 95% 95% 87%
Asbury Commons Apartments 84% 96% 92% 91% 91%
Item 3.
Item 3. Legal Proceedings
In November 1994, a series of purported class actions (the "New York Limited Partnership Actions") were filed in the United States District Court for the Southern District of New York concerning PaineWebber Incorporated's sale and sponsorship of various limited partnership investments, including those offered by the Partnership. The lawsuits were brought against PaineWebber Incorporated and PaineWebber Group Inc. (together "PaineWebber"), among others, by allegedly dissatisfied partnership investors. In March 1995, after the actions were consolidated under the title In re PaineWebber Limited Partnership Litigation, the plaintiffs amended their complaint to assert claims against a variety of other defendants, including Second Equity Partners, Inc. and Properties Associates 1986, L.P. ("PA1986"), which are the General Partners of the Partnership and affiliates of PaineWebber. On May 30, 1995, the court certified class action treatment of the claims asserted in the litigation.
The amended complaint in the New York Limited Partnership Actions alleged that, in connection with the sale of interests in PaineWebber Equity Partners Two Limited Partnership, PaineWebber, Second Equity Partners, Inc. and PA1986 (1) failed to provide adequate disclosure of the risks involved; (2) made false and misleading representations about the safety of the investments and the Partnership's anticipated performance; and (3) marketed the Partnership to investors for whom such investments were not suitable. The plaintiffs, who purported to be suing on behalf of all persons who invested in PaineWebber Equity Partners Two Limited Partnership, also alleged that following the sale of the partnership interests, PaineWebber, Second Equity Partners, Inc. and PA1986 misrepresented financial information about the Partnership's value and performance. The amended complaint alleged that PaineWebber, Second Equity Partners, Inc. and PA1986 violated the Racketeer Influenced and Corrupt Organizations Act ("RICO") and the federal securities laws. The plaintiffs sought unspecified damages, including reimbursement for all sums invested by them in the partnerships, as well as disgorgement of all fees and other income derived by PaineWebber from the limited partnerships. In addition, the plaintiffs also sought treble damages under RICO.
In January 1996, PaineWebber signed a memorandum of understanding with the plaintiffs in the New York Limited Partnership Actions outlining the terms under which the parties agreed to settle the case. Pursuant to that memorandum of understanding, PaineWebber irrevocably deposited $125 million into an escrow fund under the supervision of the United States District Court for the Southern District of New York to be used to resolve the litigation in accordance with a definitive settlement agreement and plan of allocation. On July 17, 1996, PaineWebber and the class plaintiffs submitted a definitive settlement agreement which provides for the complete resolution of the class action litigation, including releases in favor of the Partnership and PWPI, and the allocation of the $125 million settlement fund among investors in the various partnerships and REITs at issue in the case. As part of the settlement, PaineWebber also agreed to provide class members with certain financial guarantees relating to some of the partnerships and REITs. The details of the settlement are described in a notice mailed directly to class members at the direction of the court. A final hearing on the fairness of the proposed settlement was held in December 1996, and in March 1997 the court announced its final approval of the settlement. The release of the $125 million of settlement proceeds had been delayed pending the resolution of an appeal of the settlement by two of the plaintiff class members. In July 1997, the United States Court of Appeals for the Second Circuit upheld the settlement over the objections of the two class members. As part of the settlement agreement, PaineWebber has agreed not to seek indemnification from the related partnerships and real estate investment trusts at issue in the litigation (including the Partnership) for any amounts that it is required to pay under the settlement.
In February 1996, approximately 150 plaintiffs filed an action entitled Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiffs' purchases of various limited partnership interests, including those offered by the Partnership. The complaint alleged, among other things, that PaineWebber and its related entities committed fraud and misrepresentation and breached fiduciary duties allegedly owed to the plaintiffs by selling or promoting limited partnership investments that were unsuitable for the plaintiffs and by overstating the benefits, understating the risks and failing to state material facts concerning the investments. The complaint sought compensatory damages of $15 million plus punitive damages against PaineWebber. In June 1996, approximately 50 plaintiffs filed an action entitled Bandrowski v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiffs' purchases of various limited partnership interests, including those offered by the Partnership. The complaint was very similar to the Abbate action described above and sought compensatory damages of $3.4 million plus punitive damages against PaineWebber. In September 1996, the court dismissed many of the plaintiffs' claims in both the Abbate and Bandrowski actions as barred by applicable securities arbitration regulations. Mediation with respect to the Abbate and Bandrowski actions was held in December 1996. As a result of such mediation, a settlement between PaineWebber and the plaintiffs was reached which provided for the complete resolution of both actions. Final releases and dismissals with regard to these actions were received during fiscal 1998.
Based on the settlement agreements discussed above covering all of the outstanding unitholder litigation, management believes that the resolution of these matters will not have a material impact on the Partnership's financial statements, taken as a whole.
The Partnership is not subject to any material pending legal proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for the Partnership's Limited Partnership Interests and Related Security Holder Matters
At March 31, 1998, there were 8,626 record holders of Units in the Partnership. There is no public market for the Units, and it is not anticipated that a public market for the Units will develop. Upon request the Managing General Partner will endeavor to assist a Unitholder desiring to transfer his Units and may utilize the services of PWI in this regard. The price to be paid for the Units will be subject to negotiation by the Unitholder. The Managing General Partner will not redeem or repurchase Units.
The Partnership had a Distribution Reinvestment Plan designed to enable Unitholders to have their distributions from the Partnership invested in additional Units of the Partnership. The Distribution Reinvestment Plan was discontinued during fiscal 1998. The terms of the Plan are outlined in detail in the Prospectus, a copy of which Prospectus, as supplemented, is incorporated herein by reference.
Reference is made to Item 6
Item 6. Selected Financial Data
PaineWebber Equity Partners Two Limited Partnership For the years ended March 31, 1998, 1997, 1996, 1995 and 1994 (in thousands, except for per Unit data)
(1) The Partnership's operating loss for fiscal 1997 reflects a loss of $2,700,000 recognized to reflect an impairment in the carrying value of one of the consolidated operating investment properties. See Note 4 to the accompanying financial statements for a further discussion.
(2) During fiscal 1995, as further discussed in Note 4 to the accompanying financial statements, the Partnership assumed control of the joint venture which owns and operates the West Ashley Shoppes Shopping Center. Accordingly, this joint venture, which had been accounted for under the equity method in prior years, has been consolidated in the Partnership's financial statements beginning in fiscal 1995.
The above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this Annual Report.
The above per 1,000 Limited Partnership Units information is based upon the 134,425,741 Limited Partnership Units outstanding during each year.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Information Relating to Forward-Looking Statements - --------------------------------------------------
The following discussion of financial condition includes forward-looking statements which reflect management's current views with respect to future events and financial performance of the Partnership. These forward-looking statements are subject to certain risks and uncertainties, including those identified below under the heading "Certain Factors Affecting Future Operating Results" which could cause actual results to differ materially from historical results or those anticipated. The words "believe," "expect," "anticipate," and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which were made based on facts and conditions as they existed as of the date of this report. The Partnership undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Liquidity and Capital Resources - -------------------------------
The Partnership commenced an offering to the public on July 21, 1986 for up to 150,000,000 units (the "Units") of limited partnership interest (at $1 per Unit) pursuant to a Registration Statement filed under the Securities Act of 1933. The Partnership raised gross proceeds of $134,425,741 between July 21, 1986 and June 2, 1988. The Partnership also received proceeds of $23 million from the issuance of zero coupon loans. The loan proceeds, net of financing expenses of approximately $908,000, were used to pay the offering and organization costs, acquisition fees and acquisition-related expenses of the Partnership and to fund the Partnership's cash reserves. The Partnership originally invested approximately $132,200,000 (net of acquisition fees) in ten operating properties through joint venture investments. Through March 31, 1998, four of these investments had been sold. The Partnership retains an interest in six operating properties, which are comprised of two multi-family apartment complexes, two office/R&D complexes and two retail shopping centers. The Partnership does not have any commitments for additional investments but may be called upon to fund its portion of operating deficits or capital improvement costs of its joint venture investments in accordance with the respective joint venture agreements.
In light of the continued strength in the national real estate market with respect to multi-family apartment properties and the recent improvements in the office/R&D property markets, management believes that this may be an opportune time to sell the Partnership's portfolio of properties. As a result, management is currently focusing on potential disposition strategies for the remaining investments in the Partnership's portfolio. As part of that plan, as discussed further below, The Gables Apartments is being actively marketed for sale now and the Hacienda Business Park property is expected to be marketed for sale sometime during the second half of calendar 1998. In addition, management is working with each property's leasing and management team to develop and implement programs that will protect and enhance value and maximize cash flow at each property. These programs include pursuing a new leasing opportunity at the 625 North Michigan Office Building, completing the leasing programs which are currently underway at Gateway Plaza and West Ashley Shoppes, and improving operating efficiency and implementing property enhancements at the Asbury Commons Apartments. These programs are expected to result in higher net sale prices for these four assets than could otherwise be achieved if these properties were sold today. Although there are no assurances, it is currently contemplated that sales of the Partnership's remaining assets could be completed within the next 2-to-3 years.
As previously reported, management discovered the existence of certain potential construction problems at the Asbury Commons Apartments during fiscal 1997. The initial analysis of the construction problems at Asbury Commons revealed extensive deterioration of the wood trim and evidence of potential structural problems affecting the exterior breezeways, the decks of certain apartment unit types and the stairway towers. A design and construction team was organized to further evaluate the potential problems, make cost-effective remediation recommendations and implement the repair program. Based on this evaluation, the structural problems may be more extensive and cost significantly more than originally estimated. It will also require further investigation which together with eventual construction repair work may result in disruptions to property operations while units are possibly taken out of service for testing and repairs. The cost of the repair work required to remediate this situation is currently estimated at between approximately $1.5 to $2 million. During the third quarter of fiscal 1998, bid application packages were distributed to pre-qualified contractors. The construction contracts were executed during the fourth quarter, and the repair and replacement work has commenced. This work is expected to be completed by late Fall 1998. During the first quarter of fiscal 1998, the Partnership filed a warranty claim against the manufacturer of the wood-composite siding used throughout Asbury Commons. During the second quarter, the Partnership filed a warranty claim against the manufacturer of the fiberglass-composite roofing shingles installed when the property was built. Subsequent to year-end, the manufacturer of the roofing shingles agreed to provide the Partnership with the materials to replace the existing roofing shingles. While there can be no assurances regarding the Partnership's ability to successfully recover any further damages relating to the siding and roofing shingles, the Partnership will diligently pursue these and other potential recovery sources. During the fourth quarter of fiscal 1998, the Partnership reached a settlement agreement with the original developer of the Asbury Commons property whereby the original developer agreed to pay the Partnership $200,000. Under the terms of this agreement, the Partnership received a payment of $100,000 during the fourth quarter of 1998, and received a final payment of $100,000 subsequent to year-end. The Partnership believes that it has adequate cash reserves to fund the repair work at Asbury Commons regardless of whether any additional recoveries are realized.
The average occupancy level at the Asbury Commons Apartments was 91% for the year ended March 31, 1998, unchanged from the prior fiscal year. In March 1997, a national property management firm was hired to take over management at Asbury Commons effective April 1, 1997. The property's management and leasing team is confident that the property will perform at average occupancies similar to comparable properties in the market, including newly constructed communities, once the repair program discussed above has been completed. The team has also indicated that effective rents can be increased at Asbury Commons through improved signage, targeted advertising and promotion, and selected unit interior upgrades. In order to attract prospective tenants, the property's management and leasing team has undertaken a number of marketing efforts which are expected to increase the number of prospective tenants looking to lease units at the property and retain as much of the existing resident base as possible. These efforts include the targeting of potential tenants at area corporations and relocation departments. In order to minimize tenant turnover, modest rental rate increases of 2% are being implemented as current leases are renewed. In addition, new tenants are being offered one month of free rent as an incentive to sign a 12-month lease on certain difficult to lease unit types in order to maximize the occupancy level.
The Gateway Plaza Shopping Center (formerly Loehmann's Plaza) in Overland Park, Kansas was 89% occupied throughout fiscal 1998, compared to an average level of 80% achieved during fiscal 1997. As previously reported, during fiscal 1997 the property's leasing team signed a 13,410 square foot lease, representing 9% of the Center's leasable area, with Gateway 2000 Country Stores to occupy the former Loehmann's space. Gateway 2000 Country Stores, a manufacturer and retailer of personal computers, opened its new store on June 30, 1997. The property's management team reports that customer traffic levels in the Center have increased since the openings of both the 13,410 square foot Gateway store and the re-opening of the expanded 13,000 square foot Alpine Hut store during the first quarter of fiscal 1998. During the third quarter of fiscal 1998, the property's leasing team signed a lease expansion and extension agreement with an existing 3,815 square foot tenant to occupy 4,830 square feet. The 1,015 square foot expansion area was carved out of the rear portion of an adjacent 2,958 square foot space that has been available for lease for over two years. The 2,958 square foot space has been difficult to lease due to its narrow but very deep configuration. With the signing of this expansion agreement, the leasing team is now marketing the more attractive 1,943 square foot front portion of this space. Subsequent to year-end, the leasing team also completed final negotiations with a tenant to lease a vacant 4,980 square foot space. Now that this lease is executed, only three spaces, comprising 5,879 square feet, or less than 4% of the Center remain available for lease.
A portion of the funds required to pay for the capital improvement work related to the leasing and expansion projects at Gateway Plaza was expected to come from a $550,000 Renovation and Occupancy Escrow withheld by the lender from the proceeds of a $4 million loan secured by the property which was obtained in February 1995. Funds were to be released from the Renovation and Occupancy Escrow to reimburse the venture for the costs of the planned renovations in the event that the venture satisfied certain requirements, which included specified occupancy and rental income thresholds. If such requirements were not met within 18 months from the date of the loan closing, the lender would have the right to apply the balance of the escrow account to the payment of loan principal. As of August 1996, 18 months from the date of the loan closing, such requirements had not been met. Therefore, the lender had the right to apply the balance of the escrow account to the payment of loan principal. In addition, the lender required that the Partnership unconditionally guaranty up to $1,400,000 of the loan obligation. This guaranty was to be released in the event that the joint venture satisfied the requirement for the release of the Renovation and Occupancy Escrow funds or upon the repayment, in full, of the entire outstanding mortgage loan liability. Once the Gateway store opened for business during fiscal 1998, the joint venture met the occupancy and rental income thresholds specified in the escrow agreement. Despite not meeting the thresholds in accordance with the timing set forth in the escrow agreement, during the third quarter of fiscal 1998 management requested and received the release of the Renovation and Occupancy Escrow Funds and the termination of the unconditional guaranty. The escrow funds, along with accumulated interest earnings, were distributed to the Partnership and were used to replenish cash reserves.
During the second quarter of fiscal 1998, the leasing team at the West Ashley Shoppes Shopping Center signed a lease for the previously vacant 36,416 square foot former Children's Palace space. As previously reported, Children's Palace closed its retail store at the center in May 1991 and subsequently filed for bankruptcy protection from creditors. This anchor space at West Ashley Shoppes had been vacant for the past six and a half years. The new tenant, Waccamaw, a national home goods retailer, opened its new store in March 1998 which brought the occupancy level at the property up to 95%. As Waccamaw should generate significant additional customer traffic into the Center, the leasing team anticipates stronger interest from prospective tenants for the remaining available 7,350 square feet of shop space.
The 625 North Michigan Office Building in Chicago, Illinois, was 88% leased on average for the year ended March 31, 1998, up slightly from the average of 87% achieved for fiscal 1997. As previously reported, the property's leasing team had been negotiating a lease with a prospective new tenant which would occupy approximately 22,000 square feet of space. Subsequent to year-end, a lease was signed with this prospective tenant for 24,276 square feet. The space is now being renovated in preparation for the tenant's expected occupancy in September 1998. Once this tenant moves into the building, the property's occupancy level will increase by 7%. Over the next year, ten leases representing a total of 22,024 square feet will expire. The property's leasing team expects that eight of these tenants occupying a total of 17,262 square feet will renew, and that the remaining space will be leased to new tenants. The downtown Chicago real estate market continues to display an improving trend. A competitive office property within the local market has recently obtained approvals to convert its lower floors into a hotel. This should result in the removal of 290,000 square feet of office space from the market. In addition, an office tenant at that property has recently completed a 62,000 square foot expansion, which brings the occupancy level in the building's office portion to 100%. In this local market, where there is no current or planned new construction of office space, this reduction in vacant office space has resulted in a reduction in the market vacancy level at March 31, 1998 to 12% and places more upward pressure on rental rates. The higher effective rents currently being achieved at 625 North Michigan are expected to increase cash flow and value as new tenants sign leases and existing tenants sign lease renewals in calendar year 1998. Retail and hotel development in the local market continues, as evidenced by plans for a Nordstrom's-anchored 95,000 square foot retail development which recently received preliminary approval from the city. This proposed development, which will be located two blocks from 625 North Michigan, is part of a master plan that includes several new hotels, entertainment and parking facilities encompassing five city blocks. Management continues to analyze a potential project for the property which includes an upgrade to the building lobby and the addition of a major retail component to the building's North Michigan Avenue frontage. Rental rates paid by high-end retailers on North Michigan Avenue are substantially greater than those paid by office tenants. While the costs of such a project would be substantial, it could have a significantly positive effect on the market value of the 625 North Michigan property. A comprehensive cost-benefit analysis of this potential project is expected to be completed over the next several months.
The four buildings comprising the Hacienda Business Park investment property in Pleasanton, California, were 94% leased to four tenants at the end of fiscal 1998. The overall market remains strong with increasing rental rates and a low vacancy level. Selective development in the area is continuing as a result of this low vacancy level. Construction of two new Pleasanton build-to-suit office developments, totalling 410,000 square feet, was completed during the fourth quarter of fiscal 1998. Two other office projects totalling 435,000 square feet are under construction in this market. One of these properties is 100% pre-leased and the other is 95% pre-leased. In addition, Peoplesoft Corporation, a major employer in the local market, purchased 17 acres in Hacienda Business Park and has begun construction of an owner/user campus totalling 350,000 square feet. The project is expected to be completed within the next several months. The existing rental rates on the leases at Hacienda Park are significantly below current market rates. Provided there is not a dramatic increase in either planned speculative development or build-to-suit development with current tenants in the local market, the Partnership would be expected to achieve a materially higher sale price for the Hacienda Park property as the existing leases with below-market rental rates approach their expiration dates. The Partnership had been planning to hold the Hacienda Park property over the near term in order to capture this expected increase in value. However, during the quarter ended September 30, 1997, a 51,683 square foot tenant occupying 28% of the property's leasable area relocated from Hacienda Business Park and consolidated its operations into a newly-constructed building in the local market. This tenant has several leases with expiration dates in 1998, 1999 and 2001 and fully leases one of the four buildings comprising the Hacienda Park investment plus 10,027 square feet in an adjoining building. While this tenant has the right to sublease the space, subject to various approval rights, it remains responsible for rental payments and its contractual share of operating expenses until the leases expire. During the fourth quarter of fiscal 1998, the Partnership accepted a net payment of $34,000 from this tenant in return for a release from all of the tenant's obligations under the 10,027 square foot lease that was scheduled to expire in January 2001. In addition, this tenant waived its sub-lease and renewal rights on the remaining five leases which expire within the next 12 months. This lease termination agreement is expected to provide the property's leasing team with more flexibility in re-leasing the space and may provide the Partnership with an opportunity to capture a significant portion of the expected increase in the value of Hacienda Park sooner than had been anticipated. In light of this situation, and given the current strength of the local market conditions, management is currently reviewing the Pleasanton office market and has interviewed potential real estate brokers in preparation for a possible marketing effort during the second half of calendar 1998.
The average occupancy level at The Gables Apartments was 95% for the year ended March 31, 1998, compared to 93% for the previous year. The high occupancy figures, coupled with favorable rental rate growth over the past year, reflect a healthy demand for apartments resulting from strong job, household formation and population growth in the Richmond, Virginia market. As job growth is projected to continue during the next few years, the economic outlook for Richmond remains positive. Two significant new employers in the Richmond market include the White Oaks semiconductor plant, which is nearly completed and projected to employ 1,500 people, and the recently completed Capital One credit facility, which will employ up to 1,000 people. While there are three apartment communities, comprising approximately 900 units, under construction in the local market, only one 280-unit community is considered competition for The Gables Apartments. The other communities are located at least five miles from The Gables and offer larger units at significantly higher rents. Given the currently favorable market conditions in Richmond and for apartment properties in general, management has decided to market The Gables Apartments for sale in calendar year 1998. During the quarter ended March 31, 1998, the Partnership and its co-venture partner held discussions concerning marketing strategies for selling The Gables Apartments. As a follow-up to these discussions, the Partnership and its co-venture partner solicited marketing proposals from area real estate brokerage firms. After reviewing these proposals and conducting interviews, the Partnership and its co-venture partner selected a regional brokerage firm subsequent to year-end. A marketing package has been prepared, and comprehensive sale efforts began in late May 1998.
At March 31, 1998, the Partnership and its consolidated joint ventures had available cash and cash equivalents of approximately $6,202,000. Such cash and cash equivalent amounts will be utilized for the working capital requirements of the Partnership, for reinvestment in certain of the Partnership's properties, including the anticipated construction repair work at Asbury Commons and the capital needs of the Partnership's commercial properties (as discussed further above), and for distributions to the partners. The source of future liquidity and distributions to the partners is expected to be through cash generated from operations of the Partnership's income-producing investment properties and proceeds received from the sale or refinancing of such properties. Such sources of liquidity are expected to be sufficient to meet the Partnership's needs on both a short-term and long-term basis.
As noted above, the Partnership expects to be liquidated within the next 2- to -3 years. Notwithstanding this, the Partnership believes that it has made all necessary modifications to its existing systems to make them year 2000 compliant and does not expect that additional costs associated with year 2000 compliance, if any, will be material to the Partnership's results of operations or financial position.
Results of Operations 1998 Compared to 1997 - ---------------------
The Partnership reported a net loss of $263,000 for fiscal 1998 as compared to a net loss of $3,266,000 in fiscal 1997. This $3,003,000 decrease in net loss is a result of a decrease in the Partnership's operating loss of $2,676,000 and an increase in the Partnership's share of unconsolidated ventures' income of $345,000. The decrease in operating loss was primarily a result of the recognition of an impairment loss of $2,700,000 on the carrying value of the consolidated West Ashley Shoppes property during fiscal 1997. In addition, rental income and expense reimbursements from the consolidated joint ventures increased by $73,000 and depreciation expense decreased by $64,000. Rental income and expense reimbursements increased as a result of an increase in rental income of $54,000 and an increase in expense reimbursements of $166,000 at the Hacienda Park joint venture. These increases were the result of an increase in rental rates and the timing of certain real estate tax reimbursements and expense escalation billings. This increase in rental income and expense reimbursements at Hacienda Park was partially offset by a decrease in rental income at Asbury Commons of $125,000 which was partly due to an increase in leasing concessions granted during the current year in order to maintain occupancy levels at the property, as discussed further above. Depreciation expense decreased mainly as a result of a decrease in deprecation at West Ashley Shoppes. Depreciation decreased at this consolidated joint venture due to the lower depreciable basis of the venture's operating property due to the impairment loss recognized in the prior year. The decrease in impairment loss, the increase in rental income and expense reimbursements and the decrease in depreciation expense were partially offset by increases in general and administrative and property operating expenses of $104,000 and $91,000, respectively. General and administrative expenses increased primarily due to an increase in certain required professional fees, including legal fees related to the examination of potential recovery sources for repair costs at the Asbury Commons Apartments, as discussed further above. Property operating expenses increased primarily due to increases in repairs and maintenance expenses at Hacienda Park and West Ashley Shoppes and administrative expenses at Asbury Commons. Repairs and maintenance expense increased at Hacienda Park due to the replacement of an aging lawn sprinkler system. Repairs and maintenance increased at West Ashley Shoppes due to roof repairs. Administrative expenses increased at Asbury Commons mainly as a result of an increase in advertising costs.
The increase in the Partnership's share of unconsolidated ventures' income of $345,000 was primarily the result of an increase in the Partnership's share of income from the Gateway Plaza Shopping Center (formerly Loehmann's Plaza) of $349,000. The increase in net income from Gateway Plaza was the result of an increase in rental income of $316,000. Rental income increased mainly due to the 13,410 square foot lease, representing 9% of the Center's leasable area, signed with Gateway 2000 Country Stores which took occupancy in June 1997, as discussed further above. In addition, net income increased at The Gables joint venture by $59,000 for the current year. Net income increased at this joint venture due to an increase in rental income resulting from an increase in average occupancy during the year. The increases in net income at Gateway Plaza Shopping Center and The Gables were partially offset by a decrease in net income at 625 North Michigan of $54,000. Net income at 625 North Michigan decreased as a result of increases in real estate taxes and repairs and maintenance expenses of $147,000 and $149,000, respectively. Real estate taxes increased due to an increase in the assessed value of the 625 North Michigan property. Repairs and maintenance expense increased mainly due to the modernization of the building's elevator controls which was completed during the current year.
1997 Compared to 1996 - ---------------------
The Partnership reported a net loss of $3,266,000 for the fiscal year ended March 31, 1997 as compared to net income of $5,523,000 for the prior year. This unfavorable change in the Partnership's net operating results was primarily due to the gains recognized on the sales of the Richland Terrace/Richmond Park and Treat Commons II properties during fiscal 1996 and the loss on the impairment of the West Ashley Shoppes property recognized in fiscal 1997, as discussed further above. The Partnership's share of the gains on the sale of the Richland Terrace/Richmond Park and Treat Commons II properties in fiscal 1996 (including the write-off of unamortized excess basis) was $4,344,000 and $2,422,000, respectively. As noted above, during fiscal 1997 the Partnership recognized an impairment loss on the carrying value of the consolidated West Ashley Shoppes property of $2,700,000.
These unfavorable changes in the Partnership's net operating results were partially offset by an increase in rental income and expense reimbursements and reductions in interest expense and property operating expenses from the consolidated joint ventures, along with a decline in Partnership general and administrative expenses. Rental revenues increased primarily due to a $280,000 increase in income at Hacienda Park due to an increase in both the property's average occupancy level and rental rates. Occupancy at Hacienda Park averaged 100% for fiscal 1997 as compared to 98% for the prior year while the property's average rental rate increased substantially due to the expansion of a major tenant and a lease renewal of another major tenant, both at substantially higher rates. Small increases in rental revenues at the other two consolidated properties, Asbury Commons and West Ashley Shoppes, also contributed to the increase in total rental revenues for fiscal 1997. Interest expense declined mainly due to the write off of certain unamortized deferred loan costs attributable to the pay off zero coupon loans refinanced in fiscal 1996. The decline in property operating expenses was mainly attributable to a reduction in repairs and maintenance costs at the consolidated West Ashley Shoppes joint venture. Partnership general and administrative expenses decreased primarily due to the additional professional fees incurred in fiscal 1996 associated with the sales of the Treat Commons, Richland Terrace and Richmond Park properties, as well as a reduction in certain other required professional fees during fiscal 1997.
The Partnership's share of unconsolidated ventures' income, excluding the gains recognized from the sale of Treat Commons II, Richland Terrace and Richmond Park in fiscal 1996, increased by $198,000 primarily due to an increase of $81,000 in rental revenues from The Gables Apartments, an increase in other income of $71,000 at the 625 North Michigan joint venture, a reduction of $86,000 in interest expense from the Loehmann's Plaza joint venture and declines in property operating expenses at all three remaining unconsolidated joint ventures. This favorable change occurred despite the fact that the Partnership's share of unconsolidated ventures' income in fiscal 1996 included the operations of the Richland Terrace and Richmond Park properties which were sold on November 2, 1995 and Treat Commons II which was sold on December 29, 1995. Rental revenues at The Gables improved due to increases in both average occupancy and rental rates due to improving market conditions. Rental revenues were down slightly at both 625 North Michigan and Loehmann's Plaza due to declines in occupancy. The reduction in interest expense at the Loehmann's Plaza joint venture was due to the fact that a portion of the venture's interest costs were capitalized during fiscal 1997 as a result of the property expansion and renovation project. The declines in property operating expenses include a $114,000 reduction in bad debt expense at Loehmann's Plaza, a decrease of $35,000 in repairs and maintenance expenses at 625 North Michigan and declines in salary and utility expenses totalling $49,000 at The Gables. The favorable changes in rental revenues, other income, interest expense and property operating expenses were partially offset by an increase of $207,000 in real estate tax expense of the 625 North Michigan joint venture during fiscal 1997.
1996 Compared to 1995 - ---------------------
The Partnership reported a net income of $5,523,000 for the fiscal year ended March 31, 1996 as compared to a net loss of $304,000 for fiscal 1995. This favorable change in the Partnership's net operating results was primarily due to the gains recognized on the sales of the Richland Terrace/Richmond Park and Treat Commons II properties during fiscal 1996. The sale of the Richland Terrace and Richmond Park Apartments generated a gain of $4,774,000 for the unconsolidated joint venture which owned the properties. The sale of the Treat Commons II Apartments resulted in a gain of $3,594,000 for the related unconsolidated joint venture. The Partnership's share of such gains (including the write-off of unamortized excess basis) was $4,344,000 and $2,422,000, respectively. Also contributing to the favorable change in net operating results was a decrease in the Partnership's operating loss of $721,000 in fiscal 1996.
The Partnership's operating loss decreased primarily due to the change in the entity reporting the interest expense associated with the borrowings secured by the Partnership's operating investment properties and the lower interest rates on the refinanced loans. As discussed further in the notes to the Partnership's financial statements which accompany this Annual Report, all of the zero coupon loans secured by the operating investment properties, except for the loan secured by the 625 North Michigan Office Building, were refinanced by the respective joint venture partnerships in fiscal 1995. As part of such refinancing transactions, the proceeds of new loans issued in the names of the joint ventures were used to repay debt which had been issued in the name of the Partnership, which effectively decreased the Partnership's interest expense while at the same time increasing the interest expense of the respective joint ventures. For the unconsolidated joint ventures, such increase in interest expense was reflected in the Partnership's share of unconsolidated ventures' income on the Partnership's fiscal 1996 consolidated statement of operations. The Partnership's operating loss, prior to the effect of the change in interest expense, increased by $34,000 primarily due to an increase in rental revenues which was partially offset by an increase in depreciation and amortization expense. Rental revenues increased at the consolidated Hacienda Park joint venture by $228,000 primarily due to increases in average occupancy from a level of 85% in calendar 1994 to 95% for calendar 1995. Rental revenues at Asbury Commons increased by $166,000 primarily due to increases in rental rates in calendar 1994 and 1995 made possible by the strong Atlanta market. The average occupancy level at the Asbury Commons Apartments actually declined from 96% for calendar 1994 to 94% for calendar 1995. Revenues at West Ashley Shoppes improved by $100,000 in calendar 1995, as compared to calendar 1994, due to a slight increase in average occupancy and an increase in tenant reimbursement income. Depreciation and amortization expense increased by $378,000 in fiscal 1996 due to the acceleration of depreciation on the consolidated Hacienda Park property, as discussed further in the notes to the accompanying financial statements, and the capitalized tenant improvements and leasing commissions associated with the increased leasing activity at Hacienda Park.
The Partnership's share of unconsolidated ventures' income, excluding the gains recognized from the sale of Treat Commons II, Richland Terrace and Richmond Park, decreased by $1,633,000 primarily due to an increase of $1,226,000 in interest expense recorded by the unconsolidated joint ventures associated with the refinancings referred to above. In addition, the combined effect of a decrease in rental revenues and an increase in depreciation and amortization expense contributed to the unfavorable change in the Partnership's share of unconsolidated ventures' income. Rental revenues decreased by $360,000 due to a decrease in average occupancy levels at Loehmann's Plaza, from 96% for calendar 1994 to 89% for calendar 1995, primarily due to a buyout of the property's anchor tenant lease. In addition, the fiscal 1996 results include less than twelve months of operations for the Richland Terrace and Richmond Park properties which were sold on November 2, 1995. Increases in occupancy at 625 North Michigan and Treat Commons II, as well as increases in rental rates at Richmond Gables, helped offset a portion of the above decrease in rental revenues. Average occupancy at 625 North Michigan increased from 83% in calendar 1994 to 88% in calendar 1995 due to a strengthening Chicago office market. Increases in average occupancy at Treat Commons II resulted from the strong local market which contributed to management's decision to sell the property. Depreciation and amortization expense increased by $274,000 mainly due to an acceleration of the depreciation rate at 625 North Michigan and additional capital improvements made to the Loehmann's Plaza property during fiscal 1996.
Certain Factors Affecting Future Operating Results - --------------------------------------------------
The following factors could cause actual results to differ materially from historical results or those anticipated:
Real Estate Investment Risks. Real property investments are subject to varying degrees of risk. Revenues and property values may be adversely affected by the general economic climate, the local economic climate and local real estate conditions, including (i) the perceptions of prospective tenants of the attractiveness of the property; (ii) the ability to retain qualified individuals to provide adequate management and maintenance of the property; (iii) the inability to collect rent due to bankruptcy or insolvency of tenants or otherwise; and (iv) increased operating costs. Real estate values may also be adversely affected by such factors as applicable laws, including tax laws, interest rate levels and the availability of financing.
Effect of Uninsured Loss. The Partnership carries comprehensive liability, fire, flood, extended coverage and rental loss insurance with respect to its properties with insured limits and policy specifications that management believes are customary for similar properties. There are, however, certain types of losses (generally of a catastrophic nature such as wars, floods or earthquakes) which may be either uninsurable, or, in management's judgment, not economically insurable. Should an uninsured loss occur, the Partnership could lose both its invested capital in and anticipated profits from the affected property.
Possible Environmental Liabilities. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may become liable for the costs of the investigation, removal and remediation of hazardous or toxic substances on, under, in or migrating from such property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances.
The Partnership is not aware of any notification by any private party or governmental authority of any non-compliance, liability or other claim in connection with environmental conditions at any of its properties that it believes will involve any expenditure which would be material to the Partnership, nor is the Partnership aware of any environmental condition with respect to any of its properties that it believes will involve any such material expenditure. However, there can be no assurance that any non-compliance, liability, claim or expenditure will not arise in the future.
Remediation of Construction Defects. As discussed further above, during fiscal 1997 management discovered the existence of certain structural problems at the Asbury Commons Apartments. Based upon an initial evaluation, the remediation of these problems may involve the disruption of property operations while apartment units are possibly taken out of service for testing and repairs. The magnitude of the repairs have been preliminarily estimated to cost between approximately $1.5 million to $2 million to complete. The prospects for any recoveries of these costs, beyond the $200,000 recovered from the original developer during fiscal 1998, from insurance or from the building materials manufacturers are uncertain at the present time. Furthermore, while management believes that these problems can be remediated without a long-term impact on the market value of the property, there can be no assurances that the disruption of property operations and the repair process itself will not adversely impact the Partnership's ability to realize the fair market value of the investment property within the next 2- to- 3 years, which is the expected time frame for the completion of a liquidation of the Partnership.
Competition. The financial performance of the Partnership's remaining real estate investments will be significantly impacted by the competition from comparable properties in their local market areas. The occupancy levels and rental rates achievable at the properties are largely a function of supply and demand in the markets. In many markets across the country, development of new multi-family properties has increased significantly over the past two years. Existing apartment properties in such markets could be expected to experience increased vacancy levels, declines in effective rental rates and, in some cases, declines in estimated market values as a result of the increased competition. The commercial office segment has begun to experience limited new development activity in selected areas after several years of virtually no new supply being added to the market. The retail segment of the real estate market is currently suffering from an oversupply of space in many markets resulting from overbuilding in recent years and the trend of consolidations and bankruptcies among retailers prompted by the generally flat rate of growth in overall retail sales. There are no assurances that these competitive pressures will not adversely affect the operations and/or market values of the Partnership's investment properties in the future.
Impact of Joint Venture Structure. The ownership of certain of the remaining investments through joint venture partnerships could adversely impact the timing of the Partnership's planned dispositions of its remaining assets and the amount of proceeds received from such dispositions. It is possible that the Partnership's co-venture partners could have economic or business interests which are inconsistent with those of the Partnership. Given the rights which both parties have under the terms of the joint venture agreements, any conflict between the partners could result in delays in completing a sale of the related operating property and could lead to an impairment in the marketability of the property to third parties for purposes of achieving the highest possible sale price. In the cases of the Hacienda Park, Asbury Commons and West Ashley Shoppes joint ventures, the co-venture partner is the Managing General Partner of the Partnership as a result of certain prior assignment transactions. No such conflicts should exist on these investments.
Availability of a Pool of Qualified Buyers. The availability of a pool of qualified and interested buyers for the Partnership's remaining assets is critical to the Partnership's ability to realize the estimated fair market values of such properties at the time of their final dispositions. Demand by buyers of multi-family apartment, office and retail properties is affected by many factors, including the size, quality, age, condition and location of the subject property, the quality and stability of the tenant roster, the terms of any long-term leases, potential environmental liability concerns, the existing debt structure, the liquidity in the debt and equity markets for asset acquisitions, the general level of market interest rates and the general and local economic climates.
Inflation - ---------
The Partnership completed its eleventh full year of operations in fiscal 1998. The effects of inflation and changes in prices on the Partnership's operating results to date have not been significant.
Inflation in future periods may increase revenues as well as operating expenses at the Partnership's operating investment properties. Most of the existing leases with tenants at the Partnership's shopping centers and office buildings contain rental escalation and/or expense reimbursement clauses based on increases in tenant sales or property operating expenses. Tenants at the Partnership's apartment properties have short-term leases, generally of one year or less in duration. Rental rates at these properties can be adjusted to keep pace with inflation, to the extent market conditions allow, as the leases are renewed or turned over. Such increases in rental income would be expected to at least partially offset the corresponding increases in Partnership and property operating expenses resulting from inflation. As noted above, the West Ashley Shoppes, Gateway Plaza and 625 North Michigan properties have, or have had in recent years, a significant amount of unleased space. During a period of significant inflation, increased operating expenses attributable to space which remained unleased at such time would not be recoverable and would adversely affect the Partnership's net cash flow.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data are included under Item 14 of this Annual Report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Partnership
The Managing General Partner of the Partnership is Second Equity Partners, Inc., a Virginia corporation, which is a wholly-owned subsidiary of PaineWebber Group, Inc. The Associate General Partner of the Partnership is Properties Associates 1986, L.P., a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner. The Managing General Partner has overall authority and responsibility for the Partnership's operations.
(a) and (b) The names and ages of the directors and principal executive officers of the Managing General Partner of the Partnership are as follows: Date elected Name Office Age to Office ---- ------ --- ---------
Bruce J. Rubin President and Director 38 8/22/96 Terrence E. Fancher Director 44 10/10/96 Walter V. Arnold Senior Vice President and Chief Financial Officer 50 10/29/85 David F. Brooks First Vice President and Assistant Treasurer 55 4/17/85 * Timothy J. Medlock Vice President and Treasurer 37 6/1/88 Thomas W. Boland Vice President and Controller 35 12/1/91
* The date of incorporation of the Managing General Partner.
(c) There are no other significant employees in addition to the directors and executive officers mentioned above.
(d) There is no family relationship among any of the foregoing directors or executive officers of the Managing General Partner of the Partnership. All of the foregoing directors and executive officers have been elected to serve until the annual meeting of the Managing General Partner.
(e) All of the directors and officers of the Managing General Partner hold similar positions in affiliates of the Managing General Partner, which are the corporate general partners of other real estate limited partnerships sponsored by PWI, and for which PaineWebber Properties Incorporated serves as the investment adviser. The business experience of each of the directors and principal executive officers of the Managing General Partner is as follows:
Bruce J. Rubin is President and Director of the Managing General Partner. Mr. Rubin was named President and Chief Executive Officer of PWPI in August 1996. Mr. Rubin joined PaineWebber Real Estate Investment Banking in November 1995 as a Senior Vice President. Prior to joining PaineWebber, Mr. Rubin was employed by Kidder, Peabody and served as President for KP Realty Advisers, Inc. Prior to his association with Kidder, Mr. Rubin was a Senior Vice President and Director of Direct Investments at Smith Barney Shearson. Prior thereto, Mr. Rubin was a First Vice President and a real estate workout specialist at Shearson Lehman Brothers. Prior to joining Shearson Lehman Brothers in 1989, Mr. Rubin practiced law in the Real Estate Group at Willkie Farr & Gallagher. Mr. Rubin is a graduate of Stanford University and Stanford Law School.
Terrence E. Fancher was appointed a Director of the Managing General Partner in October 1996. Mr. Fancher is the Managing Director in charge of PaineWebber's Real Estate Investment Banking Group. He joined PaineWebber as a result of the firm's acquisition of Kidder, Peabody. Mr. Fancher is responsible for the origination and execution of all of PaineWebber's REIT transactions, advisory assignments for real estate clients and certain of the firm's real estate debt and principal activities. He joined Kidder, Peabody in 1985 and, beginning in 1989, was one of the senior executives responsible for building Kidder, Peabody's real estate department. Mr. Fancher previously worked for a major law firm in New York City. He has a J.D. from Harvard Law School, an M.B.A. from Harvard Graduate School of Business Administration and an A.B. from Harvard College.
Walter V. Arnold is a Senior Vice President and Chief Financial Officer of the Managing General Partner and Senior Vice President and Chief Financial Officer of the Adviser which he joined in October 1985. Mr. Arnold joined PWI in 1983 with the acquisition of Rotan Mosle, Inc. where he had been First Vice President and Controller since 1978, and where he continued until joining the Adviser. Mr. Arnold is a Certified Public Accountant licensed in the state of Texas.
David F. Brooks is a First Vice President and Assistant Treasurer of the Managing General Partner and a First Vice President and an Assistant Treasurer of the Adviser which he joined in March 1980. From 1972 to 1980, Mr. Brooks was an Assistant Treasurer of Property Capital Advisors, Inc. and also, from March 1974 to February 1980, the Assistant Treasurer of Capital for Real Estate, which provided real estate investment, asset management and consulting services.
Timothy J. Medlock is a Vice President and Treasurer of the Managing General Partner and Vice President and Treasurer of the Adviser which he joined in 1986. From June 1988 to August 1989, Mr. Medlock served as the Controller of the Managing General Partner and the Adviser. From 1983 to 1986, Mr. Medlock was associated with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate University in 1983 and received his Masters in Accounting from New York University in 1985.
Thomas W. Boland is a Vice President and Controller of the Managing General Partner and a Vice President and Controller of the Adviser which he joined in 1988. From 1984 to 1987, Mr. Boland was associated with Arthur Young & Company. Mr. Boland is a Certified Public Accountant licensed in the state of Massachusetts. He holds a B.S. in Accounting from Merrimack College and an M.B.A. from Boston University.
(f) None of the directors and officers was involved in legal proceedings which are material to an evaluation of his or her ability or integrity as a director or officer.
(g) Compliance With Exchange Act Filing Requirements: The Securities Exchange Act of 1934 requires the officers and directors of the Managing General Partner, and persons who own more than ten percent of the Partnership's limited partnership units, to file certain reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and ten-percent beneficial holders are required by SEC regulations to furnish the Partnership with copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it, the Partnership believes that, during the year ended March 31, 1998, all filing requirements applicable to the officers and directors of the Managing General Partner and ten-percent beneficial holders were complied with.
Item 11.
Item 11. Executive Compensation
The directors and officers of the Partnership's Managing General Partner receive no current or proposed remuneration from the Partnership.
The General Partners are entitled to receive a share of Partnership cash distributions and a share of profits and losses. These items are described in Item 13.
The Partnership paid cash distributions to the Limited Partners on a quarterly basis at a rate of 5.25% per annum on invested capital from January 1, 1991 through the quarter ended June 30, 1994 and at a rate of 2% per annum on invested capital from July 1, 1994 through September 30, 1995. Effective with the payment for the quarter ended December 31, 1995, the annualized distribution rate was reduced to 1% on a Limited Partner's remaining capital account, where it has remained through fiscal 1998. However, the Partnership's Limited Partnership Units are not actively traded on any organized exchange, and accordingly, no accurate price information exists for these Units. Therefore, a presentation of historical Unitholder total returns would not be meaningful.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) The Partnership is a limited partnership issuing Units of limited partnership interest, not voting securities. All the outstanding stock of the Managing General Partner, Second Equity Partners Fund, Inc. is owned by PaineWebber. Properties Associates 1986, L.P., the Associate General Partner, is a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner. No limited partner is known by the Partnership to own beneficially more than 5% of the outstanding interests of the Partnership.
(b) The directors and officers of the Managing General Partner do not directly own any Units of limited partnership interest of the Partnership. No director or officer of the Managing General Partner, nor any limited partner of the Associate General Partner, possesses a right to acquire beneficial ownership of Units of limited partnership interest of the Partnership.
(c) There exists no arrangement, 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
All distributable cash, as defined, for each fiscal year shall be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners until the Limited Partners have received an amount equal to a 7.5% noncumulative annual return on their adjusted capital contributions. The General Partners will then receive distributions until they have received an amount equal to 1.01% of total distributions of distributable cash which has been made to all partners and PWPI has received an amount equal to 3.99% of all distributions to all partners. The balance will be distributed 95% to the Limited Partners, 1.01% to the General Partners and 3.99% to PWPI. Payments to PWPI represent asset management fees for PWPI's services in managing the business of the Partnership. No management fees were earned for the fiscal year ended March 31, 1998. All sale or refinancing proceeds shall be distributed in varying proportions to the Limited and General Partners, as specified in the amended Partnership Agreement.
All taxable income (other than from a Capital Transaction) in each year will be allocated to the Limited Partners and the General Partners in proportion to the amounts of distributable cash distributed to them (excluding the asset management fee) in that year or, if there are no distributions of distributable cash, 98.95% to the Limited Partners and 1.05% to the General Partners. All tax losses (other than from a Capital Transaction) will be allocated 98.95% to the Limited Partners and 1.05% to the General Partners. Taxable income or tax loss arising from a sale or refinancing of investment properties will be allocated to the Limited Partners and the General Partners in proportion to the amounts of sale or refinancing proceeds to which they are entitled; provided that the General Partners shall be allocated at least 1% of taxable income arising from a sale or refinancing. If there are no sale or refinancing proceeds, tax loss or taxable income from a sale or refinancing will be allocated 98.95% to the Limited Partners and 1.05% to the General Partner. Allocations of the Partnership's operations between the General Partners and the Limited Partners for financial accounting purposes have been made in conformity with the allocations of taxable income or tax loss.
The Managing General Partner and its affiliates are reimbursed for their direct expenses relating to the offering of Units, the administration of the Partnership and the acquisition and operations of the Partnership's operating property investment.
An affiliate of the Adviser performs certain accounting, tax preparation, securities law compliance and investor communications and relations services for the Partnership. The total costs incurred by this affiliate in providing such services are allocated among several entities, including the Partnership. Included in general and administrative expenses for the year ended March 31, 1998 is $230,000, representing reimbursements to this affiliate of the Managing General Partner for providing such services to the Partnership.
The Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins") for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $17,000 included in general and administrative expenses for managing the Partnership's cash assets during fiscal 1998. Fees charged by Mitchell Hutchins are based on a percentage of invested cash reserves which varies based on the total amount of invested cash which Mitchell Hutchins manages on behalf of the PWPI.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this report:
(1) and (2) Financial Statements and Schedules:
The response to this portion of Item 14 is submitted as a separate section of this Report. See Index to Financial Statements and Financial Statement Schedules at page.
(3) Exhibits:
The exhibits on the accompanying index to exhibits at page IV-3 are filed as part of this Report.
(b) No reports on Form 8-K were filed during the last quarter of fiscal 1998.
(c) Exhibits
See (a)(3) above.
(d) Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate section of this Report. See Index to Financial Statements and Financial Statement Schedules at page.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP
By: Second Equity Partners, Inc. --------------------------- Managing General Partner
By: /s/ Bruce J. Rubin ------------------ Bruce J. Rubin President and Chief Executive Officer
By: /s/ Walter V. Arnold -------------------- Walter V. Arnold Senior Vice President and Chief Financial Officer
By: /s/ Thomas W. Boland -------------------- Thomas W. Boland Vice President and Controller
Dated: June 26, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Partnership and in the capacities and on the dates indicated.
By:/s/ Bruce J. Rubin Date: June 26, 1998 --------------------------- ------------- Bruce J. Rubin Director
By:/s/ Terrence E. Fancher Date: June 26, 1998 ----------------------------- ------------- Terrence E. Fancher Director
Other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements, including the notes thereto.
REPORT OF INDEPENDENT AUDITORS
The Partners PaineWebber Equity Partners Two Limited Partnership:
We have audited the accompanying consolidated balance sheets of PaineWebber Equity Partners Two Limited Partnership as of March 31, 1998 and 1997, and the related consolidated statements of operations, changes in partners' capital (deficit), and cash flows for each of the three years in the period ended March 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule 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, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PaineWebber Equity Partners Two Limited Partnership at March 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/S/ ERNST & YOUNG LLP --------------------- ERNST & YOUNG LLP
Boston, Massachusetts June 12, 1998
PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS March 31, 1998 and 1997 (In thousands, except for per Unit data)
ASSETS 1998 1997 ---- ---- Operating investment properties: Land $ 7,351 $ 7,351 Building and improvements 40,616 40,018 --------- ---------- 47,967 47,369 Less accumulated depreciation (14,044) (12,155) --------- ---------- 33,923 35,214
Investments in unconsolidated joint ventures, at equity 30,237 31,784 Cash and cash equivalents 6,202 5,322 Escrowed cash 398 279 Accounts receivable 236 151 Prepaid expenses 31 50 Deferred rent receivable 737 832 Deferred expenses, net of accumulated amortization of $883 ($734 in 1997) 510 646 --------- ---------- $ 72,274 $ 74,278 ========= ==========
LIABILITIES AND PARTNERS' CAPITAL
Accounts payable and accrued expenses $ 427 $ 271 Net advances from consolidated ventures 115 400 Tenant security deposits 111 116 Bonds payable 2,171 2,297 Mortgage notes payable 19,369 19,650 Other liabilities 331 331 --------- ---------- Total liabilities 22,524 23,065
Partners' capital: General Partners: Capital contributions 1 1 Cumulative net income 158 161 Cumulative cash distributions (713) (701)
Limited Partners ($1 per Unit; 134,425,741 Units issued): Capital contributions, net of offering costs 119,747 119,747 Cumulative net income 15,309 15,569 Cumulative cash distributions (84,752) (83,564) --------- ---------- Total partners' capital 49,750 51,213 --------- ---------- $ 72,274 $ 74,278 ========= ==========
See accompanying notes.
PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS For the years ended March 31, 1998, 1997 and 1996 (In thousands, except for per Unit data)
1998 1997 1996 ---- ---- ---- Revenues: Rental income and expense reimbursements $ 5,084 $ 5,011 $ 4,706 Interest and other income 403 358 363 ------- -------- ------- 5,487 5,369 5,069 Expenses: Loss on impairment of operating investment property - 2,700 - Interest expense 1,961 1,990 2,083 Depreciation expense 1,889 1,953 1,886 Property operating expenses 1,370 1,279 1,320 Real estate taxes 521 479 422 General and administrative 632 528 729 Amortization expense 105 107 137 ------- -------- ------- 6,478 9,036 6,577 ------- -------- -------
Operating loss (991) (3,667) (1,508)
Venture partner's share of consolidated venture's operations - 18 -
Investment income: Partnership's share of unconsolidated ventures' income 728 383 185 Interest income on note receivable from unconsolidated venture - - 80 Partnership's share of gains on sale of unconsolidated operating investment properties - - 6,766 ------- -------- ------- 728 383 7,031 ------- -------- ------- Net income (loss) $ (263) $ (3,266) $ 5,523 ======= ======== =======
Net income (loss) per 1,000 Limited Partnership Units $ (1.94) $(24.04) $40.68 ======= ======= ======
Cash distributions per 1,000 Limited Partnership Units $ 8.84 $ 8.84 $77.52 ======= ======= ======
The above per 1,000 Limited Partnership Units information is based upon the 134,425,741 Limited Partnership Units outstanding during each year.
See accompanying notes.
PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) For the years ended March 31, 1998, 1997 and 1996 (In thousands)
General Limited Partners Partners Total -------- -------- -----
Balance at March 31, 1995 $ (527) $61,126 $ 60,599
Cash distributions (22) (10,421) (10,443)
Net income 55 5,468 5,523 ------ ------- --------
Balance at March 31, 1996 (494) 56,173 55,679
Cash distributions (13) (1,187) (1,200)
Net loss (32) (3,234) (3,266) ------ ------- --------
Balance at March 31, 1997 (539) 51,752 51,213
Cash distributions (12) (1,188) (1,200)
Net loss (3) (260) (263) ------ ------- --------
Balance at March 31, 1998 $ (554) $50,304 $ 49,750 ====== ======= ========
See accompanying notes.
See accompanying notes.
PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Nature of Operations -------------------------------------
PaineWebber Equity Partners Two Limited Partnership (the "Partnership") is a limited partnership organized pursuant to the laws of the State of Virginia on May 16, 1986 for the purpose of investing in a diversified portfolio of existing, newly-constructed or to-be-built income-producing real properties. The Partnership authorized the issuance of a maximum of 150,000,000 Partnership Units (the "Units") of which 134,425,741 Units, representing capital contributions of $134,425,741, were subscribed and issued between June 1986 and June 1988.
The Partnership originally invested approximately $132,200,000 (net of acquisition fees) in ten operating properties through joint venture investments. Through March 31, 1998, four of these investments had been sold. The Partnership retains an interest in six operating properties, which are comprised of two multi-family apartment complexes, two office/R&D complexes and two retail shopping centers. The Partnership is currently focusing on potential disposition strategies for the investments in its portfolio. Although no assurances can be given, it is currently contemplated that sales of the Partnership's remaining assets could be completed within the next 2- to 3- years.
2. Use of Estimates and Summary of Significant Accounting Policies ---------------------------------------------------------------
The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of March 31, 1998 and 1997 and revenues and expenses for each of the three years in the period ended March 31, 1998. Actual results could differ from the estimates and assumptions used.
The accompanying financial statements include the Partnership's investments in certain joint venture partnerships which own or owned operating properties. Except as described below, the Partnership accounts for its investments in joint ventures using the equity method because the Partnership does not have majority voting control in the ventures. Under the equity method the ventures are carried at cost adjusted for the Partnership's share of the ventures' earnings or losses and distributions. All of the joint venture partnerships are required to maintain their accounting records on a calendar year basis for income tax reporting purposes. As a result, the Partnership recognizes its share of the earnings or losses from the unconsolidated joint ventures based on financial information which is three months in arrears to that of the Partnership. See Note 5 for a description of the unconsolidated joint venture partnerships.
As discussed further in Note 4, the Partnership acquired control of Hacienda Park Associates on December 10, 1991 and the Atlanta Asbury Partnership on February 14, 1992. In addition, the Partnership acquired control of West Ashley Shoppes Associates in May of 1994. Accordingly, these joint ventures are presented on a consolidated basis in the accompanying financial statements. As discussed above, these joint ventures also have a December 31 year-end and operations of the ventures continue to be reported on a three-month lag. All material transactions between the Partnership and the joint ventures have been eliminated upon consolidation, except for lag-period cash transfers. Such lag period cash transfers are accounted for as advances to and from consolidated ventures on the accompanying balance sheets.
The operating investment properties owned by the consolidated joint ventures are carried at cost, net of accumulated depreciation, or an amount less than cost if indicators of impairment are present in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which the Partnership adopted in fiscal 1996. SFAS No. 121 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. The Partnership generally assesses indicators of impairment by a review of independent appraisal reports on each operating investment property. Such appraisals make use of a combination of certain generally accepted valuation techniques, including direct capitalization, discounted cash flows and comparable sales analysis. During fiscal 1997, the independent appraisal of the West Ashley Shoppes operating investment property indicated that certain operating assets, consisting of land and improvements and building and improvements, were impaired. In accordance with SFAS No. 121, the consolidated West Ashley Shoppes joint venture recorded a reduction in the net carrying value of such assets amounting to $2,700,000 relating to the land and improvements ($1,457,000), building and improvements ($1,822,000) and related accumulated depreciation ($579,000).
Through March 31, 1995, depreciation expense on the operating investment properties carried on the Partnership's consolidated balance sheet was computed using the straight-line method over the estimated useful lives of the operating investment properties, generally five years for the furniture and fixtures and thirty-one and a half years for the buildings and improvements. During fiscal 1996, circumstances indicated that the consolidated Hacienda Park operating investment property might be impaired. The Partnership's estimate of undiscounted cash flows indicated that the property's carrying amount was expected to be recovered, but that the reversion value could be less than the carrying amount at the time of disposition. As a result of such assessment, the joint venture commenced recording an additional annual charge to depreciation expense of $250,000 in calendar 1995 to adjust the carrying value of the Hacienda Park property such that it will match the expected reversion value at the time of disposition. Such amount is included in depreciation and amortization on the accompanying fiscal 1998, 1997 and 1996 consolidated statements of operations. Such an annual charge will continue to be recorded in future periods. Acquisition fees paid to PaineWebber Properties Incorporated and costs of identifiable improvements have been capitalized and are included in the cost of the operating investment properties. Capitalized construction period interest and taxes of West Ashley Shoppes, in the aggregate amount of approximately $485,000, is included in the balance of operating investment properties on the accompanying consolidated balance sheets. Maintenance and repairs are charged to expense when incurred.
For long-term commercial leases, rental income is recognized on the straight-line basis over the term of the related lease agreement, taking into consideration scheduled cost increases and free-rent periods offered as inducements to lease the property. Deferred rent receivable represents rental income earned by Hacienda Park Associates and West Ashley Shoppes Associates which has been recognized on the straight-line basis over the term of the related lease agreement.
Deferred expenses at March 31, 1998 and 1997 include loan costs incurred in connection with the Asbury Commons and Hacienda Park mortgage notes payable described in Note 6, which are being amortized using the straight-line method, which approximates the effective interest method, over their respective terms. The amortization of such costs is included in interest expense on the accompanying statements of operations. Deferred expenses also include legal fees associated with the organization of the Hacienda Park joint venture, which were amortized on the straight-line basis over a sixty-month term, and deferred commissions and lease cancellation fees of Hacienda Park Associates and West Ashley Shoppes Associates, which are being amortized on a straight-line basis over the term of the respective lease.
Escrowed cash includes funds escrowed for the payment of property taxes and tenant security deposits of the Asbury Commons and Hacienda Park consolidated joint ventures.
For purposes of reporting cash flows, the Partnership considers all highly liquid investments with original maturities of 90 days or less to be cash equivalents.
No provision for income taxes has been made as the liability for such taxes is that of the partners rather than the Partnership.
The cash and cash equivalents, escrowed cash, bonds payable and mortgage notes payable appearing on the accompanying consolidated balance sheets represent financial instruments for purposes of Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments." The carrying amounts of cash and cash equivalents and escrowed cash approximate their fair values as of March 31, 1998 and 1997 due to the short-term maturities of these instruments. It is not practicable for management to estimate the fair value of the bonds payable without incurring excessive costs due to the unique nature of such obligations. The fair value of mortgage notes payable is estimated using discounted cash flow analysis, based on the current market rates for similar types of borrowing arrangements (see Note 6).
Certain prior year amounts have been reclassified to conform to the fiscal 1998 presentation.
3. The Partnership Agreement and Related Party Transactions --------------------------------------------------------
The General Partners of the Partnership are Second Equity Partners, Inc. (the "Managing General Partner"), a wholly-owned subsidiary of PaineWebber Group Inc. ("PaineWebber") and Properties Associates 1986, L.P. (the "Associate General Partner"), a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner. Affiliates of the General Partners will receive fees and compensation determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the Units and the acquisition, management, financing and disposition of Partnership properties. The Managing General Partner and its affiliates are reimbursed for their direct expenses relating to the offering of Units, the administration of the Partnership and the acquisition and operations of the Partnership's operating property investment.
All distributable cash, as defined, for each fiscal year shall be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners until the Limited Partners have received an amount equal to a 7.5% noncumulative annual return on their adjusted capital contributions. The General Partners will then receive distributions until they have received an amount equal to 1.01% of total distributions of distributable cash which has been made to all partners and PWPI has received an amount equal to 3.99% of all distributions to all partners. The balance will be distributed 95% to the Limited Partners, 1.01% to the General Partners and 3.99% to PWPI. Payments to PWPI represent asset management fees for PWPI's services in managing the business of the Partnership. Due to the reduction in the Partnership's quarterly distribution rate to 2% during fiscal 1992, no management fees were earned for the fiscal years ended March 31, 1998, 1997 and 1996, in accordance with the advisory agreement. All sale or refinancing proceeds shall be distributed in varying proportions to the Limited and General Partners, as specified in the amended Partnership Agreement.
All taxable income (other than from a Capital Transaction) in each year will be allocated to the Limited Partners and the General Partners in proportion to the amounts of distributable cash distributed to them (excluding the asset management fee) in that year or, if there are no distributions of distributable cash, 98.95% to the Limited Partners and 1.05% to the General Partners. All tax losses (other than from a Capital Transaction) will be allocated 98.95% to the Limited Partners and 1.05% to the General Partners. Taxable income or tax loss arising from a sale or refinancing of investment properties will be allocated to the Limited Partners and the General Partners in proportion to the amounts of sale or refinancing proceeds to which they are entitled; provided that the General Partners shall be allocated at least 1% of taxable income arising from a sale or refinancing. If there are no sale or refinancing proceeds, tax loss or taxable income from a sale or refinancing will be allocated 98.95% to the Limited Partners and 1.05% to the General Partner. Allocations of the Partnership's operations between the General Partners and the Limited Partners for financial accounting purposes have been made in conformity with the allocations of taxable income or tax loss.
Included in general and administrative expenses for the years ended March 31, 1998, 1997 and 1996 is $230,000, $224,000 and $260,000, respectively, representing reimbursements to an affiliate of the Managing General Partner for providing certain financial, accounting and investor communication services to the Partnership.
The Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins") for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $17,000, $13,000 and $4,000 (included in general and administrative expenses) for managing the Partnership's cash assets during fiscal 1998, 1997 and 1996, respectively.
4. Operating Investment Properties -------------------------------
The Partnership's balance sheets at March 31, 1998 and 1997 include three operating investment properties: Saratoga Center and EG&G Plaza, owned by Hacienda Park Associates; the Asbury Commons Apartments, owned by Atlanta Asbury Partnership; and the West Ashley Shoppes Shopping Center, owned by West Ashley Shoppes Associates. In May 1994, the Partnership and the co-venturer in the West Ashley joint venture executed a settlement agreement whereby the Partnership assumed control over the affairs of the venture. The Partnership obtained controlling interests in the other two joint ventures during fiscal 1992. Accordingly, all three joint ventures are presented on a consolidated basis in the accompanying financial statements. The Partnership's policy is to report the operations of these consolidated joint ventures on a three-month lag.
Hacienda Park Associates ------------------------
On December 24, 1987, the Partnership acquired an interest in Hacienda Park Associates (the "joint venture"), a California general partnership organized in accordance with a joint venture agreement between the Partnership and Callahan Pentz Properties (the "co-venturer"). The joint venture was organized to own and operate three buildings in the Hacienda Business Park, which is located in Pleasanton, California, consisting of Saratoga Center, a multi-tenant office building and EG&G Plaza, originally a single tenant facility, now leased to two tenants. Saratoga Center, completed in 1985, consists of approximately 83,000 net rentable square feet located on approximately 5.6 acres of land. Phase I of EG&G Plaza was completed in 1985 and Phase II was completed in 1987. Both phases together consist of approximately 102,000 net rentable square feet located on approximately 7 acres of land. The aggregate cash investment by the Partnership for its interest was $24,930,043 (including an acquisition fee of $890,000 paid to PWPI and certain closing costs of $40,043).
During the guaranty period, which was to have run from December 24, 1987 to December 24, 1991, the co-venturer had guaranteed to fund all operating deficits, capital costs and the Partnership's preference return distribution in the event that cash flow from property operations was insufficient. The co-venturer defaulted on the guaranty obligations in fiscal 1990 and negotiations between the Partnership and the co-venturer to reach a resolution of the default were ongoing until fiscal 1992, when the venturers reached a settlement agreement. During fiscal 1992, the co-venturer assigned its remaining joint venture interest to the Managing General Partner of the Partnership. The co-venturer also executed a five-year promissory note in the initial face amount of $300,000 payable to the Partnership without interest. Unless prepaid, the balance of the note escalates as to the principal balance annually up to a maximum of $600,000. In exchange, it was agreed that the co-venturer or its affiliates would have no further liability to the Partnership for any guaranteed preference payments. Due to the uncertainty regarding the collection of the note receivable, such compensation will be recognized as payments are received. Any amounts received will be reflected as reductions to the carrying value of the operating investment properties. No payments have been received to date. The $600,000 balance of the note receivable became due and payable on October 31, 1996. The Partnership will continue to pursue collection of this balance during fiscal 1999. However, there are no assurances that any portion of this balance will be collected. Concurrent with the execution of the settlement agreement, the property's management contract with an affiliate of the co-venturer was terminated.
Per the terms of the joint venture agreement, net cash flow of the joint venture is to be distributed monthly in the following order of priority: (1) the Partnership will receive a cumulative preferred return of 9.25% on its net investment until December 31, 1989, 9.75% for the next two years, and 10% per annum thereafter, (2) to pay any capital expenditures and leasing costs, as defined (3) to the co-venturer in an amount up to their mandatory contribution, (4) to capital reserves (5) to pay interest on accrued preferences and unpaid advances, and (6) the balance will be distributed 75% to the Partnership and 25% to the co-venturer.
Net proceeds from sales or refinancings shall be distributed as follows: (1) to the Partnership to the extent of any unpaid preferred return and accrued interest thereon; (2) to the Partnership to the extent of its net investment plus $2,400,000 and (3) 75% to the Partnership and 25% to the co-venturer. The co-venturer and the Partnership will also receive pro rata, any outstanding advances, including interest thereon, from proceeds from sales or refinancings prior to a return of capital.
Net income from operations shall be allocated first to the Partnership to the extent of its preference return and then 75% to the Partnership and 25% to the co-venturer. Net losses from operations shall be allocated 75% to the Partnership and 25% to the co-venturer.
Atlanta Asbury Partnership --------------------------
On March 12, 1990, the Partnership acquired an interest in Atlanta Asbury Partnership (the "joint venture"), a Georgia general partnership organized in accordance with a joint venture agreement between the Partnership and Asbury Commons/Summit Limited Partnership, an affiliate of Summit Properties (the "co-venturer"). The joint venture was organized to own and operate Asbury Commons Apartments, a newly constructed 204-unit residential apartment complex located in Atlanta, Georgia. The aggregate cash investment by the Partnership for its interest was $14,417,791 (including an acquisition fee of $50,649 payable to PWPI and certain closing costs of $67,142).
During fiscal 1997, the Partnership became aware of certain potential construction problems at the Asbury Common Apartments. The initial analysis of the construction problems revealed extensive deterioration of the wood trim and evidence of potential structural problems affecting the exterior breezeways, the decks of certain apartment unit types and the stairway towers. A design and construction team was organized to further evaluate the potential problems, make cost-effective remediation recommendations and implement the repair program. Based on this evaluation, the structural problems may be more extensive and cost significantly more than originally estimated. It will also require further investigation which together with eventual construction repair work may result in disruptions to property operations while units are possibly taken out of service for testing and repairs. The cost of the repair work required to remediate this situation is currently estimated at between approximately $1.5 to $2 million. During fiscal 1998, the Partnership distributed bid application packages to pre-qualified contractors and executed construction contracts for the repair work. Repair and replacement work commenced subsequent to year-end. Also during fiscal 1998, the Partnership filed a warranty claim against the manufacturer of the wood-composite siding used throughout the Asbury Commons property and filed a warranty claim against the manufacturer of the fiberglass-composite roofing shingles installed when the property was built. Subsequent to year-end, the manufacturer of the roofing shingles agreed to provide the Partnership with the materials to replace the existing roofing shingles. While there can be no assurances regarding the Partnership's ability to successfully recover any further damages relating to the siding and roofing shingles, the Partnership will diligently pursue these and other potential recovery sources. Subsequent to year-end, the Partnership reached a settlement agreement with the original developer of the Asbury Commons property whereby the developer agreed to pay the Partnership $200,000. Under the terms of this agreement, the Partnership received a payment of $100,000 during the fourth quarter of fiscal 1998, and received a final payment of $100,000 subsequent to year-end. The Partnership believes that it has adequate cash reserves to fund the repair work at Asbury Commons regardless of whether any additional recoveries are realized.
During the Guaranty Period, from March 13, 1990 to March 15, 1992, as defined, the co-venturer had agreed to unconditionally guarantee to fund all operating deficits, capital costs and the Partnership's preference return distribution in the event that cash flow from property operations was insufficient. The co-venturer was not in compliance with the mandatory payment provisions of the Partnership agreement for the period from November 30, 1990 to February 14, 1992. On February 14, 1992, a settlement agreement between the Partnership and the co-venturer was executed whereby the co-venturer agreed to do the following: 1) pay the Partnership $275,000; (2) release all escrowed purchase price funds, amounting to $230,489, to the joint venture; (3) assign 99% of its joint venture interest to the Partnership and 1% of its joint venture interest to the Managing General Partner and withdraw from the joint venture; and 4) reimburse the Partnership for legal expenses up to $10,000. In return the co-venturer was released from its obligations under the joint venture agreement.
Subsequent to the withdrawal of the original co-venture partner and the assignments of its interest in the venture to the Partnership and the Managing General Partner, on September 26, 1994, the joint venture agreement was amended and restated. The terms of the amended and restated venture agreement call for net cash flow from operations of the joint venture to be distributed as follows: (1) to the Partnership until the Partnership has received a cumulative non-compounded return of 10% on the Partnership's net investment and any additional contributions made by the Partnership (2) to the Partners in proportion to their joint venture interests.
Proceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) to the Partnership an amount of gain equal to the aggregate negative capital account of the Partnership, (2) to the Managing General Partner in an amount of gain equal to the negative capital account of the Managing General Partner, (3) to the Partnership until the Partnership has been allocated an amount equal to a 10% cumulative non-compounded return on the Partnership's net investment and any additional contributions made by the Partnership, (4) to the Partnership until the Partnership has received an amount equal to 1.10 times the Partnership's net investment and any additional contributions made by the Partnership, and (5) any remaining gain shall be allocated 99% to the Partnership and 1% to the Managing General Partner. Net losses from the sale or refinancing of the property will be allocated to the Partners in the following order of priority: (1) to the Partnership in an amount of loss equal to the positive capital account of the Partnership, (2) to the Managing General Partner in an amount of loss equal to the positive capital account of the Managing General Partner, and (3) to the extent the net losses exceed the aggregate capital accounts of the Partners, all losses in excess of such capital accounts shall be allocated to the Partnership.
Net income will be allocated as follows: (1) 100% to the Partnership until the Partnership has been allocated an amount equal to a 10% cumulative non-compounded return on the Partnership's net investment and any additional contributions made by the Partnership, and (2) thereafter, 99% to the Partnership and 1% to the Managing General Partner. Losses will be allocated 99% to the Partnership and 1% to the Managing General Partner.
West Ashley Shoppes Associates ------------------------------
On March 10, 1988 the Partnership acquired an interest in West Ashley Shoppes Associates (the "joint venture"), a South Carolina general partnership organized in accordance with a joint venture agreement between the Partnership and Orleans Road Development Company, an affiliate of the Leo Eisenberg Company (the "co-venturer"). The joint venture was organized to own and operate West Ashley Shoppes, a newly constructed shopping center located in Charleston, South Carolina. The property consists of 134,000 net rentable square feet on approximately 17.25 acres of land.
The aggregate cash investment by the Partnership for its interest was $10,503,841 (including an acquisition fee of $365,000 paid to PWPI and certain closing costs of $123,841). During the Guaranty Period, from March 10, 1988 to March 10, 1993, the co-venturer had agreed to unconditionally guarantee to fund any deficits and to ensure that the joint venture could distribute to the Partnership its preference return. During fiscal 1990, the co-venturer defaulted on its guaranty obligation. On April 25, 1990, the Partnership and the co-venturer entered into the second amendment to the joint venture agreement. In accordance with the amendment, the Partnership contributed $300,000 to the joint venture, in exchange for the co-venturer's transfer of rights to certain out-parcel land. The $300,000 was then repaid to the Partnership as a distribution to satisfy the co-venturer's obligation to fund net cash flow shortfalls in arrears at December 31, 1989. Subsequent to the amendment to the joint venture agreement, the co-venturer defaulted on the guaranty obligations again. Net cash flow shortfall contributions of approximately $1,060,000 were in arrears at December 31, 1993. During 1991, the Partnership had filed suit against the co-venturer and the individual guarantors to collect the amount of the cash flow shortfall contributions in arrears. In May 1994, the Partnership and the co-venturer executed a settlement agreement to resolve their outstanding disputes regarding the net cash flow shortfall contributions described above. Under the terms of the settlement agreement, the co-venturer assigned 96% of its interest in the joint venture to the Partnership and the remaining 4% of its interest in the joint venture to Second Equity Partners, Inc. (SEPI), Managing General Partner of the Partnership. In return for such assignment, the Partnership agreed to release the co-venturer from all claims regarding net cash flow shortfall contributions owed to the joint venture. In conjunction with the assignment of its interest and withdrawal from the joint venture, the co-venturer agreed to release certain outstanding counter claims against the Partnership.
Subsequent to the settlement agreement and assignment of joint venture interest described above, the terms of the joint venture agreement call for net cash flow from operations of the joint venture to be distributed as follows: (1) the Partnership will receive a preference return of 10% per annum on its net cash investment; (2) next to the partners on a pro rata basis to repay unpaid additional contribution returns and return on accrued preference, as defined; (3) net, until all additional contributions, tenant improvement contributions and accrued preference returns have been paid in full, 50% of remaining cash flow to the partners on a pro rata basis to repay such items, 49.5% to the Partnership, and 0.5% to the co-venturer; and (4) thereafter, any remaining cash would be distributed 99% to the Partnership and 1% to the co-venturer.
Proceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) the Partnership will receive the aggregate amount of its cumulative annual preferred return not previously paid, (2) to the Partnership and co-venturer to pay additional contributions, (3) the Partnership will receive an amount equal to the Partnership's net investment and (4) thereafter, any remaining proceeds will be distributed 99% to the Partnership and 1% to the co-venturer.
Net income or loss will be allocated to the Partnership and the co-venturer in the same proportion as cash distributions except for certain items which are specifically allocated to the partners, as defined, in the joint venture agreement. Such items include amortization of acquisition fee and organization expenses and allocation of depreciation related to recording of the building at fair value based upon its purchase price.
The following is a combined summary of property operating expenses for the consolidated joint ventures for the years ended December 31, 1997, 1996 and 1995 (in thousands):
1997 1996 1995 ---- ---- ----
Property operating expenses: Utilities $ 207 $ 205 $ 219 Repairs and maintenance 451 425 385 Salaries and related costs 224 210 216 Administrative and other 282 225 300 Insurance 53 53 51 Management fees 153 161 149 -------- -------- --------- $ 1,370 $ 1,279 $ 1,320 ======== ======== =========
5. Investments in Unconsolidated Joint Ventures --------------------------------------------
The Partnership has investments in three unconsolidated joint venture partnerships which own operating investment properties at March 31, 1998 and 1997 (five at March 31, 1996, including two ventures which were in the process of liquidating as a result of the sales of their operating investment properties during calendar 1995).
Condensed combined financial statements of the unconsolidated joint ventures, for the periods indicated, are as follows:
Condensed Combined Balance Sheets December 31, 1997 and 1996 (in thousands)
Assets 1997 1996 ---- ----
Current assets $ 1,234 $ 1,264 Operating investment properties, net 54,902 55,402 Other assets 4,367 4,992 -------- -------- $ 60,503 $ 61,658 ======== ========
Liabilities and Venturers' Capital
Current liabilities $ 2,740 $ 2,515 Other liabilities 318 315 Long-term debt 8,720 8,857 Partnership's share of venturers' capital 29,874 30,726 Co-venturers' share of venturers' capital 18,851 19,245 -------- -------- $ 60,503 $ 61,658 ======== ========
Condensed Combined Summary of Operations For the years ended December 31, 1997, 1996 and 1995 (in thousands)
1997 1996 1995 ---- ---- ---- Revenues: Rental revenues and expense reimbursements $ 9,814 $ 9,297 $ 11,844 Interest and other income 481 343 330 --------- --------- --------- 10,295 9,640 12,174
Expenses: Property operating and other expenses 3,230 3,009 4,177 Real estate taxes 2,323 2,212 2,248 Interest on long-term debt 661 663 1,535 Interest on note payable to venturer - - 100 Depreciation and amortization 3,177 3,158 3,704 --------- --------- --------- 9,391 9,042 11,764 --------- --------- ---------
Operating income 904 598 410 Gains on sale of operating investment properties - - 8,368 --------- --------- --------- Net income $ 904 $ 598 $ 8,778 ========= ========= =========
Net income: Partnership's share of combined income $ 786 $ 441 $ 7,512 Co-venturers' share of combined income 118 157 1,266 --------- --------- --------- $ 904 $ 598 $ 8,778 ========= ========= =========
Reconciliation of Partnership's Investment March 31, 1998 and 1997 (in thousands) 1998 1997 ---- ----
Partnership's share of capital at December 31, as shown above $ 29,874 $ 30,726 Excess basis due to investments in joint ventures, net (1) 1,036 1,094 Timing differences (2) (673) (36) -------- --------- Investments in unconsolidated joint ventures, at equity at March 31 $ 30,237 $ 31,784 ======== ========
(1)At March 31, 1998 and 1997, the Partnership's investment exceeds its share of the joint venture partnerships' capital accounts by approximately $1,036,000 and $1,094,000, respectively. This amount, which relates to certain costs incurred by the Partnership in connection with acquiring its joint venture investments, is being amortized over the estimated useful life of the investment properties (generally 30 years).
(2)The timing differences between the Partnership's share of capital account balances and its investments in joint ventures consist of capital contributions made to joint ventures and cash distributions received from joint ventures during the period from January 1 to March 31 in each year. These differences result from the lag in reporting period discussed in Note 2.
Reconciliation of Partnership's Share of Operations For the years ended March 31, 1998, 1997 and 1996 (in thousands)
1998 1997 1996 ---- ---- ----
Partnership's share of operations, as shown above $ 786 $ 441 $ 7,512 Amortization of excess basis (58) (58) (561) ------- -------- -------- Partnership's share of unconsolidated ventures' net income $ 728 $ 383 $ 6,951 ======= ======== ========
The Partnership's share of the net income of the unconsolidated joint ventures is presented as follows in the accompanying statements of operations:
1998 1997 1996 ---- ---- ----
Partnership's share of unconsolidated ventures' income $ 728 $ 383 $ 185 Partnership's share of gains on sale of unconsolidated operating investment properties - - 6,766 ------- ------- -------- $ 728 $ 383 $ 6,951 ======= ======= ========
Investments in unconsolidated joint ventures, at equity, is the Partnership's net investment in the joint venture partnerships. These joint ventures are subject to Partnership agreements which determine the distribution of available funds, the disposition of the venture's assets and the rights of the partners, regardless of the Partnership's percentage ownership interest in the venture. As a result, substantially all of the Partnership's investments in these joint ventures are restricted as to distributions.
Investments in unconsolidated joint ventures, at equity, on the accompanying balance sheets is comprised of the following equity method carrying values (in thousands): 1998 1997 ---- ----
Chicago-625 Partnership $ 18,131 $ 18,937 Richmond Gables Associates (244) 34 Daniel/Metcalf Associates Partnership 12,350 12,813 -------- -------- Investments in unconsolidated joint ventures $ 30,237 $ 31,784 ======== ========
The Partnership received cash distributions from the unconsolidated ventures during the years ended March 31, 1998, 1997 and 1996 as set forth below (in thousands):
1998 1997 1996 ---- ---- ----
Chicago-625 Partnership $ 1,504 $ 1,689 $ 1,158 Richmond Gables Associates 206 198 158 Daniel/Metcalf Associates Partnership 1,530 641 600 TCR Walnut Creek Limited Partnership - 182 3,216 Portland Pacific Associates - 34 10,434 ------- ------- -------- $ 3,240 $ 2,744 $ 15,566 ======= ======= ========
A description of the ventures' properties and the terms of the joint venture agreements are summarized as follows:
a. Chicago - 625 Partnership -------------------------
The Partnership acquired an interest in Chicago - 625 Partnership (the "joint venture"), an Illinois general partnership organized on December 16, 1986 in accordance with a joint venture agreement between the Partnership, an affiliate of the Partnership and Michigan-Ontario Limited, an Illinois limited partnership and an affiliate of Golub & Company (the "co-venturer"), to own and operate 625 North Michigan Avenue Office Tower (the "property"). The property is a 27-story commercial office tower containing an aggregate of 324,829 square feet of leasable space on approximately .38 acres of land. The property is located in Chicago, Illinois.
The aggregate cash investment made by the Partnership for its current interest was $26,010,000 (including an acquisition fee of $1,316,600 paid to PWPI and certain closing costs of $223,750). At the same time the Partnership acquired its interest in the joint venture, PaineWebber Equity Partners One Limited Partnership (PWEP1), an affiliate of the Managing General Partner with investment objectives similar to the Partnership's investment objectives, acquired an interest in this joint venture. PWEP1's cash investment for its current interest was $17,278,000 (including an acquisition fee of $383,400 paid to PWPI). During 1990, the joint venture agreement was amended to allow the Partnership and PWEP1 the option to make contributions to the joint venture equal to total costs of capital improvements, leasehold improvements and leasing commissions ("Leasing Expense Contributions") incurred since April 1, 1989, not in excess of the accrued and unpaid Preference Return due to the Partnership and PWEP1. The Partnership had made Leasing Expense Contributions totalling $3,748,000 through December 31, 1997.
During calendar 1995, circumstances indicated that Chicago 625 Partnership's operating investment property might be impaired. The joint venture's estimate of undiscounted cash flows indicated that the property's carrying amount was expected to be recovered, but that the reversion value could be less than the carrying amount at the time of disposition. As a result of such assessment, the venture commenced recording an additional annual depreciation charge of $350,000 in calendar 1995 to adjust the carrying value of the operating investment property such that it will match the expected reversion value at the time of disposition. The Partnership's share of such amount is reflected in the Partnership's share of unconsolidated ventures' income in fiscal 1997 and 1996. Such an annual charge will continue to be recorded in future periods.
The joint venture agreement provides for aggregate distributions of cash flow and sale or refinancing proceeds to the Partnership and PWEP1. These amounts are then distributed to the Partnership and PWEP1 based on their respective cash investments in the joint venture exclusive of acquisition fees. As a result of the transfers of the Partnership's interests to PWEP1 as discussed above, cash flow distributions and sale or refinancing proceeds will now be split approximately 59% to the Partnership and 41% to PWEP1.
Net cash flow will be distributed as follows: First, a preference return, payable monthly, to the Partnership and PWEP1 of 9% of their respective net cash investments, as defined. Second, to the payment of any unpaid accrued interest and principal on all outstanding default notes. Third, to the payment of any unpaid accrued interest and principal on all outstanding operating notes. Fourth, 70% in total to the Partnership and PWEP1 and 30% to the co-venturer. The cumulative unpaid and unaccrued Preference Return due to the Partnership totalled $8,704,000 at December 31, 1997.
Profits for each fiscal year shall be allocated, to the extent that such profits do not exceed the net cash flow for such fiscal year, in proportion to the amount of such net cash flow distributed to the Partners for such fiscal year. Profits in excess of net cash flow shall be allocated 99% in total to the Partnership and PWEP1 and 1% to the co-venturer. Losses shall be allocated 99% in total to the Partnership and PWEP1 and 1% to the co-venturer.
Proceeds from the sale or refinancing of the property shall be allocated as follows:
First, to the payment of all unpaid accrued interest and principal on all outstanding default notes. Second, to the Partnership, PWEP1 and the co-venturer for the payment of all unpaid accrued interest and principal on all outstanding operating notes. Third, 100% to the Partnership and PWEP1 until they have received the aggregate amount of their respective Preference Return not yet paid. Fourth, 100% to the Partnership and PWEP1 until they have received an amount equal to their respective net investments. Fifth, 100% to the Partnership and PWEP1 until they have received an amount equal to the PWEP Leasing Expense Contributions less any amount previously distributed, pursuant to this provision. Sixth, 100% to the co-venturer until it has received an amount equal to $6,000,000, less any amount of proceeds previously distributed to the co-venturer, as defined. Seventh, 100% to the co-venturer until it has received an amount equal to any reduction in the amount of net cash flow that it would have received had the Partnership not incurred indebtedness in the form of operating notes. Eighth, 100% to the Partnership and PWEP1 until they have received $2,067,500, less any amount of proceeds previously distributed to the Partnership and PWEP1, pursuant to this provision. Ninth, 75% in total to the Partnership and PWEP1 and 25% to the co-venturer until the Partnership and PWEP1 have received $20,675,000, less any amount previously distributed to the Partnership and PWEP1, pursuant to this provision. Tenth, 100% to the Partnership and PWEP1 until the Partnership and PWEP1 have received an amount equal to a cumulative return of 9% on the PWEP Leasing Expense Contributions. Eleventh, any remaining balance will be distributed 55% in total to the Partnership and PWEP1 and 45% to the co-venturer.
Gains resulting from the sale of the property shall be allocated as follows:
First, capital profits shall be allocated to Partners having negative capital account balances, until the balances of the capital accounts of such Partners equal zero. Second, any remaining capital profits up to the amount of capital proceeds distributed to the Partners pursuant to distribution of proceeds of a sale or refinancing with respect to the capital transaction giving rise to such capital profits shall be allocated to the Partners in proportion to the amount of capital proceeds so distributed to the Partners. Third, capital profits in excess of capital proceeds, if any, shall be allocated between the Partners in the same proportions that capital proceeds of a subsequent capital transaction would be distributed if the capital proceeds were equal to the remaining amount of capital profits to be allocated.
Capital losses shall be allocated as follows:
First, capital losses shall be allocated to the Partners in an amount up to and in proportion to their respective positive capital balances. Then, all remaining capital losses shall be allocated 70% in total to the Partnership and PWEP1 and 30% to the co-venturer.
The Partnership has a property management agreement with an affiliate of the co-venturer that provides for management and leasing commission fees to be paid to the property manager. The management fee is 4% of gross rents and the leasing commission is 7%, as defined. The property management contract is cancellable at the Partnership's option upon the occurrence of certain events and is currently cancellable by the co-venturer at any time.
b) Richmond Gables Associates --------------------------
On September 1, 1987 the Partnership acquired an interest in Richmond Gables Associates (the "joint venture"), a Virginia general partnership organized in accordance with a joint venture agreement between the Partnership and Richmond Erin Shades Company Limited Partnership, an affiliate of The Paragon Group (the "co-venturer"). The joint venture was organized to own and operate the Gables at Erin Shades, a newly constructed apartment complex located in Richmond, Virginia. The property consists of 224 units with approximately 156,000 net rentable square feet on approximately 15.6 acres of land.
The aggregate cash investment by the Partnership for its interest was $9,076,982 (including an acquisition fee of $438,500 paid to PWPI and certain closing costs of $84,716). On November 7, 1994, the joint venture obtained a $5,200,000 first mortgage note payable which bears interest at 8.72% per annum. Principal and interest payments of $42,646 are due monthly through October 15, 2001 at which time the entire unpaid balance of principal and interest is due. The net proceeds of the loan were recorded as a distribution to the Partnership by the joint venture. The Partnership used the proceeds of the loan in conjunction with the retirement of the zero coupon loans described in Note 6. The Partnership has indemnified the joint venture and the related co-venture partners, against all liabilities, claims and expenses associated with the borrowing.
Net cash flow from operations of the joint venture will be distributed in the following order of priority: first, a preference return, payable monthly, to the Partnership of 9% on its net cash investment as defined; second, to pay interest on additional capital contributions; thereafter, 70% to the Partnership and 30% to the co-venturer.
Proceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) the Partnership will receive the aggregate amount of its cumulative annual preferred return not previously paid, (2) the Partnership will receive an amount equal to the Partnership's net investment, (3) $450,000 each to the Partnership and the co-venturer, (4) the Partnership and co-venturer will receive proceeds in proportion to contribution loans made plus accrued interest, (5) 70% to the Partnership and 30% to the co-venturer until the Partnership has received an additional $5,375,000; and (6) thereafter, any remaining proceeds will be distributed 60% to the Partnership and 40% to the co-venturer.
Net income and loss will be allocated as follows: (1) depreciation will be allocated to the Partnership, (2) income will be allocated to the Partnership and co-venturer in the same proportion as cash distributions. Losses will be allocated in amounts equal to the positive capital accounts of the Partnership and co-venturer and (3) all other profits and losses will be allocated 70% to the Partnership and 30% to the co-venturer.
During the Guaranty Period, which expired in September 1990, the co-venturer agreed to unconditionally guarantee to fund any deficits and to ensure that the joint venture could distribute to the Partnership its preference return. Total mandatory payments contributed by the co-venturer amounted to $152,048 in 1990. At December 31, 1997, there was a cumulative unpaid preferred distribution payable to the Partnership of $1,096,000. This amount will be paid to the Partnership if and when there is available cash flow.
The joint venture has entered into a management contract with an affiliate of the co-venturer which is cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee is 5% of gross rents, as defined.
c) Daniel/Metcalf Associates Partnership -------------------------------------
The Partnership acquired an interest in Daniel/Metcalf Associates Partnership (the "joint venture"), a Virginia general partnership organized on September 30, 1987 in accordance with a joint venture agreement between the Partnership and Plaza 91 Investors, L.P., an affiliate of Daniel Realty Corp., organized to own and operate Gateway Plaza Shopping Center (formerly Loehmann's Plaza), a community shopping center located in Overland Park, Kansas. The property consists of approximately 142,000 net rentable square feet on approximately 19 acres of land.
The aggregate cash investment by the Partnership for its interest was $15,488,352 (including an acquisition fee of $689,000 paid to PWPI and certain closing costs of $64,352). On February 10, 1995, the joint venture obtained a first mortgage loan secured by the operating investment property in the initial principal amount of $4,000,000. The proceeds of the loan, along with additional funds contributed by the Partnership, were used to repay the portion of the zero coupon note liability of the Partnership which was secured by the operating property (see Note 6). In addition, a portion of the proceeds were used to repay the $700,000 mortgage loan of the joint venture and to establish a Renovation and Occupancy Escrow in the amount of $550,000 as required by the new mortgage loan. The new first mortgage loan was issued in the name of the joint venture, bears interest at an annual rate of 9.04% and matures on February 15, 2003. The loan requires monthly principal and interest payments of $33,700. Funds were to be released from the Renovation and Occupancy Escrow to reimburse the Gateway Plaza joint venture for the costs of certain planned renovations in the event that the joint venture satisfied certain requirements which included specified occupancy and rental income thresholds. As of August 1996, eighteen months subsequent to the date of the loan closing, such requirements had not been met. Therefore, the lender had the right to apply the balance of the escrow account to the payment of loan principal. In addition, the lender required that the Partnership unconditionally guaranty up to $1,400,000 of the loan obligation. This guaranty was to be released in the event that the joint venture satisfied the requirement for the release of the Renovation and Occupancy Escrow funds or upon the repayment, in full, of the entire outstanding mortgage loan liability. During fiscal 1998, the venture achieved the aforementioned occupancy and rental income thresholds. During the third quarter of fiscal 1998, management requested and received the release of the Renovation and Occupancy Escrow Funds and the termination of the unconditional guaranty. The escrow funds were distributed to the Partnership and were used to replenish cash reserves.
The closing of the February 1995 financing transaction described above was executed in conjunction with an amendment to the Partnership Agreement. The purpose of the amendment was to establish the portion of the new first mortgage loan which was used to repay the borrowing of the Partnership described in Note 6 (the "Partnership Component") as the sole responsibility of the Partnership. Accordingly, any debt service payments attributable to the Partnership Component will be deducted from the Partnership's share of operating cash flow distributions or sale or refinancing proceeds. Furthermore, all expenses associated with such portion of the new borrowing will be specifically allocated to the Partnership. The Partnership has agreed to indemnify the joint venture and co-venture partner against all losses, damages, liabilities, claims, costs, fees and expenses incurred in connection with the Partnership Component of the first mortgage loan. The portion of the new first mortgage loan which was used to repay the joint venture's $700,000 mortgage loan and to establish the Renovation and Occupancy Escrow will be treated as a joint venture borrowing subject to the terms and conditions of the original joint venture agreement.
Net cash flow of the joint venture is to be distributed monthly in the following order of priority: (1) the Partnership will receive a cumulative preferred return (the "Preferred Return") of 9.25% on its initial net investment of $14,300,000 from October, 1987 through September, 1989, 9.75% from October, 1989 through September, 1990 and 10% thereafter, (2) to the Partnership and co-venturer for the payment of all unpaid accrued interest and principal on all outstanding notes. Any additional cash flow shall be distributed 75% to the Partnership and 25% to the co-venturer.
The co-venturer agreed to contribute to the joint venture all funds that were necessary so the joint venture could distribute to the Partnership its preference return for 36 months from the date of closing (the "Guaranty Period"). Contributions for the final 12 months of the Guaranty Period, which ended September 30, 1990, were in the form of mandatory loans. Such loans are non-interest bearing and will be repaid upon sale or refinancing of the Property. The Partnership's cumulative unpaid preferential return as of December 31, 1997 amounted to $3,797,000. If the joint venture requires additional funds after the Guaranty Period, and such funds are not available from third party sources, they are to be provided in the form of operating and capital deficit loans, 75% by the Partnership and 25% by the co-venturer. At December 31, 1997, the co-venturer was obligated to make additional capital contributions of at least $88,644 with respect to cumulative unfunded shortfalls in the Partnership's preferential return through September 30, 1990.
Proceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) to the Partnership and to the co-venturer, to repay any additional capital contributions and loans and unpaid preferential returns, (2) $15,015,000 to the Partnership, (3) $200,000 to the co-venturer and (4) 75% to the Partnership and 25% to the co-venturer.
Taxable income will be allocated to the Partnership and the co-venturer in any year in the same proportions as actual cash distributions, except to the extent partners are required to make capital contributions, as defined, then an amount equal to such contribution will be allocated to the partners. Profits in excess of net cash flow are allocated 75% to the Partnership and 25% to the co-venturer. Losses are allocated 99% to the Partnership and 1% to the co-venturer. Contributions or loans made to the joint venture by the Partnership or co-venturer will result in a loss allocation to the Partnership or co-venturer of an equal amount.
The joint venture has entered into a management contract with an affiliate of the co-venturer cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee is equal to 3% of gross rents, as defined. In addition, the affiliate of the co-venturer also earns a subordinated management fee of 2% of gross rents during any year in which the net cash flow of the operating property exceeds the Partnership's preference return. Otherwise the fee is accrued subject to a maximum amount of $50,000 and payable only from the proceeds of a capital transaction.
d) TCR Walnut Creek Limited Partnership ------------------------------------
The Partnership acquired an interest in TCR Walnut Creek Limited Partnership (the "joint venture"), a Texas limited partnership organized on December 24, 1987 in accordance with a joint venture agreement between the Partnership and Trammell S. Crow (the "co-venturer") organized to own and operate Treat Commons Phase II Apartments, an apartment complex located in Walnut Creek, California. The property consists of 160 units on approximately 3.98 acres of land.
The aggregate cash investment by the Partnership for its interest was $13,143,079 (including an acquisition fee of $602,400 payable to PWPI and certain closing costs of $40,679). The initial cash investment also included the sum of $1,000,000 that was contributed in the form of a permanent nonrecourse loan to the venture on which the Partnership received interest payments at the rate of 10% per annum until the commencement of the guaranty period, 9.5% per annum during the guaranty period and 10% per annum thereafter. On September 27, 1994, the joint venture obtained a $7,400,000 first mortgage note payable which bore interest at 8.54% per annum. Principal and interest payments of $31,598 were due monthly through September 2001 at which time the entire unpaid balance of principal and interest was to be due.
On December 29, 1995, TCR Walnut Creek Limited Partnership sold the Treat Commons Phase II Apartments to a third party for approximately $12.1 million. The Partnership received net proceeds of approximately $4.1 million after deducting closing costs and the repayment of the existing mortgage note of approximately $7.3 million. The Partnership was entitled to 100% of the net sale proceeds and cash flow from operations of the venture in accordance with the joint venture agreement. The Partnership distributed approximately $3.1 million of these net sale proceeds to the Limited Partners in a Special Distribution made on February 15, 1996. The remaining sale proceeds of approximately $1 million were retained by the Partnership for potential future capital requirements.
e) Portland Pacific Associates ---------------------------
On January 12, 1988 the Partnership acquired an interest in Portland Pacific Associates (the "joint venture"), a California limited partnership organized in accordance with a joint venture agreement between the Partnership and Pacific Union Investment Corporation (the "co-venturer"). The joint venture was organized to own and operate Richland Terrace and Richmond Park Apartments located in Portland, Oregon. The property consists of a total of 183 units located on 9.52 acres of land. The aggregate cash investment by the Partnership for its interest was $8,251,500 (including an acquisition fee of $380,000 paid to PWPI and certain closing costs of $33,500).
On November 2, 1995, Portland Pacific Associates sold the Richmond Park and Richland Terrace Apartments to a third party for $11 million. The Partnership received net proceeds of approximately $8 million after deducting closing costs, the co-venturer's share of the proceeds and repayment of a $2 million borrowing secured by the Partnership's share of the proceeds. The Partnership distributed approximately $5.1 million of these net proceeds to the Limited Partners in a Special Distribution made on December 27, 1995. The remaining sale proceeds were retained by the Partnership for the potential future capital needs of the Partnership's commercial property investments.
6. Mortgage Notes Payable -----------------------
Mortgage notes payable on the consolidated balance sheets of the Partnership at March 31, 1998 and 1997 consist of the following (in thousands):
1998 1997 ---- ----
9.125% mortgage note payable to an insurance company secured by the 625 North Michigan Avenue operating investment property (see discussion below). The loan requires monthly principal and interest payments of $83 through maturity on May 1, 1999. The terms of the note were modified effective May 31, 1994. The fair value of the mortgage note approximated its carrying value at March 31, 1998 and 1997. $ 9,282 $ 9,418
8.75% mortgage note payable to an insurance company secured by the Asbury Commons operating investment property (see discussion below). The loan requires monthly principal and interest payments of $58 through maturity on October 15, 2001. The fair value of the mortgage note approximated its carrying value at December 31, 1997 and 1996. 6,707 6,806
9.04% mortgage note payable to an insurance company secured by the Saratoga Center and Hacienda Plaza operating investment property (see discussion below). The loan requires monthly principal and interest payments of $29 through maturity on January 20, 2002. The fair value of the mortgage note approximated its carrying value at December 31, 1997 and 1996. 3,380 3,426 ------- -------
$19,369 $19,650 ======= =======
The scheduled annual principal payments to retire mortgage notes payable are as follows (in thousands):
Year ended March 31,
1999 $ 308 2000 9,305 2001 189 2002 6,417 2003 3,150 ------- $19,369 =======
On April 29, 1988, the Partnership borrowed $6,000,000 in the form of a zero coupon loan which had a scheduled maturity date in May of 1995. The note bore interest at an effective compounded annual rate of 9.8% and was secured by the 625 North Michigan Avenue Office Building. Payment of all interest was deferred until maturity, at which time principal and interest totalling approximately $11,556,000 was to be due and payable. The carrying value on the Partnership's balance sheet at March 31, 1994 of the loan plus accrued interest aggregated approximately $10,404,000. The terms of the loan agreement required that if the loan ratio, as defined, exceeded 80%, the Partnership was required to deposit additional collateral in an amount sufficient to reduce the loan ratio to 80%. During fiscal 1994, the lender informed the Partnership that based on an interim property appraisal, the loan ratio exceeded 80% and that a deposit of additional collateral was required. Subsequently, the Partnership submitted an appraisal which demonstrated that the loan ratio exceeded 80% by an amount less than previously demanded by the lender. During the third quarter of fiscal 1994, the Partnership deposited additional collateral of $208,876 in accordance with the higher appraised value. The lender accepted the Partnership's deposit of additional collateral (included in escrowed cash on the accompanying balance sheet at March 31, 1994) but disputed whether the Partnership had complied with the terms of the loan agreement regarding the 80% loan ratio. During the quarter ended June 30, 1994, an agreement was reached with the lender of the zero coupon loan on a proposal to refinance the loan and resolve the outstanding disputes. The terms of the agreement called for the Partnership to make a principal pay down of $801,000, including the application of the additional collateral referred to above. The maturity date of the loan, which now requires principal and interest payments on a monthly basis as set forth above, was extended to May 31, 1999. The terms of the loan agreement also required the establishment of an escrow account for real estate taxes, as well as a capital improvement escrow which is to be funded with monthly deposits from the Partnership aggregating approximately $1 million through the scheduled maturity date. Formal closing of the modification and extension agreement occurred on May 31, 1994.
On June 20, 1988, the Partnership borrowed $17,000,000 in the form of zero coupon loans due in June of 1995. These notes bore interest at an annual rate of 10%, compounded annually. As of March 31, 1994, such loans had an outstanding balance, including accrued interest, of approximately $23,560,000 and were secured by Saratoga Center and EG&G Plaza, Loehmann's Plaza Shopping Center, Richland Terrace and Richmond Park Apartments, West Ashley Shoppes, The Gables Apartments, Treat Commons Phase II Apartments and Asbury Commons Apartments. During fiscal 1995, the remaining balances of the zero coupon loans were repaid from the proceeds of five new conventional mortgage loans issued to the Partnership's joint venture investees, together with funds contributed by the Partnership, as set forth below.
On September 27, 1994, the Partnership refinanced the portion of the zero coupon loan secured by the Treat Commons Phase II apartment complex, of approximately $3,353,000, with the proceeds of a new $7.4 million loan obtained by the TCR Walnut Creek Limited Partnership joint venture. The $7.4 million loan was secured by the Treat Commons apartment complex, carried an annual interest rate of 8.54% and was scheduled to mature in 7 years. As discussed in Note 5, the Treat Commons property was sold and this loan obligation was repaid in full on December 29, 1995. On September 28, 1994, the Partnership repaid the portion of the zero coupon loan secured by the Asbury Commons apartment complex, of approximately $3,836,000, with the proceeds of a new $7 million loan obtained by the consolidated Asbury Commons joint venture. The $7 million loan is secured by the Asbury Commons apartment complex, carries an annual interest rate of 8.75% and matures in 7 years. The loan requires monthly principal and interest payments of $88,000. On October 22, 1994, the Partnership applied a portion of the excess proceeds from the refinancings of the Treat Commons and Asbury Commons properties described above and repaid the portion of the zero coupon loan which had been secured by West Ashley Shoppes of approximately $2,703,000 and made a partial prepayment toward the portion of the zero coupon loan secured by Hacienda Business Park of $3,000,000. On November 7, 1994, the Partnership repaid the portion of the zero coupon loans secured by The Gables Apartments and the Richland Terrace and Richmond Park apartment complexes of approximately $2,353,000 and $2,106,000, respectively, with the proceeds of a new $5.2 million loan secured by The Gables Apartments. The new $5.2 million loan bears interest at 8.72% and matures in 7 years. The loan requires monthly principal and interest payments of $43,000. On February 9, 1995, the Partnership repaid the remaining portion of the zero coupon loan secured by the Hacienda Business Park, of approximately $3,583,000, with the proceeds of a new $3.5 million loan obtained by the consolidated Hacienda Park Associates joint venture along with additional funds contributed by the Partnership. The $3.5 million loan is secured by the Hacienda Business Park property, carries an annual interest rate of 9.04% and matures in 7 years. The loan requires monthly principal and interest payments of $36,000. On February 10, 1995, the Partnership repaid the portion of the zero coupon loan secured by the Gateway Plaza Shopping Center, of approximately $4,093,000, with the proceeds of a new $4 million loan obtained by the Daniel/Metcalf Associates Partnership joint venture along with additional funds contributed by the Partnership. The $4 million loan is secured by the Gateway Plaza Shopping Center, carries an annual interest rate of 9.04% and matures on February 15, 2003. The loan requires monthly principal and interest payments of $34,000. Legal liability for the repayment of the new mortgage loans secured by the Gables and Gateway Plaza properties rests with the respective joint ventures. Accordingly the mortgage loan liabilities are recorded on the books of these unconsolidated joint ventures. The Partnership has indemnified Richmond Gables Associates and Daniel/Metcalf Associates Partnership and the related co-venture partners, against all liabilities, claims and expenses associated with these borrowings.
7. Bonds Payable -------------
Bonds payable consist of the Hacienda Park joint venture's share of liabilities for bonds issued by the City of Pleasanton, California for public improvements that benefit Hacienda Business Park and the operating investment property and are secured by liens on the operating investment property. The bonds for which the operating investment property is subject to assessment bear interest at rates ranging from 5% to 7.87%, with an average rate of approximately 7.2%. Principal and interest are payable in semi-annual installments and mature in years 2004 through 2017. In the event the operating investment property is sold, the liability for the bond assessments would be transferred to the buyer. Accordingly, the Hacienda Park joint venture would no longer be liable for the bond assessments.
Future scheduled principal payments on bond assessments are as follows (in thousands):
Year ended December 31,
1998 $ 110 1999 119 2000 128 2001 137 2002 148 Thereafter 1,529 -------- $ 2,171 ======== 8. Rental Revenue --------------
The buildings owned by Hacienda Park Associates and West Ashley Shoppes Associates are leased under noncancellable, multi-year leases. Minimum future rentals due under the terms of these leases at December 31, 1997 are as follows (in thousands):
Future Minimum Contractual Payments --------
1998 $ 3,029 1999 2,167 2000 1,930 2001 1,446 2002 1,069 Thereafter 1,112 -------- $ 10,753 ========
9. Subsequent Events -----------------
On May 15, 1998, the Partnership paid distributions to the Limited and General Partners in the amounts of $297,000 and $3,000, respectively, for the quarter ended March 31, 1998.
REPORT OF INDEPENDENT AUDITORS
The Partners of PaineWebber Equity Partners Two Limited Partnership:
We have audited the accompanying combined balance sheets of the Combined Joint Ventures of PaineWebber Equity Partners Two Limited Partnership as of December 31, 1997 and 1996, and the related combined statements of income and changes in venturers' capital, and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule 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, the combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Combined Joint Ventures of PaineWebber Equity Partners Two Limited Partnership at December 31, 1997 and 1996, and the combined results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ERNST & YOUNG LLP -------------------- ERNST & YOUNG LLP
Boston, Massachusetts February 18, 1998
COMBINED JOINT VENTURES OF PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP
COMBINED BALANCE SHEETS December 31, 1997 and 1996 (In thousands)
Assets
1997 1996 ---- ---- Current assets: Cash and cash equivalents $ 395 $ 600 Accounts receivable, net of allowance for doubtful accounts of $45 ($146 in 1996) 774 637 Prepaid distribution to venturer 37 - Prepaid expenses 28 27 --------- ------- Total current assets 1,234 1,264
Operating investment properties: Land 15,222 15,222 Buildings, improvements and equipment 61,649 59,902 Construction in progress 3,161 2,528 --------- ------- 80,032 77,652 Less accumulated depreciation (25,130) (22,250) --------- ------- 54,902 55,402
Escrowed funds 1,144 1,747 Due from affiliates 269 269 Deferred expenses, net of accumulated amortization of $1,767 ($1,428 in 1996) 1,635 1,608 Other assets 1,319 1,368 --------- ------- $ 60,503 $61,658 ========= =======
Liabilities and Venturers' Capital
Current liabilities: Accounts payable and accrued expenses $ 481 $ 372 Accrued real estate taxes 2,122 2,017 Distributions payable to venturers - 1 Current portion - long-term debt 137 125 --------- ------- Total current liabilities 2,740 2,515
Tenant security deposits 268 265
Subordinated management fee payable to affiliate 50 50
Long-term debt 8,720 8,857
Venturers' capital 48,725 49,971 --------- ------- $ 60,503 $61,658 ========= =======
See accompanying notes.
COMBINED JOINT VENTURES OF PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP
COMBINED STATEMENTS OF INCOME AND CHANGES IN VENTURERS' CAPITAL
For the years ended December 31, 1997, 1996 and 1995 (In thousands)
1997 1996 1995 ---- ---- ---- Revenues: Rental income and expense reimbursements $ 9,814 $ 9,297 $ 11,844 Interest and other income 481 343 330 --------- -------- -------- 10,295 9,640 12,174
Expenses: Real estate taxes 2,323 2,212 2,248 Depreciation expense 2,880 2,896 2,756 Property operating expenses 641 602 908 Repairs and maintenance 1,047 879 1,093 Management fees 314 318 459 Professional fees 107 82 88 Salaries 634 591 882 Advertising 60 46 71 Interest expense on long-term debt 661 663 1,535 Interest on note payable to venturer - - 100 General and administrative 417 438 564 Amortization expense 297 262 948 Bad debt expense - 45 1 Other 10 8 111 --------- -------- -------- 9,391 9,042 11,764 --------- -------- --------
Operating income 904 598 410
Gains on sale of operating investment properties - - 8,368 --------- -------- --------
Net income 904 598 8,778
Contributions from venturers 2,160 2,303 1,494
Distributions to venturers (4,310) (3,735) (19,187)
Venturers' capital, beginning of year 49,971 50,805 59,720 --------- -------- --------
Venturers' capital, end of year $ 48,725 $ 49,971 $ 50,805 ========= ======== ========
See accompanying notes.
See accompanying notes.
COMBINED JOINT VENTURES OF PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP NOTES TO COMBINED FINANCIAL STATEMENTS
1. Organization ------------
The accompanying financial statements of the Combined Joint Ventures of PaineWebber Equity Partners Two Limited Partnership (Combined Joint Ventures) include the accounts of Chicago-625 Partnership, an Illinois general partnership; Richmond Gables Associates, a Virginia general partnership; Daniel/Metcalf Associates Partnership, a Kansas general partnership; TCR Walnut Creek Limited Partnership, a Texas limited partnership and Portland Pacific Associates, a California general partnership. The financial statements of the Combined Joint Ventures are presented in combined form due to the nature of the relationship between each of the co-venturers and PaineWebber Equity Partners Two Limited Partnership ("EP2").
The financial statements of the Combined Joint Ventures have been prepared based on the periods that EP2 held an interest in the individual joint ventures. The dates of EP2's acquisition of interests in the joint ventures are as follows: Date of Acquisition Joint Venture of Interest ------------- -----------
Chicago-625 Partnership December 16, 1986 Richmond Gables Associates September 1, 1987 Daniel/Metcalf Associates Partnership September 30, 1987 TCR Walnut Creek Limited Partnership December 24, 1987 (1) Portland Pacific Associates January 12, 1988 (2)
(1)On December 29, 1995, the TCR Walnut Creek Limited Partnership sold its operating investment property. The joint venture was liquidated during 1996.
(2)On November 2, 1995, Portland Pacific Associates sold its two operating investment properties. Portland Pacific Associates was liquidated during 1996.
2. Summary of Significant Accounting Policies ------------------------------------------
Use of estimates ----------------
The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles which required management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of December 31, 1997 and 1996 and revenues and expenses for each of the three years in the period ended December 31, 1997. Actual results could differ from the estimates and assumptions used.
Deferred expenses -----------------
Deferred expenses include capitalized debt issuance costs which are being amortized on a straight-line basis, which approximates the effective interest method, over the terms of the related loans. Amortization of deferred loan costs is included in interest expense on the accompanying statement of income. Deferred expenses also include organization costs which are being amortized over 5 years and lease commissions and rental concessions which are being amortized over the life of the applicable leases.
Income tax matters ------------------
The Combined Joint Ventures are comprised of entities which are not taxable and, accordingly, the results of their operations are included on the tax returns of the various partners. Accordingly, no income tax provision is reflected in the accompanying combined financial statements.
Cash and cash equivalents -------------------------
For purposes of reporting cash flows, the Combined Joint Ventures consider all highly liquid investments, money market funds and certificates of deposit purchased with original maturities of three months or less to be cash equivalents.
Rental revenues ---------------
Certain joint ventures have long-term operating leases with tenants which provide for fixed minimum rents and reimbursements of certain operating costs. Rental revenues are recognized on a straight-line basis over the term of the related lease agreements.
Fair value of financial instruments -----------------------------------
The carrying amounts of cash and cash equivalents and escrowed funds approximate their respective fair values at December 31, 1997 and 1996 due to the short-term maturities of such instruments. Where practicable, the fair value of long-term debt is estimated using discounted cash flow analysis, based on the current market rates for similar types of borrowing arrangements.
Operating investment properties -------------------------------
Operating investment properties are stated at cost, net of accumulated depreciation, or an amount less than cost if indicators of impairment are present in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which was adopted in 1995. SFAS No. 121 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amount.
Through December 31, 1994, depreciation expense was computed on a straight-line basis over the estimated useful lives of the operating investment properties, generally 5 years for the equipment and fixtures and 31.5 years for the buildings and improvements. During 1995, circumstances indicated that Chicago 625 Partnership's operating investment property might be impaired. The joint venture's estimate of undiscounted cash flows indicated that the property's carrying amount was expected to be recovered, but that the reversion value could be less that the carrying amount at the time of disposition. As a result of such assessment, the venture commenced recording an additional annual depreciation charge of $350,000 in 1995 to adjust the carrying value of the operating investment property such that it will match the expected reversion value at the time of disposition. Such an annual charge will continue to be recorded in future periods. The Combined Joint Ventures capitalized property taxes and interest incurred during the construction period of the projects along with the costs of identifiable improvements. The Combined Joint Ventures also capitalized certain acquisition, construction and guaranty fees paid to affiliates. In certain circumstances the carrying values of the operating properties have been adjusted for mandatory payments received from venture partners.
3. Joint Ventures -------------
See Note 5 to the financial statements of EP2 included in this Annual Report for a more detailed description of the joint ventures. Descriptions of the ventures' properties are summarized below:
a. Chicago-625 Partnership -----------------------
The joint venture owns and operates 625 North Michigan Avenue, a 325,000 square foot office building located in Chicago, Illinois.
b. Richmond Gables Associates --------------------------
The joint venture owns and operates The Gables of Erin Shades, a 224-unit apartment complex located in Richmond, Virginia.
c. Daniel/Metcalf Associates Partnership -------------------------------------
The joint venture owns and operates the Gateway Plaza Shopping Center (formerly Loehmann's Plaza), a 142,000 square foot shopping center located in Overland Park, Kansas.
d. TCR Walnut Creek Limited Partnership ------------------------------------
The joint venture formerly owned and operated Treat Commons Phase II Apartments, a 160-unit apartment complex located in Walnut Creek, California. On December 29, 1995, TCR Walnut Creek Limited Partnership sold the Treat Commons Phase II Apartments to a third party for approximately $12.1 million. EP2 received net proceeds of approximately $4.1 million after deducting closing costs and the repayment of the existing mortgage note of approximately $7.3 million. EP2 was entitled to 100% of the net sale proceeds and cash flow from operations of the venture in accordance with the joint venture agreement. The joint venture recognized a gain of $3,594,000 on the sale, representing the amount by which the sale proceeds exceeded the net carrying amount of the operating investment property at the date of the sale.
e. Portland Pacific Associates ---------------------------
The joint venture formerly owned and operated two apartment complexes, Richmond Park Apartments and Richland Terrace Apartments, which contain a total of 183 units located in Washington County, Oregon. On November 2, 1995, Portland Pacific Associates sold the Richmond Park and Richland Terrace Apartments to a third party for $11 million. EP2 received net proceeds of approximately $8 million after deducting closing costs, the co-venturer's share of the proceeds and repayment of a $2 million borrowing of EP2's which encumbered the property. The joint venture recognized a gain of $4,774,000 on the sale, representing the amount by which the sale proceeds exceeded the net carrying amount of the operating investment properties at the date of the sale.
The following description of the joint venture agreements provides certain general information.
Allocations of net income and loss ----------------------------------
Except for certain items which are specifically allocated to the partners, as defined in the joint venture agreements, the joint venture agreements generally provide that profits up to the amount of net cash flow distributable shall be allocated between EP2 and the co-venturers in proportion to the amount of net cash flow distributed to each partner for such year. Profits in excess of net cash flow shall be allocated between 59% -99% to EP2 and 1% - 41% to the co-venturers. Losses are allocated in varying proportions 59% - 100% to EP2 and 0% - 41% to the co-venturers as specified in the joint venture agreements.
Gains or losses resulting from sales or other dispositions of the projects shall be allocated as specified in the joint venture agreements.
Distributions -------------
The joint venture agreements provide that distributions will generally be paid from net cash flow monthly or quarterly, equivalent to 9% - 10% per annum return on EP2's net investment in the joint ventures. Any remaining cash flow is generally to be distributed first, to repay accrued interest and principal on certain loans and second, to EP2 and the co-venturers until they have received their accrued preference returns. The balance of any net cash flow is to be distributed in amounts ranging from 59% - 75% to EP2 and 25% - 41% to the co-venturers as specified in the joint venture agreements.
Distributions of net proceeds upon the sale or disposition of the projects shall be made in accordance with formulas provided in the joint venture agreements.
Guaranty Period ---------------
The joint venture agreements provided that during the Guaranty Periods (as defined in the joint venture agreements), in the event that net cash flow was insufficient to fund operations including amounts necessary to pay EP2 preferred distributions, the co-venturers were to be required to fund amounts equal to such deficiencies. The co-venturers' obligation to fund such amounts pursuant to their guarantees was generally to be in the form of capital contributions to the joint ventures. For a specified period of time subsequent to the Guaranty Period, one of the joint venture agreements required that mandatory loans be made to the joint venture by the co-venturer to the extent that operating revenues were insufficient to pay operating expenses.
The Guaranty and Mandatory Loan Periods of the joint ventures were generally from the date EP2 entered a joint venture for a period ranging from one to five years.
The expiration dates of the Guaranty and Mandatory Loan Periods for the joint ventures were as follows:
Guaranty Period Mandatory Loan Period --------------- ---------------------
Chicago-625 Partnership December 15, 1989 N/A Richmond Gables Associates September 1, 1990 N/A Daniel/Metcalf Associates Partnership September 30, 1989 September 30, 1990 TCR Walnut Creek Limited Partnership August 31, 1990 N/A Portland Pacific Associates February 1, 1991 N/A
As of December 31, 1997, the co-venturer in the Daniel/Metcalf Associates Partnership is obligated to make additional capital contributions of at least $89,000 (subject to adjustment pending the venture partners' determination of an additional amount, if any, of working capital reserves to be funded by the co-venturer) with respect to cumulative unfunded shortfalls in EP2's preferred return through September 30, 1990. Such additional capital contributions are not recorded as a receivable in the accompanying financial statements.
4. Related Party Transactions --------------------------
The Combined Joint Ventures originally entered into property management agreements with affiliates of the co-venturers, cancellable at EP2's option upon the occurrence of certain events. The management fees are equal to 3.5%-5% of gross receipts, as defined in the agreements. Affiliates of certain co-venturers also receive leasing commissions with respect to new leases acquired.
The related property manager for the 625 North Michigan property leases space in the property under a lease agreement extending through October 31, 2001. The 1997, 1996 and 1995 revenues include $178,000, $175,000 and $236,000, respectively, relating to this lease.
5. Capital Reserves ----------------
The joint venture agreements generally provide that reserves for future capital expenditures be established and administered by affiliates of the co-venturers. The co-venturers are to pay periodically into the reserve (as defined) as funds are available after paying all expenses and the EP2 preferred distribution. No contributions were made to the reserves in 1997, 1996 or 1995.
6. Rental Revenues ---------------
Certain joint ventures have operating leases with tenants which provide for fixed minimum rents and reimbursements of certain operating costs. Rental revenues are recognized on a straight-line basis over the life of the related lease agreements.
Minimum rental revenues to be recognized on the straight-line basis in the future on noncancellable leases are as follows (in thousands):
1998 $ 6,873 1999 6,617 2000 6,034 2001 3,867 2002 2,699 Thereafter 5,876 --------- $ 31,966 =========
Leases with four tenants of the 625 North Michigan Office Building accounted for approximately $2,234,000, or 44%, of the rental revenue generated by that property for 1997.
7. Long-Term Debt --------------
Long term debt payable at December 31, 1997 and 1996 consists of the following (in thousands):
1997 1996 ---- ----
9.04% mortgage note payable to an insurance company secured by the Gateway Plaza operating investment property. The loan requires monthly principal and interest payments of $34 through maturity on February 15, 2003 (see discussion below). $ 3,862 $ 3,915
8.72% mortgage note payable to an insurance company secured by the The Gables operating investment property. The loan requires monthly principal and interest payments of $43 through maturity on October 15, 2001 (see discussion below). 4,995 5,067 ------- ------- 8,857 8,982
Less: current portion (137) (125) ------- ------- $ 8,720 $ 8,857 ======= =======
On November 7, 1994, a mortgage note payable was obtained by Richmond Gables Associates in the initial principal amount of $5,200,000. The mortgage payable is secured by a deed of trust on the venture's operating investment property and a collateral assignment of the venture's interest in the leases. The net proceeds from this mortgage note payable were remitted directly to EP2 per the agreement of the partners. EP2 used the proceeds of the loan in conjunction with the repayment of the encumbrances described in Note 8. The fair value of this mortgage note approximated its carrying value as of December 31, 1997 and 1996.
On January 27, 1995 the Gateway Plaza joint venture obtained a first mortgage loan, secured by the operating investment property, in the initial principal amount of $4,000,000. The proceeds of the loan were used to repay, in full, a $700,000 mortgage loan outstanding at December 31, 1994 and to establish a renovation and occupancy escrow in the amount of $550,000. The remainder of the proceeds, along with additional funds contributed by EP2, were used to repay, in full, the borrowing described in Note 8. The new first mortgage loan bears interest at an annual rate of 9.04% and matures on February 15, 2003. The loan requires monthly principal and interest payments of $34,000. On October 10, 1997, the renovation and occupancy escrow of $550,000 plus interest of $60,000 was released by the lender to EP2. At December 31, 1997 and 1996, the fair value of the mortgage note payable approximated its carrying value based on an estimate of the current market interest rate which would have been charged if the borrowing had been originated as of such dates.
The closing of the Gateway Plaza financing transaction described above was executed in conjunction with an amendment to the Joint Venture Agreement. The purpose of the amendment was to establish the portion of the new first mortgage loan which was used to repay the borrowing of EP2 described in Note 8 ("the PWEP Component") as the sole responsibility of EP2. Accordingly, any debt service payments attributable to the PWEP Component will be deducted from PWEP's share of operating cash flow distributions or sale or refinancing proceeds. Furthermore, all expenses associated with such portion of the new borrowing will be specifically allocated to PWEP. PWEP has agreed to indemnify the joint venture and the co-venturer against all losses, damages, liabilities, claims, costs, fees and expenses incurred in connection with the PWEP Component of the first mortgage loan. The portion of the new first mortgage loan which was used to repay the venture's $700,000 mortgage loan and to establish the Renovation and Occupancy Escrow will be treated as a joint venture borrowing subject to the terms and conditions of the original Joint Venture Agreement.
The scheduled annual principal payments to retire long-term debt are as follows (in thousands):
1998 $ 137 1999 150 2000 163 2001 4,810 ` 2002 82 Thereafter 3,515 --------- $ 8,857 =========
8. Encumbrances on Operating Investment Properties -----------------------------------------------
Under the terms of the joint venture agreements, EP2 is entitled to use the joint venture operating properties as security for certain borrowings, subject to various restrictions. EP2 (together in one instance with an affiliated partnership) had exercised its options pursuant to this arrangement by issuing certain zero coupon notes between April and June of 1988. The operating investment properties of all of the Combined Joint Ventures had been pledged as security for these loans which were scheduled to mature in 1995. During calendar 1994, the portion of the zero loans secured by Treat Commons, The Gables, Richmond Park and Richland Terrace properties were repaid in full from the proceeds of new mortgage loans obtained by certain of the joint ventures as described in Note 7. On February 10, 1995 the zero coupon note secured by Gateway Plaza, due to mature in June of 1995, was repaid in full with the proceeds of a loan obtained by this joint venture (see Note 7).
The zero coupon loan secured by the 625 North Michigan Office Building had required that if the loan ratio, as defined, exceeded 80%, then EP2, together with its affiliated partnership, was required to deposit additional collateral in an amount sufficient to reduce the loan ratio to 80%. During 1993, the lender informed EP2 and its affiliated partnership that based on an interim property appraisal, the loan ratio exceeded 80% and demanded that additional collateral be deposited. Subsequently, EP2 and its affiliated partnership submitted an appraisal which demonstrated that the loan ratio exceeded 80% by an amount less than previously demanded by the lender and deposited additional collateral in accordance with the higher appraised value. The lender accepted the deposit of additional collateral, but disputed whether EP2 and its affiliated partnership had complied with the terms of the loan agreement regarding the 80% loan ratio. On May 31, 1994, an agreement was reached with the lender to refinance the loan and resolve the outstanding disputes. The terms of the agreement extended the maturity date of the loan to May 1999. The new principal balance of the loan, after a principal paydown of $1,342,000, which was funded by EP2 and its affiliated partnership in the ratios of 59% and 41%, respectively, was $16,225,000. The new loan bears interest at a rate of 9.125% per annum and requires the current payment of interest and principal on a monthly basis based on a 25-year amortization period. Under the terms of the modification and extension agreement, this loan remains a direct obligations of EP2 and its affiliate and, therefore, is not reflected in the accompanying financial statements. EP2 is required to make all loan payments and has indemnified the joint venture and the other partners against all liabilities, claims and expenses associated with this borrowing. At December 31, 1997, the aggregate indebtedness of EP2 and its affiliated partnership which is secured by the 625 North Michigan Office Building was approximately $15,644,000. The terms of the loan agreement also required the establishment of an escrow account for real estate taxes, as well as a capital improvement escrow which is to be funded with monthly deposits from EP2 and its affiliated partnership aggregating $1,750,000 through the scheduled maturity date of the loan. Such escrow accounts are recorded on the books of the joint venture and are included in the balance of escrowed cash on the accompanying balance sheets.
9. Property Renovation -------------------
During 1997 and 1996, the Gateway Plaza joint venture incurred certain architectural, engineering and other costs relating to a major renovation of its operating property. These costs have been capitalized and are included in the construction in progress account in the accompanying balance sheet. The total cost of the renovation has amounted to approximately $3,200,000 as of December 31, 1997. EP2 is expected to make additional capital contributions, as needed, sufficient to cover the cost of this renovation.
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