ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . 1
ITEM 2.
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . 5
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not aware of any material pending legal proceedings as of February 9, 1999, nor were any material proceedings terminated during the quarter ended December 31, 1998.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matter to a vote of our shareholders during the fourth quarter of 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S SHARES AND RELATED SHAREHOLDER MATTERS
Our shares are included for quotation on the NASDAQ National Market (symbol - BSRTS). The table below shows the quarterly high and low bid prices reported by NASDAQ and the amount of cash distributions we paid per share for the years ended December 31, 1998 and 1997.
---- Quarter Share Per Share Declaration Ended Price Distributions Date - ------- ----- ------------- -----------
3/31 High $6.25 $0.12 3/16/98 Low $5.13
6/30 High $7.75 $0.12 7/6/98 Low $5.94
9/30 High $7.19 $0.12 10/6/98 Low $5.50
12/31 High $6.31 $0.12 1/6/99 Low $4.63
---- Quarter Share Per Share Declaration Ended Price Distributions Date - ------- ----- ------------- -----------
3/31 High $5.00 $0.10 4/8/97 Low $3.75
6/30 High $4.62 $0.10 7/3/97 Low $3.62
9/30 High $5.50 $0.10 10/7/97 Low $4.00
12/31 High $6.87 $0.10 1/7/98 Low $5.06
On January 6, 1999, we declared a cash distribution for the quarter ended December 31, 1998 of $0.12 per share payable February 22, 1999 to shareholders of record on January 22, 1999.
During 1998 and 1997, we paid distributions equal to $0.46 and $0.40 per share, respectively. A total of $0.01 (1998) and $0.38 (1997) represented a return of capital.
Our ability to make future distributions to our shareholders is dependent upon, among other things:
. sustaining the operating performance of our existing real estate investments through scheduled increases in base rents under existing leases and through general improvement in the real estate markets where our properties are located;
. the operating performance of future acquisitions; and
. our level of operating expenses.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Factors" for a more complete discussion.
As of February 9, 1999, there were 3,595 record holders of shares of beneficial interest.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
We have acquired a large number of properties during each of the periods discussed below. Thus, period to period results are not entirely comparable. At December 31, 1998, we owned individually or, in some cases, through joint ventures:
. thirteen flex industrial properties totalling 1,841,000 rentable square feet;
. fourteen office properties totalling 1,545,600 rentable square feet;
. four apartment complexes containing 864 units;
. one retail center which contains 321,600 rentable square feet.
During the year ended December 31, 1998, we acquired four office properties totalling 354,800 rentable square feet and six flex industrial properties totalling 479,800 rentable square feet.
COMPARISON OF YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997
During the year ended December 31, 1998 and 1997 our net income totalled approximately $5.4 million ($0.40 per basic common share) and approximately $3.5 million ($0.32 per basic common share), respectively. The approximately $1.9 million increase resulted primarily from revenue growth of approximately $10.6 million reduced by expense growth of approximately $7.8 million. In particular, our total revenues increased by approximately $10.6 million or 36.8% to approximately $39.4 million from approximately $28.8 million, due primarily to an increase in the number of properties that we own. We attribute approximately $9.9 million or 93.4%, of this increase to properties acquired in 1998 and the net full-year effect of properties we either acquired or sold during 1997. On a "same- store" basis (comparing the results of operations of the properties owned during the entire year ended December 31, 1998 with the results of the same properties owned during the year ended December 31, 1997), total revenues increased by approximately $0.7 million or 3.5% to approximately $20.7 million from approximately $20.0 million, due to increased rental rates at these properties and recognition of lease termination fees at certain properties. Our portfolio occupancy as of December 31, 1998 was lower than it historically has been as a result of the termination of leases during the quarter. Therefore, our ability to maintain same store growth in revenue will in the future be dependent on the time it takes to re-lease this and future vacant space and the rental rates at which we sign new leases. In addition, property acquisitions during 1997 and 1998 have significantly contributed to our growth in those years. Our ability to make acquisitions in the future will depend upon our ability to raise additional equity through realizing gains on the sale of properties, selling additional shares of beneficial interest and/or issuing operating partnership units in the Operating Partnership. See Risk Factors for additional discussion.
In 1998, our total operating expenses, which include property operating, repair and maintenance, real estate taxes, and ground lease, increased by approximately $2.7 million to approximately $13.4 million from approximately $10.7 million in 1997, primarily due to an increase in the number of properties that we own, which accounted for approximately $2.3 million or 85.2% of this increase. On a "same-store" basis, total operating expenses increased by approximately $0.4 million or 6.3% to approximately $6.7 million from approximately $6.3 million. Interest expense increased by approximately $3.4 million from approximately $6.4 million to approximately $9.8 million, primarily due to an increase in the amount we have borrowed in connection with the acquisitions we completed in 1998. Depreciation and amortization expense also increased approximately
$1.7 million. We attribute most of the increase to the fact that we own more properties. Total general and administrative expenses increased by approximately $0.3 million due to costs incurred in connection with due diligence for transactions that were not completed in 1998 and due to an increase in administrative staff hired to oversee our properties and the legal fees associated with acquiring properties during 1998.
COMPARISON OF YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996
During the year ended December 31, 1997, our net income totalled approximately $3.5 million ($0.32 per common share) compared to a net loss of approximately $1.8 million (($0.17) per common share) for the year ended December 31, 1996. We explain the $5.3 million increase by noting that revenues grew by $7.4 million in 1997 while expenses grew by $2.1 million. In particular, our total revenues increased 34.6% to approximately $28.8 million from approximately $21.4 million due primarily to an increase in the number of properties that we own. We attribute approximately $6.5 million or 87.8%, of this increase to properties we either acquired or sold in 1997 and the full-year effect of properties acquired during 1996. On a "same-store" basis (comparing the results of operations of the properties we owned during the entire year ended December 31, 1997 with the results of the same properties owned during the year ended December 31, 1996), our total revenues increased by approximately $1.2 million, or 7.2%, to approximately $17.9 million from approximately $16.7 million due in part to increased occupancy. In addition, our operating cost recoveries increased by approximately $0.2 million. The remainder of the increase in revenue generated by same store properties was due to increased rental rates. The increase in total revenues was partially offset by a decrease in interest income earned on mortgage loans of approximately $0.4 million, which were sold during 1996.
Our total operating expenses increased by approximately $1.4 million in 1997 to approximately $10.7 million from approximately $9.3 million in 1996. This increase is almost exclusively due to an increase in the number of properties that we own. Our interest expense increased to approximately $6.4 million from approximately $4.0 million primarily due to the fact that the we increased the amount of money borrowed from approximately $59.1 million at December 31, 1996 to approximately $92.1 million at December 31, 1997. We used the additional loans to pay for our new acquisitions. Our depreciation and amortization expense also increased by approximately $1.2 million. We attribute most of the increase to the fact that we own more properties. Our total general and administrative expenses increased by approximately $1.2 million. We attribute this increase to a larger administrative staff hired to oversee our properties, the legal fees associated with acquiring our properties during 1997 and amounts we paid as incentive compensation.
During the year ended December 31, 1997, we realized net income from our interest in the H Street Venture of $37,126 compared to a net loss of ($3,301,212) for the same period in 1996. The net loss in 1996 was due to our decision to reduce the carrying value of our interest in the H Street Venture. In March 1997, the venture sold a property which it owned and we received a distribution of approximately $1.0 million from the venture. On July 29, 1997, the venture sold its remaining assets. We received a distribution of approximately $4.5 million and recognized a loss of approximately $0.1 million. We have no further interest in the H Street Venture.
LIQUIDITY AND CAPITAL RESOURCES
We expect to fund our short-term liquidity needs, including recurring capital expenditures, from our working capital (including the restricted cash which is available for capital expenditures, real estate taxes and insurance), and from income derived primarily from our property operations.
We anticipate using these monies to fund periodic tenant-related capital
expenditures and other capital improvements. We believe that our Funds Available for Distribution (as defined below) will be sufficient for the twelve months after the date of this report to pay quarterly distributions of $0.12 per common share.
We expect to fund our long-term liquidity needs, including monies required to acquire and develop property and funds necessary for other non- recurring capital improvements, from long-term secured and unsecured debt and through issuing debt or equity securities, including issuing units in the Operating Partnership in exchange for properties. We expect that we will fund a portion of the cost of buying and improving properties in the future by borrowing under our credit facilities or by mortgaging properties we acquire.
At December 31, 1998, our assets totalled approximately $222.6 million, an increase of approximately $63.0 million from total assets at December 31, 1997 of approximately $159.6 million. Our liabilities totalled approximately $158.0 million at December 31, 1998 an increase of approximately $61.9 million from a total of approximately $96.1 million at December 31, 1997. Our shareholders equity increased by approximately $0.1 million to approximately $62.4 million at December 31, 1998 from approximately $62.3 million at December 31, 1997.
Cash and cash equivalents consist of cash and short-term investments. Our cash and cash equivalents balance was approximately $3.7 million at December 31, 1998 and approximately $4.4 million at December 31, 1997. The decrease in total cash and cash equivalents from year-end 1997 to year-end 1998 results from using approximately $61.8 million on investing activities while receiving approximately $49.9 million in financing and approximately $11.2 million from operations.
Cash Flows From Operating Activities: Net cash provided by operating activities increased in 1998 by approximately $2.6 million to approximately $11.2 million from approximately $8.6 million in 1997. This increase is primarily due to an increase in the net operating income generated by the properties acquired in 1998 and 1997. See Results of Operations above for further discussion of the operations of our real estate assets.
Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts ("NAREIT"), an industry trade group, has promulgated a standard known as "Funds from Operations", or "FFO" for short, which it believes more accurately reflects the operating property performance of a REIT such as our company. As defined by NAREIT, FFO means net income computed in accordance with generally accepted accounting principles ("GAAP"), less extraordinary, unusual and nonrecurring items, excluding gains (or losses) from debt restructuring and sales of property plus depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures in which the REIT holds an interest. We have adopted the NAREIT definition for computing FFO because we believe that, subject to the following limitations, FFO provides a basis for comparing the performance and operations of a REIT such as our company. The calculation of FFO may vary from entity to entity in that capitalization and expense policies may vary from entity to entity. Items which are capitalized do not decrease FFO whereas items that are expensed decrease FFO. As such, our presentation of FFO may not be comparable to other similarly titled measures presented by other REIT's. We do not intend for FFO to be an alternative to Net Income as an indication of our performance nor an alternative to Cash Flows from Operating Activities (as calculated in accordance with GAAP) as a measure of our capacity to pay distributions.
For the years ended December 31, 1998, 1997 and 1996, our properties generated FFO of approximately $10.4 million, $5.8 million and $3.6 million, respectively. FFO increased on a year to year basis due primarily to an increase in the number of properties owned from period to period.
FFO for the years ended December 31, 1998, 1997, and 1996 is calculated as follows:
1998 1997 1996 --------- -------- -------- (Dollars in thousands) Net Income (Loss) $ 5,378 $ 3,546 $ (1,757)
Plus: Depreciation expense 4,770 3,277 2,355 Depreciation included in Operations of Real Estate Ventures -- 15 31 Lease Commission Amortization 406 208 98 Less: Minority Interest Share of Depreci- ation Expense (284) (254) (228) Minority Interest Share of Lease Commission Amortization (31) (21) (13) Recovery of Losses on Loans, Notes and Interest Receivable -- (161) (17)
Valuation Allowance Included in Operations of Real Estate Venture -- -- 3,180
Net Gain on Disposition of Investments in Real Estate -- (881) --
Extraordinary Item, Net of Minority Interest 141 64 -- -------- -------- -------- Funds From Operations $ 10,380 $ 5,793 $ 3,649 ======== ======== ======== Cash Flows Provided By (Used For): Operating Activities $ 11,220 $ 8,644 $ 5,730 Investing Activities $(61,790) $(27,575) $ (6,598) Financing Activities $ 49,872 $19,555 $ (827)
Our ability to pay any distribution is influenced by the amount of monies that we have available to distribute known as Funds Available for Distribution or "FAD" for short. FAD is calculated by increasing or decreasing FFO to give effect to items such as the impact of straight- lining rents, lease commissions paid and normalized reserves for capital improvements. The capital reserve is $0.075 per square foot for flex/industrial properties, $0.10 per square foot for office properties, $0.15 per square foot for retail property and $200 per residential unit.
Our ability to make future distributions to our shareholders is dependent upon, among other things:
. sustaining the operating performance of our existing real estate investments through scheduled increases in base rents under existing leases and through general improvement in the real estate markets where our properties are located;
. the operating performance of future acquisitions; and
. our level of operating expenses.
See Risk Factors for additional discussion.
FAD for the years ended December 31, 1998, 1997 and 1996 is calculated as follows:
1998 1997 1996 ------- ------- ------- (Dollars in thousands) Funds From Operations . . . . . . $10,380 $ 5,793 $ 3,649 Straight-line Rents . . . . . . . (544) (386) (289) Lease Commissions . . . . . . . . (739) (630) (382) Capital Reserve . . . . . . . . . (493) (381) (350) ------- ------- ------- Funds Available for Distribution. $ 8,604 $ 4,396 $ 2,628 ======= ======= =======
Cash Flows From Investing Activities: During the year ended December 31, 1998, we used approximately $61.8 million primarily to acquire properties compared to approximately $27.6 million in the same period in 1997. During the year ended December 31, 1998 we purchased four office and six flex/industrial properties for approximately $55.9 million. Cash flow was also used to make capital improvements at our various properties in the amount of approximately $5.3 million. In comparison, during the same period in 1997, we generated a total of approximately $12.5 million from sale of our interests in (i) the Hallmark Village property; (ii) the H Street Assemblage Parcel and the Victor building; and (iii) the Colonial Courts Apartments; acquired six office and four apartment properties for a total of approximately $37.5 million and made capital improvements in the amount of approximately $2.5 million.
PROPERTY ACQUISITIONS AND OTHER INFORMATION
ACQUISITION ACTIVITIES:
During the year ended December 31, 1998, we acquired interests in several properties. The table below presents a summary of 1998 acquisitions.
Purchase Name and Date of Price Location Acquisi- (in of Property Sq. Ft. tion millions) Description - --------------- -------- --------- --------- ----------------
Peachtree Pointe 71,700 01/20/98 $4.6 Five one-story Office Park office buildings; Norcross, Georgia Twenty-three tenants at the time of acqui- sition
Avalon Center 53,300 03/20/98 4.4 Two one-story Office Park office buildings; Norcross, Georgia Three tenants at the time of acquisition
Avalon Ridge 57,400 04/24/98 3.9 Two one-story Business Park flex/industrial Norcross, Georgia buildings; Two tenants at the time of acquisition
Tower Lane 95,900 04/27/98 5.2 Two one-story Business Park (1) flex/industrial Bensenville, buildings; Illinois Seventeen tenants at the time of acquisition
Purchase Name and Date of Price Location Acquisi- (in of Property Sq. Ft. tion millions) Description - --------------- -------- --------- --------- ----------------
University 127,800 04/30/98 10.2 Seven one-story Corporate Center flex/industrial Winter Park, buildings; Florida Twenty-six tenants at the time of acquisition
Metric Plaza 32,000 04/30/98 2.6 Two one-story Winter Park, flex/industrial Florida buildings; Two tenants at the time of acquisition
Park Center 47,400 04/30/98 3.7 Two one-story Orlando, Florida flex/industrial buildings; Sixteen tenants at the time of acquisition
Sand Lake 84,100 04/30/98 6.8 Five one-story Tech Center office buildings; Orlando, Florida Three tenants at the time of acquisition
Johns Creek 119,300 08/14/98 5.8 Two flex/indus- Office and trial buildings; Industrial Park Two tenants Duluth and Suwanne, at the time Georgia of acquisition
Technology 145,700 08/14/98 12.4 Three office Park buildings; Norcross, Twelve tenants Georgia at the time -------- ----- of acquisition Total 834,600 $59.6 ======== =====
(1) In April 1998, we formed a new joint venture, Butterfield O'Hare L.P., in which we have an 89.1% limited partnership interest and .9% general partnership interest. The portfolio owned by the venture consists of two properties, Butterfield Office Plaza, a property we formerly owned solely, and Tower Lane Business Park ("Tower Lane"), which the venture purchased on April 27, 1998. Upon forming the venture and acquiring Tower Lane, the venture assumed a permanent mortgage loan encumbering the Tower Lane property in the amount of approximately $3.7 million. The loan matures in November, 2001, bears an interest rate of 8.35% and is payable in monthly installments of interest and principal, with principal amortized over a 264-month period. The financing secured by the Butterfield property in the amount of approximately $9.9 million was also assumed by the venture.
Cash Flows From Financing Activities: During the years ended December 31, 1998 and 1997, financing activities generated $49.9 million and $19.6 million, respectively. During the year ended December 31, 1998 these cash flows resulted primarily from approximately $55.9 million of net proceeds from bonds and mortgage loans reduced by distributions paid to shareholders of approximately $6.1 million. The cash flows provided by financing activities for the year ended December 31, 1997 resulted primarily from approximately $16.9 million of net proceeds from bonds and mortgage loans and approximately $10.0 million of net proceeds from issuance of shares reduced by distributions paid to shareholders of approximately $4.5 million.
FINANCINGS:
On April 30, 1998, we entered into a $25 million line of credit agreement (the "CCA Line") with Nomura Asset Capital Corporation ("Nomura"). Nomura subsequently assigned its interest to its subsidiary - The Capital Company of America LLC ("CCA"). The CCA Line has an initial term of twenty-four months. Draws on the line bear interest at a rate equal to LIBOR plus 2.00%. We have an option to extend the line for one additional year for a fee of $125,000. The agreement with CCA requires that we satisfy certain financial covenants, including maintaining a consolidated tangible net worth of at least $52.5 million and a leverage ratio of debt to consolidated net worth of 3:1 or less. As of December 31, 1998, we had borrowed about $12.9 million on the CCA Line leaving approximately $12.1 million available for future borrowing. We are presently in the process of evaluating the adequacy of the amount of this available credit and are exploring options to expand the debt capital available to us on an interim and long-term basis for purposes of providing financing for future acquisitions. At December 31, 1998, our debt to total market capitalization ratio was 66.8% based upon the closing share price on that date of $5.625.
On June 22, 1998 and May 22, 1998, we entered into three permanent loan agreements with Nomura, which also were assigned to CCA. The first loan, known as the "Pool A Loan", was in the amount of $38.3 million and was funded on June 5, 1998. The second loan, known as the "Pool B Loan", in the amount of $7.7 million, was funded June 5, 1998. The third loan, known as the "Pool C Loan", was in the amount of $7.65 million and was funded on June 30, 1998.
The Pool A Loan matures on June 11, 2028 and the Pool C Loan matures on July 11, 2028. We may prepay either of these loans during the 90 days preceding July 11, 2008. The interest rate is effectively 6.95% for the first ten years of each loan. With respect to either loan, if we have not repaid the loan by July 11, 2008, the interest rate will be increased by 2%.
The Pool B Loan matures on June 11, 2029, and we may prepay the loan during the 90 days preceding June 11, 2009. The interest rate on the Pool B Loan is 7.07% for the first eleven years of the loan. If we have not repaid the loan by June 11, 2009, the interest rate will be reset and will be equal to the sum of 5% per year plus the greater of: (i) 8.38%; or (ii) a rate based on the rate of U.S. Treasury obligation with a maturity date closest to that of the loan, plus 1.35% per year.
In addition to the prepayment options in 2008 and 2009 for these loans, we may prepay all or part of the Pool A or Pool C Loans, on the applicable release dates, by depositing with an escrow agent sufficient funds to purchase U.S. Treasury obligations to repay the principal and interest on the loans as if the loans had been held to maturity. The "Release Dates" occur in September 2000 for the Pool A and Pool C Loans, and in June 2002 for the Pool B Loan or, if earlier, two years after the date the lender includes the applicable facility in a mortgage-backed securitization program. In addition, if the ratio of net operating income to principal and interest on the Pool B loan is less than 1.65:1.00 on June 11, 1999 based on the net operating income of the property securing the Pool B Loan, CCA can require that we repay a portion of the Pool B Loan or add additional collateral to the pool.
Restrictions in the loan documents effectively prevent us from selling any of the properties securing the loans until the release dates occur in 2000 and 2002. After the release date, we may make certain payments which will cause the lender to release the mortgage on a particular property. In addition, after the release date but before the optional prepayment dates of July 11, 2008 (the Pool A and Pool C Loans) or June 11, 2009 (the Pool B Loan), we may substitute different properties as collateral under each loan as long as the loan amount collateralized by all properties replaced does not exceed fifty percent of the total loan amount and certain other conditions are satisfied.
The Pool A Loan is secured by cross-collateralized first mortgages on:
The Colonial Penn Building, Phoenix Business Park, Newtown Business Center, Southlake Corporate Center, Technology Center, Airways Plaza Office Center, Peachtree Pointe Office Park, Avalon Center Office Park, Sand Lake Tech Center, Metric Plaza, Park Center, and University Corporate Center. The Pool B Loan is secured by a first mortgage on the Lexington Business Center. The Pool C Loan is secured by cross-collateralized first mortgages on the Milwaukee Industrial Portfolio and Elmhurst Metro Court.
We used the proceeds from these loans to repay the amounts outstanding under the CCA Line ($23.25 million) and the line of credit provided by American National Bank ($20.65 million). We also repaid mortgage loans secured by the Milwaukee Industrial Portfolio ($3.5 million) and the Elmhurst Metro Court ($3.8 million). We used the balance of the CCA loan proceeds to pay transaction related costs and for general operating reserves.
During the third quarter of 1998, we borrowed $7.4 million under a convertible term loan agreement entered into with a group of lenders in October 1997. We used the proceeds to acquire the Johns Creek Office and Industrial Park and Technology Park. The loan matures on September 30, 2002 and bears interest at 12% per year, payable quarterly. In addition, on October 14 of each year, we are required to pay an annual fee equal to 2% of the amount outstanding as of that date. The amounts outstanding on the loan are convertible, at the lenders' option, into Series A convertible preferred shares at a conversion price of $100 per share or into common shares at a conversion price of $5.15 per share. These lenders also had a right exercisable until November 13, 1998 to purchase up to $12.6 million in preferred or common shares. This right was not, however, exercised and has expired.
IMPACT OF THE YEAR 2000
The Year 2000 issue, or Y2K for short, is the result of computer programs utilizing two digits rather than four digits to define the applicable year. Any of our computer programs or hardware that have date- sensitive software or embedded chips may therefore recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or in miscalculations causing disruptions of real estate operations, such as the functioning of property mechanical systems, and other activities, such as a temporary inability to process transactions, generate invoices or reports, manage our portfolio, comply with regulatory requirements or engage in similar normal business activities.
We have formed a Y2K Compliance Committee consisting of at least one representative from each of our departments: legal, accounting, asset management, investor relations and acquisitions. Our Y2K Compliance Committee, in accordance with the Year 2000 Information and Readiness Disclosure Act, has formulated the following Year 2000 Readiness Disclosure:
We believe that the members of our committee, drawing upon their various disciplines and resources available to them through professional organizations and contacts, will collectively be able to formulate the necessary initial questionnaires and inquiries described below and to develop a comprehensive plan for testing and evaluating responses to our inquiries.
Our committee will, as circumstances dictate, retain third party consultants and professionals to assist it in evaluating technical issues or making strategic recommendations for remedial action, if necessary.
We have established a plan for assessing and mitigating our exposure to Y2K matters. The plan consists of several elements including a complete upgrade of our computer hardware and software programs; assessing Y2K compliance programs at each property and each property's reliance on computer programs in operations; and inquiry and dialogue with our significant suppliers, vendors and tenants as to their Y2K compliance initiatives.
We have upgraded our networking, financial analysis, general ledger and accounts payable software programs in order to minimize the potential impact of Y2K at our headquarters. In addition, we expect to complete testing procedures that will ensure that all upgraded systems will operate subsequent to December 31, 1999. These testing procedures will include simulating operating all systems at a date after December 31, 1999. As of December 31, 1998, we have expended $35,000 on Y2K compliance issues. The vast majority of these funds have been expended on the network and computer software upgrades.
We anticipate a total expenditure of less than $50,000 on Y2K compliance at our corporate headquarters. Based solely upon preliminary discussions with our ten property managers, we do not presently anticipate significant expenses at the property level. However, if there are significant expenditures at the property level, we will revise our projection of Y2K related costs.
We are also assessing the operations at each of our properties in an effort to diagnose the impact that Y2K may have on property operations, particularly mechanical systems. We anticipate completing this assessment in the second quarter of 1999. At this time, we are gathering information to evaluate what, if any, remedial action will be necessary and the potential costs associated with the action.
We rely on various third parties to provide property level and other administrative functions. We have sent a questionnaire to each of our property managers inquiring about their ability to address the effect of the Y2K issue on their own operations. To date, we have received responses from nine of our ten property managers. Of the responding managers, five have systems that, in their view, are Y2K compliant, three expect to become compliant by the second quarter of 1999 and one expects to be compliant by the third quarter of 1999. We are currently in the process of determining whether or not the other property manager has addressed the Y2K issue and anticipate that the process will be completed in the first quarter of 1999.
We intend to further verify and test each significant property manager's compliance by the second quarter of 1999. The computerized aspect of the relationship between us and our property managers is most prevalent in the accounting and reporting functions from the property level to our headquarters. We believe that the potential impact of a non- compliant property manager is minimized because we have the right to cancel
our property management contracts generally on 30-day notice at no cost to us. Therefore, any property managers who may not be Y2K compliant can be replaced with a manager that has Y2K compliant systems. In spite of the above steps to verify Y2K compliance, if any property manager is unable to perform accounting functions after December 31, 1999, we expect to have the internal capability to process all accounting transactions and to produce financial statements needed to manage the properties and comply with our reporting requirements.
We have also received Y2K reports from our payroll processing service provider, our transfer agent and our principal bank. Our payroll service provider has represented that it processes our payroll using Y2K compliant software. Our principal bank represented that as of December 31, 1998, its Y2K renovation and testing of its systems was substantially complete. The remaining Y2K related system changes as well as external testing and contingency planning is expected to be completed by June 30, 1999. Our transfer agent has represented that all of its "mission critical" systems and nearly all of its "non-mission critical" systems have been tested for Y2K readiness. Furthermore, it continues to develop Business Resumption Contingency Plans for each line of its business that will ensure operations will continue with minimum disruption.
We are also in the process of contacting other service providers and vendors to ascertain their ability to continue to provide goods and services to us. We are developing a mechanism to continue the review and assessment of service providers and vendors on a regular basis until circumstances no longer warrant monitoring. Other than described in the preceding paragraph, the future success of our operations is not closely tied to any one third party vendor, supplier or service provider. As such, if any of these third parties fails to conduct business due to Y2K related problems, we expect to be able to contract with other third parties without experiencing any material disruption of our operations or financial condition. We cannot quantify the potential costs and uncertainties associated with potential Y2K program flaws at this time as they may relate to other organizations that we rely upon but we do not anticipate that the effect of this potential computer program flaw upon our operations will be significant.
As of December 31, 1998, we had over 500 tenants. Our ten (10) largest tenants account for approximately twenty percent (20%) of our total projected revenues for 1999 based on properties owned as of December 31, 1998. Because of our broad tenant base, our future operations, particularly our ability to collect rent, is not closely tied to the ability of any one particular tenant to pay rent or other charges. We currently believe that there will not be a material adverse effect upon our operations or financial condition if any one tenant or small group of tenants ceases to conduct business (and pay rent) or is simply unable to pay rent on a timely-basis due to Y2K problems. However, if a large number of tenants, particularly several of the ten largest tenants, fail to pay rent for an extended period of time, our cash flow may be adversely effected. During the first quarter of 1999, we initiated contact with our 68 largest tenants to survey their plans to address Y2K related issues. This sampling includes all tenants whose annual rental payments are greater than $100,000.
We are currently formulating a contingency plan to address potential failures:
- at our home office; - at our properties; - regarding our property managers; - regarding our tenants; - regarding our suppliers and vendors.
We expect to formulate our contingency plan by June 1999.
We are focusing our efforts on determining a contingency plan for what we believe to be the most likely worst case scenario - an isolated failure in one or two of the categories described above. For example, there is the possibility that we may be unable to provide an adequate working environment for some of our tenants due to the failure of building mechanical, life safety or security systems. Furthermore, the worst case scenario would include Y2K problems inhibiting our ability to collect rent or preventing some of our tenants from paying rent caused by Y2K issues unrelated to property operations. We could be subject to litigation for failing to provide an adequate working environment for our tenants as a result of Y2K computer system disruptions. More immediately, the tenants may cease paying rent which could impact our liquidity. The amount of potential liability and lost revenue cannot be reasonably estimated at this time.
We have not focused our contingency planning for a "doomsday" scenario in which a near-universal malfunction of computers would have a sweeping effect upon all businesses. It is unlikely that any planning we could presently formulate would assist in the vast recovery process necessitated by this unlikely event.
RISK FACTORS
REAL ESTATE RISKS
WE MAY NOT BE ABLE TO ACQUIRE ADDITIONAL PROPERTIES ON ACCEPTABLE TERMS. The success of our business strategy depends in part on our ability to acquire additional properties that satisfy our investment parameters. We may not be able to identify properties that meet these standards or acquire properties at a price that allows us to earn an attractive return since we compete for acquisitions with other real estate investors, some of whom have significantly greater resources at their disposal.
WE HAVE A LIMITED HISTORY WITH OUR EXISTING PROPERTIES AND HAVE RECENTLY ACQUIRED MANY NEW PROPERTIES. We have acquired all of our properties within the last six years and have acquired twenty of these properties since January 1, 1997. Our most recently acquired properties, and properties that we acquire in the future, may have characteristics or deficiencies unknown to us that may impact their value or revenue potential. We are currently experiencing a period of rapid growth. Our ability to manage our growth effectively requires us to assimilate new acquisitions into our portfolio with minimal operating disruptions and unanticipated costs. We may not be able to successfully integrate these properties into our portfolio or these properties may not perform as expected.
WE COMPETE FOR TENANTS. All of our office and flex industrial properties are located in highly-developed areas that include other office and flex industrial properties. Some of these properties are newer or better located than our properties. Further, our competitors may have greater resources than we do, which could allow them to reduce rents to a level that is not profitable for us. We may also have to spend money upgrading or renovating our properties to make them attractive to both existing and potential tenants thus increasing our expenses and reducing our cash resources. The number of properties or other companies that compete in our market areas could have a material effect on:
. our ability to lease space at our properties; . the amount of rent that we can charge on new leases or renewals; . the dollar amount of tenant improvements or leasing commissions required to lease a property; and . the number of acquisition opportunities.
WE OWN PROPERTIES IN A LIMITED NUMBER OF MARKETS. Our properties are located in the Midwestern and Southeastern United States, primarily suburban Chicago, where we own properties that account for 19% of our gross rental revenue, and suburban Atlanta, where we own properties that account for 24% of our gross rental revenue. Our ability to maintain or increase our revenues or to generate revenues that exceed our operating expenses is affected by economic conditions in the Midwestern and Southeastern United States. Like other real estate markets, these markets have experienced economic downturns in the past and will likely experience downturns in the future. Layoffs or downsizing, industry slowdowns, changing demographics, increases in the supply of property or reduced demand for office or flex industrial space may decrease our revenues or increase our operating expenses or both.
LEASES ON APPROXIMATELY 19% OF OUR RENTABLE SQUARE FEET EXPIRE IN THE NEXT TWELVE MONTHS. As leases expire, we may not be able to renew or re- lease space at rates comparable to or better than the rates contained in the expiring leases. Leases on a total of approximately 19% of our rentable square feet will expire prior to December 31, 1999. If we fail to renew or re-lease space at rates that are at least comparable to the rates on expiring leases, the revenues generated by our properties will decline. Further, we may have to spend significant sums of money to renew or re- lease space covered by expiring leases, potentially reducing the amount of money that we have available to distribute to you or to use for other purposes.
OUR TENANTS MAY NOT PAY THEIR RENT OR MAY DECLARE BANKRUPTCY. We derive substantially all of our revenue from leasing space at our properties. Consequently, our ability to make distributions to you may be negatively affected if tenants leasing a significant percentage of our rentable square feet fail to pay their rent or if we are unable to profitably lease space. We may experience substantial delays and incur significant expenses enforcing our rights against tenants who do not pay their rent. A tenant may also seek the protection of the bankruptcy laws and delay making rental payments to us or actually reject or terminate its lease under those laws. Even if a tenant did not seek the protection of the bankruptcy laws, the tenant may from time to time experience a downturn in its business which may weaken its financial condition and its ability to make rental payments to us when due.
WE MAY NOT BE ABLE TO QUICKLY VARY OUR PORTFOLIO. Investments in real estate are relatively illiquid. In addition, in order to continue qualifying as a REIT, we are subject to rules and regulations which limit our ability to sell properties within a short period of time. Further, under the loan agreement with CCA, we may not sell any of the properties that are mortgaged to secure payment prior to 2000. We have mortgaged fifteen of our properties representing approximately 42% of our rentable square footage to secure payment on the CCA loans. Thus, we may be unable to sell a property even if market conditions or our financial condition warrant such a sale.
WE ARE REQUIRED TO COMPLY WITH VARIOUS LAWS AND REGULATIONS. As an owner of property, we are required to comply with a variety of federal, state and local laws. Complying with these laws and regulations may increase our operating expenses and reduce our profits. For example, we are required to comply with laws and regulations that impose liability on a property owner for the costs of removing or remediating certain hazardous materials released on a property. We are subject to these laws even if we are not aware of, or responsible for, releasing these materials. These laws or regulations may also restrict the way that we can use a property or the type of business which may be operated on the property. Further, if we fail to comply with these laws or regulations by, for example, failing to properly remediate a release of hazardous material, we may not be able to sell the affected property or borrow money using the property as collateral
for a loan. We may also be required to pay money to individuals who are injured due to the presence of hazardous materials on our property. Although we are not aware of any hazardous materials at our properties, these materials may exist and the cost of removing or remediating them may be material and could adversely affect the value of the property affected. We may also be required to pay the cost of removing or remediating hazardous materials from a disposal or treatment facility to which we may have shipped hazardous or toxic substances even if we never owned or operated the disposal or treatment facility. Our properties must also comply with the Americans with Disabilities Act. This act establishes certain standards related to access and use of properties by disabled persons. We may be required, for example, to remove any barriers to access. If we fail to comply, the U.S. government may fine us or we may be required to pay damages to a disabled person. Complying with these requirements may increase our expenses and changes in these requirements may result in unexpected expenses.
OUR OBJECTIVES MAY CONFLICT WITH THOSE OF OUR JOINT VENTURE PARTNERS. We own eight of our properties, or approximately 30% of our rentable square footage through controlling interest in joint ventures with various third parties. We may purchase additional properties through joint ventures with third parties. Investments in joint ventures which own properties may involve risks that are not otherwise present when we wholly own the property directly or through one of our subsidiaries. For example, our co- venturer may file for bankruptcy protection or may have economic or business interests or goals which are inconsistent with our goals or interests. Further, although we own a controlling interest in each of these ventures, we may owe fiduciary duties to our partners.
WE MAY NOT HAVE ENOUGH INSURANCE. We have customary comprehensive liability, fire, flood, earthquake, extended coverage and rental loss policies that insure us against losses at our properties with policy specifications and insurance limits that we believe are reasonable. There are certain types of losses, for example environmental, that we may decide not to insure against since the cost of insuring for the loss is not economically practical. We use our discretion in determining the amount of coverage, the limits on this coverage and the deductibles that apply to the coverage in an attempt to balance the amount of insurance that we purchase and the cost of that insurance. We may, however, suffer losses that exceed our insurance coverage. Further, inflation, changes in building codes and ordinances or other factors such as environmental laws may make it too expensive to repair or replace a property that has been damaged or destroyed, even if covered by insurance.
PROPERTY TAXES MAY INCREASE. We are required to pay taxes based on the assessed value of our properties to various taxing authorities such as state or local governments. These taxing authorities may increase the tax rate imposed on a property or may reassess property value, either of which could increase our operating expenses.
REAL ESTATE FINANCIAL RISKS
WE OFTEN NEED TO BORROW MONEY TO FINANCE OUR BUSINESS. Our ability to internally fund our capital needs is limited since we must distribute at least 95% of our net taxable income (excluding net capital gains) to our shareholders to qualify as a REIT. Consequently, we often borrow money to fund our operating or capital needs, and may borrow monies to satisfy the 95% distribution requirement. The documents which govern how we may conduct our business do not limit the amount of money that we may borrow. Borrowing money to fund operating or capital needs exposes us to various risks. For example, our properties may not generate enough cash to pay the
principal and interest obligations on our loans or we may violate a loan covenant that results in the lender accelerating the maturity date of a loan. As of December 31, 1998, we owed a total of approximately $151.6 million, including approximately $144.2 million secured by mortgages on certain of our properties. If we fail to make timely payments on our loans, including those cases where a lender has accelerated the maturity date due to a violation of a loan covenant, the lenders could foreclose on the properties securing their loans and we could lose our entire investment in those properties. Once a loan becomes due, we must either pay the remaining balance or borrow new money to pay off the maturing loan. We may not, however, be able to obtain a new loan, or the terms of the new loan, such as the interest rate or payment schedule, may not be as favorable as the terms of the maturing loan. Thus, we may be forced to sell a property at an unfavorable price to pay off the maturing loan or agree to less favorable loan terms. A total of $2.0 and $15.0 million of our indebtedness matures on or before December 31, 1999 and 2000 respectively.
We occasionally enter into loans where the interest rate may be increased from time to time. As of December 31, 1998, we owed approximately $17.7 million that bore interest at variable rates. We may borrow additional amounts that bear interest at variable rates. If interest rates increase, the amount of interest that we are required to pay on these borrowings will also increase. Any such increase would increase our operating expenses and potentially impact in a negative manner our ability to pay distributions to our shareholders.
WE MAY CHANGE OUR INVESTMENT POLICIES WITHOUT YOUR APPROVAL. Our investment policies, including the type of properties that we purchase, the manner in which these properties are managed and the amount of money that we borrow are all determined by our board and may be changed without your approval.
WE DEPEND ON A SMALL NUMBER OF KEY PERSONNEL. Our success depends, in part, on the efforts of our principal executive officers, particularly Messrs. Levine, Hansen, Schmidt and Teglia. Although we have entered into employment contracts with each of these individuals, the loss of their services could have an adverse effect on our operations.
THIRD PARTIES MAY BE DISCOURAGED FROM MAKING ACQUISITION OR OTHER PROPOSALS THAT MAY BE IN YOUR BEST INTERESTS. Under our Declaration, no single person or group of persons (an entity is considered a person) may own more than 9.9% of our outstanding common shares. The employment contracts we have with each of our senior executives also require us to make certain payments to these individuals if a "change of control" occurs. A "change of control" is defined in each of these agreements to mean that the members of the board of trustees as of the date the agreement is signed fail to constitute a majority of the board members provided that if the chief executive officer consents to a new board member, that person is treated for purposes of this test as if he or she was a member of the board at the time that the agreement was signed. These provisions may prevent or discourage a third party from making a tender offer or other business combination proposal such as a merger, even if such a proposal would be in the best interest of our shareholders.
WE MIGHT FAIL TO QUALIFY AS A REIT. If we fail to qualify as a REIT, we would not be allowed to deduct amounts distributed to our shareholders in computing our taxable income and would incur substantially greater expenses for taxes and would have less money available to distribute to you. We would also be subject to federal income tax at regular corporate rates as well as potentially the alternative minimum tax. Unless we satisfied some exceptions, we could not elect to be taxed as a REIT for the four taxable years following the year during which we were disqualified. We may fail to qualify as a REIT if, among other things:
. less than 75% of the value of our total assets consists of real estate assets, cash and government securities at the close of each fiscal quarter;
. more than 5% of the value of our assets consists of securities of any one issuer or we hold more than 10% of the outstanding voting securities of any one issuer at the close of each fiscal quarter;
. less than 75% of our gross income is generated from rents from real property, interest on obligations secured by mortgages, gain from the sale of property, and certain other property-related revenue sources; or
. we fail to distribute at least 95% of our taxable income to our shareholders.
If we fail to distribute enough money to satisfy the REIT requirements, we may also have to pay a non-deductible excise tax. This tax is equal to 4% of the amount in any year that our distributions are less than the sum of 85% of our ordinary income in the current year plus 95% of our net income from capital gains in the current year plus 100% of the taxable income that we did not distribute in prior years. We may also lose our REIT status if the Internal Revenue Service were to successfully challenge the tax status of the Operating Partnership as a partnership for federal income tax purposes. In this case the Operating Partnership would be taxable as a corporation and we would lose our status as a REIT if we did not own 100% of the Operating Partnership. If the Operating Partnership were to be required to pay taxes as a corporation, it would substantially reduce the amount of money that the Operating Partnership would have to distribute to us and ultimately to you.
WE MAY SPEND ADDITIONAL MONEY ON OUR COMPUTER PROGRAMS DUE TO THE YEAR 2000 ISSUE. See IMPACT OF YEAR 2000 above.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We do not engage in any hedge transaction or in the ownership of any derivative financial instruments. To mitigate the impact of fluctuations in interest rates, we generally maintained over 70% of our debt as fixed rate in nature by borrowing on a long-term basis.
As of December 31, 1998, we had approximately $151.6 million of outstanding long-term debt, of which $17.7 million bears interest at variable rates. As of December 31, 1998, the weighted-average interest rate on this variable rate debt was 6.84%. If interest rates on this variable rate debt increased by one percentage point (1%), interest expense would increase by $177,000 on an annual basis.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
BANYAN STRATEGIC REALTY TRUST INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ----
Report of Independent Auditors 35
Consolidated Balance Sheets, December 31, 1998 and 1997 36
Consolidated Statements of Operations For the Years Ended December 31, 1998, 1997 and 1996 38
Consolidated Statements of Shareholders' Equity For the Years Ended December 31, 1998, 1997 and 1996 40
Consolidated Statements of Cash Flows For the Years Ended December 31, 1998, 1997 and 1996 41
Notes to Consolidated Financial Statements 43
Schedule -------- Consolidated Real Estate and Accumulated Depreciation III
SCHEDULES NOT FILED:
All schedules other than those indicated in the above index are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements and notes thereto.
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF BANYAN STRATEGIC REALTY TRUST
We have audited the accompanying consolidated balance sheets of Banyan Strategic Realty Trust as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the index at Item 8. These financial statements and schedule are the responsibility of the Trust'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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Banyan Strategic Realty Trust at December 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 December 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.
ERNST & YOUNG LLP
Chicago, Illinois February 9, 1999
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Banyan Strategic Realty Trust (the "Trust") was organized as a business trust in 1986 under the laws of the Commonwealth of Massachusetts.
The business of the Trust is the ownership and operation of real estate properties. At December 31, 1998, the Trust owned thirty-two properties located principally in the Midwest and Southeast United States. See Note 8 for information with respect to the Trust's business segments.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of the Trust, its wholly-owned subsidiaries and its controlled Partnerships. In all of its partnerships, the Trust is the managing general partner and retains sole authority over all significant decisions. All intercompany balances and transactions have been eliminated in consolidation. Investment in a Real Estate Venture disposed of in 1997 was accounted for on the equity method (see Note 6).
INVESTMENT IN REAL ESTATE
Costs incurred with respect to third parties for the acquisition, development, construction and improvement of properties are capitalized. Certain costs of yet-to-be acquired properties, including deposits and professional fees, are capitalized as other assets. These costs are subsequently capitalized as property acquisition costs or charged to expense when it becomes apparent that acquisition of a particular property is not probable. Maintenance and repairs are charged to expense when incurred.
Depreciation of buildings is computed using the straight-line method over the estimated useful lives of the assets; generally 40 years. Depreciation of tenant improvements is computed using the straight-line method over the shorter of the lease term or useful life. For the years ended December 31, 1998, 1997 and 1996, depreciation expenses amounted to $4,793, $3,282 and $2,355, respectively.
The Trust recognizes impairment losses for its properties when indicators of impairment are present and a property's expected undiscounted cash flows are not sufficient to recover the property's carrying amount.
The Trust classifies its real estate properties as held for sale when its Board of Trustees has authorized the sale and an active program to find a buyer has been initiated. The Trust currently classifies none of its properties as held for sale.
DEFERRED FINANCING COSTS
Deferred financing costs are amortized over the term of the related loans.
REVENUE RECOGNITION
Minimum rentals are recognized on a straight-line basis over the term of the related leases. Additional rents in the form of operating expense reimbursements for common area maintenance expenses and real estate taxes are recognized in the period in which the related expenses are incurred.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Trust believes the carrying amount of its financial instruments approximates fair value at December 31, 1998 and 1997, because (i) the fixed rates on mortgage loans payable are comparable to rates currently offered in the market, (ii) the rates on the line of credit and bonds payable are variable and the terms are comparable to those currently offered in the market and (iii) the maturities of the Trust's cash equivalents are relatively short.
INCOME TAXES
For the years ended December 31, 1998, 1997 and 1996, the Trust elected to be treated as a real estate investment trust ("REIT") under Internal Revenue Code Sections 856-860. In order to qualify, the Trust is required to distribute at least 95% of its "REIT" taxable income to shareholders, meet asset and income tests and comply with certain other requirements.
As of December 31, 1998, Investment in Real Estate has a gross and net basis, respectively, of $220,916 and $209,489, respectively, for income tax purposes. Additionally, investment in a liquidating trust with a tax basis of $675 has not been accorded any value for financial reporting purposes.
As of December 31, 1998, the Trust has a net operating loss carry- forward of $18,952 which will expire in 2005 ($444), 2006 ($10,266), 2008 ($789) and 2012 ($7,453).
CASH EQUIVALENTS
The Trust considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
RESTRICTED CASH
Restricted cash represents amounts held by lenders to provide for future real estate tax expenditures and tenant improvements, utility deposits and security deposits. Certain of these amounts may be reduced upon the fulfillment of certain conditions.
STOCK OPTIONS
The Trust has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), in accounting for its stock options. Under APB 25, no compensation expense is recognized because the exercise price of the Trust's employee stock options equals or exceeds the market price of the underlying stock at the date of grant.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
RECLASSIFICATIONS
Certain reclassifications have been made to the previously reported 1997 and 1996 consolidated financial statements in order to provide comparability with the 1998 consolidated financial statements. These reclassifications have not changed the 1997 or 1996 results.
3. EARNINGS PER SHARE
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
4. LONG-TERM DEBT
The Trust's long-term debt consists of the following at December 31, 1998 and 1997:
1998 1997 ----------------------- ------------------------- Weighted Weighted Average Average Interest Interest Balance Rate Balance Rate --------- -------- ------------ -------- Mortgage loans. . . . $123,108 7.44% $ 70,503 7.90% Bonds . . . . 21,140 6.77% 21,615 6.85% -------- -------- ---------- -------- Total collaterized debt . . . . $144,248 7.34% $ 92,118 7.65% ======== ======== ========== ======== Unsecured loans. . . . $ 7,400 12.00% -- -- ======== ======== ========== ========
The mortgage loans have fixed interest rates that ranged from 6.95% to 8.89% at December 31, 1998. Bonds payable at December 31, 1998 include $4,800 of variable rate tax exempt revenue bonds which bear interest equal to 5.0% per annum and $16,340 of fixed rate combined taxable and tax exempt revenue bonds which bear interest at a blended rate equal to 7.3%. Substantially all of the mortgage loans and bonds contain prepayment penalties. During 1998 and 1997, the Trust recognized extraordinary losses of $141 and $64, respectively, related to prepayments on refinanced debt and the writeoff of unamortized financing costs. Substantially all of the Trust's real estate is pledged as collateral for the mortgage loans and bonds.
On April 30, 1998, the Trust entered into a $25 million line of credit agreement (the "Revolving Line"). Borrowings under the Revolving Line bear interest at an annual rate of LIBOR plus 2.00% payable monthly. The Revolving Line has an initial term of twenty-four months. The Trust has an option to extend the Revolving Line for one additional year for a fee of $125. As of December 31, 1998, the Trust had borrowed approximately $12.9 million on the Revolving Line (included in Mortgage Loans), leaving approximately $12.1 million available for future borrowing.
During 1998, the Trust borrowed $7.4 million pursuant to its $20 million 1997 Convertible Term Loan Agreement for an unsecured convertible term loan (the "Unsecured Loan"). The Unsecured Loan bears interest at an annual interest rate of 12% payable quarterly and matures on September 30, 2002. In addition, on October 14, of each year, the Trust is required to pay an annual fee equal to 2% of the amount outstanding as of that date. The amounts outstanding on the Unsecured Loan are convertible into Series A convertible preferred shares at a conversion price of $100 per share or into common shares at a conversion price of $5.15 per share. In addition, the lenders had the option to purchase Series A convertible preferred shares to the extent that any part of the $20 million loan commitment was unused in an amount equal to the unfunded portion at a price equal to $100 per preferred share. These preferred shares would also be convertible into common shares at a conversion price of $5.15 per share. No preferred shares were issued prior to the termination of the purchase option on November 13, 1998.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The principal balance of the Trust's long-term debt at December 31, 1998, is scheduled to be repaid as follows:
1999 . . . . . . . . . . . . $ 2,007 2000 . . . . . . . . . . . . 15,023 2001 . . . . . . . . . . . . 5,705 2002 . . . . . . . . . . . . 12,026 2003 . . . . . . . . . . . . 13,956 Thereafter . . . . . . . . . 102,931 -------- $151,648 ========
5. SHARE PURCHASE AGREEMENT
Simultaneously with the execution of the Convertible Term Loan Agreement, the Trust entered into a Share Purchase Agreement (the "Agreement") with the same group of accredited investors to which the Trust issued the Unsecured Loan (see Note 4). Under the Agreement, the Trust sold, in October 1997, 2,192,501 shares of beneficial interest at $5.00 per share, for an aggregate gross proceeds of approximately $11 million. The Trust paid approximately $1.4 million of transaction costs in connection with the share issuance.
6. INVESTMENT IN REAL ESTATE
ACQUISITION ACTIVITIES
The following properties were acquired in 1998 and 1997; the results of their operations are included in the consolidated statements of operations from their respective dates of acquisition.
- ---- Purchase Date of Price Property's Name Acquisi- (in and Location tion millions) Description - --------------- --------- --------- ----------------
Peachtree Pointe 01/20/98 $4.6 Five one-story Office Park office buildings Norcross, GA
Avalon Center 03/20/98 4.4 Two one-story Office Park office buildings Norcross, GA
Avalon Ridge 04/24/98 3.9 Two one-story Business Park flex/industrial Norcross, GA
Tower Lane 04/27/98 5.2 Two one-story Business Park (1) flex/industrial Bensenville, IL buildings
University 04/30/98 10.2 Seven one-story Corporate Center flex/industrial Winter Park, FL buildings
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Purchase Date of Price Property's Name Acquisi- (in and Location tion millions) Description - --------------- --------- --------- ----------------
Metric Plaza 04/30/98 $2.6 Two one-story Winter Park, FL flex/industrial buildings
Park Center 04/30/98 3.7 Two one-story Orlando, FL flex/industrial buildings
Sand Lake 04/30/98 6.8 Five one-story Tech Center office buildings Orlando, FL
Johns Creek 08/14/98 5.8 Two flex/indus- Office and trial buildings Industrial Park Duluth and Suwanne, GA
Technology Park 08/14/98 12.4 Three office Norcross, GA buildings ----- Total $59.6 =====
- -----------------
(1) Upon the acquisition of Tower Lane, the Trust assumed a permanent mortgage loan in the amount of approximately $3.7 million.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- ---- Purchase Acquisition Date of Price Financing Property's Name Acquisi- (in (in millions) and Location tion millions) (1) Description - --------------- -------- --------- ----------- ---------------- [S] [C] [C] [C] [C] Phoenix Business 01/15/97 $ 5.5 Three-building Park office/industrial Atlanta, GA complex
Butterfield Office04/30/97 15.1 Three-story Plaza office building Oak Brook, IL
Woodrun Village 05/22/97 4.6 $3.6 Apartment complex Apartments Yukon, OK
Country Creek 05/22/97 7.5 5.9 Apartment complex Apartments Oklahoma City, OK
Willowpark 05/22/97 4.5 3.5 Apartment complex Apartments Lawton, OK
Winchester Run 05/22/97 4.5 3.6 Apartment complex Apartments Oklahoma City, OK
Southlake 07/30/97 4.5 Three-story Corporate Center office building Morrow, GA
University Square 08/26/97 7.3 5.0 Six one-story Business Center office building Huntsville, AL
Technology Center 08/26/97 2.5 Three-story Huntsville, AL office building
Airways Plaza 12/10/97 3.2 Five one-story Office Center office buildings Memphis, TN ----- ----- Total $59.2 $21.6 ===== ===== - ----------------
(1) Represents the amount of permanent mortgage financing assumed at the time of acquisition. All other additional acquisition costs were paid by either a draw upon the Trust's line of credit or from cash and cash equivalents.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DISPOSITION ACTIVITIES
H STREET ASSEMBLAGE
Prior to 1998, the Trust had a 53% interest in a venture that owned 17,000 square feet of undeveloped land in downtown Washington, D.C. plus an approximately 55,900 square foot office building (the "H Street Assemblage"). During 1996, based on sales agreements for the H Street Assemblage, the Trust recorded a valuation allowance of $3,180 which was included in loss from operations of real estate ventures in the 1996 consolidated statement of operations. The H Street Assemblage was sold in 1997 and the Trust recognized a loss of approximately $61. The Trust has no further interest in the H Street Assemblage.
OTHER
During 1997, the Trust sold its interests in Hallmark Village Apartments and the Colonial Courts Apartments. The Trust received proceeds of approximately $7.3 million and recognized a gain of approximately $942.
7. PRO FORMA INFORMATION (UNAUDITED)
The following unaudited pro forma summary presents information as if the Trust's property acquisitions, property dispositions, and sales of shares of beneficial interests through December 31, 1998 had occurred at the beginning of each year. The pro forma information is provided for information purposes only. It is based on historical information and does not necessarily reflect the actual results that would have occurred nor is it necessarily indicative of future results of operations of the Company.
Years Ended December 31, ----------------------------- 1998 1997 ----------- -----------
Total revenue. . . . . . . . $ 42,260 $ 39,368 Net income . . . . . . . . . 5,187 3,756 Basic earnings per share . . 0.39 0.29 Diluted earnings per share . 0.38 0.28
8. BUSINESS SEGMENTS
The Trust acquires and operates real estate properties located principally in the Midwest and Southeast United States. The Trust has four operating segments corresponding to the four property types comprising its real estate assets: flex/industrial, office, residential and retail. As of December 31, 1998, the flex/industrial segment comprised of thirteen complexes with long-term leases to approximately 210 tenants; the office segment comprised of fourteen office sites with long-term leases to approximately 280 tenants; the residential segment comprised of four apartment complexes with 864 units leased principally for six months; and the retail segment was comprised of one retail center with long-term leases to approximately 50 tenants. The Trust's long-term tenants are in a variety of business and no single tenant is significant to the Trust's business.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Information by business segments is set forth below:
1998 1997 1996 -------- -------- -------- Revenue Flex/Industrial . $ 10,838 $ 7,830 $ 6,275 Office. . . . . . 19,577 11,946 6,812 Residential . . . 4,170 4,138 3,398 Retail. . . . . . 4,646 4,604 4,318 Corporate/Other . 185 267 601 -------- -------- -------- $ 39,416 $ 28,785 $ 21,404 ======== ======== ========
1998 1997 1996 -------- -------- -------- Income (loss) before extraordinary item Flex/Industrial . $ 3,787 $ 3,349 $ 2,365 Office. . . . . . 5,124 3,298 2,226 Residential . . . 682 952 (830) Retail. . . . . . 550 976 877 Corporate/Other . (4,624) (4,965) (6,395) -------- -------- -------- $ 5,519 $ 3,610 $ (1,757) ======== ======== ========
1998 1997 -------- -------- Total Assets Flex/Industrial . $ 74,513 $ 41,323 Office. . . . . . 105,049 74,434 Residential . . . 21,038 21,369 Retail. . . . . . 18,359 18,858 Corporate/Other . 3,631 3,650 -------- -------- $222,590 $159,634 ======== ========
1998 1997 1996 -------- -------- -------- Depreciation and amortization Flex/Industrial . $ 1,714 $ 1,156 $ 884 Office. . . . . . 2,404 1,259 695 Residential . . . 534 559 421 Retail. . . . . . 523 503 453 Corporate/Other . 37 13 -- -------- -------- -------- $ 5,212 $ 3,490 $ 2,453 ======== ======== ======== Interest expense Flex/Industrial . $ 2,669 $ 1,373 $ 1,114 Office. . . . . . 4,524 2,850 1,130 Residential . . . 1,199 1,235 887 Retail. . . . . . 1,338 939 880 Corporate/Other . 48 50 -- -------- -------- -------- $ 9,778 $ 6,447 $ 4,011 ======== ======== ========
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
1998 1997 1996 -------- -------- -------- Additions to Investment in Real Estate Flex/Industrial . $ 32,942 $ 376 $ 10,660 Office. . . . . . 31,533 39,089 5,505 Residential . . . 324 21,626 440 Retail. . . . . . 69 481 377 Corporate/Other . 28 80 -- -------- -------- -------- $ 64,896 $ 61,652 $ 16,982 ======== ======== ========
9. TRANSACTIONS WITH AFFILIATES
Effective January 1, 1997, the Trust began paying employees directly in contrast to the prior practice of reimbursing Banyan Management Corp. ("BMC") on an hourly basis for the services of BMC's personnel. In prior years, these payroll costs along with administrative costs were allocated to the Trust and other entities to which BMC provided administrative services based upon the actual number of hours spent by BMC personnel on matters related to that particular entity in relation to the total number of BMC personnel hours. From January 1, 1997 through September 30, 1997, the Trust shared only certain administrative items such as office rent and office expenses with other companies for which BMC provided services. These costs were shared based upon the total hours worked by employees of the Trust relative to total hours worked by employees of BMC and the Trust combined. The Trust's allocable share of costs for the years ended December 31, 1997 and 1996 amounted to $403 and $1,275, respectively. Beginning October 1, 1997, the Trust paid all of its administrative costs directly and no longer shared these costs with other companies.
As of December 15, 1997, all shareholders of BMC, other than the Trust, had terminated their administrative services relationship with and had surrendered their respective ownership interest in BMC, making the Trust the sole remaining shareholder of BMC. On that date, BMC merged into a wholly-owned subsidiary of the Trust, BSRT Management Corp. As a result of the merger, the Trust assumed current liabilities of $102, cash of $83 and other assets of $64. BSRT Management Corp. paid a dividend to the Trust in the amount of $150 representing a distribution of its accumulated earnings and profits. This amount has been included in "Other Income" of the Trust for the year ended December 31, 1997.
During the year ended December 31, 1998 and 1997, the Trust paid no salary to, but purchased legal services from an executive officer of the Trust. Fees for legal services totalled $391 and $338, respectively. The executive pays no rent, as such, to the Trust for the use of office space or equipment but grants the Trust a discount equal to approximately 20% compared to rates charged to third parties for all time billed to the Trust by the executive and his employees. The executive also reimburses the Trust for the cost of two full time and certain part time employees. The amount paid to the executive for the year ended December 31, 1996 was paid as salary and is included in the costs allocated to the Trust from BMC.
10. DISTRIBUTIONS PAID AND PAYABLE
To qualify as a REIT, the Trust must distribute at least 95% of its "REIT Taxable Income" to shareholders. A portion of the distributions paid during the subsequent year may be allocable to taxable income earned in the prior year.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Trust has determined the shareholders' treatment for federal income tax purposes to be as follows:
1998 1997 1996 ------- ------- ------- Ordinary income. . . . $ 5,978 $ 283 $ 2,842 Return of capital. . . 140 4,201 1,349 ------- ------- ------- $ 6,118 $ 4,484 $ 4,191 ======= ======= =======
On January 6, 1999, the Trust declared a cash distribution for the quarter ended December 31, 1998 of $0.12 per share payable February 22, 1999 to shareholders of record on January 22, 1999.
11. LEASES
MINIMUM RENTALS UNDER OPERATING LEASES
The Trust receives rental income from the rental of retail, office and flex/industrial space under operating leases. The following is the minimum future base rentals (excluding amounts representing executory costs such as taxes, maintenance and insurance) on operating leases for the Trust's industrial, office and retail projects held at December 31, 1998:
1999 . . . . . . $ 30,336 2000 . . . . . . 23,281 2001 . . . . . . 17,409 2002 . . . . . . 12,340 2003 . . . . . . 8,094 Thereafter . . . 13,773 -------- $105,233 ========
No single tenant at the Trust's operating properties produced ten percent or more of total income from property operating activities.
The Trust is subject to the usual business risks regarding the collection of the above-mentioned rentals.
GROUND LEASE
The Trust owns a leasehold interest in a shopping center in Atlanta, Georgia. The lease expires in 2067. The ground lease requires annual lease payments of $600 through October 4, 2007 plus 7% of total annual gross rental income commencing when gross rental income exceeds $2,000 from the operations of the shopping center. The ground lease also requires that the Trust pay property operating expenses, including real estate taxes. The base rent is reset in 2007 based upon a market rent within a contractually defined range.
12. OMNIBUS STOCK AND INCENTIVE PLAN
On May 14, 1997, the Board of Trustees (the "Board") adopted and on July 8, 1997, the shareholders of the Trust approved, the 1997 Omnibus Stock and Incentive Plan (the "Plan") which allows the Trust to make stock- based awards as part of its employee and Trustee compensation program. Under the Plan, the Trust is authorized to issue options to purchase up to one million shares of beneficial interest in the form of incentive stock options, non-statutory stock options, stock appreciation rights, performance shares and units.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FIXED STOCK OPTIONS
The Board administers the Plan and has the authority to determine, among other things, the individuals to be granted options, the exercise price at which shares may be acquired, the number of shares subject to options and the vesting requirements and the exercise period of each option. The Board is granted discretion to determine the term of each option granted under the Plan to employees, executives and Trustees, but in no event will the term exceed ten years and one day from the date of the grant.
A summary of the Trust's fixed stock option activity, and related information for the years ended December 31, 1997 and 1998 follows:
Weighted Shares Average Subject Exercise Price to Options Per Share ---------- -------------- Outstanding at December 31, 1996. . . -- $ -- Options granted . . . . . . . . . . 380,000 5.637 Options canceled. . . . . . . . . . (5,000) 4.08 -------- -------- Outstanding at December 31, 1997. . . 375,000 $ 5.658 Options granted . . . . . . . . . . 116,000 5.375 Options exercised . . . . . . . . . (9,324) 4.08 Options canceled. . . . . . . . . . (2,000) 6.375 ------- ------- Outstanding at December 31, 1998. . . 479,676 5.617 ======= ======= Exercisable at 12/31/97 . . . . . . 100,000 $ 5.50 Exercisable at 12/31/98 . . . . . . 174,287 $ 5.68
At December 31, 1998, options to purchase 361,000 shares were available for future grant and options outstanding that are not exercisable vest in varying annual amounts through 2001.
The weighted average grant date fair value of options granted in 1998 and 1997 was $.54. The remaining weighted-average contractual life of these options was 9.05 years. Exercise prices for options outstanding at December 31, 1998 ranged from $4.08 to $6.375 per share.
TARGET STOCK PRICE PERFORMANCE OPTIONS
The exercise price of each target stock price performance option granted is equal to the market price of the Trust's common shares on the date of grant and vests as the Trust's common share price achieves certain pre-established targets which were set on the date of grant. In conjunction with the March 11, 1998 signing of an employment agreement between the Trust and its President Leonard G. Levine, effective retroactively to October 1, 1997, the Board granted Mr. Levine stock options to purchase an aggregate of 150,000 shares of the Trust's common shares of beneficial interest at an exercise price equal to $5.50 per share. Options to purchase 50,000 shares will vest and become exercisable if during any consecutive thirty trading days during the term of the agreement the closing price of the common shares averages $8.50 per share. Options to purchase an additional 100,000 shares will vest and become exercisable on a proportionate basis if during any thirty consecutive trading days during the term of the agreement the closing price of the shares averages more than $8.50 per share with full vesting occurring with
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
respect to 75,000 shares if the closing price averages $9.00 per share, and $10.00 per share with respect to the other 25,000 shares. The number of shares underlying the options and the exercise price of each option are subject to adjustment from time to time under certain circumstances.
All of the options must be exercised by October 1, 2007, except that if Mr. Levine dies or becomes permanently disabled during the term of the agreement, then all options which have vested must be exercised within one year of death or permanent disability. In addition, upon death or permanent disability, all options not otherwise vested, but which would or will vest within six months following the date of death or permanent disability either by passage of time or satisfaction of the various performance standards will be deemed vested and become exercisable within the same one-year time period.
A summary of the Trust's target stock price performance option activity, and related information for the years ended December 31, 1997 and 1998 follows: Weighted Shares Average Subject Exercise Price to Options Per Share ---------- -------------- Outstanding at December 31, 1996. . . -- $ -- Options granted . . . . . . . . . . 150,000 5.500 ------- ------ Outstanding at December 31, 1997 and 1998. . . . . . . . . . . . . . 150,000 $5.500 ======= ======
At December 31, 1998, none of the target stock price options were exercisable. Exercise prices for options outstanding at December 31, 1998 were $5.50 per share. The remaining weighted-average contractual life of these options was 8.8 years. The weighted average grant date fair value of all options granted during 1997 is $0.96.
Pro forma information regarding net income and earnings per share is required by SFAS No. 123 "Accounting for Stock Based Compensation", and has been determined as if the Trust had accounted for all options granted under the plan using the fair value method of that statement. The fair value for the fixed stock options was estimated at the date of grant using the Black- Scholes option pricing model with the following weighted-average assumptions for 1998 and 1997: risk free interest rates of 5.31% and 5.58%; expected dividend yields of 7.47% and 7.19%; volatility factors of the expected market price of the Trust's common stock of .201 and .225; and a weighted-average expected lives of the options of 5 years and 10 years, respectively. In addition, the fair value for the target stock price performance options was estimated at the date of grant using a modified Black-Scholes option pricing model which, in addition to the required inputs above, takes into consideration the target stock price (or barrier) which must be attained. The following weighted-average assumptions were incorporated into the model for the target stock price performance options granted in 1997: risk-free interest rate of 5.92%; expected dividend yield of 7.27%; a volatility factor of the expected market price of the Trust's common stock of .225; and expected lives of the options of 10 years.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models, such as the Black-Scholes model, require the input of highly subjective assumptions including the expected stock price volatility. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management's view, the existing models do not necessarily provide a reliable single measure of the fair value of the options granted under the Plan.
The effects on 1998 and 1997 pro forma net income and pro forma earnings per common share of amortizing to expense the estimated fair value of stock options are not necessarily representative of the effects on net income to be reported in future years due to such things as the vesting period of the stock options, and potential for issuance of additional stock options in future years. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.
The Trust's pro forma information is as follows:
Years Ended December 31, ----------------------- 1998 1997 ------- ------- Pro forma net income. . . . . . . . . $ 5,279 $ 3,474 Pro forma basic earnings per share. . $ 0.40 $ 0.31 Pro forma diluted earnings per share. $ 0.38 $ 0.31
13. DISTRIBUTION REINVESTMENT AND SHARE PURCHASE PLAN
On April 23, 1997, the Trust filed a Registration Statement on Form S- 3 under the Securities Act of 1933 in order to register the shares issuable under the Trust's Distribution Reinvestment and Share Purchase Plan (the "DRIP Plan"). The DRIP Plan allows shareholders of the Trust to: (i) automatically reinvest the cash distributions on all, or part, of shares registered in their name; and (ii) make cash investments of not more than $120 per calendar year. Shares purchased under the DRIP Plan will be issued directly by the Trust at either: (i) 97% of the average closing sales price of the shares as reported on the NASDAQ National Market on the last five business days preceding the relevant investment date in the case of reinvested cash distributions; or (ii) 100% of the aforementioned average closing price in the case of cash investments. For the years ended December 31, 1998 and 1997, the Trust issued 141,321 and 72,094 shares of beneficial interest under the DRIP Plan and received total proceeds of $818 and $379, respectively.
14. AWARD SHARES AND WEIGHTED AVERAGE SHARES OUTSTANDING
Pursuant to the March 19, 1997 Amendment and the September 3, 1997 Second Amendment to the Second Amended and Restated Employment Agreement of Leonard G. Levine, the Trust's president, and pursuant to the shareholder approval which was obtained at the Trust's 1996 Annual Meeting held on July 8, 1997, all incentive compensation earned by Mr. Levine for the fiscal years ended December 31, 1996 and 1997 has been paid in shares of the Trust's stock ("Award Shares").
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONCLUDED
On July 9, 1997, the Trust issued 95,635 Award Shares to Mr. Levine, representing Mr. Levine's incentive compensation earned on the performance of the Trust's assets acquired subsequent to January 1, 1993 ("Reinvestment Activities") for the fiscal year ending December 31, 1996 (the "1996 Award Shares"). On September 3, 1997, the Trust issued 400,000 Award Shares representing the final payment and settlement of Mr. Levine's compensation earned on Reinvestment Activities for the fiscal year ending December 31, 1997 and for cumulative incentive compensation for the period January 1, 1993 through August 31, 1997 (the "Final Award Shares"). Prior to the September 3, 1997 Amendment, Mr. Levine would have been entitled to receive shares in respect of additional compensation which would have been determined as of December 31, 1997 and issued and paid no later than March 1998. The issuance of the Final Award Shares fixed the amount of compensation that the Trust had been accruing through December 31, 1997. The 95,635 Award Shares were valued at $4.125 per share, or $394. The 400,000 Final Award Shares were valued at $4.812 per share, or $1,925 of which $650 was expensed in 1996, and the balance was ratably expensed during 1997. The 1996 Award Share price of $4.125 was based upon the average closing price of the Trust's shares for the five business days ending December 31, 1996. The Final Award Shares price of $4.812 was based on the average closing price of the Trust's shares for the five business days ending August 31, 1997. The 1996 Award Shares and Final Award Shares are included in the total shares outstanding of the Trust when calculating Net Income Per Share of Beneficial Interest Based on Weighted Average Number of Shares Outstanding.
All of the Award Shares issued prior to January 1, 1997 and 20% of Award Shares issued for the fiscal year ended December 31, 1996 were held in escrow by the Trust, through the vesting date, September 29, 1997. Subsequent to that date, Mr. Levine became fully vested and the Award Shares were immediately transferred and are otherwise freely transferable subject to compliance with registration requirements of the federal and state securities laws or exemptions therefrom.
15. LITIGATION
The Trust is involved in various litigation arising in the ordinary course of business. Although the final outcome of these matters cannot be determined, based on the facts presently known, it is management's opinion that the final resolution of these matters will not have an adverse effect on the Trust's financial position or results of operations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in, or disagreements with, the accountants on any matter of accounting principles, practices or financial statement disclosure.
PART III
ITEM 10. OUR TRUSTEES AND EXECUTIVE OFFICERS
The information required by this item is incorporated herein by reference to the materials appearing in the Trust's definitive proxy statement to be filed with the Securities and Exchange Commission (the "Proxy Statement") under the caption, "Election of Trustees" and "Management".
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the materials appearing in the Proxy Statement under the caption "Management".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference to the materials appearing in the Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management".
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the materials appearing in the Proxy Statement under the caption "Certain Relationships and Related Transactions".
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements of the Company are set forth in this report in Item 8.
(2) Financial Statement Schedule is set forth in this report in Item 8.
(b) Report on Form 8-KA dated October 1, 1998 was filed to provide the Financial Statements and related pro forma information required by Item 7 of Form 8-K in connection with the Trust's acquisition of the properties known as Technology Park and Johns Creek Office and Industrial Park.
(c) Exhibits (see Exhibit Index included elsewhere herein).
(d) None.
SIGNATURES
PURSUANT to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
BANYAN STRATEGIC REALTY TRUST
By: /s/ Leonard G. Levine Date: March 11, 1999 Leonard G. Levine, President
PURSUANT to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on our behalf and in the capacities and on the dates indicated.
By: /s/ Leonard G. Levine Date: March 11, 1999 Leonard G. Levine, President and Trustee
By: /s/ Joel L. Teglia Date: March 11, 1999 Joel L. Teglia, Vice President and Chief Financial Officer
By: /s/ Norman M. Gold Date: March 11, 1999 Norman M. Gold, Trustee
By: /s/ Walter E. Auch, Sr. Date: March 11, 1999 Walter E. Auch, Sr., Trustee
By: /s/ Marvin A. Sotoloff Date: March 11, 1999 Marvin A. Sotoloff, Trustee
EXHIBIT INDEX -------------
3.1 Second Amended and Restated Declaration of Trust dated as of August 8, 1986, as amended on March 8, 1991, May 1, 1993 and August 12, 1998, including Certificate of designations, preferences and rights of Series A convertible preferred shares. (1)
3.2 By-Laws dated March 13, 1996. (2)
3.3 BSRT UPREIT Limited Partnership Limited Partnership Agreement *
4.1 Convertible Term Loan Agreement dated as of October 10, 1997 among Banyan Strategic Realty Trust, as Borrower, and the Entities listed therein, as Lenders. (3)
4.2 First Amendment to Convertible Term Loan Agreement dated as of March 30, 1998 made by and among Banyan Strategic Realty Trust and the Entities listed therein, as Lenders. (4)
4.3 Second Amendment to Convertible Term Loan Agreement dated as of June 26, 1998 made by and among Banyan Strategic Realty Trust and the Entities listed therein, as Lenders. (5)
4.4 Revolving Credit Agreement dated April 30, 1998 among Banyan Strategic Realty Trust, as Borrower and the Capital Company of America, as Lender. (6)
4.5 Loan Agreement dated May 22, 1998 among BSRT Fountain Square L.L.C., BSRT Phoenix Business Park L.L.C., BSRT Newtown Trust, BSRT Southlake L.L.C., BSRT Technology Center L.L.C., BSRT Airways Plaza L.L.C., BSRT Peachtree Pointe L.L.C., BSRT Avalon Center L.L.C., BSRT Sand Lake Tech Center L.L.C., BSRT Park Center L.L.C., BSRT Metric Plaza L.L.C., and BSRT University Corporate Center L.L.C., as Borrower, and the Capital Company of America, as Lender. (5)
4.6 First Amendment to Loan Agreement dated September 11, 1998 among BSRT Fountain Square L.L.C., BSRT Phoenix Business Park L.L.C., BSRT Newtown Trust, BSRT Southlake L.L.C., BSRT Technology Center L.L.C., BSRT Airways Plaza L.L.C., BSRT Peachtree Pointe L.L.C., BSRT Avalon Center L.L.C., BSRT Sand Lake Tech Center L.L.C., BSRT Park Center L.L.C., BSRT Metric Plaza L.L.C., and BSRT University Corporate Center L.L.C., as Borrower, and the Capital Company of America LLC, as Lender. (1)
4.7 Loan Agreement dated May 22, 1998 between BSRT Lexington B Corp. and BSRT Lexington Trust, as Borrower and the Capital Company of America, as Lender. (5)
4.8 First Amendment to Loan Agreement dated September 11, 1998 between BSRT Lexington B Corp., and BSRT Lexington Trust, as Borrower and the Capital Company of America LLC, as Lender. (1)
EXHIBIT INDEX -------------
4.9 Loan Agreement dated June 22, 1998 between Banyan/Morgan Wisconsin L.L.C., and Banyan/Morgan Elmhurst L.L.C., as Borrower and the Capital Company of America, as Lender. (5)
4.10 First Amendment to Loan Agreement dated September 11, 1998 between Banyan/Morgan Wisconsin L.L.C., and Banyan/Morgan Elmhurst L.L.C., as Borrower and the Capital Company of America LLC, as Lender. (1)
10.1 Employment Agreement of Leonard G. Levine as of October 1, 1997. (7)
10.2 Employment Agreement of Joel L. Teglia dated December 31, 1998. *
10.3 Employment Agreement of Neil Hansen dated December 31, 1998. *
10.4 Employment Agreement of Jay Schmidt dated December 31, 1998. *
10.5 1997 Omnibus Stock and Incentive Plan dated July 9, 1997. (8)
10.6 Share Purchase Agreement by and among Banyan Strategic Realty Trust and the Purchasers listed on the signature page attached thereto dated as of October 10, 1997. (3)
10.7 Registration Rights Agreement dated as of October 10, 1997 between Banyan Strategic Realty Trust and the Purchasers listed on the Signature Pages attached thereto. (3)
10.8 Registration Rights Agreement dated as of October 1, 1997 between Banyan Strategic Realty Trust and Leonard G. Levine. *
21 Subsidiaries of Banyan Strategic Realty Trust *
23 Consent of Ernst & Young LLP *
27 Financial Data Schedule *
99.2 Press Release dated February 17, 1999 *
- --------------------
* Filed herewith.
(1) Incorporated by reference from the Trust's Form 8- K/A-1 dated August 14, 1998.
(2) Incorporated by reference from the Trust's Registration Statement on Form S-11 (file number 33-4169).
(3) Incorporated by reference from the Trust's Form 8-K dated October 14, 1997.
(4) Incorporated by reference from the Trust's Form 10- K/A for the year ended December 31, 1997.
(5) Incorporated by reference from the Trust's Form 8-K dated May 22, 1998.
(6) Incorporated by reference from the Trust's Form 10- Q dated March 31, 1998.
(7) Incorporated by reference from the Trust's Form 10- K dated December 31, 1997.
(8) Incorporated by reference from the Trust's Form 10- Q for the quarter ended June 30, 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
We have acquired a large number of properties during each of the periods discussed below. Thus, period to period results are not entirely comparable. At December 31, 1998, we owned individually or, in some cases, through joint ventures:
. thirteen flex industrial properties totalling 1,841,000 rentable square feet;
. fourteen office properties totalling 1,545,600 rentable square feet;
. four apartment complexes containing 864 units;
. one retail center which contains 321,600 rentable square feet.
During the year ended December 31, 1998, we acquired four office properties totalling 354,800 rentable square feet and six flex industrial properties totalling 479,800 rentable square feet.
COMPARISON OF YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997
During the year ended December 31, 1998 and 1997 our net income totalled approximately $5.4 million ($0.40 per basic common share) and approximately $3.5 million ($0.32 per basic common share), respectively. The approximately $1.9 million increase resulted primarily from revenue growth of approximately $10.6 million reduced by expense growth of approximately $7.8 million. In particular, our total revenues increased by approximately $10.6 million or 36.8% to approximately $39.4 million from approximately $28.8 million, due primarily to an increase in the number of properties that we own. We attribute approximately $9.9 million or 93.4%, of this increase to properties acquired in 1998 and the net full-year effect of properties we either acquired or sold during 1997. On a "same- store" basis (comparing the results of operations of the properties owned during the entire year ended December 31, 1998 with the results of the same properties owned during the year ended December 31, 1997), total revenues increased by approximately $0.7 million or 3.5% to approximately $20.7 million from approximately $20.0 million, due to increased rental rates at these properties and recognition of lease termination fees at certain properties. Our portfolio occupancy as of December 31, 1998 was lower than it historically has been as a result of the termination of leases during the quarter. Therefore, our ability to maintain same store growth in revenue will in the future be dependent on the time it takes to re-lease this and future vacant space and the rental rates at which we sign new leases. In addition, property acquisitions during 1997 and 1998 have significantly contributed to our growth in those years. Our ability to make acquisitions in the future will depend upon our ability to raise additional equity through realizing gains on the sale of properties, selling additional shares of beneficial interest and/or issuing operating partnership units in the Operating Partnership. See Risk Factors for additional discussion.
In 1998, our total operating expenses, which include property operating, repair and maintenance, real estate taxes, and ground lease, increased by approximately $2.7 million to approximately $13.4 million from approximately $10.7 million in 1997, primarily due to an increase in the number of properties that we own, which accounted for approximately $2.3 million or 85.2% of this increase. On a "same-store" basis, total operating expenses increased by approximately $0.4 million or 6.3% to approximately $6.7 million from approximately $6.3 million. Interest expense increased by approximately $3.4 million from approximately $6.4 million to approximately $9.8 million, primarily due to an increase in the amount we have borrowed in connection with the acquisitions we completed in 1998. Depreciation and amortization expense also increased approximately
$1.7 million. We attribute most of the increase to the fact that we own more properties. Total general and administrative expenses increased by approximately $0.3 million due to costs incurred in connection with due diligence for transactions that were not completed in 1998 and due to an increase in administrative staff hired to oversee our properties and the legal fees associated with acquiring properties during 1998.
COMPARISON OF YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996
During the year ended December 31, 1997, our net income totalled approximately $3.5 million ($0.32 per common share) compared to a net loss of approximately $1.8 million (($0.17) per common share) for the year ended December 31, 1996. We explain the $5.3 million increase by noting that revenues grew by $7.4 million in 1997 while expenses grew by $2.1 million. In particular, our total revenues increased 34.6% to approximately $28.8 million from approximately $21.4 million due primarily to an increase in the number of properties that we own. We attribute approximately $6.5 million or 87.8%, of this increase to properties we either acquired or sold in 1997 and the full-year effect of properties acquired during 1996. On a "same-store" basis (comparing the results of operations of the properties we owned during the entire year ended December 31, 1997 with the results of the same properties owned during the year ended December 31, 1996), our total revenues increased by approximately $1.2 million, or 7.2%, to approximately $17.9 million from approximately $16.7 million due in part to increased occupancy. In addition, our operating cost recoveries increased by approximately $0.2 million. The remainder of the increase in revenue generated by same store properties was due to increased rental rates. The increase in total revenues was partially offset by a decrease in interest income earned on mortgage loans of approximately $0.4 million, which were sold during 1996.
Our total operating expenses increased by approximately $1.4 million in 1997 to approximately $10.7 million from approximately $9.3 million in 1996. This increase is almost exclusively due to an increase in the number of properties that we own. Our interest expense increased to approximately $6.4 million from approximately $4.0 million primarily due to the fact that the we increased the amount of money borrowed from approximately $59.1 million at December 31, 1996 to approximately $92.1 million at December 31, 1997. We used the additional loans to pay for our new acquisitions. Our depreciation and amortization expense also increased by approximately $1.2 million. We attribute most of the increase to the fact that we own more properties. Our total general and administrative expenses increased by approximately $1.2 million. We attribute this increase to a larger administrative staff hired to oversee our properties, the legal fees associated with acquiring our properties during 1997 and amounts we paid as incentive compensation.
During the year ended December 31, 1997, we realized net income from our interest in the H Street Venture of $37,126 compared to a net loss of ($3,301,212) for the same period in 1996. The net loss in 1996 was due to our decision to reduce the carrying value of our interest in the H Street Venture. In March 1997, the venture sold a property which it owned and we received a distribution of approximately $1.0 million from the venture. On July 29, 1997, the venture sold its remaining assets. We received a distribution of approximately $4.5 million and recognized a loss of approximately $0.1 million. We have no further interest in the H Street Venture.
LIQUIDITY AND CAPITAL RESOURCES
We expect to fund our short-term liquidity needs, including recurring capital expenditures, from our working capital (including the restricted cash which is available for capital expenditures, real estate taxes and insurance), and from income derived primarily from our property operations.
We anticipate using these monies to fund periodic tenant-related capital
expenditures and other capital improvements. We believe that our Funds Available for Distribution (as defined below) will be sufficient for the twelve months after the date of this report to pay quarterly distributions of $0.12 per common share.
We expect to fund our long-term liquidity needs, including monies required to acquire and develop property and funds necessary for other non- recurring capital improvements, from long-term secured and unsecured debt and through issuing debt or equity securities, including issuing units in the Operating Partnership in exchange for properties. We expect that we will fund a portion of the cost of buying and improving properties in the future by borrowing under our credit facilities or by mortgaging properties we acquire.
At December 31, 1998, our assets totalled approximately $222.6 million, an increase of approximately $63.0 million from total assets at December 31, 1997 of approximately $159.6 million. Our liabilities totalled approximately $158.0 million at December 31, 1998 an increase of approximately $61.9 million from a total of approximately $96.1 million at December 31, 1997. Our shareholders equity increased by approximately $0.1 million to approximately $62.4 million at December 31, 1998 from approximately $62.3 million at December 31, 1997.
Cash and cash equivalents consist of cash and short-term investments. Our cash and cash equivalents balance was approximately $3.7 million at December 31, 1998 and approximately $4.4 million at December 31, 1997. The decrease in total cash and cash equivalents from year-end 1997 to year-end 1998 results from using approximately $61.8 million on investing activities while receiving approximately $49.9 million in financing and approximately $11.2 million from operations.
Cash Flows From Operating Activities: Net cash provided by operating activities increased in 1998 by approximately $2.6 million to approximately $11.2 million from approximately $8.6 million in 1997. This increase is primarily due to an increase in the net operating income generated by the properties acquired in 1998 and 1997. See Results of Operations above for further discussion of the operations of our real estate assets.
Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts ("NAREIT"), an industry trade group, has promulgated a standard known as "Funds from Operations", or "FFO" for short, which it believes more accurately reflects the operating property performance of a REIT such as our company. As defined by NAREIT, FFO means net income computed in accordance with generally accepted accounting principles ("GAAP"), less extraordinary, unusual and nonrecurring items, excluding gains (or losses) from debt restructuring and sales of property plus depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures in which the REIT holds an interest. We have adopted the NAREIT definition for computing FFO because we believe that, subject to the following limitations, FFO provides a basis for comparing the performance and operations of a REIT such as our company. The calculation of FFO may vary from entity to entity in that capitalization and expense policies may vary from entity to entity. Items which are capitalized do not decrease FFO whereas items that are expensed decrease FFO. As such, our presentation of FFO may not be comparable to other similarly titled measures presented by other REIT's. We do not intend for FFO to be an alternative to Net Income as an indication of our performance nor an alternative to Cash Flows from Operating Activities (as calculated in accordance with GAAP) as a measure of our capacity to pay distributions.
For the years ended December 31, 1998, 1997 and 1996, our properties generated FFO of approximately $10.4 million, $5.8 million and $3.6 million, respectively. FFO increased on a year to year basis due primarily to an increase in the number of properties owned from period to period.
FFO for the years ended December 31, 1998, 1997, and 1996 is calculated as follows:
1998 1997 1996 --------- -------- -------- (Dollars in thousands) Net Income (Loss) $ 5,378 $ 3,546 $ (1,757)
Plus: Depreciation expense 4,770 3,277 2,355 Depreciation included in Operations of Real Estate Ventures -- 15 31 Lease Commission Amortization 406 208 98 Less: Minority Interest Share of Depreci- ation Expense (284) (254) (228) Minority Interest Share of Lease Commission Amortization (31) (21) (13) Recovery of Losses on Loans, Notes and Interest Receivable -- (161) (17)
Valuation Allowance Included in Operations of Real Estate Venture -- -- 3,180
Net Gain on Disposition of Investments in Real Estate -- (881) --
Extraordinary Item, Net of Minority Interest 141 64 -- -------- -------- -------- Funds From Operations $ 10,380 $ 5,793 $ 3,649 ======== ======== ======== Cash Flows Provided By (Used For): Operating Activities $ 11,220 $ 8,644 $ 5,730 Investing Activities $(61,790) $(27,575) $ (6,598) Financing Activities $ 49,872 $19,555 $ (827)
Our ability to pay any distribution is influenced by the amount of monies that we have available to distribute known as Funds Available for Distribution or "FAD" for short. FAD is calculated by increasing or decreasing FFO to give effect to items such as the impact of straight- lining rents, lease commissions paid and normalized reserves for capital improvements. The capital reserve is $0.075 per square foot for flex/industrial properties, $0.10 per square foot for office properties, $0.15 per square foot for retail property and $200 per residential unit.
Our ability to make future distributions to our shareholders is dependent upon, among other things:
. sustaining the operating performance of our existing real estate investments through scheduled increases in base rents under existing leases and through general improvement in the real estate markets where our properties are located;
. the operating performance of future acquisitions; and
. our level of operating expenses.
See Risk Factors for additional discussion.
FAD for the years ended December 31, 1998, 1997 and 1996 is calculated as follows:
1998 1997 1996 ------- ------- ------- (Dollars in thousands) Funds From Operations . . . . . . $10,380 $ 5,793 $ 3,649 Straight-line Rents . . . . . . . (544) (386) (289) Lease Commissions . . . . . . . . (739) (630) (382) Capital Reserve . . . . . . . . . (493) (381) (350) ------- ------- ------- Funds Available for Distribution. $ 8,604 $ 4,396 $ 2,628 ======= ======= =======
Cash Flows From Investing Activities: During the year ended December 31, 1998, we used approximately $61.8 million primarily to acquire properties compared to approximately $27.6 million in the same period in 1997. During the year ended December 31, 1998 we purchased four office and six flex/industrial properties for approximately $55.9 million. Cash flow was also used to make capital improvements at our various properties in the amount of approximately $5.3 million. In comparison, during the same period in 1997, we generated a total of approximately $12.5 million from sale of our interests in (i) the Hallmark Village property; (ii) the H Street Assemblage Parcel and the Victor building; and (iii) the Colonial Courts Apartments; acquired six office and four apartment properties for a total of approximately $37.5 million and made capital improvements in the amount of approximately $2.5 million.
PROPERTY ACQUISITIONS AND OTHER INFORMATION
ACQUISITION ACTIVITIES:
During the year ended December 31, 1998, we acquired interests in several properties. The table below presents a summary of 1998 acquisitions.
Purchase Name and Date of Price Location Acquisi- (in of Property Sq. Ft. tion millions) Description - --------------- -------- --------- --------- ----------------
Peachtree Pointe 71,700 01/20/98 $4.6 Five one-story Office Park office buildings; Norcross, Georgia Twenty-three tenants at the time of acqui- sition
Avalon Center 53,300 03/20/98 4.4 Two one-story Office Park office buildings; Norcross, Georgia Three tenants at the time of acquisition
Avalon Ridge 57,400 04/24/98 3.9 Two one-story Business Park flex/industrial Norcross, Georgia buildings; Two tenants at the time of acquisition
Tower Lane 95,900 04/27/98 5.2 Two one-story Business Park (1) flex/industrial Bensenville, buildings; Illinois Seventeen tenants at the time of acquisition
Purchase Name and Date of Price Location Acquisi- (in of Property Sq. Ft. tion millions) Description - --------------- -------- --------- --------- ----------------
University 127,800 04/30/98 10.2 Seven one-story Corporate Center flex/industrial Winter Park, buildings; Florida Twenty-six tenants at the time of acquisition
Metric Plaza 32,000 04/30/98 2.6 Two one-story Winter Park, flex/industrial Florida buildings; Two tenants at the time of acquisition
Park Center 47,400 04/30/98 3.7 Two one-story Orlando, Florida flex/industrial buildings; Sixteen tenants at the time of acquisition
Sand Lake 84,100 04/30/98 6.8 Five one-story Tech Center office buildings; Orlando, Florida Three tenants at the time of acquisition
Johns Creek 119,300 08/14/98 5.8 Two flex/indus- Office and trial buildings; Industrial Park Two tenants Duluth and Suwanne, at the time Georgia of acquisition
Technology 145,700 08/14/98 12.4 Three office Park buildings; Norcross, Twelve tenants Georgia at the time -------- ----- of acquisition Total 834,600 $59.6 ======== =====
(1) In April 1998, we formed a new joint venture, Butterfield O'Hare L.P., in which we have an 89.1% limited partnership interest and .9% general partnership interest. The portfolio owned by the venture consists of two properties, Butterfield Office Plaza, a property we formerly owned solely, and Tower Lane Business Park ("Tower Lane"), which the venture purchased on April 27, 1998. Upon forming the venture and acquiring Tower Lane, the venture assumed a permanent mortgage loan encumbering the Tower Lane property in the amount of approximately $3.7 million. The loan matures in November, 2001, bears an interest rate of 8.35% and is payable in monthly installments of interest and principal, with principal amortized over a 264-month period. The financing secured by the Butterfield property in the amount of approximately $9.9 million was also assumed by the venture.
Cash Flows From Financing Activities: During the years ended December 31, 1998 and 1997, financing activities generated $49.9 million and $19.6 million, respectively. During the year ended December 31, 1998 these cash flows resulted primarily from approximately $55.9 million of net proceeds from bonds and mortgage loans reduced by distributions paid to shareholders of approximately $6.1 million. The cash flows provided by financing activities for the year ended December 31, 1997 resulted primarily from approximately $16.9 million of net proceeds from bonds and mortgage loans and approximately $10.0 million of net proceeds from issuance of shares reduced by distributions paid to shareholders of approximately $4.5 million.
FINANCINGS:
On April 30, 1998, we entered into a $25 million line of credit agreement (the "CCA Line") with Nomura Asset Capital Corporation ("Nomura"). Nomura subsequently assigned its interest to its subsidiary - The Capital Company of America LLC ("CCA"). The CCA Line has an initial term of twenty-four months. Draws on the line bear interest at a rate equal to LIBOR plus 2.00%. We have an option to extend the line for one additional year for a fee of $125,000. The agreement with CCA requires that we satisfy certain financial covenants, including maintaining a consolidated tangible net worth of at least $52.5 million and a leverage ratio of debt to consolidated net worth of 3:1 or less. As of December 31, 1998, we had borrowed about $12.9 million on the CCA Line leaving approximately $12.1 million available for future borrowing. We are presently in the process of evaluating the adequacy of the amount of this available credit and are exploring options to expand the debt capital available to us on an interim and long-term basis for purposes of providing financing for future acquisitions. At December 31, 1998, our debt to total market capitalization ratio was 66.8% based upon the closing share price on that date of $5.625.
On June 22, 1998 and May 22, 1998, we entered into three permanent loan agreements with Nomura, which also were assigned to CCA. The first loan, known as the "Pool A Loan", was in the amount of $38.3 million and was funded on June 5, 1998. The second loan, known as the "Pool B Loan", in the amount of $7.7 million, was funded June 5, 1998. The third loan, known as the "Pool C Loan", was in the amount of $7.65 million and was funded on June 30, 1998.
The Pool A Loan matures on June 11, 2028 and the Pool C Loan matures on July 11, 2028. We may prepay either of these loans during the 90 days preceding July 11, 2008. The interest rate is effectively 6.95% for the first ten years of each loan. With respect to either loan, if we have not repaid the loan by July 11, 2008, the interest rate will be increased by 2%.
The Pool B Loan matures on June 11, 2029, and we may prepay the loan during the 90 days preceding June 11, 2009. The interest rate on the Pool B Loan is 7.07% for the first eleven years of the loan. If we have not repaid the loan by June 11, 2009, the interest rate will be reset and will be equal to the sum of 5% per year plus the greater of: (i) 8.38%; or (ii) a rate based on the rate of U.S. Treasury obligation with a maturity date closest to that of the loan, plus 1.35% per year.
In addition to the prepayment options in 2008 and 2009 for these loans, we may prepay all or part of the Pool A or Pool C Loans, on the applicable release dates, by depositing with an escrow agent sufficient funds to purchase U.S. Treasury obligations to repay the principal and interest on the loans as if the loans had been held to maturity. The "Release Dates" occur in September 2000 for the Pool A and Pool C Loans, and in June 2002 for the Pool B Loan or, if earlier, two years after the date the lender includes the applicable facility in a mortgage-backed securitization program. In addition, if the ratio of net operating income to principal and interest on the Pool B loan is less than 1.65:1.00 on June 11, 1999 based on the net operating income of the property securing the Pool B Loan, CCA can require that we repay a portion of the Pool B Loan or add additional collateral to the pool.
Restrictions in the loan documents effectively prevent us from selling any of the properties securing the loans until the release dates occur in 2000 and 2002. After the release date, we may make certain payments which will cause the lender to release the mortgage on a particular property. In addition, after the release date but before the optional prepayment dates of July 11, 2008 (the Pool A and Pool C Loans) or June 11, 2009 (the Pool B Loan), we may substitute different properties as collateral under each loan as long as the loan amount collateralized by all properties replaced does not exceed fifty percent of the total loan amount and certain other conditions are satisfied.
The Pool A Loan is secured by cross-collateralized first mortgages on:
The Colonial Penn Building, Phoenix Business Park, Newtown Business Center, Southlake Corporate Center, Technology Center, Airways Plaza Office Center, Peachtree Pointe Office Park, Avalon Center Office Park, Sand Lake Tech Center, Metric Plaza, Park Center, and University Corporate Center. The Pool B Loan is secured by a first mortgage on the Lexington Business Center. The Pool C Loan is secured by cross-collateralized first mortgages on the Milwaukee Industrial Portfolio and Elmhurst Metro Court.
We used the proceeds from these loans to repay the amounts outstanding under the CCA Line ($23.25 million) and the line of credit provided by American National Bank ($20.65 million). We also repaid mortgage loans secured by the Milwaukee Industrial Portfolio ($3.5 million) and the Elmhurst Metro Court ($3.8 million). We used the balance of the CCA loan proceeds to pay transaction related costs and for general operating reserves.
During the third quarter of 1998, we borrowed $7.4 million under a convertible term loan agreement entered into with a group of lenders in October 1997. We used the proceeds to acquire the Johns Creek Office and Industrial Park and Technology Park. The loan matures on September 30, 2002 and bears interest at 12% per year, payable quarterly. In addition, on October 14 of each year, we are required to pay an annual fee equal to 2% of the amount outstanding as of that date. The amounts outstanding on the loan are convertible, at the lenders' option, into Series A convertible preferred shares at a conversion price of $100 per share or into common shares at a conversion price of $5.15 per share. These lenders also had a right exercisable until November 13, 1998 to purchase up to $12.6 million in preferred or common shares. This right was not, however, exercised and has expired.
IMPACT OF THE YEAR 2000
The Year 2000 issue, or Y2K for short, is the result of computer programs utilizing two digits rather than four digits to define the applicable year. Any of our computer programs or hardware that have date- sensitive software or embedded chips may therefore recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or in miscalculations causing disruptions of real estate operations, such as the functioning of property mechanical systems, and other activities, such as a temporary inability to process transactions, generate invoices or reports, manage our portfolio, comply with regulatory requirements or engage in similar normal business activities.
We have formed a Y2K Compliance Committee consisting of at least one representative from each of our departments: legal, accounting, asset management, investor relations and acquisitions. Our Y2K Compliance Committee, in accordance with the Year 2000 Information and Readiness Disclosure Act, has formulated the following Year 2000 Readiness Disclosure:
We believe that the members of our committee, drawing upon their various disciplines and resources available to them through professional organizations and contacts, will collectively be able to formulate the necessary initial questionnaires and inquiries described below and to develop a comprehensive plan for testing and evaluating responses to our inquiries.
Our committee will, as circumstances dictate, retain third party consultants and professionals to assist it in evaluating technical issues or making strategic recommendations for remedial action, if necessary.
We have established a plan for assessing and mitigating our exposure to Y2K matters. The plan consists of several elements including a complete upgrade of our computer hardware and software programs; assessing Y2K compliance programs at each property and each property's reliance on computer programs in operations; and inquiry and dialogue with our significant suppliers, vendors and tenants as to their Y2K compliance initiatives.
We have upgraded our networking, financial analysis, general ledger and accounts payable software programs in order to minimize the potential impact of Y2K at our headquarters. In addition, we expect to complete testing procedures that will ensure that all upgraded systems will operate subsequent to December 31, 1999. These testing procedures will include simulating operating all systems at a date after December 31, 1999. As of December 31, 1998, we have expended $35,000 on Y2K compliance issues. The vast majority of these funds have been expended on the network and computer software upgrades.
We anticipate a total expenditure of less than $50,000 on Y2K compliance at our corporate headquarters. Based solely upon preliminary discussions with our ten property managers, we do not presently anticipate significant expenses at the property level. However, if there are significant expenditures at the property level, we will revise our projection of Y2K related costs.
We are also assessing the operations at each of our properties in an effort to diagnose the impact that Y2K may have on property operations, particularly mechanical systems. We anticipate completing this assessment in the second quarter of 1999. At this time, we are gathering information to evaluate what, if any, remedial action will be necessary and the potential costs associated with the action.
We rely on various third parties to provide property level and other administrative functions. We have sent a questionnaire to each of our property managers inquiring about their ability to address the effect of the Y2K issue on their own operations. To date, we have received responses from nine of our ten property managers. Of the responding managers, five have systems that, in their view, are Y2K compliant, three expect to become compliant by the second quarter of 1999 and one expects to be compliant by the third quarter of 1999. We are currently in the process of determining whether or not the other property manager has addressed the Y2K issue and anticipate that the process will be completed in the first quarter of 1999.
We intend to further verify and test each significant property manager's compliance by the second quarter of 1999. The computerized aspect of the relationship between us and our property managers is most prevalent in the accounting and reporting functions from the property level to our headquarters. We believe that the potential impact of a non- compliant property manager is minimized because we have the right to cancel
our property management contracts generally on 30-day notice at no cost to us. Therefore, any property managers who may not be Y2K compliant can be replaced with a manager that has Y2K compliant systems. In spite of the above steps to verify Y2K compliance, if any property manager is unable to perform accounting functions after December 31, 1999, we expect to have the internal capability to process all accounting transactions and to produce financial statements needed to manage the properties and comply with our reporting requirements.
We have also received Y2K reports from our payroll processing service provider, our transfer agent and our principal bank. Our payroll service provider has represented that it processes our payroll using Y2K compliant software. Our principal bank represented that as of December 31, 1998, its Y2K renovation and testing of its systems was substantially complete. The remaining Y2K related system changes as well as external testing and contingency planning is expected to be completed by June 30, 1999. Our transfer agent has represented that all of its "mission critical" systems and nearly all of its "non-mission critical" systems have been tested for Y2K readiness. Furthermore, it continues to develop Business Resumption Contingency Plans for each line of its business that will ensure operations will continue with minimum disruption.
We are also in the process of contacting other service providers and vendors to ascertain their ability to continue to provide goods and services to us. We are developing a mechanism to continue the review and assessment of service providers and vendors on a regular basis until circumstances no longer warrant monitoring. Other than described in the preceding paragraph, the future success of our operations is not closely tied to any one third party vendor, supplier or service provider. As such, if any of these third parties fails to conduct business due to Y2K related problems, we expect to be able to contract with other third parties without experiencing any material disruption of our operations or financial condition. We cannot quantify the potential costs and uncertainties associated with potential Y2K program flaws at this time as they may relate to other organizations that we rely upon but we do not anticipate that the effect of this potential computer program flaw upon our operations will be significant.
As of December 31, 1998, we had over 500 tenants. Our ten (10) largest tenants account for approximately twenty percent (20%) of our total projected revenues for 1999 based on properties owned as of December 31, 1998. Because of our broad tenant base, our future operations, particularly our ability to collect rent, is not closely tied to the ability of any one particular tenant to pay rent or other charges. We currently believe that there will not be a material adverse effect upon our operations or financial condition if any one tenant or small group of tenants ceases to conduct business (and pay rent) or is simply unable to pay rent on a timely-basis due to Y2K problems. However, if a large number of tenants, particularly several of the ten largest tenants, fail to pay rent for an extended period of time, our cash flow may be adversely effected. During the first quarter of 1999, we initiated contact with our 68 largest tenants to survey their plans to address Y2K related issues. This sampling includes all tenants whose annual rental payments are greater than $100,000.
We are currently formulating a contingency plan to address potential failures:
- at our home office; - at our properties; - regarding our property managers; - regarding our tenants; - regarding our suppliers and vendors.
We expect to formulate our contingency plan by June 1999.
We are focusing our efforts on determining a contingency plan for what we believe to be the most likely worst case scenario - an isolated failure in one or two of the categories described above. For example, there is the possibility that we may be unable to provide an adequate working environment for some of our tenants due to the failure of building mechanical, life safety or security systems. Furthermore, the worst case scenario would include Y2K problems inhibiting our ability to collect rent or preventing some of our tenants from paying rent caused by Y2K issues unrelated to property operations. We could be subject to litigation for failing to provide an adequate working environment for our tenants as a result of Y2K computer system disruptions. More immediately, the tenants may cease paying rent which could impact our liquidity. The amount of potential liability and lost revenue cannot be reasonably estimated at this time.
We have not focused our contingency planning for a "doomsday" scenario in which a near-universal malfunction of computers would have a sweeping effect upon all businesses. It is unlikely that any planning we could presently formulate would assist in the vast recovery process necessitated by this unlikely event.
RISK FACTORS
REAL ESTATE RISKS
WE MAY NOT BE ABLE TO ACQUIRE ADDITIONAL PROPERTIES ON ACCEPTABLE TERMS. The success of our business strategy depends in part on our ability to acquire additional properties that satisfy our investment parameters. We may not be able to identify properties that meet these standards or acquire properties at a price that allows us to earn an attractive return since we compete for acquisitions with other real estate investors, some of whom have significantly greater resources at their disposal.
WE HAVE A LIMITED HISTORY WITH OUR EXISTING PROPERTIES AND HAVE RECENTLY ACQUIRED MANY NEW PROPERTIES. We have acquired all of our properties within the last six years and have acquired twenty of these properties since January 1, 1997. Our most recently acquired properties, and properties that we acquire in the future, may have characteristics or deficiencies unknown to us that may impact their value or revenue potential. We are currently experiencing a period of rapid growth. Our ability to manage our growth effectively requires us to assimilate new acquisitions into our portfolio with minimal operating disruptions and unanticipated costs. We may not be able to successfully integrate these properties into our portfolio or these properties may not perform as expected.
WE COMPETE FOR TENANTS. All of our office and flex industrial properties are located in highly-developed areas that include other office and flex industrial properties. Some of these properties are newer or better located than our properties. Further, our competitors may have greater resources than we do, which could allow them to reduce rents to a level that is not profitable for us. We may also have to spend money upgrading or renovating our properties to make them attractive to both existing and potential tenants thus increasing our expenses and reducing our cash resources. The number of properties or other companies that compete in our market areas could have a material effect on:
. our ability to lease space at our properties; . the amount of rent that we can charge on new leases or renewals; . the dollar amount of tenant improvements or leasing commissions required to lease a property; and . the number of acquisition opportunities.
WE OWN PROPERTIES IN A LIMITED NUMBER OF MARKETS. Our properties are located in the Midwestern and Southeastern United States, primarily suburban Chicago, where we own properties that account for 19% of our gross rental revenue, and suburban Atlanta, where we own properties that account for 24% of our gross rental revenue. Our ability to maintain or increase our revenues or to generate revenues that exceed our operating expenses is affected by economic conditions in the Midwestern and Southeastern United States. Like other real estate markets, these markets have experienced economic downturns in the past and will likely experience downturns in the future. Layoffs or downsizing, industry slowdowns, changing demographics, increases in the supply of property or reduced demand for office or flex industrial space may decrease our revenues or increase our operating expenses or both.
LEASES ON APPROXIMATELY 19% OF OUR RENTABLE SQUARE FEET EXPIRE IN THE NEXT TWELVE MONTHS. As leases expire, we may not be able to renew or re- lease space at rates comparable to or better than the rates contained in the expiring leases. Leases on a total of approximately 19% of our rentable square feet will expire prior to December 31, 1999. If we fail to renew or re-lease space at rates that are at least comparable to the rates on expiring leases, the revenues generated by our properties will decline. Further, we may have to spend significant sums of money to renew or re- lease space covered by expiring leases, potentially reducing the amount of money that we have available to distribute to you or to use for other purposes.
OUR TENANTS MAY NOT PAY THEIR RENT OR MAY DECLARE BANKRUPTCY. We derive substantially all of our revenue from leasing space at our properties. Consequently, our ability to make distributions to you may be negatively affected if tenants leasing a significant percentage of our rentable square feet fail to pay their rent or if we are unable to profitably lease space. We may experience substantial delays and incur significant expenses enforcing our rights against tenants who do not pay their rent. A tenant may also seek the protection of the bankruptcy laws and delay making rental payments to us or actually reject or terminate its lease under those laws. Even if a tenant did not seek the protection of the bankruptcy laws, the tenant may from time to time experience a downturn in its business which may weaken its financial condition and its ability to make rental payments to us when due.
WE MAY NOT BE ABLE TO QUICKLY VARY OUR PORTFOLIO. Investments in real estate are relatively illiquid. In addition, in order to continue qualifying as a REIT, we are subject to rules and regulations which limit our ability to sell properties within a short period of time. Further, under the loan agreement with CCA, we may not sell any of the properties that are mortgaged to secure payment prior to 2000. We have mortgaged fifteen of our properties representing approximately 42% of our rentable square footage to secure payment on the CCA loans. Thus, we may be unable to sell a property even if market conditions or our financial condition warrant such a sale.
WE ARE REQUIRED TO COMPLY WITH VARIOUS LAWS AND REGULATIONS. As an owner of property, we are required to comply with a variety of federal, state and local laws. Complying with these laws and regulations may increase our operating expenses and reduce our profits. For example, we are required to comply with laws and regulations that impose liability on a property owner for the costs of removing or remediating certain hazardous materials released on a property. We are subject to these laws even if we are not aware of, or responsible for, releasing these materials. These laws or regulations may also restrict the way that we can use a property or the type of business which may be operated on the property. Further, if we fail to comply with these laws or regulations by, for example, failing to properly remediate a release of hazardous material, we may not be able to sell the affected property or borrow money using the property as collateral
for a loan. We may also be required to pay money to individuals who are injured due to the presence of hazardous materials on our property. Although we are not aware of any hazardous materials at our properties, these materials may exist and the cost of removing or remediating them may be material and could adversely affect the value of the property affected. We may also be required to pay the cost of removing or remediating hazardous materials from a disposal or treatment facility to which we may have shipped hazardous or toxic substances even if we never owned or operated the disposal or treatment facility. Our properties must also comply with the Americans with Disabilities Act. This act establishes certain standards related to access and use of properties by disabled persons. We may be required, for example, to remove any barriers to access. If we fail to comply, the U.S. government may fine us or we may be required to pay damages to a disabled person. Complying with these requirements may increase our expenses and changes in these requirements may result in unexpected expenses.
OUR OBJECTIVES MAY CONFLICT WITH THOSE OF OUR JOINT VENTURE PARTNERS. We own eight of our properties, or approximately 30% of our rentable square footage through controlling interest in joint ventures with various third parties. We may purchase additional properties through joint ventures with third parties. Investments in joint ventures which own properties may involve risks that are not otherwise present when we wholly own the property directly or through one of our subsidiaries. For example, our co- venturer may file for bankruptcy protection or may have economic or business interests or goals which are inconsistent with our goals or interests. Further, although we own a controlling interest in each of these ventures, we may owe fiduciary duties to our partners.
WE MAY NOT HAVE ENOUGH INSURANCE. We have customary comprehensive liability, fire, flood, earthquake, extended coverage and rental loss policies that insure us against losses at our properties with policy specifications and insurance limits that we believe are reasonable. There are certain types of losses, for example environmental, that we may decide not to insure against since the cost of insuring for the loss is not economically practical. We use our discretion in determining the amount of coverage, the limits on this coverage and the deductibles that apply to the coverage in an attempt to balance the amount of insurance that we purchase and the cost of that insurance. We may, however, suffer losses that exceed our insurance coverage. Further, inflation, changes in building codes and ordinances or other factors such as environmental laws may make it too expensive to repair or replace a property that has been damaged or destroyed, even if covered by insurance.
PROPERTY TAXES MAY INCREASE. We are required to pay taxes based on the assessed value of our properties to various taxing authorities such as state or local governments. These taxing authorities may increase the tax rate imposed on a property or may reassess property value, either of which could increase our operating expenses.
REAL ESTATE FINANCIAL RISKS
WE OFTEN NEED TO BORROW MONEY TO FINANCE OUR BUSINESS. Our ability to internally fund our capital needs is limited since we must distribute at least 95% of our net taxable income (excluding net capital gains) to our shareholders to qualify as a REIT. Consequently, we often borrow money to fund our operating or capital needs, and may borrow monies to satisfy the 95% distribution requirement. The documents which govern how we may conduct our business do not limit the amount of money that we may borrow. Borrowing money to fund operating or capital needs exposes us to various risks. For example, our properties may not generate enough cash to pay the
principal and interest obligations on our loans or we may violate a loan covenant that results in the lender accelerating the maturity date of a loan. As of December 31, 1998, we owed a total of approximately $151.6 million, including approximately $144.2 million secured by mortgages on certain of our properties. If we fail to make timely payments on our loans, including those cases where a lender has accelerated the maturity date due to a violation of a loan covenant, the lenders could foreclose on the properties securing their loans and we could lose our entire investment in those properties. Once a loan becomes due, we must either pay the remaining balance or borrow new money to pay off the maturing loan. We may not, however, be able to obtain a new loan, or the terms of the new loan, such as the interest rate or payment schedule, may not be as favorable as the terms of the maturing loan. Thus, we may be forced to sell a property at an unfavorable price to pay off the maturing loan or agree to less favorable loan terms. A total of $2.0 and $15.0 million of our indebtedness matures on or before December 31, 1999 and 2000 respectively.
We occasionally enter into loans where the interest rate may be increased from time to time. As of December 31, 1998, we owed approximately $17.7 million that bore interest at variable rates. We may borrow additional amounts that bear interest at variable rates. If interest rates increase, the amount of interest that we are required to pay on these borrowings will also increase. Any such increase would increase our operating expenses and potentially impact in a negative manner our ability to pay distributions to our shareholders.
WE MAY CHANGE OUR INVESTMENT POLICIES WITHOUT YOUR APPROVAL. Our investment policies, including the type of properties that we purchase, the manner in which these properties are managed and the amount of money that we borrow are all determined by our board and may be changed without your approval.
WE DEPEND ON A SMALL NUMBER OF KEY PERSONNEL. Our success depends, in part, on the efforts of our principal executive officers, particularly Messrs. Levine, Hansen, Schmidt and Teglia. Although we have entered into employment contracts with each of these individuals, the loss of their services could have an adverse effect on our operations.
THIRD PARTIES MAY BE DISCOURAGED FROM MAKING ACQUISITION OR OTHER PROPOSALS THAT MAY BE IN YOUR BEST INTERESTS. Under our Declaration, no single person or group of persons (an entity is considered a person) may own more than 9.9% of our outstanding common shares. The employment contracts we have with each of our senior executives also require us to make certain payments to these individuals if a "change of control" occurs. A "change of control" is defined in each of these agreements to mean that the members of the board of trustees as of the date the agreement is signed fail to constitute a majority of the board members provided that if the chief executive officer consents to a new board member, that person is treated for purposes of this test as if he or she was a member of the board at the time that the agreement was signed. These provisions may prevent or discourage a third party from making a tender offer or other business combination proposal such as a merger, even if such a proposal would be in the best interest of our shareholders.
WE MIGHT FAIL TO QUALIFY AS A REIT. If we fail to qualify as a REIT, we would not be allowed to deduct amounts distributed to our shareholders in computing our taxable income and would incur substantially greater expenses for taxes and would have less money available to distribute to you. We would also be subject to federal income tax at regular corporate rates as well as potentially the alternative minimum tax. Unless we satisfied some exceptions, we could not elect to be taxed as a REIT for the four taxable years following the year during which we were disqualified. We may fail to qualify as a REIT if, among other things:
. less than 75% of the value of our total assets consists of real estate assets, cash and government securities at the close of each fiscal quarter;
. more than 5% of the value of our assets consists of securities of any one issuer or we hold more than 10% of the outstanding voting securities of any one issuer at the close of each fiscal quarter;
. less than 75% of our gross income is generated from rents from real property, interest on obligations secured by mortgages, gain from the sale of property, and certain other property-related revenue sources; or
. we fail to distribute at least 95% of our taxable income to our shareholders.
If we fail to distribute enough money to satisfy the REIT requirements, we may also have to pay a non-deductible excise tax. This tax is equal to 4% of the amount in any year that our distributions are less than the sum of 85% of our ordinary income in the current year plus 95% of our net income from capital gains in the current year plus 100% of the taxable income that we did not distribute in prior years. We may also lose our REIT status if the Internal Revenue Service were to successfully challenge the tax status of the Operating Partnership as a partnership for federal income tax purposes. In this case the Operating Partnership would be taxable as a corporation and we would lose our status as a REIT if we did not own 100% of the Operating Partnership. If the Operating Partnership were to be required to pay taxes as a corporation, it would substantially reduce the amount of money that the Operating Partnership would have to distribute to us and ultimately to you.
WE MAY SPEND ADDITIONAL MONEY ON OUR COMPUTER PROGRAMS DUE TO THE YEAR 2000 ISSUE. See IMPACT OF YEAR 2000 above.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We do not engage in any hedge transaction or in the ownership of any derivative financial instruments. To mitigate the impact of fluctuations in interest rates, we generally maintained over 70% of our debt as fixed rate in nature by borrowing on a long-term basis.
As of December 31, 1998, we had approximately $151.6 million of outstanding long-term debt, of which $17.7 million bears interest at variable rates. As of December 31, 1998, the weighted-average interest rate on this variable rate debt was 6.84%. If interest rates on this variable rate debt increased by one percentage point (1%), interest expense would increase by $177,000 on an annual basis.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
BANYAN STRATEGIC REALTY TRUST INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ----
Report of Independent Auditors 35
Consolidated Balance Sheets, December 31, 1998 and 1997 36
Consolidated Statements of Operations For the Years Ended December 31, 1998, 1997 and 1996 38
Consolidated Statements of Shareholders' Equity For the Years Ended December 31, 1998, 1997 and 1996 40
Consolidated Statements of Cash Flows For the Years Ended December 31, 1998, 1997 and 1996 41
Notes to Consolidated Financial Statements 43
Schedule -------- Consolidated Real Estate and Accumulated Depreciation III
SCHEDULES NOT FILED:
All schedules other than those indicated in the above index are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements and notes thereto.
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF BANYAN STRATEGIC REALTY TRUST
We have audited the accompanying consolidated balance sheets of Banyan Strategic Realty Trust as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the index at Item 8. These financial statements and schedule are the responsibility of the Trust'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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Banyan Strategic Realty Trust at December 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 December 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.
ERNST & YOUNG LLP
Chicago, Illinois February 9, 1999
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Banyan Strategic Realty Trust (the "Trust") was organized as a business trust in 1986 under the laws of the Commonwealth of Massachusetts.
The business of the Trust is the ownership and operation of real estate properties. At December 31, 1998, the Trust owned thirty-two properties located principally in the Midwest and Southeast United States. See Note 8 for information with respect to the Trust's business segments.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of the Trust, its wholly-owned subsidiaries and its controlled Partnerships. In all of its partnerships, the Trust is the managing general partner and retains sole authority over all significant decisions. All intercompany balances and transactions have been eliminated in consolidation. Investment in a Real Estate Venture disposed of in 1997 was accounted for on the equity method (see Note 6).
INVESTMENT IN REAL ESTATE
Costs incurred with respect to third parties for the acquisition, development, construction and improvement of properties are capitalized. Certain costs of yet-to-be acquired properties, including deposits and professional fees, are capitalized as other assets. These costs are subsequently capitalized as property acquisition costs or charged to expense when it becomes apparent that acquisition of a particular property is not probable. Maintenance and repairs are charged to expense when incurred.
Depreciation of buildings is computed using the straight-line method over the estimated useful lives of the assets; generally 40 years. Depreciation of tenant improvements is computed using the straight-line method over the shorter of the lease term or useful life. For the years ended December 31, 1998, 1997 and 1996, depreciation expenses amounted to $4,793, $3,282 and $2,355, respectively.
The Trust recognizes impairment losses for its properties when indicators of impairment are present and a property's expected undiscounted cash flows are not sufficient to recover the property's carrying amount.
The Trust classifies its real estate properties as held for sale when its Board of Trustees has authorized the sale and an active program to find a buyer has been initiated. The Trust currently classifies none of its properties as held for sale.
DEFERRED FINANCING COSTS
Deferred financing costs are amortized over the term of the related loans.
REVENUE RECOGNITION
Minimum rentals are recognized on a straight-line basis over the term of the related leases. Additional rents in the form of operating expense reimbursements for common area maintenance expenses and real estate taxes are recognized in the period in which the related expenses are incurred.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Trust believes the carrying amount of its financial instruments approximates fair value at December 31, 1998 and 1997, because (i) the fixed rates on mortgage loans payable are comparable to rates currently offered in the market, (ii) the rates on the line of credit and bonds payable are variable and the terms are comparable to those currently offered in the market and (iii) the maturities of the Trust's cash equivalents are relatively short.
INCOME TAXES
For the years ended December 31, 1998, 1997 and 1996, the Trust elected to be treated as a real estate investment trust ("REIT") under Internal Revenue Code Sections 856-860. In order to qualify, the Trust is required to distribute at least 95% of its "REIT" taxable income to shareholders, meet asset and income tests and comply with certain other requirements.
As of December 31, 1998, Investment in Real Estate has a gross and net basis, respectively, of $220,916 and $209,489, respectively, for income tax purposes. Additionally, investment in a liquidating trust with a tax basis of $675 has not been accorded any value for financial reporting purposes.
As of December 31, 1998, the Trust has a net operating loss carry- forward of $18,952 which will expire in 2005 ($444), 2006 ($10,266), 2008 ($789) and 2012 ($7,453).
CASH EQUIVALENTS
The Trust considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
RESTRICTED CASH
Restricted cash represents amounts held by lenders to provide for future real estate tax expenditures and tenant improvements, utility deposits and security deposits. Certain of these amounts may be reduced upon the fulfillment of certain conditions.
STOCK OPTIONS
The Trust has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), in accounting for its stock options. Under APB 25, no compensation expense is recognized because the exercise price of the Trust's employee stock options equals or exceeds the market price of the underlying stock at the date of grant.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
RECLASSIFICATIONS
Certain reclassifications have been made to the previously reported 1997 and 1996 consolidated financial statements in order to provide comparability with the 1998 consolidated financial statements. These reclassifications have not changed the 1997 or 1996 results.
3. EARNINGS PER SHARE
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
4. LONG-TERM DEBT
The Trust's long-term debt consists of the following at December 31, 1998 and 1997:
1998 1997 ----------------------- ------------------------- Weighted Weighted Average Average Interest Interest Balance Rate Balance Rate --------- -------- ------------ -------- Mortgage loans. . . . $123,108 7.44% $ 70,503 7.90% Bonds . . . . 21,140 6.77% 21,615 6.85% -------- -------- ---------- -------- Total collaterized debt . . . . $144,248 7.34% $ 92,118 7.65% ======== ======== ========== ======== Unsecured loans. . . . $ 7,400 12.00% -- -- ======== ======== ========== ========
The mortgage loans have fixed interest rates that ranged from 6.95% to 8.89% at December 31, 1998. Bonds payable at December 31, 1998 include $4,800 of variable rate tax exempt revenue bonds which bear interest equal to 5.0% per annum and $16,340 of fixed rate combined taxable and tax exempt revenue bonds which bear interest at a blended rate equal to 7.3%. Substantially all of the mortgage loans and bonds contain prepayment penalties. During 1998 and 1997, the Trust recognized extraordinary losses of $141 and $64, respectively, related to prepayments on refinanced debt and the writeoff of unamortized financing costs. Substantially all of the Trust's real estate is pledged as collateral for the mortgage loans and bonds.
On April 30, 1998, the Trust entered into a $25 million line of credit agreement (the "Revolving Line"). Borrowings under the Revolving Line bear interest at an annual rate of LIBOR plus 2.00% payable monthly. The Revolving Line has an initial term of twenty-four months. The Trust has an option to extend the Revolving Line for one additional year for a fee of $125. As of December 31, 1998, the Trust had borrowed approximately $12.9 million on the Revolving Line (included in Mortgage Loans), leaving approximately $12.1 million available for future borrowing.
During 1998, the Trust borrowed $7.4 million pursuant to its $20 million 1997 Convertible Term Loan Agreement for an unsecured convertible term loan (the "Unsecured Loan"). The Unsecured Loan bears interest at an annual interest rate of 12% payable quarterly and matures on September 30, 2002. In addition, on October 14, of each year, the Trust is required to pay an annual fee equal to 2% of the amount outstanding as of that date. The amounts outstanding on the Unsecured Loan are convertible into Series A convertible preferred shares at a conversion price of $100 per share or into common shares at a conversion price of $5.15 per share. In addition, the lenders had the option to purchase Series A convertible preferred shares to the extent that any part of the $20 million loan commitment was unused in an amount equal to the unfunded portion at a price equal to $100 per preferred share. These preferred shares would also be convertible into common shares at a conversion price of $5.15 per share. No preferred shares were issued prior to the termination of the purchase option on November 13, 1998.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The principal balance of the Trust's long-term debt at December 31, 1998, is scheduled to be repaid as follows:
1999 . . . . . . . . . . . . $ 2,007 2000 . . . . . . . . . . . . 15,023 2001 . . . . . . . . . . . . 5,705 2002 . . . . . . . . . . . . 12,026 2003 . . . . . . . . . . . . 13,956 Thereafter . . . . . . . . . 102,931 -------- $151,648 ========
5. SHARE PURCHASE AGREEMENT
Simultaneously with the execution of the Convertible Term Loan Agreement, the Trust entered into a Share Purchase Agreement (the "Agreement") with the same group of accredited investors to which the Trust issued the Unsecured Loan (see Note 4). Under the Agreement, the Trust sold, in October 1997, 2,192,501 shares of beneficial interest at $5.00 per share, for an aggregate gross proceeds of approximately $11 million. The Trust paid approximately $1.4 million of transaction costs in connection with the share issuance.
6. INVESTMENT IN REAL ESTATE
ACQUISITION ACTIVITIES
The following properties were acquired in 1998 and 1997; the results of their operations are included in the consolidated statements of operations from their respective dates of acquisition.
- ---- Purchase Date of Price Property's Name Acquisi- (in and Location tion millions) Description - --------------- --------- --------- ----------------
Peachtree Pointe 01/20/98 $4.6 Five one-story Office Park office buildings Norcross, GA
Avalon Center 03/20/98 4.4 Two one-story Office Park office buildings Norcross, GA
Avalon Ridge 04/24/98 3.9 Two one-story Business Park flex/industrial Norcross, GA
Tower Lane 04/27/98 5.2 Two one-story Business Park (1) flex/industrial Bensenville, IL buildings
University 04/30/98 10.2 Seven one-story Corporate Center flex/industrial Winter Park, FL buildings
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Purchase Date of Price Property's Name Acquisi- (in and Location tion millions) Description - --------------- --------- --------- ----------------
Metric Plaza 04/30/98 $2.6 Two one-story Winter Park, FL flex/industrial buildings
Park Center 04/30/98 3.7 Two one-story Orlando, FL flex/industrial buildings
Sand Lake 04/30/98 6.8 Five one-story Tech Center office buildings Orlando, FL
Johns Creek 08/14/98 5.8 Two flex/indus- Office and trial buildings Industrial Park Duluth and Suwanne, GA
Technology Park 08/14/98 12.4 Three office Norcross, GA buildings ----- Total $59.6 =====
- -----------------
(1) Upon the acquisition of Tower Lane, the Trust assumed a permanent mortgage loan in the amount of approximately $3.7 million.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
- ---- Purchase Acquisition Date of Price Financing Property's Name Acquisi- (in (in millions) and Location tion millions) (1) Description - --------------- -------- --------- ----------- ---------------- [S] [C] [C] [C] [C] Phoenix Business 01/15/97 $ 5.5 Three-building Park office/industrial Atlanta, GA complex
Butterfield Office04/30/97 15.1 Three-story Plaza office building Oak Brook, IL
Woodrun Village 05/22/97 4.6 $3.6 Apartment complex Apartments Yukon, OK
Country Creek 05/22/97 7.5 5.9 Apartment complex Apartments Oklahoma City, OK
Willowpark 05/22/97 4.5 3.5 Apartment complex Apartments Lawton, OK
Winchester Run 05/22/97 4.5 3.6 Apartment complex Apartments Oklahoma City, OK
Southlake 07/30/97 4.5 Three-story Corporate Center office building Morrow, GA
University Square 08/26/97 7.3 5.0 Six one-story Business Center office building Huntsville, AL
Technology Center 08/26/97 2.5 Three-story Huntsville, AL office building
Airways Plaza 12/10/97 3.2 Five one-story Office Center office buildings Memphis, TN ----- ----- Total $59.2 $21.6 ===== ===== - ----------------
(1) Represents the amount of permanent mortgage financing assumed at the time of acquisition. All other additional acquisition costs were paid by either a draw upon the Trust's line of credit or from cash and cash equivalents.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DISPOSITION ACTIVITIES
H STREET ASSEMBLAGE
Prior to 1998, the Trust had a 53% interest in a venture that owned 17,000 square feet of undeveloped land in downtown Washington, D.C. plus an approximately 55,900 square foot office building (the "H Street Assemblage"). During 1996, based on sales agreements for the H Street Assemblage, the Trust recorded a valuation allowance of $3,180 which was included in loss from operations of real estate ventures in the 1996 consolidated statement of operations. The H Street Assemblage was sold in 1997 and the Trust recognized a loss of approximately $61. The Trust has no further interest in the H Street Assemblage.
OTHER
During 1997, the Trust sold its interests in Hallmark Village Apartments and the Colonial Courts Apartments. The Trust received proceeds of approximately $7.3 million and recognized a gain of approximately $942.
7. PRO FORMA INFORMATION (UNAUDITED)
The following unaudited pro forma summary presents information as if the Trust's property acquisitions, property dispositions, and sales of shares of beneficial interests through December 31, 1998 had occurred at the beginning of each year. The pro forma information is provided for information purposes only. It is based on historical information and does not necessarily reflect the actual results that would have occurred nor is it necessarily indicative of future results of operations of the Company.
Years Ended December 31, ----------------------------- 1998 1997 ----------- -----------
Total revenue. . . . . . . . $ 42,260 $ 39,368 Net income . . . . . . . . . 5,187 3,756 Basic earnings per share . . 0.39 0.29 Diluted earnings per share . 0.38 0.28
8. BUSINESS SEGMENTS
The Trust acquires and operates real estate properties located principally in the Midwest and Southeast United States. The Trust has four operating segments corresponding to the four property types comprising its real estate assets: flex/industrial, office, residential and retail. As of December 31, 1998, the flex/industrial segment comprised of thirteen complexes with long-term leases to approximately 210 tenants; the office segment comprised of fourteen office sites with long-term leases to approximately 280 tenants; the residential segment comprised of four apartment complexes with 864 units leased principally for six months; and the retail segment was comprised of one retail center with long-term leases to approximately 50 tenants. The Trust's long-term tenants are in a variety of business and no single tenant is significant to the Trust's business.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Information by business segments is set forth below:
1998 1997 1996 -------- -------- -------- Revenue Flex/Industrial . $ 10,838 $ 7,830 $ 6,275 Office. . . . . . 19,577 11,946 6,812 Residential . . . 4,170 4,138 3,398 Retail. . . . . . 4,646 4,604 4,318 Corporate/Other . 185 267 601 -------- -------- -------- $ 39,416 $ 28,785 $ 21,404 ======== ======== ========
1998 1997 1996 -------- -------- -------- Income (loss) before extraordinary item Flex/Industrial . $ 3,787 $ 3,349 $ 2,365 Office. . . . . . 5,124 3,298 2,226 Residential . . . 682 952 (830) Retail. . . . . . 550 976 877 Corporate/Other . (4,624) (4,965) (6,395) -------- -------- -------- $ 5,519 $ 3,610 $ (1,757) ======== ======== ========
1998 1997 -------- -------- Total Assets Flex/Industrial . $ 74,513 $ 41,323 Office. . . . . . 105,049 74,434 Residential . . . 21,038 21,369 Retail. . . . . . 18,359 18,858 Corporate/Other . 3,631 3,650 -------- -------- $222,590 $159,634 ======== ========
1998 1997 1996 -------- -------- -------- Depreciation and amortization Flex/Industrial . $ 1,714 $ 1,156 $ 884 Office. . . . . . 2,404 1,259 695 Residential . . . 534 559 421 Retail. . . . . . 523 503 453 Corporate/Other . 37 13 -- -------- -------- -------- $ 5,212 $ 3,490 $ 2,453 ======== ======== ======== Interest expense Flex/Industrial . $ 2,669 $ 1,373 $ 1,114 Office. . . . . . 4,524 2,850 1,130 Residential . . . 1,199 1,235 887 Retail. . . . . . 1,338 939 880 Corporate/Other . 48 50 -- -------- -------- -------- $ 9,778 $ 6,447 $ 4,011 ======== ======== ========
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
1998 1997 1996 -------- -------- -------- Additions to Investment in Real Estate Flex/Industrial . $ 32,942 $ 376 $ 10,660 Office. . . . . . 31,533 39,089 5,505 Residential . . . 324 21,626 440 Retail. . . . . . 69 481 377 Corporate/Other . 28 80 -- -------- -------- -------- $ 64,896 $ 61,652 $ 16,982 ======== ======== ========
9. TRANSACTIONS WITH AFFILIATES
Effective January 1, 1997, the Trust began paying employees directly in contrast to the prior practice of reimbursing Banyan Management Corp. ("BMC") on an hourly basis for the services of BMC's personnel. In prior years, these payroll costs along with administrative costs were allocated to the Trust and other entities to which BMC provided administrative services based upon the actual number of hours spent by BMC personnel on matters related to that particular entity in relation to the total number of BMC personnel hours. From January 1, 1997 through September 30, 1997, the Trust shared only certain administrative items such as office rent and office expenses with other companies for which BMC provided services. These costs were shared based upon the total hours worked by employees of the Trust relative to total hours worked by employees of BMC and the Trust combined. The Trust's allocable share of costs for the years ended December 31, 1997 and 1996 amounted to $403 and $1,275, respectively. Beginning October 1, 1997, the Trust paid all of its administrative costs directly and no longer shared these costs with other companies.
As of December 15, 1997, all shareholders of BMC, other than the Trust, had terminated their administrative services relationship with and had surrendered their respective ownership interest in BMC, making the Trust the sole remaining shareholder of BMC. On that date, BMC merged into a wholly-owned subsidiary of the Trust, BSRT Management Corp. As a result of the merger, the Trust assumed current liabilities of $102, cash of $83 and other assets of $64. BSRT Management Corp. paid a dividend to the Trust in the amount of $150 representing a distribution of its accumulated earnings and profits. This amount has been included in "Other Income" of the Trust for the year ended December 31, 1997.
During the year ended December 31, 1998 and 1997, the Trust paid no salary to, but purchased legal services from an executive officer of the Trust. Fees for legal services totalled $391 and $338, respectively. The executive pays no rent, as such, to the Trust for the use of office space or equipment but grants the Trust a discount equal to approximately 20% compared to rates charged to third parties for all time billed to the Trust by the executive and his employees. The executive also reimburses the Trust for the cost of two full time and certain part time employees. The amount paid to the executive for the year ended December 31, 1996 was paid as salary and is included in the costs allocated to the Trust from BMC.
10. DISTRIBUTIONS PAID AND PAYABLE
To qualify as a REIT, the Trust must distribute at least 95% of its "REIT Taxable Income" to shareholders. A portion of the distributions paid during the subsequent year may be allocable to taxable income earned in the prior year.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Trust has determined the shareholders' treatment for federal income tax purposes to be as follows:
1998 1997 1996 ------- ------- ------- Ordinary income. . . . $ 5,978 $ 283 $ 2,842 Return of capital. . . 140 4,201 1,349 ------- ------- ------- $ 6,118 $ 4,484 $ 4,191 ======= ======= =======
On January 6, 1999, the Trust declared a cash distribution for the quarter ended December 31, 1998 of $0.12 per share payable February 22, 1999 to shareholders of record on January 22, 1999.
11. LEASES
MINIMUM RENTALS UNDER OPERATING LEASES
The Trust receives rental income from the rental of retail, office and flex/industrial space under operating leases. The following is the minimum future base rentals (excluding amounts representing executory costs such as taxes, maintenance and insurance) on operating leases for the Trust's industrial, office and retail projects held at December 31, 1998:
1999 . . . . . . $ 30,336 2000 . . . . . . 23,281 2001 . . . . . . 17,409 2002 . . . . . . 12,340 2003 . . . . . . 8,094 Thereafter . . . 13,773 -------- $105,233 ========
No single tenant at the Trust's operating properties produced ten percent or more of total income from property operating activities.
The Trust is subject to the usual business risks regarding the collection of the above-mentioned rentals.
GROUND LEASE
The Trust owns a leasehold interest in a shopping center in Atlanta, Georgia. The lease expires in 2067. The ground lease requires annual lease payments of $600 through October 4, 2007 plus 7% of total annual gross rental income commencing when gross rental income exceeds $2,000 from the operations of the shopping center. The ground lease also requires that the Trust pay property operating expenses, including real estate taxes. The base rent is reset in 2007 based upon a market rent within a contractually defined range.
12. OMNIBUS STOCK AND INCENTIVE PLAN
On May 14, 1997, the Board of Trustees (the "Board") adopted and on July 8, 1997, the shareholders of the Trust approved, the 1997 Omnibus Stock and Incentive Plan (the "Plan") which allows the Trust to make stock- based awards as part of its employee and Trustee compensation program. Under the Plan, the Trust is authorized to issue options to purchase up to one million shares of beneficial interest in the form of incentive stock options, non-statutory stock options, stock appreciation rights, performance shares and units.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FIXED STOCK OPTIONS
The Board administers the Plan and has the authority to determine, among other things, the individuals to be granted options, the exercise price at which shares may be acquired, the number of shares subject to options and the vesting requirements and the exercise period of each option. The Board is granted discretion to determine the term of each option granted under the Plan to employees, executives and Trustees, but in no event will the term exceed ten years and one day from the date of the grant.
A summary of the Trust's fixed stock option activity, and related information for the years ended December 31, 1997 and 1998 follows:
Weighted Shares Average Subject Exercise Price to Options Per Share ---------- -------------- Outstanding at December 31, 1996. . . -- $ -- Options granted . . . . . . . . . . 380,000 5.637 Options canceled. . . . . . . . . . (5,000) 4.08 -------- -------- Outstanding at December 31, 1997. . . 375,000 $ 5.658 Options granted . . . . . . . . . . 116,000 5.375 Options exercised . . . . . . . . . (9,324) 4.08 Options canceled. . . . . . . . . . (2,000) 6.375 ------- ------- Outstanding at December 31, 1998. . . 479,676 5.617 ======= ======= Exercisable at 12/31/97 . . . . . . 100,000 $ 5.50 Exercisable at 12/31/98 . . . . . . 174,287 $ 5.68
At December 31, 1998, options to purchase 361,000 shares were available for future grant and options outstanding that are not exercisable vest in varying annual amounts through 2001.
The weighted average grant date fair value of options granted in 1998 and 1997 was $.54. The remaining weighted-average contractual life of these options was 9.05 years. Exercise prices for options outstanding at December 31, 1998 ranged from $4.08 to $6.375 per share.
TARGET STOCK PRICE PERFORMANCE OPTIONS
The exercise price of each target stock price performance option granted is equal to the market price of the Trust's common shares on the date of grant and vests as the Trust's common share price achieves certain pre-established targets which were set on the date of grant. In conjunction with the March 11, 1998 signing of an employment agreement between the Trust and its President Leonard G. Levine, effective retroactively to October 1, 1997, the Board granted Mr. Levine stock options to purchase an aggregate of 150,000 shares of the Trust's common shares of beneficial interest at an exercise price equal to $5.50 per share. Options to purchase 50,000 shares will vest and become exercisable if during any consecutive thirty trading days during the term of the agreement the closing price of the common shares averages $8.50 per share. Options to purchase an additional 100,000 shares will vest and become exercisable on a proportionate basis if during any thirty consecutive trading days during the term of the agreement the closing price of the shares averages more than $8.50 per share with full vesting occurring with
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
respect to 75,000 shares if the closing price averages $9.00 per share, and $10.00 per share with respect to the other 25,000 shares. The number of shares underlying the options and the exercise price of each option are subject to adjustment from time to time under certain circumstances.
All of the options must be exercised by October 1, 2007, except that if Mr. Levine dies or becomes permanently disabled during the term of the agreement, then all options which have vested must be exercised within one year of death or permanent disability. In addition, upon death or permanent disability, all options not otherwise vested, but which would or will vest within six months following the date of death or permanent disability either by passage of time or satisfaction of the various performance standards will be deemed vested and become exercisable within the same one-year time period.
A summary of the Trust's target stock price performance option activity, and related information for the years ended December 31, 1997 and 1998 follows: Weighted Shares Average Subject Exercise Price to Options Per Share ---------- -------------- Outstanding at December 31, 1996. . . -- $ -- Options granted . . . . . . . . . . 150,000 5.500 ------- ------ Outstanding at December 31, 1997 and 1998. . . . . . . . . . . . . . 150,000 $5.500 ======= ======
At December 31, 1998, none of the target stock price options were exercisable. Exercise prices for options outstanding at December 31, 1998 were $5.50 per share. The remaining weighted-average contractual life of these options was 8.8 years. The weighted average grant date fair value of all options granted during 1997 is $0.96.
Pro forma information regarding net income and earnings per share is required by SFAS No. 123 "Accounting for Stock Based Compensation", and has been determined as if the Trust had accounted for all options granted under the plan using the fair value method of that statement. The fair value for the fixed stock options was estimated at the date of grant using the Black- Scholes option pricing model with the following weighted-average assumptions for 1998 and 1997: risk free interest rates of 5.31% and 5.58%; expected dividend yields of 7.47% and 7.19%; volatility factors of the expected market price of the Trust's common stock of .201 and .225; and a weighted-average expected lives of the options of 5 years and 10 years, respectively. In addition, the fair value for the target stock price performance options was estimated at the date of grant using a modified Black-Scholes option pricing model which, in addition to the required inputs above, takes into consideration the target stock price (or barrier) which must be attained. The following weighted-average assumptions were incorporated into the model for the target stock price performance options granted in 1997: risk-free interest rate of 5.92%; expected dividend yield of 7.27%; a volatility factor of the expected market price of the Trust's common stock of .225; and expected lives of the options of 10 years.
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models, such as the Black-Scholes model, require the input of highly subjective assumptions including the expected stock price volatility. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management's view, the existing models do not necessarily provide a reliable single measure of the fair value of the options granted under the Plan.
The effects on 1998 and 1997 pro forma net income and pro forma earnings per common share of amortizing to expense the estimated fair value of stock options are not necessarily representative of the effects on net income to be reported in future years due to such things as the vesting period of the stock options, and potential for issuance of additional stock options in future years. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.
The Trust's pro forma information is as follows:
Years Ended December 31, ----------------------- 1998 1997 ------- ------- Pro forma net income. . . . . . . . . $ 5,279 $ 3,474 Pro forma basic earnings per share. . $ 0.40 $ 0.31 Pro forma diluted earnings per share. $ 0.38 $ 0.31
13. DISTRIBUTION REINVESTMENT AND SHARE PURCHASE PLAN
On April 23, 1997, the Trust filed a Registration Statement on Form S- 3 under the Securities Act of 1933 in order to register the shares issuable under the Trust's Distribution Reinvestment and Share Purchase Plan (the "DRIP Plan"). The DRIP Plan allows shareholders of the Trust to: (i) automatically reinvest the cash distributions on all, or part, of shares registered in their name; and (ii) make cash investments of not more than $120 per calendar year. Shares purchased under the DRIP Plan will be issued directly by the Trust at either: (i) 97% of the average closing sales price of the shares as reported on the NASDAQ National Market on the last five business days preceding the relevant investment date in the case of reinvested cash distributions; or (ii) 100% of the aforementioned average closing price in the case of cash investments. For the years ended December 31, 1998 and 1997, the Trust issued 141,321 and 72,094 shares of beneficial interest under the DRIP Plan and received total proceeds of $818 and $379, respectively.
14. AWARD SHARES AND WEIGHTED AVERAGE SHARES OUTSTANDING
Pursuant to the March 19, 1997 Amendment and the September 3, 1997 Second Amendment to the Second Amended and Restated Employment Agreement of Leonard G. Levine, the Trust's president, and pursuant to the shareholder approval which was obtained at the Trust's 1996 Annual Meeting held on July 8, 1997, all incentive compensation earned by Mr. Levine for the fiscal years ended December 31, 1996 and 1997 has been paid in shares of the Trust's stock ("Award Shares").
BANYAN STRATEGIC REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONCLUDED
On July 9, 1997, the Trust issued 95,635 Award Shares to Mr. Levine, representing Mr. Levine's incentive compensation earned on the performance of the Trust's assets acquired subsequent to January 1, 1993 ("Reinvestment Activities") for the fiscal year ending December 31, 1996 (the "1996 Award Shares"). On September 3, 1997, the Trust issued 400,000 Award Shares representing the final payment and settlement of Mr. Levine's compensation earned on Reinvestment Activities for the fiscal year ending December 31, 1997 and for cumulative incentive compensation for the period January 1, 1993 through August 31, 1997 (the "Final Award Shares"). Prior to the September 3, 1997 Amendment, Mr. Levine would have been entitled to receive shares in respect of additional compensation which would have been determined as of December 31, 1997 and issued and paid no later than March 1998. The issuance of the Final Award Shares fixed the amount of compensation that the Trust had been accruing through December 31, 1997. The 95,635 Award Shares were valued at $4.125 per share, or $394. The 400,000 Final Award Shares were valued at $4.812 per share, or $1,925 of which $650 was expensed in 1996, and the balance was ratably expensed during 1997. The 1996 Award Share price of $4.125 was based upon the average closing price of the Trust's shares for the five business days ending December 31, 1996. The Final Award Shares price of $4.812 was based on the average closing price of the Trust's shares for the five business days ending August 31, 1997. The 1996 Award Shares and Final Award Shares are included in the total shares outstanding of the Trust when calculating Net Income Per Share of Beneficial Interest Based on Weighted Average Number of Shares Outstanding.
All of the Award Shares issued prior to January 1, 1997 and 20% of Award Shares issued for the fiscal year ended December 31, 1996 were held in escrow by the Trust, through the vesting date, September 29, 1997. Subsequent to that date, Mr. Levine became fully vested and the Award Shares were immediately transferred and are otherwise freely transferable subject to compliance with registration requirements of the federal and state securities laws or exemptions therefrom.
15. LITIGATION
The Trust is involved in various litigation arising in the ordinary course of business. Although the final outcome of these matters cannot be determined, based on the facts presently known, it is management's opinion that the final resolution of these matters will not have an adverse effect on the Trust's financial position or results of operations.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in, or disagreements with, the accountants on any matter of accounting principles, practices or financial statement disclosure.
PART III
ITEM 10.
ITEM 10. OUR TRUSTEES AND EXECUTIVE OFFICERS
The information required by this item is incorporated herein by reference to the materials appearing in the Trust's definitive proxy statement to be filed with the Securities and Exchange Commission (the "Proxy Statement") under the caption, "Election of Trustees" and "Management".
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to the materials appearing in the Proxy Statement under the caption "Management".
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference to the materials appearing in the Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management".
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to the materials appearing in the Proxy Statement under the caption "Certain Relationships and Related Transactions".
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements of the Company are set forth in this report in Item 8.
(2) Financial Statement Schedule is set forth in this report in Item 8.
(b) Report on Form 8-KA dated October 1, 1998 was filed to provide the Financial Statements and related pro forma information required by Item 7 of Form 8-K in connection with the Trust's acquisition of the properties known as Technology Park and Johns Creek Office and Industrial Park.
(c) Exhibits (see Exhibit Index included elsewhere herein).
(d) None.
SIGNATURES
PURSUANT to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
BANYAN STRATEGIC REALTY TRUST
By: /s/ Leonard G. Levine Date: March 11, 1999 Leonard G. Levine, President
PURSUANT to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on our behalf and in the capacities and on the dates indicated.
By: /s/ Leonard G. Levine Date: March 11, 1999 Leonard G. Levine, President and Trustee
By: /s/ Joel L. Teglia Date: March 11, 1999 Joel L. Teglia, Vice President and Chief Financial Officer
By: /s/ Norman M. Gold Date: March 11, 1999 Norman M. Gold, Trustee
By: /s/ Walter E. Auch, Sr. Date: March 11, 1999 Walter E. Auch, Sr., Trustee
By: /s/ Marvin A. Sotoloff Date: March 11, 1999 Marvin A. Sotoloff, Trustee
EXHIBIT INDEX -------------
3.1 Second Amended and Restated Declaration of Trust dated as of August 8, 1986, as amended on March 8, 1991, May 1, 1993 and August 12, 1998, including Certificate of designations, preferences and rights of Series A convertible preferred shares. (1)
3.2 By-Laws dated March 13, 1996. (2)
3.3 BSRT UPREIT Limited Partnership Limited Partnership Agreement *
4.1 Convertible Term Loan Agreement dated as of October 10, 1997 among Banyan Strategic Realty Trust, as Borrower, and the Entities listed therein, as Lenders. (3)
4.2 First Amendment to Convertible Term Loan Agreement dated as of March 30, 1998 made by and among Banyan Strategic Realty Trust and the Entities listed therein, as Lenders. (4)
4.3 Second Amendment to Convertible Term Loan Agreement dated as of June 26, 1998 made by and among Banyan Strategic Realty Trust and the Entities listed therein, as Lenders. (5)
4.4 Revolving Credit Agreement dated April 30, 1998 among Banyan Strategic Realty Trust, as Borrower and the Capital Company of America, as Lender. (6)
4.5 Loan Agreement dated May 22, 1998 among BSRT Fountain Square L.L.C., BSRT Phoenix Business Park L.L.C., BSRT Newtown Trust, BSRT Southlake L.L.C., BSRT Technology Center L.L.C., BSRT Airways Plaza L.L.C., BSRT Peachtree Pointe L.L.C., BSRT Avalon Center L.L.C., BSRT Sand Lake Tech Center L.L.C., BSRT Park Center L.L.C., BSRT Metric Plaza L.L.C., and BSRT University Corporate Center L.L.C., as Borrower, and the Capital Company of America, as Lender. (5)
4.6 First Amendment to Loan Agreement dated September 11, 1998 among BSRT Fountain Square L.L.C., BSRT Phoenix Business Park L.L.C., BSRT Newtown Trust, BSRT Southlake L.L.C., BSRT Technology Center L.L.C., BSRT Airways Plaza L.L.C., BSRT Peachtree Pointe L.L.C., BSRT Avalon Center L.L.C., BSRT Sand Lake Tech Center L.L.C., BSRT Park Center L.L.C., BSRT Metric Plaza L.L.C., and BSRT University Corporate Center L.L.C., as Borrower, and the Capital Company of America LLC, as Lender. (1)
4.7 Loan Agreement dated May 22, 1998 between BSRT Lexington B Corp. and BSRT Lexington Trust, as Borrower and the Capital Company of America, as Lender. (5)
4.8 First Amendment to Loan Agreement dated September 11, 1998 between BSRT Lexington B Corp., and BSRT Lexington Trust, as Borrower and the Capital Company of America LLC, as Lender. (1)
EXHIBIT INDEX -------------
4.9 Loan Agreement dated June 22, 1998 between Banyan/Morgan Wisconsin L.L.C., and Banyan/Morgan Elmhurst L.L.C., as Borrower and the Capital Company of America, as Lender. (5)
4.10 First Amendment to Loan Agreement dated September 11, 1998 between Banyan/Morgan Wisconsin L.L.C., and Banyan/Morgan Elmhurst L.L.C., as Borrower and the Capital Company of America LLC, as Lender. (1)
10.1 Employment Agreement of Leonard G. Levine as of October 1, 1997. (7)
10.2 Employment Agreement of Joel L. Teglia dated December 31, 1998. *
10.3 Employment Agreement of Neil Hansen dated December 31, 1998. *
10.4 Employment Agreement of Jay Schmidt dated December 31, 1998. *
10.5 1997 Omnibus Stock and Incentive Plan dated July 9, 1997. (8)
10.6 Share Purchase Agreement by and among Banyan Strategic Realty Trust and the Purchasers listed on the signature page attached thereto dated as of October 10, 1997. (3)
10.7 Registration Rights Agreement dated as of October 10, 1997 between Banyan Strategic Realty Trust and the Purchasers listed on the Signature Pages attached thereto. (3)
10.8 Registration Rights Agreement dated as of October 1, 1997 between Banyan Strategic Realty Trust and Leonard G. Levine. *
21 Subsidiaries of Banyan Strategic Realty Trust *
23 Consent of Ernst & Young LLP *
27 Financial Data Schedule *
99.2 Press Release dated February 17, 1999 *
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* Filed herewith.
(1) Incorporated by reference from the Trust's Form 8- K/A-1 dated August 14, 1998.
(2) Incorporated by reference from the Trust's Registration Statement on Form S-11 (file number 33-4169).
(3) Incorporated by reference from the Trust's Form 8-K dated October 14, 1997.
(4) Incorporated by reference from the Trust's Form 10- K/A for the year ended December 31, 1997.
(5) Incorporated by reference from the Trust's Form 8-K dated May 22, 1998.
(6) Incorporated by reference from the Trust's Form 10- Q dated March 31, 1998.
(7) Incorporated by reference from the Trust's Form 10- K dated December 31, 1997.
(8) Incorporated by reference from the Trust's Form 10- Q for the quarter ended June 30, 1997.