AMERICAN REALTY INVESTORS INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our consolidated financial statements and related notes in Part II, Item 8 of this Report. Our results of operations for the year ended December 31, 2023 were affected by a acquisitions and disposition, refinancing activity, development activity as discussed below. Management's Overview We are an externally advised and managed real estate investment company that owns a diverse portfolio of income-producing properties and land held for development throughout the Southern United States. Our portfolio of income-producing properties generally includes multifamily residential properties, office buildings and other commercial properties. Our investment strategy includes acquiring existing income-producing properties as well as developing new properties on land already owned or acquired for a specific development project. Our operations are managed by Pillar in accordance with an Advisory Agreement and a Cash Management Agreement. Pillar’s duties include, but are not limited to, locating, evaluating and recommending real estate and real estate-related investment opportunities. Pillar also arranges our debt and equity financing with third party lenders and investors. We rely upon the employees of Pillar to render services to us in accordance with the terms of the Advisory Agreement. Pillar is considered to be a related party due to its ownership by RAI. 15 The following is a summary of our recent acquisition, disposition, financing and development activities: Acquisitions and Dispositions • On March 30, 2021, we sold a 50% ownership interest in Overlook at Allensville Phase II, a 144 unit multifamily property in Sevierville, Tennessee to Macquarie, for $2.6 million, resulting in a gain on sale of $1.4 million. Concurrent with the sale, we each contributed our 50% ownership interests in the property into VAA. • On August 26, 2021, we sold 600 Las Colinas, a 512,173 square foot office building in Irving, Texas for $74.8 million, resulting in a gain on sale of $27.3 million. We used the proceeds from the sale to pay off the mortgage note payable on the property (See "Financing Activities") and for general corporate purposes. • During the year ended December 31, 2021, we sold a total of 134.7 acres of land from our holdings in Windmill Farms for $20.2 million in aggregate, resulting in gains on sale of $10.3 million . In addition, we sold 14.1 acres of land from our holdings in Mercer Crossing for $9.0 million , resulting in a gain on sale of $6.4 million . • On January 14, 2022, we sold Toulon, a 240 unit multifamily property in Gautier, Mississippi for $26.8 million, resulting in a gain on sale of $9.4 million. We used the proceeds from the sale to pay off the $14.7 million mortgage note payable on the property and for general corporate purposes. • On May 17, 2022 , we sold Fruitland Park, a 6,722 square foot commercial building in Fruitland Park, Florida for $0.8 million , resulting in a gain on sale of $0.7 million . We used the proceeds from the sale for general corporate purposes. • On September 16, 2022, we sold Sugar Mill Phase III, a 72 unit multifamily property in Baton Rouge , Louisiana for $11.8 million in connection with the sale of properties by VAA (See "Other Developments"), resulting in a gain on sale of $1.9 million. We used the proceeds from the sale to pay off the $9.6 million mortgage note payable on the property and for general corporate purposes. • On November 1, 2022, we acquired the seven multifamily properties from VAA (See "Other Developments") with a fair value of $219.5 million . • During the year ended December 31, 2022 , we sold a total of 26.9 acres of land from our holdings in Windmill Farms for $5.1 million in aggregate, resulting in gains on sale of $4.2 million. In addition, we sold 0.9 acres of land from our holdings in Mercer Crossing for $0.7 million, resulting in a gain on sale of $0.2 million. Financing Activities • On March 2, 2021 , we extended our loan on Athens to August 28, 2022 . • On March 4, 2021 , we extended the maturity of our loan on Windmill Farms until February 28, 2023 at a reduced interest rate of 5%. • On August 25, 2021, we replaced the existing loan on Villas at Bon Secour with a new $20.0 million loan that bears interest at 3.08% and matures on September 1, 2031. • On August 26, 2021, we paid off the $35.9 million loan on 600 Las Colinas in connection with the sale of the underlying property (See "Acquisitions and Dispositions"). • On January 14, 2022, we paid off the $14.7 million loan on Toulon in connection with the sale of the underlying property (See "Acquisitions and Dispositions"). • On March 3, 2022 , we extended the loan on Stanford Center to February 26, 2023 . • On September 1, 2022 , we extended our loan on Athens to August 28, 2023. • On September 16, 2022 , we paid off the $9.6 million loan on Sugar Mill Phase III in connection with the sale of the underlying property (See "Acquisitions and Dispositions"). • On October 21, 2022, we paid off the $38.5 million loan on Stanford Center from a portion of our share of the proceeds from sale of the VAA Sale Portfolio (See "Other Developments"). • On November 1, 2022, we agreed to assume the $70.3 million mortgage notes payable on the VAA Holdback Portfolio in connection with the distribution of the underlying properties from VAA (See "Other Developments"). • On January 31, 2023 , we paid off our $67.5 million of Series C bonds. • On February 28, 2023 , we extended the maturity of our loan on Windmill Farms until February 28, 2024 at a revised interest rate of 7.75%. 16 • On March 15, 2023 , we entered into a $33.0 million construction loan to finance the development of Lake Wales (See "Development Activities") that bears interest at SOFR plus 3% and matures on March 15, 2026 , with two one-year extension options. • On May 4, 2023, we paid off the remaining $14.0 million of our Series A Bonds and $28.9 million of our Series B Bonds, which resulted in a loss on early extinguishment of debt of $1.7 million. • On August 28, 2023, we paid off our $1.2 million loan on Athens . • On November 6, 2023 , we entered into a $25.4 million construction loan to finance the development of Merano (See "Development Activities") that bears interest at prime plus 0.25% and matures on November 6, 2028 . As of December 31, 2023 , no advances have been drawn on the loan. • On December 15, 2023 , we entered into a $23.5 million construction loan to finance the development of Bandera Ridge (See "Development Activities") that bears interest at SOFR plus 3% and matures on December 15, 2028 . • On February 8, 2024, we extended the maturity of our loan on Windmill Farms to February 28, 2026 at an interest rate of 7.50%. Development Activities During 2023, we spent $5.0 million on our ongoing development of Windmill Farms . Our expenditure included $0.5 million on the development of land lots for sale to single family home developers and $4.5 million on reimbursable infrastructure investments. In connection with the project, we entered into an agreement to sell 276 lots for a total of $13.1 million. The agreement provides for the lots to be delivered over a two-year period. We expect the first installment to be completed in June 2024. On March 15, 2023, we entered into a development agreement with Pillar to build a 240 unit multifamily property in Lake Wales, Florida (" Lake Wales ") that is expected to be completed in 2025 for a total cost of approximately $55.3 million. The cost of construction will be funded in part by a $33.0 million construction loan (See "Financing Activities") . The development agreement provides for a $1.6 million fee that will be paid to Pillar over the construction period. In connection with the closing of the loan, we purchased the land and certain entitlement costs from a related party at an appraised value of $6.1 million. As of December 31, 2023, we have incurred a total of $16.9 million in development costs. On November 6, 2023, we entered into a development agreement with Pillar to build a 216 unit multifamily property in McKinney , Texas (" Merano ") that is expected to be completed in 2025 for a total cost of approximately $51.9 million. The cost of construction will be funded in part by a $25.4 million construction loan (See "Financing Activities") . The development agreement provides for a $1.6 million fee that will be paid to Pillar over the construction period. As of December 31, 2023, we have incurred a total of $7.2 million in development costs. On December 15, 2023, we entered into a development agreement with Pillar to build a 216 unit multifamily property in Temple , Texas (" Bandera Ridge ") that is expected to be completed in 2025 for a total cost of approximately $49.6 million. The cost of construction will be funded in part by a $23.5 million construction loan (See "Financing Activities") . The development agreement provides for a $1.6 million fee that will be paid to Pillar over the construction period. In connection with the closing of the loan, we purchased the land from a related party at an appraised value of $2.7 million. As of December 31, 2023, we have incurred a total of $3.1 million in development costs. In 2021, Landing on Bayou Cane, a 240 unit multifamily property in Houma , Louisiana suffered extensive damage from Hurricane Ida and required extensive renovation. As of December 31, 2023, we completed the restoration and lease-up of the property for a total cost of $16.7 million, which was primarily funded by insurance proceeds. 17 Other Developments On September 16, 2022, VAA sold 45 properties (“VAA Sale Portfolio”) for $1.8 billion, resulting in a gain on sale of $738.4 million to the joint venture. In connection with the sale, we received an initial distribution of $182.8 million from VAA. On November 1, 2022, we received an additional distribution from VAA, which included the full operational control of the remaining seven properties (collectively referred to herein as the “VAA Holdback Portfolio”) and a cash payment of $204.0 million. The VAA Holdback Portfolio consists of Blue Lake Villas , a 186 unit multifamily property in Waxahachie , Texas ; Blue Lake Villas Phase II , a 70 unit multifamily property in Waxahachie , Texas ; Northside on Travis , a 200 unit multifamily property in Sherman , Texas ; Parc at Denham Springs , a 224 unit multifamily property in Denham Spring , Louisiana ; Residences at Holland Lake , a 208 unit multifamily property in Weatherford , Texas ; Villas of Park West I , a 148 unit multifamily property in Pueblo , Colorado; and Villas of Park West II , a 112 unit multifamily property in Pueblo , Colorado. On March 23, 2023, we received $18.0 million from VAA, which represented the remaining distribution of the proceeds from the sale of the VAA Sale Portfolio. We used our share of the proceeds from the sale of the VAA Sale Portfolio to invest in short-term investments and real estate, pay down our debt and for general corporate purposes. Critical Accounting Policies The preparation of our consolidated financial statements in conformity with United States generally accepted accounting principles (“GAAP”) 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. Some of these estimates and assumptions include judgments on revenue recognition, estimates for common area maintenance and real estate tax accruals, provisions for uncollectible accounts, impairment of long-lived assets, the allocation of purchase price between tangible and intangible assets, capitalization of costs and fair value measurements. Our significant accounting policies are described in more detail in Note 2—Summary of Significant Accounting Policies in our notes to the consolidated financial statements. However, the following policies are deemed to be critical. Fair Value of Financial Instruments We apply the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures,” to the valuation of real estate assets. These provisions define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date that is other than in a forced or liquidation sale, establish a hierarchy that prioritizes the information used in developing fair value estimates and require disclosure of fair value measurements by level within the fair value hierarchy. The hierarchy gives the highest priority to quoted prices in active markets (Level 1 measurements) and the lowest priority to unobservable data (Level 3 measurements), such as the reporting entity’s own data. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and includes three levels defined as follows: Level 1—Unadjusted quoted prices for identical and unrestricted assets or liabilities in active markets. Level 2—Quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3—Unobservable inputs that are significant to the fair value measurement. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. 18 Related Parties We apply ASC Topic 805, “Business Combinations”, to evaluate business relationships. Related parties are persons or entities who have one or more of the following characteristics, which include entities for which investments in their equity securities would be required, trust for the benefit of persons including principal owners of the entities and members of their immediate families, management personnel of the entity and members of their immediate families and other parties with which the entity may deal if one party controls or can significantly influence the decision making of the other to an extent that one of the transacting parties might be prevented from fully pursuing our own separate interests, or affiliates of the entity. Environmental Matters Under various federal, state and local environmental laws, ordinances and regulations, we may be potentially liable for removal or remediation costs, as well as certain other potential costs, relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery for personal injury associated with such materials. We are not aware of any environmental liability relating to the above matters that would have a material adverse effect on our business, assets or results of operations. Inflation The effects of inflation on our operations are not quantifiable. Revenues from property operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect sales values of properties and the ultimate gain to be realized from property sales. To the extent that inflation affects interest rates, our earnings from short-term investments, the cost of new financings and the cost of variable interest rate debt will be affected. Results of Operations Many of the variations in the results of operations, discussed below, occurred because of the transactions affecting our properties described above, including those related to the Redevelopment Property, Acquisition Properties and the Disposition Properties (each as defined below). For purposes of the discussion below, we define "Same Properties" as all of our properties with the exception of those properties that have been recently constructed or leased-up (“Redevelopment Property”), properties that have recently been acquired ("Acquisition Properties") and properties that have been disposed ("Disposition Properties"). A developed property is considered leased-up, when it achieves occupancy of 80% or more. We move a property in and out of Same Properties based on whether the property is substantially leased-up and in operation for the entirety of both periods of the comparison. For the comparison of the year ended December 31, 2023 to the year ended December 31, 2022 , the Redevelopment Property is Landing on Bayou Cane. The Acquisition Properties are Blue Lake Villas, Blue Lake Villas Phase II, Northside on Travis, Parc at Denham Springs, Residences at Holland Lake, Villas of Park West I and Villas of Park West II. The Disposition Properties are Fruitland Park, Sugar Mill Phase III and Toulon. 19 The following table (amounts in thousands) provides a summary of the results of operations of 2023 and 2022: For the Years Ended December 31, 2023 2022 Variance Multifamily Segment Revenue $ 32,608 $ 17,828 $ 14,780 Operating expenses (17,749) (9,524) (8,225) 14,859 8,304 6,555 Commercial Segment Revenue 14,415 16,252 (1,837) Operating expenses (10,147) (8,815) (1,332) 4,268 7,437 (3,169) Segment operating income 19,127 15,741 3,386 Other non-segment items of income (expense) Depreciation and amortization (13,646) (9,686) (3,960) General, administrative and advisory (20,198) (18,786) (1,412) Interest income, net 17,345 9,030 8,315 Loss on early extinguishment of debt (1,710) (2,805) 1,095 Gain on foreign currency transactions 993 20,067 (19,074) (Loss) gain sale, remeasurement or write down of assets (1,923) 87,132 (89,055) Income from joint ventures 3,242 469,268 (466,026) Other income (expense) 2,021 (94,644) 96,665 Net income $ 5,251 $ 475,317 $ (470,066) Comparison of the year ended December 31, 2023 to the year ended December 31, 2022: Our $470.1 million decrease in net income in 2023 is primarily attributed to the following: • The $6.6 million increase in profit from the multifamily properties is due to increases of $5.6 million from the Acquisition Properties and $2.3 million from the Redevelopment Property offset in part by decreases of $1.0 million from the Same Properties and $0.3 million from the Disposition Properties . The increase in profit from the Redevelopment property is due to the completion of the restoration and lease-up of Landing on Bayou Cane in 2023. The decrease in profit from the Same Properties is primarily due to an increase in insurance cost in 2023. • The $3.2 million decrease in profit from the commercial properties is primarily due to a decline in occupancy and an increase in insurance cost . • The $8.3 million increase in interest income, net is due to a $8.0 million decrease in interest expense and a $0.3 million increase in interest income. The decrease in interest expense is primarily due to the pay down of our bonds payable in 2023 (See " Financing Activities " in Management's Overview). The increase in interest income is primarily due to a $9.9 million increase in interest on short term investments offset in part by a $9.6 million decrease in interest income from notes receivable and receivable from related party. The increase in short-term investments is primarily due to the $388.0 million in cash distributions received from VAA in 2022 (See " Other Developments" in Management's Overview ). The decrease in interest income from notes receivable is primarily due to the forgiveness of $4.2 million in interest income in connection with the UHF loan modification in 2023. • The decrease in gain on foreign currency transactions is due to a change in the U.S. Dollar and the New Israeli Shekel conversion rate in connection with the bonds that were listed on the Tel-Aviv Stock Exchange (See "Financing Activities") . 20 • (Loss) gain on sale, remeasurement or write down of assets changed $91.1 million from a gain of $89.2 million in 2022 to a loss of $1.9 million in 2023. The decrease in gain is primarily due to the $73.2 million gain on remeasurement of the VAA Holdback Portfolio in 2022 (See "Other Developments" in Management's Overview) and property dispositions in 2022 (See "Acquisitions and Dispositions" in Management's Overview). • The decrease in income from joint ventures is primarily due to our share of the gain on the sale of the VAA Sale Portfolio in 2022 (See "Other Developments" in Management's Overview). • The $101.3 million change in other income (expense) is primarily due to the income tax expense incurred in connection with the sale of the VAA Sale Portfolio in 2022 (See "Other Developments" in Management's Overview). Comparison of the year ended December 31, 2022 to the year ended December 31, 2021: See Item 7 of Part II in our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the SEC on March 23, 2023 for a discussion of our results of operations for the year ended December 31, 2022. Liquidity and Capital Resources Our principal sources of cash have been, and will continue to be, property operations; proceeds from land and income-producing property sales; collection of mortgage notes receivable; collections of receivables from related companies; refinancing of existing mortgage notes payable; and additional borrowings, including mortgage notes and bonds payable, and lines of credit. Our principal liquidity needs are to fund normal recurring expenses; meet debt service and principal repayment obligations including balloon payments on maturing debt; fund capital expenditures, including tenant improvements and leasing costs; fund development costs not covered under construction loans; and fund possible property acquisitions. We anticipate that our cash, cash equivalents and short-term investments as of December 31, 2023, along with cash that will be generated in 2024 from notes and interest receivables, will be sufficient to meet all of our cash requirements. We may also selectively sell land and income-producing assets, refinance or extend real estate debt and seek additional borrowings secured by real estate to meet our liquidity requirements. Although history cannot predict the future, historically, we have been successful at refinancing and extending a portion of our current maturity obligations. Cash Flow Summary The following summary discussion of our cash flows is based on the consolidated statements of cash flows in Part II, Item 8. “Consolidated Financial Statements and Supplementary Data” and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below (dollars in thousands): Year Ended December 31, 2023 2022 Variance Net cash used in operating activities $ (31,054) $ (45,386) $ 14,332 Net cash provided by investing activities $ 26,813 $ 307,357 $ (280,544) Net cash used in financing activities $ (139,020) $ (112,377) $ (26,643) The decrease in cash used in operating activities is primarily due to an increase in interest income and an increase in rents provided by the Acquisition Properties (See "Acquisitions and Dispositions" in Management's Overview). The increase in interest income is primarily due to an increase in short-term investments and cash equivalents and an increase in interest rates. The decrease in cash provided by investing activities is primarily due to a $362.9 million decrease in distribution from joint venture (See "Other Developments" in Management's Overview) and a $44.4 million decrease in proceeds from the sale of real estate (See " Acquisitions and Dispositions " in Management's Overview), offset in part by a $131.7 million decrease in investment in short-term investments. The decrease in distribution from joint venture is due to the sale of the VAA Sale Portfolio in 2022 (See "Other Developments" in Management's Overview) and the decrease in investment in short-term investments is due to the investment of those distributions in 2022. 21 The $26.6 million increase in cash used in financing activities is primarily due to an $87.4 million increase in the repayments of bond payable offset in part by a $60.8 million decrease in repayments of mortgage and other notes payable. The increase in repayments of bonds payable is primarily due to the payoff of our bonds in 2023 (See " Financing Activities " in Management's Overview) and the decrease in the repayments of the mortgage and other notes payable is primarily due to the payoff of the mortgage notes on Toulon and Sugar Mill Phase III in 2022 in connection with the sales of the underlying properties. Funds From Operations ("FFO") We use FFO in addition to net income to report our operating and financial results and considers FFO and FFO-diluted as supplemental measures for the real estate industry and a supplement to GAAP measures. The National Association of Real Estate Investment Trusts ("Nareit") defines FFO as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales of properties, plus real estate related depreciation and amortization, impairment write-downs of real estate and write-downs of investments in an affiliate where the write-downs have been driven by a decrease in the value of real estate held by the affiliate and after adjustments for unconsolidated joint ventures. Adjustments for unconsolidated joint ventures are calculated to reflect FFO on the same basis. We also present FFO excluding the impact of the effects of foreign currency translation. FFO and FFO on a diluted basis are useful to investors in comparing operating and financial results between periods. This is especially true since FFO excludes real estate depreciation and amortization, as we believe real estate values fluctuate based on market conditions rather than depreciating in value ratably on a straight-line basis over time. We believe that such a presentation also provides investors with a meaningful measure of our operating results in comparison to the operating results of other real estate companies. In addition, we believe that FFO excluding gain (loss) from foreign currency transactions provide useful supplemental information regarding our performance as they show a more meaningful and consistent comparison of our operating performance and allows investors to more easily compare our results. We believe that FFO does not represent cash flow from operations as defined by GAAP, should not be considered as an alternative to net income as defined by GAAP, and is not indicative of cash available to fund all cash flow needs. We also caution that FFO, as presented, may not be comparable to similarly titled measures reported by other real estate companies. We compensate for the limitations of FFO by providing investors with financial statements prepared according to GAAP, along with this detailed discussion of FFO and a reconciliation of net income to FFO and FFO-diluted. We believe that to further understand our performance, FFO should be compared with our reported net income and considered in addition to cash flows in accordance with GAAP, as presented in our consolidated financial statements. The following reconciles our net income attributable to FFO and FFO-basic and diluted, excluding loss from foreign currency transactions and loss on extinguishment of debt for the years ended December 31, 2023, 2022 and 2021 (dollars and shares in thousands): For the Year Ended December 31, 2023 2022 2021 Net income attributable to the Company $ 3,968 $ 373,349 $ 3,347 Depreciation and amortization on consolidated assets 13,646 9,686 11,870 Loss (gain) on sale, remeasurement or write down of assets 1,923 (87,132) (24,647) Gain on sale of land 188 4,752 16,645 Gain on sale of assets from unconsolidated joint venture at our pro rata share — (265,804) — Depreciation and amortization on unconsolidated joint ventures at pro rata share 272 8,424 11,604 FFO-Basic and Diluted 19,997 43,275 18,819 Loss on early extinguishment of debt 1,710 2,805 1,451 Loss on early extinguishment of debt from unconsolidated joint venture at our pro rata share — 15,254 — (Gain) loss on foreign currency transactions (993) (20,067) 6,175 FFO-adjusted $ 20,714 $ 41,267 $ 26,445