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, 2024 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 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. • On December 13, 2024 , we sold 30 single family lots from our holdings in Windmill Farms for $1.4 million, resulting in a gain on sale of $1.1 million. Financing Activities • 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%. • On March 15, 2023 , we entered into a $33.0 million construction loan to finance the development of Alera (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, 2024 , 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%. • On January 1, 2024, we amended our cash management agreement with Pillar . As a result, the interest rate on the related party receivable (" Pillar Receivable ") changed from prime plus one to SOFR. • 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%. 16 • On July 10, 2024, we replaced the existing loan on Forest Grove with a $6.6 million loan that bears interest at SOFR plus 2.15% and matures on August 1, 2031. • On October 21, 2024 , we entered into a $27.5 million construction loan to finance the development of Mountain Creek (See "Development Activities") that bears interest at SOFR plus 3.45% and matures on October 20, 2026. Development Activities We have agreements to develop two parcels of land (" PODs") from our land holdings in Windmill Farms . The agreements provide for the development of 125 acres of raw land into approximately 470 land lots to be used for single family homes for a total of $24.3 million. We estimate that we will complete the development of these PODs over a two-year period starting during the fourth quarter of 2024. During 2024, we spent $3.6 million on reimbursable infrastructure investments. On March 15, 2023, we entered into a development agreement with Pillar to build a 240 unit multifamily property in Lake Wales, Florida (" Alera ") 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, 2024, we have incurred a total of $36.6 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, 2024, we have incurred a total of $24.8 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, 2024, we have incurred a total of $26.3 million in development costs. On October 21, 2024, we entered into a development agreement with Pillar to build a 234 unit multifamily property in Dallas , Texas (" Mountain Creek ") that is expected to be completed in 2026 for a total cost of approximately $49.8 million. The cost of construction will be funded in part by a $27.5 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. As of December 31, 2024, we have incurred a total of $5.0 million in development costs. 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. In December 2024, we dissolved VAA. 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. We had been engaged in litigation with David Clapper and entities related to Mr. Clapper (collectively, “Clapper") since 1999. The matter originally involved a transaction in 1998 in which we were to acquire eight multifamily properties from the Clapper. Through the years, several rulings, both for and against us, were issued with a range of settlement from zero to $148.0 million . On October 31, 2024, we executed a Settlement Agreement and General Release (the “Settlement Agreement”) and paid $23.4 million to resolve all claims. 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, 2024 to the year ended December 31, 2023 , the Redevelopment Property is Landing on Bayou Cane. The change in revenues and expenses of the Redevelopment Property from 2023 to 2024 is primarily due to the lease-up of the property in 2023 as the restored units were placed in service. There were no Acquisition Properties or Disposition Properties f or the comparison of the year ended December 31, 2024 to the year ended December 31, 2023 . 19 The following table (amounts in thousands) provides a summary of the results of operations of 2024 and 2023: For the Years Ended December 31, 2024 2023 Variance Multifamily Segment Revenue $ 34,103 $ 34,962 $ (859) Operating expenses (18,252) (17,749) (503) 15,851 17,213 (1,362) Commercial Segment Revenue 12,967 14,943 (1,976) Operating expenses (8,811) (10,147) 1,336 4,156 4,796 (640) Segment operating income 20,007 22,009 (2,002) Other non-segment items of income (expense) Depreciation and amortization (12,276) (13,646) 1,370 General, administrative and advisory (14,620) (20,198) 5,578 Interest income, net 12,135 17,345 (5,210) Loss on early extinguishment of debt — (1,710) 1,710 Gain on foreign currency transactions — 993 (993) Loss on real estate transactions (23,989) (1,923) (22,066) Income from joint ventures 1,449 3,242 (1,793) Other income (expense) 3,855 (861) 4,716 Net (loss) income $ (13,439) $ 5,251 $ (18,690) Comparison of the year ended December 31, 2024 to the year ended December 31, 2023: Our $18.7 million decrease in net income in 2024 is primarily attributed to the following: • The $1.4 million decrease in profit from the multifamily properties is due to a $1.0 million decrease from the Redevelopment Property. The decrease in profit from the Redevelopment property is due to the receipt of $1.3 million of business interruption insurance proceeds in 2023. • The $0.4 million decrease in profit from the commercial properties is primarily due to a decline in occupancy. • The $5.6 million decrease in general, administrative and advisory expenses is primarily due to a reduction in legal cost associated with the Nixdorf litigation in 2023 and due to auditing and other administrative expenses associated with the bonds payable, which were repaid in 2023. • The $22.1 million increase in loss on real estate transactions is primarily due to the settlement of the Clapper litigation in 2024 (See " Other Transactions " in Management's Overview). • The $5.2 million decrease in interest income, net is due to a $6.9 million decrease in interest income offset in part by a $1.7 million decrease in interest expense. The decrease in interest income is primarily due to a decrease in interest rates on the UHF notes in 2023 and a decrease in interest rates on the Pillar Receivable in 2024. The decrease in interest expense is primarily due to the repayment of the bonds payable in 2023 (See " Financing Activities " in Management's Overview). • The loss from early extinguishment of debt and the gain on foreign currency transactions are due to the bonds payable that were outstanding in 2023. • The decrease in gain on foreign currency transactions is due to the 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 Comparison of the year ended December 31, 2023 to the year ended December 31, 2022: See Item 7 of Part II in our Annual Report on Form 10-K for the year ended December 31, 2023 filed with the SEC on March 21, 2024 for a discussion of our results of operations for the year ended December 31, 2023. 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, 2024, along with cash that will be generated in 2025 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, 2024 2023 Variance Net cash provided by (used in) operating activities $ 1,089 $ (31,054) $ 32,143 Net cash (used in) provided by investing activities $ (41,340) $ 26,813 $ (68,153) Net cash provided by (used in) financing activities $ 1,659 $ (139,020) $ 140,679 The increase in cash from operating activities is primarily due to a decrease in interest payments and insurance cost in comparison to prior year. The $68.2 million increase in cash used in investing activities is primarily due to the $39.5 million increase in development and renovation of real estate, the $21.4 million decrease in distribution from joint venture and the $18.7 million decrease in net redemption of short term investments offset in part by the $6.5 million decrease in originations and advances on notes receivable and the $3.8 million increase in collection of notes receivable . The increase in development and renovation of real estate relates to the construction start of Merano and Bandera Ridge in 2024. The distribution from joint venture in 2023 relates to the final distribution of proceeds from the sale of the VAA Sale Portfolio in 2022. The $140.7 million decrease in cash used in financing activities is primarily due to the $131.2 million repayment of our bonds in 2023. Funds From Operations ("FFO") We use FFO in addition to net income to report our operating and financial results and consider 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. 21 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, 2024, 2023 and 2022 (dollars and shares in thousands): For the Year Ended December 31, 2024 2023 2022 Net (loss) income attributable to the Company $ (14,703) $ 3,968 $ 373,349 Depreciation and amortization on consolidated assets 12,276 13,646 9,686 Loss (gain) on real estate transactions 23,989 1,923 (87,132) Gain on sale of land 1,095 188 4,752 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 206 272 8,424 FFO-Basic and Diluted 22,863 19,997 43,275 Loss on early extinguishment of debt — 1,710 2,805 Loss on early extinguishment of debt from unconsolidated joint venture at our pro rata share — — 15,254 Gain on foreign currency transactions — (993) (20,067) FFO-adjusted $ 22,863 $ 20,714 $ 41,267 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Optional and not included. 22