Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations
The following discussion and analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements included in this report on Form 10-Q for the quarter ended September 30, 2021 (the “Report”), the audited financial statements for the year ended December 31, 2020, which are included in Form 10-K filed with the SEC on February 22, 2021, and the risk factors in Item 1A, “Risk Factors,” of Form 10-K for the year ended December 31, 2020.
This discussion and analysis, and other sections of this Report contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with respect to the expectations for future periods. Forward-looking statements do not discuss historical fact, but instead include statements related to expectations, projections, intentions or other items related to the future. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “will,” “assumes,” “may,” “projects,” “outlook,” “future,” and variations of those words and similar expressions are intended to identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause the actual results, performance, or achievements to be materially different from the results of operations, financial condition, or plans expressed or implied by the forward-looking statements. Although we believe the expectations reflected in these forward-looking statements are based upon reasonable assumptions, we can give no assurance that our expectations will be achieved. Any statements contained herein that are not statements of historical fact should be deemed forward-looking statements. As a result, reliance should not be placed on these forward-looking statements, as these statements are subject to known and unknown risks, uncertainties, and other factors beyond the our control and could differ materially from actual results and performance.
The following factors, among others, could cause our future results to differ materially from those expressed in the forward-looking statements:
• the COVID-19 pandemic and its ongoing effects on our employees, residents, and commercial tenants, third party vendors and suppliers, and apartment communities, as well as our cash flow, business, financial condition, and results of operation;
• deteriorating economic conditions and rising unemployment rates in the markets where we own apartment communities or in which it may invest in the future;
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• rental conditions in our markets, including occupancy levels and rental rates, potential inability to renew residents or obtain new residents upon expiration of existing leases, changes in tax and housing laws, or other factors, including the impact of the COVID-19-related governmental rules and regulations relating to rental rates, evictions, and other rental conditions;
• changes in operating costs, including real estate taxes, utilities, insurance costs, and expenses related to complying with COVID-19 restrictions or otherwise responding to the COVID-19 pandemic;
• timely access to material required to renovate apartment communities;
• adverse changes in our markets, including future demand for apartment homes in those markets, barriers of entry into new markets, limitations on the ability to increase rental rates, inability to identify and consummate attractive acquisitions and dispositions on favorable terms, inability to reinvest sales proceeds successfully, and inability to accommodate any significant decline in the market value of real estate serving as collateral for mortgage obligations;
• reliance on a single asset class (multifamily) and certain geographic areas of the U.S.;
• inability to expand operations into new or existing markets successfully;
• failure of new acquisitions to achieve anticipated results or be efficiently integrated;
• inability to complete lease-up of projects on schedule and on budget;
• inability to sell non-core properties on terms that are acceptable;
• failure to reinvest proceeds from sales of properties into tax-deferred exchanges, which could necessitate special dividend and/or tax protection payments;
• inability to fund capital expenditures out of cash flow;
• inability to pay, or need to reduce, dividends on common shares;
• financing risks, including the potential inability to meet existing covenants in existing credit facilities or to obtain new debt or equity financing on favorable terms, or at all;
• level and volatility of interest or capitalization rates or capital market conditions;
• loss contingencies and the availability and cost of casualty insurance for losses;
• inability to continue to satisfy complex rules in order to maintain status as a REIT for federal income tax purposes, inability of the Operating Partnership to satisfy the rules to maintain its status as a partnership for federal income tax purposes, and the risk of changes in laws affecting REITs;
• inability to attract and retain qualified personnel;
• cyber liability or potential liability for breaches of privacy or information security systems;
• inability to address catastrophic weather, natural events, and climate change;
• inability to comply with laws and regulations applicable to the business and any related investigations or litigation; and
• other risks identified in this Report, in other SEC reports, or in other documents that we publicly disseminate.
New factors may also arise from time to time that could have an adverse effect on our business and results of operations. Except as otherwise required by law, we undertake no obligation to publicly update or revise these forward-looking statements to reflect events, circumstances, or changes in expectations after the date on which this Report is filed. Readers also should review the risks and uncertainties detailed from time to time in filings with the SEC, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” contained in our Annual Report on Form 10-K for the year ended December 31, 2020.
Executive Summary
We own, manage, acquire, redevelop, and develop apartment communities. We primarily focus on investing in markets characterized by stable and growing economic conditions, strong employment, and an attractive quality of life that we believe, in combination, lead to higher demand for apartment homes and retention of residents. As of September 30, 2021, we owned interests in 79 apartment communities consisting of 14,275 apartment homes. Property owned, as presented in our Condensed Consolidated Balance Sheets, was $2.2 billion at September 30, 2021, compared to $1.8 billion at December 31, 2020.
Renting apartment homes is our primary source of revenue, and our business objective is to provide great homes for our residents. We strive to maximize resident satisfaction and retention by investing in high-quality assets in desirable locations and creating vibrant apartment communities through service-oriented operations. We believe that delivering superior resident experiences will enhance resident satisfaction while also driving profitability for the business and shareholders. We have paid quarterly distributions continuously since our first distribution in 1971.
COVID-19 Developments
The COVID-19 pandemic has affected our business since March 2020, when it spread to many of the markets in which we own properties. Our first priority continues to be the health and well-being of our residents, team members, and the communities we serve. We enhanced cleaning protocols at our communities and offices, implemented physical distancing in community
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common spaces, and instituted remote work guidelines for team members, all in accordance with state and local guidelines. We are using technology to allow property teams to interact remotely with prospective residents through virtual leasing. We provided rent deferrals to residents and rent abatement to commercial tenants who were financially impacted by the COVID-19 pandemic. To support team members working on-site, we provided additional COVID-19 paid time off and enhanced flextime arrangements.
Certain states and cities, including some of those in which our apartment communities are located, have reacted to the COVID-19 pandemic by instituting quarantines, restrictions on travel, shelter-in-place or stay-at-home directives, restrictions on types of businesses that may continue to operate, and restrictions on the types of construction projects that may continue. The availability of vaccines has led many states and cities to lift restrictions; however, due to new variants of the virus, we cannot predict whether restrictions will be reinstated or if additional restrictions will be imposed in the future. We implemented a plan to safely re-open common spaces in our communities while adhering to state and local guidelines, but recognize that an increase in COVID-19 cases in these markets could cause us to close common spaces or take other preventive measures.
We cannot predict the continued impact of the pandemic, including the impact of the proposed U.S. vaccine mandate , and the degree to which our business and results of operations may be affected, particularly given the extended duration of the pandemic.
Financial Impact of the COVID-19 Pandemic
Many companies, especially in urban areas, have extended directives for employees to work from home during the COVID-19 pandemic. These extended directives have resulted in decreased traffic to businesses and, in some cases, closures of businesses in urban areas, which has resulted in lower demand and lower rent increases for our five urban based apartment communities. The COVID-19 pandemic and these directives have affected operations and the conduct of business at apartment communities and offices, but did not have a material impact on our financial condition, operating results, or cash flows.
The ongoing COVID-19 pandemic and the new variants of the virus could result in adverse financial and economic impacts that could include, but are not limited to, the following:
• cause our residents or commercial tenants to defer or stop rental payments, and abandon or fail to renew leases, which would reduce our primary source of net operating income and cash flows;
• cause the capital markets generally to become restricted or unavailable, thereby limiting our access to any needed debt or equity capital financing;
• impact the business of, or cause the loss of, certain critical third-party suppliers or other service providers;
• restrict our ability to continue to pay dividends on a quarterly basis at the current rate;
• impair the value of tangible or intangible assets;
• require us to record loss contingencies and incur additional expenses related to its COVID-19 response; or
• cause the U.S. economy to suffer an extended economic slowdown, which could lead to a prolonged recession or even economic depression, which in turn would affect the demand for apartment communities and could have an adverse impact on our business and operating results.
We have taken the following actions in order to protect our residents and employees, manage expenses and preserve cash flow during the COVID-19 pandemic:
• reduced planned travel for team members through 2021;
• left vacant positions unfilled;
• used onsite team members to perform work normally contracted to third parties; and
• moved the meetings of the Board of Trustees to virtual meetings, thereby limiting the expense associated with in-person meetings.
Despite our efforts to manage our r esponse to the effects of the COVID-19 pandemic, the ultimate impact of the COVID-19 pandemic on rental revenue for 2021 and in future years cannot be determined at present. The situation surrounding the COVID-19 pandemic remains fluid, and we are actively managing our response in collaboration with residents, commercial tenants, government officials, and business partners and assessing potential impacts to financial position and operating results, as well as potential adverse impacts on our business. Our management remains committed to ensuring the safety of team members, residents, and communities, and to maintaining the financial stability of our business enterprise for the duration of the COVID-19 pandemic.
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Overview of the Three Months Ended September 30, 2021
On September 1, 2021, we closed on a strategic portfolio acquisition in Minneapolis and St. Cloud, Minnesota for an aggregate acquisition cost of $359.9 million. The portfolio is comprised of 14 apartment communities in Minneapolis and three apartment communities in St. Cloud with a total of 2,696 apartment homes. In connection with this transaction, we issued 1.8 million Series E preferred units with a par value of $100 per unit. The Series E preferred units pay a 3.875% dividend rate and are convertible, at the holder’s option, into Units at an exchange rate of 1.2048 Units per Series E preferred unit, representing a conversion price of $83.00 per Unit. The acquired assets were subject to $126.5 million in mortgage liabilities, of which $20.0 million was assumed at a rate of 4.31% with the remaining amount financed through a $198.9 million Fannie Mae credit facility agreement. The FMCF includes tranches in 7, 10, and 12-year increments with a weighted average interest rate of 2.78%.
See Note 8 of the Notes to Condensed Consolidated Financial Statements in this Report for a table detailing acquisitions and dispositions during the nine months ended September 30, 2021 and 2020.
For the three months ended September 30, 2021, revenue increased by $6.3 million to $50.4 million, compared to $44.1 million for the three months ended September 30, 2020, primarily due to same-store and non-same-store communities, offset by dispositions. Total expenses increased by $7.1 million to $49.3 million for the three months ended September 30, 2021, compared to $42.1 million for the three months ended September 30, 2020 primarily due to increased property operating expenses, depreciation and amortization, and general and administrative expenses. Funds from Operations (“FFO”) applicable to common shares and Units for the three months ended September 30, 2021 decreased by $3.3 million to $9.3 million compared to $12.6 million for the three months ended September 30, 2020. This decrease was primarily due to losses related to termination of interest rate swaps, increased property management and general and administrative expenses, and decreased NOI from dispositions, offset by increased NOI from same-store and non-same-store communities. The drivers of these changes are discussed in more detail in the “Results of Operations” section below.
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Results of Operations
Reconciliation of Operating Income to Net Operating Income
The following table provides a reconciliation of operating income to net operating income (“NOI”) (non-GAAP), which is defined below.
(in thousands, except percentages)
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 $ Change % Change 2021 2020 $ Change % Change
Operating income $ 1,144 $ 2,002 $ (858) (42.9) % $ 5,518 $ 6,530 $ (1,012) (15.5) %
Adjustments:
Property management expenses 2,203 1,442 761 52.8 % 6,055 4,341 1,714 39.5 %
Casualty (gain) loss (10) 91 (101) (111.0) % 64 1,331 (1,267) (95.2) %
Depreciation and amortization 22,447 18,995 3,452 18.2 % 61,747 55,311 6,436 11.6 %
General and administrative expenses 4,279 3,077 1,202 39.1 % 11,982 9,707 2,275 23.4 %
Net operating income $ 30,063 $ 25,607 $ 4,456 17.4 % $ 85,366 $ 77,220 $ 8,146 10.5 %
Consolidated Results of Operations
The following consolidated results of operations cover the three and nine months ended September 30, 2021 and 2020.
(in thousands, except percentages)
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 $ Change % Change 2021 2020 $ Change % Change
Revenue
Same-store $ 42,034 $ 39,571 $ 2,463 6.2 % $ 122,555 $ 118,627 $ 3,928 3.3 %
Non-same-store 7,214 1,117 6,097 545.8 % 15,892 2,319 13,573 585.3 %
Other properties 1,120 833 287 34.5 % 2,415 2,208 207 9.4 %
Dispositions 45 2,617 (2,572) (98.3) % 2,855 9,300 (6,445) (69.3) %
Total 50,413 44,138 6,275 14.2 % 143,717 132,454 11,263 8.5 %
Property operating expenses, including real estate taxes
Same-store 17,126 16,409 717 4.4 % 50,032 48,631 1,401 2.9 %
Non-same-store 2,940 491 2,449 498.8 % 5,875 995 4,880 490.5 %
Other properties 317 229 88 38.4 % 873 759 114 15.0 %
Dispositions (33) 1,402 (1,435) (102.4) % 1,571 4,849 (3,278) (67.6) %
Total 20,350 18,531 1,819 9.8 % 58,351 55,234 3,117 5.6 %
Net operating income
Same-store 24,908 23,162 1,746 7.5 % 72,523 69,996 2,527 3.6 %
Non-same-store 4,274 626 3,648 582.7 % 10,017 1,324 8,693 656.6 %
Other properties 803 604 199 32.9 % 1,542 1,449 93 6.4 %
Dispositions 78 1,215 (1,137) (93.6) % 1,284 4,451 (3,167) (71.2) %
Total $ 30,063 $ 25,607 $ 4,456 17.4 % $ 85,366 $ 77,220 $ 8,146 10.5 %
Property management expenses (2,203) (1,442) 761 52.8 % (6,055) (4,341) 1,714 39.5 %
Casualty gain (loss) 10 (91) (101) (111.0) % (64) (1,331) (1,267) (95.2) %
Depreciation and amortization (22,447) (18,995) 3,452 18.2 % (61,747) (55,311) 6,436 11.6 %
General and administrative expenses (4,279) (3,077) 1,202 39.1 % (11,982) (9,707) 2,275 23.4 %
Interest expense (7,302) (6,771) 531 7.8 % (21,622) (20,622) 1,000 4.8 %
Interest and other income (loss) (5,082) 277 (5,359) (1,934.7) % (4,032) (1,979) (2,053) 103.7 %
NET INCOME (LOSS) $ (11,240) $ 21,184 $ (32,424) (153.1) % $ 6,704 $ 9,415 $ (2,711) (28.8) %
Dividends to Series D preferred unitholders (160) (160) — — (480) (480) — —
Net (income) loss attributable to noncontrolling interests – Operating Partnership and Series E preferred units 1,930 (1,387) 3,317 (239.1) % 1,013 (248) 1,261 (508.5) %
Net (income) loss attributable to noncontrolling interests – consolidated real estate entities (22) (8) (14) 175.0 % (58) 132 (190) (143.9) %
Net income (loss) attributable to controlling interests (9,492) 19,629 (29,121) (148.4) % 7,179 8,819 (1,640) (18.6) %
Dividends to preferred shareholders (1,607) (1,607) — — % (4,821) (4,921) 100 (2.0) %
Redemption of Preferred Shares — (1) 1 (100.0) % — 297 (297) (100.0) %
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS $ (11,099) $ 18,021 $ (29,120) (161.6) % $ 2,358 $ 4,195 $ (1,837) (43.8) %
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Three Months Ended September 30, Nine Months Ended September 30,
Weighted Average Occupancy (1)
2021 2020 2021 2020
Same-store 94.3 % 94.3 % 94.7 % 94.7 %
Non-same-store 95.1 % 96.3 % 93.8 % 95.1 %
Total 94.4 % 94.3 % 94.6 % 94.7 %
(1) Weighted average occupancy is defined as the percentage resulting from dividing actual rental revenue by scheduled rental revenue. Scheduled rental revenue represents the value of all apartment homes, with occupied homes valued at contractual rental rates pursuant to leases and vacant homes valued at estimated market rents. When calculating actual rents for occupied homes and market rents for vacant homes, delinquencies, and concessions are not taken into account. Market rates are determined using the currently offered effective rates on new leases at the community and are used as the starting point in determination of the market rates of vacant apartment homes. Centerspace believes that weighted average occupancy is a meaningful measure of occupancy because it considers the value of each vacant unit at its estimated market rate. Weighted average occupancy may not completely reflect short-term trends in physical occupancy, and the calculation of weighted average occupancy may not be comparable to that disclosed by other REITs.
Number of Apartment Homes September 30, 2021 September 30, 2020
Same-store 10,676 10,676
Non-same-store 3,599 647
Total 14,275 11,323
NOI is a non-GAAP financial measure, which we define as total real estate revenues less property operating expenses, including real estate taxes. We believe that NOI is an important supplemental measure of operating performance for real estate because it provides a measure of operations that is unaffected by depreciation, amortization, financing, property management overhead, casualty losses, and general and administrative expenses. NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered an alternative to net income, net income available for common shareholders, or cash flow from operating activities as a measure of financial performance.
We have provided certain information on a same-store and non-same-store basis. Same-store apartment communities are owned or in service for the entirety of the periods being compared, and, in the case of newly-constructed properties, have achieved a target level of physical occupancy of 90%. On the first day of each calendar year, we determine the composition of our same-store pool for that year as well as adjust the previous year, which allows us to evaluate full period-over-period operating comparisons for existing apartment communities and their contribution to net income. We believe that measuring performance on a same-store basis is useful to investors because it enables evaluation of how a fixed pool of communities are performing year-over-year. We use this measure to assess whether or not we have been successful in increasing NOI, raising average rental revenue, renewing the leases on existing residents, controlling operating costs, and making prudent capital improvements. The discussion below focuses on the main factors affecting real estate revenue and expenses from same-store apartment communities because changes from one year to another in real estate revenue and expenses from non-same-store apartment communities are generally due to the addition of those properties to the real estate portfolio, and accordingly provide less useful information for evaluating ongoing operational performance of the real estate portfolio.
For the comparison of the nine months ended September 30, 2021 and 2020, twenty apartment communities were non-same-store. Sold communities are included in “Dispositions,” while “Other” includes non-multifamily properties and the non-multifamily components of mixed-use properties.
Revenue. Revenue increased by 14.2% to $50.4 million for the three months ended September 30, 2021, compared to $44.1 million in the three months ended September 30, 2020. Revenue from non-same-store communities and other properties increased by $6.1 million and $287,000, respectively, offset by a decrease of $2.6 million from dispositions. Revenue from same-store communities increased 6.2% or $2.5 million in the three months ended September 30, 2021, compared to the same period in the prior year. The increase was attributable to 6.2% growth in average rental revenue for the three months ended September 30, 2021 and 2020, respectively.
Revenue increased by 8.5% to $143.7 million for the nine months ended September 30, 2021, compared to $132.5 million in the nine months ended September 30, 2020. Revenue from non-same-store communities and other properties increased by $13.6 million and 207,000, respectively, offset by a decrease of $6.4 million from dispositions. Revenue from same-store communities increased 3.3% or $3.9 million in the nine months ended September 30, 2021, compared to the same period in the prior year. The increase was attributable to 3.3% growth in average rental revenue for the nine months ended September 30, 2021 and 2020, respectively.
Property operating expenses, including real estate taxes . Property operating expenses, including real estate taxes, increased by 9.8% to $20.4 million in the three months ended September 30, 2021, compared to $18.5 million in the same period of the prior year. An increase of $2.4 million at non-same-store communities was offset by a decrease $1.4 million from dispositions. Property operating expenses, including real estate taxes, at same-store communities increased by 4.4% or $717,000 in the three
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months ended September 30, 2021, compared to the same period in the prior year. At same-store communities, controllable expenses (which exclude insurance and real estate taxes) increased by $319,000, primarily due to increased compensation and utilities costs. Non-controllable expenses at same-store communities increased by $398,000, primarily due to insurance costs.
Property operating expenses, including real estate taxes, increased by $3.1 million to $58.4 million in the nine months ended September 30, 2021, compared to $55.2 million in the same period of the prior year. An increase of $4.9 million at non-same-store communities was offset by a decrease of $3.3 million from dispositions. Property operating expenses, including real estate taxes, at same-store communities increased by 2.9% or $1.4 million in the nine months ended September 30, 2021, compared to the same period of the prior year. At same-store communities, controllable expenses (which exclude insurance and real estate taxes), increased by $521,000, primarily due to increases in compensation and utilities costs. Non-controllable expenses at same-store communities increased by $880,000 primarily due to insurance costs.
Property management expenses . Property management expense, consisting of property management overhead and property management fees paid to third parties increased by 52.8% to $2.2 million in the three months ended September 30, 2021, compared to $1.4 million in the same period of the prior year. The increase is primarily due to $364,000 in nonrecurring technology initiatives as well as $276,000 in compensation costs due to the filling of open positions.
Property management expense increased by 39.5% to $6.1 million in the nine months ended September 30, 2021, compared to $4.3 million in the same period of the prior year. The increase is primarily due to $889,000 in nonrecurring technology initiatives as well as $586,000 in compensation costs due to the filling of open positions.
Casualty gain (loss). Casualty gain (loss) decreased by 111.0% to a gain of $10,000 in the three months ended September 30, 2021, compared to a loss of $91,000 in the same period of the prior year. The decrease is primarily due to weather related losses in the prior year which have not occurred in the current year.
Casualty gain (loss) decreased by 95.2% to $64,000 in the nine months ended September 30, 2021, compared to $1.3 million in the same period of the prior year. The decrease is primarily due to weather-related losses that occurred in the prior year which did not occur in the current year.
Depreciation and amortization. Depreciation and amortization increased by 18.2% to $22.4 million in the three months ended September 30, 2021, compared to $19.0 million in the same period of the prior year, attributable to an increase of $4.8 million from non-same-store properties, offset by a decrease of $350,000 from same-store properties and $906,000 from sold properties.
Depreciation and amortization increased by 11.6% to $61.7 million in the nine months ended September 30, 2021, compared to $55.3 million in the same period of the prior year, attributable to an increase of $10.4 million from non-same-store properties, offset by decreases of $1.9 million and $2.0 million at same-store communities and sold properties, respectively.
General and administrative expenses. General and administrative expenses increased by 39.1% to $4.3 million in the three months ended September 30, 2021, compared to $3.1 million in the same period of the prior year, primarily attributable to $374,000 in incentive-based compensation costs related to company performance and share-based compensation arrangements due to the timing and form of grants, $261,000 in nonrecurring technology initiatives, and $204,000 in nonrecurring consulting costs.
General and administrative expenses increased by 23.4% to $12.0 million in the nine months ended September 30, 2021, compared to $9.7 million in the same period of the prior year, primarily attributable to increases of $1.3 million in incentive-based compensation costs related to company performance and share-based compensation arrangements due to the timing and form of grants and $597,000 in nonrecurring technology initiatives.
Interest expense. Interest expense increased by 7.8% to $7.3 million in the three months ended September 30, 2021, compared to $6.8 million in the same period of the prior year, primarily due to maintaining a larger average balance on the line of credit compared to the same period of the prior year and the addition of new unsecured senior notes and the Fannie Mae credit facility, offset by a lower weighted average interest rate.
Interest expense increased by 4.8% to $21.6 million in the nine months ended September 30, 2021, compared to $20.6 million in the same period of the prior year, primarily due to maintaining a larger average balance on the line of credit compared to the same period of the prior year and the addition of new unsecured senior notes and the Fannie Mae credit facility, offset by a lower weighted average interest rate.
Interest and other income (loss). Interest and other income decreased to a loss of $5.1 million in the three months ended September 30, 2021, compared to income of $277,000 in the same period of the prior year. The decrease was primarily due to a $5.4 million loss related to the termination of interest rate swaps in the current period.
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Interest and other income decreased to a loss of $4.0 million in the nine months ended September 30, 2021, compared to a loss of $2.0 million in the same period of the prior year. The change was primarily due to a $5.4 million loss related to the termination of interest rate swaps in the nine months ended September 30, 2021, compared to a $3.4 million loss in the value of marketable securities during the nine months ended September 30, 2020.
Net income (loss) available to common shareholders. Net income available to common shareholders decreased to a loss of $11.1 million for the three months ended September 30, 2021, compared to net income of $18.0 million in the three months ended September 30, 2020.
Net income available to common shareholders decrease to net income of $2.4 million for the nine months ended September 30, 2021, compared to a net loss of $4.2 million in the same period of the prior year.
Funds from Operations .
We believe that Funds from Operations (“FFO”), which is a non-GAAP financial measures used as a standard supplemental measure for equity real estate investment trusts, is helpful to investors in understanding operating performance, primarily because its calculation does not assume the value of real estate assets diminishes predictably over time, as implied by the historical cost convention of GAAP and the recording of depreciation.
We use the definition of Funds from Operations FFO adopted by the National Association of Real Estate Investment Trusts, Inc. (“Nareit”). Nareit defines FFO as net income or loss calculated in accordance with GAAP, excluding:
• depreciation and amortization related to real estate;
• gains and losses from the sale of certain real estate assets; and
• impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity.
The exclusion in Nareit’s definition of FFO of impairment write-downs and gains and losses from the sale of real estate assets helps to identify the operating results of the long-term assets that form the base of investments, and assists management and investors in comparing those operating results between periods.
Due to limitations of the Nareit FFO definition, we have made certain interpretations in applying this definition. We believe that all such interpretations not specifically provided for in the Nareit definition are consistent with this definition. Nareit’s FFO White Paper 2018 Restatement clarified that impairment write-downs of land related to a REIT’s main business are excluded from FFO and a REIT has the option to exclude impairment write-downs of assets that are incidental to the main business.
While FFO is widely used by us as a primary performance metric, not all real estate companies use the same definition of FFO or calculate FFO the same way. Accordingly, FFO presented here is not necessarily comparable to FFO presented by other real estate companies. FFO should not be considered as an alternative to net income or any other GAAP measurement of performance, but rather should be considered as an additional, supplemental measure. FFO also does not represent cash generated from operating activities in accordance with GAAP, nor is it indicative of funds available to fund all of the our needs, including our ability to service indebtedness or make distributions to shareholders.
FFO applicable to common shares and Units for the three months ended September 30, 2021, decreased to $9.3 million compared to $12.6 million for the comparable period ended September 30, 2020, a decrease of 26.1%. This decrease was primarily due to losses related to termination of interest rate swaps, increased property management and general and administrative expenses, and decreased NOI from dispositions, offset by increased NOI from same-store and non-same-store communities.
FFO applicable to common shares and Units for the nine months ended September 30, 2021, increased to $35.9 million compared to $33.7 million for the same period of the prior year, an increase of 6.7%. The increase was primarily due to increased NOI from same-store and non-same-store communities as well as lower casualty losses and a prior year loss of $3.4 million on marketable securities that did not occur in the current year. These increases were offset by a decrease in NOI from dispositions as well as losses related to termination of interest rate swaps and increases in property management and general and administrative expenses.
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Reconciliation of Net Income Available to Common Shareholders to Funds from Operations
(in thousands, except per share and unit amounts)
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
Net income (loss) available to common shareholders $ (11,099) $ 18,021 $ 2,358 $ 4,195
Adjustments:
Noncontrolling interests – Operating Partnership and Series E preferred units (1,930) 1,387 (1,013) 248
Depreciation and amortization 22,447 18,995 61,747 55,311
Less depreciation – non real estate (80) (85) (265) (266)
Less depreciation – partially owned entities (24) (31) (72) (346)
(Gain) loss on sale of real estate — (25,676) (26,840) (25,486)
Funds from operations applicable to common shares and Units $ 9,314 $ 12,611 $ 35,915 $ 33,656
Funds from operations applicable to common shares and Units $ 9,314 $ 12,611 $ 35,915 $ 33,656
Dividends to preferred unitholders 160 160 480 480
Funds from operations applicable to common shares and Units - diluted $ 9,474 $ 12,771 $ 36,395 $ 34,136
Per Share Data
Earnings (loss) per common share - diluted $ (0.81) $ 1.38 $ 0.12 $ 0.33
FFO per share and Unit - diluted $ 0.60 $ 0.90 $ 2.44 $ 2.49
Weighted average shares and Units - diluted 15,922 14,143 14,917 13,704
Acquisitions and Dispositions
On September 1, 2021, we closed on a strategic portfolio acquisition in Minneapolis and St. Cloud, Minnesota for an aggregate acquisition cost of $359.9 million. The portfolio is comprised of 14 apartment communities in Minneapolis and three apartment communities in St. Cloud with a total of 2,696 apartment homes. In connection with this transaction, we issued 1.8 million Series E preferred units with a par value of $100 per unit. The Series E preferred units pay a 3.875% dividend rate and are convertible, at the holder’s option, into Units at an exchange rate of 1.2048 Units per Series E preferred unit, representing a conversion price of $83.00 per Unit. The acquired assets were subject to approximately $126.5 million in mortgage liabilities, of which $20.0 million was assumed at a rate of 4.31% with the remaining amount refinanced through a $198.9 million Fannie Mae credit facility agreement. The FMCF includes tranches in 7, 10, and 12-year increments with a weighted average interest rate of 2.78%. See Note 8 of the Notes to Condensed Consolidated Financial Statements in this Report for a table detailing acquisitions and dispositions during the nine-month periods ended September 30, 2021 and 2020.
Distributions Declared
Distributions of $0.72 and $2.12 per common share and Unit were declared during the three and nine months ended September 30, 2021, respectively. Distributions of $0.70 and $2.10 per common share and Unit were declared during the three and nine months ended September 30, 2020, respectively. Distributions of $0.4140625 and $1.242188 per Series C preferred share were declared during the three and nine months ended September 30, 2021 and 2020, respectively. Distributions of $0.9655 and $2.8965 per Series D preferred unit were declared during the three and nine months ended September 30, 2021 and 2020, respectively. Distributions of $0.322917 per Series E preferred unit were declared during the three and nine months ended September 30, 2021.
Liquidity and Capital Resources
Overview
We strive to maintain a strong balance sheet and preserve financial flexibility, which we believe should enhance our ability to capitalize on appropriate investment opportunities as they may arise. We intend to continue to focus on core fundamentals, which include generating positive cash flows from operations, maintaining appropriate debt levels and leverage ratios, and controlling overhead costs.
Our primary sources of liquidity are cash and cash equivalents on hand and cash flows generated from operations. Other sources include availability under the unsecured lines of credit, proceeds from property dispositions, including restricted cash
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related to net tax deferred proceeds, offerings of preferred and common shares under the shelf registration statement, including offerings of common shares under the 2021 ATM Program, and long-term unsecured debt and secured mortgages.
Our primary liquidity demands are normally-recurring operating and overhead expenses, debt service and repayments, capital improvements to communities, distributions to the holders of preferred shares, common shares, Series D and Series E preferred units, and Units, value-add redevelopment, common and preferred share buybacks and Unit redemptions, and acquisitions of additional communities.
Although we believe that our financial condition and liquidity are sufficient to meet our reasonably anticipated liquidity demands, factors that could impact our future liquidity include, but are not limited to, volatility in capital and credit markets, the ability to access capital and credit markets, the effects of the COVID-19 pandemic, including its potential impact on our ability to access the capital and credit markets on reasonable terms (or at all), the minimum REIT dividend requirements, and our ability to complete asset purchases, sales, or developments.
As of September 30, 2021, we had total liquidity of approximately $219.8 million, which included $199.0 million available on the lines of credit and $20.8 million of cash and cash equivalents. As of December 31, 2020, we had total liquidity of approximately $97.5 million, which included $97.1 million on the lines of credit and $392,000 of cash and cash equivalents.
COVID-19-Related Impacts on Liquidity
We anticipate that our primary sources of liquidity will continue to be cash and cash equivalents on hand, cash flows generated from operations and availability under the unsecured lines of credit. Although cash flows may be reduced as a result of lower monthly collections of rent as well as the potential for lower occupancy or reduced rental rates during and after the COVID-19 pandemic, we have other available sources of liquidity such as proceeds from property dispositions; offerings of preferred and common shares under the shelf registration statement, including offerings of common shares under the 2021 ATM Program; and long term unsecured term loans and secured mortgages. We have the following contractual obligations over the next twelve months:
• no debt maturities remaining in 2021;
• $29.8 million debt maturities in 2022; and
• approximately $3.9 million remaining to fund under a mezzanine loan we originated for the development of a multifamily community in Minneapolis, Minnesota.
Potential Impact of COVID-19-Related Effects on Continuing Debt Availability
Although we are in compliance with the covenants under all of our debt facilities and currently expect to continue to remain in compliance with these covenants, there can be no assurance that we will remain in compliance with those covenants or be able to access these funds depending on the length of the COVID-19 pandemic and the breadth of its impact on the U.S. economy generally and the credit markets in particular. Under the terms of our credit facility, we may be unable to obtain advances under the credit facility if:
• we are unable to make certain representations and warranties, including a certification that, since September 30, 2021, there has been no adverse change in the business, financial condition, operations, performance or properties, taken as a whole, which would reasonably be expected to have a material adverse effect;
• changes in our unencumbered properties may reduce or eliminate availability under the credit facility; or
• changes in the nature and composition (including occupancy rate) of our unencumbered properties could reduce or eliminate the availability under the credit facility.
Even if we remain in compliance with the foregoing representations, warranties, and covenants, it may be unable to access the full amount available under the credit facilities if our lenders fail to fund their commitments, which could occur if:
• credit market deterioration or overall economic conditions affect the ability of one or more of our lenders to meet their funding commitments under the revolving credit facility. If a lender fails to fund its commitment under the revolving credit facility, that portion of the credit facility will be unavailable if the lender’s commitment is not replaced by a new commitment from an alternate lender;
• distressed market conditions cause our lenders to transfer their commitments to other institutions, which could result in committed funds not being available, particularly if consolidation of the commitments under the credit facility or among its lenders were to occur; or
• we are unable to obtain additional letters of credit due to a default by any lender in meeting its funding obligations.
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As of the date of this filing, we have not experienced any restrictions or limitations on the availability of credit in its markets or with its lenders, although there can be no assurance that we will continue to be able to access the credit markets generally or the credit facility in the future.
Debt
On September 30, 2021, we amended and restated our unsecured credit facility. The amended agreement provides for a revolving line of credit for $250.0 million, a $400.0 million accordion option, and extends the maturity date to September 2025. Prior to the amendment, the unsecured credit facility included $145.0 million allocated between two term loans: a $70.0 million unsecured term loan and a $75.0 million unsecured term loan, which have been paid in full as of September 30, 2021.
As of September 30, 2021, the line of credit had total commitments and borrowing capacity of $250.0 million, based on the value of unencumbered properties. As of September 30, 2021, the additional borrowing availability was $193.0 million beyond the $57.0 million drawn. At December 31, 2020, the line of credit borrowing capacity was $250.0 million based on the unencumbered asset pool (“UAP”), of which $152.9 million was drawn on the line, including the balance on the operating line of credit.
In January 2021, we amended and expanded our private shelf agreement to increase the aggregate amount available for issuance of unsecured senior promissory notes to $225.0 million. Under this agreement, we issued $200.0 million unsecured senior notes with $25.0 million remaining available. In September 2021, we entered into a note purchase agreement for the issuance of $125.0 million of senior unsecured promissory notes. The following table shows the notes issued under both agreements.
(in thousands)
Amount Maturity Date Interest Rate
Series A $ 75,000 September 13, 2029 3.84 %
Series B $ 50,000 September 30, 2028 3.69 %
Series C $ 50,000 June 6, 2030 2.70 %
Series 2021-A $ 35,000 September 17, 2030 2.50 %
Series 2021-B $ 50,000 September 17, 2031 2.62 %
Series 2021-C $ 25,000 September 17, 2032 2.68 %
Series 2021-D $ 15,000 September 17, 2034 2.78 %
In September 2021, we entered into a $198.9 million Fannie Mae Credit Facility Agreement (the “FMCF”) for the financing of certain apartment communities. The FMCF is currently secured by mortgages on those apartment communities. The notes are interest-only, have varying maturity dates of 7, 10, and 12 months, and a blended, weighted average interest rate of 2.78%. As of September 30, 2021, the FMCF had a balance of $198.9 million. The FMCF is included within mortgages payable on the Condensed Consolidated Balance Sheets.
Mortgage loan indebtedness, excluding the FMCF, was $293.5 million and $298.4 million at September 30, 2021 and December 31, 2020, respectively. All of our mortgage debt is at fixed rates of interest, with staggered maturities. This decreases the exposure to changes in interest rates, which reduces the effect of interest rate fluctuations on our results of operations and cash flows. As of September 30, 2021, the weighted average interest rate on mortgage debt was 3.83%, compared to 3.93% as of December 31, 2020.
We also have a $6.0 million operating line of credit. This operating line of credit is designed to enhance treasury management activities and more effectively manage cash balances. This operating line matures on November 29, 2021, with pricing based on a market spread plus the one-month LIBOR index rate.
Equity
We had an equity distribution agreement in connection with the 2019 ATM Program through which we could offer and sell common shares having an aggregate gross sales price of up to $150.0 million. Under the 2019 ATM Program, we sold shares having an aggregate sales price of $149.9 million. During the three months ended September 30, 2021, we replaced the 2019 ATM Program with the 2021 ATM Program, through which we may offer and sell common shares having an aggregate sales price of up to $250.0 million, in amounts and at times determined by management. The proceeds from the sale of common shares under the 2021 ATM program are intended to be used for general corporate purposes, which may include the funding of acquisitions and the repayment of indebtedness. During the nine months ended September 30, 2021, we issued 1.1 million common shares under the 2019 and 2021 ATM programs at an average price of $78.63 per share, net of commissions. Total consideration, net of commissions and issuance costs, was $86.1 million. As of September 30, 2021, common shares having an aggregate offering price of up to $230.1 million remained available under the 2021 ATM Program.
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On September 1, 2021, we issued 1.8 million Series E preferred units with a par value of $100 per Series E preferred unit as partial consideration for the acquisition of 17 apartment communities. The Series E preferred unit holders receive a preferred distribution at the rate of 3.875% per year. Each Series E preferred unit is convertible, at the holder's option, into 1.2048 Units, representing a conversion exchange rate of $83.00 per unit. The Series E preferred units have an aggregate liquidation preference of $181.4 million. The holders of the Series E preferred units do not have voting rights.
Changes in Cash, Cash Equivalents, and Restricted Cash
The following discussion relates to changes in consolidated cash, cash equivalents, and restricted cash which are presented in the Condensed Consolidated Statements of Cash Flows in Part I, Item 1 above.
In addition to cash flow from operations, during the nine months ended September 30, 2021, we generated capital from various activities, including:
• Receiving $174.5 million, net of fees, from the issuance of unsecured senior notes;
• Receiving $59.2 million, net of transaction costs, from the sale of five apartment communities in Rochester, Minnesota;
• Receiving $196.7 million, net of fees, from the Fannie Mae credit facility which was used to pay off debt as partial consideration for the September 1, 2021 portfolio acquisition; and
• Receiving $85.9 million in net proceeds from the issuance of 1.1 million common shares under the 2019 and 2021 ATM Programs.
During the nine months ended September 30, 2021, we used capital for various activities, including:
• Acquiring Union Pointe, a 256-home apartment community located in Longmont, Colorado, for an aggregate purchase price of $76.9 million;
• Acquiring a portfolio of 17 apartment communities located in Minneapolis, Minnesota and St. Cloud, Minnesota, for $15.7 million in cash, the paydown of $106.7 million in existing mortgages, and the remainder through the issuance of Series E preferred units;
• Funding of mezzanine and construction loans of $17.5 million;
• Repaying $27.7 million of mortgage principal;
• Repaying $95.9 million on the line of credit;
• Paying off $145.0 million in term loans;
• Paying $3.8 million for the termination of interest rate swaps; and
• Funding capital improvements for apartment communities of approximately $20.7 million.
Contractual Obligations and Other Commitments
Contractual obligations and other commitments were disclosed in our Form 10-K for the year ended December 31, 2020. There have been no material changes to our contractual obligations and other commitments since that report was filed.
Off-Balance Sheet Arrangements
As of September 30, 2021, we had no significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Critical Accounting Policies
In preparing the Condensed Consolidated Financial Statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. A summary of critical accounting policies is included in our Form 10-K for the year ended December 31, 2020, filed with the SEC on February 22, 2021 under the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Refer to Note 2 of the Notes to Condensed Consolidated Financial Statements in this report for additional information. There have been no other significant changes to the our critical accounting policies during the nine months ended September 30, 2021.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.