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, our audited financial statements for the year ended December 31, 2019, which are included in our Form 10-K filed with the SEC on February 19, 2020, and the risk factors in Item 1A, “Risk Factors,” of our Form 10-K for the year ended December 31, 2019, and in our Form 10-Q for the quarter ended September 30, 2020 (the "Report"). Currently, one of the most significant risk factors is the continuing adverse effects of the COVID-19 pandemic and its associated potential economic impact on our financial condition, results of operations, and cash flows as well as the adverse effects on our residents
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and commercial tenants, the real estate market, and the global economy and financial markets generally. The extent to which COVID-19 continues to impact us and our residents and commercial tenants will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity, and duration of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic and containment measures. Moreover, you should interpret many of the risks identified in this Report, as well as the risks set forth below, as being heightened as a result of the ongoing and numerous adverse impacts of COVID-19.
We consider this and other sections of this Report to 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 our 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,” 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 our 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 our control and could differ materially from our 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 we may invest in the future;
• government actions or regulations arising out of the COVID-19 pandemic that limit economic and consumer activity or affect the operation of our properties;
• rental conditions in our markets, including occupancy levels and rental rates, our 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;
• adverse changes in our markets, including future demand for apartment homes in our markets, barriers of entry into new markets, limitations on our ability to increase rental rates, our inability to identify and consummate attractive acquisitions and dispositions on favorable terms, our inability to reinvest sales proceeds successfully, and our inability to accommodate any significant decline in the market value of real estate serving as collateral for our mortgage obligations;
• reliance on a single asset class (multifamily) and certain geographic areas of the U.S.;
• inability to expand our 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 our projects on schedule and on budget;
• inability to sell our 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 tax protection payments;
• inability to fund capital expenditures out of cash flow;
• inability to pay, or need to reduce, dividends on our common shares;
• inability to raise additional equity capital;
• financing risks, including our potential inability to meet existing covenants in our 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 our 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;
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• inability to attract and retain qualified personnel;
• cyber liability or potential liability for breaches of our privacy or information security systems;
• inability to address catastrophic weather, natural events, and climate change;
• inability to comply with laws and regulations applicable to our 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 our 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, 2019.
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 our apartment homes and retention of our residents. As of September 30, 2020, we owned interests in 67 apartment communities consisting of 11,910 apartment homes. Property owned, as presented in the condensed consolidated balance sheets, was $1.8 billion at September 30, 2020, compared to $1.6 billion at December 31, 2019.
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 our business and our shareholders. We have paid quarterly distributions continuously since our first distribution in 1971.
COVID-19 Developments
The COVID-19 pandemic has had an impact on 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. Enhanced cleaning protocols at our communities and offices, implemented physical distancing in communities common spaces, and instituted remote work guidelines for our team members, all in accordance with state and local guidelines. We are utilizing technology to allow our property teams to interact remotely with prospective residents through virtual leasing. We have provided rent deferrals to residents and rent abatement to commercial tenants who were financially impacted by the COVID-19 pandemic. To support our team members working on-site, IRET has 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. We cannot predict when restrictions currently in place will expire or whether additional restrictions will be imposed in the future. In the second quarter, we implemented a plan to safely re-open common spaces in several of our communities while adhering to state and local guidelines, but we recognize that an increase in COVID-19 cases in these markets could cause us to close common spaces or take other preventive measures.
The COVID-19 pandemic is likely to continue to have an impact on the U.S. economy and our business for the foreseeable future, but it is difficult to predict the magnitude of the effects of the COVID-19 pandemic due to the uncertainties regarding the scope, severity, and duration of the pandemic, the nature and extent of actions taken to combat the pandemic and mitigate its effects, and the direct and indirect economic effects of the pandemic and associated containment measures. In addition, ongoing social distancing requirements and stay-at-home directives affect the daily lives of our employees and residents and impact our ability to show apartment homes to potential residents, while the ongoing loss of jobs, rising unemployment levels, and closing of certain commercial businesses affect the ability of certain of our residents and commercial tenants to pay rent on a timely basis, renew existing leases, or enter into new leases.
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Financial Impact of the COVID-19 Pandemic
Although the COVID-19 pandemic has affected our operations and the conduct of business at our apartment communities and offices, the COVID-19 pandemic did not have a material impact on our financial condition, operating results, or cash flows for the three months ended September 30, 2020. 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. Absent the ability to contain or treat the COVID-19 virus, with a corresponding re-opening of the economy, the COVID-19 pandemic could adversely impact our financial condition, results of operations, and cash flows in future quarters.
Under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act”), the federal government provided $600 per week in unemployment benefits in addition to any state unemployment benefits for unemployed workers, but this additional federal funding expired on July 31, 2020. We believe that the absence of this funding could impact our residents' ability to pay rent, particularly since unemployment rates continue to remain high as a result of the ongoing COVID-19 pandemic, which in turn could adversely affect our results of operations.
The ongoing COVID-19 pandemic may have the following adverse financial and economic impacts, which would be exacerbated by the continued absence of federal government relief for unemployed workers:
• 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, or at all, which could hinder our ability to meet the REIT distribution requirements and continue to qualify as a REIT ;
• impair the value of our tangible or intangible assets;
• require us to record loss contingencies and incur additional expenses related to our 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 our 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:
• with respect to capital projects and investments, we continue to monitor changing government rules and regulations related to COVID-19 and continue to abide by the guidelines set forth by the Center for Disease Control and initiated a review of capital spend to identify projects that were delayed;
• we have eliminated the majority of planned travel expense for our team members through the end of 2020; and
• we have moved the meetings of our 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 our rental revenue for the remainder of 2020 and 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 our financial position and operating results, as well as potential adverse impacts on our business. Our management remains committed to ensuring the safety of our team members, residents, and communities, and to maintaining the financial stability of our business enterprise for the duration of the COVID-19 pandemic.
Overview of the Three Months Ended September 30, 2020
For the three months ended September 30, 2020, revenue decreased by $3.3 million to $44.1 million, compared to $47.4 million for the three months ended September 30, 2019, primarily due to dispositions. Total expenses decreased by $1.7 million to $42.1 million for the three months ended September 30, 2020, compared to $43.8 million for the three months ended
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September 30, 2019 primarily due to decreased property operating expenses as a result of dispositions, net of acquisitions. Funds from Operations ("FFO") applicable to common shares and Units for the three months ended September 30, 2020 increased to $12.6 million compared to $12.2 million for the comparable period ended September 30, 2019, primarily due to reductions in interest expense, debt extinguishment costs, and general and administrative expense. The drivers of these changes are discussed in more detail in the “Results of Operations” section below.
In our ongoing efforts to improve the quality of our portfolio and balanc e sheet, during the third quarter of 2020, we acquired Parkhouse Apartment Homes in Thornton, Colorado for $144.8 million. We also disposed of four apartment communities in Grand Forks, North Dakota and one commercial property for a total sale price of $43.0 million.
See Note 8 of the Notes to Condensed Consolidated Financial Statements in this Report for a table detailing our acquisitions and dispositions during the nine months ended September 30, 2020 and 2019.
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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"), which is defined below.
(in thousands, except percentages)
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
Operating income $ 2,002 $ 3,596 $ (1,594) (44.3) % $ 6,530 $ 8,951 $ (2,421) (27.0) %
Adjustments:
Property management expenses 1,442 1,553 (111) (7.1) 4,341 4,552 (211) (4.6) %
Casualty loss 91 178 (87) (48.9) % 1,331 911 420 46.1 %
Depreciation and amortization 18,995 18,751 244 1.3 % 55,311 55,299 12 —
General and administrative expenses 3,077 3,448 (371) (10.8) % 9,707 10,803 (1,096) (10.1) %
Net operating income $ 25,607 $ 27,526 $ (1,919) (7.0) % $ 77,220 $ 80,516 $ (3,296) (4.1) %
Consolidated Results of Operations
The following consolidated results of operations cover the three and nine months ended September 30, 2020 and 2019.
(in thousands, except percentages)
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
Revenue
Same-store $ 38,043 $ 37,627 $ 416 1.1 % $ 114,208 $ 111,897 $ 2,311 2.1 %
Non-same-store 4,420 1,344 3,076 228.9 % 12,088 2,829 9,259 327.3 %
Other properties and dispositions 1,675 8,465 (6,790) (80.2) % 6,158 25,252 (19,094) (75.6) %
Total 44,138 47,436 (3,298) (7.0) % 132,454 139,978 (7,524) (5.4) %
Property operating expenses, including real estate taxes
Same-store 16,198 15,493 705 4.6 % 47,857 46,190 1,667 3.6 %
Non-same-store 1,712 550 1,162 211.3 % 4,546 1,197 3,349 279.8 %
Other properties and dispositions 621 3,867 (3,246) (83.9) % 2,831 12,075 (9,244) (76.6) %
Total 18,531 19,910 (1,379) (6.9) % 55,234 59,462 (4,228) (7.1) %
Net operating income
Same-store 21,845 22,134 (289) (1.3) % 66,351 65,707 644 1.0 %
Non-same-store 2,708 794 1,914 241.1 % 7,542 1,632 5,910 362.1 %
Other properties and dispositions 1,054 4,598 (3,544) (77.1) % 3,327 13,177 (9,850) (74.8) %
Total $ 25,607 $ 27,526 $ (1,919) (7.0) % $ 77,220 $ 80,516 $ (3,296) (4.1) %
Property management expenses (1,442) (1,553) (111) (7.1) % (4,341) (4,552) (211) (4.6)
Casualty gain (loss) (91) (178) (87) (48.9) % (1,331) (911) 420 46.1 %
Depreciation and amortization (18,995) (18,751) 244 1.3 % (55,311) (55,299) 12 —
General and administrative expenses (3,077) (3,448) (371) (10.8) % (9,707) (10,803) (1,096) (10.1) %
Interest expense (6,771) (7,694) (923) (12.0) % (20,622) (23,180) (2,558) (11.0) %
Loss on extinguishment of debt (4) (1,087) (1,083) (99.6) % (21) (1,496) (1,475) (98.6) %
Interest and other income (loss) 281 498 (217) (43.6) % (1,958) 1,390 (3,348) (240.9) %
Income (loss) before gain (loss) on sale of real estate and other investments, and gain (loss) on litigation settlement
(4,492) (4,687) 195 (4.2) % (16,071) (14,335) (1,736) 12.1 %
Gain (loss) on sale of real estate and other investments 25,676 39,105 (13,429) (34.3) % 25,486 39,774 (14,288) (35.9) %
Gain (loss) on litigation settlement — 300 (300) (100.0) % — 6,586 (6,586) (100.0) %
NET INCOME (LOSS) $ 21,184 $ 34,718 $ (13,534) (39.0) % $ 9,415 $ 32,025 $ (22,610) (70.6) %
Dividends to preferred unitholders (160) (160) — — (480) (377) (103) 27.3 %
Net (income) loss attributable to noncontrolling interests – Operating Partnership (1,387) (3,145) 1,758 (55.9) % (248) (2,550) 2,302 (90.3) %
Net (income) loss attributable to noncontrolling interests – consolidated real estate entities (8) 183 (191) (104.4) % 132 913 (781) (85.5) %
Net income (loss) attributable to controlling interests 19,629 31,596 (11,967) (37.9) % 8,819 30,011 (21,192) (70.6) %
Dividends to preferred shareholders (1,607) (1,705) 98 (5.7) % (4,921) (5,116) 195 (3.8) %
Redemption of Preferred Shares (1) — (1) (100.0) % 297 — 297 100.0 %
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS $ 18,021 $ 29,891 $ (11,870) (39.7) % $ 4,195 $ 24,895 $ (20,700) (83.1) %
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Three Months Ended September 30, Nine Months Ended September 30,
Weighted Average Occupancy (1)
2020 2019 2020 2019
Same-store 94.4 % 93.5 % 94.8 % 94.5 %
Non-same-store 93.9 % 96.3 % 93.7 % 97.2 %
Total 94.3 % 93.6 % 94.7 % 94.6 %
(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. We believe 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 our calculation of weighted average occupancy may not be comparable to that disclosed by other REITs.
Number of Apartment Homes September 30, 2020 September 30, 2019
Same-store 10,567 11,785
Non-same-store 1,343 1,551
Total 11,910 13,336
NOI is a non-GAAP 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 development 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 our 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 our real estate portfolio, and accordingly provide less useful information for evaluating ongoing operational performance of our real estate portfolio.
For the comparison of the nine months ended September 30, 2020 and 2019, five apartment communities were non-same-store. Sold communities are included in "Other," which also includes non-multifamily properties and the non-multifamily components of mixed-use properties.
Revenue. Revenue decreased by 7.0% to $44.1 million for the three months ended September 30, 2020, compared to $47.4 million in the three months ended September 30, 2019. Revenue from dispositions and other properties decreased by $6.8 million, offset by a $3.1 million increase from non-same-store communities. Revenue from same-store communities increased 1.1% or $416,000 in the three months ended September 30, 2020, compared to the same period in the prior year. The increase was attributable to 0.2% growth in average rental revenue and a 0.9% increase in occupancy as weighted average occupancy increased to 94.4% from 93.5% for the three months ended September 30, 2020 and 2019, respectively.
Revenue decreased by 5.4% to $132.5 million for the nine months ended September 30, 2020, compared to $140.0 million in the nine months ended September 30, 2019. Revenue from dispositions and other properties decreased by $19.1 million, offset by a $9.3 million increase from non-same-store communities. Revenue from same-store communities increased 2.1% or $2.3 million in the nine months ended September 30, 2020, compared to the same period in the prior year. The increase was attributable to 1.8% growth in average rental revenue and a 0.3% increase in occupancy as weighted average occupancy increased to 94.8% from 94.5% for the nine months ended September 30, 2020 and 2019, respectively.
Property operating expenses, including real estate taxes . Property operating expenses, including real estate taxes, decreased by 6.9% to $18.5 million in the three months ended September 30, 2020, compared to $19.9 million in the same period of the prior year. A decrease of $3.2 million from dispositions and other properties was offset by an increase of $1.2 million at non-same-store communities. Property operating expenses, including real estate taxes, at same-store communities increased by 4.6% or
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$705,000 in the three months ended September 30, 2020, compared to the same period in the prior year. At same-store communities, real estate taxes increased by $367,000 and insurance expenses increased by $105,000. Controllable expenses (which exclude insurance and real estate taxes) increased by $233,000. The same-store increases in controllable expenses were primarily due to increased compensation costs.
Property operating expenses, including real estate taxes, decreased by 7.1% to $55.2 million in the nine months ended September 30, 2020, compared to $59.5 million in the same period of the prior year. A decrease of $9.2 million from dispositions and other properties was offset by an increase of $3.3 million at non-same-store communities. Property operating expenses, including real estate taxes, at same-store communities increased by 3.6% or $1.7 million in the nine months ended September 30, 2020, compared to the same period in the prior year. At same-store communities, real estate taxes increased by $1.3 million. Insurance expense at same-store properties increased by $1.0 million. These same-store increases were partially offset by a decrease in controllable expenses (which exclude insurance and real estate taxes) of $624,000, primarily due to lower snow removal expenses, utility costs, and general maintenance activities, offset by increased compensation costs.
Property management expenses . Property management expense, consisting of property management overhead and property management fees paid to third parties, was $1.4 million and $1.6 million in the three months ended September 30, 2020 and 2019, respectively.
Property management expense was $4.3 million and $4.6 million in the nine months ended September 30, 2020 and 2019, respectively.
Casualty gain (loss). Casualty loss was $91,000 in the three months ended September 30, 2020, compared to $178,000 in the same period of the prior year. The current quarter's loss included $695,000 related to hail damage incurred during the quarter, offset by a reduction in the estimate of a prior quarter loss of $532,000.
Casualty loss was $1.3 million in the nine months ended September 30, 2020, compared to $911,000 in the same period of the prior year. The increase was primarily due to weather-related losses and an increase in our aggregate stop loss and deductible. During the nine months ended September 30, 2020, we incurred an estimated $2.4 million in hail damage at five communities in Rapid City, SD, and one community in Lincoln, NE, resulting in $1.1 million of casualty loss recorded during the period, largely from the write off of the affected assets. Approximately $2.0 million is expected to be spent over the next 12 months to replace the impacted assets.
Depreciation and amortization. Depreciation and amortization increased by 1.3% to $19.0 million in the three months ended September 30, 2020, compared to $18.8 million in the same period of the prior year, attributable to an increase of $1.9 million from non-same-store properties, offset by a decrease of $1.8 million from sold properties.
Depreciation and amortization was $55.3 million in the nine months ended September 30, 2020, compared to $55.3 million in the same period of the prior year, attributable to a $5.7 million decrease from sold properties, offset by an increase of $5.6 million from non-same-store properties.
General and administrative expenses. General and administrative expenses decreased by 10.8% to $3.1 million in the three months ended September 30, 2020, compared to $3.4 million in the same period of the prior year, primarily attributable to decreases in compensation, healthcare, travel, and consulting costs in the current period.
General and administrative expenses decreased by 10.1% to $9.7 million in the nine months ended September 30, 2020, compared to $10.8 million in the same period of the prior year, primarily attributable to decreases in legal fees, compensation, and travel costs.
Interest expense. Interest expense decreased by 12.0% to $6.8 million in the three months ended September 30, 2020, compared to $7.7 million in the same period of the prior year, primarily due to the replacement of maturing debt with lower rate debt and lower average balances on our lines of credit and mortgage loans.
Interest expense decrease by 11.0% to $20.6 million in the nine months ended September 30, 2020, compared to $23.2 million in the same period of the prior year, primarily due to the replacement of maturing debt with lower rate debt and lower average balances on our lines of credit and mortgage loans.
Interest and other income (loss). We recorded interest and other income of $281,000 in the three months ended September 30, 2020, compared to income of $498,000 in the same period of the prior year.
We recorded a loss of $2.0 million in interest and other income (loss) for the nine months ended September 30, 2020, compared to income of $1.4 million in the same period of the prior year. The decrease was primarily due to a $3.4 million loss in the value of our marketable securities during the during the nine months ended September 30, 2020.
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Gain (loss) on sale of real estate and other investments. We had a gain of $25.7 million in the three months ended September 30, 2020, compared to $39.1 million in the same period of the prior year.
We had a gain of $25.5 million in the nine months ended September 30, 2020, compared to $39.8 million in the same period of the prior year. Refer to Note 8 of the Notes to Condensed Consolidated Financial Statements in this Report for a table detailing our acquisitions and dispositions during the nine-month periods ended September 30, 2020 and 2019.
Net income (loss) available to common shareholders. Net income available to common shareholders was $18.0 million for the three months ended September 30, 2020, compared to $29.9 million in the three months ended September 30, 2019. Net income available to common shareholders was $4.2 million for the nine months ended September 30, 2020, compared to $24.9 million in the nine months ended September 30, 2019.
Funds from Operations .
We believe that Funds from Operations ("FFO"), which is a standard supplemental measure for equity real estate investment trusts, is helpful to investors in understanding our 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 our 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, and is not necessarily indicative of sufficient cash flow to fund all of our needs or our ability to service indebtedness or make distributions.
FFO applicable to common shares and Units for the three months ended September 30, 2020, increased to $12.6 million compared to $12.2 million for the comparable period ended September 30, 2019, an increase of 3.7%. This increase was primarily due to reductions in interest expense, debt extinguishment costs, and general and administrative expense, partially offset by decreased NOI from sold properties. For the nine months ended September 30, 2020, FFO applicable to common shares and Units decreased to $33.7 million compared to $41.1 million for the comparable period of 2019, representing a decrease of 18.2%. This decrease was primarily due to a gain on litigation settlement of $6.6 million in 2019 that did not recur in the current period, a loss on marketable securities of $3.4 million in the current period, decreased NOI from sold properties, and increased casualty loss, partially offset by reductions in interest expense, debt extinguishment costs, and general and administrative expense.
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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,
2020 2019 2020 2019
Net income (loss) available to common shareholders $ 18,021 $ 29,891 $ 4,195 $ 24,895
Adjustments:
Noncontrolling interests – Operating Partnership 1,387 3,145 248 2,550
Depreciation and amortization 18,995 18,751 55,311 55,299
Less depreciation – non real estate (85) (71) (266) (235)
Less depreciation – partially owned entities (31) (452) (346) (1,604)
(Gain) loss on sale of real estate (25,676) (39,105) (25,486) (39,774)
Funds from operations applicable to common shares and Units $ 12,611 $ 12,159 $ 33,656 $ 41,131
Funds from operations applicable to common shares and Units $ 12,611 $ 12,159 $ 33,656 $ 41,131
Dividends to preferred unitholders 160 160 480 377
Funds from operations applicable to common shares and Units - diluted $ 12,771 $ 12,319 $ 34,136 $ 41,508
Per Share Data
Earnings (loss) per common share - diluted $ 1.38 $ 2.54 $ 0.33 $ 2.11
FFO per share and Unit - diluted $ 0.90 $ 0.93 $ 2.49 $ 3.15
Weighted average shares and Units - diluted 14,143 13,087 13,704 13,174
Acquisitions and Dispositions
During the third quarter of 2020, we acquired $144.8 million in new real estate compared to $125.3 million of acquisitions in the same period of the prior year. During the third quarter of 2020, we had five dispositions for an aggregate sale price of $43.0 million, compared to seven dispositions in the third quarter of 2019 for an aggregate sale price of $85.0 million. See Note 8 of the Notes to Condensed Consolidated Financial Statements in this Report for a table detailing our acquisitions and dispositions during the nine-month periods ended September 30, 2020 and 2019.
Distributions Declared
Distributions of $0.70 and $2.10 per common share and Unit were declared during the three and nine months ended September 30, 2020 and 2019. Distributions of $0.4140625 and $1.2421875 per Series C preferred share were declared during the three and nine months ended September 30, 2020 and 2019. Distributions of $0.9655 and $2.8965 per Series D preferred unit were declared during the three and nine months ended September 30, 2020 and 2019, respectively.
Liquidity and Capital Resources
Overview
We desire to strengthen the current balance sheet, which offers financial flexibility and enables us to pursue and acquire apartment communities that enhance our portfolio composition, operating metrics, and cash flow growth prospects. We intend to strengthen our capital and liquidity positions by continuing to focus on improving our 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 our unsecured lines of credit, proceeds from property dispositions, including restricted cash related to net tax deferred proceeds, offerings of preferred and common shares under our shelf registration statement, including offerings of common shares under our 2019 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 our communities, distributions to the holders of our preferred shares, common shares, Series D preferred units, and Units, value-add redevelopment, common and preferred share buybacks and Unit redemptions, and acquisitions of additional communities.
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Although we believe that our financial condition and liquidity are sufficient to meet our reasonably anticipated liquidity demands during 2020, factors that could impact our future liquidity include, but are not limited to, volatility in capital and credit markets, our 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, 2020, we had total liquidity of approximately $131.8 million, which included $115.0 million available on our line of credit and $16.8 million of cash and cash equivalents. As of December 31, 2019, we had total liquidity of approximately $226.5 million, which included $199.9 million on our line of credit and $26.6 million of cash and cash equivalents. The decline in total liquidity since the end of the second quarter is primarily a result of funding our acquisition of Parkhouse Apartment Homes.
As of September 30, 2020, we had 45 unencumbered apartment communities, representing 64.6% of third quarter multifamily NOI, of which 4 apartment communities, representing approximately 5.4% of third quarter NOI, are not pledged under the UAP.
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 our 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, including restricted cash related to net tax deferred proceeds; offerings of preferred and common shares under our shelf registration statement, including offerings of common shares under our 2019 ATM Program; and long term unsecured term loans and secured mortgages. We have the following contractual obligations over the next fifteen months:
• no debt maturities remaining in 2020 and $35.3 million of debt maturities in 2021 and
• approximately $27.2 million remaining to fund, primarily over the next 12 months, under construction and mezzanine loans we originated for the development of a multifamily community in Minneapolis, Minnesota.
Due to the economic disruption caused by COVID-19-related events, the terms of future debt and equity issuances may not be as favorable for the foreseeable future as they have been in recent years. For a discussion of our debt facilities and the impact of COVID-19-related effects thereon, see "Debt" and "Potential Impact of COVID-19-Related Effects on Continuing Debt Availability" below.
Debt
We have an unsecured credit facility for $395.0 million, with the commitment allocated to a revolving line of credit for $250.0 million and the remaining $145.0 million allocated between two term loans: a $70.0 million unsecured term loan that matures on January 15, 2024 and a $75.0 million unsecured term loan that matures on August 31, 2025.
As of September 30, 2020, our line of credit had total commitments of $250.0 million, with borrowing capacity based on the value of properties contained in an unencumbered asset pool ("UAP"). The UAP provided for a borrowing capacity of approximately $250.0 million at quarter-end, offering additional borrowing availability of $115.0 million beyond the $135.0 million drawn, including the balance on our operating line of credit, as of September 30, 2020. At December 31, 2019, the line of credit borrowing capacity was $250.0 million based on the UAP, of which $50.1 million was drawn on the line, including the balance on our operating line of credit. This credit facility matures on August 31, 2022, with one twelve-month option to extend the maturity date at our election.
As of September 30, 2020, we had a private shelf agreement for the issuance of up to $150.0 million of unsecured senior promissory notes. In September 2019, we issued $75.0 million of Series A notes due September 13, 2029, bearing interest at a rate of 3.84% annually, and $50.0 million of Series B notes due September 30, 2028, bearing interest at a rate of 3.69% annually, under this facility. An additional $25.0 million remains available under this agreement.
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 August 1, 2021, with pricing based on a market spread plus the one-month LIBOR index rate.
Mortgage loan indebtedness was $314.5 million and $331.4 million on September 30, 2020 and December 31, 2019, 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, 2020, the weighted average interest rate on our mortgage debt was 3.99%.
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Potential Impact of COVID-19-Related Effects on Continuing Debt Availability
Although we are in compliance with our 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 our credit facility if:
• we are unable to make certain representations and warranties, including a certification that, since April 30, 2018, there has been no adverse change in our 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 consolidated property NOI or capitalization rates applicable to the properties in our borrowing base reduce or eliminate availability under our credit facility; or
• changes in the nature and composition (including occupancy rate) of the properties in our borrowing base cause these properties to become ineligible to be part of our borrowing base, and if we are not able to replace such properties with other qualifying properties, such ineligibility could reduce or eliminate the availability under our credit facility.
Even if we remain in compliance with the foregoing representations, warranties, and covenants, we may be unable to access the full amount available under our 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 our 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 our 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.
As of the date of this filing, we have not experienced any restrictions or limitations on the availability of credit in our markets or with our lenders, although there can be no assurance that we will continue to be able to access the credit markets generally or our credit facility in the future.
Equity
We have an equity distribution agreement in connection with the 2019 ATM Program through which we may offer and sell common shares having an aggregate gross sales price of up to $150.0 million, in amounts and at times that we determine. The proceeds from the sale of common shares under the 2019 ATM program are intended to be used for general corporate purposes, which may include the funding of future acquisitions and the repayment of indebtedness. During the nine months ended September 30, 2020, we issued approximately 819,082 common shares under the 2019 ATM program at an average price of $70.23 per share, net of commissions. Total consideration, net of commissions and issuance costs, was $57.5 million. As of September 30, 2020, common shares having an aggregate offering price of up to $69.2 million remained available under the 2019 ATM Program.
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 our 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, 2020, we generated capital from various activities, including:
• Receiving $57.5 million in net proceeds from the issuance of 819,082 common shares under our 2019 ATM Program;
• Receiving $10.0 million for the payoff of a note receivable;
• Selling $3.9 million of marketable securities;
• Disposing of four apartment communities in Grand Forks, North Dakota and one commercial property for $43.0 million; and
• Selling a parcel of unimproved land for $1.3 million.
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During the nine months ended September 30, 2020, we used capital for various activities, including:
• Acquiring Ironwood Apartments, a 182-home apartment community located in New Hope, Minnesota, an inner-ring suburb of Minneapolis, for an aggregate purchase price of $46.3 million, of which $28.6 million was paid in cash and $17.7 million from payoff of a note receivable and accrued interest;
• Acquiring Parkhouse Apartment Homes, a 465-home apartment community located in Thornton, Colorado, a suburb of Denver, for an aggregate purchase price of $144.8 million;
• Acquiring the remaining noncontrolling interests in 71 France for $12.2 million;
• Funding of mezzanine/construction loans of $11.9 million;
• Repaying $16.9 million of mortgage principal;
• Repurchasing 237,007 Series C preferred shares for an aggregate total cost of approximately $5.6 million;
• Funding acquisition capital for apartment communities of approximately $1.3 million; and
• Funding capital improvements for apartment communities of approximately $20.4 million.
Contractual Obligations and Other Commitments
Contractual obligations and other commitments were disclosed in our Form 10-K for the year ended December 31, 2019. 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, 2020, 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 our critical accounting policies is included in our Form 10-K for the year ended December 31, 2019, filed with the SEC on February 19, 2020 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 our critical accounting policies during the nine months ended September 30, 2020.
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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.