ITEM 1. BUSINESS Introduction
The Company is a real estate investment trust engaged in the acquisition and operation of apartment communities in the Southwestern United States. At December 31, 1995, the Company owned 18 apartment communities, containing 2,683 units, located in Phoenix and Tucson, Arizona, Houston, Texas and Albuquerque, New Mexico. As of such date, the total book value of the apartments was $71.3 million, and the apartments were subject to first mortgage loans totaling $49.6 million. Each of the properties is owned by a wholly owned subsidiary of the Company and the first mortgage loans are generally non-recourse and non-cross collateralized. The Company also owned through joint ventures six apartment communities, containing 1,441 units, located in Phoenix and Tucson, Arizona. The Company's investments in the joint ventures totalled $3.0 million at December 31, 1995.
Prior to 1993, the Company invested in mortgage assets ("Mortgage Assets") that entitled it to receive the excess cash flows from a pool of mortgage instruments over the required payments on the related structured financing. In early 1993, the Company determined to shift its focus to the acquisition, development and operation of apartment communities. The Company plans to hold the existing Mortgage Assets and use the cash flows for apartment acquisitions, operations, payment of dividends and other corporate purposes. At December 31, 1995, the Mortgage Assets had a carrying value of $11.9 million, of which $7.6 million were pledged as collateral for short-term borrowing of $4.5 million.
Pima Mortgage Limited Partnership (the "Manager") manages the day-to-day operations of the Company, subject to the supervision of the Company's Board of Directors, pursuant to the terms of a management agreement. The Company also has entered into property management agreements with Pima Realty Advisors, Inc. (the "Property Manager"), an affiliate of the Manager, for each of its current apartment properties.
The Company has elected to be taxed as a real estate investment trust ("REIT") pursuant to sections 856 through 860 of the Code. The Company generally will not be subject to tax on its income to the extent that it distributes its taxable income to its stockholders and it maintains its qualification as a REIT. See "Business -- Federal Income Tax Considerations."
The Company was incorporated in the State of Maryland on June 18, 1987 and commenced its operations on August 26, 1987. The Company's Common Stock is listed on the American Stock Exchange under the symbol "ASR." The Company effected a reserve stock split on July 7, 1995 under which one new share of common stock was issued in exchange for five shares of outstanding common stock. Accordingly, all data relating to the number of shares and per share amounts for prior periods have been adjusted to reflect the reverse stock split.
The principal executive offices of the Company and the Manager are located at 335 North Wilmot, Suite 250, Tucson, Arizona 85711, telephone number (520) 748-2111. Unless the context otherwise requires, the term Company means ASR Investments Corporation and its subsidiaries.
Operating Policies And Strategies
Real Estate Activities Introduction
The Company has developed various business objectives and operating, acquisition, financing and investment strategies and policies relative to its real estate activities. These policies and strategies have been determined by the directors of the Company and may be amended or revised from time to time at the discretion of the directors without a vote of the stockholders of the Company.
Business Objectives
The Company's current business objectives are to increase the cash flow and value of its existing portfolio of apartment communities and to acquire additional communities.
Investment Policies
The Company's current portfolio consists of apartment communities in the southwestern region of the United States and investments in joint ventures that own apartment communities. The Company intends to continue to focus on apartment communities in this region. However, future investments, including the activities described below, are not limited (as to percentage of assets or otherwise) to any geographic area or any specific type of property. In this regard, the Company expand its current geographic focus and may acquire other types of income-producing properties, including hotels, motels, shopping centers and office buildings.
The Company believes that attractive opportunities continue to be available to acquire apartment communities. The Company may enter into agreements to acquire newly developed properties upon completion or upon achievement of certain specified occupancy rates. The Company also intends to develop new apartment communities for its own account or through joint ventures with others.
The Company may purchase or lease income-producing properties for long-term investment and improve its properties, or sell such properties, in whole or in part, when circumstances warrant. The Company also may participate with other entities in property ownership, through joint ventures or other types of co-ownership. Equity investments may be subject to existing mortgage financing and other indebtedness or such financing or indebtedness may be incurred in connection with acquiring investments. Any such financing or indebtedness will have a priority over the equity interest of the Company.
While the Company will emphasize equity real estate investments in properties, it may, in its discretion, invest in mortgages and other real estate interests or make loans secured by mortgages on or interests in real estate properties. Its investments in mortgages may include participating or convertible mortgages if the Company concludes that it may benefit from the cash flow and/or any appreciation potential in the value of the property. Such mortgages may be similar to equity participations.
Subject to the percentage of ownership limitations and gross income tests necessary for REIT qualification (see "Federal Income Tax Considerations"), the Company also may invest in securities of concerns engaged in real estate activities or securities of other issuers. The Company in the future may acquire all or substantially all of the securities or assets of other REITs or similar entities when it believes such investments would be consistent with the Company's investment policies. In any event, the Company does not intend that its investments in securities will require the Company to register as an "investment company" under the Investment Company Act of 1940, and the Company intends to divest securities before any such registration would be required.
Acquisitions In evaluating acquisitions, the Company considers such factors as: (i) the geographic location and type of property; (ii) the age, construction quality, condition and design of the property; (iii) the current and projected cash flow of the property and the potential to increase cash flow; (iv) the potential for capital appreciation of the property; (v) the terms of tenant leases, including the potential for rent increases; (vi) the potential for economic growth and the tax and regulatory environment of the community in which the property is located; (vii) the occupancy and demand by tenants for properties of similar type in the vicinity; and (viii) the prospects for liquidity through sale, financing or refinancing of the property.
In acquiring apartment properties, the Company generally seeks properties that (a) are available at prices below estimated replacement cost after initial renovations and improvements, or can be developed at a cost that is below the estimated value upon completion, (b) are well-located in their markets and (c) are capable of enhanced performance through intensive asset management and cosmetic improvements.
Operating Strategies
The Company's operating strategies are to (i) achieve and maintain high occupancy and increase rental rates through effective leasing, reducing turnover rates and providing quality maintenance and services to maximize tenant satisfaction; (ii) manage operating expenses and achieve cost reductions through operating efficiencies and economies of scale generally inherent in the management of a large property portfolio in a specific region; and (iii) emphasize regular programs of repairs and capital improvements to enhance the properties' competitive advantages in their respective markets.
Financing Policies The Company intends to finance acquisitions with the most appropriate sources of capital, which may include undistributed funds from operations, the issuance of equity securities, the sale of assets, bank and other institutional borrowings and the issuance of debt securities. Future borrowings by the Company for acquisitions may be either on a secured or unsecured basis.
The Company also may incur indebtedness for purposes other than the acquisition of properties when the Company believes it is advisable to do so. For short-term purposes, the Company, from time to time, may arrange for short-term borrowings from banks or in the commercial paper market or otherwise. The Company also may arrange for long-term borrowings from institutional lenders or through public or private offerings or other means. The Company has no commitments from anyone with respect to any such borrowings, and there is no assurance that any such borrowings will be available.
In addition, the Company may incur debt secured by equity investments held in its portfolio. The Company may invest in properties subject to existing loans secured by mortgages, deeds of trust or similar liens on the properties, or such financing and other indebtedness may be incurred in connection with acquiring investments. The Company also may obtain other mortgage financing for unleveraged or underleveraged properties or may refinance properties acquired on a leveraged basis. The mortgage financings may be recourse, non- recourse or cross-collateralized. The Company does not have a policy limiting the number or amount of mortgages that may be placed on any particular property, but mortgage financing instruments usually limit additional indebtedness on such properties. The Company also may determine to finance acquisitions through the exchange of properties or issuance of stock or other securities.
Policies with Respect to Other Activities
The Company may make investments other than as previously described. The Company has authority to offer its Common Shares or other equity or debt securities in exchange for property and to repurchase or otherwise reacquire its Common Shares or any other securities and may engage in such activities in the future. The Company also may in the future make loans to joint ventures in which it participates. The Company will not engage in trading, underwriting or the agency distribution or sale of securities of other issuers. At all times, the Company intends to make investments in such a manner as to be consistent with the requirements of the Code to qualify as a REIT unless, because of circumstances applicable to the Company, changes in the Code (or changes in the regulations promulgated under the Code), the Company determines that it is no longer in the best interests of the Company to qualify as a REIT. The Company's policies with respect to such activities may be reviewed and modified from time to time by the Company without the vote of the stockholders.
Property Management
The Company has entered into property management agreements with Pima Realty Advisors, Inc. (the "Property Manager") for each of its current apartment communities. The Property Manager is an affiliate of the Manager. Each property management agreement, which has a current term through December 31, 1996, was approved by the Unaffiliated Directors. Under each agreement, the Property Manager provides the customary property management services at its cost without profit or distributions to its owners, subject to the maximum limitation of the prevailing management fee rates for similar properties in the market. The Property Manager currently manages over 5,000 apartment units, including those owned by the Company.
The Property Manager has developed computer, accounting, management, reporting and control systems to monitor property operations. Detailed annual budgets are prepared for each property. Monthly, quarterly and annual reports are prepared addressing occupancy rates, turnover ratios, budget variances, delinquencies and other operating information. Weekly reports are provided for each property detailing leasing and occupancy activities. The Property Manager also maintains and analyzes demographic resident data. Prior to entering into a lease, the Property Manager generally reviews the credit of the prospective tenant to attempt to minimize bad credit risks and identify tenants having a poor rental history. This information is intended to enable the Property Manager to identify and act quickly on specific conditions affecting individual properties.
Each of the current properties is operated by a staff, including a resident manager and a maintenance and apartment preparation staff. Policies and procedures utilized at the property sites follow established federal and state laws and regulations, including lease contracts, on-site marketing procedures, credit collection and eviction standards. As a result of active onsite management and strict prospective tenant qualification standards, the Company expects to experience low rent loss to delinquencies or early lease terminations.
Individual property lease programs are structured to respond to local market conditions. The Company attempts to balance rent increases with high occupancy and stabilized turnover costs. None of the current properties is currently subject to rent control or rent stabilization regulations. Standard lease terms stipulate due dates for rent payments, late charges, no offset or withholding provisions, security deposits and damage reimbursement clauses and other provisions considered favorable to the Company.
Development of Properties
In March 1996, the Company commenced the development of a luxury apartment community located in Tempe, Arizona. The community is being built on 20 acres and is planned for 356 units with an average size of 919 square feet. The total estimated cost of the community is approximately $20 million, and the Company has obtained a construction loan for $15,350,000. The Company expects to have the first group of units available for rent near the end of 1996 and the community completed in the third quarter of 1997. As of December 31, 1995, the Company had invested $3.0 million.
The Company has acquired three other parcels of land for future development of apartment communities. The Company may develop or sell one or more of these parcels. As of December 31, 1995, the Company had invested $900,000.
Current Properties
As of December 31, 1995, the Company owned 24 apartment communities consisting of 4,124 units located in Arizona, New Mexico and Texas. All of the apartment communities are owned directly by the Company with the exception of six which are owned through joint ventures with affiliates of Citicorp.
The apartment communities are "garden apartments" (two to three story apartments with ground level parking) with recreational facilities such as pools and clubhouses. They are well maintained and landscaped and are targeted at providing an attractive lifestyle at low to moderate rents. Average monthly rent at year end was $495 per month, with community averages ranging from $385 to $862.
The following table set forth certain information regarding the Company's existing apartment communities.
Mortgage Assets
General
Each of the Company's Mortgage Assets entitle the Company to receive the excess of the cash flows (the "Net Cash Flows") on pools of residential mortgage loans and mortgage-backed certificates (collectively the "Mortgage Instruments") over the required payments on the related series of structured financing (the "Structured Financing") secured by such Mortgage Instruments. All of the Mortgage Instruments bear fixed interest rates and a portion of the Structured Financing bears variable interest rates that are adjusted monthly or quarterly. The Net Cash Flows result primarily from (i) the favorable spread between the interest rates on the Mortgage Instruments over those on the Structured Financing, (ii) reinvestment income on the funds collected on the Morgage Instruments before payment on the Structured Financing, (iii) any prepayments of the Mortgage Instruments that are not necessary for payments on the Structured Financing, and (iv) net proceeds from early redemption of Structured Financing. For most of the Mortgage Assets, the Company has the option to redeem the Structured
Financing (generally at par) after the specified conditions are met, generally when the outstanding balance of the Structured Financing declines below a specified amount or after a specified date. In such event, the Mortgage Instruments are sold and the net proceeds after redemption of the Structured Financing are remitted to the Company.
At December 31, 1995, the carrying value of the Company's Mortgage Assets was $11.9 million. The Company does not intend to acquire any additional Mortgage Assets, but plans to hold the existing Mortgage Assets and use the cash flows for apartment acquisitions, operations, payment of dividends and other corporate purposes.
Each Structured Financing is issued in series consisting of several classes. Each series of Structured Financing generally constitutes a nonrecourse obligation of the Company, which is payable solely from the pledged Mortgage Instruments. Each series is structured so that the monthly payments on the pledged Mortgage Instruments, together with the reinvestment income at assumed rates, are sufficient to make the required interest and principal payments on the series on a timely basis. Principal and interest payments (including prepayments) on the Morgage Instruments are first applied to principal and interest payments on one or more classes of the Structured Financing according to the terms of the related indenture, and any excess cash flow is remitted to the Company. Factors Affecting Net Cash Flows
The Net Cash Flows represent both the return of and the return on the investment in the Mortgage Assets. Thus, Mortgage Assets are amortizing assets. The principal factors which influence the Net Cash Flows of a Mortgage Asset are as follows:
(1) Other factors being equal, Net Cash Flows in each payment period tend to decline over the life a Structured Financing, because (a) as normal amortization of principal and principal prepayments occur on the Mortgage Instruments, the principal balances of the Mortgage Instruments are reduced; (b) the principal payments on the Mortgage Instruments generally are first used to pay the principal on the earlier, lower-yielding classes of such Structured Financing, thereby resulting in a reduction of the favorable spread between the interest rate on the Mortgage Instruments and the interest rates on the outstanding classes, and (c) the higher coupon Mortgage Instruments are likely to be prepaid faster, reinforcing the same effect.
(2) The rate of prepayments on the Mortgage Instruments significantly affects the Net Cash Flows. Because prepayments shorten the life of the Mortgage Instruments, a higher rate of prepayments normally reduces overall Net Cash Flows. The rate of prepayments is affected by mortgage interest rates and other factors. Generally, increases in mortgage interest rates reduce prepayment rates, while decreases in mortgage interest rates increase prepayment rates. In addition, prepayments occuring during the early life of a Structured Financing have a more negative effect on Net Cash Flows than the same volume of prepayments have at a later date.
(3) With respect to variable rate classes of the Structured Financing, increases in the interest rate index increase the interest payments and thus reduce or, in some instances, eliminate the Net Cash Flows, while decreases in the index decrease the interest payments and thus increase the Net Cash Flows.
(4) The interest rate at which the monthly cash flow from the Mortgage Instruments may be reinvested until payment dates for the Structured Financing influences the amount of the Net Cash Flows unless such reinvestment income is not paid to the owner of the Mortgage Asset.
(5) The administrative expenses, if any, of a series of Structured Financing may increase as a percentage of Net Cash Flows where some of such administrative expenses are fixed. In later years, it can be expected that fixed expenses will exceed the available cash flow. Although reserve funds generally are established to cover such shortfalls, there can be no assurance that such reserves will be sufficient to cover such shortfalls. The Company may be liable for administrative expenses relating to a series of Structured Financing if reserves prove to be insufficient. Moreover, any unanticipated liability or expenses with respect to the Structured Financing could adversely affect Net Cash Flows.
(6) The Net Cash Flows from the early redemptions of a Mortgage Asset are determined by the principal balance and market value of the Mortgage Instruments. Generally, lower mortgage interest rates
result in higher market value for the Mortgage Instruments. Furthermore, when a Mortgage Asset is redeemed, there will not be any future Net Cash Flows from that Mortgage Asset. CAPITAL RESOURCES
Subject to the terms of the Company's Bylaws, the availability and cost of borrowings, various market conditions and restrictions that may be contained in the Company's financing arrangements from time to time and other factors as described herein, the Company increases the amount of funds available for its activities with the proceeds of borrowings including mortgage loans, short-term borrowing and other credit arrangements. It can be anticipated that a substantial portion of the assets of the Company will be pledged to secure indebtedness incurred by the Company. Accordingly, such assets will not be available for distribution to the stockholders of the Company in the event of the Company's liquidation except to the extent that the value of such assets exceeds the amount of such indebtedness.
The Company has obtained a first mortgage loan for each of its 18 apartment communities. At December 31, 1995, the mortgage loans totalled $49.6 million, of which $46.0 million bears fixed interest rates that averaged 8.6% and $3.6 million bears a variable interest rate at the LIBOR rate plus 2.25%. In addition, each of the Company's joint ventures has obtained a first mortgage loan. The mortgage loans generally are non-recourse to the Company and are not cross-collateralized.
The Company also had outstanding short-term borrowings of $4.5 million at December 31, 1995 that were secured by Mortgage Assets with a total carrying value of $7.6 million. Under the short-term borrowings, if the value of the collateral (as estimated by the lender) declines, the Company is required to provide additional collateral or reduce the borrowed amount.
During 1995, the Company used the proceeds from Mortgage Asset redemptions and short-term borrowing to prepay the notes payable secured by Mortgage Assets and the unsecured real estate notes payable. The Company plans to use the proceeds from Mortgage Asset redemptions in 1996 to reduce the short-term borrowing.
The Company's Bylaws provide that it may not incur indebtedness if, after giving effect to the incurrence thereof, aggregate indebtedness , secured and unsecured, would exceed 300% of the Company's net assets, on a consolidated basis, unless approved by a majority of the Unaffiliated Directors. For this purpose, the term "net assets" means the total assets (less intangibles) of the Company at cost, before deducting depreciation or other non-cash reserves, less total liabilities, as calculated at the end of each quarter in accordance with generally accepted accounting principles.
The Company may increase its capital resources by making additional offerings of its Common Stock or securities convertible into the Company's Common Stock. The actual or perceived effect of such offerings may be the dilution of the book value or earnings per share which may result in the reduction of the market price of shares of the Company's Common Stock. The Company is unable to estimate the amount, timing or nature of future sales of its Common Stock as such sales will depend upon market conditions and other factors. See "Business -- Special Considerations -- Future Offerings of Common Stock."
Operating Restrictions
The Company presently may not purchase commodities or commodity futures contracts (other than interest rate futures when used solely for hedging). The Company may not invest in unimproved real property or underwrite securities of other issuers. The foregoing restrictions may not be changed without the approval of the holders of a majority of the outstanding shares of the Company's Common Stock.
Except as otherwise restricted, the operating policy of the Company is controlled by its Board of Directors, which has the power to modify or alter such policy without the consent of the stockholders. Although the Company has no present intention of modifying its operating policies described herein, the Board of Directors in the future may conclude that it would be advantageous for the Company to do so.
Competition
There are numerous real estate companies, insurance companies, financial institutions, pension funds and other property owners that compete with the Company in seeking properties for acquisition and in attracting and retaining tenants. Employees
The Company currently has five full-time salaried employees.
Management Agreement
The Manager is an Arizona limited partnership. The Manager engages in the business of advising the Company with respect to various aspects of the Company's business and operations, managing the overall business and operations of the Company and representing the Company in its dealings with third parties. Jon A. Grove, Frank S. Parise, Jr. and Joseph C. Chan have been directors or officers of general partners of the Manager since its organization.
Terms Of The Management Agreement
The Company and the Manager are parties to a Management Agreement with a term expiring on December 31, 1996, subject to annual extensions between the Company and the Manager. The Management Agreement may be terminated by the Company without cause at any time upon 60 days written notice by a majority vote of its Unaffiliated Directors or by a vote of the holders of a majority of the outstanding shares of Common Stock. In addition, the Company has the right to terminate the Management Agreement for cause in the event of (i) a breach by the Manager of any provision contained in the Management Agreement occurs; (ii) an order for relief is entered with respect to the Manager in an involuntary case under federal or state bankruptcy, insolvency or other similar laws; or (iii) the Manager (a) ceases or admits in writing its inability to pay its debts as they become due, or makes a general assignment for the benefit of or enters into an arrangement with creditors, (b) applies for or consents to the appointment of a receiver, trustee, assignee, custodian, liquidator or sequestrator, or proceedings seeking such appointment are commenced, (c) authorizes or files a voluntary petition in bankruptcy, or applies for or consents to the application of any bankruptcy, reorganization, arrangement, readjustment of debt, insolvency, dissolution, liquidation or other similar law, or proceedings to such end are instituted against the Manager, or (d) permits or suffers all or any substantial part of its properties or assets to be sequestered or attached by court order, or (iv) if any two of Messrs. Grove, Parise or Chan shall cease to be a director, officer or shareholder of at least one partner of the Manager or if they collectively cease to control the majority of the voting decisions of the Manager.
The Manager at all times is subject to the supervision of the Company's Board of Directors and has only such functions and authority as the Company may delegate to it. The Manager is responsible for the day-to-day operations of the Company and performs such services and activities relating to the assets and operations of the Company as may be appropriate, including:
(a) serving as the Company's consultant with respect to formulation of investment criteria by the Board of Directors;
(b) representing the Company in connection with the purchase of assets;
(c) structuring financings of the Company;
(d) furnishing reports and statistical and economic research to the Company regarding the Com- pany's activities and the services performed for the Company by the Manager;
(e) providing the executive and administrative personnel, office space and services required in rendering services to the Company;
(f) administering the day-to-day operations of the Company and performing and supervising the performance of such other administrative functions necessary in the management of the Company as may
be agreed upon by the Manager and the Board of Directors, including the collection of revenues, the payment of the Company's debts and obligations and maintenance of appropriate computer services to perform such administrative functions;
(g) communicating on behalf of the Company with the holders of the equity and debt securities of the Company as required to satisfy the reporting and other requirements of any governmental bodies or agencies and to maintain effective relations with such holders;
(h) counseling the Company in connection with policy decisions to be made by the Board of Directors; and
(i) upon request by and in accordance with the direction of the Board of Directors, investing or reinvesting any money of the Company.
Management Fee
The Manager receives an annual management fee equal to 3/8 of 1% of the "Average Invested Assets" of the Company and its subsidiaries for each year. The Management Agreement provides for a quarterly management fee, although the Board of Directors has approved payment of the management fee monthly, with adjustments made quarterly. The term "Average Invested Assets" for any period means the average of the aggregate book value of the consolidated assets of the Company and its subsidiaries before reserves for depreciation or bad debts or other similar non-cash reserves. In the event that the Management Agreement is terminated by the Company or is not renewed by the Company on terms at least as favorable to the Manager as the current Management Agreement, other than as a result of a termination by the Company for cause (as specified above and defined in the Management Agreement), the Manager will be entitled to receive from the Company the management fee that would have been payable by the Company to the Manager pursuant to such Management Agreement based on the investments made by the Company prior to the date on which the Management Agreement is so terminated (or not renewed) for the 12 full fiscal quarters beginning on the date of such termination (or failure to renew) as more fully described in the Management Agreement.
The management fee must be calculated by the Manager within 45 days after the end of each quarter, and such calculation must be promptly delivered to the Company for payment within 60 days of the end of each fiscal quarter, subject to adjustment at the end of the year.
For information relating to management fees, see Note 7 to consolidated financial statements.
Administration Fees
The Manager also performs certain analysis and other services in connection with the administration of the Structured Financing relating to the Company's Mortgage Assets, including working with the Master Servicer, if any, and the Company or the other Issuer to ensure proper servicing and administration. For such activities, the Company currently pays the Manager an annual administration fee of $10,000 for each Mortgage Asset acquired before 1991, $20,000 for the total Mortgage Assets acquired in 1991 and $20,000 for the total Mortgage Assets acquired in 1992.
Expenses
The Manager is required to pay employment expenses of its personnel, rent, telephone, utilities and other office expenses (except those relating to a separate office or office facilities, if any, maintained by the Company or its subsidiaries, if any), and certain travel and miscellaneous administrative expenses of the Manager. The Company is required to pay all other expenses of operation (as set forth in the Management Agreement) up to an amount per year with respect to certain of such expenses equal to the greater of 2% of the Company's Average Invested Assets or 25% of the Company's Net Income for that year. Expenses in excess of such amount will be paid by the Manager, unless the Unaffiliated Directors determine that, based upon unusual or non-recurring factors, a higher level of expenses is justified for such fiscal year. In the event that the Company's operating expenses for any fiscal year total less than the greater of 2% of the Company's Average Invested Assets or 25% of its Net Income for that fiscal year, then, within 120 days after the end of such fiscal year, with the consent of the Unaffiliated Directors, the
Manager will be repaid all compensation previously reimbursed by the Manager to the Company on account of operating expenses having exceeded the greater of 2% of its Average Invested Assets or 25% of its Net Income during one or more prior fiscal years, except that the amount of any repayment of compensation to the Manager may not, when added to all other operating expenses of the Company for such fiscal year, exceed the greater of 2% of the Company's Average Invested Assets or 25% of its Net Income for that fiscal year. The Manager's right to repayment of previously reimbursed compensation will be cumulative, and the amount of previously reimbursed compensation which has not been repaid to the Manager will be carried forward to and be repaid to the Manager in subsequent fiscal years. Prior to any such repayment, the Unaffiliated Directors must determine that the Company's operating expenses which were in excess of the limitation set forth above in one or more prior fiscal years were reasonable when incurred in connection with the operations of the Company.
Right of First Refusal
The Manager has granted the Company a right of first refusal, for as long as the Manager or an affiliate of the Manager acts as the Company's manager pursuant to the Management Agreement or any extension thereof, to purchase any assets held by the Manager or its affiliates prior to any sale, conveyance or other transfer, voluntarily or involuntarily, of such assets by the Manager or its affiliates. See "Business -- Special Considerations -- Potential Conflicts of Interest."
Limits of Responsibility
Pursuant to the Management Agreement, the Manager will not assume any responsibility other than to render the services called for thereunder and will not be responsible for any action of the Company's Board of Directors in following or declining to follow its advice or recommendations. The Manager, the partners of the Manager and any of their partners, directors, officers, stockholders and employees will not be liable to the Company, any other Issuer, any subsidiary of the Company, the Unaffiliated Directors, the Company's stockholders or any subsidiary's stockholders for acts performed in accordance with and pursuant to the Management Agreement, except by reason of acts constituting bad faith, willful misconduct, gross negligence or reckless disregard of their duties under the Management Agreement. The Company has agreed to indemnify the Manager, the partners of the Manager and any of their partners, directors, officers, stockholders and employees, with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from any of their acts or omissions not constituting bad faith, willful misconduct, gross negligence or reckless disregard of duties, performed in good faith in accordance with and pursuant to the Management Agreement. The Management Agreement does not limit or restrict the right of the Manager, the partners of the Manager or any of their partners, directors, officers, stockholders, employees or affiliates from engaging in any business or rendering services of any kind to any other person, including the purchase of, or rendering advice to others purchasing, assets which meet the Company's policies and criteria, except that the Manager (but not its partners or any of their partners, directors, officers, stockholders, employees or agents) is not permitted to provide any such services to any residential mortgage REIT other than the Company and its subsidiaries. The Manager has the right to subcontract with third parties, including affiliates of the Manager, to provide services to the Manager and the Company. Any payment of fees to such third parties will be the sole responsibility of the Manager.
The Subcontract Agreement
The Manager and American Southwest Financial Services ("ASFS"), Inc. are parties to a Subcontract Agreement pursuant to which ASFS performs certain services for the Manager in connection with the administration of the Structured Financing issued by any Issuer affiliated with ASFS with respect to which the Company owns the Mortgage Asset. Under the Subcontract Agreement, ASFS charges an administration fee for each series of Structured Financing of $12,500 per year. ASFS is a wholly-owned subsidiary of American Southwest Holdings, Inc., a privately held Arizona corporation engaged in the business of issuing and administering the Structured Financing. Jon A. Grove, Chairman and President of the Company, owns 12.5% of American Southwest Holdings, Inc.
The Subcontract Agreement extends through December 31, 1996. Thereafter, successive extensions, each for a period not to exceed one year, may be made by agreement between the Manager and ASFS.
The Subcontract Agreement may be terminated by either party upon six months prior written notice, except that the Manager may terminate the Subcontract Agreement at any time upon 60 days written notice in the event the Company no longer retains the Manager. In addition, the Manager has the right to terminate the Subcontract Agreement upon the happening of certain specified events, including a breach by ASFS of any provision contained in the Subcontract Agreement.
The Company has agreed to indemnify and hold harmless ASFS, its affiliates and their officers and directors from any action or claim brought or asserted by any party by reason of any allegation that ASFS or its affiliates is an affiliate or is otherwise accountable or liable for the debts or obligations of the Company or its affiliates. The Company has no affiliations, agreements or relationships with ASFS or its affiliates, except for (i) the Subcontract Agreement with ASFS, (ii) the indemnification granted by the Company to ASFS, its affiliates and their officers and directors against certain liabilities, (iii) one common director and officer and (iv) the indirect ownership by a general partner of the Manager of 12.5% of the voting stock of American Southwest Holdings, Inc.
Property Management Agreement
The Company has entered into property management agreements with Pima Realty Advisors, Inc. (the "Property Manager") for each of its current properties. The Property Manager is an affiliate of the Manager. Each property management agreement, which has a current term through December 31, 1996, was approved by the Unaffiliated Directors. Under the agreements, the Property Manager provides the customary property management services at its cost without profit or distributions to its owners, subject to the limitation of the prevailing management fee rates for similar properties in the market. The Property Manager currently manages over 5,000 apartment units, including those owned by the Company.
The Property Manager has developed computer, accounting, management, reporting and control systems to monitor property operations. Detailed annual budgets are prepared for each property. Monthly, quarterly and annual reports are prepared addressing occupancy rates, turnover ratios, budget variances, delinquencies and other operating information. Weekly reports are provided for each property detailing leasing and occupancy activities. The Property Manager also maintains and analyzes demographic resident data. Prior to entering into a lease, the Property Manager generally reviews the credit of the prospective tenant to attempt to minimize bad credit risks and identify tenants having a poor rental history. This information is intended to enable the Property Manager to identify and act quickly on specific conditions affecting individual properties.
Each of the current properties is operated by a staff including a resident manager and a maintenance and apartment preparation staff. Policies and procedures utilized at the property sites follow established federal and state laws and regulations, including lease contracts, on-site marketing procedures, credit collection and eviction standards. As a result of active onsite management and strict prospective tenant qualification standards, the Company expects to experience low rent loss to delinquencies or early lease terminations.
Special Considerations
Real Estate Investment Considerations
General
Real property investments are subject to varying degrees of risk. The yields available from equity investments in real estate depend on the amount of income earned and capital appreciation generated by the related properties as well as the expenses incurred. If the properties do not generate income sufficient to meet operating expenses, including debt service and capital expenditures, the Company's income will be adversely affected. Income from the properties may be adversely affected by the general economic climate (including unemployment rates), local conditions such as oversupply of competing properties or a reduction in demand for properties in the area, the attractiveness of the properties to tenants, competition from other available properties, the affordability of single family homes, the ability of the Company
to provide adequate maintenance and insurance and increased operating costs (including real estate taxes). Certain significant expenditures associated with an investment in real estate (such as mortgage payments, real estate taxes and maintenance costs) generally are not reduced when circumstances cause a reduction in income from the investment. In addition, income from properties and real estate values are also affected by a variety of other factors, such as governmental regulations and applicable laws (including real estate, zoning and tax laws), interest rate levels and the availability of financing. Furthermore, real estate investments are relatively illiquid and, therefore, will tend to limit the Company's ability to vary its portfolio promptly in response to changes in economic or other conditions.
Potential Environmental Liability
Under various federal, state and local laws, ordinances and regulations, an owner of real estate may be held liable for the costs of removal or remediation of certain hazardous or toxic substances located on or in the property. These laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of the hazardous or toxic substances. The presence of such substances, or the failure to remediate such substances properly, may adversely affect the owner's ability to sell or rent the property or to borrow using the property as collateral. Other federal and state laws require the removal of damaged asbestos-containing material in the event of remodeling or renovation.
All of the current properties have been subject to a Phase I environmental site assessment and limited asbestos survey (which involve inspection without soil or groundwater analysis) by independent environmental consultants engaged by the Company at the time of acquisition. As a result of the findings of the Phase I environmental assessment, a Phase II assessment involving soil and groundwater testing was performed at four properties by independent environmental consultants. The assessment shows that the groundwater at one of the properties is contaminated. Based on the report of the environmental engineers, the Company believes that the contamination has been caused by a nearby service station and that the owner of the station has commenced clean up procedures under the direction of the local governmental authority. The Company has informed the local governmental authority of the groundwater contamination and asked the authority to expand the clean up procedures to include the Company's property. The Company believes that the environmental liability for its property would not have a material adverse effect on the Company's business or results of operations.
The Company has determined that there are minor amounts of asbestos-containing materials ("ACMs") in five of the Company's properties. The Company maintains an Operations and Maintenance Program that details operating procedures with respect to ACMs prior to any renovation and that requires periodic inspection by the Company's employees for any change in condition of existing ACMs.
In addition, the apartment site under development in Tempe, Arizona was formerly used for agricultural purposes and a portion of the site was used as the runway for a pesticide aerial application firm located adjacent to the apartment site. The site of the pesticide aerial application firm is currently a subject of remediation by the U.S. Enviromental Protection Agency ("EPA") and the Arizona Department of Enviromental Quality ("ADEQ"). Extensive soil tests on the apartment site revealed that a few samples contained minor amounts of toxaphene above the regulatory level. The Company engaged an independent environmental consulting firm to conduct a "site specific risk assessment" to evaluate the potential threat to human health based on exposures and conditions unique to the site. The consulting firm's report indicates that the potential threat is minimal and no further action is necessary prior to the development of the site as an apartment community. The EPA and ADEQ have not required the Company to take any remedial actions on the site. The agencies also have not informed the Company of any regulatory actions on the site.
Except as set forth above, the reports have not revealed any environmental liability, nor is the Company aware of any environmental liability, that the Company believes would have a material adverse effect on the Company's business, assets or results of operation. No assurance, however, can be given that these reports reveal all environmental liabilities, or that no prior owner created any material environmental condition not known to the Company or that future uses and conditions (including changes in
applicable environmental laws and regulations) will not result in imposition of environmental liability. In the event the Company discovers a material environmental condition relating to any of its properties, the Company could be required to expend funds to remedy such condition.
Uninsured Loss
The Company will carry comprehensive liability, fire, flood (where applicable), extended coverage and rental loss insurance with policy specifications, limits and deductibles customarily carried for similar properties. There are, however, certain types of extraordinary losses (such as losses resulting from earthquakes) that may be either uninsurable or not economically insurable. Should an uninsured loss occur, the Company could lose its investment in and anticipated profits and cash flow from a property and would continue to be obligated on any mortgage indebtedness on the property.
Americans with Disabilities Act
The Company's properties must comply with Title III of the Americans with Disabilities Act (the "ADA") to the extent that the properties are "public accommodations" and/or "commercial facilities" as defined by the ADA. Compliance with the ADA requirements could require removal of structural barriers to handicapped access in certain public access areas of the Company's properties, where such removal is readily achievable. The ADA does not, however, consider residential properties, such as apartment communities to be public accommodation or commercial facilities, except to the extent portions of such facilities, such as a leasing office, are open to the public. Noncompliance with the ADA could result in imposition of fines or an award of damages to private litigants. If required changes involve a greater expenditure than the Company currently anticipates, or if the changes must be made on a more accelerated basis than it anticipates, the Company's operations could be adversely affected. No specific regulations have been promulgated under the ADA and, thus, it is uncertain how enforcement of the ADA would affect specific building attributes. However, the Company believes that the properties comply with all present requirements under the ADA.
Fair Housing Amendments Act of 1988
The Fair Housing Amendments Act of 1988 (the "FHA") requires multifamily residential properties first occupied after March 13, 1991 to be accessible to the handicapped. Noncompliance with the FHA could result in the imposition of fines or an award of damages to private litigants. The Company believes that its properties that are subject to the FHA are in compliance with such law.
Risks of Real Estate Development
The Company plans to seek selective opportunities for development. The real estate development business involves significant risks in addition to those involved in the acquisition, ownership and operation of established apartment communities. The development risks include the risks that construction financing may not be available on favorable terms for development, construction delays, construction costs in excess of the budgeted amounts, adverse changes in rental rates and occupancy rates in the market, and availability of long-term permanent financing upon completion.
Market Risks Relating To Mortgage Assets General
The results of the Company's operations depend, among other things, on the level of Net Cash Flows generated by the Company's Mortgage Assets. The Net Cash Flows vary primarily as a result of changes in mortgage prepayment rates, short-term interest rates, reinvestment income and borrowing costs, all of which involve various risks and uncertainties as set forth below. Prepayment rates, interest rates, reinvestment income and borrowing costs depend upon the nature and terms of the Mortgage Assets, the geographic location of the properties securing the mortgage loans included in or underlying the Mortgage Assets, conditions in financial markets, the fiscal and monetary policies of the United States Government and the Board of Governors of the Federal Reserve System, international economic and financial conditions, competition and other factors, none of which can be predicted with any certainty. See "Management's Discussion and Analysis of Financial Conditions and Results of Operations -- General" and "Business -- Operating Policies and Strategies -- Net Cash Flows."
The projected rates of return to the Company on its Mortgage Assets will be based upon assumed levels of prepayments on the underlying Mortgage Instruments, assumed rates of interest or pass-through rates on the Structured Financings that bear variable interest rates, and assumed rates of reinvestment income and expenses with respect to such Structured Financing. The actual levels of interest rates on Structured Financing bearing variable interest rates, prepayment rates, reinvestment income and administration expenses will affect the level of the Company's Net Cash Flows. To the extent that the assumptions employed by the Company vary from actual experience, the actual Net Cash Flows received by the Company may vary significantly from those projected by the Company as to timing and amount over the lives of such Structured Financing and from one period to another, and such returns could be negative under certain circumstances.
Prepayment Risks
Mortgage prepayments shorten the life of the Mortgage Instruments underlying the Company's Mortgage Assets, thereby reducing the overall Net Cash Flows and causing and inherent decline in the Company's income. Prepayments of Mortgage Instruments generally increase when then current mortgage interest rates fall below the interest rates on the fixed-rate mortgage loans included in such Mortgage Instruments. Conversely, prepayments decrease when then current mortgage interest rates exceed the interest rates on the mortgage loans included in such Mortgage Instruments. Prepayment experience also may be affected by the geographic location of the mortgage loans included in Mortgage Instruments, the types (whether fixed or adjustable rate) and assumability of such mortgage loans, conditions in the mortgage loan, housing and financial markets, and general economic conditions.
Interest Rate Fluctuation Risks
Changes in interest rates affect the performance of the Company and its Mortgage Assets. A portion of the outstanding Structured Financing bears variable interest rates. As of December 31, 1995, $65 million of the $882 million of the outstanding Structured Financing relating to the Company's Mortgage Assets bore variable interest rates. Consequently, changes in short-term interest rates significantly influence the Company's net income.
Risks of Decline in Net Cash Flows and Income from Mortgage Assets
The Company's income derives primarily from the Net Cash Flows received on its Mortgage Assets, which decline over time. For both tax and accounting purposes, the Company's Net Cash Flows consist of two components -- one representing return of a portion of the purchase price of the Mortgage Asset (the "Cost Component") and one representing income on the investment (the "Income Component"). The Income Component will be highest in years immediately following the purchase of the Mortgage Asset and will decline over time. In addition, to the extent that actual mortgage prepayments or variable interest rates experienced exceed those assumed, this inherent decline in Net Cash Flows and income is accelerated.
As the Company has made the determination to reinvest the Net Cash Flows in income-producing properties which may have a lower current yield than Mortgage Assets, without regard to the mortgage prepayment rates and variable interest rates, the Company may report declining operating income over time without the effect of any gain or loss on the sale of the properties. See "Business -- Special Considerations -- Competition."
Inability to Predict Effects of Market Risks
Because none of the above factors including changes in prepayment rates, interest rates, reinvestment income, expenses and borrowing costs are susceptible to accurate projection, the Net Cash Flows generated by the Company's Mortgage Assets, and thus distributions to the Company's stockholders, cannot be predicted.
Borrowing Risks
Subject to the terms of the Company's Bylaws, the availability and cost of borrowings, various market conditions, restrictions that may be contained in the Company's financing arrangements from time to time and other factors, the Company increases the amount of funds available for its activities with funds from
borrowings including borrowings under loan agreements, repurchase agreements and other credit facilities. The Company's borrowings may bear fixed or variable interest rates, may require additional collateral in the event that the value of existing collateral declines on a market value basis and may be due on demand or upon the occurrence of certain events. To the extent that the Company's borrowings bear variable interest rates, changes in short-term interest rates will significantly influence the cost of such borrowings and can result in losses in certain circumstances. The Company also may increase the amount of its available funds through the issuance of debt securities.
The Company's Bylaws limit borrowings, to no more than 300% of the amount of its net assets (as described herein) unless borrowings in excess of that amount are approved by a majority of the Unaffiliated Directors (as defined herein). See "Business -- Operating Policies and Strategies -- Capital Resources." Each of the Company's 18 apartment communities has been pledged to secure a first mortgage loan; such mortgage loans totalled $49.6 million at December 31, 1995. In addition, the Company had short-term borrowing of $4.5 million secured by Mortgage Assets having an aggregate carrying value of $7.6 million.
No assurance can be given as to the actual effect of borrowings by the Company.
Pledged Assets
A substantial portion of the Company's assets currently are and in the future can be expected to be pledged to secure its borrowings. Therefore, such assets will not be available to the stockholders in the event of the liquidation of the Company except to the extent that the market value thereof exceeds the amounts due to the creditors. However, the market value of the Mortgage Assets is uncertain because the market for Mortgage Assets of the type owned by the Company is not well developed and fluctuates rapidly as the result of numerous market factors (including interest rates and prepayment rates) as well as the supply of and demand for such assets.
Competition
There are numerous real estate companies, insurance companies, financial institutions, pension funds and other property owners that compete with the Company in seeking properties for acquisition and in attracting and retaining clients.
Market Price Of Common Stock
The market price of the Company's Common Stock has been extremely sensitive to a wide variety of factors including the Company's operating results, dividend payments (if any), actual or perceived changes in short-term and mortgage interest rates and their relationship to each other, actual or perceived changes in mortgage prepayment rates, and any variation between the net yield on the Company's assets and prevailing market interest rates. It can be expected that the performance of the Company's income-producing properties will have an increasingly important effect on the market price of the Company's Common Stock. Any actual or perceived unfavorable changes in the real estate market and other factors may adversely affect the market price of the Company's Common Stock.
Future Offerings Of Common Stock
The Company in the future may increase its capital resources by making additional offerings of its Common Stock or securities convertible into its Common Stock. The actual or perceived effect of such offerings may be the dilution of the book value or earnings per share of the Company's Common Stock which may result in the reduction of the market price of the Company's Common Stock. The Company is unable to estimate the amount, timing or nature of future sales of its Common Stock as such sales will depend upon market conditions and other factors such as its need for additional equity, its ability to apply or invest the proceeds of such sales of its Common Stock, the terms upon which its Common Stock could be sold.
Management Fees
The Manager advises the Company with respect to various aspects of the Company's business and operations, manages the Company's overall business and operations, and represents the Company in its
dealings with third parties pursuant to the terms of the Management Agreement. In the event that the Management Agreement is terminated by the Company or is not renewed by the Company on terms at least as favorable to the Manager as the current Management Agreement other than as a result of a termination by the Company for cause (as specified above and defined in the Management Agreement), the Manager will be entitled to receive from the Company the management fee that would have been payable by the Company to the Manager pursuant to such Management Agreement based on the investments made by the Company prior to the date on which the Management Agreement is so terminated (or not renewed) for the 12 full fiscal quarters beginning on the date of such termination (or failure to renew) as more fully described in the Management Agreement.
Potential Conflicts Of Interest
The Company is subject to potential conflicts of interest arising from its relationship with the Manager, the Property Manager and ASFS under the "Subcontract Agreement." The Management Agreement does not limit or restrict the right of the Manager, the partners of the Manager or any of their directors, officers or employees from engaging in any business or rendering services of any kind to any other person except that the Manager (but not its partners or their directors, officers or employees) are not permitted to provide any such services to any residential mortgage REIT other than the Company. The Company may purchase assets from entities which may be affiliates of the Manager. Although certain agreements and activities must be approved by the Unaffiliated directors (as described below), the day-to-day transactions between the Company and the Manager and the Property Manager are not subject to the specific pre-approval of the Unaffiliated Directors. See "Business -- Management Agreement -- Terms of Management Agreement" and "Business -- Property Management Agreement."
The Company's Articles of Incorporation limit the liability of its directors and officers to the Company and its stockholders to the fullest extent permitted by Maryland law, and both the Company's Articles and Bylaws provide for indemnification of the directors and officers to such extent. The Management Agreement also limits the responsibilities and liabilities of the Manager, the partners of the Manager and any of their partners, directors, officers, stockholders and employees and provides for their indemnification against liabilities except in certain circumstances. See "Business -- Management Agreement -- Terms of the Management Agreement -- Limits of Responsibility." The Property Management Agreement also limits the responsibilities and liabilities of the Property Manager. See "Business -- Property Management Agreement." In addition, the Subcontract Agreement limits the responsibilities of ASFS and provides for the indemnification of ASFS, its affiliates and their directors and officers against various liabilities. See "Business -- Management Agreement -- The Subcontract Agreement."
Counsel to the Company has furnished, and in the future may furnish, legal services to the Manager, affiliates of the Manager and certain Issuers (including those affiliated with ASFS). There is a possibility that in the future the interests of certain of such parties may become adverse, and counsel may be precluded from representing one or all of such parties. If any situation arises in which the interests of the Company appear to be in conflict with those of the Manager, or its affiliates, additional counsel may be retained by one or more of the parties.
With a view toward protecting the interests of the Company's stockholders, the Bylaws of the Company provide that a majority of the Board of Directors (and a majority of each committee of the Board of Directors) must not be "Affiliates"of the Manager or "Advisors," as these terms are defined in the Bylaws, and that the investment policies of the Company must be reviewed annually by these directors (the "Unaffiliated Directors"). Moreover, the annual renewals of the Management Agreement and the Property Management Agreement require the affirmative vote of a majority of the Unaffiliated Directors. In addition, a majority of such Unaffiliated Directors may terminate the Management Agreement or the Property Management Agreement at any time upon 60 days' notice. See "Business -- The Management Agreement."
Certain Consequences Of And Failure To Maintain Reit Status
In order to maintain its qualification as a REIT for federal income tax purposes, the Company must continually satisfy certain tests with respect to the sources of its income, the nature and diversification of
its assets, the amount of its distributions to stockholders and the ownership of its stock. See "Business -- Federal Income Tax Considerations -- Qualification of the Company as a REIT." Among other things, these restrictions may limit the Company's ability to acquire certain types of assets that it otherwise would consider desirable, limit the ability of the Company to dispose of assets that it has held for less than four years if the disposition would result in gains exceeding specified amounts, limit the ability of the Company to engage in hedging transactions that could result in income exceeding specified amounts, and require the Company to make distributions to its stockholders at times that the Company may deem it more advantageous to utilize the funds available for distribution for other corporate purposes (such as the purchase of additional assets or the repayment of debt) or at times that the Company may not have funds readily available for distribution.
The Company's operations from time to time generate taxable income in excess of its net income for financial reporting purposes. The Company also may experience a situation in which its taxable income is in excess of the actual cash receipts. See "Business -- Federal Income Tax Considerations -- Activities of the Company." To the extent that the Company does not otherwise have funds available, either situation may result in the Company's inability to distribute substantially all of its taxable income as required to maintain its REIT status. See "Business -- Federal Income Tax Considerations." Alternatively, the Company may be required to borrow funds to make the required distributions which could have the effect of reducing the yield to its stockholders, to sell a portion of its assets at times or for amounts that are not advantageous, or to distribute amounts that represent a return of capital which would reduce the equity of the Company. In evaluating assets for purchase, the Company considers the anticipated tax effects of the purchase including the possibility of any excess of taxable income over projected cash receipts.
If the Company should not qualify as a REIT in any tax year, it would be taxed as a regular domestic corporation and, among other consequences, distributions to the Company's stockholders would not be deductible by the Company in computing its taxable income. Any such tax liability could be substantial and would reduce the amount of cash available for distributions to the Company's stockholders. See "Business -- Federal Income Tax Considerations." In addition, the unremedied failure of the Company to be treated as a REIT for any one year would disqualify the Company from being treated as a REIT for the four subsequent years.
Excess Inclusions
A portion of the dividends paid by the Company constitutes unrelated business taxable income to certain otherwise tax-exempt stockholders which will constitute a floor for the taxable income of stockholders not exempt from tax, and will not be eligible for any reduction (by treaty or otherwise) in the rate of income tax withholding in the case of nonresident alien stockholders. For 1995, the entire ordinary income portion ($0.29 per share) of the dividend was excess inclusion income. See "Business -- Federal Income Tax Considerations -- Tax Consequences of Common Stock Ownership -- Excess Inclusion Rule."
Marketability Of Shares Of Common Stock And Restriction On Ownership
The Company's Articles of Incorporation prohibit ownership of its Common Stock by tax-exempt entities that are not subject to tax on unrelated business taxable income and by certain other persons (collectively "Disqualified Organizations"). Such restrictions on ownership exist so as to avoid imposition of a tax on a portion of the Company's income from excess inclusions.
Provisions of the Company's Articles of Incorporation also are designed to prevent concentrated ownership of the Company which might jeopardize its qualification as a REIT under the Code. Among other things, these provisions provide (i) that any acquisition of shares that would result in the disqualification of the Company as a REIT under the Code will be void, and (ii) that in the event any person acquires, owns or is deemed, by operation of certain attribution rules set out in the Code, to own a number of shares in excess of 9.8% of the outstanding shares of the Company's Common Stock ("Excess Shares"), the Board of Directors, at its discretion, may redeem the Excess Shares. In addition, the Company may refuse to effectuate any transfer of Excess Shares and certain stockholders, and proposed transferees of
shares, may be required to file an affidavit with the Company setting forth certain information relating, generally, to their ownership of the Company's Common Stock. These provisions may inhibit market activity and the resulting opportunity for the Company's stockholders to receive a premium for their shares that might otherwise exist if any person were to attempt to assemble a block of shares of the Company's Common Stock in excess of the number of shares permitted under the Articles of Incorporation. Such provisions also may make the Company an unsuitable investment vehicle for any person seeking to obtain (either alone or with others as a group) ownership of more than 9.8% of the outstanding shares of Common Stock. Investors seeking to acquire substantial holdings in the Company should be aware that this ownership limitation may be exceeded by a stockholder without any action on such stockholder's part in the event of a reduction in the number of outstanding shares of the Company's Common Stock.
Federal Income Tax Considerations
Qualification Of The Company As A Reit
General
The Company has made an election to be treated as a real estate investment trust ("REIT"). Thus, if the Company satisfies certain tests in each taxable year with respect to the nature of its income, assets, share ownership and the amount of its distributions, among other things, it generally should not be subject to tax at the corporate level on its income to the extent that it distributes cash in the amount of such income to its stockholders.
Generally, the unremedied failure of the Company to be treated as a REIT for any taxable year could materially and adversely affect the stockholders as net income of the Company would be taxed at ordinary corporate rate, and the Company would not receive a deduction for any dividends to the stockholders and thus cause a material reduction of the cash available for distribution to the stockholders as dividends.
In order to maintain its qualification as a REIT for federal income tax purposes, the Company must continually satisfy certain tests with respect to the sources of its income, the nature and diversification of its assets, the amount of its distributions, and the ownership of the Company. The following is a summary discussion of those various tests.
Sources of Income
The Company must satisfy three separate income tests for each taxable year with respect to which it intends to qualify as a REIT: (i) the 75% income test; (ii) the 95% income test; and (iii) the 30% income test.
Under the first test, at least 75% of the Company's gross income for the taxable year must be derived from certain qualifying real estate related sources. The 95% income test requires that at least 95% of the Company's gross income for the taxable year must be derived from the items of income that either qualify under the 75% test or are from certain other types of passive investments. Finally, the 30% income test requires the Company to derive less than 30% of its gross income for the taxable year from the sale or other disposition of (1) real property, including interests in real property and interests in mortgages on real property, held for less than four years, other than foreclosure property or property involuntarily converted through destruction, condemnation or similar events, (2) stock or securities or swap agreements held for less than one year, and (3) property in "prohibited transactions." A prohibited transaction is a sale or disposition of dealer property that is not foreclosure property or, under certain circumstances, a real estate asset held for at least four years.
If the Company inadvertently fails to satisfy either the 75% income test or the 95% income test, or both, and if the Company's failure to satisfy either or both tests is due to reasonable cause and not willful neglect, the Company may avoid loss of REIT status by satisfying certain reporting requirements and paying a tax equal to 100% of any excess nonqualifying income. See "Business -- Federal Income Tax Considerations -- Taxation of the Company." There is no comparable safeguard that could protect against REIT disqualification as a result of the Company's failure to satisfy the 30% income test.
The Company anticipates that its gross income will continue to consist principally of the income that satisfies the 75% income test. The composition and sources of the Company income should allow the Company to satisfy the income tests during each year of its existence. Certain short-term reinvestments, however, may generate qualifying income for purposes of the 95% income test but nonqualifying income for purposes of the 75% income test, and certain hedging transactions could give rise to income that, if excessive, could result in the Company's disqualification as a REIT for failing to satisfy the 30% income test, the 75% income test, and/or the 95% income test. The Company intends to monitor its reinvestments and hedging transactions closely to attempt to avoid disqualification as a REIT.
Nature and Diversification of Assets
At the end of each quarter of the Company's taxable year, at least 75% of the value of the Company's assets must be cash and cash items (including receivables), federal government securities and qualifying real estate assets. Qualifying real estate assets include interests in real property, and mortgages, equity interests in other REITs, any stock or debt instrument for so long as the income therefrom is qualified temporary investment income and, subject to certain limitations, interests in REMICs. The balance of the Company's assets may be invested without restriction, except that holdings of the securities of any one non-governmental issuer may not exceed 5% of the value of the Company's assets or 10% of the outstanding voting securities of that issuer.
If the Company fails to satisfy the 75% asset test at the end of any quarter of its taxable year as a result of its acquisition of securities or other property during that quarter, the failure can be cured by a disposition of sufficient nonqualifying assets within 30 days after the close of that quarter. The Company will take such action as may be required to cure any failure to satisfy the 75% asset test within 30 days after the close of any quarter. The Company may not be able to cure any failure to satisfy the 75% asset test, however, if assets that the Company believes are qualifying assets for purposes of the 75% asset test are later determined to be nonqualifying assets.
Distributions
Each taxable year the Company must distribute as dividends to its stockholders an amount at least equal to (i) 95% of its REIT taxable income (determined before the deduction of dividends paid and excluding any net capital gain) plus (ii) 95% of the excess of its net income from foreclosure property over the tax imposed on such income by the Code, less (iii) any excess noncash income (as determined under the Code).
Generally, a distribution must be made in the taxable year to which it relates. A portion of the required distribution, however, may be made in the following year if certain guidelines are followed. Further, if the Company fails to meet the 95% distribution requirement as a result of an adjustment to the Company's tax returns by the Internal Revenue Service ("IRS "), the Company may, if the deficiency is not due to fraud with intent to evade tax or a willful failure to file a timely tax return, retroactively cure the failure by paying a deficiency dividend to stockholders and certain interest and penalties to the IRS. The Company intends to make distributions to its stockholders on a basis that will allow the Company to satisfy the distribution requirement. In certain instances, however, the Company's pre-distribution taxable income may exceed its cash flow and the Company may have difficulty satisfying the distribution requirement. The Company intends to monitor closely the relationship between its pre-distribution taxable income and its cash flow. It is possible, although unlikely, that the Company may decide to terminate its REIT status as a result of any such cash shortfall. Such a termination would have adverse consequences to the stockholders. See "Business -- Federal Income Tax Considerations -- Status of the Company as a REIT."
The Company has a net operating loss carryforward for income taxes (the "NOL") at December 31, 1995 of approximately $75 million. Under REIT tax rules, the Company is allowed to offset taxable income (except for Excess Inclusion Income) by the available NOL and thus, under most circumstances, is not currently required to make distributions to stockholders except for Excess Inclusion Income. The NOL expires in 2009 (1999 for state tax purposes).
Ownership of the Company
Shares of the Company's Common Stock must be held by a minimum of 100 persons for at least 335 days in each taxable year after the Company's first taxable year. Further, at no time during the second half of any taxable year after the Company's first taxable year may more than 50% of the Company's shares be owned, actually or constructively, by five or fewer individuals (including pension funds and certain other types of tax-exempt entities). To evidence compliance with these requirements, the Company is required to maintain records that disclose the actual ownership of its outstanding shares. Each year, in order to satisfy that requirement, the Company will demand written statements from record holders owning designated percentages of Common Stock disclosing, among other things, the identities of the actual owners of such shares. The Company's Articles of Incorporation contain repurchase provisions and transfer restrictions designed to prevent violation of the latter requirement. Therefore, the Company believes that its shares of Common Stock currently are owned by a sufficient number of unrelated persons to allow the Company to satisfy the ownership requirements for REIT qualification.
Taxation of The Company
For any taxable year in which the Company qualifies and elects to be treated as a REIT under the Code, it generally will not be subject to federal income tax on that portion of its taxable income that is distributed to its stockholders in or with respect to that year. Regardless of distributions to stockholders, however, the Company may become subject to a tax on certain types of income.
The Company uses the calendar year both for tax purposes and for financial reporting purposes. Due to the differences between tax accounting rules and generally accepted accounting principles, the Company's REIT Taxable Income will vary from its net income for financial reporting purposes.
Tax Consequences Of Common Stock Ownership
The federal income tax consequences of ownership in the Company's common is a complex matter and may vary depending on the income tax status of the stockholder. Accordingly, the following discussion is intended to be general in nature. Stockholders should consult their own tax advisors regarding the income tax considerations with respect to their investments in the Company.
Dividend Income
Distributions to stockholders out of the Company's current or accumulated earnings and profits will be taxable as "portfolio income" in the year received and not as income from a passive activity. With respect to any dividend payable to stockholders of record as of a specified date prior to the end of the year, that dividend is deemed to have been received by the stockholder on December 31 if the dividend is paid in January of the following calendar year.
The Company's dividends are not eligible for the dividends-received deduction for corporations. If the Company's total distributions for a taxable year exceed its current and accumulated earnings and profits, a portion of each distribution will be treated first as a return of capital, reducing a stockholder's basis in his shares (but not below zero), and then as capital gain in the event such distributions are in excess of a stockholder's adjusted basis in his shares.
Distributions properly designated by the Company as "capital gain dividends" will be taxable to the stockholders as long-term capital gain, to the extent those dividends do not exceed the Company's actual net capital gain for the taxable year, without regard to the stockholder's holding period for his shares. The Company will notify stockholders after the close of its taxable year regarding the portions of the distributions that constitute ordinary income, return of capital and capital gain. The Company also will notify shareholders regarding their reported share of excess inclusion income. See "Excess Inclusion Rule" below.
The total dividends of $2.00 per share for 1995 consists of ordinary income of $0.29 and return of capital of $1.71 per share.
Excess Inclusion Rule
Ownership by the Company of residual interests in REMICs may adversely affect the federal income taxation of the Company and of certain stockholders to the extent those residual interests generate "excess inclusion income." The Company's excess inclusion income during a calendar quarter generally will equal the excess of its taxable income from residual interests in REMICs over its "daily accruals" with respect to those residual interests for the calendar quarter. The daily accruals are calculated by multiplying the adjusted issue price of the residual interest by 120 percent of the long-term federal interest rate in effect on the REMIC's startup date. It is possible that the Company will have excess inclusion income without associated cash. In taxable years in which the Company has both a net operating loss and excess inclusion income it will still have to report a minimum amount of taxable income equal to its excess inclusion income. In order to maintain its REIT status, the Company will be required to distribute at least 95 percent of its taxable income, even if its taxable income is comprised exclusively of excess inclusion income and otherwise has a net operating loss.
In general, each stockholder is required to treat the stockholder's allocable share of the portion of the Company's "excess inclusions" that is not taxable to the Company as an "excess inclusion" received by such stockholder. The portion of the Company's dividends that constitute excess inclusions typically will rise as the degree of leveraging of the Company's activities increase. Therefore, all or a portion of the dividends received by the stockholders may be excess inclusion income. Excess inclusion income will constitute unrelated business taxable income for tax-exempt entities and may not be used to offset deductions or net operating losses from other sources for most other taxpayers. For 1995, the entire ordinary income portion ($0.29 per share) of the dividend was excess inclusion income.
Tax-exempt Organizations As Stockholders
The Code requires a tax-exempt stockholder of the Company to treat as unrelated business taxable income its allocable share of the Company's excess inclusions. The Company is likely to receive excess inclusion income. See "Excess Inclusion Rule," above. The Company's Common Stock may not be held by tax-exempt entities which are not subject to tax on unrelated business taxable income.
Taxation Of Foreign Stockholders
Distributions of cash generated by the Company in its operations that are paid to foreign persons generally will be subject to United States withholding tax rate at a rate of 30 percent or at a lower rate if a foreign person can claim the benefit of a tax treaty. Notwithstanding the foregoing, distributions made to foreign stockholders will not be subject to treaty withholding reductions to the extent of their allocable shares of the portion of the Company's excess inclusions that are not taxable to the Company for the period under review. It is expected that the Company will continue to have excess inclusions. Distributions to foreign persons of cash attributable to gain on the Company's sale or exchange of real properties, if any, generally will be subject to full United States taxation and withholding. If a foreign person holds more than five percent of the shares of the Company, gain from the sale of the person's shares could be subject to full United States taxation if the Company held any real property interests and was not a domestically controlled REIT.
The federal income taxation of foreign persons is a highly complex matter that may be affected by many considerations. Accordingly, foreign investors in the Company should consult their own tax advisors regarding the income and withholding tax considerations with respect to their investments in the Company. Foreign governments and organizations, and their instrumentalities, may not invest in the Company.
Backup Withholding
The Company is required by the Code to withhold from dividends 20% of the amount paid to stockholders, unless the stockholder (i) files a correct taxpayer identification number with the Company, (ii) certifies as to no loss of exemption from backup withholding and (iii) otherwise complies with the applicable requirements of the backup withholding rules. The Company will report to its stockholders and
the IRS the amount of dividends paid during each calendar year and the amount of tax withheld, if any. Stockholders should consult their tax advisors as to the procedure for insuring that the Company dividends to them will not be subject to backup withholding.
State And Local Taxes
The discussion herein concerns only the federal income tax treatment likely to be accorded the Company and its stockholders. No discussion has been provided regarding the state or local tax treatment of the Company and its stockholders. The state and local tax treatment may not conform to the federal income tax treatment described above and each investor should discuss such issues with his state and local tax advisor.
ITEM 2.

ITEM 2. PROPERTY
See "Business -- Operating Policies and Strategies -- Real Estate Activities -- Current Properties."
The principal executive offices of the Company and the Manager are located at 335 North Wilmot, Suite 250, Tucson, Arizona 85711, telephone (520) 748-2111.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed and principally traded on the American Stock Exchange ("AMEX") under the symbol the "ASR". The following table sets forth for the periods indicated the high and low sales prices of the Company's Common Stock as reported by the AMEX and the cash dividends paid per share on the Company's Common Stock for the periods indicated.
Dividend High Low Per Share -------- ------- ------------- First quarter .....$20 $10 15/16 $0.50 Second quarter ... 19 3/8 16 1/4 0.50 Third quarter ..... 20 1/2 17 3/4 0.50 Fourth quarter ... 18 3/8 15 0.50 First quarter ..... 10 15/16 7 1/2 -- Second quarter ... 15 5 15/16 -- Third quarter ..... 13 3/4 6 1/4 -- Fourth quarter ... 14 1/16 9 3/8 0.50 First quarter ..... 15 15/16 10 -- Second quarter ... 10 15/16 5 15/16 -- Third quarter ..... 9 3/8 6 1/4 0.25 Fourth quarter ... 10 15/16 7 1/2 0.90
On March 21, 1996, the closing sales prices for shares of the Company's Common Stock on the AMEX Composite Tape was $16 1/2 per share and the approximate number of holders of common shares was 2,000.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS EXCEPT FOR PER SHARE DATA)
The following selected financial data are qualified in its entirety by, and should be read in conjunction with, the consolidated financial statements and notes thereto appearing elsewhere herein. The data below have been derived from the audited consolidated financial statements of the Company.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS For the Years Ended December 31, 1995, 1994 and 1993
General
In 1993, the Company determined to become an apartment real estate investment trust. The Company continues to hold its mortgage assets and use the cash flows for apartment acquisitions and development, operations, payment of dividends and other corporate purposes.
In January 1994, the Company acquired its initial portfolio of seventeen apartment communities (2,461 units) located in Tucson, Arizona, Houston, Texas, and Albuquerque, New Mexico. The total cost was approximately $61,600,000 which was financed by non-recourse first mortgage loans of $45,700,000, seller carryback financing of $6,500,000 and cash of $9,400,000. In February 1995, the Company acquired a 222-unit apartment community in Mesa, Arizona for $6,356,000, which was financed with a $3,770,000 non-recourse first mortgage loan.
In addition to wholly owned apartment communities, the Company has acquired six apartment communities (1,441 units) in Phoenix and Tucson, Arizona through joint ventures with a pension plan affiliate of Citicorp. The Company is a 15% equity partner and managing member of the joint ventures. The Company receives between 15% and 51% of the net profits and cash flow depending on the performance of the joint ventures.
The operating income from apartments is affected primarily by rental rates, occupancy rates and operating expenses. Rental rates and occupancy rates are affected by the strength of the local economy, the local housing market and the supply of and demand for apartment communities.
The Company continues to own mortgage assets acquired prior to 1993 to generate cash flows for apartment acquisitions and development and other corporate purposes. These mortgage assets entitle the Company to receive the excess of the cash flow on pools of mortgage instruments over the required payments on a series of structured financings which they secure. Income and cash flows from mortgage assets are affected primarily by mortgage prepayment rates and short-term interest rates. Higher mortgage prepayment rates or higher short-term rates reduce the income and total cash flows over the life of the mortgage assets. Prepayment rates are affected primarily by mortgage interest rates. Mortgage assets are amortizing assets and the cash flows decline over time.
In 1993, mortgage interest rates dropped to their lowest level in twenty years and prepayment rates reached record levels. In 1994, mortgage interest rates increased and actual and anticipated prepayment rates decreased. In 1995, although prepayment rates increased because mortgage rates declined to near the 1993 lows by year end, they were well below the 1993 record levels.
The Company also has the option to cause the early redemption of the structured financings at par after specified conditions are met (generally when the structured financing is below a specified balance or after a specified date). In such event, the mortgage instruments are sold and the net proceeds after the redemption of the structured financing are remitted to the Company. Mortgage asset redemptions have the effect of accelerating the cash flows and increasing the value. Redemption transactions occur from time to time as specified conditions are met rather than on a monthly or quarterly basis, and the net proceeds are affected by the market price of the mortgage instruments. Thus, the cash flows and income from redemption transactions fluctuate significantly between periods. Mortgage asset redemptions reduce the cash flows and income in future periods.
On July 7, 1995, the Company completed a reverse stock split under which one new share of common stock was issued in exchange for five shares of outstanding stock. Accordingly, the number of common stock issued and all per share amounts for all years have been adjusted for the reverse stock split.
Results of Operations
1995 Compared to 1994
Income and expenses from real estate operations increased in 1995 due to the acquisition of an apartment community in February 1995 as well as new investments in joint ventures. Net operating income (before depreciation) from apartments (including the Company's share of results of the joint venture) for 1995 and 1994 was $7,651,000 and $7,119,000, respectively. On a same store basis, net operating income for 1995 decreased by 5% primarily due to a 10% increase in operating expenses and real estate taxes. The increase in operating expenses was caused by a decrease in occupancy rates from 94% in 1994 to 91% in 1995 (mostly in Tucson) which resulted in higher turnover, marketing and payroll expenses. The increase in expenses was mitigated by a 2% increase in rental and other income due to higher rental rates. Depreciation expenses increased due to acquisitions and capital expenditures incurred in 1994 and 1995.
As a result of amortization of the investment in and redemption of mortgage assets during 1994 and 1995, the average balance of mortgage assets decreased from $26,691,000 for 1994 to $14,827,000 for 1995. While the average prospective yield was 28% for 1995 compared with 24% for 1994, the prospective yield income decreased by $2,549,000. Income from redemptions in 1995 totaled $5,302,000 consisting of $2,882,000 from redemption of five mortgage assets and $2,420,000 from the reversal of the excess yield maintenance payment accrued in 1993 on notes payable. Income from redemptions of $4,263,000 in 1994 resulted from the redemption of four mortgage assets.
Operating and administrative expenses increased in 1995 primarily due to an increase in expense accruals for stock appreciation rights of $381,000 (caused by higher stock price) and dividend equivalent payments on stock options of $600,000. The higher stock appreciation rights and dividend equivalent expenses were mitigated by a decrease in management fees of $170,000 in 1995 compared to 1994.
Interest and other income decreased in 1995 due to the use of the cash held by trustee to prepay the notes payable secured by mortgage assets in February 1995. Interest expense on real estate mortgages increased due to the borrowing for the February 1995 purchase of an apartment community. Other interest expense decreased due to the prepayment of the notes payable secured by mortgage assets in February 1995 and the prepayment of the real estate notes in April 1995.
1994 Compared to 1993
The Company had net income of $7,702,000 in 1994 compared with a net loss of $40.6 million in 1993. The income in 1994 resulted from operating income generated by the apartments and the existing mortgage assets.
In 1994, net operating income (before depreciation) from the apartments was $7,119,000 (including the Company's share of results of the joint ventures) which, after deducting related interest expense, amounted to an annualized return of 20% on the average invested equity. As a result of high demand, rental rates in the Company's apartment communities increased during 1994 by 10% in Tucson, 5% in Albuquerque and 2% in Houston while maintaining each apartment community's occupancy rate.
Prospective yield income from mortgage assets decreased due to a reduction of $18,916,000 in the net carrying value, mitigated by a higher yield in 1994 due to significantly lower mortgage prepayment rates. The average yield on the mortgage assets for 1994 was approximately 24%. The Company realized income in 1994 of $4,263,000 from the redemption of four mortgage assets and the sale of the underlying mortgage instruments. The provision for reserve for 1993 was due to the decrease in the estimated future cash flows of certain mortgage assets. The charge from the cumulative effect of accounting change in 1993 was due to adoption of SFAS No. 115 which resulted in the reduction of the net carrying values of substantially all of the mortgage assets to their estimated fair market values. Both the provision for reserve and the cumulative effect of accounting change were caused by very low mortgage interest rates which resulted in historically high levels of mortgage prepayment rates.
Interest and other interest income increased due to higher interest rates on investments and a write down of a short-term investment ($254,000) in 1993.
Operating expenses increased in 1994 due to the accrual in 1994 of expenses relating to the stock appreciation rights ($324,000) and dividend equivalent payments on the options and stock appreciation rights ($200,000), offset by a reduction in the 1994 management fees of $81,000, the Company's efforts to reduce operating expenses and a reduction in the 1993 expenses of $470,000 relating to the legal fees reimbursement from insurance carriers relating to legal fees relating to the class action suit settled in 1992.
Interest expense on real estate mortgages increased because of the borrowing incurred in connection with acquisition of the apartments in January 1994. Other interest expense decreased due to a decrease in the notes payable secured by mortgage assets.
Liquidity, Capital Resources and Commitments
Cash provided by operations in 1995 was lower than 1994 as $2,420,000 of the 1995 income from redemption related to the reversal of the yield maintenance payment which did not provide cash. Cash provided by operations in 1995 and 1994 were both higher than 1993 primarily due to the addition of real estate operations and redemption income.
Operating cash flow (net of interest expense) from apartments was $3,264,000 for 1995 compared to $3,178,000 for 1994. Cash flow generated from mortgage assets was $13,854,000 during 1995 compared to $29,612,000 during 1994. As mortgage assets are amortizing assets, the cash flows generally decline over time as they are amortized or redeemed. The Company also realized higher cash flows from mortgage asset redemptions in 1994.
In 1995, the Company acquired (i) an apartment community for $6,241,000 which was financed by a first mortgage loan of $3,770,000; (ii) land for development of the Finisterra Apartments in Tempe, Arizona for $2,670,000 and (iii) two apartment communities through joint ventures for equity investments of $1,853,000. The Company reduced its borrowing in 1995 by (i) prepaying the notes secured by mortgage assets (net balance of $6,422,000 at December 31, 1994) and (ii) prepaying the unsecured real estate notes ($4,868,000 at December 31, 1994). The Company incurred short-term borrowing of $4,495,000 to fund a portion of these debt prepayments. The Company plans to use the cash flows from mortgage asset redemptions in 1996 to reduce the short-term borrowing.
The Company continues to rely on the cash flows from mortgage assets to fund its apartment acquisitions and development. A majority of the mortgage cash flows is from early redemptions and sales which in effect accelerate the cash flows and thus increase the present value. In March 1996, the
Company sold for $2.4 million a 40% interest in one mortgage asset anticipated to be redeemed in the second quarter, resulting in income of approximately $1.9 million. The subsequent redemption is expected to generate an additional cash flow of $3.6 million and income of $3.0 million.
The Company has prepared the following estimates of future cash flows from the mortgage assets. Cases 1, 2 and 3 assume that except for the early redemption of the mortgage asset in April as described in the preceding paragraph, there will be no further early redemptions of mortgage assets. The assumed interest rate and mortgage prepayment rates in Case 2 are the approximate interest rate and forecasts of prepayment rates made by market participants as of December 31, 1995. The estimates in Case 4 have been prepared using the same interest rate and mortgage prepayment rates as Case 2 except that each mortgage asset is assumed to be redeemed at the first available date and the underlying mortgages sold at the December 31, 1995 prices. Mortgage prepayment rates represent the average annual prepayment rate assumed for the underlying mortgage instruments. (Dollars in thousands.)
Case 1 Case 2 Case 3 Case 4 ------- ------- ------- ------- Assumed one month LIBOR 4.0% 6.0% 8.0% 6.0% Assumed mortgage prepayments 21.3% 10.6% 6.9% 10.6% Average sale price of mortgages (% of par) 107.1%
Estimated cash flows 1996 $12,148 $11,452 $10,746 $16,444 1997 4,527 4,120 3,541 11,642 1998 3,052 3,112 2,917 2,244 1999 2,116 2,368 2,398 13,223 2000 1,422 1,812 1,991 7,785 2001-2018 6,568 13,480 24,599 470 ------- ------- ------- ------- Total $29,833 $36,344 $46,192 $51,808 ======= ======= ======= =======
There can be no assurance that the actual interest and prepayment rates will be as assumed or that the prices of the mortgage instruments will remain at the assumed levels. Proceeds from redemptions are highly dependent on prices available upon sale of the mortgages as well as the timing of meeting the conditions for redemption (generally reduction of the structured financing to a specified percentage of the original balance or a specified date). As an example, if the average price assumed for mortgage sales in Case 4 above were to decrease by half (the average mortgage prices decreases to 103.5%), the estimated total cash flow in Case 4 would decline by $15,187,000 of which $3,257,000 would relate to 1996.
The Company has commenced the development of its Finisterra Apartment community in Tempe, Arizona. The total construction costs are estimated to be approximately $20,000,000. As of December 31, 1995, the Company has invested approximately $2,800,000. The Company has obtained a $15,350,000 construction loan. Construction is expected to be completed in mid-1997.
At December 31, 1995, the Company had unrestricted cash of $2,421,000. The Company intends to use such funds for acquisition of apartments, capital improvements on existing properties and working capital.
Each of the apartment communities is pledged to secure a nonrecourse and non-cross collateralized first mortgage loan. The loans generally bear fixed interest rates which averaged 8.6% at December 31, 1995. The principal and interest payments on these loans are approximately $385,000 per month. In addition, the Company is required to deposit $55,000 per month with the lender to be used for specified capital replacement expenditures, property taxes and insurance premiums. At December 31, 1995, $2,122,000 was held by lenders.
Other Information
Apartment leases generally are for terms of six to 12 months. Management believes that such short-term leases lessen the impact of inflation as a result of the ability to adjust rental rates to market levels as leases expire. To the extent that the inflation rate influences federal monetary policy and results in rising short-term interest rates or declines in mortgage interest rates, the timing of income and cash flows from the mortgage assets would be affected.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the report thereon, the notes thereto and the supplementary data commencing at page of this report, which financial statements, report, notes and data are incorporated herein by reference.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated herein by reference to the definitive proxy statement to be filed pursuant to Regulation 14A.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to the definitive proxy statement to be filed pursuant to Regulation 14A.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference to the definitive proxy statement to be filed pursuant to Regulation 14A.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference to the definitive proxy statement to be filed pursuant to Regulation 14A.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules filed as part of this report: 1. Financial Statements of the Company -- as listed in the "Index to Financial Statements and Financial Statement Schedule" on page of this Annual Report Form 10-K. 2. Financial Statement Schedules -- Schedule III on page F- 15. No other schedules are required because of the absense of conditions under which they are required or because the information is given in the financial statements and notes beginning on page of this Annual Report on Form 10-K.
(b) Exhibits
(Footnotes to table on previous page) - ---------- (1) Incorporated herein by reference to Registrant's Registration Statement on Form S-11 (No. 33- 15232) filed August 19, 1987 and declared effective on August 19, 1987. (2) Incorporated herein by reference to Registrant's Registration Statement on Form S-11 (No. 33-20429) filed March 16, 1988 and declared effective on March 17, 1988. (3) Incorporated herein by reference to Registrant's Form 10-K for the year ended December 31, 1988 as filed with the Commission on or about March 30, 1989. (4) Incorporated herein by reference to Registrant's Registration Statement on Form S-3 (33-42923) filed on September 30, 1991 and declared effective on October 1, 1991. (5) Incorporated herein by reference to Registrant's Form 10-K for the year ended December 31, 1992. (6) Incorporated herein by reference to Registrant's Report on Form 8-K filed with the Commission on or about March 29, 1994.
(c) Reports on Form 8-K: No Current Reports on Form 8-K were filed by the Company during the fourth quarter of 1995.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ASR INVESTMENTS CORPORATION
By: /s/ JON A. GROVE ----------------------------------------------- Jon A. Grove
Date: March 22, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
ASR INVESTMENTS CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of ASR Investments Corporation.
We have audited the accompanying consolidated balance sheets of ASR Investments Corporation as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. Our audit also included the financial statement schedule listed in the Index at Item 14. The financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1995 and 1994, and the results of its operations and cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, which considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
DELOITTE & TOUCHE LLP
Tucson, Arizona February 19, 1996
CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands Except Per Share Amounts)
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands)
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1995, 1994 and 1993 (In Thousands)
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 1995, 1994 and 1993
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - ASR Investments Corporation (the Company) is a real estate investment trust engaged in the acquisition and operation of apartment communities in the southwestern United States. At December 31, 1995, the Company owned 24 apartment communities (including six owned through joint ventures) located in Arizona, Texas and New Mexico. In addition, the Company continues to hold mortgage assets and use the cash flows for apartment acquisitions, operations, payment of dividends and other corporate purposes.
Principles of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Investments in joint ventures are accounted on the equity method as the Company does not own a controlling interest. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.
Common Stock - On July 7, 1995, the Company effected a reverse stock split under which one new share of common stock was issued in exchange for five shares of outstanding stock. Accordingly, the consolidated financial statements reflect the reverse stock split and the number of common stock issued and the per share amounts have been adjusted for the reverse stock split for all years.
Real Estate - Real estate is recorded at cost. Depreciation is computed on a declining balance basis over the estimated remaining useful lives of the assets, which are 27-1/2 years for buildings and improvements and 7 years for furniture, fixture and equipment. Expenditures for ordinary maintenance and repairs are charged to operations as incurred, and significant renovations and improvements that improve or extend the useful life of the asset are capitalized. Rental income is recorded when due from tenants.
Deferred Loan Costs - Deferred loan costs are amortized using the interest method over the terms of the related debt.
Mortgage Assets - The Company owns mortgage assets which entitle it to receive the excess of the cash flows on pools of mortgage instruments over the required payments on a series of structured financings which they secure. The Company also has the right to cause the early redemption of the structured financings under specified limited conditions; in such event, the mortgage instruments are sold and the net proceeds after the redemption of the structured financings are remitted to the Company. Redemption transactions occur from time to time as specified conditions are met rather than on a monthly or quarterly basis; therefore, the amount of net proceeds and the income from the redemption transactions fluctuates significantly between periods.
Presentation and Income Recognition. Mortgage assets are stated at their net investment amounts. Income is recognized using the prospective yield method prescribed by EITF 89-4. Under this method, an effective yield is calculated at the beginning of an accounting period using the then net carrying value of the asset and the estimated future net cash flow assuming no early redemption. The estimated future net cash flow is calculated using variable interest rates and current projected mortgage prepayment rates for the underlying mortgages. The calculated yield is used to accrue income for the accounting period. Actual cash flow received is first applied to the accrued income and any remaining amount is used to reduce the carrying value of the asset. Income from early redemption is recognized when the transaction occurs.
Write-down or reserves for impairment. Prior to December 1993, the Company followed the practice of writing down the carrying value of a mortgage asset (including an allocated portion of the deferred hedging cost) to its estimated future cash flows. In December 1993, the Company adopted SFAS No. 115 which requires that the carrying value of a mortgage asset be written down to its estimated fair value when its estimated yield is less than a "risk-free yield." As a result, the Company wrote down substantially all its mortgage assets in 1993 to their estimated fair value and recorded a charge of $21,091,000 which was reported as a cumulative effect of accounting change.
Income Taxes - The Company has elected to be taxed as a real estate investment trust (REIT) under the Internal Revenue Code of 1986, as amended. As a REIT, the
Company must distribute to its stockholders at least 95% of the higher of (i) its annual taxable income after the use of net operating loss carryforward or (ii) its annual excess inclusion income. Accordingly, no provision has been made for income taxes in the accompanying consolidated financial statements.
Earnings Per Share - Earnings per share are computed using the weighted average number of shares of common stock and common stock equivalents (if dilutive) outstanding during the year.
New Accounting Standards - In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation." This Statement encourages, but does not require, companies to adopt a new accounting method for stock-based compensation awards. Beginning with 1996 financial statements, companies that do not adopt the new accounting method will be required to provide the disclosures required by the Statement for any awards made in 1995 and after. The Company, which currently follows APB Opinion No. 25, does not plan to adopt the new accounting method, and will provide the required disclosures in the 1996 financial statements.
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect some of the amounts reported in the consolidated financial statements. Actual results could differ from those estimates.
Reclassifications - Certain reclassifications have been made to conform the prior years with the current year presentation.
2. REAL ESTATE INVESTMENTS
Wholly Owned Apartments
In January 1994, the Company acquired its initial portfolio of seventeen apartment communities (2,461 units) located in Tucson, Arizona, Houston, Texas, and Albuquerque, New Mexico. In February 1995, the Company acquired a 222-unit apartment community in Mesa, Arizona. At December 31, 1995 and 1994, investment in apartments consisted of the following (in thousands):
1995 1994 ---- ---- Land $ 15,514 $ 13,681 Building and Improvements 57,214 50,583 Accumulated Depreciation (4,687) (1,995) Restricted Cash and Deferred Loan fees 3,297 4,237 -------- -------- Apartments, net $ 71,338 $ 66,506 ======== ========
Investments in Joint Ventures
The Company has acquired six apartment communities (1,441 units) in Phoenix and Tucson, Arizona through joint ventures with a pension plan affiliate of Citicorp. The Company is a 15% equity partner and the managing partner or managing member of the joint ventures. The Company is entitled to receive between 15% and 51% of the total profits and cash flows depending on the financial performance of the joint ventures. The condensed combined financial statements for the joint ventures are as follows (in thousands):
Condensed Combined Balance Sheets December 31, 1995 1994 ---- ---- Real estate, at cost net of depreciation $54,489 $23,778 Cash and other assets 2,133 1,424 ------- ------- Total Assets $56,622 $25,202 ======= ======= Notes payable $35,754 $15,644 Other liabilities 575 424 ------- ------- Total Liabilities 36,329 16,068 ------- -------
Equity The Company 3,043 1,364 Joint venture partner 17,250 7,770 ------- ------- Total Equity 20,293 9,134 ------- ------- Total Liabilities and Equity $56,622 $25,202 ======= =======
Condensed Combined Statement of Operations
Years Ended December 31 ----------------------- 1995 1994 ---- ---- Revenues $ 7,014 $ 1,263 Operating expenses (3,110) (551) Depreciation (1,437) (283) Interest expense (2,338) (373) ------- ------- Net Income $ 129 $ 56 ======= ======= Allocation of Net Income The Company $ 19 $ 9 Joint Venture Partner $ 110 $ 47
In December 1994, the Company entered into a joint venture to develop and construct the Finisterra Apartments community in Tempe, Arizona. In April 1995, the Company acquired the land from the joint venture for $2,670,000 and terminated the joint venture. As of December 31, 1995, the investment in the Finisterra Apartments land was $2,732,000. The Company expects to begin construction in March 1996.
Operating income from apartments is affected primarily by rental rates, occupancy rates and operating expenses. Rental rates and occupancy rates are affected by the strength of the local economy, the local housing market and the supply of and demand for apartment communities.
3. MORTGAGE ASSETS
Income
For 1995 and 1994, the average carrying value of the mortgage assets was $14,827,000 and $26,691,000, respectively, and the average prospective yield was 28% and 24%, respectively. At December 31, 1995, the prospective yield was 29%. As discussed in Note 1, in 1993, a majority of the mortgage assets were not accounted for under the prospective yield method and the Company recorded substantial amount of reserves for write down.
During 1995, the Company exercised its redemption rights on five mortgage assets for net proceeds of $6,438,000 and income of $2,882,000. Using proceeds from one of the redemptions, the Company prepaid its Secured Notes (see Note 4) and recorded income of $2,420,000 for the excess accrual of the yield maintenance payment on the Notes. The income has been included in income from redemptions of mortgage assets. During 1994, the Company exercised its redemption rights on four mortgage assets for net proceeds of $11,227,000 and income of $4,263,000.
The cash flows and prospective yield income are affected primarily by mortgage prepayment rates and short-term interest rates. Higher mortgage prepayment rates or higher short-term rates reduce the income and total cash flows over the life of the mortgage assets. Income from mortgage asset redemptions is affected by the timing of meeting the specified conditions for redemptions and the value of the underlying mortgage instruments. As a result, mortgage asset redemptions do not occur on a regular basis and the income can fluctuate significantly between periods. In addition, redemption of mortgage assets reduces the prospective yield income in future periods.
Hedging transactions
In 1992, the Company purchased "Cap Agreements" to protect against the negative effect on mortgage asset cash flows of increases in interest rates in 1994. The "Cap Agreements," purchased for $2,459,000, called for payments to the Company equal to the excess of one-month LIBOR over 5.5% on specified dates during 1994 (generally monthly) times $240,000,000. The effect of the Cap Agreements was to provide that the interest paid on structured financing during 1994 did not exceed 5.5%.
Also in 1992, the Company executed short sales of Eurodollar Futures Contracts on the International Monetary Market exchange. The effect of the Futures Contracts was to "fix" the interest rate on $190,000,000 of the structured financings at approximately 6.75% for 1995. In 1993, the Company recorded losses of $4,168,000 on the
Future Contracts. In 1994, the Company closed out its Futures Contract position and realized a gain of $1,152,000 which was recorded as set forth below.
Both the Cap Agreements and Futures Contracts transactions were entered into as hedges against the interest rate impact on mortgage asset cash flows in 1994 and 1995. The cost of the Cap Agreements ($2,459,000) and the losses incurred on the Futures Contracts during 1993 ($4,168,000) were accounted for as additional costs of the mortgage assets and were written off in connection with the adoption of SFAS No. 115 in December 1993. Such amounts are included in the "cumulative effect of accounting change" in the accompanying consolidated statements of operations. The 1994 gain on the Futures Contracts ($1,152,000) was recorded as a reduction in the carrying value of the mortgage assets.
Because of (1) the decline in importance of mortgage assets as a result of the Company's emphasis on investments in apartments and (2) the decline in the amount of variable rate structured financing underlying the mortgage assets, the Company no longer plans to invest in similar hedging transactions and had no such investments at December 31, 1995 and 1994.
4. NOTES PAYABLE
Real estate notes payable
The apartment communities acquired in January 1994 were financed by first mortgage loans totaling $45,700,000 and seller carryback notes of $6,500,000. The first mortgage loans are nonrecourse and non-cross collateralized. They generally have a ten year term and bear fixed interest rates ranging from 8.5% to 10.1%, with a weighted average fixed rate of 8.6% at December 31, 1995 and 1994. The wholly owned 222-unit community in Mesa, Arizona, which was purchased in February 1995, was financed by a $3,770,000 first mortgage loan bearing interest at 225 basis points over three-month LIBOR. Amortization of deferred loan fees was $120,000 and $88,000 for 1995 and 1994
The seller carryback notes were unsecured, bore a fixed interest rate of 7.5% and were to be amortized over a three-year period ending February 1, 1997 with monthly principal and interest payments of $202,000. As provided for by the note agreements, the Company repaid the notes in 1995 at a discount of $311,000 which was recorded as a credit to income.
The scheduled maturities of the real estate notes payable are as follows (in thousands):
1996 $ 773 1997 2,317 1998 440 1999 4,227 2000 552 2001-2004 41,324 ---- --------------- Total $ 49,633 ===============
Mortgage assets notes payable
In 1992, the Company issued $80,000,000 of Secured Notes ("Notes") at an interest rate of 9.02% per year. The Notes were collateralized by a majority of the Company's mortgage assets and funds held by the trustee (restricted cash). The Company was required to use the net proceeds from the redemptions of the mortgage interest to prepay the Notes at a premium. During 1994, the Company made prepayments of $10,355,000.
In February 1995, the Company used the proceeds from a mortgage asset redemption of $2,800,000, $393,000 of its cash and the funds held by the trustee to prepay the
entire balance of the Notes. Accordingly, the funds held by the trustee ($21,583,000 at December 31, 1994) were presented as a reduction of the Notes balance in the consolidated balance sheets. Amortization of deferred loan cost was $549,000 for 1993.
Short-term Borrowing
At December 31, 1995, the Company had borrowings under reverse repurchase agreements of $2,170,000 secured by five mortgage assets with a total carrying value of $2,645,000. The Company also had short-term borrowings of $2,325,000 secured by two mortgage assets with a total carrying value of $4,994,000. The interest rate averaged 6.55% during 1995 and 6.69% at December 31, 1995.
5. STOCK OPTIONS
The Company has two stock option plans which are administered by the Board of Directors. The purpose of the plans is to provide a means of performance-based compensation to attract and retain directors and key personnel.
Under the plans, options to acquire a maximum of 140,000 shares of the Company's common stock may be granted at an exercise price not less than the fair market value of the stock. The options expire ten years after the date of grant. Upon exercise of the options, the Company can elect to distribute cash in lieu of shares.
In addition, in connection with the renewal of the management agreement for 1994, the Company and the Manager agreed to eliminate the incentive management fee provision and the Company granted to the partners of the Manager non-qualified options to purchase 309,800 shares of common stock and 90,200 shares of stock appreciation rights ("SARs") with an exercise price of $8.60 per share. The exercise price was 10% above the closing market price of the common stock on the grant date. The holders will also receive payments equal to the product of the per share dividend amount times the number of options and SARs outstanding. The options and SARs will expire in December 1998. As of December 31, 1995, all of the options and SARs are exercisable and none of them have been exercised. Upon exercise of the options, the Company can elect to distribute cash in lieu of shares.
In 1995, certain holders exercised options to purchase 50,496 shares by giving full recourse notes totaling $653,000 to the Company. The notes are secured by the shares of common stock issued and bear interest at the prime rate plus 1%. The notes are due on December 31, 1996 and can be repaid by giving the Company shares of common stock owned by the optionholders based on the then market price of the common stock.
Information on all stock options granted is summarized below:
Number Option of Price Shares Per Share ------ --------- Outstanding at December 31, 1993 403,141 $ 8.13-$20.90 Options and DERs canceled (4,901) 11.19-$20.00 Options granted 14,000 $11.25 Outstanding at ------- December 31, 1994 412,240 $8.13-$20.90
Options exercised (54,496) $11.25-13.13 Outstanding at ------- December 31, 1995 357,744 $8.13-$20.90 =======
6. Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No.107, "Disclosures about Fair Values of Financial Instruments." Although management uses its best judgement in estimating the fair value of these instruments, there are inherent limitations in any estimation technique and the estimates are thus not necessarily indicative of the amounts which the Company could realize in a current transaction.
Basis of Estimates
Mortgage Assets. The fair value of mortgage assets is generally dependent on interest rate and other economic factors, including (1) the characteristics of the asset, (2) estimates of future cash flows and (3) the discount rate used to calculate the present value of the cash flows. The market for the Company's mortgage assets is very illiquid and traded prices are determined on a privately negotiated basis. Thus, except for one mortgage asset which the Company has agreed to redeem in the second quarter of 1996 for total income of $4.9 million, the Company uses the carrying values as the estimated values.
Management believes, however, that it is meaningful to provide the following present value of the estimated cash flows using the interest rates and mortgage prepayment rates as of December 31, 1995. The estimates without redemptions assume that the mortgage assets are held until the stated maturity (with the exception of one mortgage asset which the Company has agreed to redeem in April 1996 for estimated net proceeds of $6,000,000). The estimates with redemptions assume that the Company would exercise the redemption rights at the earliest dates and sell the mortgage instruments at the estimated market prices as of December 31, 1995. (Dollars in thousands.)
Discount With Without Rate Redemptions Redemptions ---- ----------- ----------- 10% $41,442 $22,967 20% $34,032 $18,484 30% $28,595 $15,890 40% $24,505 $14,048 50% $21,354 $12,635
Real Estate Notes Payable. The Company has used the carrying value of real estate notes payable as their fair value. At December 31, 1995, the interest rates on the Company's notes payable approximated the market rates for debt instruments with similar terms and maturities.
Short-term borrowing. The Company has used the carrying value of short-term borrowing as its fair value as the interest rates are adjusted monthly and the maturity terms are less than one year.
Estimated Fair Values (in thousands):
Carrying Estimated Amount Fair Value ------ ---------- Mortgage assets $11,877 $16,777 Real estate notes payable 49,633 49,633 Short-term borrowing 4,495 4,495
7. RELATED PARTY TRANSACTIONS
Subject to the supervision of the Company's Board of Directors, Pima Mortgage Limited Partnership (the "Manager") manages the day-to-day operations of the Company pursuant to a management agreement which has a current term through December 31, 1996. Pursuant to the agreement, the Manager receives a base management fee of 3/8 of 1% per annum of the Company's average invested assets before deduction for reserves and depreciation. The management fees for 1995, 1994 and 1993 were $374,000, $544,000, and $625,000, respectively.
Under the agreement, the Manager must reimburse the Company for any management fees received for the year to the extent that the operating expenses (as defined) for the year exceed the greater of 2% of the Company's average invested assets or 25% of its net income (as defined), unless the unaffiliated directors determine that a higher level of expenses is justified for such year. There were no such excess operating expenses in 1995, 1994 or 1993. Additionally, if the agreement is terminated without cause (as defined) or not renewed on terms as favorable to the Manager, the Manager will be entitled to receive the management fees relating to the invested assets purchased prior to the termination date, for a three-year period as if the agreement had remained in effect.
Under the agreement, the Manager also performs certain analyses and other services in connection with the administration of structured financing related to the Company's mortgage assets. For such services, the Company paid the Manager $216,000 for 1995, $247,500 for 1994, and $260,000 for 1993.
As discussed in Note 5, the Company and the Manager agreed to eliminate the incentive fee provision in the management agreement beginning with 1994. The Company granted to the owners of the Manager options and stock appreciation rights ("SARs") that provide for dividend equivalent payments based on the per share amounts of dividends paid on the common stock. In 1995 and 1994, the dividend equivalent payments were $800,000 and $200,000 which are included in operating expenses. As a result of the increase in the common stock price, the Company recorded an accrual for the SARs of $705,000 in 1995 and $324,000 in 1994, which amounts are included in operating expenses.
The Company has entered into a property management agreement with Pima Realty Advisors, Inc. the "Property Manager"), an affiliate of the Manager, for each of its apartment properties. Under the property management agreements, the Property Manager provides the customary property management services at its cost without profit or distributions to its owners, subject to the limitation of the prevailing management fee rates for similar properties in the market. The costs are allocated to the Company monthly based on the ratio of the number of units owned by the Company relative to the total apartment units managed by the Property Manager. The costs allocated to the Company for 1995 and 1994 were $417,000 and $184,000 respectively (net of an allocated credit of $246,000 applicable only in 1994), which were equal to approximately 3% and 1.4% of the real estate operating income.
8. TAXABLE INCOME (LOSS) (unaudited)
As of December 31, 1995, the Company had an estimated net operating loss ("NOL") carryforward of $75,000,000 which can be used to offset taxable income other than excess inclusion income through 2009 (1999 for state taxes). Substantially all of the dividends for 1994 and 1993 constitute ordinary income. Approximately 14.5% of the 1995 dividend is ordinary income and 85.5% is a return of capital for income tax purposes. During 1995, 1994, and 1993, the Company had excess inclusion income from the residual interest in certain real estate mortgage investment conduits ("REMICs") which cannot be used to offset operating losses (including NOL carryforward) and deductions from other sources. Under the current tax law for REITs, excess inclusion income is required to be distributed as dividends. The estimated taxable income of $900,000 for 1995 represents excess inclusion income.
Net income reported in the accompanying consolidated financial statements is different than the taxable income due to the reporting of some income and expense items in different periods for income tax purposes. The difference consists primarily of (1) reserves taken on mortgage assets in prior years which were not allowed for income taxes, (2) differences in income recognition methods on mortgage assets and (3) excess inclusion income for tax purposes. These timing differences will reverse in future years.
Taxable income for 1995 is subject to change when the Company prepares and files its income tax returns. The taxable income amounts also are subject to adjustments, if any, resulting from audits of the Company's tax returns by the Internal Revenue Service.
9. QUARTERLY FINANCIAL DATA (unaudited) (Dollars in Thousands Except Per Share Amounts) Net Income Dividend Total ---------------- Per Income Amount Per share share ------ ------ --------- ----- First $ 7,983 $ 3,359 $ 1.10 $ 0.50 Second 6,410 2,015 0.65 0.50 Third 4,798 570 0.18 0.50 Fourth 5,008 610 0.19 0.50
First $ 5,263 $ 1,218 $ 0.56 $ -- Second 7,369 2,698 0.85 -- Third 6,228 2,074 0.65 -- Fourth 5,087 1,712 0.55 0.50
First $ (9,069) $(11,174) $ (3.60) $ -- Second (1,126) (2,877) (0.95) -- Third 530 (1,320) (0.45) 0.25 Fourth (2,288) (25,199) (8.10) 0.90
ASR INVESTMENTS CORPORATION SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION (in thousands)
A summary of activity for real estate investments and accumulated depreciation is as follows:
1995 1994 ---------- --------- Real Estate Investments: Balance, beginning of year $64,264 $ 0 Acquisitions .............. 6,358 61,593 Improvements .............. 2,106 2,671 Dispositions and other ... 0 0 ---------- --------- Balance, end of year .....$ 72,728 $64,264 ========== =========
Accumulated Depreciation: Balance, beginning of year $ 1,995 $ 0 Depreciation .............. 2,692 1,995 Dispositions and other ... 0 0 ---------- --------- Balance, end of year .....$ 4,687 $ 1,995 ========== =========