Associated Estates Realty Corporation
Overview
Associated Estates Realty Corporation (the "Company") is a Real Estate Investment Trust ("REIT") which, at December 31, 1997 owned or was a joint venture partner in 88 multifamily properties containing 17,600 suites located in Ohio, Michigan, Indiana and western Pennsylvania.
The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Historical results and percentage relationships set forth in the Consolidated Statements of Operations contained in the financial statements, including trends which might appear, should not be taken as indicative of future operations.
Liquidity and capital resources
The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, commencing with its taxable year ending December 31, 1994. REITs are subject to a number of organization and operational requirements including a requirement that 95% of the income that would otherwise be considered as taxable income be distributed to its shareholders. Providing the Company continues to qualify as a REIT, it will generally not be subject to a Federal income tax on net income.
The Company expects to meet its short-term liquidity requirements generally through its net cash provided by operations. The Company believes that its net cash provided by operations will be sufficient to meet both operating requirements and the payment of dividends in accordance with REIT requirements in both the short and long term.
Financing
The Company utilizes borrowings under a $100 million unsecured revolving credit facility (the "Line of Credit") for the acquisition and development of multifamily properties and working capital purposes. The Company reached an agreement to increase the total borrowing capacity under the Line of Credit from $75 to $100 million in September 1997. The Line of Credit includes certain restrictive covenants which, among others, requires the Company to maintain a minimum level of net worth, to limit dividends to 90% of Distributable Cash Flow, to restrict the use of its borrowings and to maintain certain debt coverage ratios. The Line of Credit provides for a scaled reduction in the LIBOR or prime rate margins and commitment fees based on the Company's credit ratings. Based on the Company's present credit ratings, the LIBOR margin is 125 basis points fixed in increments of 30, 60, 90, 120 or 180 days and Prime Rate borrowings are at the Prime Rate with no margin. An annual commitment fee of between 15 basis points and 25 basis points on the average daily unused amount of the facility is paid quarterly in arrears. The Line of Credit expires in September 1998. At December 31, 1997, $83 million was drawn on the Line of Credit with a weighted average interest rate of 7.04%.
Seventy-one of the Company's 81 wholly owned properties were unencumbered at December 31, 1997 with annualized earnings before interest, depreciation and amortization of approximately $51.9 million and an historical cost basis of approximately $527.4 million. The remaining ten of the Company's wholly owned properties have an historical cost basis of $91.0 million and secured property specific debt of $57.8 million at December 31, 1997. Unsecured debt, which totaled $260.3 million at December 31, 1997, consisted of $92.5 million in Medium-Term Notes, Senior Notes of $84.8 million and amounts drawn on the revolving credit facility of $83.0 million. The Company's proportionate share of the mortgage debt relating to the seven joint venture properties was $17.8 million at December 31, 1997. The weighted average interest rate on the secured, unsecured and the Company's proportionate share of the joint venture debt was 7.53% at December 31, 1997.
During the year ended December 31, 1997, the Company issued four Medium-Term Notes (the "MTN's") aggregating $50 million under its $75 million and $102.5 million MTN programs. The principal amounts of these MTN's range from $2.5 million to $20 million and bear interest from 6.2% to 7.9% over terms of between two to 30 years. The holder of a $5 million, 30 year MTN has the option to require payment on February 20, 2002. The net proceeds to the Company with respect to these issuances were $49.8 million, which were applied to amounts outstanding under the Line of Credit.
Registration statements filed in connection with financing
The Company has filed a shelf registration statement with the Securities and Exchange Commission relating to the proposed offering of up to $368.8 million of debt securities, preferred shares, depositary shares, common shares and common share warrants. The total amount of the shelf filing includes a $102.5 million MTN program. The securities may be offered from time to time at prices and upon terms to be determined at the time of sale.
Acquisitions, development and dispositions
The Company intends to continue to finance its multifamily property acquisitions and development with the most appropriate sources of capital, which may include undistributed Funds From Operations, the issuance of equity securities, bank and other institutional borrowings, the issuance of debt securities, the assumption of mortgage indebtedness or through the exchange of properties. The Company may also determine to raise additional working capital through one or more of these sources.
During the year ended December 31, 1997, the Company acquired, in separate purchase transactions, eight multifamily properties containing an aggregate of 1,762 suites and two parcels of land consisting of 14.7 acres for an aggregate purchase price of $105.1 million, of which $4.5 million represents liabilities assumed. The acquired properties are located in Clinton Township and Farmington Hills, Michigan; Indianapolis, Indiana; and Cincinnati, Columbus and Toledo, Ohio. The purchase price of the acquired properties has been financed primarily with proceeds from borrowings on the Company's Line of Credit.
Subsequent to December 31, 1997, the Company acquired four multifamily properties containing an aggregate of 1,320 suites for an aggregate purchase price of $74.4 million, of which $15.5 million represents liabilities assumed which includes mortgage indebtedness of $15.0 million. The balance of the purchase price was financed using borrowings under an unsecured 90 day term loan of $44.5 million and borrowings under the Company's Line of Credit of approximately $14.4 million. The properties are located in Coconut Creek, Florida; Duluth, Georgia; Columbia, Maryland; and Toledo, Ohio. The Falls Apartments was acquired by AERC of Georgia, a wholly owned qualified REIT subsidiary of the Company. The Company will manage all of the Acquired Properties; however, interim management agreements have been entered into with the current managers for the properties located in Florida, Georgia and Maryland. The interim management agreements are cancelable upon 30 days' notice by the Company. The Company has given notice to the managing agent of Cypress Shores that an affiliate of MIG Realty Advisors, Inc. ("MIGRA") will commence managing the property on March 1, 1998. The Falls Apartments and Reflections Apartments will be managed by affiliates of MIGRA.
The remainder of the acquisitions, development and dispositions section contains forward-looking statements and certain risks, trends and uncertainties that could cause actual results to vary from those contained in the forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which are based only on current judgements and current knowledge of management. These forward-looking statements are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Factors which could cause actual results to differ materially from those projected include the general economic climate; the supply and demand for multifamily properties; interest rate levels; the availability of financing; and other risks associated with the acquisition, development and disposition of properties, including risks that development or lease-up may not be completed on schedule, or that the merger did not close. Furthermore, there can be no assurances that the Company will be successful in acquiring the multifamily properties and the land parcels under contract as described below.
The Company has three newly constructed multifamily properties in lease-up. Bradford at Easton, a 324 suite property located in Columbus, Ohio was completed in the fourth quarter of 1997 and presently has 270 suites leased. The Residence at Barrington, a planned 288 suite property located in Aurora, Ohio (a city located southeast of Cleveland), had 120 suites completed and 146 suites leased. The Village of Western Reserve, a 108 suite property in Streetsboro, Ohio (also located southeast of Cleveland) had 43 suites completed and 71 suites leased. The Company has also commenced construction on a 120 suite expansion to Georgetown Park Apartments, a multifamily property owned by the Company in Fenton, Michigan. The Village of Western Reserve and The Residence at Barrington (the "New Construction Properties") are scheduled for completion in the second and fourth quarter of 1998, respectively. The Company anticipates completing the Georgetown addition in the fourth quarter of 1998.
The Company is anticipating the construction of an additional 398 suites (collectively the "Suite Additions") during 1998 on land adjacent to multifamily properties currently owned by the Company as follows:
The Company is exploring opportunities to dispose of several of its multifamily properties.
The Company has also entered into separate contracts to purchase three parcels of undeveloped land containing an aggregate of 144 acres for an approximate purchase price of $9.8 million. One of the parcels is located in Avon, Ohio (a suburb of Cleveland), one of the parcels is located in Crestview Hills, Kentucky adjacent to a multifamily real estate property currently under contract and one of the parcels is located in Cranberry Township, Pennsylvania (a suburb of Pittsburgh). Approximately 838 multifamily apartments may be constructed on the undeveloped land; 312 in Avon, Ohio; 300 in Crestview Hills, Kentucky; and 226 in Cranberry Township, Pennsylvania. The Company expects to finance the undeveloped land acquisitions using borrowings under the Line of Credit.
The proposed merger with MIG Realty Advisors, Inc.
Subject to customary conditions to closing and the approval of the Company's shareholders, the Company has entered into a definitive merger agreement with MIGRA. Pursuant to the terms of the merger agreement with MIGRA, the Company will also acquire the property management business of several of MIGRA's affiliates and the right to receive certain asset management fees, including disposition fees that would have otherwise been received by MIGRA upon the sale of certain of the properties owned by institutions advised by MIGRA. Founded in 1982, MIGRA currently manages, through its affiliated management companies, 36 Multifamily Apartment Properties containing 11,059 suites. MIGRA's asset management, property management, investment advisory and mortgage servicing operations are collectively referred to herein as the "MIGRA Operations."
In exchange for their interest in MIGRA and the affiliated property management businesses, the shareholders of MIGRA will receive approximately 408,318 (based on the average closing prices of the Company's common shares for the 20 trading days preceding the date of the merger agreement price, which average price is $23.63) of the Company's common shares at the closing of the merger. Subject to the achievement of certain performance criteria, the shareholders of MIGRA have the opportunity to receive additional contingent consideration to be paid in the form of the Company's common shares. Such contingent consideration may aggregate up to $3.1 million and $6.4 million on the first and second anniversary of the merger, respectively. A portion of the shares to be issued will be based on the average closing price of the Company's common shares for the 20 days immediately preceding the contingent payment date. Assuming all contingent consideration is paid, the total purchase price for MIGRA, the property management business, and the rights to the disposition fees will be approximately $19.1 million.
The Company may reduce the purchase price for the MIGRA Operations to the extent that any of MIGRA's or a MIGRA affiliate's advisory clients have not consented to the assignment of or have terminated any advisory, asset, property management or mortgage servicing agreement to the Company. Conversely, the purchase price may be increased to the extent that MIGRA enters into any new asset or property management or mortgage servicing agreement on or before the 90 days preceding the closing of the merger. In no event, however, will the amount of any price increase exceed the amount of any price decrease.
The proposed acquisition of multifamily real estate properties
On January 28, 1998 (the "Contract Date"), the Company entered into a contract to acquire certain assets, consisting principally of the multifamily properties as further described below, from the named seller (the "Proposed Acquisition Properties"). The Proposed Acquisition Properties are as follows:
The seller of the Proposed Acquisition Properties has agreed to exchange its assets for a combination of cash and an equity interest (the "Equity Consideration") in the Company totaling $108.5 million. The cash portion of the purchase price may not exceed $11.1 million. The number of common shares issued will be determined based on the amount of Equity Consideration divided by the average closing price of the Company's common shares over the 20 day period preceding the purchase of the Proposed Acquisition Properties. For purposes of determining the number of shares issued as Equity Consideration, however, the 20 day average price cannot exceed the average closing price of the Company's common shares over the 20 day period preceding Contract Date times 106%. The Company intends to finance any cash portion of the purchase price with borrowings made available through the Company's revolving credit facility (the "Line of Credit"). The amount of cash ultimately paid will be determined at the discretion of the Seller in an amount up to $11.1 million.
Dividends
On December 10, 1997, the Company declared a dividend of $0.465 per common share for the quarter ending December 31, 1997 which was paid on January 15, 1998 to shareholders of record on December 31, 1997. On November 24, 1997, the Company declared a dividend of $0.60938 per depositary share on its Class A Cumulative Preferred Shares (the "Perpetual Preferred Shares") which was paid on December 15, 1997 to shareholders of record on December 4, 1997.
Cash flow sources and applications
Net cash provided by operating activities decreased $1,124,100 from $31,060,500 to $29,936,400 for the year ended December 31, 1996 when compared with the year ended December 31, 1997. This decrease was primarily the result of increases in accounts and notes receivable and restricted cash which was offset somewhat by decreases in other operating assets and liabilities and an increase in cash provided by the income derived from the Company's multifamily property operations.
Net cash flows used for investing activities of $131,908,000 for the year ended December 31, 1997 were primarily used for the acquisition and development of multifamily real estate, properties and undeveloped land parcels.
Net cash flows provided by financing activities of $102,936,400 for the year ended December 31, 1997 were primarily comprised of borrowings on the Line of Credit and the issuance of MTN's and the 1,750,000 common shares. Funds were also used to pay dividends on the Company's common and Perpetual Preferred Shares as well as repayments on the Line of Credit.
RESULTS OF OPERATIONS
Comparison of the year ended December 31, 1997 to the year ended December 31,1996
Overall, total revenue increased $14,354,800 or 15.2% and total expenses increased $15,833,700 or 21.0% for the year. Net income applicable to common shares increased $1,408,400 or 10.2%, after the dividends on the Company's Perpetual Preferred Shares.
In the following discussion of the comparison of the year ended December 31, 1997 to the year ended December 31, 1996, the term Core Portfolio Properties refers to the 35 wholly owned multifamily properties acquired by the Company at the time of the IPO and the 32 properties acquired during 1994 and 1995 and the acquisition of the remaining 50% interest in two properties in which the Company was a joint venture partner at the time of the IPO. Acquired Properties refers to the 14 properties acquired between January 1, 1996 and December 31, 1997.
During the year ended December 31, 1997, the Acquired Properties generated total revenues of $18,768,700 while incurring property, operating and maintenance expenses of $7,048,300.
Rental revenues
Rental revenues increased $13,664,500 or 15.5% for the year. Rental revenues from the Acquired Properties increased $12,685,292 for the year. Increases in occupancy and suite rents at the Core Portfolio Market-rate and Government-Assisted Properties resulted in a $979,300 or 1.2% increase in rental revenue from these properties. The balance of the increase resulted from increased rental revenues attributable to office space and other miscellaneous rental revenue items.
Other revenues
Other income increased $687,600 or 64.5% for the year. The increase is due primarily to (i) an increase in the amount of real estate tax refunds received as well as (ii) an increase in the amount of interest income earned in comparison to the prior year.
Property operating and maintenance expenses
Property operating and maintenance expenses increased $6,173,800 or 16.7% for the year. Operating and maintenance expenses at the Acquired Properties increased $4,730,300 for the year due primarily to the operating and maintenance expenses incurred at the eight properties acquired during 1997 and the recognition of a full year's operating expenses at the six properties acquired during 1996. Property operating and maintenance expenses at the Core Portfolio Properties increased $1,443,400, or 4.2% when compared to the prior 12 month period primarily due to increases in personnel, utilities and building and grounds repair and maintenance expenses which were offset by a decrease in advertising expenses. Building renovations and suite and common area refurbishment in the Core Portfolio Properties that were not considered to be capital in nature averaged $565 per suite for the year ended December 31, 1997 as compared to $515 per suite for the year ended December 31, 1996.
Other expenses
Depreciation and amortization increased $3,730,200 or 24.0% for the year primarily due to the increased depreciation and amortization expense recognized on the Acquired Properties.
Costs associated with abandoned projects of $309,800 were expensed during the year. These costs consist primarily of certain pre-development costs, such as architectural, legal and accounting fees, that were incurred on projects that the Company decided not to pursue.
General and administrative expenses increased $172,500 or 2.9% for the year. This increase is primarily attributable to payroll and related expenses.
A charge for unrecoverable funds advanced to non-owned properties and other costs totaling $1,764,000 was incurred during 1997. This charge primarily relates to the write-off of two advances to managed but non-owned properties (third parties) that were deemed to be uncollectible.
Interest expense increased $3,628,300 or 23.4% for the year primarily due to the interest incurred with respect to the additional borrowings under the Line of Credit that were used for the acquisition of properties.
The gain on sale of land resulted from the sale of a 90-acre parcel of land zoned for office and industrial use which was one of the assets acquired by the Company at the time of the Company's initial public offering.
Extraordinary items
In 1997, unamortized debt discount was written off upon the early repayment of mortgage debt of $1,023,713 and was recognized as an extraordinary item in the Consolidated Statements of Income.
Net income applicable to common shares
Net income applicable to common shares is reduced by dividends on the Perpetual Preferred Shares of $5,484,400.
Comparison of the year ended December 31, 1996 to the year ended December 31, 1995
Overall, total revenue increased $17,377,900 or 22.6% and total expenses increased $15,352,800 or 25.5% for the year. Net income applicable to common shares decreased $221,200 or 1.6%, after the dividends on the Company's Perpetual Preferred Shares.
In the following discussion of the comparison of the year ended December 31, 1996 to the year ended December 31, 1995, the term Core Portfolio Properties refers to the 36 wholly owned multifamily properties acquired by the Company at the time of the IPO and the 21 properties acquired during 1994 and the acquisition of the remaining 50% interest in two properties in which the Company was a joint venture partner at the time of the IPO. Acquired Properties refers to the 21 properties acquired between January 1, 1995 and December 31, 1996.
During the year ended December 31, 1996, the Acquired Properties generated total revenues of $24,525,700 while incurring property, operating and maintenance expenses of $9,534,800.
Rental revenues
Rental revenues increased $17,929,700 or 25.6% for the year. Rental revenues from the Acquired Properties increased $15,564,900 for the year. Increases in occupancy and suite rents at the Core Portfolio Market-rate and Government-Assisted Properties resulted in a $2,364,800 or 3.9% increase in rental revenue from these properties. The balance of the increase resulted from increased rental revenues attributable to office space and other miscellaneous rental revenue items.
Other revenues
Property management fees decreased $432,800 or 10.3% for the year. This decrease was due in part to a decline in management fees attributable to a supplemental management fee pursuant to the terms of the management contract between the Company and a managed property. No supplemental management fee was earned at this managed property in 1996 due to an increase in operating and repair and maintenance expenses.
Painting service revenue increased $567,300 or 53.2% for the year and reflects an increase in revenue generated from suite painting and major renovation projects when compared to the previous year. The increase in painting service was partially offset by an increase in painting service expenses as discussed elsewhere herein.
Other income decreased $686,200 or 39.2% for the year. The decrease is due primarily to a reduction in the amount of real estate tax refunds received in comparison to the prior year as well as a reduction of supervisory management fees earned for overseeing the improvement of tenant space at the commercial properties managed by the Company.
Property operating and maintenance expenses
Property operating and maintenance expenses increased $7,778,900 or 26.6% for the year. Operating and maintenance expenses at the Acquired Properties increased $6,780,800 for the year due primarily to the operating and maintenance expenses incurred at the six properties acquired during 1996 and the recognition of a full year's operating expenses at the 15 properties acquired during 1995. Property operating and maintenance expenses at the Core Portfolio Properties increased $998,100, or 3.8% when compared to the prior 12 month period primarily due to increases in personnel, utilities and real estate taxes which were partially offset by a decrease in building and grounds repair and maintenance expenses for suite improvements such as the replacement of appliances and carpeting. Total expenditures for building renovations and suite and common area refurbishment in the Core Portfolio Properties that were not considered to be capital in nature averaged $270 per suite for the year ended December 31, 1996 as compared to $301 per suite for the year ended December 31, 1995.
Other expenses
Depreciation and amortization increased $2,878,200 or 22.7% for the year primarily due to the increased depreciation and amortization expense recognized on the Acquired Properties.
Painting service expenses increased $435,500 or 43.5% for the year. These increases were primarily the result of payroll related expenses attributable to the increased sales activity of the painting company.
General and administrative expenses increased $441,300 or 8.1% for the year. This increase is primarily attributable to payroll and related expenses.
Interest expense increased $3,864,500 or 33.2% for the year primarily due to the interest incurred with respect to the additional borrowings under the Line of Credit that were used for the acquisition of properties.
Extraordinary items
The extraordinary item of $1,097,500 recognized during 1995 primarily relates to the write off of $911,000 of deferred financing costs in connection with the extinguishment of the Revolving Credit Facility. The balance of the extraordinary item recognized during the year relates to the write off of deferred financing costs in connection with the repayment of certain mortgage indebtedness.
Net income applicable to common shares
Net income applicable to common shares is reduced by dividends on the Perpetual Preferred Shares of $2,132,700.
Equity in net income of joint ventures
The combined equity in net income of joint ventures increased $255,700 or 83.8%, $7,800 or 2.6%, and $163,900 or 122.8% for the years ended December 31, 1997, 1996 and 1995, respectively. These increases are primarily attributable to increased rents and occupancies.
The following table presents the historical statements of operations of the Company's beneficial interest in the operations of the joint ventures for the years ended December 31, 1997, 1996 and 1995.
Outlook
The following two paragraphs contain forward-looking statements and are subject to certain risks, trends and uncertainties that could cause actual results to vary from those projected. Readers are cautioned not to place undue reliance on forward-looking statements, which are based only on current judgments and current knowledge. These forward-looking statements are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that the Company's forward-looking statements involve risks and uncertainty, including without limitation risks of a lessening of demand for the apartments owned by the Company, changes in government regulations affecting the Government-Assisted Properties, and expenditures that cannot be anticipated such as utility rate and usage increases, unanticipated repairs, additional staffing, insurance increases and real estate tax valuation reassessments.
Approximately 52% of the Company's multifamily properties are located in the greater Cleveland/Akron, Ohio area which is the fourteenth largest consumer market in the United States containing over four million people within a 50 mile radius of Akron. In central Ohio, Columbus is the only city in the northeast quadrant of the country that has experienced continuous population growth since 1970, according to Census Bureau data. Columbus, Ohio was selected by the E & Y Kenneth Leventhal Real Estate Group as one of the 12 best investment markets in the country because of its well-diversified economic base, strong rental growth and lower vacancy rates. The Company's Michigan portfolio is located in ten separate markets having a combined projected population growth of approximately 4.2%, or 153,000 people, with a projected 8.5% increase in job growth or an additional 17,000 jobs.
With an average economic occupancy for the Core Portfolio Market-rate Properties over 94%, and strong market fundamentals, it would appear that opportunities exist for increasing the rate of rental growth at the Company's Market-rate Properties. Though the Company expected to increase rents at the Core Portfolio Market-rate Properties by four to five percent in 1997, lower than expected inflation and the dynamics of the respective markets impeded the Company's ability to increase rents. While the Company anticipated a reduction in its overall economic occupancy in conjunction with its four to five percent rental growth objective, higher than expected vacancies also depressed overall revenue growth.
The Company anticipates that rental revenues will increase between two to three percent in 1998 when compared to 1997. The 1998 rental revenue increase objective should be achieved through a combination of rent and occupancy increases. Markets like Columbus and Indianapolis, where there is an abundance of undeveloped land suitable for development, will continue to be sensitive to the impact of new multifamily housing starts. Some of these new starts, particularly those in proximity to the Company's properties, may have a short-term effect on occupancies. The Company believes that its 1998 rental revenue growth objectives are reasonable given the geographic diversity of the Company's Core Portfolio Market-rate Properties.
The Company expects that building and grounds repair and maintenance expenditures for the Core Portfolio Properties will increase when compared to the prior year as the Company continues to maintain its properties to maximize their earnings potential. Real estate tax increases should begin to moderate as the effect of the reassessed values diminishes over time. Utility expenditures will vary over prior periods as the effect of weather related usage variances is factored into the level of utility expense.
Inflation
Substantially all of the Market-rate residential leases at the properties allow, at the time of renewal, for adjustments in the rent payable thereunder, and thus may enable the Company to seek increases in rents. The substantial majority of these leases are for one year or less and the remaining leases are for terms up to two years. The short-term nature of these leases generally serves to reduce the risk to the Company of the adverse effect of inflation.
Contingencies
There are no recorded amounts resulting from environmental liabilities as there are no known contingencies with respect thereto. Future claims for environmental liabilities are not measurable given the uncertainties surrounding whether there exists a basis for any such claims to be asserted and, if so, whether any claims will, in fact, be asserted. Furthermore, no condition is known to exist that would give rise to a liability for site restoration, post closure and monitoring commitments, or other costs that may be incurred with respect to the sale or disposal of a property. Phase I environmental audits have been completed on all of the Company's wholly owned and joint venture properties. The Company has obtained environmental insurance covering (i) pre-existing contamination, (ii) on-going third party contamination, (iii) third party bodily injury and (iv) remediation. The policy is for a five year term and carries a limit of liability of $2 million per environmental contamination discovery (with a $50,000 deductible) and has a $10 million policy term aggregate. Management has no plans to abandon any of the properties and is unaware of any other material loss contingencies. The Company has completed the installation of financial reporting and leasing management systems, which together comprise the Company's primary reporting systems, that are Year 2000 compliant.
HUD recently notified the Company that Rainbow Terrace Apartments, Inc. (the Company's subsidiary corporation that owns Rainbow Terrace Apartments) is in default under the terms of the Regulatory Agreement and Housing Assistance Payments Contract ("HAP Contract") pertaining to this property. Among other matters, HUD alleges that the property is poorly managed and Rainbow Terrace Apartments has failed to complete certain physical improvements to the property. Moreover, HUD claims that the property is not in compliance with numerous technical regulations concerning whether certain expenses are properly chargeable to the property. As provided in the Regulatory Agreement and HAP Contract, in the event of a default, HUD has the right to exercise various remedies including terminating future payments under the HAP Contract and foreclosing the government-insured mortgage encumbering the property.
This controversy arose out of a Comprehensive Management Review of the property initiated by HUD in the Spring of 1997, which included a complete physical inspection of the property. Rainbow Terrace Apartments believes that it has corrected the management deficiencies cited by HUD in the Comprehensive Management Review (other than the completion of certain physical improvements to the property) and, in a series of written responses to HUD, justified the expenditures questioned by HUD as being properly chargeable to the property in accordance with HUD's regulations. Moreover, Rainbow Terrace Apartments believes it has repaired any physical deficiencies noted by HUD in its Comprehensive Management Review that might pose a threat to the life and safety of its residents. The Company is unable to predict the outcome of the controversy with HUD, but does not believe it will have a material adverse effect on the Company's financial position, results of operations or cash flows.
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