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INVESTORS REAL ESTATE TRUST 10-K 2008 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
Annual
Report Pursuant to Section 13 or 15(d)
of
the Securities Exchange Act of 1934
For
the fiscal year ended April 30, 2008
Commission
File Number 000-14851
Investors
Real Estate Trust
(Exact
name of Registrant as specified in its charter)
12
Main Street South
Minot,
North Dakota 58701
(Address
of principal executive offices)
701-837-4738
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
Common
Shares of Beneficial Interest (no par value) - NASDAQ
Global Select Market
Series A
Cumulative Redeemable Preferred Shares of Beneficial Interest (no par value) -
NASDAQ
Global Select Market
Securities
registered pursuant to Section 12(g) of the Act:
None
________________________________
Indicate
by check mark if the Registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Indicate
by check mark if the Registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act.
Indicate
by check mark whether the Registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o
2008 Annual
Report
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
The
aggregate market value of the Registrant’s outstanding common shares of
beneficial interest held by non-affiliates (i.e., by persons other than officers
and trustees of the Registrant as reflected in the table in Item 12 of this Form
10-K, incorporated by reference from the Registrant’s definitive Proxy Statement
for its 2008 Annual Meeting of Shareholders) was $592,992,811 based on the last
reported sale price on the NASDAQ Global Select Market on October 31,
2007.
The
number of common shares of beneficial interest outstanding as of June 30, 2008,
was 57,869,815.
References
in this Annual Report on Form 10-K to the “Company,” “IRET,” “we,” “us,” or
“our” include consolidated subsidiaries, unless the context indicates
otherwise.
Documents
Incorporated by Reference: Portions of IRET’s definitive Proxy Statement for its
2008 Annual Meeting of Shareholders to be held on September 16, 2008 are
incorporated by reference into Part III (Items 10, 11, 12, 13 and 14)
hereof.
2008 Annual
Report 2
INVESTORS
REAL ESTATE TRUST
INDEX
2008 Annual Report
3
Special
Note Regarding Forward Looking Statements
Certain
statements included in this Annual Report on Form 10-K and the documents
incorporated into this document by reference are “forward-looking statements”
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as
amended (the “Exchange Act”). Such forward-looking statements include statements
about our belief that we have the liquidity and capital resources necessary to
meet our known obligations and to make additional real estate acquisitions and
capital improvements when appropriate to enhance long term growth; and other
statements preceded by, followed by or otherwise including words such as
“believe,” “expect,” “intend,” “project,” “plan,” “anticipate,” “potential,”
“may,” “will,” “designed,” “estimate,” “should,” “continue” and other similar
expressions. These statements indicate that we have used assumptions that are
subject to a number of risks and uncertainties that could cause our actual
results or performance to differ materially from those projected.
Although
we believe that the expectations reflected in such forward-looking statements
are based on reasonable assumptions, we can give no assurance that these
expectations will prove to have been correct. Important factors that could cause
actual results to differ materially from the expectations reflected in the
forward-looking statements include:
Readers
should carefully review our financial statements and the notes thereto, as well
as the section entitled “Risk Factors” in Item 1A of this Annual Report on Form
10-K and the other documents we file from time to time with the Securities and
Exchange Commission (“SEC”).
In light
of these uncertainties, the events anticipated by our forward-looking statements
might not occur. We undertake no obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. The foregoing review of factors that could cause our actual
results to differ materially from those contemplated in any forward-looking
statements included in this Annual Report on Form 10-K should not be construed
as exhaustive.
2008 Annual
Report 4
PART
I
Overview
Investors
Real Estate Trust is a self-advised equity Real Estate Investment Trust (“REIT”)
organized under the laws of North Dakota. Since our formation in 1970, our
business has consisted of owning and operating income-producing real estate
properties. We are structured as an Umbrella Partnership Real Estate Investment
Trust or UPREIT and we conduct our day-to-day business operations though our
operating partnership, IRET Properties, a North Dakota Limited Partnership
(“IRET Properties” or the “Operating Partnership”). Our investments consist of
multi-family residential properties and commercial office, medical, industrial
and retail properties. These properties are located primarily in the upper
Midwest states of Minnesota and North Dakota. For the twelve months ended April
30, 2008, our real estate investments in these two states accounted for 67.4% of
our total gross revenue. Our principal executive offices are located in Minot,
North Dakota. We also have offices in Minneapolis, Minnesota and Omaha,
Nebraska, and property management offices in Kansas City, Kansas and St. Louis,
Missouri.
We seek
to diversify our investments among multi-family residential and office, medical,
industrial and retail properties. As of April 30, 2008, our real estate
portfolio consisted of:
Our
residential leases are generally for a one-year term. Our commercial properties
are typically leased to tenants under long-term lease arrangements. As of April
30, 2008, no single tenant accounted for more than 10% of our total rental
revenues.
Structure
We were
organized as a REIT under the laws of North Dakota on July 31,
1970.
Since our
formation, we have operated as a REIT under Sections 856-858 of the Internal
Revenue Code of 1986, as amended (the “Code”), and since February 1, 1997, we
have been structured as an UPREIT. Since restructuring as an UPREIT, we have
conducted all of our daily business operations through IRET Properties. IRET
Properties is organized under the laws of North Dakota pursuant to an Agreement
of Limited Partnership dated January 31, 1997. IRET Properties is principally
engaged in acquiring, owning, operating and leasing multi-family residential and
commercial real estate. The sole general partner of IRET Properties is IRET,
Inc., a North Dakota corporation and our wholly-owned subsidiary. All of our
assets (except for qualified REIT subsidiaries) and liabilities were contributed
to IRET Properties, through IRET, Inc., in exchange for the sole general
partnership interest in IRET Properties. As of April 30, 2008, IRET, Inc. owned
a 73.1% interest in IRET Properties. The remaining ownership of IRET Properties
is held by individual limited partners.
Investment
Strategy and Policies
Our
business objective is to increase shareholder value by employing a disciplined
investment strategy. This strategy is focused on growing assets in desired
geographical markets, achieving diversification by property type and location,
and adhering to targeted returns in acquiring properties.
2008 Annual
Report 5
We
generally use available cash or short-term floating rate debt to acquire real
estate. We then replace such cash or short-term floating rate debt with
fixed-rate secured debt, typically in an amount equal to 65.0% to 75.0% of a
property’s appraised value. In appropriate circumstances, we also may acquire
one or more properties in exchange for our common shares of beneficial interest
(“common shares”) or for limited partnership units of IRET Properties (“limited
partnership units” or “UPREIT Units”), which are convertible, after the
expiration of a minimum holding period of one year, into cash or, at our sole
discretion, into our common shares on a one-to-one basis.
Our
investment strategy is to invest in multi-family residential properties, and in
office, medical, industrial and retail commercial properties that are leased to
single or multiple tenants, usually for five years or longer, and are located
throughout the upper Midwest. We operate mainly within the states of North
Dakota and Minnesota, although we also have real estate investments in South
Dakota, Montana, Nebraska, Colorado, Idaho, Iowa, Kansas, Michigan, Missouri,
Texas and Wisconsin.
In order
to implement our investment strategy we have certain investment policies. Our
significant investment policies are as follows:
Investments in the securities of, or
interests in, entities primarily engaged in real estate activities and other
securities. While we are permitted to invest in the securities of other
entities engaged in the ownership and operation of real estate, as well as other
securities, we currently have no plans to make any investments in other
securities.
Any
policy, as it relates to investments in other securities, may be changed by a
majority of the members of our Board of Trustees at any time without notice to
or a vote of our shareholders.
Investments in real estate or
interests in real estate. We currently own multi-family residential
properties and/or commercial properties in 13 states. We may invest in real
estate, or interests in real estate, located anywhere in the United States;
however, we currently plan to focus our investments in those states in which we
already have property, with specific concentration in Minnesota, North Dakota,
Nebraska, Iowa, Colorado, Montana, South Dakota, and Kansas. Similarly, we may
invest in any type of real estate or interest in real estate including, but not
limited to, office buildings, apartment buildings, shopping centers, industrial
and commercial properties, special purpose buildings and undeveloped acreage.
Under our Third Restated Trustees’ Regulations (Bylaws), however, we may not
invest more than 10.0% of our total assets in unimproved real estate, excluding
property being developed or property where development will be commenced within
one year.
It is not
our policy to acquire assets primarily for capital gain through sale in the
short term. Rather, it is our policy to acquire assets with an intention to hold
such assets for at least a 10-year period. During the holding period, it is our
policy to seek current income and capital appreciation through an increase in
value of our real estate portfolio, as well as increased revenue as a result of
higher rents.
Any
policy, as it relates to investments in real estate or interests in real estate
may be changed by our Board of Trustees at any time without notice to or a vote
of our shareholders.
Investments in real estate
mortgages. While not our primary business focus, from time to time we
make loans to others that are secured by mortgages, liens or deeds of trust
covering real estate. We have no restrictions on the type of property that may
be used as collateral for a mortgage loan; provided, however, that except for
loans insured or guaranteed by a government or a governmental agency, we may not
invest in or make a mortgage loan unless an appraisal is obtained concerning the
value of the underlying property. Unless otherwise approved by our
Board of Trustees, it is our policy that we will not invest in mortgage loans on
any one property if in the aggregate the total indebtedness on the property,
including our mortgage, exceeds 85.0% of the property’s appraised
value. We can invest in junior mortgages without notice to, or the
approval of, our shareholders. As of April 30, 2007 and 2008, we had
no junior mortgages outstanding. We had one contract for deed
outstanding as of April 30, 2007, with a balance of approximately $399,000, net
of reserves, due to us. We had two contracts for deed outstanding as of April
30, 2008, with a combined balance of approximately $541,000, net of reserves,
due to us.
Our
policies relating to mortgage loans, including second mortgages, may be changed
by our Board of Trustees at any time, or from time to time, without notice to,
or a vote of, our shareholders.
2008 Annual
Report 6
Policies
With Respect to Certain of Our Activities
Our
current policies as they pertain to certain of our activities are described as
follows:
Cash distributions to shareholders
and holders of limited partnership units. One of the requirements of the
Internal Revenue Code of 1986, as amended, for a REIT is that it distribute 90%
of its net taxable income, excluding net capital gains, to its shareholders.
There is a separate requirement to distribute net capital gains or pay a
corporate level tax in lieu thereof. We intend to continue our policy of
making cash distributions to our common shareholders and the holders of limited
partnership units of approximately 65.0% to 90.0% of our funds from operations
and to use the remaining funds for capital improvements or the purchase of
additional properties. This policy may be changed at any time by our Board of
Trustees without notice to, or approval of, our shareholders. We have increased
our cash distributions every year since our inception 38 years ago and every
quarter since 1988.
Issuing senior securities. On
April 26, 2004, we issued 1,150,000 shares of 8.25% Series A Cumulative
Redeemable Preferred Shares of Beneficial Interest (the “Series A preferred
shares”). Depending on future interest rate and market conditions, we may issue
additional preferred shares or other senior securities which would have dividend
and liquidation preference over our common shares.
Borrowing money. We rely on
borrowed funds in pursuing our investment objectives and goals. It is generally
our policy to seek to borrow up to 65.0% to 75.0% of the appraised value of all
new real estate acquired or developed. This policy concerning borrowed funds is
vested solely with our Board of Trustees and can be changed by our Board of
Trustees at any time, or from time to time, without notice to, or a vote of, our
shareholders. Such policy is subject, however, to the limitation in our Bylaws,
which provides that unless approved by a majority of the independent members of
our Board of Trustees and disclosed to our shareholders in our next quarterly
report along with justification for such excess, we may not borrow in excess of
300.0% of our total Net Assets (as such term is used in our Bylaws, which usage
is not in accordance with GAAP, “Net Assets” means our total assets at cost
before deducting depreciation or other non-cash reserves, less total
liabilities). Our Bylaws do not impose any limitation on the amount that we may
borrow against any one particular property. As of April 30, 2008, our
ratio of total real estate mortgages to total real estate assets was 73.1% while
our ratio of total indebtedness as compared to our Net Assets (computed in
accordance with our Bylaws) was 143.8%.
Offering securities in exchange for
property. Our organizational structure allows us to issue shares and to
offer limited partnership units of IRET Properties in exchange for real estate.
The limited partnership units are convertible into cash, or, at our option,
common shares on a one-for-one basis after a minimum one-year holding period.
All limited partnership units receive the same cash distributions as those paid
on common shares. Limited partners are not entitled to vote on any matters
affecting us until they convert their limited partnership units to common
shares.
Our
Articles of Amendment and Third Restated Declaration of Trust does not contain
any restrictions on our ability to offer limited partnership units of IRET
Properties in exchange for property. As a result, any decision to do so is
vested solely in our Board of Trustees. This policy may be changed at any time,
or from time to time, without notice to, or a vote of, our shareholders. For the
three most recent fiscal years ended April 30, we have issued the following
limited partnership units of IRET Properties in exchange for
properties:
Acquiring or repurchasing shares.
As a REIT, it is our intention to invest only in real estate assets. Our
Articles of Amendment and Third Restated Declaration of Trust does not prohibit
the acquisition or repurchase of our common or preferred shares or other
securities so long as such activity does not prohibit us from operating as a
REIT under the Code. Any policy regarding the acquisition or repurchase of
shares or other securities is vested solely in our Board of Trustees and may be
changed at any time, or from time to time, without notice to, or a vote of, our
shareholders.
During
fiscal year 2008, we did not repurchase any of our outstanding common shares,
preferred shares or limited partnership units, except for the redemption of a
nominal amount of fractional common shares held by shareholders, upon
request.
2008 Annual Report
7
To make loans to other persons.
Our organizational structure allows us to make loans to other persons,
subject to certain conditions and subject to our election to be taxed as a REIT.
All loans must be secured by real property or limited partnership units of IRET
Properties. Our mortgage loans receivables (including contracts for deed), net
of reserves, totaled approximately $541,000 as of April 30, 2008, and $399,000
as of April 30, 2007.
To invest in the securities of other
issuers for the purpose of exercising control. We have not, for the
past three years, engaged in, and we are not currently engaging in, investment
in the securities of other issuers for the purpose of exercising control. Our
Articles of Amendment and Third Restated Declaration of Trust does not impose
any limitation on our ability to invest in the securities of other issuers for
the purpose of exercising control. Any decision to do so is vested solely in our
Board of Trustees and may be changed at any time, or from time to time, without
notice to, or a vote of, our shareholders.
To provide summary reports to our
shareholders. We also have a policy of mailing summary quarterly reports
to our shareholders in January, April, July, and October of each year. The
quarterly reports do not contain financial statements audited by an independent
registered public accounting firm. This policy of providing a summary quarterly
report to our shareholders is not required by our organizational documents and
may be changed by a majority of our Board of Trustees at any time without notice
to or a vote of our shareholders.
Information
about Segments
We
currently operate in five reportable real estate segments: multi-family
residential, office, medical (including senior housing), industrial and retail.
For further information on these segments and other related information, see
Note 11 of our consolidated financial statements, and Management’s Discussion
and Analysis of Financial Condition and Results of Operations in Item 7 of this
Annual Report on Form 10-K.
Our
Executive Officers
Set forth
below are the names, ages, titles and biographies of each of our executive
officers as of July 1, 2008.
Thomas A. Wentz, Sr. is a
graduate of Harvard College and Harvard Law School, and has been associated with
us since our formation on July 31, 1970. Mr. Wentz was a member of our Board of
Trustees from 1970 to 1998, Secretary from 1970 to 1987, Vice President from
1987 to July 2000, and has been President and Chief Executive Officer since July
2000. Previously, from 1985 to 1991, Mr. Wentz was a Vice President of our
former advisor, Odell-Wentz & Associates, L.L.C., and, until August 1, 1998,
was a partner in the law firm of Pringle & Herigstad, P.C.
Timothy P. Mihalick joined us
as a financial officer in May 1981, after graduating from Minot State
University. He has served in various capacities with us over the years and was
named Vice President in 1992. Mr. Mihalick has served as the Chief Operating
Officer since 1997, as a Senior Vice President since 2002, and as a member of
our Board of Trustees since 1999.
Thomas A. Wentz, Jr. is a
graduate of Harvard College and the University of North Dakota School of Law,
and joined us as General Counsel and Vice President in January 2000. He has
served as a Senior Vice President of Asset Management and Finance since 2002 and
as a member of our Board of Trustees since 1996. Prior to 2000, Mr. Wentz was a
shareholder in the law firm of Pringle & Herigstad, P.C. from 1992 to 1999.
Mr. Wentz is a member of the American Bar Association and the North Dakota Bar
Association, and he is a Director of SRT Communications, Inc. Mr. Wentz is the
son of Thomas A. Wentz, Sr.
Diane K. Bryantt is a
graduate of Minot State University, joined us in June 1996, and served as our
Controller and Corporate Secretary before being appointed to the positions of
Senior Vice President and Chief Financial Officer in 2002. Prior to joining us,
Ms. Bryantt was employed by First American Bank, Minot, North
Dakota.
2008 Annual
Report 8
Michael A. Bosh joined us as
Associate General Counsel and Secretary in September 2002, and was named General
Counsel in September 2003. Prior to 2002, Mr. Bosh was a shareholder in the law
firm of Pringle & Herigstad, P.C. Mr. Bosh graduated from Jamestown College
in 1992 and from Washington & Lee University School of Law in 1995. Mr. Bosh
is a member of the American Bar Association and the North Dakota Bar
Association.
Kelly A. Walters joined IRET
in October of 2006 as Vice President of Capital Markets and New Business
Development. Prior to joining IRET, Mr. Walters spent ten years as Senior Vice
President of Magnum Resources, Inc., a privately held real estate investment and
operating firm, based in Omaha, NE, and from 1993 through 1996, he was a senior
portfolio manager with Brown Brothers Harriman & Co. in Chicago, IL. Prior
to 1993, Mr. Walters spent five years as the Investment Manager at Peter Kiewit
and Sons, Inc. in Omaha, NE. Mr. Walters earned his undergraduate
degree in finance at the University of Nebraska at Omaha, and received his MBA
from the University of Nebraska.
Employees
As of
April 30, 2008, we had 69 employees.
Environmental
Matters and Government Regulation
Under
various federal, state and local laws, ordinances and regulations relating to
the protection of the environment, a current or previous owner or operator of
real estate may be liable for the costs of removal or remediation of certain
hazardous or toxic substances released at a property, and may be held liable to
a governmental entity or to third parties for property damage or personal
injuries and for investigation and clean-up costs incurred in connection with
any contamination. In addition, some environmental laws create a lien on a
contaminated site in favor of the government for damages and costs it incurs in
connection with the contamination. These laws often impose liability without
regard to whether the current owner was responsible for, or even knew of, the
presence of such substances. It is generally our policy to obtain from
independent environmental consultants a “Phase I” environmental audit (which
involves visual inspection but not soil or groundwater analysis) on all
properties that we seek to acquire. We do not believe that any of our properties
are subject to any material environmental contamination. However, no assurances
can be given that:
In
addition to laws and regulations relating to the protection of the environment,
many other laws and governmental regulations are applicable to our properties,
and changes in the laws and regulations, or in their interpretation by agencies
and the courts, occur frequently. Under the Americans with Disabilities Act of
1990 (the “ADA”), all places of public accommodation are required to meet
certain federal requirements related to access and use by disabled persons. In
addition, the Fair Housing Amendments Act of 1988 (the “FHAA”) requires
apartment communities first occupied after March 13, 1990, to be accessible to
the handicapped. Non-compliance with the ADA or the FHAA could result in the
imposition of fines or an award of damages to private litigants. We believe that
those of our properties to which the ADA and/or FHAA apply are substantially in
compliance with present ADA and FHAA requirements.
Competition
Investing
in and operating real estate is a very competitive business. We compete with
other owners and developers of multi-family and commercial properties to attract
tenants to our properties. Ownership of competing properties is diversified
among other REITs, financial institutions, individuals and public and private
companies who are actively engaged in this business. Our multi-family properties
compete directly with other rental apartments, as well as with condominiums and
single-family homes that are available for rent or purchase in the areas in
which our properties are located. Our commercial properties compete with other
commercial properties for tenants. Additionally, we compete with other real
estate investors, including other REITs, pension and investment funds,
partnerships and investment companies, to acquire properties. This competition
affects our ability to acquire properties we want to add to our portfolio and
the price we pay in acquisitions. We do not believe we have a dominant position
in any of
2008 Annual
Report 9
the
geographic markets in which we operate, but some of our competitors are dominant
in selected markets. Many of our competitors have greater financial and
management resources than we have. We believe, however, that the geographic
diversity of our investments, the experience and abilities of our management,
the quality of our assets and the financial strength of many of our commercial
tenants affords us some competitive advantages that have in the past and will in
the future allow us to operate our business successfully despite the competitive
nature of our business.
Corporate
Governance
The
Company’s Board of Trustees has adopted various policies and initiatives to
strengthen the Company’s corporate governance and increase the transparency of
financial reporting. Each of the committees of the Company’s Board of
Trustees operates under written charters, and the Company’s independent trustees
meet regularly in executive sessions at which only the independent trustees are
present. The Board of Trustees has also adopted a Code of Conduct
applicable to trustees, officers and employees, and a Code of Ethics for Senior
Financial Officers, and has established processes for shareholder communications
with the Board of Trustees.
Additionally,
the Company’s Audit Committee has established procedures for the receipt,
retention and treatment of complaints regarding accounting, internal accounting
controls or auditing matters, including procedures for the confidential,
anonymous submission by Company employees of concerns regarding accounting or
auditing matters. The Audit Committee also maintains a policy requiring Audit
Committee approval of all audit and non-audit services provided to the Company
by the Company’s independent registered public accounting firm.
The
Company will disclose any amendment to its Code of Ethics for Senior Financial
officers on its website. In the event the Company waives compliance by any of
its trustees or officers subject to the Code of Ethics or Code of Conduct, the
Company will disclose such waiver in a Form 8-K filed within four business
days.
Website
and Available Information
Our
internet address is www.iret.com. We make available, free of charge, through the
“SEC filings” tab under the Investor Relations section of our internet website,
our Annual Report on Form 10-K, our quarterly reports on Form 10-Q, our current
reports on Form 8-K, and amendments to such reports filed or furnished pursuant
to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable
after such forms are filed with or furnished to the SEC. Current copies of our
Code of Conduct, Code of Ethics for Senior Financial Officers, and Charters for
the Audit, Compensation, Executive and Nominating Committees of our Board of
Trustees are also available on our website under the heading “Corporate
Governance” in the Investor Relations section of our website. Copies of these
documents are also available to shareholders upon request addressed to the
Secretary at Investors Real Estate Trust, P.O. Box 1988, Minot, North Dakota
58701. Information on our internet website does not constitute part of this
Annual Report on Form 10-K.
Risks
Related to Our Properties and Business
Our performance and share value are
subject to risks associated with the real estate industry. Our
results of operations and financial condition, the value of our real estate
assets, and the value of an investment in us are subject to the risks normally
associated with the ownership and operation of real estate
properties. These risks include, but are not limited to, the
following factors which, among others, may adversely affect the income generated
by our properties:
2008 Annual
Report 10
Our property acquisition activities
subject us to various risks which could adversely affect our operating results.
We have acquired in the past and intend to continue to pursue the
acquisition of properties and portfolios of properties, including large
portfolios that could increase our size and result in alterations to our capital
structure. Our acquisition activities and their success are subject to numerous
risks, including, but not limited to:
These
risks could have an adverse effect on our results of operations and financial
condition and the amount of cash available for payment of
distributions.
Acquired properties may subject us
to unknown liabilities which could adversely affect our operating results.
We may acquire properties subject to liabilities and without any
recourse, or with only limited recourse against prior owners or other third
parties, with respect to unknown liabilities. As a result, if
liability were asserted against us based upon ownership of these properties, we
might have to pay substantial sums to settle or contest it, which could
adversely affect our results of operations and cash flows. Unknown
liabilities with respect to acquired properties might include liabilities for
clean-up of undisclosed environmental contamination; claims by tenants, vendors
or other persons against the former owners of the properties; liabilities
incurred in the ordinary course of business; and claims for indemnification by
general partners, directors, officers and others indemnified by the former
owners of the properties.
Our geographic concentration in
Minnesota and North Dakota may result in losses due to our significant
exposure to the effects of economic and real estate conditions in those
markets. For the fiscal year ended April 30, 2008, we received
approximately 67.4% of our gross revenue from properties in Minnesota and North
Dakota. As a result of this concentration, we are subject to
substantially greater risk than if our investments were more geographically
dispersed. Specifically, we are more significantly exposed to the effects of
economic and real estate conditions in those particular markets, such as
building by competitors, local vacancy and rental rates and general levels of
employment and economic activity. To the extent that weak economic or
real estate conditions affect Minnesota and/or North Dakota more severely than
other areas of the country, our financial performance could be negatively
impacted.
If we are not able to renew leases
or enter into new leases on favorable terms or at all as our existing leases
expire, our revenue, operating results and cash flows will be
reduced. We may be unable to renew leases with our
existing
2008 Annual
Report 11
tenants
or enter into new leases with new tenants due to economic and other factors as
our existing leases expire or are terminated prior to the expiration of their
current terms. As a result, we could lose a significant source of
revenue while remaining responsible for the payment of our
obligations. In addition, even if we were able to renew existing
leases or enter into new leases in a timely manner, the terms of those leases
may be less favorable to us than the terms of expiring leases, because the
rental rates of the renewal or new leases may be significantly lower than those
of the expiring leases, or tenant installation costs, including the cost of
required renovations or concessions to tenants, may be
significant. If we are unable to enter into lease renewals or new
leases on favorable terms or in a timely manner for all or a substantial portion
of space that is subject to expiring leases, our revenue, operating results and
cash flows will be adversely affected. As a result, our ability to make
distributions to the holders of our shares of beneficial interest may be
adversely affected. As of April 30, 2008, approximately 879,000 square feet, or
7.6% of our total commercial property square footage, was vacant.
Approximately 747 of our 9,500 apartment units, or 7.9%, were vacant. As of
April 30, 2008, leases covering approximately 8.3% of our total commercial
segments net rentable square footage will expire in fiscal year 2009, 12.7% in
fiscal year 2010, 21.0% in fiscal year 2011, 12.8% in fiscal year 2012, and 9.6%
in fiscal year 2013.
We face potential adverse effects
from commercial tenant bankruptcies or insolvencies. The
bankruptcy or insolvency of our commercial tenants may adversely affect the
income produced by our properties. If a tenant defaults, we may
experience delays and incur substantial costs in enforcing our rights as
landlord. If a tenant files for bankruptcy, we cannot evict the
tenant solely because of such bankruptcy. A court, however, may
authorize the tenant to reject and terminate its lease with us. In
such a case, our claim against the tenant for unpaid future rent would be
subject to a statutory cap that might be substantially less than the remaining
rent actually owed under the lease, and it is unlikely that a bankrupt tenant
would pay in full amounts it owes us under a lease. This shortfall
could adversely affect our cash flow and results of operations. If a
tenant experiences a downturn in its business or other types of financial
distress, it may be unable to make timely rental payments. Under some
circumstances, we may agree to partially or wholly terminate the lease in
advance of the termination date in consideration for a lease termination fee
that is less than the agreed rental amount. Additionally, without
regard to the manner in which a lease termination occurs, we are likely to incur
additional costs in the form of tenant improvements and leasing commissions in
our efforts to lease the space to a new tenant, as well as possibly lower rental
rates reflective of declines in market rents.
Because real estate investments are
generally illiquid, and various factors limit our ability to dispose of assets,
we may not be able to sell properties when appropriate. Real
estate investments are relatively illiquid and, therefore, we have limited
ability to vary our portfolio quickly in response to changes in economic or
other conditions. In addition, the prohibitions under the federal
income tax laws on REITs holding property for sale and related regulations may
affect our ability to sell properties. Our ability to dispose of
assets may also be limited by constraints on our ability to utilize disposition
proceeds to make acquisitions on financially attractive terms, and the
requirement that we take additional impairment charges on certain
assets. More specifically, we are required to distribute or pay tax
on all capital gains generated from the sale of assets, and, in addition, a
significant number of our properties were acquired using limited partnership
units of IRET Properties, our operating partnership, and are subject to certain
agreements which restrict our ability to sell such properties in transactions
that would create current taxable income to the former owners. As a
result, we are motivated to structure the sale of these assets as tax-free
exchanges. To accomplish this we must identify attractive
re-investment opportunities. Recently, while capital market
conditions have been favorable for dispositions, investment yields on
acquisitions have been less attractive due to the abundant capital inflows into
the real estate sector. These considerations impact our decisions on
whether or not to dispose of certain of our assets.
Inability to manage our rapid growth
effectively may adversely affect our operating results. We have
experienced significant growth in recent years, increasing our total assets from
approximately $1.2 billion at April 30, 2006, to $1.6 billion at April 30, 2008,
principally through the acquisition of additional real estate properties.
Subject to our continued ability to raise equity capital and issue limited
partnership units of IRET Properties and identify suitable investment
properties, we intend to continue our acquisition of real estate properties.
Effective management of this level of growth presents challenges,
including:
2008 Annual
Report 12
We may
not be able to maintain similar rates of growth in the future, or manage our
growth effectively. Our failure to do so may have a material adverse
effect on our financial condition and results of operations and ability to make
distributions to the holders of our shares of beneficial interest.
Competition may negatively impact
our earnings. We compete with many kinds of institutions, including other
REITs, private partnerships, individuals, pension funds and banks, for tenants
and investment opportunities. Many of these institutions are active in the
markets in which we invest and have greater financial and other resources that
may be used to compete against us. With respect to tenants, this competition may
affect our ability to lease our properties, the price at which we are able to
lease our properties and the cost of required renovations or tenant
improvements. With respect to acquisition and development investment
opportunities, this competition may cause us to pay higher prices for new
properties than we otherwise would have paid, or may prevent us from purchasing
a desired property at all.
An inability to make accretive
property acquisitions may adversely affect our ability to increase our
operating income. From our fiscal year ended April 30, 2006, to our
fiscal year ended April 30, 2008, our operating income increased from $9.9
million to $12.3 million. The acquisition of additional real estate
properties is critical to our ability to increase our operating
income. If we are unable to continue to make real estate acquisitions
on terms that meet our financial and strategic objectives, whether due to market
conditions, a changed competitive environment or unavailability of capital, our
ability to increase our operating income may be materially and adversely
affected.
High leverage on our overall
portfolio may result in losses. As of April 30, 2008, our ratio of total
indebtedness to total Net Assets (as that term is used in our Bylaws, which
usage is not in accordance with GAAP, “Net Assets” means our total assets at
cost before deducting depreciation or other non-cash reserves, less total
liabilities) was approximately 143.8%. As of April 30, 2007 and 2006, our
percentage of total indebtedness to total Net Assets was approximately 149.6%
and 138.0%, respectively. Under our Bylaws we may increase our total
indebtedness up to 300.0% of our Net Assets, or by an additional approximately
$1.2 billion. There is no limitation on the increase that may be permitted if
approved by a majority of the independent members of our board of trustees and
disclosed to the holders of our shares of beneficial interest in the next
quarterly report, along with justification for any excess.
This
amount of leverage may expose us to cash flow problems if rental income
decreases. Under those circumstances, in order to pay our debt obligations we
might be required to sell properties at a loss or be unable to make
distributions to the holders of our shares of beneficial interest. A failure to
pay amounts due may result in a default on our obligations and the loss of the
property through foreclosure. Additionally, our degree of leverage
could adversely affect our ability to obtain additional financing and may have
an adverse effect on the market price of our common shares.
Our inability to renew, repay or
refinance our debt may result in losses. We incur a significant amount of
debt in the ordinary course of our business and in connection with acquisitions
of real properties. In addition, because we are unable to retain earnings as a
result of the REIT distribution requirements, we will generally be required to
refinance debt that matures with additional debt or equity. We are
subject to the normal risks associated with debt financing, including the risk
that:
These
risks increase when the credit markets are tight, as they are now; in general,
when the credit markets are constrained, we may encounter resistance from
lenders when we seek financing or refinancing for properties or proposed
acquisitions, and the terms of such financing or refinancing are likely to be
less favorable to us than the terms of our current indebtedness.
We
anticipate that only a small portion of the principal of our debt will be repaid
prior to maturity. Therefore, we are likely to need to refinance at
least a portion of our outstanding debt as it matures. We cannot
guarantee that any refinancing of debt with other debt will be possible on terms
that are favorable or acceptable to us. If we cannot refinance,
extend or pay principal payments due at maturity with the proceeds of other
capital transactions, such as
2008 Annual Report
13
new
equity capital, our cash flows may not be sufficient in all years to repay debt
as it matures. Additionally, if we are unable to refinance our
indebtedness on acceptable terms, or at all, we may be forced to dispose of one
or more of our properties on disadvantageous terms, which may result in losses
to us. These losses could have a material adverse effect on us, our ability to
make distributions to the holders of our shares of beneficial interest and our
ability to pay amounts due on our debt. Furthermore, if a property is mortgaged
to secure payment of indebtedness and we are unable to meet mortgage payments,
the mortgagee could foreclose upon the property, appoint a receiver and receive
an assignment of rents and leases or pursue other remedies, all with a
consequent loss of our revenues and asset value. Foreclosures could also create
taxable income without accompanying cash proceeds, thereby hindering our ability
to meet the REIT distribution requirements of the Internal Revenue
Code.
The cost of our indebtedness may
increase. Portions of our fixed-rate indebtedness incurred for past
property acquisitions come due on a periodic basis. Rising interest
rates could limit our ability to refinance this existing debt when it matures,
and would increase our interest costs, which could have a material adverse
effect on us, our ability to make distributions to the holders of our shares of
beneficial interest and our ability to pay amounts due on our
debt. In addition, we have incurred, and we expect to continue to
incur, indebtedness that bears interest at a variable rate. As of April 30,
2008, $11.7 million, or approximately 1.1%, of the principal amount of our total
mortgage indebtedness was subject to variable interest rate
agreements. If short-term interest rates rise, our debt service
payments on adjustable rate debt would increase, which would lower our net
income and could decrease our distributions to the holders of our shares of
beneficial interest.
We depend on distributions and other
payments from our subsidiaries that they may be prohibited from making to us,
which could impair our ability to make distributions to holders of our shares of
beneficial interest. Substantially all of our assets are held
through IRET Properties, our operating partnership, and other of our
subsidiaries. As a result, we depend on distributions and other payments from
our subsidiaries in order to satisfy our financial obligations and make
distributions to the holders of our shares of beneficial
interest. The ability of our subsidiaries to make such distributions
and other payments depends on their earnings, and may be subject to statutory or
contractual limitations. As an equity investor in our subsidiaries,
our right to receive assets upon their liquidation or reorganization effectively
will be subordinated to the claims of their creditors. To the extent
that we are recognized as a creditor of such subsidiaries, our claims may still
be subordinate to any security interest in or other lien on their assets and to
any of their debt or other obligations that are senior to our
claims.
Our current or future insurance may
not protect us against possible losses. We carry comprehensive liability,
fire, extended coverage and rental loss insurance with respect to our properties
at levels that we believe to be adequate and comparable to coverage customarily
obtained by owners of similar properties. However, the coverage limits of our
current or future policies may be insufficient to cover the full cost of repair
or replacement of all potential losses. Moreover, this level of coverage may not
continue to be available in the future or, if available, may be available only
at unacceptable cost or with unacceptable terms. Additionally, there
may be certain extraordinary losses, such as those resulting from civil unrest,
terrorism or environmental contamination, that are not generally, or fully,
insured against because they are either uninsurable or not economically
insurable. For example, we do not currently carry insurance against losses as a
result of environmental contamination. Should an uninsured or underinsured loss
occur to a property, we could be required to use our own funds for restoration
or lose all or part of our investment in, and anticipated revenues from, the
property. In any event, we would continue to be obligated on any mortgage
indebtedness on the property. Any loss could have a material adverse effect on
us, our ability to make distributions to the holders of our shares of beneficial
interest and our ability to pay amounts due on our debt. In addition,
in most cases we have to renew our insurance policies on an annual basis and
negotiate acceptable terms for coverage, exposing us to the volatility of the
insurance markets, including the possibility of rate increases. Any
material increase in insurance rates or decrease in available coverage in the
future could adversely affect our business and financial condition and results
of operations, which could cause a decline in the market value of our
securities.
We have significant investments in
medical properties and adverse trends in healthcare provider operations may
negatively affect our lease revenues from these properties. We have
acquired a significant number of specialty medical properties (including senior
housing) and may acquire more in the future. As of April 30, 2008, our real
estate portfolio consisted of 48 medical properties, with a total real estate
investment amount, net of accumulated depreciation, of $327.5 million, or
approximately 22.9% of the total real estate investment amount, net of
accumulated depreciation, of our entire real estate portfolio. The
healthcare industry is currently experiencing changes in the demand for, and
methods of delivery of, healthcare services; changes in third-party
reimbursement policies; significant unused capacity in certain areas, which has
created substantial competition for patients among healthcare providers in those
areas; continuing pressure by private and governmental payors to reduce payments
to
2008 Annual
Report 14
providers
of services; and increased scrutiny of billing, referral and other practices by
federal and state authorities. Sources of revenue for our medical property
tenants may include the federal Medicare program, state Medicaid programs,
private insurance carriers and health maintenance organizations, among others.
Efforts by such payors to reduce healthcare costs will likely continue, which
may result in reductions or slower growth in reimbursement for certain services
provided by some of our tenants. These factors may adversely affect
the economic performance of some or all of our medical services tenants and, in
turn, our lease revenues. In addition, if we or our tenants terminate the leases
for these properties, or our tenants lose their regulatory authority to operate
such properties, we may not be able to locate suitable replacement tenants to
lease the properties for their specialized uses. Alternatively, we may be
required to spend substantial amounts to adapt the properties to other uses. Any
loss of revenues and/or additional capital expenditures occurring as a result
could hinder our ability to make distributions to the holders of our shares of
beneficial interest.
Adverse changes in applicable laws
may affect our potential liabilities relating to our properties and
operations. Increases in real estate taxes and income, service and
transfer taxes cannot always be passed through to all tenants in the form of
higher rents. As a result, any increase may adversely affect our cash available
for distribution, our ability to make distributions to the holders of our shares
of beneficial interest and our ability to pay amounts due on our debt.
Similarly, changes in laws that increase the potential liability for
environmental conditions existing on properties, that increase the restrictions
on discharges or other conditions or that affect development, construction and
safety requirements may result in significant unanticipated expenditures that
could have a material adverse effect on us, our ability to make distributions to
the holders of our shares of beneficial interest and our ability to pay amounts
due on our debt. In addition, future enactment of rent control or rent
stabilization laws or other laws regulating multi-family residential properties
may reduce rental revenues or increase operating costs.
Complying with laws benefiting
disabled persons or other safety regulations and requirements may affect our
costs and investment
strategies. Federal, state and local laws and regulations designed to
improve disabled persons’ access to and use of buildings, including the
Americans with Disabilities Act of 1990, may require modifications to, or
restrict renovations of, existing buildings. Additionally, these laws and
regulations may require that structural features be added to buildings under
construction. Legislation or regulations that may be adopted in the
future may impose further burdens or restrictions on us with respect to improved
access to, and use of these buildings by, disabled persons. Noncompliance could
result in the imposition of fines by government authorities or the award of
damages to private litigants. The costs of complying with these laws
and regulations may be substantial, and limits or restrictions on construction,
or the completion of required renovations, may limit the implementation of our
investment strategy or reduce overall returns on our investments. This could
have an adverse effect on us, our ability to make distributions to the holders
of our shares of beneficial interest and our ability to pay amounts due on our
debt. Our properties are also subject to various other federal, state
and local regulatory requirements, such as state and local fire and life safety
requirements. If we fail to comply with these requirements, we could
incur fines or private damage awards. Additionally, in the event that
existing requirements change, compliance with future requirements may require
significant unanticipated expenditures that may adversely affect our cash flow
and results of operations.
We may be responsible for potential
liabilities under environmental laws. Under various federal, state and
local laws, ordinances and regulations, we, as a current or previous owner or
operator of real estate may be liable for the costs of removal of, or
remediation of, hazardous or toxic substances in, on, around or under that
property. These laws may impose liability without regard to whether we knew of,
or were responsible for, the presence of the hazardous or toxic substances. The
presence of these substances, or the failure to properly remediate any property
containing these substances, may adversely affect our ability to sell or rent
the affected property or to borrow funds using the property as collateral. In
arranging for the disposal or treatment of hazardous or toxic substances, we may
also be liable for the costs of removal of, or remediation of, these substances
at that disposal or treatment facility, whether or not we own or operate the
facility. In connection with our current or former ownership (direct or
indirect), operation, management, development and/or control of real properties,
we may be potentially liable for removal or remediation costs with respect to
hazardous or toxic substances at those properties, as well as certain other
costs, including governmental fines and claims for injuries to persons and
property. A finding of liability for an environmental condition as to any one or
more properties could have a material adverse effect on us, our ability to make
distributions to the holders of our shares of beneficial interest and our
ability to pay amounts due on our debt.
Environmental
laws also govern the presence, maintenance and removal of asbestos, and require
that owners or operators of buildings containing asbestos properly manage and
maintain the asbestos; notify and train those who
2008 Annual
Report 15
may come
into contact with asbestos; and undertake special precautions if asbestos would
be disturbed during renovation or demolition of a building. Indoor
air quality issues may also necessitate special investigation and
remediation. These air quality issues can result from inadequate
ventilation, chemical contaminants from indoor or outdoor sources, or biological
contaminants such as molds, pollen, viruses and bacteria. Such
asbestos or air quality remediation programs could be costly, necessitate the
temporary relocation of some or all of the property’s tenants or require
rehabilitation of an affected property.
It is
generally our policy to obtain a Phase I environmental study on each property
that we seek to acquire. A Phase I environmental study generally
includes a visual inspection of the property and the surrounding areas, an
examination of current and historical uses of the property and the surrounding
areas and a review of relevant state and federal documents, but does not involve
invasive techniques such as soil and ground water sampling. If the Phase I
indicates any possible environmental problems, our policy is to order a Phase II
study, which involves testing the soil and ground water for actual hazardous
substances. However, Phase I and Phase II environmental studies, or any other
environmental studies undertaken with respect to any of our current or future
properties, may not reveal the full extent of potential environmental
liabilities. We currently do not carry insurance for environmental
liabilities.
We may be unable to retain or
attract qualified management. We are dependent upon our senior officers
for essentially all aspects of our business operations. Our senior officers have
experience in the specialized business segments in which we operate, and the
loss of them would likely have a material adverse effect on our operations, and
could adversely impact our relationships with lenders, industry personnel and
potential tenants. We do not have employment contracts with any of
our senior officers. As a result, any senior officer may terminate his or her
relationship with us at any time, without providing advance
notice. If we fail to manage effectively a transition to new
personnel, or if we fail to attract and retain qualified and experienced
personnel on acceptable terms, our business and prospects could be
harmed. The location of our company headquarters in Minot, North
Dakota, may make it more difficult and expensive to attract, relocate and retain
current and future officers and employees.
Failure to comply with changing
regulation of corporate governance and public disclosure could have a material
adverse effect on our business, operating results and stock price, and
continuing compliance will result in additional expenses. The
Sarbanes-Oxley Act of 2002, as well as new rules and standards subsequently
implemented by the Securities and Exchange Commission and NASDAQ, have required
changes in some of our corporate governance and accounting practices, and are
creating uncertainty for us and many other public companies, due to varying
interpretations of the rules and their evolving application in
practice. We expect these laws, rules and regulations to increase our
legal and financial compliance costs, and to subject us to additional
risks. In particular, if we fail to maintain the adequacy of our
internal controls in accordance with Section 404 of the Sarbanes-Oxley Act of
2002, as such standards may be modified, supplemented or amended from time to
time, a material misstatement could go undetected, and we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal
controls over financial reporting. Failure to maintain an effective
internal control environment could have a material adverse effect on our
business, operating results, and stock price. Additionally, our
efforts to comply with Section 404 of the Sarbanes-Oxley Act and the related
regulations have required, and we believe will continue to require, the
commitment of significant financial and managerial resources.
Risks
Related to Our Structure and Organization
We may incur tax liabilities as a
consequence of failing to qualify as a REIT. Although our management
believes that we are organized and have operated and are operating in such a
manner to qualify as a “real estate investment trust,” as that term is defined
under the Internal Revenue Code, we may not in fact have operated, or may not be
able to continue to operate, in a manner to qualify or remain so qualified.
Qualification as a REIT involves the application of highly technical and complex
Internal Revenue Code provisions for which there are only limited judicial or
administrative interpretations. Even a technical or inadvertent
mistake could endanger our REIT status. The determination that we
qualify as a REIT requires an ongoing analysis of various factual matters and
circumstances, some of which may not be within our control. For example, in
order to qualify as a REIT, at least 95% of our gross income in any year must
come from qualifying sources that are itemized in the REIT tax laws, and we are
prohibited from owning specified amounts of debt or equity securities of some
issuers. Thus, to the extent revenues from non-qualifying sources,
such as income from third-party management services, represent more than five
percent of our gross income in any taxable year, we will not satisfy the 95%
income test and may fail to qualify as a REIT, unless certain relief provisions
contained in the Internal Revenue Code apply. Even if relief provisions apply,
however, a tax would be imposed with respect to excess net income. We are also
required to make
2008 Annual Report
16
distributions
to the holders of our shares of beneficial interest of at least 90% of our REIT
taxable income, excluding net capital gains. The fact that we hold
substantially all of our assets (except for qualified REIT subsidiaries) through
IRET Properties, our operating partnership, and its subsidiaries, and our
ongoing reliance on factual determinations, such as determinations related to
the valuation of our assets, further complicates the application of the REIT
requirements for us. Additionally, if IRET Properties, our operating
partnership, or one or more of our subsidiaries is determined to be taxable as a
corporation, we may fail to qualify as a REIT. Either our failure to qualify as
a REIT, for any reason, or the imposition of taxes on excess net income from
non-qualifying sources, could have a material adverse effect on us, our ability
to make distributions to the holders of our shares of beneficial interest and
our ability to pay amounts due on our debt. Furthermore, new legislation,
regulations, administrative interpretations or court decisions could change the
tax laws with respect to our qualification as a REIT or the federal income tax
consequences of our qualification.
If we
failed to qualify as a REIT, we would be subject to federal income tax
(including any applicable alternative minimum tax) on our taxable income at
corporate rates, which would likely have a material adverse effect on us, our
ability to make distributions to the holders of our shares of beneficial
interest and our ability to pay amounts due on our debt. In addition, we could
be subject to increased state and local taxes, and, unless entitled to relief
under applicable statutory provisions, we would also be disqualified from
treatment as a REIT for the four taxable years following the year during which
we lost our qualification. This treatment would reduce funds available for
investment or distributions to the holders of our shares of beneficial interest
because of the additional tax liability to us for the year or years involved. In
addition, we would no longer be able to deduct, and would not be required to
make, distributions to holders of our common shares. To the extent that
distributions to the holders of our shares of beneficial interest had been made
in anticipation of qualifying as a REIT, we might be required to borrow funds or
to liquidate certain investments to pay the applicable tax.
Failure of our operating partnership
to qualify as a partnership would have a material adverse effect on
us. We believe that IRET Properties, our operating
partnership, qualifies as a partnership for federal income tax
purposes. No assurance can be given, however, that the Internal
Revenue Service will not challenge its status as a partnership for federal
income tax purposes, or that a court would not sustain such a
challenge. If the Internal Revenue Service were to be successful in
treating IRET Properties as an entity that is taxable as a corporation, we would
cease to qualify as a REIT because the value of our ownership interest in IRET
Properties would exceed 5% of our assets, and because we would be considered to
hold more than 10% of the voting securities of another
corporation. Also, the imposition of a corporate tax on IRET
Properties would reduce significantly the amount of cash available for
distribution by it.
Certain provisions of our Articles
of Amendment and Third Restated Declaration of Trust may limit a change in control and deter a
takeover. In order to maintain our qualification as a REIT, our Third
Restated Declaration of Trust provides that any transaction, other than a
transaction entered into through the NASDAQ National Market, (recently renamed
the NASDAQ Global Market), or other similar exchange, that would result in our
disqualification as a REIT under Section 856 of the Internal Revenue Code,
including any transaction that would result in (i) a person owning in excess of
the ownership limit of 9.8%, in number or value, of our outstanding shares of
beneficial interest, (ii) less than 100 people owning our shares of beneficial
interest, (iii) our being “closely held” within the meaning of Section 856(h) of
the Internal Revenue Code, or (iv) 50% or more of the fair market value of our
shares of beneficial interest being held by persons other than “United States
persons,” as defined in Section 7701(a)(30) of the Internal Revenue Code, will
be void ab initio. If the transaction is not void ab initio, then the shares of
beneficial interest in excess of the ownership limit, that would cause us to be
closely held, that would result in 50% or more of the fair market value of our
shares of beneficial interest to be held by persons other than United States
persons or that otherwise would result in our disqualification as a REIT, will
automatically be exchanged for an equal number of excess shares, and these
excess shares will be transferred to an excess share trustee for the exclusive
benefit of the charitable beneficiaries named by our board of trustees. These
limitations may have the effect of preventing a change in control or takeover of
us by a third party, even if the change in control or takeover would be in the
best interests of the holders of our shares of beneficial interest.
In order to maintain our REIT
status, we may be forced to borrow funds during unfavorable market
conditions. In order to maintain our REIT status, we may need
to borrow funds on a short-term basis to meet the REIT distribution
requirements, even if the then-prevailing market conditions are not favorable
for these borrowings. To qualify as a REIT, we generally must
distribute to our shareholders at least 90% of our net taxable income each year,
excluding net capital gains. In addition, we will be subject to a 4%
nondeductible excise tax on the amount, if any, by which certain distributions
made by us with respect to the calendar year are less than the sum of 85% of our
ordinary
2008 Annual Report
17
income,
95% of our capital gain net income for that year, and any undistributed taxable
income from prior periods. We intend to make distributions to our
shareholders to comply with the 90% distribution requirement and to avoid the
nondeductible excise tax and will rely for this purpose on distributions from
our operating partnership. However, we may need short-term debt or
long-term debt or proceeds from asset sales or sales of common shares to fund
required distributions as a result of differences in timing between the actual
receipt of income and the recognition of income for federal income tax purposes,
or the effect of non-deductible capital expenditures, the creation of reserves
or required debt or amortization payments. The inability of our cash
flows to cover our distribution requirements could have an adverse impact on our
ability to raise short and long-term debt or sell equity securities in order to
fund distributions required to maintain our REIT status.
Our board of trustees may make
changes to our major policies without approval of the holders of our shares of
beneficial interest. Our operating and financial policies, including
policies relating to development and acquisition of real estate, financing,
growth, operations, indebtedness, capitalization and distributions, are
exclusively determined by our board of trustees. Our board of trustees may amend
or revoke those policies, and other policies, without advance notice to, or the
approval of, the holders of our shares of beneficial
interest. Accordingly, our shareholders do not control these
policies, and policy changes could adversely affect our financial condition and
results of operations.
Risks
Related to the Purchase of our Shares of Beneficial Interest
Our future growth depends, in part,
on our ability to raise additional equity capital, which will have the
effect of diluting the interests of the holders of our common shares.
Our future growth depends upon, among other things, our ability to raise
equity capital and issue limited partnership units of IRET Properties. The
issuance of additional common shares, and of limited partnership units for which
we subsequently issue common shares upon the redemption of the limited
partnership units, will dilute the interests of the current holders of our
common shares. Additionally, sales of substantial amounts of our
common shares or preferred shares in the public market, or issuances of our
common shares upon redemption of limited partnership units in our operating
partnership, or the perception that such sales or issuances might occur, could
adversely affect the market price of our common shares.
We may issue additional classes or
series of our shares of beneficial interest with rights and preferences
that are superior to the rights and preferences of our common shares.
Without the approval of the holders of our common shares, our board of
trustees may establish additional classes or series of our shares of beneficial
interest, and such classes or series may have dividend rights, conversion
rights, voting rights, terms of redemption, redemption prices, liquidation
preferences or other rights and preferences that are superior to the rights of
the holders of our common shares.
Payment of distributions on our
shares of beneficial interest is not guaranteed. Our board of
trustees must approve our payment of distributions and may elect at any time, or
from time to time, and for an indefinite duration, to reduce the distributions
payable on our shares of beneficial interest or to not pay distributions on our
shares of beneficial interest. Our board of trustees may reduce distributions
for a variety of reasons, including, but not limited to, the
following:
Our distributions are not eligible
for the lower tax rate on dividends except in limited
situations. The tax rate applicable to qualifying corporate
dividends received by certain non-corporate shareholders prior to 2010 has been
reduced to a maximum rate of 15%. This special tax rate is generally
not applicable to distributions paid by a REIT, unless such distributions
represent earnings on which the REIT itself had been taxed. As a result,
distributions (other than capital gain distributions) paid by us to certain
non-corporate shareholders will generally be subject to the tax rates that are
otherwise applicable to ordinary income which, currently, are as high as
35%. This law change may make an investment in our common shares
comparatively less attractive relative to an investment in the shares of other
entities which pay dividends but are not formed as REITs.
2008 Annual Report
18
Changes in market conditions could
adversely affect the price of our shares of beneficial
interest. As is the case with any publicly-traded securities, certain
factors outside of our control could influence the value of our common
shares,
Series A
preferred shares and any other classes or series of preferred shares of
beneficial interest to be issued in the future. These conditions include, but
are not limited to:
Higher market interest rates may
adversely affect the market price of our common shares, and low trading volume
on the NASDAQ Global Select Market may prevent the timely resale of our common shares.
One of the factors that investors may consider important in deciding whether to
buy or sell shares of a REIT is the distribution with respect to such REIT’s
shares as a percentage of the price of those shares, relative to market interest
rates. If market interest rates rise, prospective purchasers of REIT
shares may expect a higher distribution rate in order to maintain their
investment. Higher market interest rates would likely increase our
borrowing costs and might decrease funds available for
distribution. Thus, higher market interest rates could cause the
market price of our common shares to decline. In addition, although
our common shares of beneficial interest are listed on the NASDAQ Global Select
Market, the daily trading volume of our shares may be lower than the trading
volume for other companies. The average daily trading volume for the
period of May 1, 2007, through April 30, 2008, was 194,469 shares and the
average monthly trading volume for the period of May 1, 2007 through April 30,
2008 was 4,100,054 shares. As a result of this trading volume, an
owner of our common shares may encounter difficulty in selling our shares in a
timely manner and may incur a substantial loss.
None.
IRET is
organized as a REIT under Section 856-858 of the Code, and is in the business of
owning, leasing, developing and acquiring real estate properties. These real
estate investments are managed by our own employees and by third-party
professional real estate management companies on our behalf.
Certain
financial information from fiscal 2007 and 2006 was adjusted to reflect the
effects of discontinued operations. See the Property Dispositions section in
Item 7, Management’s Discussion and Analysis of Financial Condition and Results
of Operations, and the discussion in Note 12 to our Consolidated Financial
Statements.
Total
Real Estate Rental Revenue
As of
April 30, 2008, our real estate portfolio consisted of 72 multi-family
residential properties and 163 commercial properties, consisting of office,
medical, industrial and retail properties, comprising 28.6%, 34.9%, 22.9%, 6.6%,
and 7.0%, respectively, of our total real estate portfolio, based on the dollar
amount of our original investment plus capital improvements, net of accumulated
depreciation, through April 30, 2008. Gross annual rental revenue and
percentages of total annual real estate rental revenue by property type for each
of the three most recent fiscal years ended April 30, are as
follows:
2008 Annual
Report 19
Economic
Occupancy Rates
Economic
occupancy levels on a stabilized property and all-property basis are shown below
for each property type in each of the three most recent fiscal years ended April
30. Economic occupancy represents actual rental revenues recognized for the
period indicated as a percentage of scheduled rental revenues for the
period. Percentage rents, tenant concessions, straightline
adjustments and expense reimbursements are not considered in computing either
actual revenues or scheduled rent revenues. Scheduled rent revenue is
determined by valuing occupied units or square footage at contract rates and
vacant units or square footage at market rates. Stabilized properties are those
properties owned for the entirety of both periods being
compared. While results presented on a stabilized property basis are
not determined in accordance with GAAP, management believes that measuring
performance on a stabilized property basis is useful to investors and to
management because it enables evaluation of how the Company’s properties are
performing year over year. In the case of multi-family residential properties,
lease arrangements with individual tenants vary from month-to-month to one-year
leases. Leases on commercial properties generally vary from month-to-month to 20
years.
Certain
Lending Requirements
In
certain instances, in connection with the acquisition of investment properties,
the lender financing such properties may require, as a condition of the loan,
that the properties be owned by a “single asset entity.” Accordingly, we have
organized a number of wholly-owned subsidiary corporations, and IRET Properties
has organized several limited partnerships, for the purpose of holding title in
an entity that complies with such lending conditions. All financial statements
of these subsidiaries are consolidated into our financial
statements.
Management
and Leasing of Our Real Estate Assets
We
conduct our operations from offices in Minot, North Dakota; Minneapolis,
Minnesota and Omaha, Nebraska. We also have property management
offices in St. Louis, Missouri; Jamestown, North Dakota and Kansas City, Kansas.
The day-to-day management of our commercial properties is carried out by our own
employees and by third-party property management companies. The management and
leasing of our multi-family residential properties are handled by locally-based,
third-party management companies.
In
markets where the amount of rentable square footage we own does not justify
self-management, when properties acquired have effective pre-existing property
management in place, or when for other reasons particular properties are in our
judgment not attractive candidates for self-management, we utilize third-party
professional management companies for day-to-day management. However,
all decisions relating to purchase, sale, insurance coverage, capital
improvements, approval of commercial leases, annual operating budgets and major
renovations are made exclusively by our employees and implemented by the
third-party management companies. As of April 30, 2008, we have under
internal management 90 commercial properties. Our remaining 73
commercial properties are managed by third parties. We plan to
continue evaluating our portfolio to identify other commercial properties that
may be candidates for management by our own employees.
2008 Annual
Report 20
As of
April 30, 2008, we had property management contracts and/or leasing agreements
with the following companies:
Generally,
our management contracts provide for compensation ranging from 2.5% to 5.0% of
gross rent collections and, typically, we may terminate these contracts in 60
days or less or upon the property manager’s failure to meet certain specified
financial performance goals.
With
respect to multi-tenant commercial properties, we rely almost exclusively on
third-party brokers to locate potential tenants. As compensation, brokers may
receive a commission that is generally calculated as a percentage of the net
rent to be paid over the term of the lease. We believe that the broker
commissions paid by us conform to market and industry standards, and accordingly
are commercially reasonable.
Summary
of Real Estate Investment Portfolio
2008 Annual Report
21
Summary
of Individual Properties Owned as of April 30, 2008
The
following table presents information regarding our 235 properties owned as of
April 30, 2008. We own the following interests in real estate either through our
wholly-owned subsidiaries or by ownership of a controlling interest in an entity
owning the real estate. We account for these interests on a consolidated basis.
Occupancy rates given are the average economic occupancy rates for the fiscal
year ended April 30, 2008:
*
= Real estate not owned in fee; all or a portion is leased under a ground or air
rights lease.
**=Single-family
house
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Report 22
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Report 23
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