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INCOME OPPORTUNITY REALTY INVESTORS INC /TX/ - Quarter Report: 2005 September (Form 10-Q)

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FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
     
þ   QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2005
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM          TO          
Commission File Number 0-8187
INCOME OPPORTUNITY REALTY INVESTORS, INC.
(Exact Name of Registrant as Specified in Its Charter)
     
Nevada   75-2615944
     
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
1755 Wittington Place, Suite 340
Dallas, Texas
 
(Address of principal executive offices)
75234
 
(Zip Code)
(800) 400-6407
(Registrant’s telephone number including area code)
 
(Former name, former address and former fiscal year, if changed since last report)
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. Yes þ. No ¨.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨. No þ.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨. No þ.
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ¨. No ¨.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.
     
Common Stock, $.01 par value
(Class)
  4,168,035
(Outstanding at September 30, 2005)
 
 

 


 

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements as of and for the three months ended September 30, 2005, have not been audited by independent certified public accountants, but in the opinion of the management of Income Opportunity Realty Investors, Inc. (“IORI”), all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of IORI’s consolidated financial position, consolidated results of operations and consolidated cash flows at the dates and for the periods indicated, have been included.
INCOME OPPORTUNITY REALTY INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
                 
    September 30,     December 31,  
    2005     2004  
            (Restated)  
    (dollars in thousands,  
    except per share)  
Assets
               
Real estate held for investment
    35,068     $ 34,988  
Less—accumulated depreciation
    (4,287 )     (3,620 )
     
 
    30,781       31,368  
 
               
Notes and interest receivable
    62,876       54,911  
Investment in real estate partnerships
    560       604  
Cash and cash equivalents
    71       399  
Receivables from affiliates
    1,275       261  
Other assets
    3,010       3,095  
     
 
    98,573     $ 90,638  
     
 
               
Liabilities and Stockholders’ Equity
               
Liabilities:
               
Notes and interest payable
    53,089     $ 44,571  
Payables to affiliates
          1,248  
Other liabilities
    606       1,529  
     
 
    53,695       47,348  
 
               
Minority interest
    475        
 
               
Stockholders’ equity:
               
Common Stock, $.01 par value; authorized, 10,000,000 shares; issued and outstanding 4,168,035 shares in 2005 and 4,316,835 shares in 2004
    42       14  
Paid-in capital
    61,955       61,983  
Accumulated deficit
    (17,594 )     (18,707 )
     
 
    44,403       43,290  
     
 
    98,573       90,638  
     
These numbers reflect corrections for discontinued operations, the issuance of 3-for-1 stock dividends, and the accounting error related to a deferral of operating income and/or expense. See “NOTE 1. BASIS OF PRESENTATION”.
The accompanying notes are an integral part of these Consolidated Financial Statements.

2


 

CONSOLIDATED STATEMENTS OF OPERATIONS
                                 
    For the Three Months     For the Nine Months  
    Ended September 30,     Ended September 30,  
    (dollars in thousands, except per share)  
    2005     2004     2005     2004  
            (Restated)             (Restated)  
Property revenue:
                               
Rents
  $ 1,688     $ 1,662     $ 4,830     $ 5,091  
Property expense:
                               
Property operations
    870       975       2,516       2,705  
     
Operating income
    818       687       2,314       2,386  
 
                               
Other income (loss):
                               
Interest
    979       1,017       2,937       2,220  
Equity in income (loss) of equity partnerships
    (17 )     (20 )     (45 )     (9 )
     
 
    962       997       2,892       2,211  
 
                               
Other expense:
                               
Interest
    989       828       2,487       2,776  
Depreciation
    189       250       539       779  
Advisory fee to affiliate
    165       179       502       573  
Net income fee to affiliate
    25       4       92       246  
General & Administrative
    132       95       473       540  
     
 
    1,500       1,356       4,093       4,914  
     
Net income (loss) from continuing operations
    280       328       1,113       (317 )
 
                               
Discontinued operations:
                               
(Loss)/Income from discontinued operations
          (7 )           (182 )
Gain on sale of operations
          15             3,689  
     
 
            8               3,507  
 
                               
Net income (loss)
  $ 280     $ 336     $ 1,113     $ 3,190  
     
 
                               
Earnings (loss) per share:
                               
Net loss from continuing operations
  $ 0.07     $ 0.07     $ 0.27     $ (0.07 )
Discontinued operations
          0.01             0.81  
     
Net income (loss)
  $ 0.07     $ 0.08     $ 0.27     $ 0.74  
     
 
                               
Weighted average common shares used in computing earnings per share
    4,168,035       4,316,835       4,168,035       4,316,835  
     
These numbers reflect corrections for the discontinued operations, the issuance of 3-for-1 stock dividends, and the accounting error related to a deferral of operating income and/or expense. See “NOTE 1. BASIS OF PRESENTATION”.
The accompanying notes are an integral part of these Consolidated Financial Statements.

3


 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
For the Nine Months Ended September 30, 2005
                                         
    Common Stock     Paid-in     Accumulated     Stockholders'  
    Shares     Amount     Capital     Deficit     Equity  
    (dollars in thousands)  
Balance, January 1, 2005 (Restated)
    1,389,345     $ 14     $ 61,983     $ (18,707 )   $ 43,290  
 
                                       
Common Stock Dividends
    2,778,690       28       (28 )            
 
                                       
Net income
                      1,113       1,113  
 
                             
 
                                       
Balance, September 30, 2005
    4,168,035     $ 42     $ 61,955     $ (17,594 )   $ 44,403  
 
                             
The accompanying notes are an integral part of these Consolidated Financial Statements.

4


 

CONSOLIDATED STATEMENTS OF CASH FLOWS
                 
    For the Nine Months  
    Ended September 30,  
    2005     2004  
            (Restated)  
    (dollars in thousands)  
Cash Flows from Operating Activities Net income/(loss)
  $ 1,113     $ 3,190  
Reconciliation of net income (loss) to net cash used by operating activities Adjustments to reconcile net income (loss) to net cash used in operating activities Depreciation and amortization
    502       779  
Gain on sale of real estate
          (3,689 )
Loss (gain) on equity partnerships
    44       9  
Increase in interest receivable
    (965 )     (391 )
Decrease (Increase) in other assets
    85       (8,712 )
Increase in interest payable
    17       (15 )
(Decrease) increase in other liabilities
    (1,054 )     2,591  
 
           
Net cash provided by (used in) operating activities
    (258 )     (6,238 )
 
               
Cash Flows from Investing Activities
               
Proceeds from sale of real estate
            3,505  
Real estate improvements
    85          
Advances from (payments to) advisor and affiliates
    (1,657 )     2,040  
 
           
Net cash provided by (used in) investing activities
    (1,572 )     5,545  
 
               
Cash Flows from Financing Activities
               
Payments on notes payable
  $ (2,110 )   $ (931 )
Advances from affiliate
            497  
Proceeds on notes payable
    3,612       1,193  
Purchase of treasury stock
            (200 )
Deferred financing costs
          169  
 
           
Net cash (used in) provided by financing activities
    1,502       728  
 
               
Net increase in cash and cash equivalents
  $ (328 )   $ 35  
Cash and cash equivalents, beginning of period
    399       58  
Cash and cash equivalents, end of period
  $ 71     $ 93  
 
           
 
               
Supplemental Disclosures of Cash Flow Information
               
Cash paid for interest
  $ 2,431     $ 3,088  
Note receivable from sale of real estate
          2,990  
The accompanying notes are an integral part of these Consolidated Financial Statements.

5


 

INCOME OPPORTUNITY INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. Operating results for the nine-month period ended September 30, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the Consolidated Financial Statements and notes thereto included in IORI’s Annual Report on Form 10-K for the year ended December 31, 2004 (the “2004 Form 10-K”). Dollar amounts in tables are in thousands, except per share amounts.
Certain balances for 2004 have been reclassified to conform to the 2005 presentation in order to properly account for the discontinued operations, the issuance of 3-for-1 stock dividends, and the correction of the accounting error in the financial statements related to formation of certain partnerships with Metra Capital LLC in April 2002, which error evolved in the establishment of the process relating to accounting for a deferral of operating income or expense from the properties in question until the sale of the applicable property; the error correction necessitates the changes described below:
    Decrease in interest expense by $28,000 for the three months ended September 30, 2004.
 
    Increase in advisory fee by $2,000 for the three months ended September 30, 2004.
 
    Increase in interest expense by $97,000 for the nine months ended September 30, 2004.
 
    Decrease in advisory fee by $4,000 for the nine months ended September 30, 2004.
NOTE 2. REAL ESTATE
The following table reflects the properties sold during the nine months ended September 30, 2004. IORI has not sold any properties during the nine months ended September 30, 2005
                                         
            Sales   Net Cash   Debt   Gain
Property   Location   Units/Sq.Ft.   Price   Received   Discharged   on Sale
First Quarter
                                       
Apartment Building
                                       
Treehouse
  San Antonio, TX   106 Units   $ 5,400     $ 1,100     $ 3,747     $ 3,257  
Second Quarter
                                       
Apartment Building
                                       
Treehouse (1)
  Irving, TX   160 Units   $ 7,500     $ (498 )   $ 5,018     $— (2)
Commercial Building
                                       
Akard Plaza
  Dallas, TX   42,258 Sq.Ft.   $ 3,900     $ 2,007     $ 1,849     $ 417  
Third Quarter
                                       
Land
                                       
Frankel Land
  Midland, TX   1 Acre   $ 63     $ 61     $     $ 15  
Fourth Quarter
                                       
Commercial Building
                                       
Chuck Yeager
  Chantilly, VA   60,060 Sq.Ft.   $ 7,600     $ 2,174     $ 5,230     $ 1,967  
 
(1)   Property sold to TCI, a related party, for assumption of debt and a note receivable, less $498,000 in cash paid.
 
(2)   Excludes a $56,000 deferred gain from a related party sale.
NOTE 3. NOTES AND INTEREST RECEIVABLE
Junior Mortgage Loans. Junior mortgage loans are loans secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on the loans ordinarily includes the real estate which secures the loan, other collateral and personal guarantees of the borrower.

6


 

NOTE 4. RECEIVABLE FROM AND PAYABLE TO AFFILIATES
Related Party. On September 19, 2002, IORI’s Board of Directors authorized the Chief Financial Officer of the Company to advance funds either to or from the Company, through the advisor without interest, in an amount up to $5.0 million on the condition that such advances shall be repaid in cash or transfers of assets within 90 days. From time-to-time, IORI and its affiliates and related parties have made unsecured advances to each other to fund their respective operations, which generally have not had specific repayment terms and have been reflected in IORI’s financial statements as other assets. IORI had receivables of $1.2 million and payables of $1.3 million to Syntek West, Inc. (“SWI”) at September 30, 2005 and December 31, 2004 respectively. IORI had payables of $141,000 and receivables of $261,000 from Transcontinental Realty Investors, Inc. (“TCI”) at September 30, 2005 and December 31, 2004, respectively. See also NOTE 6. “RELATED PARTY TRANSACTIONS”.
NOTE 5. NOTES AND INTEREST PAYABLE
In April 2002, the Company transferred all of its residential properties to partnerships formed with Metra Capital LLC (“Metra”). The properties included the 60-unit Brighton Court, the 92-unit Del Mar, the 68-unit Enclave, the 280-unit Meridian, the 57-unit Signature, and the 114-unit Sinclair, all located in Midland, Texas, and the 106-unit Treehouse located in San Antonio, Texas. Innovo Realty, Inc., a subsidiary of Innovo Group, Inc. (“Innovo”) is a limited partner in the partnerships that purchased the properties. A former director of American Realty Investors, Inc. (“ARI”), a related party, controlled approximately 11.67% of the outstanding common stock of Innovo. The transfer constituted 23% of the total assets of the Company as of December 31, 2001. The transfer price for the properties totaled $26.2 million, of which the Company received $5.3 million in cash after the payment of $15.9 million in debt and various closing costs. Management determined to account for the transaction as a refinancing transaction (rather than a sale) in accordance with SFAS 66 “Accounting for Sales of Real Estate.” At the time of the transaction in April 2002, ARI was a related party to the Company by virtue of ARI’s subsidiaries’ ownership of approximately 28.5% of the then outstanding common stock of the Company, and the fact that ARI and the Company had the same persons as executive officers. The compensation price for the properties transferred totaled $26.2 million and possible additional contingent consideration depending upon the sale price of the properties by the Metra partnerships. The Company also received $5.2 million in value of 8% non-recourse, non-convertible preferred stock of Innovo. Based upon the prospect of additional consideration, ultimate continued involvement through the preferred stock and the related-party nature of the former ARI director’s involvement, as well as the Company retaining a right to approve the price of any ultimate sale by a Metra partnership of the properties, and a process by which the Company effectively guaranteed a preferential return to the Metra investors, management determined that the transaction must be classified as a financing transaction and not a sale. The Company continued to be able to exert control over the Metra partnerships, and no sale was recorded. The Treehouse property was subsequently sold to a non-related party in February 2004, and all of its debts have been repaid to the lenders at the time of the sale. During August 2004, certain entities, including the Company, instituted an action in a Texas state court against Innovo and Metra and others over the process, as well as distribution questions. During April 2005, a resolution of the litigation occurred settling all liabilities remaining from the original partnership arrangements which included a return of the Metra investor equity, prepayment of prospective asset management fees and miscellaneous fees and transaction costs from the Company and the other plaintiffs as a payment of the Preferential Return along with the delegation of management to another entity. Of the payment made, the Company has recognized expense of $56,000 and a reduction of $1,476,000 in liabilities during the second quarter of 2005.
NOTE 6. RELATED PARTY TRANSACTIONS
Prior to the time of settlement with Metra in April 2005 as mentioned in “NOTE 5. NOTES AND INTEREST PAYABLE”, IORI had been under a contractual agreement to pay a management fee, a cumulative annual amount of .5% of the average outstanding balance of the mortgage indebtedness secured by the properties, each to Metra and Innovo. Per the settlement, IORI’s obligation to pay the management fee to Metra has been delegated to Prime. ARI, TCI, and IORI acquired Innovo whose name was changed to Midland Odessa Properties, Inc. (“MOPI”). ARI paid $475,000 to acquire from IORI an additional 9.05% ownership of MOPI, which reduced IORI’s ownership interest in MOPI to 19.9%.
In August 2005 IORI purchased 10.08 acres from TCI , an affiliate for $13 million. The purchase price was paid by giving TCI $7 million in cash, which was raised through new financing collateralized by the acquired land and providing TCI with 3 mortgages with principal and interest approximating $6 million. The purchase agreement provides that for a period of one year following the closing and 90 days thereafter, IORI has the right to convey the land to TCI for the original sales price, plus a 12% preferred return per annum accruing from the closing date. Due to the related party nature of the transaction, and the anticipation that the put will be exercised the transaction has been treated as a financing transaction. IORI has recorded a receivable from TCI equal to the amount borrowed.

7


 

The following table reconciles the beginning and ending balances of Accounts Receivable from Affiliates as of September 30, 2005.
                                 
    SWI     Prime     ARI     TCI  
Balance, December 31, 2004
  $ (1,248 )   $     $     $ 261  
Cash transfers
    (9,104 )           475       141  
Cash repayments
    11,926       22             (261 )
Other additions
                       
Other repayments
    (440 )     (22 )     (475 )      
 
                       
Balance, June 30, 2005
                               
 
  $ 1,134     $     $     $ 141  
 
                       

8


 

NOTE 7. OPERATING SEGMENTS
Significant differences among the accounting policies of the operating segments as compared to the Consolidated Financial Statements principally involve the calculation and allocation of general and administrative expenses. Management evaluates the performance of the operating segments and allocates resources to each of them based on their operating income and cash flow. Items of income that are not reflected in the segments are interest and equity in partnerships totaling $962,000 and $2.9 million for the three and six months ended September 30, 2005, and $997,000 and $2.2 million for the three and six months ended September 30, 2004. Expenses that are not reflected in the segments are general and administrative expenses, advisory fees, and net income fees totaling $322,000 and $1.1 million for the three and nine months ended September 30, 2005, and $278,000 and $1.4 million for the three and nine months ended September 30, 2004. Excluded from operating segment assets are assets of $67.8 million at September 30, 2005 and $59.5 million at September 30, 2004, which are not identifiable with an operating segment. There are no intersegment revenues and expenses and all business is conducted in the United States.
Presented below is the operating income and assets of each operating segment.
                         
Three Months Ended   Commercial              
September 30, 2005   Properties     Apartments     Total  
Rents
  $ 410     $ 1,278     $ 1,688  
Property operating expenses
    165       685       850  
 
                 
Operating income (loss)
  $ 245     $ 593     $ 838  
 
                 
 
                       
Depreciation
  $ 78     $ 111     $ 189  
Interest
    571       418       989  
Real estate improvements
    85              
Assets
    12,857       17,924       30,781  
                         
Nine Months Ended                        
September 30, 2005                        
Rents
  $ 1,106     $ 3,724     $ 4,830  
Property operating expenses
    611       1,905       2,516  
 
                 
Operating income (loss)
  $ 495     $ 1,819     $ 2,314  
 
                 
 
                       
Depreciation
  $ 205     $ 334     $ 539  
Interest
    1,492       997       2,487  
Real estate improvements
                 
Assets
    12,857       17,924       30,781  

9


 

                                 
Three Months Ended                          
September 30, 2004           Commercial              
(Restated)   Land     Properties     Apartments     Total  
Rents
  $     $ 490 *   $ 1,172     $ 1,662 *
Property operating expenses
          262 *     713       975 *
 
                       
Operating income (loss)
  $     $ 228 *   $ 459     $ 687 *
 
                       
 
                               
Depreciation
  $     $ 139 *   $ 111     $ 250 *
Interest
    63       446 *     319 *     828 *
Real estate improvements
                       
Assets
          18,321       18,481       36,802  
                                 
Six Months Ended                                
June 30, 2004                                
(Restated)                                
Rents
  $     $ 1,609 *   $ 3,482     $ 5,091 *
Property operating expenses
          720 *     1,985       2,705 *
 
                       
Operating income (loss)
  $     $ 889 *   $ 1,497     $ 2,386 *
 
                       
 
                               
Depreciation
  $     $ 445 *   $ 334     $ 779 *
Interest
    778       877 *     1,121 *     2,776 *
Real estate improvements
                       
Assets
  $       18,321       18,481       36,802  
 
*   These are the restated numbers which reflect corrections for the discontinued operations, the issuance of 3-for-1 stock dividends, and the accounting error related to a deferral of operating income and/or expense. See “NOTE 1. BASIS OF PRESENTATION”.
NOTE 8. ADVISORY FEES, PROPERTY MANAGEMENT, ETC.
Revenue, fees and cost reimbursements to its advisors and affiliates for the six months ended:
                 
    For the Nine Months  
    Ended September 30,  
    2005     2004  
            (Restated)  
Fees
               
Advisory
  $ 502     $ 573  
Net income
    9       246  
 
  $ 511     $ 819  
 
           
Cost reimbursements
  $ 36     $ 58  
 
           

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NOTE 9. DISCONTINUED OPERATIONS
Effective January 1, 2002, IORI adopted Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), which established a single accounting model for the impairment or disposal of long-lived assets including discontinued operations. This statement requires that the operations related to properties that have been sold, or properties that are intended to be sold, be presented as discontinued operations in the statement of operations for all periods presented, and the properties intended to be sold are to be designated as “held for sale” on the balance sheet. In the event of a future asset sale, IORI is required to reclassify portions of previously reported operations to discontinued operations within the Statements of Operations. No property was sold during the nine months ended September 30, 2005. The following table summarizes revenue and expense information for the properties sold.
                                 
    For the Three Months     For the Nine Months  
    Ended September 30,     Ended September 30,  
    2005     2004     2005     2004  
Revenue
                               
Rental
  $     $       $     $ 973  
Property Operations
          7             748  
 
                       
Operating income
          (7 )           225  
 
                               
Expense
                               
Interest
                      301  
Depreciation
                      106  
 
                       
Total expenses
                      407  
 
                               
Net gain from discontinued operations before gains on sale of operations
          (7 )           (182 )
 
                               
Gain on sale of operations
          15             3,689  
 
                       
 
                               
Net income/(loss) from discontinued
                               
operations
  $     $ 8     $     $ 3,507  
 
                       
Discontinued operations have not been segregated in the consolidated statement of cash flows. Therefore, amounts for certain captions will not agree with respective consolidated statements of operations.
NOTE 10. COMMITMENTS AND CONTINGENCIES
Liquidity. Management anticipates that IORI will generate excess cash from operations in 2005 due to increased rental rates and occupancy at its properties, however, such excess may not be sufficient to discharge all of IORI’s debt obligations as they mature. Management may selectively sell income producing assets, refinance real estate and/or incur additional borrowings against real estate to meet its cash requirements.
Other Litigation. IORI is also involved in various other lawsuits arising in the ordinary course of business. Management is of the opinion that the outcome of these lawsuits will have no material impact on the Company’s financial condition, results of operations or liquidity.

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
IORI invests in equity interests in real estate through acquisitions, leases and partnerships and also invests in mortgage loans. IORI is the successor to a California business trust organized on December 14, 1984, which commenced operations on April 10, 1985.
Critical Accounting Policies
Critical accounting policies are those that are both important to the presentation of IORI’s financial condition and results of operations and require management’s most difficult, complex or subjective judgments. IORI’s critical accounting policies relate to the evaluation of impairment of long-lived assets and the evaluation of the collectibility of accounts and notes receivable.
If events or changes in circumstances indicate that the carrying value of a rental property to be held and used or land held for development may be impaired, management performs a recoverability analysis based on estimated undiscounted cash flows to be generated from the property in the future. If the analysis indicates that the carrying value is not recoverable from future cash flows, the property is written down to estimated fair value and an impairment loss is recognized. If management decides to sell rental properties or land held for development, management evaluates the recoverability of the carrying amounts of the assets. If the evaluation indicates that the carrying value is not recoverable from estimated net sales proceeds, the property is written down to estimated fair value less costs to sell and an impairment loss is recognized within income from continuing operations. IORI’s estimates of cash flow and fair values of the properties are based on current market conditions and consider matters such as rental rates and occupancies for comparable properties, recent sales data for comparable properties and, where applicable, contracts or the results of negotiations with purchasers or prospective purchasers. IORI’s estimates are subject to revision as market conditions and IORI’s assessments of them change.
IORI’s allowance for doubtful accounts receivable and notes receivable is established based on analysis of the risk of loss on specific accounts. The analysis places particular emphasis on past due accounts. Management considers such information as the nature and age of the receivable, the payment history of the tenant or other debtor, the financial condition of the tenant or other debtor and IORI’s assessment of its ability to meet its lease or interest obligations. IORI’s estimate of the required allowance, which is reviewed on a quarterly basis, is subject to revision as these factors change and is sensitive to the effects of economic and market conditions. Typically, IORI’s notes receivable are collateralized by income producing real estate. IORI had notes receivable of $62.9 million at September 30, 2005 and $54.9 million at December 31, 2004.
Liquidity and Capital Resources
Cash and cash equivalents at September 30, 2005 were $71,000, compared with $399,000 at December 31, 2004. IORI’s principal sources of cash have been and will continue to be property operations, proceeds from asset sales, interest earned on notes receivable, financings and refinancings and partnership distributions. Management anticipates that IORI will generate excess cash from operations in 2005 due to increased rental receipts at its properties, however, such excess may not be sufficient to discharge all of IORI’s debt obligations as they mature. Management may selectively sell income producing assets, refinance real estate and/or incur additional borrowings against real estate to meet its cash requirements.
The Company reported net income of $1,113,000 for the nine months ended September 30, 2005, which included the following changes: depreciation and amortization of $502,000, decreases in other assets of $85,000, increases in interest receivable of $965,000, increases in interest payable of $17,000, loss on equity partnership of $44,000, and decreases in other liabilities of $1,054,000. Net cash used in operating activities amounted to $258,000 for the nine months ended September 30, 2005. During the nine months ended September 30, 2005, the decrease in other liabilities was primarily due to a decrease in accrued property taxes and the decrease in other assets was primarily due to a decrease in deposits, deferred borrowing costs, and accounts receivable. Net cash used in investing activities of $1.6 million was principally net advances to SWI. Net cash provided in financing activities of $1.5 million was proceeds from new financings in excess of the payments on obligations.
Management reviews the carrying values of IORI’s properties at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. If impairment is found to exist, a provision for loss is recorded by a charge against earnings. The property review generally includes selective property inspections, discussions with the manager of the property, visits to selected properties in the area and a review of the following: (1) the property’s current rents compared to market rents, (2) the property’s expenses, (3) the property’s maintenance requirements and (4) the property’s cash flows.

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Results of Operations
IORI had net income of $280,000 for the three months ended September 30 2005, and net income of $1,113,000 for the nine months ended September 30, 2005, as compared to net income of $336,000 and $3.2 million for the corresponding periods in 2004. The net income in 2004 included gains on sale of real estate totaling $3.7 million whereas no property was sold in 2005. Fluctuations in components of revenue and expense between the 2005 and 2004 periods are discussed below.
Rents in the three and nine months ended September 30, 2005 were $1.7 million and $4.8 million versus $1.7 million and $5.1 million in the corresponding periods in 2004.
Property operations expense in the three and nine months ended September 30, 2005 were $870,000 and $2.5 million versus $975,000 and $2.7 million in the corresponding periods in 2004.
Interest income in the three and nine months ended September 30, 2005 was $1 million and $2.9 million versus $1 million and $2.2 million in the corresponding periods in 2004. The increase in 2005 from 2004 was due to additional interest earned from the additional notes receivable obtained from affiliates of IORI. Interest income is expected to exceed the previous year in the remaining quarter of 2005 due to the increase in notes receivable during 2004.
Interest expense in the three and nine months ended September 30, 2005 was $1 million and $2.5 million versus $828,000 and $2.8 million in the corresponding periods in 2004. The decrease in 2005 from 2004 was primarily due to the retirement of four notes payable from sale of properties during 2004. The increase in the third quarter is due to the additional debt that was incurred.
Depreciation expense in the three and nine months ended September 30, 2005 was $189,000 and $539,000 versus $250,000 and $779,000 in the corresponding periods in 2004. The decrease in 2005 from 2004 was due to sale of properties and fully depreciated tenant improvements in 2004.
Advisory fee to affiliate in the three and nine months ended September 30, 2005 was $165,000 and $502,000 versus $179,000 and $573,000 in the corresponding periods in 2004. The decrease in 2005 from 2004 was due to changes in gross assets, the basis of the fee. See NOTE 8. “ADVISORY FEES.”
Net income fee to affiliate was $92,000 for the nine months ended September 30, 2005. Net income fee is based on 7.5% of IORI’s net income.
General and administrative expense in the three and nine months ended September 30, 2005 was $132,000 and $473,000 versus $95,000 and $540,000 in the corresponding periods in 2004. The decrease in 2005 from 2004 was primarily due to a decrease in property insurance and rental expense.
Related Party Transactions
Historically, IORI, ARI, Regis Realty I, LLC (“Regis I”), and TCI have each engaged in and may continue to engage in business transactions, including real estate partnerships with related parties. Management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to IORI, ARI, Regis I, and TCI as could have been obtained from unrelated third parties.
Taxes
For the tax years prior to 2003, IORI elected and qualified to be treated as a Real Estate Investment Trust (“REIT”), as defined in Sections 856 and 860 of the Internal Revenue Code of 1986, as amended (the “Code”), and as such was not taxed for federal income tax purposes on that portion of its taxable income which is distributed to stockholders. Due to the completion of a tender offer by ARI, an affiliate, and the resulting concentration of ownership, IORI no longer met the requirements for tax treatment as a REIT under the Code as of January 1, 2003, and is prohibited for re-qualifying for REIT status for at least five years.
Financial statement income varies from taxable income principally due to the accounting for income and losses of investees, gains and losses from asset sales, depreciation on owned properties, amortization of discounts on notes receivable and payable and the difference in the allowance for estimated losses. IORI had a loss for federal income tax purposes for the first nine months of 2005 and a loss for federal income tax purposes after the use of net operating loss carryforwards for the first nine months of 2004; therefore, it recorded no provision for income taxes.
At September 30, 2005, IORI had a net deferred tax asset of approximately $2.2 million due to tax deductions available to it in future years. However, as management cannot determine that it is more likely than not that IORI will realize the benefit of the deferred tax asset, a 100% valuation allowance has been established.

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Inflation
The effects of inflation on IORI’s operations are not quantifiable. Revenues from apartment operations tend to fluctuate proportionately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales value of properties and the ultimate gain to be realized from property sales. To the extent that inflation affects interest rates, earnings from short-term investments and the cost of new financings, as well as the cost of variable interest rate debt, will be affected.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and regulations, IORI may be potentially liable for removal or remediation costs, as well as certain other potential costs, relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air and third parties may seek recovery for personal injury associated with such materials.
Management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on IORI’s business, assets or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK
At September 30, 2005, IORI’s exposure to a change in interest rates on its debt is as follows:
                         
            Weighted     Effect of 1%  
            Average     Increase In  
    Balance     Interest Rate     Base Rates  
Wholly-owned debt:
                       
Variable rate
  $ 11,125       8.03 %   $ 111  
 
                   
 
                       
Total decrease in IORI’s annual Net income
                  $ 111  
 
                     
 
                       
Per share
                  $ 0.03  
 
                     

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ITEM 4. CONTROLS AND PROCEDURES
Based upon their most recent evaluation, which was completed as of the end of the period covered by this Report, the Acting Principal Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at September 30, 2005, to ensure that information required to be disclosed in reports that the Company files or submits under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported within the time period specified in Securities and Exchange Commission rules and forms. There were no changes in the Company’s internal controls over financial reporting during the quarter ended September 30, 2005, except as described in the following paragraph, that have materially affected or are reasonably likely to materially affect the Company’s internal controls over financial reporting.
However, the Company and its accountants identified a control deficiency in its internal controls over financial reporting as of April 2002 which continued undetected through March 2005 , which constituted a “material weakness” within the meaning of the Public Company Accounting Oversight Board Auditing Standard No. 2. A “material weakness” is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of annual or interim financial statements will not be prevented or detected. The material weakness related to the Company’s accounting for the “Metra” transaction in April 2002, which included a deferral of operating income and/or expense until the time of ultimate sale of a property to an independent third party purchaser. As a result, an error was discovered that affected the consolidated balance sheet, consolidated statement of operations, consolidated statements of stockholders’ equity, and consolidated statements of cash flows for 2002 and subsequent periods. The amounts for 2002 were not material, but the amounts for 2003 were material which causes the need for correction of the 2003 financial statements. Management undertook exhaustive efforts to obtain relevant financial records to support the correction of error as of June 30, 2005 and concluded that the financial statements were improperly stated for such periods. In response to the material weakness, Management
     (i) is continuing to re-evaluate its control procedures with the assistance of an outside consulting firm that specializes in internal control procedures,
     (ii) has concluded that at a minimum, Management will, beginning August 1, 2005, review all material historical transactions and supporting documents that could have a continuing impact upon any current reporting periods,
     (iii) will review quarterly on a sampling basis non-material historical transactions that are included in financial statements for any current reporting period,
     (iv) will continue the process of reviewing all current transactions included in current reporting period financial statements, and
     (v) believes that the transaction involving the error was uniquely complex and is not likely to be repeated, but Management is working with its outside consultant for guidance about other possible control procedures to ensure that in the future, errors will be detected and material misstatement of annual or interim financial statements will be prevented.
WARNING CONCERNING FORWARD LOOKING STATEMENTS
This quarterly report on Form 10-Q and IORI’s 2004 Form 10-K, referred to herein, contain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These statements concern the intent, belief or expectations of IORI’s officers with respect to IORI’s ability to lease its properties, tenant’s ability to pay rents, purchase of additional properties, ability to pay interest and debt principal and make distributions, policies and plans regarding investments and financings, and other matters. Also, words such as “believe”, “expect”, “anticipate”, “intend”, “plan”, “estimate”, or similar expressions identify forward looking statements. Actual results may differ materially from those contained in or implied by the forward looking statements as a result of various factors. Such factors include, without limitation, the impact of changes in the economy and the capital markets on IORI and its tenants, competition within the real estate industry or those industries in which its tenants operate, and changes in federal, state and local legislation. For example: Some of IORI’s tenants may not renew expiring leases and IORI may be unable to locate new tenants to maintain the historical occupancy rates of the properties; rents which IORI can achieve at its properties may decline; tenants may experience losses and become unable to pay rents; and IORI may be unable to identify or to negotiate acceptable purchase prices for new properties. These results could occur due to many different circumstances, some of which, such as changes in IORI’s tenants’ financial conditions or needs for leased space, or changes in the capital markets or the economy, generally, are beyond IORI’s control. Forward looking statements are only expressions of IORI’s present expectations and intentions. Forward looking statements are not guaranteed to occur, and they may not occur. You should not place undue reliance upon forward looking statements.

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PART II. OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) During the period of time covered by this Report, the Company did not repurchase any of its equity securities. The following table sets forth a summary by month for the quarter indicating no repurchases were made, and that at the end of the period covered by this Report, a specified number of shares may yet be purchased under the program specified below:
                                 
                    Total Number of     Maximum Number  
                    Shares Purchased     of Shares that May  
                    as Part of Publicly     Yet be Purchased  
    Total Number of     Average Price     Announced     Under the  
Period   Shares Purchased     Paid per Share     Program     Program(1)  
July 1-30, 2005
        $              
August 1-31, 2005
                       
September 1-30, 2005.
                       
 
                       
Total
        $               31,596  
 
                       
 
(1)   On September 23, 2000, the IORI Board of Directors approved a share repurchase program for up to 300,000 shares of our common stock. This repurchase program has no termination date.

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ITEM 6. EXHIBITS
     The following exhibits are filed herewith or incorporated by reference as indicated below:
     
Exhibit No.   Exhibit Designation
 
   
3.0
  Articles of Incorporation of Income Opportunity Realty Investors, Inc. (incorporated by reference to Appendix C to the Registrant’s Registration Statement on Form S-4 dated February 12, 1996).
 
   
3.1
  Bylaws of Income Opportunity Realty Investors, Inc. (incorporated by reference to Appendix D to the Registrant’s Registration Statement on Form S-4 dated February 12, 1996).
 
   
31.1
  * Certification pursuant to Rule 13a-14 and 15d-14 under the Securities Exchange Act of 1934
 
   
32.1
  * Certification pursuant to 18 U.S.C. 1350.
 
    *Filed herewith.

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SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
             
        INCOME OPPORTUNITY REALTY INVESTORS, INC.
 
           
Date:
  November 14, 2005   By:   /s/ Robert N. Crouch II
 
           
 
          Robert N. Crouch II
 
          Executive Vice President, Chief Financial Officer, and Acting Principal Executive Officer

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INCOME OPPORTUNITY REALTY INVESTORS, INC.
EXHIBITS TO
QUARTERLY REPORT ON FORM 10-Q
For the Quarter ended September 30, 2005
             
Exhibit       Page
Number   Description   Number
 
           
31.1
  Certification Pursuant to Rules 13a-14 and 15d-14 Under the Securities Exchange Act of 1934.     20  
 
           
32.1
  Certification Pursuant to 18 U.S.C. Section 1350.     21  

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