Whitestone REIT - Annual Report: 2006 (Form 10-K)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
[Mark
One]
| x |
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT
OF
1934
|
For
the
fiscal year ended December 31, 2006
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: 000-50256
Hartman
Commercial Properties REIT
(Exact
Name of Registrant as Specified in Its Charter)
|
Maryland
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
76-0594970
(I.R.S.
Employer
Identification
No.)
|
|
1450
West Sam Houston Parkway North, Suite 111, Houston, Texas
(Address
of Principal Executive Offices)
|
77043-3124
(Zip
Code)
|
Registrant’s
telephone number, including area code: (713)
827-9595
Securities
registered pursuant to section 12(b) of the Act:
None
Securities
registered pursuant to section 12(g) of the Act:
Common
Shares of Beneficial Interest, par value $0.001 per share
Indicate
by check mark if the
Registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes ¨
No
ý
Indicate
by check mark if the
Registrant is not required to file reports pursuant to Section 13 or 15(d)
of
the Act. Yes ¨
No
ý
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
ý
No
¨
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 or 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. ¨
Indicate
by check mark whether the
Registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of “accelerated filer and large
accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)
Large
accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer ý
Indicate
by check mark whether the
Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨
No
ý
The
aggregate market value of the
voting stock held by nonaffiliates of the Registrant as of June 30, 2006 (the
last business day of the Registrant’s most recently completed second fiscal
quarter) was $91,796,082 assuming a market value of $10 per share.
As
of March 30, 2007, the Registrant
had 10,001,269 common shares of beneficial interest outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE: We incorporate by reference into Part III portions
of
our proxy statement for the 2007 annual meeting of shareholders.
HARTMAN
COMMERCIAL PROPERTIES REIT
FORM
10-K
Year
Ended December 31, 2006
TABLE
OF CONTENTS
|
Page
|
||
|
1
|
||
|
1
|
||
|
9
|
||
|
16
|
||
|
20
|
||
|
21
|
||
|
22
|
||
|
22
|
||
|
25
|
||
|
26
|
||
|
39
|
||
|
39
|
||
|
39
|
||
|
39
|
||
|
39
|
||
|
40
|
||
|
40
|
||
|
40
|
||
|
40
|
||
|
40
|
||
|
40
|
||
|
41
|
||
|
41
|
||
|
42
|
||
Unless
the context otherwise requires, all references in this report to “HCP,” “we,”
“us” or “our” are to Hartman Commercial Properties REIT and its
subsidiaries.
Forward-Looking
Statements
This
annual report contains forward-looking statements, including discussion and
analysis of our financial condition, anticipated capital expenditures required
to complete projects, amounts of anticipated cash distributions to our
shareholders in the future and other matters. These forward-looking statements
are not historical facts but are the intent, belief or current expectations
of
our management based on its knowledge and understanding of our business and
industry. Forward-looking statements are typically identified by the use of
terms such as “may,” “will,” “should,” “potential,” “predicts,” “anticipates,”
“expects,” “intends,” “plans,” “believes,” “seeks,” “estimates” or the negative
of such terms and variations of these words and similar expressions. These
statements are not guarantees of future performance and are subject to risks,
uncertainties and other factors, some of which are beyond our control, are
difficult to predict and could cause actual results to differ materially from
those expressed or forecasted in the forward-looking statements.
Forward-looking
statements that were true at the time made may ultimately prove to be incorrect
or false. You are cautioned to not place undue reliance on forward-looking
statements, which reflect our management’s view only as of the date of this Form
10-K. We undertake no obligation to update or revise forward-looking statements
to reflect changed assumptions, the occurrence of unanticipated events or
changes to future operating results. Factors that could cause actual results
to
differ materially from any forward-looking statements made in this Form 10-K
include:
|
·
|
changes
in general economic conditions;
|
|
·
|
changes
in real estate conditions;
|
|
·
|
construction
costs that may exceed estimates;
|
|
·
|
construction
delays;
|
|
·
|
increases
in interest rates;
|
|
·
|
litigation
risks;
|
|
·
|
lease-up
risks;
|
|
·
|
inability
to obtain new tenants upon the expiration of existing leases;
and
|
|
·
|
the
potential need to fund tenant improvements or other capital expenditures
out of operating cash flow.
|
The
forward-looking statements should be read in light of these factors and the
factors identified in the “Risk Factors” sections of this Form 10-K and our
Registration Statement on Form S-11, as amended, as previously filed with the
Securities and Exchange Commission.
PART
I
| Item 1. |
Business.
|
General
Description of Business
We
are a
Maryland real estate investment trust (“REIT”) organized in December 2003 for
the purpose of merging with Hartman Commercial Properties REIT, a Texas real
estate investment trust organized in August 1998. We are the surviving entity
resulting from the merger, which was consummated on July 28, 2004. We have
elected to be taxed as a REIT trust under federal income tax laws. We invest
in
and operate retail, office and warehouse properties located primarily in the
Houston, Dallas and San Antonio, Texas metropolitan areas. In the future, we
plan to expand our investments to similar properties in major metropolitan
cities in the United States. Each of our properties is leased to one or more
tenants.
Substantially
all of our business is conducted through Hartman REIT Operating Partnership,
L.P., a Delaware limited partnership organized in 1998 (the “Operating
Partnership”). We are the sole general partner of the Operating Partnership. As
of December 31, 2006, we owned a 62.34% interest in the Operating
Partnership.
On
December 31, 2006, we owned 36 properties. All of our properties are located
in
the Houston, Dallas and San Antonio, Texas metropolitan areas. The properties
consist of 19 retail, 6 office and 11 warehouse properties, and each is designed
to meet the needs of surrounding local communities. As of December 31, 2006,
our
properties contained approximately 3,093,000 square feet of gross leasable
area
in the aggregate.
As
of
December 31, 2006, our properties were approximately 83.3% leased. Substantially
all of our revenues consist of base rents received under long-term leases.
For
the year ended December 31, 2006, our total revenues were approximately $29.8
million. Approximately 84.7% of our existing leases contain “step up” rental
clauses that provide for increases in the base rental payments.
Business
Objectives and Strategy
Our
strategy is to remain focused on being a value-added commercial property REIT
that acquires and expands its ownership of primarily C-class retail, office
and
warehouse properties. We will look for properties that are under leased and/or
under managed in markets with potential upside, and add-value through our
management and leasing expertise. The key elements of our strategy
include:
| · |
Capitalize
on Our Value-Added Acquisition Strategy.
We invest in a mixture of (i) properties that we perceive are undervalued
due to low occupancy, poor management, market inefficiencies and/or
inadequate capitalization where we can create value by using our
leasing
and property management expertise, and (ii) stabilized properties
that are
relatively well occupied and managed and provide steady current net
operating income with lower growth
potential.
|
| · |
Take
Advantage of Economic Cycles.
We diversify our property and tenant mixes in order to take advantage
of
opportunities in, and manage the risks resulting from, different
economic
cycles that occur among various property
types.
|
| · |
Investment
Outside of Texas Market.
We
seek to invest in similar properties outside of Texas in
cities with exceptional demographics to diversify market risk.
|
| · |
Selectively
Develop Properties.
We intend to selectively develop properties where land prices and
economic
trends indicate higher potential future returns from development
than from
acquisitions.
|
| · |
Strengthen
Our Balance Sheet. We
intend to selectively dispose of assets that have little or no growth
potential and recycle the capital into assets having potential for
greater
returns.
|
1
Recent
Developments
Property
Management and Advisory Agreements
On
October 2, 2006, our Board of Trustees (our “Board”) terminated for cause our
amended and restated property management agreement, dated September 1, 2004,
with Hartman Management, L.P. (“Hartman Management”). Our Board determined that
it was in the best interests of HCP and our shareholders to terminate this
agreement because of numerous unresolved issues and conflicts of interest
between Allen R. Hartman, Hartman Management and HCP. In addition, our Board
believed that it was in the best interests of HCP and our shareholders to move
forward as a self-managed, self-administered REIT with a new, fully integrated
management team.
In
addition, our Board elected not to renew our advisory agreement, dated August
31, 2004, with Hartman Management. This agreement had been extended on a
month-to-month basis and ultimately expired on September 30, 2006.
Pursuant
to these agreements, Hartman Management had acted as our advisor and manager
of
our day-to-day operations and portfolio of properties. Mr. Hartman, our former
President, Secretary, Chief Executive Officer, and Chairman of the Board, is
the
sole limited partner of Hartman Management, as well as the president, secretary,
sole trustee and sole shareholder of the general partner of Hartman Management.
As described below, Mr. Hartman was removed by our Board as our President,
Secretary, and Chief Executive Officer on October 2, 2006, and he resigned
from
our Board on October 27, 2006.
Departure
of Directors or Principal Officers; Election of Directors; Appointment of
Principal Officer
On
October 2, 2006, our Board voted to terminate Mr. Hartman from his positions
as
our President, Secretary and Chief Executive Officer and appointed James C.
Mastandrea to serve as our interim Chief Executive Officer and Chairman of
our
Board. Mr. Mastandrea had served as an independent member of our Board since
July 5, 2006. There are no arrangements or understandings between Mr. Mastandrea
and any other person pursuant to which Mr. Mastandrea was selected as an
officer. Since the beginning of our last fiscal year, Mr. Mastandrea has had
no
direct or indirect interest in any transaction to which we were a party. On
October 27, 2006, Mr. Hartman resigned from our Board.
Litigation
between HCP and Allen R. Hartman and Hartman Management
In
October 2006, we initiated an action in the 333rd
Judicial
District Court of Harris County, Texas against Mr. Hartman and Hartman
Management. We are seeking damages for breach of contract, fraudulent inducement
and breach of fiduciary duties.
In
November 2006, Mr. Hartman and Hartman Management filed a counterclaim against
us, the members of our Board, and our Chief Operating Officer, John J. Dee.
The
counterclaim has since been amended to drop the claims against the individual
defendants with the exception of Messrs. Mastandrea and Dee. The amended
counterclaim asserts claims against us for alleged breach of contract and
alleges that we owe Mr. Hartman and Hartman Management fees for the termination
of an advisory agreement. The amended counterclaim asserts claims against
Messrs. Mastandrea and Dee for tortious interference with the advisory agreement
and a management agreement and conspiracy to seize control of us for their
own
financial gains. We have indemnified Messrs. Mastandrea and Dee to the extent
allowed by our governing documents and Maryland law. The amended counterclaim
also asserts claims against our prior outside law firm and one of its
partners.
Limited
discovery has been conducted in this case as of the date of this filing. The
case is set for trial in July 2007.
It
is too
early to express an opinion concerning the likelihood of an adverse outcome
on
the counterclaim, although we intend to vigorously defend against those claims
and vigorously prosecute our affirmative claims.
2
In
December 2006, we also initiated an action in
the
United States District Court for the Southern District of Texas complaining
of
the attempts by Mr. Hartman and Hartman Management to solicit written consents
from shareholders to replace our Board.
Mr.
Hartman and Hartman Management have filed a counterclaim claiming that changes
to our bylaws and declaration of trust are invalid and that their enactment
is a
breach of fiduciary duty. They are seeking a declaration that the changes to
our
bylaws and declaration of trust are invalid and an injunction barring their
enforcement. These changes, among other things, stagger the terms of our Board
members over three years, require two-thirds vote of the outstanding common
shares to remove a Board member and provide that our secretary may call a
special meeting of shareholders only upon the written request of a majority
of
outstanding common shares. We believe the changes to our bylaws and declaration
of trust are valid under Maryland law and in the best interest of our
shareholders. We have filed a motion to dismiss the counterclaims. A group
of
shareholders has filed a request to intervene in this action to assert claims
similar to those asserted by Mr. Hartman and Hartman Management. We have opposed
the intervention.
There
has
been limited discovery in this case as of the date of this report. Documents
have been produced and interrogatory responses exchanged. We have produced
the
members of our Board for deposition as well as Mr. Dee. The Court has conducted
a hearing on the parties’ cross request for preliminary injunction, but has not
yet ruled on that request.
It
is too
early to express an opinion concerning the likelihood of an adverse outcome
on
the counterclaim, although we intend to vigorously defend against those claims
and vigorously prosecute our affirmative claim.
Public
Offering
On
September 15, 2004, our Registration Statement on Form S-11, with respect to
a
public offering of up to 10,000,000 common shares of beneficial interest offered
at a price of $10 per share was declared effective under the Securities Act
of
1933. The Registration Statement also covered up to 1,000,000 shares available
pursuant to our dividend reinvestment plan offered at a price of $9.50 per
share. The shares were offered to investors on a best efforts basis.
Post-Effective Amendments No. 1, 2 and 3 to the Registration Statement were
declared effective by the SEC on June 27, 2005, March 9, 2006 and May 3, 2006,
respectively.
On
October 2, 2006, our Board terminated the public offering. On March 27, 2006,
we
gave the required ten days notice to our participants informing them that we
intend to terminate our dividend reinvestment plan. As a result our dividend
reinvestment program will terminate on April 6, 2007.
As
of
December 31, 2006, 2,831,184 shares had been issued pursuant to our public
offering with net offering proceeds received of approximately $24.6 million.
An
additional 138,033 shares had been issued pursuant to the dividend reinvestment
plan in lieu of dividends totaling approximately $1.3 million. Shareholders
that
received shares pursuant to our dividend reinvestment plan on or after October
2, 2006 may have recission rights. See “Dividend
Reinvestment Plan” in
Item 5
of this report.
Investment
Objectives and Criteria
The
following is an overview of our current policies with respect to investments,
borrowing, affiliate transactions, equity capital and certain other activities.
All of these policies have been established in our governance documents or
by
our management and may be amended or revised from time to time (and at any
time)
by our management or trustees without a vote or the approval of our
shareholders. We cannot assure you that our policies or investment objectives
will be attained or that the value of our common shares will not
decrease.
3
General
We
invest
in commercial real estate properties, primarily retail centers, office buildings
and warehouse properties. Our primary business and investment objectives
are:
|
·
|
to
maximize cash dividends paid to our
shareholders;
|
| · |
to
obtain and preserve long-term capital appreciation in the value of
our
properties to be realized upon our ultimate sale of our properties;
and
|
| · |
to
provide our shareholders with liquidity for their investment in us
by
listing our shares on a national exchange.
|
In
addition, to the extent we determine that it is advantageous to make or invest
in mortgage loans, we will also seek to obtain fixed income through the receipt
of payments on mortgage loans. Our management intends to limit mortgage
investments to 15% of our total investment portfolio unless prevailing economic
or portfolio circumstances require otherwise. We cannot assure you that we
will
attain these objectives or that our capital will not decrease. We currently
have
no investment in mortgage loans.
We
may
not materially change our investment objectives, except upon approval of
shareholders holding a majority of our common shares of beneficial interest.
Our
independent trustees will review our investment objectives at least annually
to
determine that our policies are in the best interests of our shareholders.
Decisions relating to the purchase or sale of our investments will be made
by
our management, subject to approval by our Board, including a majority of our
independent trustees.
Acquisition
and Investment Policies
Although
the Company acquired no properties in 2006, we intend to continue to acquire
community retail centers, office and warehouse properties for long-term
ownership and for the purpose of producing income and generating value growth.
We seek to acquire and own properties that generally have business addresses
in
desirable locations. These properties generally are of high quality
construction, offer personalized tenant amenities and attract higher quality
tenants. We generally intend to hold our properties for an extended period
of
time, which we believe is optimal to enable us to capitalize on the potential
for increased income and capital appreciation of our properties. However,
economic or market conditions may influence us to hold our investments for
different periods of time. Also our management believes that targeting this
type
of property for investment will enhance our ability to enter into joint ventures
with other institutional real property investors (such as pension funds, public
REITs and other large institutional real estate investors), allowing us greater
diversity of investment by increasing the number of properties in which we
invest. Our management also believes that by owning a portfolio consisting
largely of the diverse types of properties described above we enhance our
liquidity opportunities for investors by making the sale of individual
properties or multiple properties attractive to purchasers.
We
acquire properties primarily for income. Historically we have invested in
properties that have been constructed and have operating histories. We may
in
the future, however, become more active in investing in land for development
or
in properties that are under development or construction where we see the
properties having the potential for greater returns than those attainable from
completed properties. To the extent feasible, we will invest in a portfolio
of
properties that will satisfy our investment objectives of maximizing cash
available for payment of dividends, preserving our capital and realizing capital
appreciation upon the ultimate sale of our properties.
Our
policy is to acquire properties that are under leased and/or under managed,
in
markets with potential upside, and add-value through our management and leasing
expertise. We anticipate that we will focus on properties in the $1 million
to
$15 million-value range. We typically lease our properties to a wide variety
of
tenants on a “triple-net” basis, which means that the tenant is responsible for
paying the cost of all maintenance and minor repairs, property taxes and
insurance relating to its leased space.
4
Although
we currently intend to invest in or develop retail, office and warehouse
properties, our future investment or redevelopment activities are not limited
to
any specified property type or use. We may invest in other commercial properties
such as manufacturing facilities, and warehouse and distribution facilities
in
order to reduce overall portfolio risk, enhance overall portfolio returns,
or
respond to changes in the real estate market if we believe it would be
advantageous to do so.
Although
we are not limited as to the form our investments may take, all of our
properties are owned by the Operating Partnership or by a wholly owned
subsidiary of the Operating Partnership in fee simple title. We expect to
continue to pursue our investment objectives through the direct ownership of
properties. However, in the future, we may also participate with other entities
in property ownership, through joint ventures, limited liability companies,
partnership, co-tenancies or other types of common ownership. We presently
have
no plans to own any property jointly with another entity or entities. In
addition, we may purchase properties and lease them back to the sellers of
these
properties. While we will use our best efforts to structure any sale-leaseback
transaction so that the lease will be characterized as a “true lease” and we
will be treated as the owner of the property for federal income tax purposes,
we
cannot assure you that the Internal Revenue Service will not challenge this
characterization. In the event that a sale-leaseback transaction is
re-characterized as a financing transaction for federal income tax purposes,
deductions for depreciation and cost recovery relating to that property would
be
disallowed.
Terms
of Leases and Tenant Credit Worthiness
While
the
terms and conditions of any lease that we enter into with our tenants may vary
substantially from those described herein, we expect that a majority of our
leases will be a form of lease customarily used between landlords and tenants
in
the geographic area where the property is located. These leases generally
provide for terms of three to five years and require the tenant to pay a pro
rata share of building expenses. In typical leases, the landlord is directly
responsible for all real estate taxes, certain sales and use taxes, special
assessments, utilities, insurance and building repairs, and other building
operation and management costs.
Borrowing
Policies
Our
organizational and governance documents generally limit the maximum amount
of
indebtedness that we may incur to 300% of our net assets as of the date of
any
borrowing. Notwithstanding the foregoing, we may exceed this borrowing limit
if
any excess in borrowing over the 300% level is approved by a majority of our
independent trustees and disclosed to our shareholders in a subsequent quarterly
report. Further, we do not have a policy limiting the amount of indebtedness
we
may incur or the amount of mortgages which may be placed on any one piece of
property. As a general policy, however, we intend to maintain a ratio of total
liabilities to total assets that is less than 60%. As of December 31, 2006,
we
had a ratio of total liabilities to total assets of 45.8%. However, we may
not
be able to continue to achieve this objective.
We
will
refinance properties during the term of a loan only in limited circumstances,
such as when a decline in interest rates makes it beneficial to prepay an
existing mortgage, when an existing mortgage matures or if an attractive
investment becomes available and the proceeds from the refinancing can be used
to purchase that investment. The benefits of the refinancing may include an
increased cash flow resulting from reduced debt service requirements, an
increase in dividend distributions from proceeds of the refinancing and an
increase in property ownership if refinancing proceeds are reinvested in real
estate.
We
may
not borrow money from any of our trustees unless the loan is approved by a
majority of the trustees, including a majority of the independent trustees
not
otherwise interested. The trustees must determine that such loan is fair,
competitive and commercially reasonable and no less favorable to us than a
comparable loan between unaffiliated parties.
Disposition
Policies
Currently
we are evaluating all of our properties to determine the best long term course
of action for each property. We may determine it is best to sell certain
properties and reinvest the proceeds in properties that we believe have greater
upside. We might sell a property if we believe the value of the property is
expected to decline substantially, an opportunity has arisen to improve other
properties that have better long-term prospects for appreciation, we can
increase cash flow through the disposition of the property and reinvestment
of
the net proceeds or the sale of the property is otherwise in our best interests.
We generally intend to hold our investments long-term. Economic or market
conditions may, however, influence us to hold our investments for different
periods of time. The determination of whether a particular property should
be
sold or otherwise disposed of will be made after consideration of relevant
factors including prevailing economic conditions, with a view to achieving
maximum capital appreciation. The selling price of a leased property is
determined in large part by the amount of rent payable by the tenants.
5
Pursuant
to our declaration of trust, if our shares are not listed for trading on the
New
York Stock Exchange, the American Stock Exchange, the NASDAQ National Market
or
another national exchange by October 2, 2018, unless this date is extended
by
the majority vote of both our Board and our independent trustees, we will be
required to begin the sale of all of our properties and to distribute to our
shareholders the net sale proceeds resulting from our liquidation. If at any
time after that date, we are not in the process of either (i) listing our shares
for trading on a national securities exchange or including our shares for
quotation on the NASDAQ Stock Market or (ii) liquidating our assets, investors
holding a majority of our shares may vote to require our liquidation. It is
our
intention to consider the process of listing or liquidation prior to October
2,
2018. In making the decision to apply for listing, our Board will try to
determine whether listing our shares or liquidating our assets will result
in
greater value for our shareholders. The circumstances, if any, under which
our
Board would agree to list our shares cannot be determined at this time. Even
if
our shares are not listed or included for quotation, we are under no obligation
to actually sell our portfolio within this period since the precise timing
will
depend on real estate and financial markets, economic conditions of the areas
in
which our properties are located and federal income tax effects on shareholders
that may prevail in the future. We may not be able to liquidate our assets.
We
will continue in existence until all of our properties are sold and our other
assets are liquidated.
Dispositions
We
sold
one property in 2006. On December 1, 2006, we sold Northwest Place II, a 27,974
square foot office/warehouse building located in Houston, Texas for a sales
price of $1,175,000. A gain of $197,000 was generated from this sale, which
is
reflected in our consolidated financial statements for the year ended December
31, 2006. It is anticipated that the funds received from this sale will be
used
for future acquisitions and/or capital improvements to properties we believe
have upside.
Securities
of or Interests in Persons Primarily Engaged in Real Estate Activities and
Other
Issuers
Consistent
with the requirements necessary to maintain our qualification as a REIT, we
may
acquire securities of entities engaged in real estate activities or securities
of other issuers, including for the purpose of exercising control over those
entities. We may acquire all or substantially all of the securities or assets
of
REITs or similar entities where the investments would be consistent with our
investment policies. We anticipate that we will only acquire securities or
other
interests in issuers engaged in commercial real estate activities involving
retail, office or office-warehouse properties. We may also invest in entities
owning undeveloped acreage. Neither our declaration of trust nor our bylaws
place any limit or restriction on the percentage of our assets that may be
invested in securities of or interests in other issuers. The governance
documents of the Operating Partnership also do not contain any such
restrictions.
We
may
also invest in limited partnerships and other ownership interests in entities
that own real property. We expect that we may make these investments when we
consider it more efficient to acquire an entity owning real property rather
than
to acquire the properties directly. We also may acquire less than all of the
ownership interests of these entities if we determine that their interests
are
undervalued and that a liquidation event in respect of their interests are
expected within the investment holding periods consistent with that of property
investments.
Other
than our interest in the Operating Partnership, we currently do not own any
securities of other entities. We do not presently intend to acquire securities
of any entities.
6
Equity
Capital
If
our
Board determines that it is advisable and in our best interests to raise
additional equity capital, it has the authority, without shareholder approval,
to authorize us to issue additional common shares or preferred shares of
beneficial interests up to the 400,000,000 authorized shares. Additionally,
our
Board could cause the Operating Partnership to issue units that are convertible
into our common shares. Subject to limitations contained in the organizational
and governance documents of the Operating Partnership, our Board could issue,
or
cause to be issued, securities in any manner (and on terms and for
consideration) they deem appropriate, including in exchange for real estate.
We
have issued securities in exchange for real estate and we expect to continue
to
do so in the future. Existing shareholders have no preemptive right to purchase
shares in any offering, and any offering might cause dilution of an existing
shareholder’s investment in our company.
Environmental
Matters
All
real
property and the operations conducted on real property are subject to federal,
state and local laws and regulations relating to environmental protection and
human health and safety. These laws and regulations generally govern wastewater
discharges, air emissions, the operation and removal of underground and
above-ground storage tanks, the use, storage, treatment, transportation and
disposal of solid and hazardous materials, and the remediation of contamination
associated with disposals. Under these laws and regulations, a current or
previous owner or operator of real property may be liable for the cost of
removal or remediation of hazardous or toxic substances on, under or in its
property. Some of these laws and regulations may impose joint and several
liability on tenants, owners or operators for the costs of investigation or
remediation of contaminated properties, regardless of fault or the legality
of
the original disposal and whether or not the owner or operator knew of, or
was
responsible for, the presence of any hazardous or toxic substances.
Environmental
laws also may impose restrictions on the manner in which property may be used
or
businesses may be operated, and complying with these restrictions may require
substantial expenditures. Environmental laws provide for sanctions in the event
of noncompliance and may be enforced by governmental agencies or, in certain
circumstances, by private parties. Certain environmental laws and common law
principles could be used to impose liability for release of and exposure to
hazardous substances, including asbestos-containing materials into the air,
and
third parties may seek recovery from owners or operators of real property for
personal injury or property damage associated with exposure to released
hazardous substances. Additionally, concern about indoor exposure to mold has
been increasing as it may cause a variety of adverse health effects and
symptoms, including allergic or other reactions. As a result, the presence
of
significant mold at any of our properties could require us to undertake a costly
remediation program to contain or remove the mold from the affected property,
and could expose us to liability to our tenants, their employees and others.
The
cost of defending against claims of liability, of compliance with environmental
regulatory requirements, of remediating any contaminated property, or of paying
personal injury claims could materially adversely affect our business, assets
or
results of operations and, consequently, amounts available for payments of
dividends to our shareholders. In addition, the presence of these substances,
or
the failure to properly remediate these substances, may adversely affect our
ability to sell or rent a property or to use the property as collateral for
future borrowing.
Some
of
these laws and regulations have been amended so as to require compliance with
new or more stringent standards as of future dates. Compliance with new or
more
stringent laws or regulations or stricter interpretation of existing laws may
require material expenditures by us. We cannot assure you that future laws,
ordinances or regulations will not impose any material environmental liability,
or that the current environmental condition of our properties will not be
affected by the operations of the tenants, by the existing condition of the
land, by operations in the vicinity of the properties, such as the presence
of
underground storage tanks, or by the activities of unrelated third parties.
In
addition, there are various local, state and federal fire, health, life-safety
and similar regulations that we may be required to comply with, and which may
subject us to liability in the form of fines or damages for
noncompliance.
7
We
will
not purchase any property unless and until we obtain what is generally referred
to as a “Phase I” environmental site assessment and are generally satisfied with
the environmental status of the property. A Phase I environmental site
assessment basically consists of a visual survey of the building and the
property in an attempt to identify areas of potential environmental concerns,
visually observing neighboring properties to assess surface conditions or
activities that may have an adverse environmental impact on the property, and
contacting local governmental agency personnel and performing a regulatory
agency file search in an attempt to determine any known environmental concerns
in the immediate vicinity of the property. A Phase I environmental site
assessment does not generally include any sampling or testing of soil,
groundwater or building materials from the property. Certain properties that
we
have acquired contain, or contained, dry-cleaning establishments utilizing
solvents. Where believed to be warranted, samplings of building materials or
subsurface investigations were undertaken with respect to these and other
properties. To date, the costs associated with these investigations and any
subsequent remedial measures taken have not been material to us.
We
believe that our properties are in compliance in all material respects with
all
federal, state and local ordinances and regulations regarding the handling,
discharge and emission of hazardous or toxic substances. We have not been
notified by any governmental authority, and are not otherwise aware, of any
material noncompliance, liability or claim relating to hazardous or toxic
substances in connection with any of our present or former properties. We have
not recorded in our financial statements any material liability in connection
with environmental matters. Nevertheless, it is possible that the environmental
assessments we have obtained or reviewed have not revealed all potential
environmental liabilities. It is also possible that subsequent environmental
assessments or investigations will identify material contamination, that adverse
environmental conditions have arisen subsequent to the performance of the
environmental assessments, or that there are material environmental liabilities
of which our management is unaware.
Competition
All
of
our properties are located in areas that include competing properties. The
amount of competition in a particular area could impact our ability to acquire
additional real estate, sell current real estate, lease space and the amount
of
rent we are able to charge. We may be competing with owners, including but
not
limited to, other REITs, insurance companies and pension funds with access
to
greater resources than those available to us.
Employees
As
of
December 31, 2006, we had 41 employees, one of whom was part-time.
Financial
Information About Segments
Our
management historically has not differentiated by property types and therefore
does not presented segment information.
Web
Site Address
We
electronically file our Annual Report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and all amendments to those reports with
the
Securities and Exchange Commission (the “SEC”). Copies of our filings with the
SEC may be obtained at the SEC’s website, at http://www.sec.gov.
Access
to these filings is free of charge. We are currently in the process of reviewing
and updating our business code of ethics. Once finalized, it may be viewed
at
http://www.hcpreit.com.
We are
also in the process of posting other corporate governance documentation to
our
website. The information on our website is not, and should not be considered,
a
part of this report.
8
| Item 1A. |
Risk
Factors.
|
There
can be no assurance that we will be able to pay or maintain cash dividends
or
that dividends will increase over time.
There
are
many factors that can affect the availability and timing of cash dividends
to
shareholders. Dividends will be based principally on cash available from our
properties, real estate securities, mortgage loans and other investments. The
amount of cash available for dividends will be affected by many factors, such
as
our ability to buy properties, the yields on securities of other real estate
programs that we invest in, and our operating expense levels, as well as many
other variables. In 2006, our Board voted to decrease our dividend rate for
the
second quarter of 2006 to $0.15 per common share, as compared to $0.1768 per
common share for the first quarter of 2006. This quarterly dividend rate
continued for the third and fourth quarters of 2006. We can give no assurance
that we will be able to pay or maintain dividends or that dividends will
increase over time. In addition, we can give no assurance that rents from the
properties will increase, that the securities we buy will increase in value
or
provide constant or increased dividends over time, or that future acquisitions
of real properties, mortgage loans or our investments in securities will
increase our cash available for dividends to shareholders. Our actual results
may differ significantly from the assumptions used by our Board in establishing
the dividend rate to shareholders.
If
we experience decreased cash flows, we may need to use other sources of cash
to
fund dividends or we may be unable to pay dividends.
Actual
cash available for dividends may vary substantially from estimates. If our
cash
dividends exceed the amount of cash available for dividends, we may need to
fund
the shortage out of working capital, borrowings under our lines of credit or
by
obtaining other debt, which would reduce the amount of proceeds available for
real estate investments.
We
may need to incur additional borrowings to meet REIT minimum distribution
requirements.
In
order
to maintain our qualification as a REIT, we are required to distribute to our
shareholders at least 90% of our annual net taxable income (excluding any net
capital gain). In addition, the Internal Revenue Code will subject us to a
4%
nondeductible excise tax on the amount, if any, by which certain distributions
paid by us with respect to any calendar year are less than the sum of (i) 85%
of
our ordinary income for that year, (ii) 95% of our net capital gain for that
year and (iii) 100% of our undistributed taxable income from prior years.
Although we intend to pay dividends to our shareholders in a manner that allows
us to meet the distribution requirement and avoid this 4% excise tax, we cannot
assure you that we will always be able to do so.
Our
income consists almost solely of our share of the Operating Partnership’s
income, and the cash available for distribution by us to our shareholders
consists of our share of cash distributions made by the Operating Partnership.
Because we are the sole general partner of the Operating Partnership, our Board
determines the amount of any distributions made by it. Our Board may consider
a
number of factors in making distributions, including:
|
·
|
the
amount of the cash available for
distribution;
|
|
·
|
the
Operating Partnership’s financial
condition;
|
|
·
|
the
Operating Partnership’s capital expenditure requirements;
and
|
|
·
|
our
annual distribution requirements necessary to maintain our qualification
as a REIT.
|
9
Differences
in timing between the actual receipt of income and actual payment of deductible
expenses and the inclusion of income and deduction of expenses when determining
our taxable income, as well as the effect of nondeductible capital expenditures
and the creation of reserves or required debt amortization payments could
require us to borrow funds on a short-term or long-term basis to meet the REIT
distribution requirement and to avoid the 4% excise tax described above. In
these circumstances, we may need to borrow funds to avoid adverse tax
consequences even if our management believes that the then prevailing market
conditions generally are not favorable for borrowings or that borrowings would
not be advisable in the absence of the tax consideration.
We
may incur mortgage indebtedness and other borrowings, which may increase our
business risks.
If
it is
determined to be in our best interests, we may, in some instances, acquire
real
properties by using either existing financing or borrowing new funds. In
addition, we may incur or increase our current mortgage debt to obtain funds
to
acquire additional real properties. We may also borrow funds if necessary to
satisfy the REIT distribution requirement described above, or otherwise as
may
be necessary or advisable to assure that we maintain our qualification as a
REIT
for federal income tax purposes.
We
may
incur mortgage debt on a particular piece of real property if we believe the
property’s projected cash flow is sufficient to service the mortgage debt. If
there is a shortfall in cash flow, however, the amount available for dividends
to shareholders may be affected. In addition, incurring mortgage debt increases
the risk of loss because defaults on such indebtedness may result in loss of
property in foreclosure actions initiated by lenders. For tax purposes, a
foreclosure of any of our properties would be treated as a sale of the property
for a purchase price equal to the outstanding balance of the debt secured by
the
mortgage. If the outstanding balance of the debt secured by the mortgage exceeds
our tax basis in the property, we would recognize taxable income on foreclosure,
but would not receive any cash proceeds. We may give lenders full or partial
guarantees for mortgage debt incurred by the entities that own our properties.
When we give a guaranty on behalf of an entity that owns one of our properties,
we will be responsible to the lender for satisfaction of the debt if it is
not
paid by that entity. If any mortgages contain cross-collateralization or
cross-default provisions, there is a risk that more than one real property
may
be affected by a default. If any of our properties are foreclosed upon due
to a
default, our ability to pay cash dividends to our shareholders will be adversely
affected.
If
we fail to qualify as a REIT, our operations and dividends to shareholders
would
be adversely impacted.
We
intend
to continue to operate so as to qualify as a REIT under the Internal Revenue
Code. A REIT generally is not taxed at the corporate level on income it
currently distributes to its shareholders. Qualification as a REIT involves
the
application of highly technical and complex rules for which there are only
limited judicial or administrative interpretations. The determination of various
factual matters and circumstances not entirely within our control may affect
our
ability to continue to qualify as a REIT. In addition, new legislation, new
regulations, administrative interpretations or court decisions could
significantly change the tax laws with respect to qualification as a REIT or the
federal income tax consequences of qualification.
If
we
were to fail to qualify as a REIT in any taxable year:
|
·
|
we
would not be allowed to deduct our distributions to shareholders
when
computing our taxable income;
|
|
·
|
we
would be subject to federal income tax (including any applicable
alternative minimum tax) on our taxable income at regular corporate
rates;
|
|
·
|
we
would be disqualified from being taxed as a REIT for the four taxable
years following the year during which qualification was lost, unless
entitled to relief under certain statutory provisions;
|
|
·
|
our
cash available for dividends would be reduced and we would have less
cash
to pay dividends to shareholders;
and
|
10
|
·
|
we
may be required to borrow additional funds or sell some of our assets
in
order to pay corporate tax obligations we may incur as a result of
our
disqualification.
|
Our
debt agreements impose limits on our operations and our ability to make
distributions to our shareholders.
The
agreements relating to the debt we incur contain financial and operating
covenants that may limit our ability to make distributions or other payments
to
our shareholders. Our existing credit facilities contain financial and operating
covenants, including:
|
·
|
debt
service coverage of at least 1.5 to
1.0;
|
|
·
|
loan-to-value
ratio of a borrowing base pool to total funded loan balance of at
least
1.67 to 1.00;
|
|
·
|
total
debt not to exceed 60% of fair market value of our real estate
assets;
|
|
·
|
the
ratio of secured debt to fair market value of our real estate assets
not
to exceed 40%;
|
|
·
|
interest
coverage ratio of at least 2.0 to
1.0;
|
|
·
|
we
must hedge certain amounts of variable interest rate
debt;
|
|
·
|
maintenance
of specific levels of insurance;
and
|
|
·
|
limitations
on our ability to make distributions or other payments to our
shareholders, sell assets or engage in mergers, consolidation or
make
certain acquisitions.
|
Failure
to comply with these covenants could result from, among other things, changes
in
our results of operations, incurrence of debt or changes in general economic
conditions. These covenants may restrict our ability to fund our operations
and
conduct our business. Failure to comply with any of these covenants could result
in a default under our credit agreement or other debt agreements we may enter
into in the future. A default could cause one or more of our lenders to
accelerate the timing of payments which could force us to dispose of one or
more
of our properties, possibly on disadvantageous terms. For more discussion,
see
Management’s
Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources.
Because
of the lack of geographic diversification of our portfolio, an economic downturn
in the Houston, Dallas or San Antonio, Texas metropolitan areas could adversely
impact our operations and ability to pay dividends to our
shareholders.
All
of
our assets and revenues are currently derived from properties located in the
Houston, Dallas and San Antonio, Texas metropolitan areas. Our results of
operations are directly contingent on our ability to attract financially sound
commercial tenants. If Houston, Dallas or San Antonio experiences a significant
economic downturn, our ability to locate and retain financially sound tenants
may be adversely impacted. Likewise, we may be required to lower our rental
rates to attract desirable tenants in such an environment. Consequently, because
of the lack of geographic diversity among our current assets, if Houston, Dallas
or San Antonio experiences an economic downturn, our operations and ability
to
pay dividends to our shareholders could be adversely impacted.
11
There
is no public trading market for our shares of common stock, making it difficult
for shareholders to sell their shares.
There
is
no current public market for our common shares of beneficial interest. If you
are able to find a buyer for your shares, you may not sell your shares to that
buyer unless the buyer meets the suitability standards applicable to him or
her,
including any suitability standards imposed by the potential purchaser’s state
of residence. Our declaration of trust also imposes restrictions on the
ownership of common shares that will apply to potential transferees that may
restrict your ability to sell your shares.
In
addition, our Board has delayed the implementation of our share redemption
program. Even if this program is implemented in the future, our Board may reject
any request for redemption of shares or amend, suspend or terminate the program
at any time. Therefore, it will be difficult for you to sell your shares
promptly or at all. You may not be able to sell your shares in the event of
an
emergency, and, if you are able to sell your shares, you may have to sell them
at a substantial discount.
We
have acquired a majority of our properties, on a non “arms-length” basis, from
entities controlled by the previous advisor and CEO, Allen
R. Hartman.
We
acquired 27 of the 36 properties we owned as of December 31, 2006, from entities
controlled by Mr. Hartman. We acquired these properties by paying cash or
issuing our commons shares of beneficial interest or units of the Operating
Partnership that are convertible into our common shares. No third parties were
retained to represent or advise these selling entities or us, and the
transactions were not conducted on an “arm’s-length” basis.
Mr.
Hartman had interests that differed from, and in certain cases conflicted with,
his co-investors in these entities. Mr. Hartman received the following as a
result of these transactions:
|
·
|
897,117.19
units of the Operating Partnership that are convertible into our
common
shares, as adjusted to reflect the recapitalization, in consideration
of
Mr. Hartman’s general partner interest in the selling
entities;
|
|
·
|
the
ability to limit his future exposure to general partner liability
as a
result of Mr. Hartman no longer serving as the general partner to
certain
of the selling entities; and
|
|
·
|
the
repayment of debt encumbering several of our properties that was
personally guaranteed by Mr.
Hartman.
|
Mr.
Hartman might not have been able to negotiate all of these benefits if the
transactions were negotiated at arm’s length. Further, Mr. Hartman did not make
any representations or warranties in regard to the properties or the selling
entities (neither personally nor in his capacity as a general partner) in the
documents evidencing the transactions. Consequently, we essentially acquired
the
properties on an “as is” basis. Therefore, we will bear the risk associated with
any characteristics of or deficiencies in these properties unknown at the
closing of the acquisitions that may affect their valuation or revenue
potential.
Approximately
43.6% of our gross leasable area is subject to leases that expire prior to
December 31, 2009.
As
of
December 31, 2006, approximately 43.6% of the aggregate gross leasable area
of
our properties is subject to leases that expire prior to December 31, 2009.
We
are subject to the risk that:
|
·
|
tenants
may choose not to renew these
leases;
|
|
·
|
we
may not be able to re-lease the space subject to these leases;
and
|
|
·
|
the
terms of any renewal or re-lease may be less favorable than the terms
of
the current leases.
|
If
any of
these risks materialize, our cash flow and ability to pay dividends could be
adversely affected.
12
The
value of investments in our common shares will be directly affected by general
economic and regulatory factors we cannot control or
predict.
We
only
own commercial real estate. Investments in real estate typically involve a
high
level of risk as the result of factors we cannot control or predict. One of
the
risks of investing in real estate is the possibility that our properties will
not generate income sufficient to meet operating expenses or will generate
income and capital appreciation, if any, at rates lower than those anticipated
or available through investments in comparable real estate or other investments.
The following factors may affect income from properties and yields from
investments in properties and are generally outside of our control:
|
·
|
conditions
in financial markets;
|
|
·
|
over-building
in our markets;
|
|
·
|
a
reduction in rental income as the result of the inability to maintain
occupancy levels;
|
|
·
|
adverse
changes in applicable tax, real estate, environmental or zoning
laws;
|
|
·
|
changes
in general economic conditions;
|
|
·
|
a
taking of any of our properties by eminent
domain;
|
|
·
|
adverse
local conditions (such as changes in real estate zoning laws that
may
reduce the desirability of real estate in the area);
|
|
·
|
acts
of God, such as earthquakes or floods and other uninsured
losses;
|
|
·
|
changes
in supply of or demand for similar or competing properties in an
area;
|
|
·
|
changes
in interest rates and availability of permanent mortgage funds, which
may
render the sale of a property difficult or unattractive; and
|
|
·
|
periods
of high interest rates and tight money
supply.
|
Some
or
all of these factors may affect our properties, which could adversely affect
our
operations and ability to pay dividends to shareholders.
We
operate in a competitive business and many of our competitors have greater
resources and operating flexibility than we do.
Numerous
real estate companies that operate in the Houston, Dallas and San Antonio,
Texas
metropolitan areas compete with us in developing and acquiring office, retail
and warehouse properties and seeking tenants to occupy their properties.
Moreover, as we seek to expand our investments and operations into other
geographic locations and other asset types, we will encounter significantly
more
competition from entities that have more financial and other resources, and
more
operating experience, than we do. This competition could adversely affect our
business. In addition, the number of entities and the amount of funds competing
for suitable investments may increase. Such an increase would result in a
heightened demand for these assets that would increase their selling prices.
If
we pay higher prices for properties and other investments our profitability
will
be reduced.
13
We
depend on tenants for our revenue and on anchor tenants to attract non-anchor
tenants.
As
rental
income from real property comprises substantially all of our income, the
inability of a single major tenant or a number of smaller tenants to meet their
obligations to us would adversely affect our income. Tenants may have the right
to terminate their leases upon the occurrence of certain customary events of
default. In addition, in some cases, tenants may have the right to terminate
if
the lease held by an anchor tenant or other principal tenant expires, is
terminated or the property subject to the lease is vacated, even if rent
continues to be paid under the lease. The weakening of a significant tenant’s
financial condition or the loss of an anchor tenant may adversely affect our
cash flow and amounts available for distribution to our
shareholders.
The
bankruptcy or insolvency of major tenants would adversely impact our
operations.
As
of
December 31, 2006, our five largest tenants generated approximately 9.3% of
the
combined rent of our properties. The bankruptcy or insolvency of a major tenant
or a number of small tenants would have an adverse impact on our income and
dividends. Generally, under bankruptcy law, a tenant has the option of
continuing or terminating any unexpired lease. If the tenant continues its
current lease, the tenant must cure all defaults under the lease and provide
adequate assurance of its future performance under the lease. If the tenant
terminates the lease, our claim for breach of the lease (absent collateral
securing the claim) will be treated as a general unsecured claim. General
unsecured claims are the last claims paid in a bankruptcy, and funds may not
be
available to pay these claims. As of December 31, 2006, none of our major
tenants were in bankruptcy or had materially defaulted on their lease. However,
any of our tenants could become insolvent or declare bankruptcy in the
future.
We
may have difficulty selling our real estate investments, which may have an
adverse impact on our ability to pay dividends.
Equity
real estate investments are relatively illiquid. We have a limited ability
to
vary our portfolio in response to changes in economic or other conditions.
The
real estate market is affected by many factors, such as general economic
conditions, availability of financing, interest rates, supply and demand and
other factors, all of which are beyond our control. We cannot predict whether
we
will be able to sell any property for the price or on the terms set by us,
or
whether any price or other terms offered by a prospective purchaser would be
acceptable to us. We cannot predict the length of time needed to find a willing
purchaser and to close the sale of a property. We are especially vulnerable
to
these risks because all but three of our current properties are located in
Houston, Texas. In addition, mortgage payments and, to the extent a property
is
not occupied entirely by tenants subject to triple net leases, certain
significant expenditures such as real estate taxes and maintenance costs
generally are not reduced when circumstances cause a reduction in income from
the investment. The occurrence of these events would adversely affect our income
and ability to pay dividends to our shareholders.
Uninsured
losses relating to real property or excessively expensive premiums for insurance
coverage may adversely affect our returns.
We
will
attempt to ensure that all of our properties are adequately insured to cover
casualty losses. However, there are types of losses, generally catastrophic
in
nature, such as losses due to wars, acts of terrorism, earthquakes, floods,
hurricanes, pollution or environmental matters, which are uninsurable or not
economically insurable, or may be insured subject to limitations, such as large
deductibles or co-payments. Insurance risks associated with potential terrorism
acts could sharply increase the premiums we pay for coverage against property
and casualty claims. In some instances, we may be required to provide other
financial support, either through financial assurances or self-insurance, to
cover potential losses. We cannot assure you that we will have adequate coverage
for these losses. In the event that any of our properties incurs a casualty
loss
that is not fully covered by insurance, the value of our assets will be reduced
by these uninsured losses. In addition, other than any reserves we may
establish, we have no source of funding to repair or reconstruct any uninsured
damaged property, and we cannot assure you that any sources of funding will
be
available to us for this purpose in the future. Also, to the extent we must
pay
unexpectedly large insurance premiums, we could suffer reduced earnings that
would result in less cash dividends to be distributed to
shareholders.
14
Discovery
of previously undetected environmentally hazardous conditions may adversely
affect our operating results.
Under
various federal, state and local environmental laws, ordinances and regulations,
a current or previous owner or operator of real property may be liable for
the
cost of removal or remediation of hazardous or toxic substances on, under or
in
its property. The costs of removal or remediation could be substantial. These
laws often impose liability whether or not the owner or operator knew of, or
was
responsible for, the presence of any hazardous or toxic substances.
Environmental laws also may impose restrictions on the manner in which property
may be used or businesses may be operated, and these restrictions may require
substantial expenditures. Environmental laws provide for sanctions in the event
of noncompliance and may be enforced by governmental agencies or, in certain
circumstances, by private parties. Certain environmental laws and common law
principles could be used to impose liability for release of and exposure to
hazardous substances, including asbestos containing materials into the air.
In
addition, third parties may seek recovery from owners or operators of real
properties for personal injury or property damage associated with exposure
to
released hazardous substances. The cost of defending against claims of
liability, of compliance with environmental regulatory requirements, of
remediating any contaminated property, or of paying personal injury claims
could
materially adversely affect our business, assets or results of operations and,
consequently, amounts available for payments of dividends to our shareholders.
Litigation
with Allen R. Hartman and Hartman Management.
We
are
currently involved in litigation with our former Chief Executive Officer, Allen
R. Hartman, and manager and advisor, Hartman Management, L.P. While we intend
to
vigorously defend against claims brought by Mr. Hartman and Hartman Management
and vigorously prosecute our claims against Mr. Hartman and Hartman Management,
there can be no assurances that we will ultimately prevail. Even if we do
ultimately prevail in these lawsuits, we may continue to incur significant
legal
costs to do so. For more discussion, see Legal
Proceedings and Management’s
Discussion and Analysis of Financial Condition and
Results of Operations - Commitments and Contingencies.
Inability
to retain key personnel may adversely impact our ability to implement our
strategic plan.
Our
success depends to a significant degree upon the continued contributions of
certain executive officers and other key personnel, including James C.
Mastandrea and John J. Dee. We do not have employment agreements with Messrs.
Mastandrea or Dee, and we cannot guarantee that they will remain employed by
us.
We have not purchased “key person” life insurance for Messrs. Mastandrea or Dee.
If Messrs. Mastandrea or Dee or any of our other key personnel were to cease
their employment with us, our operating results could suffer. We believe that
our future success depends, in large part, upon our ability to retain and hire
highly skilled managerial, operational and marketing personnel. Competition
for
skilled personnel is intense, and we cannot assure you that we will be
successful in attracting and retaining skilled personnel. If we lose or are
unable to obtain the services of key personnel, our ability to implement our
business strategies could be delayed or hindered.
Shareholders
that received shares under our dividend reinvestment plan on or after October
2,
2006, could be entitled to recission rights.
Our
dividend reinvestment plan allowed our shareholders to elect to have dividends
from our common shares reinvested in additional common shares at a purchase
price per share of $9.50. Our dividend reinvestment plan will terminate on
April
6, 2007. Shares issued under our dividend reinvestment plan were registered
on
our Registration Statement on Form S-11. We did not amend or supplement our
Registration Statement following our change in management on October 2, 2006,
and the events that occurred thereafter. As a result, shareholders that received
approximately 64,000 shares issued under our dividend reinvestment plan, on
or
after that date could be entitled to recission rights. These rights would
entitle these holders to recovery of their purchase price less any income
received on their shares. If these rights are successfully exercised, the
repayment of the purchase price and associated expenses could adversely affect
our cash flow and ability to pay dividends to our shareholders.
15
| Item 2. |
Properties.
|
On
December 31, 2006, we owned the 36 properties discussed below. We own 33
properties located in the Houston, Texas, 2 properties located in Dallas, Texas
and 1 property located in San Antonio, Texas. Our properties consist of 19
retail centers with approximately 1,293,000 square feet of gross leasable area,
11 warehouse properties with approximately 1,202,000 square feet of gross
leasable area and 6 office buildings with approximately 598,000 square feet
of
gross leasable area. Each property is designed to meet the needs of surrounding
local communities. A nationally or regionally recognized tenant typically
anchors each of our retail properties. As of December 31, 2006, our properties
contain approximately 3,093,000 square feet of gross leasable area.
As
of
December 31, 2006, our retail, warehouse and office properties were
approximately 82.0%, 85.5% and 81.5% leased, respectively.
Anchor
space at our retail properties, representing approximately 7.5% of total
leasable area, was approximately 81.8% leased, while non-anchor space,
accounting for the remaining 92.5% balance, was approximately 83.4% leased.
Approximately 75.5% of our tenants are local tenants and 14.0% and 10.5% of
our
tenants are national and regional tenants, respectively. We define:
|
·
|
national
tenants as any tenant that operates in at least four metropolitan
areas
located in more than one region (i.e. Northwest, Midwest, Southwest
or
Southeast) of the United States;
|
|
·
|
regional
tenants as any tenant that operates in two or more metropolitan areas
located within the same region of the United States;
and
|
|
·
|
local
tenants as any tenant that operates stores only in one metropolitan
area.
|
Substantially
all of our revenues consist of base rents received under long-term leases.
For
the year ended December 31, 2006, our total revenues were approximately $29.8
million. Approximately 84.7% of our existing leases contain “step up” rental
clauses that provide for increases in base rental payments.
The
following table lists the five properties that generated the most rents during
the year 2006.
|
Property
Name
|
Total
Rents Received
in
2006
(in
thousands)
|
Percent
of Company’s Total Rents Received
in
2006
|
||||||
|
Uptown
Tower
|
$
|
3,375
|
11.4
|
%
|
||||
|
Windsor
Park Centre
|
1,742
|
5.9
|
%
|
|||||
|
Corporate
Park Northwest
|
1,577
|
5.3
|
%
|
|||||
|
Corporate
Park West
|
1,495
|
5.0
|
%
|
|||||
|
9101
LBJ Freeway
|
1,471
|
5.0
|
%
|
|||||
|
Total
|
$
|
9,660
|
32.6
|
%
|
||||
As
of
December 31, 2006, we had one property that accounted for more than 10% of
total
gross revenue. Uptown Tower is an office building located in Dallas, Texas
that
was acquired during 2005 and accounts for 11.4% of our total revenue and 11.2%
of real estate, net.
16
General
Physical Attributes
The
following table lists, for all properties owned by us on December 31, 2006,
the
year each property was developed or significantly renovated, the total leasable
area of each property and the purchase price we paid for each
property.
|
Property
Name
|
Location
|
Year
Developed/
Renovated
|
Total
Leasable
Area
(Sq. Ft.)
|
Purchase
Price
|
||||||||||
|
Retail
Properties:
|
||||||||||||||
|
Bellnott
Square
|
Houston
|
1982
|
73,930
|
$
|
5,792,294
|
|||||||||
|
Bissonnet/Beltway
|
Houston
|
1978
|
|
29,205
|
2,361,323
|
|||||||||
|
Centre
South
|
Houston
|
1974
|
44,543
|
2,077,198
|
||||||||||
|
Garden
Oaks
|
Houston
|
1954
|
95,046
|
6,577,782
|
||||||||||
|
Greens
Road
|
Houston
|
1979
|
20,507
|
1,637,217
|
||||||||||
|
Holly
Knight
|
Houston
|
1984
|
20,015
|
1,612,801
|
||||||||||
|
Kempwood
Plaza
|
Houston
|
1974
|
112,359
|
2,531,876
|
||||||||||
|
Lion
Square
|
Houston
|
1980
|
119,621
|
5,835,108
|
||||||||||
|
Northeast
Square
|
Houston
|
1984
|
40,525
|
2,572,512
|
||||||||||
|
Providence
|
Houston
|
1980
|
90,327
|
4,593,668
|
||||||||||
|
South
Richey
|
Houston
|
1980
|
69,928
|
3,361,887
|
||||||||||
|
South
Shaver
|
Houston
|
1978
|
21,926
|
817,003
|
||||||||||
|
SugarPark
Plaza
|
Houston
|
1974
|
95,032
|
8,906,057
|
||||||||||
|
Sunridge
|
Houston
|
1979
|
49,359
|
1,461,571
|
||||||||||
|
Torrey
Square
|
Houston
|
1983
|
105,766
|
4,952,317
|
||||||||||
|
Town
Park
|
Houston
|
1978
|
43,526
|
3,760,735
|
||||||||||
|
Webster
Point
|
Houston
|
1984
|
26,060
|
1,870,365
|
||||||||||
|
Westchase
|
Houston
|
1978
|
42,924
|
2,173,300
|
||||||||||
|
Windsor
Park
|
San
Antonio
|
1992
|
192,458
|
13,102,500
|
||||||||||
|
1,293,057
|
$
|
75,997,514
|
||||||||||||
|
Warehouse
Properties:
|
||||||||||||||
|
Brookhill
|
Houston
|
1979
|
74,757
|
$
|
973,264
|
|||||||||
|
Corporate
Park Northwest
|
Houston
|
1981
|
185,627
|
7,839,539
|
||||||||||
|
Corporate
Park West
|
Houston
|
1999
|
175,665
|
13,062,980
|
||||||||||
|
Corporate
Park Woodland
|
Houston
|
2000
|
99,937
|
6,028,362
|
||||||||||
|
Dairy
Ashford
|
Houston
|
1981
|
42,902
|
1,437,020
|
||||||||||
|
Holly
Hall
|
Houston
|
1980
|
90,000
|
3,123,400
|
||||||||||
|
Interstate
10
|
Houston
|
1980
|
151,000
|
3,908,072
|
||||||||||
|
Main
Park
|
Houston
|
1982
|
113,410
|
4,048,837
|
||||||||||
|
Plaza
Park
|
Houston
|
1982
|
|
105,530
|
4,195,116
|
|||||||||
|
Westbelt
Plaza
|
Houston
|
1978
|
65,619
|
2,733,009
|
||||||||||
|
Westgate
|
Houston
|
1984
|
97,225
|
3,448,182
|
||||||||||
|
1,201,672
|
$
|
50,797,781
|
||||||||||||
|
Office
Properties:
|
||||||||||||||
|
9101
LBJ Freeway
|
Dallas
|
1985
|
125,874
|
$
|
8,093,296
|
|||||||||
|
Featherwood
|
Houston
|
1983
|
49,670
|
2,959,309
|
||||||||||
|
Royal
Crest
|
Houston
|
1984
|
24,900
|
1,864,065
|
||||||||||
|
Uptown
Tower
|
Dallas
|
1982
|
253,981
|
17,171,486
|
||||||||||
|
Woodlake
Plaza
|
Houston
|
1974
|
106,169
|
5,532,710
|
||||||||||
|
Zeta
Building
|
Houston
|
1982
|
37,740
|
2,456,589
|
||||||||||
|
598,334
|
$
|
38,077,455
|
||||||||||||
|
Grand
Totals
|
3,093,063
|
$
|
164,872,750
|
|||||||||||
17
General
Economic Attributes
The
following table lists certain information that relates to the rents generated
by
each property, the anchor or largest tenant at the property and the date their
leases expire. All of the information listed in this table is as of December
31,
2006.
|
Property
Name
|
Percent Leased
|
Total
Annualized Rents Based on Occupancy
(in
thousands)
|
Effective
Net Rent
Per Sq. Ft.
|
Anchor
or Largest Tenant
|
Lease
Expiration Date
|
|||||||||||
|
Retail
Properties:
|
||||||||||||||||
|
Bellnott
Square
|
98.1
|
%
|
$
|
806
|
$
|
10.91
|
Kroger
Food Store # 277
|
07/31/07
|
||||||||
|
Bissonnet/Beltway
|
75.7
|
%
|
453
|
15.51
|
Lydia
& Ajibade Owoyemi
|
09/30/09
|
||||||||||
|
Centre
South
|
75.1
|
%
|
385
|
8.63
|
Carlos
Alvarez
|
10/31/10
|
||||||||||
|
Garden
Oaks
|
78.0
|
%
|
932
|
9.81
|
Bally
Total Fitness
|
12/31/12
|
||||||||||
|
Greens
Road
|
85.4
|
%
|
335
|
16.34
|
Celaya
Meat Market
|
01/31/12
|
|
|||||||||
|
Holly
Knight
|
100.0
|
%
|
384
|
19.20
|
Quick
Wash Laundry
|
09/30/09
|
|
|||||||||
|
Kempwood
Plaza
|
69.3
|
%
|
775
|
6.90
|
Dollar
General
|
01/31/08
|
||||||||||
|
Lion
Square
|
63.5
|
%
|
971
|
8.12
|
Family
Dollar Stores
|
12/31/07
|
||||||||||
|
Northeast
Square
|
82.3
|
%
|
431
|
10.65
|
Sultan
Allana / 99 Cent Store
|
11/30/08
|
||||||||||
|
Providence
|
93.5
|
%
|
936
|
10.36
|
99
Cents Only Stores Texas
|
09/09/08
|
||||||||||
|
South
Richey
|
78.3
|
%
|
487
|
6.96
|
Kroger
Food Store # 303
|
02/28/11
|
||||||||||
|
South
Shaver
|
98.1
|
%
|
304
|
13.87
|
EZ
Pawn
|
11/30/07
|
||||||||||
|
SugarPark
Plaza
|
100.0
|
%
|
1,234
|
12.99
|
Marshall's
|
01/31/08
|
||||||||||
|
Sunridge
|
80.0
|
%
|
481
|
9.74
|
Puro
Latino, Inc.
|
05/31/10
|
||||||||||
|
Torrey
Square
|
73.9
|
%
|
912
|
8.65
|
99
Cents Only Stores Texas
|
09/14/08
|
||||||||||
|
Town
Park
|
100.0
|
%
|
821
|
18.85
|
Raphael
& Elvira Ortega
|
12/31/13
|
||||||||||
|
Webster
Point
|
84.6
|
%
|
340
|
13.06
|
Houston
Learning Academy
|
12/31/09
|
||||||||||
|
Westchase
|
84.9
|
%
|
440
|
10.26
|
Apolinar
& Leticia
|
11/30/11
|
||||||||||
|
Windsor
Park
|
82.3
|
%
|
1,550
|
8.05
|
Sports
Authority
|
08/31/15
|
||||||||||
|
82.0
|
%
|
$
|
12,977
|
$
|
10.04
|
|||||||||||
|
Warehouse
Properties:
|
||||||||||||||||
|
Brookhill
|
100.0
|
%
|
354
|
4.74
|
T.S.
Moly-Lubricants
|
09/30/07
|
||||||||||
|
Corporate
Park Northwest
|
83.5
|
%
|
1,595
|
8.59
|
Region
IV Education
|
02/28/09
|
|
|||||||||
|
Corporate
Park West
|
81.2
|
%
|
1,481
|
8.43
|
LTC
Pharmacy Services
|
05/31/09
|
||||||||||
|
Corporate
Park Woodland
|
100.0
|
%
|
1,166
|
11.67
|
Carrier
Sales & Distribution
|
07/31/08
|
||||||||||
|
Dairy
Ashford
|
47.8
|
%
|
175
|
4.08
|
Foster
Wheeler USA Corp
|
01/31/09
|
||||||||||
|
Holly
Hall
|
80.4
|
%
|
455
|
5.05
|
The
Methodist Hospital
|
12/31/11
|
||||||||||
|
Interstate
10
|
100.0
|
%
|
921
|
6.10
|
River
Oaks L-M, Inc.
|
12/31/09
|
||||||||||
|
Main
Park
|
84.1
|
%
|
561
|
4.95
|
Transport
Sales Associates
|
08/31/08
|
||||||||||
|
Plaza
Park
|
68.5
|
%
|
807
|
7.65
|
American
Medical
|
05/31/11
|
||||||||||
|
Westbelt
Plaza
|
76.9
|
%
|
418
|
6.37
|
Hartman
Management, L.P.
|
M-to-M
|
||||||||||
|
Westgate
|
96.3
|
%
|
792
|
8.14
|
Postmark
DMS, LLC
|
02/28/09
|
||||||||||
|
85.5
|
%
|
$
|
8,725
|
$
|
7.26
|
|||||||||||
|
Office
Properties:
|
||||||||||||||||
|
9101
LBJ Freeway
|
72.7
|
%
|
1,451
|
11.51
|
Compass
Insurance
|
01/31/11
|
||||||||||
|
Featherwood
|
96.1
|
%
|
927
|
18.66
|
Transwestern
Publishing
|
11/30/07
|
||||||||||
|
Royal
Crest
|
90.0
|
%
|
311
|
12.49
|
Emerald
Environmental Service
|
12/31/07
|
||||||||||
|
Uptown
Tower
|
80.5
|
%
|
3,230
|
12.72
|
Brockett
Davis Drake, Inc.
|
04/30/11
|
||||||||||
|
Woodlake
Plaza
|
79.7
|
%
|
1,321
|
12.44
|
Rock
Solid Images
|
07/31/09
|
||||||||||
|
Zeta
Building
|
97.5
|
%
|
592
|
15.70
|
Texas
Retirement & Tax Advisors
|
05/30/11
|
||||||||||
|
81.5
|
%
|
$
|
7,832
|
$
|
13.09
|
|||||||||||
|
Grand
Totals/Averages
|
83.3
|
%
|
$
|
29,534
|
$
|
9.55
|
||||||||||
18
Lease
Expirations
The
following table lists, on an aggregate basis, all of our scheduled lease
expirations over the next 10years.
|
|
|
|
|
Gross
Leasable Area
|
|
Annualized
Base Rent
as
of December 31, 2006
|
|
|||||||||
|
Year
|
|
Number
of Leases
|
|
Approximate
Square
Feet
|
|
Percent
of Total
Leasable
Area
|
|
Amount
(in
thousands)
|
|
Percent
of the Total Annualized Base Rent
|
|
|||||
|
2007
|
133
|
395,968
|
12.8
|
%
|
$
|
4,075
|
16.6
|
%
|
||||||||
|
2008
|
144
|
463,693
|
15.0
|
4,174
|
17.0
|
|||||||||||
|
2009
|
167
|
487,518
|
15.8
|
4,991
|
20.3
|
|||||||||||
|
2010
|
73
|
229,998
|
7.4
|
2,558
|
10.4
|
|||||||||||
|
2011
|
117
|
435,266
|
14.1
|
4,492
|
18.3
|
|||||||||||
|
2012
|
42
|
160,806
|
5.2
|
1,253
|
5.1
|
|||||||||||
|
2013
|
24
|
116,613
|
3.8
|
1,415
|
5.8
|
|||||||||||
|
2014
|
10
|
43,512
|
1.4
|
496
|
2.0
|
|||||||||||
|
2015
|
15
|
98,710
|
3.2
|
837
|
3.4
|
|||||||||||
|
2016
|
3
|
27,870
|
0.9
|
218
|
0.9
|
|||||||||||
|
Total
|
728
|
2,459,954
|
79.6
|
%
|
$
|
24,509
|
99.8
|
%
|
||||||||
Insurance
We
believe that we have property and liability insurance with reputable,
commercially rated companies. We also believe that our insurance policies
contain commercially reasonable deductibles and limits, adequate to cover our
properties. We expect to maintain this type of insurance coverage and to obtain
similar coverage with respect to any additional properties we acquire in the
near future. Further, we have title insurance relating to our properties in
an
aggregate amount that we believe to be adequate.
Regulations
Our
properties, as well as any other properties that we may acquire in the future,
are subject to various federal, state and local laws, ordinances and
regulations. They include, among other things, zoning regulations, land use
controls, environmental controls relating to air and water quality, noise
pollution and indirect environmental impacts such as increased motor vehicle
activity. We believe that we have all permits and approvals necessary under
current law to operate our properties.
19
The
nature of our business exposes us to the risk of lawsuits for damages or
penalties relating to, among other things, breach of contract and employment
disputes. We are currently involved in the following litigation:
Hartman
Commercial Properties REIT and Hartman REIT Operating Partnership, L.P. v.
Allen
R. Hartman and Hartman Management, L.P., in the 333rd
Judicial District Court of Harris County, Texas
On
October 2, 2006, we initiated this action against our former Chief Executive
Officer, Allen R. Hartman, and our former manager and advisor, Hartman
Management, L.P. We are seeking damages for breach of contract, fraudulent
inducement and breach of fiduciary duties.
In
November 2006, Mr. Hartman and Hartman Management filed a counterclaim against
us, the members of our Board and our Chief Operating Officer, John J. Dee.
The
counterclaim has since been amended to drop the claims against the individual
defendants with the exception of our current interim Chief Executive Officer,
James C. Mastandrea, and Mr. Dee. The amended counterclaim asserts claims
against us for alleged breach of contract and alleges that we owe Mr. Hartman
and Hartman Management fees for the termination of an advisory agreement. The
amended counterclaim asserts claims against Messrs. Mastandrea and Dee for
tortious interference with the advisory agreement and a management agreement
and
conspiracy to seize control of us for their own financial gains. We have
indemnified Messrs. Mastandrea and Dee to the extent allowed by our governing
documents and Maryland law. The amended counterclaim also asserts claims against
our prior outside law firm and one of its partners.
Limited
discovery has been conducted in this case as of the date of this report. The
case is set for trial in July 2007.
It
is too
early to express an opinion concerning the likelihood of an adverse outcome
on
the counterclaim, although we intend to vigorously defend against those claims
and vigorously prosecute our affirmative claims.
Hartman
Commercial Properties REIT v. Allen R. Hartman, et al; in the United States
District Court for the Southern District of Texas
On
December 8, 2006, we initiated this action complaining of the attempt by Mr.
Hartman and Hartman Management to solicit written consents from shareholders
to
replace our Board.
Mr.
Hartman and Hartman Management have filed a counterclaim claiming that certain
changes to our bylaws and declaration of trust are invalid and that their
enactment is a breach of fiduciary duties. They are seeking a declaration that
the changes to our bylaws and declaration of trust are invalid and an injunction
barring their enforcement. Theses changes, among other things, stagger the
terms
of our Board members over three years, require two-thirds vote of the
outstanding common shares to remove a Board member and provide that our
secretary may call a special meeting of shareholders only on the written request
of a majority of outstanding common shares. We believe the changes to our bylaws
and declaration of trust are valid under Maryland law and in the best interest
of our shareholders. We have filed a motion to dismiss the counterclaims. A
group of shareholders has filed a request to intervene in this action to assert
claims similar to those asserted by Mr. Hartman and Hartman Management. We
have
opposed the intervention.
There
has
been limited discovery in this case as of the date of this report. Documents
have been produced and interrogatory responses exchanged. We have produced
the
members of our Board for deposition as well as Mr. Dee. The Court has conducted
a hearing on the parties’ cross request for preliminary injunction, but has not
yet ruled on that request.
It
is too
early to express an opinion concerning the likelihood of an adverse outcome
on
the counterclaim, although we intend to vigorously defend against those claims
and vigorously prosecute our affirmative claim.
20
Other
We
are a
participant in various other legal proceedings and claims that arise in the
ordinary course of our business. These matters are generally covered by
insurance. While the resolution of these matters cannot be predicted with
certainty, we believe that the final outcome of these matters will not have
a
material effect on our financial position, results of operations or cash
flows.
None.
21
PART
II
|
Market
for Registrant’s Common Equity, Related Shareholder Matters and Issuer
Purchases of Equity
Securities.
|
Market
Information
There
is
no established trading market for our common shares of beneficial interest.
As
of March 31, 2007, we had 10,001,269 common shares of beneficial interest
outstanding held by a total of approximately 1,423 shareholders.
Public
Offering Proceeds
On
September 15, 2004, our Registration Statement on Form S-11, with respect our
public offering of up to 10,000,000 common shares of beneficial interest to
be
offered at a price of $10 per share was declared effective under the Securities
Act of 1933. The Registration Statement also covers up to 1,000,000 shares
available pursuant to our dividend reinvestment plan to be offered at a price
of
$9.50 per share. The shares are offered to investors on a best efforts basis.
Post-Effective Amendments No. 1, 2 and 3 to the Registration Statement were
declared effective by the SEC on June 27, 2005, March 9, 2006 and May 3, 2006,
respectively.
As
of
December 31, 2006, 2,831,184 shares had been issued pursuant to our public
offering with gross offering proceeds received of $28.3 million. An additional
138,033 shares had been issued pursuant to the dividend reinvestment plan in
lieu of dividends totaling $1.3 million. Shareholders that received shares
pursuant to our dividend reinvestment plan on or after October 2, 2006, may
have
recission rights as described in “Dividend
Reinvestment Plan”
below.
The
application of our gross offering proceeds from the offering are as follows
(in
thousands):
|
Description
of Use of Offering Proceeds
|
Amount
of Proceeds Utilized
|
||||
|
Selling
Commissions paid to broker/ dealers not affiliated with
|
|||||
|
D.H.
Hill Securities , LLP
|
$
|
1,644
|
|||
|
Selling
Discounts
|
71
|
||||
|
Dealer
Manager Fee paid to Hartman Management
|
705
|
||||
|
Offering
expense reimbursements paid to the Hartman Management
|
708
|
||||
|
Acquisition
Fees paid to Hartman Management
|
566
|
||||
|
Total
Offering Expenses
|
$
|
3,694
|
|||
|
Net
Offering Proceeds
|
$
|
25,930
|
|||
|
Repayment
of Lines of Credit
|
$
|
18,300
|
|||
|
Used
for Working Capital
|
$
|
7,630
|
|||
We
initially used approximately $18,300,000 and $7,630,000 of our net proceeds
from
the offering to repay our lines of credit and for working capital, respectively.
We subsequently purchased real estate assets by re-drawing on our lines of
credit and using working capital. Therefore, the ultimate use of our net
offering proceeds was the acquisition of real estate assets.
On
October 2, 2006, our Board terminated the public offering. On March 27, 2006,
we
gave the required ten day notice to plan participants informing them that we
intend to terminate our dividend reinvestment plan. As a result, our dividend
reinvestment plan will terminate on April 6, 2007.
22
Issuer
Repurchases
We
did
not repurchase any of our equity securities during 2006. Our Board has approved
(but delayed the implementation of) a share redemption program that would enable
shareholders to sell shares to us after holding them for at least one year
under
limited circumstances. Our Board could choose to amend the provisions of the
share redemption program without shareholder approval. Our Board has chosen
not
to implement the share redemption program at this time.
Dividends
In
order
to remain qualified as a REIT, we are required to distribute at least 90% of
our
annual taxable income to our shareholders. We currently accrue dividends
quarterly and pay dividends in three monthly installments following the end
of
the quarter. We intend to continue paying dividends in this manner. For a
discussion of our cash flow as compared to dividends, see Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources.
The
following table reflects the total dividends we have paid (including the total
amount paid and the amount paid per share) in each indicated quarter. The
amounts provided give effect to our reorganization as a Maryland real estate
investment trust and the concurrent recapitalization of our common shares on
July 28, 2004.
|
Quarter
Paid
|
Total
Amount of
Dividends
Paid
(in
thousands)
|
Dividends
per Share
|
||||||
|
03/31/2005
|
$
|
1,230
|
$
|
0.1755
|
||||
|
06/30/2005
|
1,282
|
0.1768
|
||||||
|
09/30/2005
|
1,351
|
0.1768
|
||||||
|
12/31/2005
|
1,412
|
0.1768
|
||||||
|
03/31/2006
|
1,525
|
0.1768
|
||||||
|
06/30/2006
|
1,631
|
0.1768
|
||||||
|
09/30/2006
|
1,443
|
0.1500
|
||||||
|
12/31/2006
|
1,477
|
0.1500
|
||||||
|
03/31/2007
|
$
|
1,495
|
$
|
0.1500
|
||||
|
Average
Per Quarter
|
$
|
0.1677
|
||||||
Dividend
Reinvestment Plan
Our
dividend reinvestment plan allowed our shareholders to elect to have dividends
from our common shares reinvested in additional common shares. The purchase
price per share under our dividend reinvestment plan was $9.50. On March 27,
2007, we gave the required ten day notice to participants informing them that
we
intend to terminate our dividend reinvestment plan. As a result, our dividend
reinvestment plan will terminate on April 6, 2007. Shares issued under our
dividend reinvestment plan were registered on our Registration Statement on
Form
S-11. We did not amend or supplement our Registration Statement following our
change in management on October 2, 2006, and the events that occurred
thereafter. As a result, shareholders that received approximately 64,000 shares
issued under our dividend reinvestment plan on or after that date could be
entitled to recission rights. These rights would entitle these shareholders
to
recovery of their purchase price less any income received on their
shares.
23
Equity
Compensation Plan Information
Please
refer to Item 12 of this report on Form 10-K for information concerning
securities authorized under our incentive share plan.
24
| Item 6. |
Selected
Financial Data.
|
The
following table sets forth our selected consolidated financial information
and
should be read in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations”
and our
audited consolidated financial statements and the notes thereto, both of which
appear elsewhere in this report.
|
Year
Ended December 31,
|
||||||||||||||||
|
(in
thousands, except per share data)
|
||||||||||||||||
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
||||||||
|
Income
Statement Data:
|
||||||||||||||||
|
Revenues
|
$
|
29,840
|
$
|
24,919
|
$
|
23,279
|
$
|
20,897
|
$
|
20,739
|
||||||
|
Operating
expenses (excluding depreciation and amortization)
|
15,832
|
11,012
|
9,183
|
8,383
|
8,242
|
|||||||||||
|
Depreciation
and amortization
|
6,476
|
6,099
|
5,223
|
4,758
|
4,042
|
|||||||||||
|
Operating
income
|
7,532
|
7,808
|
8,873
|
7,756
|
8,455
|
|||||||||||
|
Interest
expense
|
(5,296
|
)
|
(3,770
|
)
|
(2,664
|
)
|
(1,323
|
)
|
(1,573
|
)
|
||||||
|
Interest
income and other
|
613
|
301
|
205
|
76
|
16
|
|||||||||||
|
Income
before minority interests
|
2,849
|
4,339
|
6,414
|
6,509
|
6,898
|
|||||||||||
|
Minority
interest in income
|
(1,068
|
)
|
(1,891
|
)
|
(2,990
|
)
|
(3,035
|
)
|
(3,193
|
)
|
||||||
|
Net
income
|
$
|
1,781
|
$
|
2,448
|
$
|
3,424
|
$
|
3,474
|
$
|
3,705
|
||||||
|
Net
income per common share
|
$
|
0.185
|
$
|
0.310
|
$
|
0.488
|
$
|
0.496
|
$
|
0.529
|
||||||
|
Weighted
average shares outstanding
|
9,652
|
7,888
|
7,010
|
7,010
|
7,007
|
|||||||||||
|
Balance
Sheet Data:
|
||||||||||||||||
|
Real
estate (net)
|
$
|
149,599
|
$
|
153,965
|
$
|
126,547
|
$
|
120,256
|
$
|
109,294
|
||||||
|
Other
assets
|
17,488
|
17,497
|
16,070
|
13,810
|
17,670
|
|||||||||||
|
Total
assets
|
$
|
167,087
|
$
|
171,462
|
$
|
142,617
|
$
|
134,066
|
$
|
126,964
|
||||||
|
Liabilities
|
$
|
76,464
|
$
|
83,462
|
$
|
66,299
|
$
|
55,183
|
$
|
45,617
|
||||||
|
Minority
interests in Operating Partnership
|
31,709
|
34,272
|
36,489
|
37,567
|
38,598
|
|||||||||||
|
Shareholders’
equity
|
58,914
|
53,728
|
39,829
|
41,316
|
42,749
|
|||||||||||
|
$
|
167,087
|
$
|
171,462
|
$
|
142,617
|
$
|
134,066
|
$
|
126,964
|
|||||||
|
Cash
Flow Data:
|
||||||||||||||||
|
Proceeds
from issuance of common shares
|
$
|
9,453
|
$
|
17,035
|
$
|
1,472
|
$
|
—
|
$
|
155
|
||||||
|
Additions
to real estate
|
$
|
2,055
|
$
|
31,792
|
$
|
10,277
|
$
|
8,242
|
$
|
1,983
|
||||||
|
Other
Financial Data:
|
||||||||||||||||
|
Dividends
per share
|
$
|
0.625
|
$
|
0.707
|
$
|
0.701
|
$
|
0.700
|
$
|
0.674
|
||||||
The
dividends per share represent total cash payments divided by weighted average
shares.
25
| Item 7. |
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
|
You
should read the following discussion of our financial condition and results
of
operations in conjunction with our audited consolidated financial statements
and
the notes thereto included in this annual report. For more detailed information
regarding the basis of presentation for the following information, you should
read the notes to our audited consolidated financial statements included in
this
annual report.
Overview
We
own 36
commercial properties, consisting of 19 retail centers, 11 warehouse properties
and 6 office buildings. All of our properties are located in the Houston, Dallas
and San Antonio, Texas metropolitan areas. As of December 31, 2006, we had
728
total tenants. No individual lease or tenant is material to our business.
Revenues from our largest lease constituted 2.98% of our total revenues for
2006. Lease terms for our properties range from one year for our smaller tenants
to over ten years for larger tenants. Our leases generally include minimum
monthly lease payments and tenant reimbursements for payment of taxes, insurance
and maintenance.
Since
November 14, 2006, we have operated as a self-managed and self-administered
REIT. As of December 31, 2006, we had 41 employees, one of whom was part-time.
We believe that our current staffing level is sufficient to effectively manage
our property portfolio for the foreseeable future. As a self-managed REIT,
we
will bear our own expenses of operations, including the salaries, benefits
and
other compensation of our employees, office expenses, legal, accounting and
investor relations expenses and other overhead. In the short term, we believe
expenses will be higher than normal due to legal expenses associated with the
litigation with Mr. Hartman and Hartman Management. In the future, we believe
that our operations will be more effective and efficient than they were when
we
were externally managed and our operating margins will improve as a
result.
Prior
to
November 14, 2006, our properties and day-to-day operations were managed by
Hartman Management, our former advisor and manager under an advisory agreement
and a management agreement. Our advisory agreement expired at the end of
September 2006 and our Board terminated our property management agreement for
cause in October 2006. Hartman Management turned over all property management
functions to us on November 14, 2006.
Under
our
management agreement in effect until November 14, 2006, we paid Hartman
Management the following:
|
·
|
Property
management fees in an amount not to exceed the fees customarily charged
in
arm’s length transactions by others rendering similar services in the
same
geographic area for similar properties as determined by a survey
of
brokers and agents in that area. Generally, these fees were between
approximately two percent (2.0%) and four percent (4.0%) of gross
revenues
for the management of office buildings and approximately five percent
(5.0%) of gross revenues for the management of retail and warehouse
properties.
|
|
·
|
For
the leasing of the properties, a separate fee for the leases of new
tenants and renewals of leases with existing tenants in an amount
not to
exceed the fee customarily charged in arm’s length transactions by others
rendering similar services in the same geographic area for similar
properties as determined by a survey of brokers and agents in that
area
(with these fees, being equal to 6% of the effective gross revenues
from
leases originated by Hartman Management and 4% of the effective gross
revenues from expansions or
renewals).
|
|
·
|
Except
as otherwise specifically provided, all costs and expenses incurred
by
Hartman Management in fulfilling its duties for the account of and
on
behalf of us. These costs and expenses were to include the wages
and
salaries and other employee-related expenses of all on-site and off-site
employees of Hartman Management who were engaged in the operation,
management, maintenance and leasing or access control of our properties,
including taxes, insurance and benefits relating to these employees,
and
legal, travel and other out-of-pocket expenses that are directly
related
to the management of specific properties.
|
26
Gross
revenues were defined as all amounts actually collected as rents or other
charges for the use and occupancy of our properties, but excluded interest
and
other investment income and proceeds received for a sale, exchange,
condemnation, eminent domain taking, casualty or other disposition of
assets.
Under
our
advisory agreement in effect until September 30, 2006, we paid Hartman
Management a quarterly fee for asset management services in an amount equal
to
one-fourth of 0.25% of the gross asset value calculated on the last day of
each
preceding quarter. Gross asset value is defined as the amount equal to the
aggregate book value of our assets (other than investments in bank accounts,
money market funds or other current assets), before depreciation, bad debts
or
other similar non-cash reserves and without reduction for any debt relating
to
our assets, at the date of measurement, except that during these periods in
which we are obtaining regular independent valuations of the current value
of
our net assets for purposes of enabling fiduciaries of employee benefit plans
to
comply with applicable Department of Labor reporting requirements, gross asset
value was the greater of (i) the amount determined pursuant to the foregoing
or
(ii) our assets’ aggregate valuation established by the most recent valuation
report without reduction for depreciation, bad debts or other similar non-cash
reserves and without reduction for any debt relating to our assets.
The
aggregate fees and reimbursements payable to Hartman Management under our
advisory agreement was not intended to be significantly different from the
fees
and reimbursements that would have been payable under our previous agreement
with Hartman Management. The asset management fee under our advisory agreement,
however, was significantly higher. Hartman Management waived the excess of
the
fee for the period September 1, 2004 through March 31, 2006 in perpetuity.
The
asset management fee payable under our advisory agreement was charged by Hartman
Management in the second and third quarters of 2006 and has been reflected
in
our consolidated financial statements as of December 31, 2006. The asset
management fee was not charged in the fourth quarter of 2006 as the advisory
agreement expired on September 30, 2006.
The
advisory agreement provided for the payment of a deferred performance fee,
payable upon certain events, including termination of the agreement. This fee
is
based upon appreciation in the value of certain of our real estate assets.
We
have not accrued any deferred performance fees, as we believe the amount of
these fees, if any are owing, cannot be determined with reasonable certainty
at
this time. Hartman Management has asserted that approximately $11 million is
owed in deferred performance fees under our advisory agreement. We believe
that
there is no reasonable basis for this assertion. Although we currently estimate
that no deferred performance fee is owed, there can be no assurance that our
view will ultimately prevail. If Hartman Management is awarded a deferred
performance fee it may have a material adverse effect on our financial condition
and results of operations.
Critical
Accounting Policies
Our
discussion and analysis of our financial condition and results of operations
are
based on our consolidated financial statements. We prepared these financial
statements in conformity with U.S. generally accepted accounting principles.
The
preparation of these financial statements required us to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
dates of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. We based our estimates on historical
experience and on various other assumptions we believe to be reasonable under
the circumstances. Our results may differ from these estimates. Currently,
we
believe that our accounting policies do not require us to make estimates using
assumptions about matters that are highly uncertain. You should read Note 1,
Summary of Significant Accounting Policies, to our consolidated financial
statements in conjunction with this Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
We
have
described below the critical accounting policies that we believe could impact
our consolidated financial statements most significantly.
27
Basis
of Consolidation.
We are
the sole general partner of the Operating Partnership and possess full legal
control and authority over its operations. As of December 31, 2006, we owned
a
majority of the partnership interests in the Operating Partnership.
Consequently, our consolidated financial statements include the accounts of
the
Operating Partnership. All significant inter-company balances have been
eliminated. Minority interest in the accompanying consolidated financial
statements represents the share of equity and earnings of the Operating
Partnership allocable to holders of partnership interests other than us. Net
income is allocated to minority interests based on the weighted-average
percentage ownership of the Operating Partnership during the year. Issuance
of
additional common shares and Operating Partnership units changes our ownership
interests as well as those of minority interests.
Real
Estate.
We
record real estate properties at cost, net of accumulated depreciation. We
capitalize improvements, major renovations and certain costs directly related
to
the acquisition, improvement and leasing of real estate. We charge expenditures
for repairs and maintenance to operations as they are incurred. We calculate
depreciation using the straight-line method over the estimated useful lives
of 5
to 39 years of our buildings and improvements. We depreciate tenant improvements
using the straight-line method over the life of the lease.
We
review
our properties for impairment annually or whenever events or changes in
circumstances indicate that the carrying amount of the assets, including accrued
rental income, may not be recoverable through our operations. We determine
whether an impairment in value has occurred by comparing the estimated future
cash flows (undiscounted and without interest charges), including the estimated
residual value of the property, with the carrying cost of the property. If
impairment is indicated, we record a loss for the amount by which the carrying
value of the property exceeds its fair value. We have determined that there
has
been no impairment in the carrying value of our real estate assets as of
December 31, 2006.
Purchase
Price Allocation.
We
record above-market and below-market in-place lease values for owned properties
based on the present value (using an interest rate which reflects the risks
associated with the leases acquired) of the difference between (i) the
contractual amounts to be paid pursuant to the in-place leases and
(ii) management’s estimate of fair market lease rates for the corresponding
in-place leases, measured over a period equal to the remaining non-cancelable
term of the lease. We amortize the capitalized above-market lease values as
a
reduction of rental income over the remaining non-cancelable terms of the
respective leases. We amortize the capitalized below-market lease values as
an
increase to rental income over the initial term and any fixed-rate renewal
periods in the respective leases. Most of the properties we have acquired have
not been subject to leases with terms materially different than then-existing
market-level terms. Most of our acquired leases are relatively short term,
have
inflation or other scheduled rent escalations, and cover periods during which
there have been few, and generally insignificant, pricing changes in the
specific properties’ markets.
We
measure the aggregate value of other intangible assets acquired based on the
difference between (i) the property valued with existing in-place leases
adjusted to market rental rates and (ii) the property valued as if vacant.
Our
management’s estimates of value are made using methods similar to those used by
independent appraisers, primarily discounted cash flow analysis. Factors
considered by management in its analysis include an estimate of carrying costs
during hypothetical expected lease-up periods considering current market
conditions, and costs to execute similar leases. We also consider information
obtained about each property as a result of our pre-acquisition due diligence,
marketing and leasing activities in estimating the fair value of the tangible
and intangible assets acquired. In estimating carrying costs, management will
also include real estate taxes, insurance and other operating expenses and
estimates of lost rentals at market rates during the expected lease-up periods,
which we expect to primarily range from four to eighteen months, depending
on
specific local market conditions. Our management also estimates costs to execute
similar leases including leasing commissions, legal and other related expenses
to the extent that these costs are not already incurred in connection with
a new
lease origination as part of the transaction.
28
The
total
amount of other intangible assets acquired is further allocated to in-place
lease values and customer relationship intangible values based on our
management’s evaluation of the specific characteristics of each tenant’s lease
and our overall relationship with that respective tenant. Characteristics
considered by our management in allocating these values include the nature
and
extent of our existing business relationships with the tenant, growth prospects
for developing new business with the tenant, the tenant’s credit quality and
expectations of lease renewals (including those existing under the terms of
the
lease agreement), among other factors.
We
amortize the value of in-place leases, if any, to expense over the remaining
initial terms of the respective leases, which, for leases with allocated
intangible value, we expect to range generally from five to ten years. The
value
of customer relationship intangibles is amortized to expense over the remaining
initial terms and any renewal periods in the respective leases, but in no event
does the amortization period for intangible assets exceed the remaining
depreciable life of the building. Should a tenant terminate its lease, the
unamortized portion of the in-place lease value and customer relationship
intangibles are charged to expense.
Revenue
Recognition.
All
leases on properties we hold are classified as operating leases, and we
recognize the related rental income on a straight-line basis over the terms
of
the related leases. We capitalize or charge to accrued rent receivable, as
applicable, differences between rental income earned and amounts due per the
respective lease agreements. Percentage rents are recognized as rental income
when the thresholds upon which they are based have been met. Recoveries from
tenants for taxes, insurance, and other operating expenses are recognized as
revenues in the period the corresponding costs are incurred. We provide an
allowance for doubtful accounts against the portion of tenant accounts
receivable which we estimate to be uncollectible.
Liquidity
and Capital Resources
General.
We
generally lease our properties on a triple-net basis or on a basis that provides
for tenants to pay for increases in operating expenses over a base year or
set
amount. During the year ended December 31, 2006, our cash provided by operating
activities was sufficient to cover our operating expenses. During the fourth
quarter of 2006, we incurred approximately $1.0 million in legal costs as a
result of the termination of the management and advisory agreements, the
termination of Mr. Hartman as President, Secretary and Chief Executive Officer
and the litigation with Mr. Hartman and Hartman Management. We do not know
when
this litigation will be resolved and the continued legal cost associated with
this litigation will have a significant impact on our cash flow. We anticipate
that cash flows from operating activities and our borrowing capacity will
provide adequate capital for our working capital requirements, anticipated
capital expenditures, litigation costs and scheduled debt payments during the
next twelve months. We also believe that cash flows from operating activities
and our borrowing capacity will allow us to make all distributions required
for
us to continue to qualify to be taxed as a REIT.
Cash
and Cash Equivalents.
We had
cash and cash equivalents of $8.3 million at December 31, 2006, as compared
to
$0.8 million on December 31, 2005. The increase was primarily the result of
the
following:
|
·
|
Repayment
of approximately $3.5 million loan from a partnership managed by
our
former advisor Hartman Management;
|
|
·
|
Proceeds
of approximately $1.1 million from the sale of our NW Place II property
in
December 2006; and
|
|
·
|
Receipt
of $3.2 million cash from the release of escrow upon the payoff of
the
GMAC loan in June 2006.
|
We
place
all cash in short-term, highly liquid investments that we believe provide
appropriate safety of principal.
29
Our
Debt for Borrowed Money.
As of
December 31, 2006 we had two active loans which are described
below:
Revolving
Credit Facility
We
have a
revolving credit facility with a consortium of banks. The credit facility is
secured by a pledge of the partnership interests in Hartman REIT Operating
Partnership III LP (“HROP III”), a wholly owned subsidiary of the Operating
Partnership that was formed to hold title to the properties comprising the
borrowing base pool for the facility. At December 31, 2006, 35 properties are
owned by HROP III.
In
2006,
the credit facility was increased to $75 million from $50 million, and may
be
increased to $100 million as the borrowing base pool expands. We entered into
this credit facility to refinance our then existing debt, to finance property
acquisitions and for general corporate purposes.
As
of
December 31, 2006 and 2005, the balance outstanding under the credit facility
was $61.2 million and $33.0 million, respectively, and the availability for
additional borrowings was $13.8 million and $17.0 million,
respectively.
Outstanding
amounts under the credit facility accrue interest computed (at our option)
at
either the LIBOR or the Alternative Base Rate on the basis of a 360 day year,
plus the applicable margin as determined from the following table:
|
Total
Leverage Ratio
|
LIBOR
Margin
|
Alternative
Base Rate Margin
|
||
|
Less
than 60% but greater than or equal to 50%
|
2.40%
|
1.150%
|
||
|
Less
than 50% but greater than or equal to 45%
|
2.15%
|
1.025%
|
||
|
Less
than 45%
|
1.90%
|
1.000%
|
The
Alternative Base Rate is a floating rate equal to the higher of the bank’s base
rate or the Federal Funds Rate plus 0.5%. LIBOR Rate loans are available in
one,
two, three or nine month periods, with a maximum of nine contracts at any time.
The effective interest rate as of December 31, 2006 was 7.28% per
annum.
Interest
only is payable monthly under the loan with the total amount of principal due
at
maturity on March 11, 2008. The loan may be prepaid at any time in part or
in
whole, provided that the credit facility is not in default. If LIBOR pricing
is
elected, there is a prepayment penalty based on a “make-whole” calculation for
all costs associated with prepaying a LIBOR borrowing.
As
of
December 31, 2005, we were in violation of a loan covenant which provides that
the ratio of declared dividends to funds from operations (as defined in the
loan
agreement) shall not be greater than 95%. As this violation constitutes an
event
of default, the lenders had the right to accelerate payment of amounts
outstanding under this credit facility. However, on May 8, 2006, we received
a
waiver from the required majority of the consortium banks in the credit facility
and also entered into a modification of the loan agreement whereby the covenant
was amended though December 31, 2006. As amended, the ratio of declared
dividends to funds from operations (as defined in the loan agreement) shall
not
exceed 107% for the three months ended March 31, 2006 and June 30, 2006, 104%
for the three months ended September 30, 2006 and 100% for the three months
ended December 31, 2006. At December 31, 2006, we are in compliance with the
covenant, as amended.
30
In
October 2006, our Board (i) elected not to renew our advisory agreement with
Hartman Management, (ii) terminated our property management agreement with
Hartman Management; and (iii) removed Mr. Hartman from his positions as our
President, Secretary and Chief Executive Officer. These actions violated certain
covenants in the loan agreement and were events of default thereunder. These
events of default have been waived by the lenders.
On
January 8, 2007, we requested that legal fees incurred in connection with the
litigation with Mr. Hartman and Hartman Management be excluded from the
definition of funds from operations in testing the covenant requiring the ratio
of declared and paid dividends to funds from operations not be in excess of
95%.
On January 23, 2007, the lenders granted the exclusion as requested.
On
March
26, 2007, we formalized this agreement in Amendment No. 3 to our Revolving
Credit Agreement which is filed as exhibit 10.26 to this
document.
The
revolving credit facility is supported by a pool of eligible properties referred
to as the borrowing base pool. The borrowing base pool must meet the following
criteria:
|
·
|
We
will provide a negative pledge on the borrowing base pool and may
not
provide a negative pledge of the borrowing base pool to any other
lender.
|
|
·
|
The
properties will be free of all liens, unless otherwise
permitted.
|
|
·
|
All
eligible properties will be retail, office-warehouse, or office
properties, will be free and clear of material environmental concerns
and
will be in good repair.
|
|
·
|
The
aggregate physical occupancy of the borrowing base pool will remain
above
80% at all times.
|
|
·
|
No
property may comprise more than 15% of the value of the borrowing
base
pool with the exception of Corporate Park Northwest, which is allowed
into
the borrowing base pool.
|
|
·
|
The
borrowing base pool will at all times be comprised of at least 10
properties.
|
|
·
|
The
borrowing base pool properties may not contain development or
redevelopment projects.
|
Properties
can be added to and removed from the borrowing base pool at any time provided
no
defaults would occur as a result of a removal. If a property does not meet
the
criteria of an eligible property and we want to include it in the borrowing
base
pool, a majority vote of the bank consortium is required.
Covenants,
tested quarterly, relative to the borrowing base pool are as
follows:
|
·
|
We
will not permit any liens on the properties in the borrowing base
pool
unless otherwise permitted.
|
|
·
|
The
ratio of aggregate net operating income from the borrowing base pool
to
debt service shall at all times exceed 1.5 to 1.0. For any quarter,
debt
service shall be equal to the average loan balance for the past quarter
times an interest rate which is the greater of (a) the then current
annual
yield on 10 year United States Treasury notes over 25 years plus
2%; (b) a
6.5% constant; or (c) the actual interest rate for the
facility.
|
|
·
|
The
ratio of the value of the borrowing base pool to total funded loan
balance
must always exceed 1.67 to 1.00. The value of the borrowing base
pool is
defined as aggregate net operating income for the preceding four
quarters,
less a $0.15 per square foot per annum capital expenditure reserve,
divided by a 9.25% capitalization
rate.
|
31
Covenants,
tested quarterly, relative to us are as follows:
|
·
|
We
will not permit our total indebtedness to exceed 60% of the fair
market
value of our real estate assets at the end of any quarter. Total
indebtedness is defined as all our liabilities, including this facility
and all other secured and unsecured debt, including letters of credit
and
guarantees. Fair market value of real estate assets is defined as
aggregate net operating income for the preceding four quarters, less
a
$0.15 per square foot per annum capital expenditure reserve, divided
by a
9.25% capitalization rate.
|
|
·
|
The
ratio of consolidated rolling four-quarter earnings before interest,
income tax, deprecation and amortization expenses to total interest
expense, including capitalized interest, shall not be less than 2.0
to
1.0.
|
|
·
|
The
ratio of consolidated earnings before interest, income tax, deprecation
and amortization expenses to total interest, including capitalized
interest, principal amortization, capital expenditures and preferred
stock
dividends shall not be less than 1.5 to 1.0. Capital expenditures
shall be
deemed to be $0.15 per square foot per
annum.
|
|
·
|
The
ratio of secured debt to fair market value of real estate assets
shall not
be greater than 40%.
|
|
·
|
The
ratio of declared dividends to funds from operations shall not be
greater
than 95%.
|
|
·
|
The
ratio of development assets to fair market value of real estate assets
shall not be greater than 20%.
|
|
·
|
We
must maintain our status as a REIT for income tax
purposes.
|
|
·
|
Total
other investments shall not exceed 30% of total asset value. Other
investments shall include investments in joint ventures, unimproved
land,
marketable securities and mortgage notes receivable. Additionally,
the
preceding investment categories shall not comprise greater than 30%,
15%,
10% and 20%, respectively, of total other
investments.
|
Within
six months of closing, we must hedge all variable rate debt above $40 million
until the point at which the ratio of variable rate debt to fixed rate debt
is
50% of total debt. Thereafter, we must maintain this type of hedge during any
period in which variable rate debt exceeds 50% of total debt. On March 27,
2006,
we executed an interest rate swap dated as of March 16, 2006, for the purpose
of
hedging variable interest rate exposure, in compliance with the requirements
of
the loan agreement. The lenders waived the default for not executing the hedge
within six months of closing, as required by the loan agreement.
On
June
30, 2006, we borrowed $34.8 million on the revolving credit facility to
extinguish the three year floating rate mortgage loan described in the following
paragraph and pay related legal and banking fees.
In
December 2002, we refinanced substantially all of our mortgage debt with a
$34.4
million three-year floating rate mortgage loan collateralized by 18 of our
then
existing properties. The loan had a maturity date of January 1, 2006, extendable
for an additional two years. Effective as of February 28, 2006, we extended
the
loan to January 1, 2008. During the initial term, the loan bore interest at
2.5%
over 30-day LIBOR (6.79% at December 31, 2005). During the extension term,
the
interest rate was 3.0% over 30-day LIBOR. Interest only payments were due
monthly, and the loan could be repaid in full or in $100,000 increments, with
a
final balloon payment due upon maturity.
32
Mortgage
Loan on Windsor Park Centre
In
connection with the purchase of the Windsor Park Centre property in December
2003, we assumed a note payable in the amount of $6.6 million, secured by the
property. The balance at December 31, 2006, was $5.1 million. The note was
payable in equal monthly installments of principal and interest of $80,445,
with
interest at the rate of 8.34% per annum. The balance of the note was payable
in
full on December 1, 2006. We obtained an extension through March 2, 2007 and
paid off this note in full with the proceeds from a $10.0 million loan described
in the following paragraph.
On
March
1, 2007, we obtained a $10.0 million loan to pay off the loan obtained upon
the
acquisition of the Windsor Park Centre property and to provide funds for future
acquisitions and improvements to existing properties. The mortgage loan is
secured by Windsor Park Centre, which is owned by HCP REIT Operating Company
IV
LLC (“HROC IV”), a wholly owned subsidiary of the Operating Partnership that was
formed to hold title to Windsor Park Centre. On March 1, 2007, we conveyed
ownership of Windsor Park Centre from the Operating Partnership to HROC IV
in
order to secure the $10.0 million loan. The note is payable in equal monthly
installments of principal and interest of $60,212, with interest at the rate
of
6.04% per annum. The balance of the note is payable in full on March 1,
2014.
Capital
Expenditures.
Currently, we are evaluating all of our properties to determine a strategy
for
each property. We may determine it is best to invest capital in properties
we
believe have potential for increasing value. We also may have unexpected capital
expenditures or improvements for our existing assets. Additionally, we intend
to
invest in similar properties outside of Texas in cities with exceptional
demographics to diversify market risk, and we may incur significant capital
expenditures or make improvements in connection with any properties we may
acquire.
Total
Contractual Cash Obligations.
A
summary of our contractual cash obligations as of December 31, 2006, is as
follows (in thousands):
|
Payment
due by period
|
||||||||||||||||
|
Contractual
Obligations
|
Total
|
Less
than
1
Year
|
1
to 3 Years
|
3
to 5 Years
|
More
than 5 Years
|
|||||||||||
|
Long-Term
Debt Obligations
|
$
|
66,363
|
$
|
5,138
|
$
|
61,225
|
$
|
—
|
$
|
—
|
||||||
|
Capital
Lease Obligations
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Operating
Lease Obligations
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Purchase
Obligations
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Other
Long-Term Liabilities
|
||||||||||||||||
|
Reflected
on the Registrant’s
|
||||||||||||||||
|
Balance
Sheet under GAAP
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Total
|
$
|
66,363
|
$
|
5,138
|
$
|
61,225
|
$
|
—
|
$
|
—
|
||||||
On
March
1, 2007 we obtained a $10.0 million loan which is payable in full in 2014.
The
proceeds from the loan were used to pay off the balance of a $5.1 million loan
which was due in 2007 and provide funds for future acquisitions and improvements
to existing properties. We have no commercial commitments, such as lines of
credit or guarantees, that might result from a contingent event and would
require our performance pursuant to a funding commitment.
33
Property
Acquisitions.
During
2006, we acquired no properties.
During
2005, we acquired from unrelated parties three multi-tenant office buildings
comprising approximately 486,024 square feet of gross leasable area. The
properties were acquired for cash for approximately $30.4 million.
During
2004, we acquired from an unrelated party one multi-tenant retail center
comprising approximately 95,032 square feet of gross leasable area. The property
was acquired for cash for approximately $8.9 million.
34
Results
of Operations
Year
Ended December 31, 2006 Compared to Year Ended December 31,
2005
General.
The
following table provides a general comparison of our results of operations
for
the years ended December 31, 2006 and December 31, 2005 (dollars in
thousands):
|
December
31, 2006
|
|
December
31, 2005
|
|||||
|
Number
of properties owned and operated
|
36
|
37
|
|||||
|
Aggregate
gross leasable area (sq. ft.)
|
3,093,063
|
3,121,037
|
|||||
|
Occupancy
rate
|
83
|
%
|
82
|
%
|
|||
|
Total
revenues
|
$
|
29,840
|
$
|
24,919
|
|||
|
Total
operating expenses
|
22,308
|
17,111
|
|||||
|
Operating
income
|
7,532
|
7,808
|
|||||
|
Other
income (expense), net
|
(4,683
|
)
|
(3,469
|
)
|
|||
|
Income
before minority interests
|
2,849
|
4,339
|
|||||
|
Minority
interests in the Operating Partnership
|
(1,068
|
)
|
(1,891
|
)
|
|||
|
Net
income
|
$
|
1,781
|
$
|
2,448
|
|||
Revenues.
Substantially
all of our revenue is derived from rents received for the use of our
properties.
We
had
rental income and tenant reimbursements of approximately $29.8 million for
the
year ended December 31, 2006, as compared to $24.9 million for the year ended
December 31, 2005, an increase of $4.9 million or 20%. Of this increase, $4.4
million or 90% was from receiving a full year of revenue on the three properties
acquired during 2005. The remaining increase resulted from an increase in rental
rates charged. Our average occupancy rate in 2006 was 83%, as compared to 85%
in
2005, and our average annualized revenue was $9.58 per square foot in 2006,
as
compared to our average annualized revenue of $9.09 per square foot in
2005.
Operating
Expenses. Our
total
operating expenses were $22.3 million for the year ended December 31, 2006,
as
compared to $17.1 million for the year ended December 31, 2005, an increase
of
$5.2 million, or 30%. Of this increase, $2.9 million or 56% was from having
a
full year of operating expenses on the three properties acquired during 2005.The
primary components of operating expense are detailed in the table below (in
thousands):
|
Year
Ended December 31,
|
|||||||
|
2006
|
|
2005
|
|||||
|
Properties
acquired in 2005
|
$
|
4,379
|
$
|
1,461
|
|||
|
Other
Properties
|
|||||||
|
Property
operations and maintanence
|
3,093
|
2,906
|
|||||
|
Real
estate taxes
|
2,993
|
2,774
|
|||||
|
Insurance
|
473
|
429
|
|||||
|
Electricity,
water and gas utilities
|
1,194
|
1,164
|
|||||
|
Property
management and asset management
|
|||||||
|
fees
to an affiliate
|
1,266
|
1,354
|
|||||
|
G
& A - professional fees
|
2,217
|
1,128
|
|||||
|
G
& A - employee compensation and office expenses
|
585
|
—
|
|||||
|
Depreciation
|
4,526
|
4,096
|
|||||
|
Amortization
|
1,167
|
1,714
|
|||||
|
Bad
Debt
|
415
|
85
|
|||||
|
$
|
17,929
|
$
|
15,650
|
||||
|
Total
Operating Expenses
|
$
|
22,308
|
$
|
17,111
|
|||
35
Properties
acquired in 2005. During
2005, we acquired from unrelated parties three multi-tenant office buildings
comprising approximately 486,024 square feet of gross leasable area. The
properties were acquired for cash for approximately $30.4 million. As these
properties were acquired during the year only a partial year of operating
expense is included in 2005. The increase is primarily a result of a full year
of operating expense in 2006 compared to a partial year in 2005.
Real
Estate Taxes. The
increase in taxes of $0.2 million is primarily a result of an approximate 8%
increase in overall property values by local appraisal districts.
Property
management and asset management fees paid to an affiliate. On
September 30, 2006, our advisory agreement with Hartman Management expired.
On
November 14, 2006, all property management functions were transferred to us
from
Hartman Management. As such, no fees were charged by Hartman Management after
November 13, 2006. The property management and asset management fees charged
by
Hartman Management through November 13, 2006 and September 30, 2006,
respectively, were $0.3 million or 24% higher than the same period in
2005.
G
& A - professional fees. The
increase in our professional fees of $1.2 million is primarily due to an
increase in legal fees in the fourth quarter resulting from the termination
of
the management and advisory agreements, the termination of Mr. Hartman as our
President, Secretary and Chief Executive Officer and the litigation with Mr.
Hartman and Hartman Management.
G
& A - employee compensation and office expenses. The
increase in employee compensation and office expense of $0.6 million is a result
of our property management and advisory functions being transferred to us from
Hartman Management during the fourth quarter of 2006.
Depreciation.
The
increase of $0.5 million is due primarily to the addition of approximately
of
$2.1 million in capitalized improvements to properties in 2006.
Amortization.
The
decrease of $0.5 million is due to the loan fees related to the GMAC loan
becoming fully amortized in 2005.
Bad
Debt. The
increase in bad debt of $0.3 million is primarily a result of (1) higher tenant
revenues, and (2) additional bad debt reserve recorded by us due to an increase
in the accounts receivable balance of $0.5 million at December 31, 2006 as
compared to December 31, 2005.
Operating
Income. Operating
income was $7.5 million for the year ended December 31, 2006, as compared to
$7.8 million for the year ended December 31, 2005, a decrease of $0.3 million
or
4%. The primary reasons for the decrease are detailed above in Revenues
and
Operating
Expenses.
Other
Expense, net. Other
expense was $4.7 million for the year ended December 31, 2006, as compared
to
$3.5 million for the year ended December 31, 2005, an increase of $1.2 million
or 34%. The primary reason for the increase was a $1.5 million increase in
interest expense as a result of higher variable interest rates in 2006, as
compared to 2005, offset by a gain of $0.2 million recorded in 2006 from the
sale of Northwest Place II.
Net Income.
Income
before minority interest was $2.8 million for the year ended December 31, 2006,
as compared to $4.3 million for the year ended December 31, 2005, a decrease
of
$1.5 million or 35%. Net income for the year ended December 31, 2006, was $1.8
million, as compared to $2.4 million for the year ended December 31, 2005,
a
decrease of $0.6 million, or 25%. These decreases are a result of the items
discussed above.
36
Year
Ended December 31, 2005 Compared to Year Ended December 31,
2004
General.
The
following table provides a general comparison of our results of operations
for
the years ended December 31, 2005 and December 31, 2004 (dollars in
thousands):
|
December
31, 2005
|
December
31, 2004
|
||||||
|
Number
of properties owned and operated
|
37
|
34
|
|||||
|
Aggregate
gross leasable area (sq. ft.)
|
3,121,037
|
2,635,063
|
|||||
|
Occupancy
rate
|
82
|
%
|
86
|
%
|
|||
|
Total
revenues
|
$
|
24,919
|
$
|
23,279
|
|||
|
Total
operating expenses
|
17,111
|
14,406
|
|||||
|
Operating
income
|
7,808
|
8,873
|
|||||
|
Other
income (expense)
|
(3,469
|
)
|
(2,459
|
)
|
|||
|
Income
before minority interests
|
4,339
|
6,414
|
|||||
|
Minority
interests in the Operating Partnership
|
(1,891
|
)
|
(2,990
|
)
|
|||
|
Net
income
|
$
|
2,448
|
$
|
3,424
|
|||
Revenues.
We
had
rental income and tenant reimbursements of $24.9 million for the year ended
December 31, 2005, as compared to revenues of $23.3 million for the year ended
December 31, 2004, an increase of $1.6 million or 7%. Substantially all of
our
revenues are derived from rents received from the use of our properties. The
increase in our revenues during 2005 as compared to 2004 was due to an increase
in the amount of rent charged at some locations and the purchase of additional
properties. Our average occupancy rate in 2005 was 85%, as compared to 87%
in
2004, and our average annualized revenue was $9.09 per square foot in 2005,
as
compared to our average annualized revenue of $9.14 per square foot in
2004.
Operating
Expenses. Our
total
operating expenses were $17.1 million for the year ended December 31, 2005, as
compared to $14.4 for the year ended December 31, 2004, an increase of $2.7
million, or 19%. The increase in our operating expenses during 2005 was
primarily the result of increased maintenance, real estate taxes, utilities
and
depreciation and amortization expenses, predominantly due to the addition of
properties acquired during the year.
The
amount we paid Hartman Management under our previous management agreements
was
based on our revenues and the book value of our assets. As a result of our
increased revenues and assets in 2005, management fees were $1.4 million in
2005, as compared to $1.3 million in 2004, an increase of $0.1 million, or
8%.
Operating
Income. Operating
income was $7.8 million for the year ended December 31, 2005, as compared to
$8.9 million for the year ended December 31, 2004, a decrease of $1.1 million,
or 12%. The primary reasons for the decrease are detailed above in Revenues
and
Operating
Expenses.
Other
Expense. Other
expense was $3.5 million for the year ended December 31, 2005, as compared
to
$2.5 million for the year ended December 31, 2004, and increase of $1.0 million
or 40%. The primary reason for the increase was a $1.1 million increase in
interest expense as a result of higher average debt outstanding and variable
interest rates in 2005, as compared to 2004.
Net Income.
Income
before minority interest was $4.3 million for the year ended December 31, 2005,
as compared to $6.4 million for the year ended December 31, 2004, a decrease
of
$2.1 million or 33%. Net income for the year ended December 31, 2005 was $2.4
million, as compared to $3.4 million for the year ended December 31, 2004,
a
decrease of $1.0 million, or 29%. These decreases are a result of the items
discussed above.
37
Taxes
We
elected to be taxed as a REIT under the Internal Revenue Code beginning with
our
taxable year ended December 31, 1999. As a REIT, we generally are not subject
to
federal income tax on income that we distribute to our shareholders. If we
fail
to qualify as a REIT in any taxable year, we will be subject to federal income
tax on our taxable income at regular corporate rates. We believe that we are
organized and operate in such a manner as to qualify to be taxed as a REIT,
and
we intend to operate so as to remain qualified as a REIT for federal income
tax
purposes.
Inflation
We
anticipate that our leases will continue to be triple-net leases or otherwise
provide that tenants pay for increases in operating expenses and will contain
provisions that we believe will mitigate the effect of inflation. In addition,
many of our leases are for terms of less than five years, which allows us to
adjust rental rates to reflect inflation and other changing market conditions
when the leases expire. Consequently, increases due to inflation, as well as
ad
valorem tax rate increases, generally do not have a significant adverse effect
upon our operating results.
Off-Balance
Sheet Arrangements
We
have
no significant off-balance sheet arrangements as of December 31,
2006.
Recent
Accounting Pronouncements
In
May
2005, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards (“SFAS”) No. 154, “Accounting
Changes and Error Corrections – A Replacement
of
APB Opinion No. 2 and FASB Statement No. 3.” (“SFAS
154”). This statement changes the requirements for the accounting for and
reporting of a change in accounting principle. This statement applies to
all voluntary changes in accounting principles. It also applies to changes
required by an accounting pronouncement in the unusual instance that the
pronouncement does not include specific transition provisions. When a
pronouncement includes specific transition provisions, those provisions should
be followed. This statement is effective for fiscal years beginning after
December 15, 2005, and did not have a material impact on our consolidated
financial statements.
In
February 2006, the FASB issued SFAS No. 155, “Accounting
for Certain Hybrid Financial Instruments
an-amendment of FASB Statements No. 133 and 140”
(“SFAS
155”). This statement will be effective beginning the first quarter of 2007.
Earlier adoption is permitted. The statement permits interests in hybrid
financial assets that contain an embedded derivative that would require
bifurcation to be accounted for as a single financial instrument at fair value
with changes in fair value recognized in earnings. This election is permitted
on
an instrument-by-instrument basis for all hybrid financial instruments held,
obtained, or issued as of the adoption date. We are currently assessing the
impact of adoption of SFAS 155.
In
March
2006, the FASB issued SFAS No. 156, “Accounting
for Servicing of Financial Assets - an amendment
of FASB Statement No. 140,”
(“SFAS
156”), which permits entities to elect to measure servicing assets and servicing
liabilities at fair value and report changes in fair value in earnings. Adoption
of SFAS 156 is required for financial periods beginning after September 15,
2006. We are currently assessing the impact and timing of adoption of SFAS
156
but do not expect the standard to have a material impact on our consolidated
financial statements.
In
September 2006, the FASB issued SFAS No. 157, “Fair
Value Measurements”
(“SFAS
157”). SFAS 157 defines fair value, establishes a framework for
measuring fair value under U.S. generally accepted accounting principles
and requires enhanced disclosures about fair value measurements. It does not
require any new fair value measurements. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. We are currently assessing
whether to early adopt SFAS 157 as of the first quarter of fiscal 2007 as
permitted, and are currently evaluating the impact adoption may have on our
consolidated financial statements.
38
In
February 2007, the FASB issued SFAS No. 159, ‘The
Fair Value Option for Financial Assets and Financial Liabilities—Including an
amendment of FASB Statement No. 115” (“SFAS
159”). SFAS 159 permits entities to choose to measure many financial instruments
and certain other items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility
in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. SFAS 159 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007 and interim periods within those fiscal years. We are
currently assessing whether to early adopt SFAS 157 as of the first quarter
of fiscal 2007 as permitted, and are currently evaluating the impact adoption
may have on our consolidated financial statements.
Market
risk is the risk of loss arising from adverse changes in market rates and
prices. The principal market risk to which we are exposed is the risk related
to
interest rate fluctuations. Based upon the nature of our operations, we are
not
subject to foreign exchange or commodity risk. We will be exposed to changes
in
interest rates as a result of our credit facilities that have floating interest
rates. As of December 31, 2006, we had $31.2 million of indebtedness outstanding
under these types of facilities. The impact of a 1% increase in interest rates
on our debt would result in an increase in interest expense and a decrease
in
income before minority interests of approximately $0.3 million annually.
The
information required by this Item 8 is incorporated by reference to our
Financial Statements beginning on page F-1 of this Annual Report on Form 10-K.
None.
Evaluation
of Disclosure Controls and Procedures
The
Company maintains disclosure controls and procedures that are designed
to ensure
that information required to be disclosed in its Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms, and that such information is accumulated and
communicated to the Company’s management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions
regarding
required disclosure. Management necessarily applied its judgment in assessing
the costs and benefits of such controls and procedures which, by their
nature,
can provide only reasonable assurance regarding management’s control
objectives.
Because,
as of December 31, 2006, we did not meet the definition of “accelerated
filer,” as defined by Rule 12b-2 of the Exchange Act, we were not required to
comply with Section 404 of the Sabanes-Oxley Act of 2002. Accordingly, we
did not engage our independent registered public accounting firm to perform
an
audit of our internal controls over financial reporting. However, our
independent registered public accounting firm, in the course of the audit
of our
financial statements, brought to management’s attention two material weaknesses
in our internal controls: (1) Inadequate controls and procedures in place
to effectively monitor and record non-routine transactions and (2)
Inadequate controls and procedures in place to effectively manage certain
spreadsheets that support the financial reporting process. Controls over
completeness, accuracy, validity, and review of, certain spreadsheet information
that supports the financial reporting process were either not designed
appropriately or did not operate as designed. As a result of these
deficiencies, our accounting personnel may not process and record transactions
or compile data appropriately that requires recognition in our financial
accounting records. Accordingly, errors in our accounting for certain
revenues and other profit and loss items may occur and may not be
detected. A material weakness (within the meaning of the Public Accounting
Oversight Board Accounting Standard No. 2) is a control deficiency, or
aggregation of control deficiencies, that result in more than a remote risk
that
a material mistatement in the Company’s annual or interim financial statements
will not be prevented or detected.
As
of the
end of the period covered by this report, an evaluation was carried out under
the supervision and with the participation of the Company’s management,
including the Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Company’s disclosure controls
and procedures pursuant to Rule 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation and the
material weakness described above, the Chief Executive Officer and Chief
Financial Officer concluded that the Company’s disclosure controls and
procedures are not effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) that is
required to be included in the Company’s Exchange Act filings. The Company
is in the process of remediating the material weaknesses and intends to engage
an external consultant to assist management in establishing and maintaining
adequate controls and remediating the identified material
weaknesses.
Changes
in Internal Controls
No
change
in our internal control over financial reporting occurred during the fourth
fiscal quarter of the period covered by this annual report that materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
None.
39
The
information required by Item 10 of Form 10-K is incorporated herein by reference
to such information as set forth in the proxy statement for our 2007 annual
meeting.
The
information required by Item 11 of Form 10-K is incorporated herein by reference
to such information as set forth in the proxy statement for our 2007 annual
meeting.
The
information required by Item 12 of Form 10-K is incorporated herein by reference
to such information as set forth in the proxy statement for our 2007 annual
meeting.
The
information required by Item 13 of Form 10-K is incorporated herein by reference
to such information as set forth in the proxy statement for our 2007 annual
meeting.
The
information required by Item 14 of Form 10-K is incorporated herein by reference
to such information as set forth in the proxy statement for our 2007 annual
meeting.
40
|
1.
|
Financial
Statements.
The list of our financial statements filed as part of this Annual
Report
on Form 10-K is set forth on page F-1
herein.
|
|
2.
|
Financial
Statement Schedules.
|
a. Schedule
II –
Valuation and Qualifying Amounts
b. Schedule
III – Real Estate and Accumulated Depreciation
All
other
financial statement schedules have been omitted because the required information
of such schedules is not present, is not present in amounts sufficient to
require a schedule or is included in the consolidated financial
statements.
|
3.
|
Exhibits.
The list of exhibits filed as part of this Annual Report on Form
10-K in
response to Item 601 of Regulation S-K is submitted on the Exhibit
Index
attached hereto.
|
41
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf
by
the undersigned, thereunto duly authorized.
|
HARTMAN
COMMERCIAL PROPERTIES REIT
|
||
| |
|
|
| Dated: March 30, 2007 |
/s/
James C. Mastandrea
|
|
|
James
C. Mastandrea, Interim CEO and
Trustee
|
||
POWER
OF ATTORNEY
KNOW
ALL
PERSONS BY THESE PRESENT, that each person whose signature appears below
constitutes and appoints James C. Mastandrea and David K. Holeman, and each
of
them, acting individually, as his attorney-in-fact, each with full power of
substitution and resubstitution, for him or her and in his or her name, place
and stead, in any and all capacities, to sign any and all amendments to this
Annual Report on Form 10-K, and to file the same, with all exhibits thereto,
and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith and about the
premises, as fully to all intents and purposes as he or she might or could
do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, or their or his or her substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
|
March
30, 2007
|
/s/
James C. Mastandrea
James
C. Mastandrea, Interim CEO and Trustee
(Principal
Executive Officer)
|
|
|
March
30, 2007
|
/s/
David K. Holeman
David
K. Holeman, Chief Financial Officer
(Principal
Financial and Principal Accounting Officer)
|
|
|
March
30, 2007
|
/s/
Chris A. Minton
Chris
A. Minton, Trustee
|
|
|
March
30, 2007
|
/s/
Jack L. Mahaffey
Jack L. Mahaffey, Trustee |
|
|
March
30, 2007
|
/s/
Chand Vyas
Chand
Vyas, Trustee
|
42
INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
|
Page
|
|
|
F-2
|
|
|
F-3
|
|
|
F-5
|
|
|
F-6
|
|
|
F-7
|
|
|
F-8
|
|
|
F-32
|
|
|
F-33
|
All
other
schedules for which provision is made in the applicable accounting regulations
of the Securities and Exchange Commission are not required under the related
instructions or are inapplicable, and therefore have been omitted.
F-1
To
the
Board of Trustees and Shareholders of Hartman Commercial Properties REIT
We
have
audited the accompanying consolidated balance sheets of Hartman Commercial
Properties REIT and subsidiary (the “Company”) as of December 31, 2006 and 2005,
and the related consolidated statements of income, shareholders’ equity and cash
flows, for each of the three years in the period ended December 31, 2006. In
connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedules as listed in the accompanying
index. These consolidated financial statements and financial statement schedules
are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements and financial statement
schedules based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures
that
are appropriate in the circumstances, but not for the purposes of expressing
an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Hartman Commercial
Properties REIT and subsidiary as of December 31, 2006 and 2005, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2006 in conformity with U.S.
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
/s/
PANNELL KERR FORSTER OF TEXAS, P.C.
Houston,
Texas
March
27,
2007
F-2
Hartman
Commercial
Properties REIT and Subsidiary
CONSOLIDATED
BALANCE SHEETS
(
in
thousands)
|
December
31,
|
|||||||
|
2006
|
2005
|
||||||
|
Assets
|
|||||||
|
Real
estate
|
|||||||
|
Land
|
$
|
32,662
|
$
|
32,770
|
|||
|
Buildings
and improvements
|
141,196
|
141,019
|
|||||
|
173,858
|
173,789
|
||||||
|
Less
accumulated depreciation
|
(24,259
|
)
|
(19,824
|
)
|
|||
|
Real
estate, net
|
149,599
|
153,965
|
|||||
|
Cash
and cash equivalents
|
8,298
|
849
|
|||||
|
Escrows
and acquisition deposits
|
382
|
5,308
|
|||||
|
Note
receivable
|
604
|
629
|
|||||
|
Receivables
|
|||||||
|
Accounts
receivable, net of allowance for doubtful accounts
|
1,727
|
1,249
|
|||||
|
Accrued
rent receivable
|
3,035
|
2,593
|
|||||
|
Due
from affiliates
|
—
|
3,181
|
|||||
|
Receivables,
net
|
4,762
|
7,023
|
|||||
|
Deferred
costs, net
|
2,890
|
3,004
|
|||||
|
Prepaid
expenses and other assets
|
552
|
684
|
|||||
|
Total
assets
|
$
|
167,087
|
$
|
171,462
|
|||
See
notes
to consolidated financial statements.
F-3
Hartman
Commercial Properties REIT and Subsidiary
CONSOLIDATED
BALANCE SHEETS
(
in
thousands except share data)
|
December
31,
|
|||||||
|
2006
|
|
2005
|
|||||
|
Liabilities
and Shareholders’ Equity
|
|||||||
|
Liabilities
|
|||||||
|
Notes
payable
|
$
|
66,363
|
$
|
73,025
|
|||
|
Accounts
payable and accrued expenses
|
5,398
|
4,063
|
|||||
|
Due
to affiliates
|
103
|
351
|
|||||
|
Tenants’
security deposits
|
1,455
|
1,441
|
|||||
|
Prepaid
rent
|
745
|
470
|
|||||
|
Offering
proceeds escrowed
|
—
|
1,560
|
|||||
|
Dividends
payable
|
1,495
|
1,525
|
|||||
|
Distributions
payable
|
905
|
1,027
|
|||||
|
Total
liabilities
|
76,464
|
83,462
|
|||||
|
Minority
interests of unit holders in Operating Partnership;
|
|||||||
|
5,808,337
units at December 31, 2006 and 2005
|
31,709
|
34,272
|
|||||
|
Shareholders’
equity
|
|||||||
|
Preferred
shares, $0.001 par value per share; 50,000,000
|
|||||||
|
shares
authorized; none issued and outstanding
|
|||||||
|
at
December 31, 2006 and 2005
|
—
|
—
|
|||||
|
Common
shares, $0.001 par value per share; 400,000,000
|
|||||||
|
shares
authorized; 9,974,362 and 8,913,654 issued and
|
|||||||
|
oustanding
at December 31, 2006 and 2005, respectively
|
10
|
9
|
|||||
|
Additional
paid-in-capital
|
72,012
|
62,560
|
|||||
|
Accumulated
deficit
|
(13,108
|
)
|
(8,841
|
)
|
|||
|
Total
shareholders’ equity
|
58,914
|
53,728
|
|||||
|
Total
liabilities and shareholders’ equity
|
$
|
167,087
|
$
|
171,462
|
|||
See
notes
to consolidated financial statements.
F-4
Hartman
Commercial
Properties REIT and Subsidiary
CONSOLIDATED
STATEMENTS OF INCOME
(in
thousands, except per share data)
|
Year
Ended December 31,
|
||||||||||
|
2006
|
|
2005
|
|
2004
|
||||||
|
Revenues
|
||||||||||
|
Rental
income
|
$
|
24,644
|
$
|
20,073
|
$
|
18,427
|
||||
|
Tenants’
reimbursements
|
4,944
|
4,635
|
4,612
|
|||||||
|
Other
income
|
252
|
211
|
240
|
|||||||
|
Total
revenues
|
29,840
|
24,919
|
23,279
|
|||||||
|
Operating
expenses
|
||||||||||
|
Property
operation and maintenance
|
4,258
|
3,227
|
2,839
|
|||||||
|
Real
estate taxes
|
3,775
|
2,981
|
2,595
|
|||||||
|
Insurance
|
589
|
456
|
460
|
|||||||
|
Electricity,
water and gas utilities
|
2,305
|
1,587
|
818
|
|||||||
|
Property
management and asset
|
||||||||||
|
management
fees to an affiliate
|
1,482
|
1,406
|
1,340
|
|||||||
|
General
and administrative
|
3,035
|
1,225
|
1,139
|
|||||||
|
Depreciation
|
5,265
|
4,374
|
3,986
|
|||||||
|
Amortization
|
1,211
|
1,725
|
1,237
|
|||||||
|
Bad
debt expense
|
388
|
130
|
(8
|
)
|
||||||
|
Total
operating expenses
|
22,308
|
17,111
|
14,406
|
|||||||
|
Operating
income
|
7,532
|
7,808
|
8,873
|
|||||||
|
Other
income (expense)
|
||||||||||
|
Interest
income
|
386
|
301
|
205
|
|||||||
|
Interest
expense
|
(5,296
|
)
|
(3,770
|
)
|
(2,664
|
)
|
||||
|
Gain
on sale of real estate
|
197
|
—
|
—
|
|||||||
|
Change
in fair value of derivative instrument
|
30
|
—
|
—
|
|||||||
|
Income
before minority interests
|
2,849
|
4,339
|
6,414
|
|||||||
|
Minority
interests in Operating Partnership
|
(1,068
|
)
|
(1,891
|
)
|
(2,990
|
)
|
||||
|
Net
income
|
$
|
1,781
|
$
|
2,448
|
$
|
3,424
|
||||
|
Net
income per common share
|
$
|
0.185
|
$
|
0.310
|
$
|
0.488
|
||||
|
Weighted-average
shares outstanding
|
9,652
|
7,888
|
7,010
|
|||||||
See
notes to consolidated financial
statements.
F-5
Hartman
Commercial
Properties REIT and Subsidiary
CONSOLIDATED
STATEMENTS OF CHANGES IN SHARHOLDERS’ EQUITY
(in
thousands except per share data)
|
Additional
|
||||||||||||||||
|
Common
Shares
|
Paid-in
|
Accumulated
|
||||||||||||||
|
Shares
|
Amount
|
Capital
|
Deficit
|
Total
|
||||||||||||
|
Balance,
December 31, 2003
|
7,010
|
$
|
7
|
$
|
45,527
|
$
|
(4,218
|
)
|
$
|
41,316
|
||||||
|
Net
income
|
—
|
—
|
—
|
3,424
|
3,424
|
|||||||||||
|
Dividends
|
—
|
—
|
—
|
(4,911
|
)
|
(4,911
|
)
|
|||||||||
|
Balance,
December 31, 2004
|
7,010
|
7
|
45,527
|
(5,705
|
)
|
39,829
|
||||||||||
|
Issuance
of common stock for
|
||||||||||||||||
|
cash,
net of offering costs
|
1,866
|
2
|
16,672
|
—
|
16,674
|
|||||||||||
|
Issuance
of shares under dividend
|
||||||||||||||||
|
reinvestment
plan at $9.50 per share
|
38
|
—
|
361
|
—
|
361
|
|||||||||||
|
Net
income
|
—
|
—
|
—
|
2,448
|
2,448
|
|||||||||||
|
Dividends
|
—
|
—
|
—
|
(5,584
|
)
|
(5,584
|
)
|
|||||||||
|
Balance,
December 31, 2005
|
8,914
|
9
|
62,560
|
(8,841
|
)
|
53,728
|
||||||||||
|
Issuance
of common stock for
|
||||||||||||||||
|
cash,
net of offering costs
|
960
|
1
|
8,501
|
—
|
8,502
|
|||||||||||
|
Issuance
of shares under dividend
|
||||||||||||||||
|
reinvestment
plan at $9.50 per share
|
100
|
—
|
951
|
—
|
951
|
|||||||||||
|
Net
income
|
—
|
—
|
—
|
1,781
|
1,781
|
|||||||||||
|
Dividends
|
—
|
—
|
—
|
(6,048
|
)
|
(6,048
|
)
|
|||||||||
|
Balance,
December 31, 2006
|
9,974
|
$
|
10
|
$
|
72,012
|
$
|
(13,108
|
)
|
$
|
58,914
|
||||||
See
notes
to consolidated financial statements.
F-6
Hartman
Commercial
Properties REIT and Subsidiary
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands)
|
Year
Ended December 31,
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Cash
flows from operating activities:
|
||||||||||
|
Net
income
|
$
|
1,781
|
$
|
2,448
|
$
|
3,424
|
||||
|
Adjustments
to reconcile net income to
|
||||||||||
|
net
cash provided by operating activities:
|
||||||||||
|
Depreciation
|
5,265
|
4,374
|
3,986
|
|||||||
|
Amortization
|
1,211
|
1,725
|
1,237
|
|||||||
|
Minority
interests in Operating Partnership
|
1,068
|
1,891
|
2,990
|
|||||||
|
Equity
in income of real estate partnership
|
—
|
—
|
(210
|
)
|
||||||
|
Gain
on sale of real estate
|
(197
|
)
|
—
|
—
|
||||||
|
Bad
debt expense (recoveries)
|
388
|
130
|
(8
|
)
|
||||||
|
Change
in fair value of derivative instrument
|
30
|
—
|
—
|
|||||||
|
Changes
in operating assets and liabilities:
|
||||||||||
|
Escrows
and acquisition deposits
|
4,896
|
(329
|
)
|
(318
|
)
|
|||||
|
Receivables
|
(1,308
|
)
|
(369
|
)
|
(1,105
|
)
|
||||
|
Due
from affiliates
|
2,933
|
(205
|
)
|
298
|
||||||
|
Deferred
costs
|
(977
|
)
|
(1,588
|
)
|
(953
|
)
|
||||
|
Prepaid
expenses and other assets
|
132
|
(591
|
)
|
353
|
||||||
|
Accounts
payable and accrued expenses
|
1,335
|
709
|
30
|
|||||||
|
Tenants’
security deposits
|
14
|
374
|
5
|
|||||||
|
Prepaid
rent
|
275
|
215
|
(199
|
)
|
||||||
|
Net
cash provided by operating activities
|
16,846
|
8,784
|
9,530
|
|||||||
|
Cash
flows from investing activities:
|
||||||||||
|
Additions
to real estate
|
(2,055
|
)
|
(31,792
|
)
|
(10,277
|
)
|
||||
|
Proceeds
from sale of real estate
|
1,065
|
—
|
—
|
|||||||
|
Proceeds
from legal settlement
|
288
|
—
|
—
|
|||||||
|
Investment
in real estate partnership
|
—
|
—
|
(9,034
|
)
|
||||||
|
Distributions
received from real estate partnership
|
—
|
10
|
9,234
|
|||||||
|
Repayment
of note receivable
|
25
|
26
|
32
|
|||||||
|
Net
cash used in investing activities
|
(677
|
)
|
(31,756
|
)
|
(10,045
|
)
|
||||
|
Cash
flows from financing activities:
|
||||||||||
|
Dividends
paid
|
(6,078
|
)
|
(5,289
|
)
|
(4,907
|
)
|
||||
|
Distributions
paid to OP unit holders
|
(3,753
|
)
|
(4,100
|
)
|
(4,066
|
)
|
||||
|
Proceeds
from issuance of common shares
|
9,453
|
17,035
|
1,472
|
|||||||
|
Increase
(decrease) in stock offering proceeds escrowed
|
(1,560
|
)
|
88
|
(1,472
|
)
|
|||||
|
Proceeds
from notes payable
|
35,281
|
46,725
|
19,013
|
|||||||
|
Repayments
of notes payable
|
(41,943
|
)
|
(30,926
|
)
|
(9,430
|
)
|
||||
|
Payments
of loan origination costs
|
(120
|
)
|
(344
|
)
|
(42
|
)
|
||||
|
|
||||||||||
|
Net
cash provided by (used in) financing activities
|
(8,720
|
)
|
23,189
|
568
|
||||||
|
Net
increase in cash and cash equivalents
|
7,449
|
217
|
53
|
|||||||
|
Cash
and cash equivalents at beginning of period
|
849
|
632
|
579
|
|||||||
|
Cash
and cash equivalents at end of period
|
$
|
8,298
|
$
|
849
|
$
|
632
|
||||
|
Supplemental
disclosure of cash flow information
|
||||||||||
|
Disposal
of fully depreciated real estate
|
$
|
570
|
$
|
—
|
$
|
—
|
||||
|
Cash
paid for interest
|
$
|
4,981
|
$
|
3,788
|
$
|
2,729
|
||||
See
notes
to consolidated financial statements.
F-7
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
1 – Summary
of Significant Accounting Policies
Description
of business and nature of operations
Hartman
Commercial Properties REIT (“HCP”) was formed as a real estate investment trust,
pursuant to the Texas Real Estate Investment Trust Act on August 20, 1998.
In
July 2004, we changed our state of organization from Texas to Maryland pursuant
to a merger of HCP directly with and into a Maryland real estate investment
trust formed for the sole purpose of the reorganization and the conversion
of
each outstanding common share of beneficial interest of the Texas entity into
1.42857 common shares of beneficial interest of the Maryland entity. We serve
as
the general partner of Hartman REIT Operating Partnership, L.P. (the “Operating
Partnership”), which was formed on December 31, 1998 as a Delaware limited
partnership. We currently conduct substantially all of our operations and
activities through the Operating Partnership. As the general partner of the
Operating Partnership, we have the exclusive power to manage and conduct the
business of the Operating Partnership, subject to certain customary exceptions.
As of December 31, 2006, 2005 and 2004, we owned and operated 36, 37 and 34
retail, warehouse and office properties, respectively, in and around Houston,
Dallas and San Antonio, Texas metropolitan areas.
Basis
of consolidation
We
are
the sole general partner of the Operating Partnership and possess full legal
control and authority over the operations of the Operating Partnership. As
of
December 31, 2006 and 2005, we owned a majority of the partnership interests
in
the Operating Partnership. Consequently, the accompanying consolidated financial
statements include the accounts of the Operating Partnership. All significant
inter-company balances have been eliminated. Minority interest in the
accompanying consolidated financial statements represents the share of equity
and earnings of the Operating Partnership allocable to holders of partnership
interests other than us. Net income is allocated to minority interests based
on
the weighted-average percentage ownership of the Operating Partnership during
the year. Issuance of additional common shares of beneficial interest in HCP
(“common shares”) and units of limited partnership interest in the Operating
Partnership (“OP Units”) changes the ownership interests of both the minority
interests and HCP.
Basis
of accounting
Our
financial records are maintained on the accrual basis of accounting whereby
revenues are recognized when earned and expenses are recorded when
incurred.
Reclassifications
We
have
reclassified certain prior fiscal year amounts in the accompanying consolidated
financial statements in order to be consistent with the current fiscal year
presentation. These reclassifications had no effect on net income or
shareholders equity.
Cash
and cash equivalents
We
consider all highly liquid debt instruments purchased with an original maturity
of three months or less to be cash equivalents. Cash and cash equivalents at
December 31, 2006 and 2005 consist of demand deposits at commercial banks and
money market funds.
F-8
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
1 – Summary of Significant Accounting Policies
(Continued)
Due
from affiliates
Due
from
affiliates at December 31, 2005, includes amounts owed to us from limited
partnerships and other entities affiliated with Hartman Management, L.P.
(“Hartman Management”) our former manager and adviser. In December 2006, a note
receivable of approximately $3.5 million was paid in full by a limited
partnership affiliated with Hartman Management.
Escrows
and acquisition deposits
Escrow
deposits include escrows established pursuant to certain mortgage financing
arrangements for real estate taxes, insurance, maintenance and capital
expenditures and escrow of proceeds of our public offering described in Note
12
prior to shares being issued for those proceeds. Acquisition deposits include
earnest money deposits on future acquisitions.
Real
estate
Real
estate properties are recorded at cost, net of accumulated depreciation.
Improvements, major renovations, and certain costs directly related to the
acquisition, improvement, and leasing of real estate are capitalized.
Expenditures for repairs and maintenance are charged to operations as incurred.
Depreciation is computed using the straight-line method over the estimated
useful lives of 5 to 39 years for the buildings and improvements. Tenant
improvements are depreciated using the straight-line method over the life of
the
lease.
Management
reviews our properties for impairment annually or whenever events or changes
in
circumstances indicate that the carrying amount of the assets, including accrued
rental income, may not be recoverable through operations. Management determines
whether an impairment in value has occurred by comparing the estimated future
cash flows (undiscounted and without interest charges), including the estimated
residual value of the property, with the carrying cost of the property. If
impairment is indicated, a loss will be recorded for the amount by which the
carrying value of the property exceeds its fair value. Management has determined
that there has been no impairment in the carrying value of our real estate
assets as of December 31, 2006.
Deferred
costs
Deferred
costs consist primarily of leasing commissions paid to Hartman Management,
our
former investment adviser, external brokers and in-house leasing agents. Leasing
commissions are amortized using the straight-line method over the terms of
the
related lease agreements. Deferred financing costs are amortized on the
straight-line method over the terms of the loans, which approximates the
interest method. Costs allocated to in-place leases whose terms differ from
market terms related to acquired properties are amortized over the remaining
life of the respective leases.
Offering
costs
Offering
costs include selling commissions, issuance costs, investor relations fees
and
unit purchase discounts. These costs were incurred in the raising of capital
through the sale of common shares and are treated as a reduction of
shareholders’ equity.
F-9
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
1 – Summary of Significant Accounting Policies
(Continued)
Revenue
recognition
All
leases on our properties are classified as operating leases, and the related
rental income is recognized on a straight-line basis over the terms of the
related leases. Differences between rental income earned and amounts due per
the
respective lease agreements are capitalized or charged, as applicable, to
accrued rent receivable. Percentage rents are recognized as rental income when
the thresholds upon which they are based have been met. Recoveries from tenants
for taxes, insurance, and other operating expenses are recognized as revenues
in
the period the corresponding costs are incurred. We have established an
allowance for doubtful accounts against the portion of tenant accounts
receivable which is estimated to be uncollectible.
Federal
income taxes
We
are
qualified as a real estate investment trust (“REIT”) under the Internal Revenue
Code of 1986 and are therefore not subject to Federal income taxes provided
we
meet all conditions specified by the Internal Revenue Code for retaining our
REIT status. We believe we have continuously met these conditions since reaching
100 shareholders in 1999 (see Note 10).
Use
of
estimates
The
preparation of financial statements in conformity with U.S. generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Significant estimates used by us include the estimated useful lives for
depreciable and amortizable assets and costs, and the estimated allowance for
doubtful accounts receivable. Actual results could differ from those
estimates.
Derivative
instruments
We
have
initiated a program designed to manage exposure to interest rate fluctuations
by
entering into financial derivative instruments. The primary objective of this
program is to comply with debt covenants on a credit facility. We entered into
an interest rate swap agreement with respect to amounts borrowed under certain
of our credit facilities, which effectively exchanges existing obligations
to
pay interest based on floating rates for obligations to pay interest based
on
fixed LIBOR rates.
Changes
in the market value of the derivative instruments and in the market value of
the
hedged items are recorded in earnings each reporting period. For items that
are
appropriately classified as cash flow hedges in accordance with Statement of
Financial Accounting Standards, (“SFAS”) No. 133, “Accounting
for Derivative
Instruments and Hedging Activities,”
changes in the market value of the instrument and in the market value of the
hedged item are recorded as other comprehensive income with the exception of
the
portion of the hedged items that are considered ineffective. The derivative
instruments are reported at fair value as other assets or other liabilities
as
applicable. As of December 31, 2006, the fair value of this instrument is
approximately $30,000 and is included in prepaid expenses and other assets
in
the consolidated balance sheet.
F-10
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
1 – Summary of Significant Accounting Policies
(Continued)
Additionally,
approximately $30,000 is included in other income on the consolidated statement
of income for the year ended December 31, 2006.
Fair
value of financial instruments
Our
financial instruments consist primarily of cash, cash equivalents, accounts
receivable, accounts and notes payable. The carrying value of cash, cash
equivalents, accounts receivable and accounts payable are representative of
their respective fair values due to the short-term nature of these instruments.
The fair value of our debt obligations is representative of its carrying value
based upon current rates offered for similar types of borrowing arrangements.
The fair value of interest rate swaps (used for hedging purposes) is the
estimated amount that the financial institution would receive or pay to
terminate the swap agreements at the reporting date, taking into account current
interest rates and the current credit worthiness of the swap
counterparties.
Concentration
of risk
Substantially
all of our revenues are obtained from office, warehouse and retail locations
in
the Houston, Dallas and San Antonio, Texas metropolitan areas. We maintain
cash
accounts in major U.S. financial institutions. The terms of these deposits
are
on demand to minimize risk. The balances of these accounts occasionally exceed
the federally insured limits, although no losses have been incurred in
connection with these deposits.
Comprehensive
income
We
follow
SFAS No. 130, “Reporting
Comprehensive Income,”
which
establishes standards for reporting and display of comprehensive income and
its
components. For the periods presented, we did not have significant amounts
of
other comprehensive income.
New
accounting pronouncements
In
May
2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154
“Accounting
Changes and Error Corrections - A Replacement of APB Opinion No. 2 and FASB
Statement No. 3”.
This
statement changes the requirements for the accounting for and reporting of
a
change in accounting principle. This statement applies to all voluntary
changes in accounting principles. It also applies to changes required by
an accounting pronouncement in the unusual instance that the pronouncement
does
not include specific transition provisions. When a pronouncement includes
specific transition provisions, those provisions should be followed. This
statement is effective for fiscal years beginning after December 15, 2005 and
did not have a material impact on our consolidated financial
statements.
In
February 2006, the FASB issued SFAS No. 155, “Accounting
for Certain Hybrid Financial Instruments-
an amendment of FASB Statements No. 133 and 140”
(“SFAS
155”). This statement will be effective beginning the first quarter of 2007.
Earlier adoption is permitted. The statement permits interests in hybrid
financial assets that contain an embedded derivative that would require
bifurcation to be accounted for as a single financial instrument at fair value
with changes in fair value recognized in earnings. This election is permitted
on
an instrument-by-instrument basis for all hybrid financial instruments held,
obtained, or issued as of the adoption date. We are currently assessing the
impact of adoption of SFAS 155.
F-11
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
1 – Summary of Significant Accounting Policies
(Continued)
New
accounting pronouncements (continued)
In
March
2006, the FASB issued SFAS No. 156, “Accounting
for Servicing of Financial Assets - an amendment
of FASB Statement No. 140,”
(“SFAS
156”), which permits entities to elect to measure servicing assets and servicing
liabilities at fair value and report changes in fair value in earnings. Adoption
of SFAS 156 is required for financial periods beginning after September 15,
2006. We are currently assessing the impact and timing of adoption of SFAS
156
but do not expect the standard to have a material impact on our consolidated
financial statements.
In
September 2006, the FASB issued SFAS No. 157, “Fair
Value Measurements”
(“SFAS
157”). SFAS 157 defines fair value, establishes a framework for measuring
fair value under U.S. generally accepted accounting principles and requires
enhanced disclosures about fair value measurements. It does not require any
new
fair value measurements. SFAS 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007 and interim periods within
those fiscal years. We are currently assessing whether to early adopt
SFAS 157 as of the first quarter of fiscal 2007 as permitted, and are currently
evaluating the impact adoption may have on our consolidated financial
statements.
In
February 2007, the FASB issued SFAS No. 159, “The
Fair Value Option for Financial Assets and Financial Liabilities—Including an
amendment of FASB Statement No. 115” (“SFAS
159”). SFAS 159 permits entities to choose to measure many financial instruments
and certain other items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility
in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. SFAS 159 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007 and interim periods within those fiscal years. We are
currently assessing whether to early adopt SFAS 159 as of the first quarter
of fiscal 2007 as permitted, and are currently evaluating the impact adoption
may have on our consolidated financial statements.
Note
2 – Interest Rate Swap
Effective
March 16, 2006, we executed an interest rate swap used to mitigate the risks
associated with adverse movements in interest rates which might affect
expenditures. We have not designated this derivative contract as a hedge, and
as
such, the change in the fair value of the derivative is recognized currently
in
earnings. This derivative instrument has a total notional amount of $30 million,
is at a fixed rate of 5.09% plus the LIBOR margin (see Note 8), and matures
monthly through March, 2008. As of December 31, 2006, the fair value of this
instrument is approximately $30,000 and is included in prepaid expenses and
other assets in our consolidated balance sheet and other income in our
consolidated statement of income.
Note
3 – Real Estate
During
2004, we acquired from an unrelated party one multi-tenant retail center
comprising approximately 95,032 square feet of gross leasable area. The property
was acquired for cash in the amount of approximately $8.9 million.
F-12
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
3 – Real Estate (Continued)
During
2005, we acquired from an unrelated party one multi-tenant office building
comprising approximately 106,169 square feet of gross leasable area. The
property was acquired for cash in the amount of approximately $5.5 million
plus
closing costs.
During
2005, we acquired from an unrelated party one multi-tenant office building
comprising approximately 125,874 square feet of gross leasable area. The
property was acquired for cash in the amount of approximately $8.0 million
plus
closing costs.
During
2005, we acquired from an unrelated party one multi-tenant office building
comprising approximately 253,981 square feet of gross leasable area. The
property was acquired for cash in the amount of approximately $17.0 million
plus
closing costs.
The
purchase prices we paid for the properties were determined by, among other
procedures, estimating the amount and timing of expected cash flows from the
acquired properties, discounted at market rates. This process in general also
results in the assessment of fair value for each property.
We
allocate the purchase price of real estate to the acquired tangible assets,
consisting of land, building and tenant improvements, and identified intangible
assets and liabilities, generally consisting of the value of above-market and
below-market leases, other value of in-place leases and value of tenant
relationships, based in each case on our management’s estimates of their fair
values.
Our
management estimates the fair value of acquired tangible assets by valuing
the
acquired property as if it were vacant. The “as-if-vacant” value (limited to the
purchase price) is allocated to land, building, and tenant improvements based
on
management’s determination of the relative fair values of these assets.
We
record
above-market and below-market in-place lease values for owned properties based
on the present value (using an interest rate which reflects the risks associated
with the leases acquired) of the difference between (i) the contractual amounts
to be paid pursuant to the in-place leases and (ii) management’s estimate of
fair market lease rates for the corresponding in-place leases, measured over
a
period equal to the remaining non-cancelable term of the lease. The capitalized
above-market lease values are amortized as a reduction of rental income over
the
remaining non-cancelable terms of the respective leases. The capitalized
below-market lease values are amortized as an increase to rental income over
the
initial term and any fixed-rate renewal periods in the respective leases.
F-13
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
3 – Real Estate (Continued)
We
measure the aggregate value of other intangible assets acquired based on the
difference between (i) the property valued with existing in-place leases
adjusted to market rental rates and (ii) the property valued as if vacant.
Our
management’s estimates of value are made using methods similar to those used by
independent appraisers, primarily discounted cash flow analysis. Factors
considered by our management in its analysis include an estimate of carrying
costs during hypothetical expected lease-up periods considering current market
conditions, and costs to execute similar leases. We also consider information
obtained about each property as a result of our pre-acquisition due diligence,
marketing and leasing activities in estimating the fair value of the tangible
and intangible assets acquired. In estimating carrying costs, our management
also includes real estate taxes, insurance and other operating expenses and
estimates of lost rentals at market rates during the expected lease-up periods,
which generally range from four to eighteen months, depending on specific local
market conditions. Our management also estimates costs to execute similar leases
including leasing commissions, legal and other related expenses to the extent
that these costs are not already incurred in connection with a new lease
origination as part of the transaction.
The
total
amount of other intangible assets acquired is further allocated to in-place
lease values and customer relationship intangible values based on our
management’s evaluation of the specific characteristics of each tenant’s lease
and our overall relationship with that respective tenant. Characteristics
considered by our management in allocating these values include the nature
and
extent of our existing business relationships with the tenant, growth prospects
for developing new business with the tenant, the tenant’s credit quality, and
expectations of lease renewals (including those existing under the terms of
the
lease agreement), among other factors.
The
value
of in-place leases, if any, is amortized to expense over the remaining initial
term of the respective leases, which, for leases with allocated intangible
value, are expected to range generally from five to ten years. The value of
customer relationship intangibles is amortized to expense over the remaining
initial term and any renewal periods in the respective leases, but in no event
does the amortization period for intangible assets exceed the remaining
depreciable life of the building. Should a tenant terminate its lease, the
unamortized portion of the in-place lease value and customer relationship
intangibles are charged to expense.
On
December 1, 2006, we sold Northwest Place II, a 27,974 square foot
office/warehouse building located in Houston, Texas for a sales price of
$1,175,000. A gain of $197,000 was generated from this sale, which is reflected
in our consolidated financial statements for the year ended December 31, 2006.
It is anticipated that the funds received from this sale will be used for future
acquisitions and/or capital improvements to existing properties. It was
determined that “discontinued operations” classification was not required due to
the immateriality of this property to our overall results.
At
December 31, 2006, we owned 36 commercial properties in the Houston, Dallas
and
San Antonio, Texas areas comprising approximately 3,093,000 square feet of
gross
leasable area.
F-14
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
4 – Note Receivable
In
January 2003, we partially financed the sale of a property we had previously
sold and for which we had taken a note receivable of $0.4 million as part of
the
consideration. We advanced $0.3 million and renewed and extended the balance
of
$0.4 million still due from the original sale.
The
original principal amount of the note receivable, dated January 10, 2003, is
$0.7 million. The note is payable in monthly installments of $6,382, including
interest at 7% per annum, for the first two years of the note. Thereafter,
monthly installments of $7,489 are due with interest at 10% per annum. The
note
is fully amortizing with the final payment due January 10, 2018.
Note
5 – Accounts Receivable, net
Accounts
receivable consists of amounts billed and due from tenants, amounts due from
insurance claims and allowance for doubtful accounts as follows (in
thousands):
|
December
31,
|
||||||||
|
2006
|
2005
|
|||||||
|
Tenant
receivables
|
$
|
1,941
|
$
|
1,458
|
||||
|
Allowance
for doubtful accounts
|
(641
|
)
|
(473
|
)
|
||||
|
Insurance
claim receivables
|
427
|
264
|
||||||
|
Totals
|
$
|
1,727
|
$
|
1,249
|
||||
F-15
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
6 - Deferred Costs
Deferred
costs consist of the following (in thousands):
|
December
31,
|
||||||||
|
2006
|
2005
|
|||||||
|
Leasing
commissions
|
$
|
6,904
|
$
|
5,921
|
||||
|
Deferred
financing costs
|
1,949
|
1,829
|
||||||
|
8,853
|
7,750
|
|||||||
|
Less:
accumulated amortization
|
(5,963
|
)
|
(4,746
|
)
|
||||
|
Totals
|
$
|
2,890
|
$
|
3,004
|
||||
A
summary
of expected future amortization of deferred costs is as follows (in
thousands):
|
Years
Ended December 31,
|
||||||
|
2007
|
$
|
987
|
||||
|
2008
|
665
|
|||||
|
2009
|
447
|
|||||
|
2010
|
301
|
|||||
|
2011
|
208
|
|||||
|
Thereafter
|
282
|
|||||
|
Total
|
$
|
2,890
|
||||
F-16
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
7 – Future Minimum Lease Income
We
lease
the majority of our office and retail properties under noncancelable operating
leases which provide for minimum base rentals plus, in some instances,
contingent rentals based upon a percentage of the tenants’ gross
receipts.
A
summary
of minimum future rentals to be received (exclusive of renewals, tenant
reimbursements, and contingent rentals) under noncancelable operating leases
in
existence at December 31, 2006 is as follows (in thousands):
|
Years
Ended December 31,
|
||||||
|
2007
|
$
|
22,483
|
||||
|
2008
|
18,710
|
|||||
|
2009
|
14,334
|
|||||
|
2010
|
10,479
|
|||||
|
2011
|
6,706
|
|||||
|
Thereafter
|
10,584
|
|||||
|
Total
|
$
|
83,296
|
||||
Note
8 – Debt
Notes
payable
Mortgages
and other notes payable consist of the following (in thousands):
|
December
31,
|
|||||||
|
2006
|
2005
|
||||||
|
Mortgages
and other notes payable
|
$
|
5,138
|
$
|
40,050
|
|||
|
Revolving
loan secured by properties
|
61,225
|
32,975
|
|||||
|
Totals
|
$
|
66,363
|
$
|
73,025
|
|||
F-17
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
8 – Debt
(Continued)
As
of
December 31, 2006, we two active loans which are described below:
Revolving
Credit Facility
We
have a
revolving credit facility with a consortium of banks. The credit facility is
secured by a pledge of the partnership interests in Hartman REIT Operating
Partnership III LP (“HROP III”), a wholly owned subsidiary of the Operating
Partnership that was formed to hold title to the properties comprising the
borrowing base pool for the facility. At December 31, 2006, 35 properties are
owned by HROP III.
In
2006,
the credit facility was increased to $75 million from $50 million and may be
increased to $100 million as the borrowing base pool expands. We entered into
this credit facility to refinance our then existing debt, to finance property
acquisitions and for general corporate purposes.
As
of
December 31, 2006 and 2005, the balance outstanding under the credit facility
was $61.2 million and $33.0 million, respectively, and the availability to
draw
was $13.8 million and $17.0 million, respectively.
Outstanding
amounts under the credit facility accrue interest computed (at our option)
at
either the LIBOR or the Alternative Base Rate on the basis of a 360 day year,
plus the applicable margin as determined from the following table:
|
Total
Leverage Ratio
|
LIBOR
Margin
|
Alternative
Base
Rate
Margin
|
||||||
|
Less
than 60% but greater than or equal to 50%
|
2.40%
|
|
1.150%
|
|
||||
|
Less
than 50% but greater than or equal to 45%
|
2.15%
|
|
1.025%
|
|
||||
|
Less
than 45%
|
1.90%
|
|
1.000%
|
|
||||
The
Alternative Base Rate is a floating rate equal to the higher of the bank’s base
rate or the Federal Funds Rate plus 0.5%. LIBOR Rate loans will be available
in
one, two, three or six month periods, with a maximum of nine contracts at any
time. The effective interest rate as of December 31, 2006 was 7.28% per
annum.
Interest
only is payable monthly under the loan with the total amount of principal due
at
maturity on March 11, 2008. The loan may be prepaid at any time in part or
in
whole, provided that the credit facility is not in default. If LIBOR pricing
is
elected, there is a prepayment penalty based on a “make-whole” calculation for
all costs associated with prepaying a LIBOR borrowing.
As
of
December 31, 2005, we were in violation of a loan covenant which provides that
the ratio of declared dividends to funds from operations (as defined in the
loan
agreement) shall not be greater than 95%. As this violation constitutes an
event
of default, the lenders had the right to accelerate payment of amounts
outstanding under this credit facility. However, on May 8, 2006, we received
a
waiver from the required majority of the consortium banks in the credit facility
and also entered into a modification of the loan agreement whereby the covenant
was amended though December 31, 2006.
F-18
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
8 – Debt (Continued)
As
amended, the ratio of declared dividends to funds from operations (as defined
in
the loan agreement) shall not exceed 107% for the three months ended March
31,
2006 and June 30,2006, 104% for the three months ended September 30, 2006 and
100% for the three months ended December 31, 2006. As of December 31, 2006,
we
are in compliance with the covenant, as amended.
On
October 2, 2006, our Board (i) elected not to renew our advisory agreement
with
Hartman Management; (ii) terminated a certain management agreement with Hartman
Management; and (iii) removed Mr. Hartman from his positions as our President,
Secretary and Chief Executive Officer. These actions violated certain covenants
in the loan agreement and were events of default thereunder. These events of
default have been waived by the lenders.
On
January 8, 2007, we requested that legal fees incurred in connection with the
litigation with Mr. Hartman and Hartman Management be excluded from the
definition of funds from operations in testing the covenant requiring the ratio
of declared and paid dividends to funds from operations not be in excess of
95%.
On January 23, 2007, the lenders granted the exclusion as requested.
On March 26, 2007, we formalized this agreement in Amendment
No. 3 to our Revolving Credit Agreement which is filed as exhibit 10.26 to
this
document.
The
revolving credit facility is supported by a pool of eligible properties referred
to as the borrowing base pool. The borrowing base pool must meet the following
criteria:
|
·
|
We
will provide a negative pledge on the borrowing base pool and may
not
provide a negative pledge of the borrowing base pool to any other
lender.
|
|
·
|
The
properties must be free of all liens, unless otherwise
permitted.
|
|
·
|
All
eligible properties must be retail, office-warehouse, or office
properties, must be free and clear of material environmental concerns
and
must be in good repair.
|
|
·
|
The
aggregate physical occupancy of the borrowing base pool must remain
above
80% at all times.
|
|
·
|
No
property may comprise more than 15% of the value of the borrowing
base
pool with the exception of Corporate Park Northwest, which is allowed
into
the borrowing base pool.
|
|
·
|
The
borrowing base pool must at all times be comprised of at least 10
properties.
|
|
·
|
The
borrowing base pool properties may not contain development or
redevelopment projects.
|
Properties
can be added to and removed from the borrowing base pool at any time provided
no
defaults would occur as a result of the removal. If a property does not meet
the
criteria of an eligible property and we want to include it in the borrowing
base
pool, a majority vote of the bank consortium is required for inclusion in the
borrowing base pool.
Covenants,
tested quarterly, relative to the borrowing base pool are as
follows:
|
·
|
We
will not permit any liens on the properties in the borrowing base
pool
unless otherwise permitted.
|
|
·
|
The
ratio of aggregate net operating income from the borrowing base pool
to
debt service shall at all times exceed 1.5 to 1.0. For any quarter,
debt
service shall be equal to the average loan balance for the past quarter
times an interest rate which is the greater of (a) the then current
annual
yield on 10 year United States Treasury notes over 25 years plus
2%; (b) a
6.5% constant; or (c) the actual interest rate for the
facility.
|
F-19
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
8 – Debt (Continued)
|
·
|
The
ratio of the value of the borrowing base pool to total funded loan
balance
must always exceed 1.67 to 1.00. The value of the borrowing base
pool is
defined as aggregate net operating income for the preceding four
quarters,
less a $0.15 per square foot per annum capital expenditure reserve,
divided by a 9.25% capitalization
rate.
|
Covenants,
tested quarterly, relative to us are as follows:
|
·
|
We
will not permit our total indebtedness to exceed 60% of the fair
market
value of our real estate assets at the end of any quarter. Total
indebtedness is defined as all our liabilities, including this facility
and all other secured and unsecured debt, including letters of credit
and
guarantees. Fair market value of real estate assets is defined as
aggregate net operating income for the preceding four quarters, less
a
$0.15 per square foot per annum capital expenditure reserve, divided
by a
9.25% capitalization rate.
|
|
·
|
The
ratio of consolidated rolling four-quarter earnings before interest,
income tax, depreciation and amortization expenses to total interest
expense, including capitalized interest, shall not be less than 2.0
to
1.0.
|
|
·
|
The
ratio of consolidated earnings before interest, income tax, depreciation
and amortization expenses to total interest expense, including capitalized
interest, principal amortization, capital expenditures and preferred
stock
dividends shall not be less than 1.5 to 1.0. Capital expenditures
shall be
deemed to be $0.15 per square foot per
annum.
|
|
·
|
The
ratio of secured debt to fair market value of real estate assets
shall not
be greater than 40%.
|
|
·
|
The
ratio of declared dividends to funds from operations shall not be
greater
than 95%.
|
|
·
|
The
ratio of development assets to fair market value of real estate assets
shall not be greater than 20%.
|
|
·
|
We
must maintain our status as a REIT for income tax
purposes.
|
|
·
|
Total
other investments shall not exceed 30% of total asset value. Other
investments shall include investments in joint ventures, unimproved
land,
marketable securities and mortgage notes receivable. Additionally,
the
preceding investment categories shall not comprise greater than 30%,
15%,
10% and 20%, respectively, of total other
investments.
|
Within
six months of closing, we must hedge all variable rate debt above $40 million
until the point at which the ratio of variable rate debt to fixed rate debt
is
50% of total debt. Thereafter, we must maintain this type of hedge during any
period in which variable rate debt exceeds 50% of total debt. On March 27,
2006,
we executed an interest rate swap dated as of March 16, 2006, for the purpose
of
hedging variable interest rate exposure, in compliance with the requirements
of
the loan agreement. The lenders waived the default for not executing the hedge
within six months of closing, as required by the loan agreement.
On
June
30, 2006, we drew down $34.8 million on the revolving credit facility to
extinguish the three year floating rate mortgage loan described in the following
paragraph and pay related legal and banking fees.
F-20
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
8 – Debt (Continued)
In
December 2002, we refinanced substantially all of our mortgage debt with a
$34.4
million three-year floating rate mortgage loan collateralized by 18 of our
then
existing properties. The loan had a maturity date of January 1, 2006, extendable
for an additional two years. Effective as of February 28, 2006, we extended
the
loan to January 1, 2008. During the initial term, the loan bore interest at
2.5%
over a 30-day LIBOR (6.79% at December 31, 2005) computed on the basis of a
360-day year. During the extension term the interest rate will be 3.0% over
30-day LIBOR. Interest only payments were due monthly, and the loan could be
repaid in full or in $100,000 increments, with a final balloon payment due
upon
maturity.
Mortgage
Loan on Windsor Park Centre
In
connection with the purchase of the Windsor Park property in December 2003,
we
assumed a note payable in the amount of $6.6 million, secured by the property.
The balance at December 31, 2006, was $5.1 million. The note was payable in
equal monthly installments of principal and interest of $80,445, with interest
at the rate of 8.34% per annum. The balance of the note was payable in full
on
December 1, 2006. We obtained an extension through March 2, 2007 and paid off
this note in full with the proceeds from a $10.0 million loan described in
the
following paragraph.
On
March
1, 2007, we obtained a $10.0 million loan to pay off the loan obtained upon
the
acquisition of the Windsor Park property and to provide funds for future
acquisitions. The mortgage loan is secured by the Windsor Park property which
is
owned by HCP REIT Operating Company IV LLC (“HROC IV”), a wholly owned
subsidiary of the Operating Partnership that was formed to hold title to the
Windsor Park property. On March 1, 2007, we conveyed ownership of the Windsor
Park property from the Operating Partnership to HROC IV in order to secure
the
$10 million mortgage loan. The note is payable in equal monthly installments
of
principal and interest of $60,212, with interest at the rate of 6.04% per annum.
The balance of the note is payable in full on March 1, 2014.
Annual
maturities of notes payable as of December 31, 2006, including the revolving
loan, are as follows (in thousands):
|
Year
Ended
December
31,
|
||||
|
2007
|
$
|
5,138
|
||
|
2008
|
61,225
|
|||
|
Total
|
$
|
66,363
|
||
F-21
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
9 – Earnings Per Share
Basic
earnings per share is computed using net income to common shareholders and
the
weighted average number of common shares outstanding. Diluted earnings per
share
reflects common shares issuable from the assumed conversion of OP Units
convertible into common shares. Only those items that have a dilutive impact
on
basic earnings per share are included in the diluted earnings per share.
Accordingly, excluded from the earnings per share calculation for each of the
years ended December 31, 2006, 2005 and 2004, are 5,808,337 OP units as their
inclusion would be antidilutive.
|
Year
Ended December 31,
|
|||||||||||
|
2006
|
2005
|
2004
|
|||||||||
|
Basic
and diluted earnings per share:
|
|||||||||||
|
Weighted
average common
|
|||||||||||
|
shares
outstanding
|
9,652
|
7,888
|
7,010
|
||||||||
|
Basic
and diluted earnings per share
|
$
|
0.185
|
$
|
0.310
|
$
|
0.488
|
|||||
|
Net
income
|
$
|
1,781
|
$
|
2,448
|
$
|
3,424
|
|||||
F-22
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
10 – Federal Income Taxes
Federal
income taxes are not provided because we intend to and believe we qualify as
a
REIT under the provisions of the Internal Revenue Code. Our shareholders include
their proportionate taxable income in their individual tax returns. As a REIT,
we must distribute at least 90% of its ordinary taxable income to our
shareholders and meet certain income sources and investment restriction
requirements. In addition, REITs are subject to a number of organizational
and
operational requirements. If we fail to qualify as a REIT in any taxable year,
we will be subject to federal income tax (including any applicable alternative
minimum tax) on our taxable income at regular corporate tax rates.
Taxable
income differs from net income for financial reporting purposes principally
due
to differences in the timing of recognition of interest, real estate taxes,
depreciation and rental revenue.
For
Federal income tax purposes, the cash dividends distributed to shareholders
are
characterized as follows for the years ended December 31:
|
2006
|
2005
|
2004
|
|||||||||
|
Ordinary
income (unaudited)
|
36.2
|
%
|
62.6
|
%
|
67.7
|
%
|
|||||
|
Return
of capital (unaudited)
|
59.9
|
%
|
37.4
|
%
|
32.3
|
%
|
|||||
|
Capital
gain distributions (unaudited)
|
3.9
|
%
|
0.0
|
%
|
0.0
|
%
|
|||||
|
Total
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
|||||
F-23
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
11 – Related-Party Transactions
In
January 1999, we entered into a property management agreement with Hartman
Management. Effective September 1, 2004, this agreement was amended and
restated. Prior to September 1, 2004, in consideration for supervising the
management and performing various day-to-day affairs, we paid Hartman Management
a management fee of 5% and a partnership management fee of 1% based on effective
gross revenues from the properties, as defined in the agreement. After September
1, 2004, we paid Hartman Management property management fees in an amount not
to
exceed the fees customarily charged in arm’s length transactions by others
rendering similar services in the same geographic area, as determined by a
survey of brokers and agents in that area. These fees have ranged between
approximately 2% and 4% of gross revenues (as defined in the amended and
restated agreement) for the management of office buildings and approximately
5%
of gross revenues for the management of retail and warehouse
properties.
In
October 2006, our Board terminated for cause our property management agreement
with Hartman Management. Hartman Management turned over all property management
functions to us on November 14, 2006.
Effective
September 1, 2004, we entered into an advisory agreement with Hartman
Management which provided that we pay Hartman Management a quarterly fee of
one-fourth of .25% of gross asset value (as defined in the advisory agreement)
for asset management services. In addition, the advisory agreement provided
for
the payment of a deferred performance fee, payable in certain events, including
termination of the advisory agreement, based upon appreciation in the value
of
certain of our real estate assets. The advisory agreement expired by its terms
on September 30, 2006.
We
incurred total management, partnership and asset management fees of $1.5
million, $1.4 million and $1.3 million, under the advisory and management
agreements for the years ended December 31, 2006, 2005 and 2004, respectively.
Management fees of $0.1 million were payable at December 31, 2005. No management
fees were payable at December 31, 2006. We have not accrued any deferred
performance fees, as we believe the amount of these fees, if any are owing,
cannot be determined with reasonable certainty at this time.
The
aggregate fees and reimbursements payable to Hartman Management under the
advisory agreement was not intended to be significantly different from the
fees
that would have been payable under our previous agreement with Hartman
Management. The asset management fee under the advisory agreement, however,
was
significantly higher. Hartman Management waived the excess of the fee for the
period September 1, 2004 through March 31, 2006 in perpetuity. The asset
management fee under the advisory agreement was charged by Hartman Management
in
the second and third quarters of 2006 and has been reflected in our consolidated
financial statements as of December 31, 2006.
F-24
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
11 – Related-Party Transactions (Continued)
During
July 2004, we amended certain terms of our declaration of trust. Under the
amended terms, Hartman Management was required to reimburse us for operating
expenses exceeding certain limitations determined at the end of each fiscal
quarter. Reimbursements, if any, from
Hartman Management were
recorded
on a quarterly basis as a reduction in property management fees.
Under
the
provisions of the management agreement, costs incurred by Hartman Management
for
the management and maintenance of the properties were reimbursable to Hartman
Management. At December 31, 2005, $0.05 million was payable to Hartman
Management related to these reimbursable costs. No such amounts were payable
at
December 31, 2006.
In
consideration of leasing the properties, we historically paid Hartman Management
leasing commissions for leases originated by Hartman Management and for
expansions and renewals of existing leases. We incurred total leasing
commissions to Hartman Management of $0.9 million, $1.6 million and $1.0 million
for the years ended December 31, 2006, 2005 and 2004, respectively, of which
$0.08 million was payable at December 31, 2005. No such amounts were payable
at
December 31, 2006.
In
connection with our public offering described in Note 12, we have reimbursed
Hartman Management up to 2.5% of the gross selling price of all common shares
sold for organization and offering expenses (excluding selling commissions
and a
dealer manager fee) incurred by Hartman Management on our behalf. We have paid
our dealer manager, through Hartman Management by agreement between them, a
fee
of up to 2.5% of the gross selling price of all common shares sold in the
offering. We incurred total fees of $0.5 million and $0.9 million for the years
ended December 31, 2006 and 2005, respectively. These fees have been treated
as
offering costs and netted against the proceeds from the sale of common shares.
On October 2, 2006, our Board elected to terminate the public offering described
in Note 12.
Also
in
connection with our public offering described in Note 12, Hartman Management
has
historically received an acquisition fee equal to 2% of the gross selling price
of all common shares sold for services in connection with the selection,
purchase, development or construction of properties for us. The advisory
agreement expired by its terms on September 30, 2006. On September 30, 2006,
$0.2 million of acquisition fees paid to Hartman Management had been capitalized
and not yet allocated to the purchase price of a property. In accordance with
advisory agreement, Hartman Management is obligated to reimburse us for any
acquisition fee that has not been allocated to the purchase price of our
properties as provided for in our declaration of trust. A letter demanding
payment was sent to Hartman Management on December 21, 2006, and $0.2 million
is
netted against other payables to Hartman Management and included in due to
affiliates in our consolidated balance sheet at December 31, 2006.
F-25
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
11 – Related-Party Transactions (Continued)
We
incurred total acquisition fees to Hartman Management of $0.2 million and $0.4
million for the years ended December 31, 2006 and 2005. At December 31, 2005,
$0.1 million was payable to Hartman Management relating to organization and
offering expenses, dealer manager fees and acquisition fees. No such amounts
were payable at December 31, 2006.
Hartman
Management was billed $0.2 million, $0.1 million and $0.1 million for office
space for the years ended December 31, 2006, 2005 and 2004, respectively. These
amounts are included in rental income in our consolidated statements of
income.
Our
day-to-day operations are strategically directed by our Board. We own
substantially all of our real estate properties through the Operating
Partnership. Mr. Hartman was our President, Secretary and Chief Executive
Officer through October 2, 2006, and he resigned as our Chairman on October
27,
2006. He is also the sole owner of Hartman Management. Mr. Hartman was owed
$44,094 and $47,478 in dividends payable on his common shares at December 31,
2006 and 2005, respectively. Mr. Hartman owned 2.9% and 3.0% of our issued
and
outstanding common shares as of December 31, 2006 and 2005,
respectively.
We
were a
party to various other transactions with related parties which are reflected
in
due to/from affiliates in the accompanying consolidated balance sheets and
also
disclosed in Notes 8 and 12.
Note
12 – Shareholders’ Equity
Under
our
declaration of trust, we have authority to issue 400 million common shares
of
beneficial interest, $0.001 par value per share, and 50 million preferred shares
of beneficial interest, $0.001 par value per share.
On
September 15, 2004, our Registration Statement on Form S-11, with respect to
our
public offering of up to 10 million common shares of beneficial interest offered
at a price of $10 per share was declared effective under the Securities Act
of
1933. The Registration Statement also covered up to 1 million shares available
pursuant to our dividend reinvestment plan offered at a price of $9.50 per
share. The shares were offered to investors on a best efforts basis.
Post-Effective Amendments No. 1, 2 and 3 to the Registration Statement were
declared effective by the SEC on June 27, 2005, March 9, 2006 and May 3, 2006,
respectively.
As
of
December 31, 2006, 2.8 million shares had been issued pursuant to our public
offering with net offering proceeds received of $24.6 million. An additional
138,000 shares had been issued pursuant to the dividend reinvestment plan in
lieu of dividends totaling $1.3 million. Shareholders that received shares
pursuant to our dividend reinvestment plan on or after October 2, 2006 may
have
recission rights. See “Dividend
Reinvestment Plan”
in
Item
5 of this report.
On
October 2, 2006, our Board terminated the public offering. On March 27, 2007,
we
gave the required ten day notice to participants informing them that we intend
to terminate our dividend reinvestment plan. As a result, our dividend
reinvestment plan will terminate on April 6, 2007.
F-26
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
12 – Shareholders’ Equity (Continued)
At
December 31, 2006 and 2005, Mr. Hartman owned 2.9% and 3.0%, respectively,
of
our outstanding shares. At December 31, 2006 and 2005, our Board collectively
owned 2.6% and 2.9%, respectively, of our outstanding shares.
All
net
proceeds of our public offering were contributed to the Operating Partnership
in
exchange for OP Units. The Operating Partnership used the proceeds to acquire
additional properties and for general working capital purposes. In accordance
with the Operating Partnership’s Agreement of Limited Partnership, in exchange
for the contribution of net proceeds from sales of stock, we received an
equivalent number of OP Units as shares of stock that are sold.
Operating
partnership units
Limited
partners in the Operating Partnership holding OP Units have the right to convert
their OP Units into common shares at a ratio of one OP Unit for one common
share. Distributions to OP Unit holders are paid at the same rate per unit
as
dividends per share of HCP. Subject to certain restrictions, OP Units are not
convertible into common shares until the later of one year after acquisition
or
an initial public offering of the common shares. As of December 31, 2006 and
2005, there were 15,421,212 and 14,360,503 OP Units outstanding,
respectively.
We owned
9,612,875 and 8,552,166 OP Units as of December 31, 2006 and 2005, respectively.
The balance of the OP Units is owned by third parties, including Mr. Hartman
and
certain trustees. Our weighted-average share ownership in the Operating
Partnership was approximately 62.43%, 56.44% and 53.37% during the years ended
December 31, 2006, 2005 and 2004, respectively. At December 31, 2006 and 2005,
Mr. Hartman owned 6.9% and 7.4%, respectively, of the Operating Partnership’s
outstanding units. At December 31, 2006 and 2005, our Board collectively owned
0.4% of the Operating Partnership’s outstanding units.
F-27
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
12 –
Shareholders’ Equity (Continued)
Dividends
and distributions
The
following tables summarize the cash dividends/distributions paid to holders
of
common shares and holders of OP Units (after giving effect to the
recapitalization) during the years ended December 31, 2006 and 2005 and the
quarter ended March 31, 2007.
|
HCP
Shareholders
|
||||
|
Dividend
per
Common Share
|
Date
Dividend
Paid
|
Total
Amount
Paid
(in thousands)
|
||
|
$
0.1755
|
Qtr
ended 03/31/05
|
$
1,230
|
||
|
0.1768
|
Qtr
ended 06/30/05
|
1,282
|
||
|
0.1768
|
Qtr
ended 09/30/05
|
1,351
|
||
|
0.1768
|
Qtr
ended 12/31/05
|
1,412
|
||
|
0.1768
|
Qtr
ended 03/31/06
|
1,526
|
||
|
0.1768
|
Qtr
ended 06/30/06
|
1,632
|
||
|
0.1500
|
Qtr
ended 09/30/06
|
1,443
|
||
|
0.1500
|
Qtr
ended 12/31/06
|
1,477
|
||
|
0.1500
|
Qtr
ended 03/31/07
|
1,495
|
||
|
OP
Unit Holders Including Minority Unit Holders
|
||||
|
Distribution
per
OP Unit
|
Date
Distribution
Paid
|
Total
Amount
Paid
(in thousands)
|
||
|
$
0.1755
|
Qtr
ended 03/31/05
|
$
2,186
|
||
|
0.1768
|
Qtr
ended 06/30/05
|
2,240
|
||
|
0.1768
|
Qtr
ended 09/30/05
|
2,308
|
||
|
0.1768
|
Qtr
ended 12/31/05
|
2,370
|
||
|
0.1768
|
Qtr
ended 03/31/06
|
2,488
|
||
|
0.1768
|
Qtr
ended 06/30/06
|
2,594
|
||
|
0.1500
|
Qtr
ended 09/30/06
|
2,260
|
||
|
0.1500
|
Qtr
ended 12/31/06
|
2,294
|
||
|
0.1500
|
Qtr
ended 03/31/07
|
2,314
|
||
F-28
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
13 – Incentive Share Plan
In
1999,
we adopted an Employee and Trust Manager Incentive Share Plan (the “Incentive
Share Plan”) to (i) furnish incentives to individuals chosen to receive
share-based awards because they are considered capable of improving operations
and increasing profits; (ii) encourage selected persons to accept or continue
employment with us; and (iii) increase the interest of our employees and
trustees in our welfare through their participation and influence on the growth
in value of our common shares. The class of eligible persons that can receive
grants of incentive awards under the Incentive Share Plan consists of key
employees, directors, non-employee trustees, and consultants as determined
by
the compensation committee of our Board. The maximum number of common shares
that may be issued under the Incentive Share Plan is the lesser of 5% of the
outstanding shares on a fully diluted basis or 5,000,000. As of December 31,
2006, no options or awards to purchase common shares have been granted under
the
Incentive Share Plan.
In
December 2004 the FASB issued SFAS No. 123R, “Share-Based
Payment,”
which
establishes accounting standards for all transactions in which an entity
exchanges its equity instruments for goods and services. This accounting
standard focuses primarily on equity transactions with employees and requires
share-based payments to be assigned a fair value and expensed over the requisite
service period of each award. As of December 31, 2006, no awards have been
granted under the Incentive Share Plan and thus, no amounts have been expensed
during the year then ended.
Note
14 – Commitments and Contingencies
The
nature of our business exposes us to the risk of lawsuits for damages or
penalties relating to, among other things, breach of contract and employment
disputes. We are currently involved in the following litigation.
Hartman
Commercial Properties REIT and Hartman REIT Operating Partnership, L.P. v.
Allen
R. Hartman and Hartman Management, L.P., in the 333rd
Judicial District Court of Harris County, Texas
In
October 2006, we initiated this action against our former Chief Executive
Officer, Allen R. Hartman, and our former manager and advisor Hartman
Management. L.P. We are seeking damages for breach of contract, fraudulent
inducement and breach of fiduciary duties.
In
November 2006, Mr. Hartman and Hartman Management filed a counterclaim against
us, the members of our Board, and our Chief Operating Officer, John J. Dee.
The
counterclaim has since been amended to drop the claims against the individual
defendants with the exception our current interim Chief Executive Officer,
James
C. Mastandrea, and Mr. Dee. The amended counterclaim asserts claims against
us
for alleged breach of contract and alleges that we owe Mr. Hartman and Hartman
Management fees for the termination of an advisory agreement. The amended
counterclaim asserts claims against Messrs. Mastandrea and Dee for tortious
interference with the advisory agreement and a management agreement and
conspiracy to seize control of us for their own financial gains. We have
indemnified Messrs. Mastandrea and Dee to the extent allowed by our governing
documents and Maryland law. The amended counterclaim also asserts claims against
our prior outside law firm and one of its partners.
F-29
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
14 – Commitments and Contingencies (Continued)
Limited
discovery has been conducted in this case as of the date of this report. The
case is set for trial in July 2007.
It
is too
early to express an opinion respecting the likelihood of an adverse outcome
on
the counterclaim, although we intend to vigorously defend against those claims
and vigorously prosecute our affirmative claims.
Hartman
Commercial Properties REIT v. Allen R. Hartman, et al; in the United States
District
Court for the Southern District of Texas
In
December 2006, we initiated this action complaining of the attempt by Mr.
Hartman and Hartman Management to solicit written consents from shareholders
to
replace our Board.
Mr.
Hartman and Hartman Management have filed a counterclaim claiming that certain
changes to our bylaws and declaration of trust are invalid and that their
enactment is a breach of fiduciary duty. They are seeking a declaration that
the
changes to our bylaws and declaration of trust are invalid and an injunction
barring their enforcement. These changes, among other things, will stagger
the
terms of our Board members over three years, require two-thirds vote of the
outstanding common shares to remove a Board member and provide that our
secretary may call a special meeting of shareholders only on the written request
of a majority of outstanding common shares. We believe the changes in our bylaws
and declaration of trust are valid under Maryland law and in the best interest
of our shareholders. We have filed a motion to dismiss the counterclaims. A
group of shareholders has filed a request to intervene in this action to assert
claims similar to those asserted by Mr. Hartman and Hartman Management. We
have
opposed the intervention.
There
has
been limited discovery in this case as of the date of this report. Documents
have been produced and interrogatory responses exchanged. We have produced
the
members of our Board for deposition as well as our Chief Operating Officer,
John
J. Dee. The Court has conducted a hearing on the parties’ cross request for
preliminary injunction, but has not yet ruled on that request.
It
is too
early to express an opinion respecting the likelihood of an adverse outcome
on
the counterclaim, although we intend to vigorously defend against those claims
and vigorously prosecute our affirmative claim.
Other
We
are a
participant in various other legal proceedings and claims that arise in the
ordinary course of our business. These matters are generally covered by
insurance. While the resolution of these matters cannot be predicted with
certainty, we believe that the final outcome of these matters will not have
a
material effect on our financial position, results of operations, or cash
flows.
F-30
Hartman
Commercial Properties REIT and Subsidiary
Notes
to
Consolidated Financial Statements
December
31, 2006
Note
15 – Segment Information
Our
management historically has not differentiated by property types and therefore
does not present segment information.
Note
16 - Selected Quarterly Financial Data (Unaudited)
The
following is a summary of our unaudited quarterly financial information for
the
years ended December 31, 2006 and 2005 (in thousands, except per share
data):
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
|||||||||||
|
2006
|
||||||||||||||
|
Revenues
|
$
|
7,414
|
$
|
7,689
|
$
|
7,416
|
$
|
7,321
|
||||||
|
Income
before minority interests
|
937
|
1,403
|
974
|
(465
|
)
|
|||||||||
|
Minority
interest in income
|
(372
|
)
|
(545
|
)
|
(371
|
)
|
220
|
|||||||
|
Net
income
|
565
|
858
|
603
|
(245
|
)
|
|||||||||
|
Basic
and diluted earnings per share
|
$
|
0.061
|
$
|
0.089
|
$
|
0.061
|
$
|
(0.025
|
)
|
|||||
|
2005
|
||||||||||||||
|
Revenues
|
$
|
6,244
|
$
|
6,246
|
$
|
6,081
|
$
|
6,348
|
||||||
|
Income
before minority interests
|
1,522
|
1,340
|
894
|
583
|
||||||||||
|
Minority
interest in income
|
(697
|
)
|
(593
|
)
|
(383
|
)
|
(218
|
)
|
||||||
|
Net
income
|
824
|
746
|
512
|
366
|
||||||||||
|
Basic
and diluted earnings per share
|
$
|
0.114
|
$
|
0.097
|
$
|
0.064
|
$
|
0.035
|
||||||
F-31
Hartman
Commercial
Properties REIT and
Subsidiary
Schedule
II - Valuation and Qualifying Accounts
|
(in
thousands)
|
|||||||||||||
|
Description
|
Balance
at
Beginning
of
Period
|
Charged
(credited)
to
Income
|
Deductions
from
Reserves
|
Balance
at
End
of
Period
|
|||||||||
|
Allowance
for doubtful accounts:
|
|||||||||||||
|
Year
ended December 31, 2006
|
$
|
473
|
$
|
388
|
$
|
(220
|
)
|
$
|
641
|
||||
|
Year
ended December 31, 2005
|
343
|
130
|
—
|
473
|
|||||||||
|
Year
ended December 31, 2004
|
351
|
(8
|
)
|
—
|
343
|
||||||||
F-32
Hartman
Commercial
Properties REIT and
Subsidiary
Schedule
III - Real Estate and Accumulated Depreciation
December
31, 2006
|
Initial
Cost
|
Costs
Capitalized Subsequent to
Acquisition
|
Gross
Amount at which Carried at End of Period (1) (2)
|
||||||||||||||||||||
|
Building
and
|
Carrying
|
Building
and
|
||||||||||||||||||||
|
Property
Name
|
Land
|
Improvements
|
Improvements
|
Costs
|
Land
|
Improvements
|
Total
|
|||||||||||||||
|
Retail
Properties:
|
||||||||||||||||||||||
|
Bellnot
Square
|
$
|
1,154
|
$
|
4,638
|
$
|
69
|
$
|
—
|
$
|
1,154
|
$
|
4,707
|
$
|
5,861
|
||||||||
|
Bissonnet
Beltway
|
415
|
1,947
|
184
|
—
|
415
|
2,131
|
2,546
|
|||||||||||||||
|
Centre
South
|
481
|
1,596
|
429
|
—
|
481
|
2,025
|
2,506
|
|||||||||||||||
|
Garden
Oaks
|
1,285
|
5,293
|
293
|
—
|
1,285
|
5,586
|
6,871
|
|||||||||||||||
|
Greens
Road
|
354
|
1,284
|
111
|
—
|
354
|
1,395
|
1,749
|
|||||||||||||||
|
Holly
Knight
|
320
|
1,293
|
66
|
—
|
320
|
1,359
|
1,679
|
|||||||||||||||
|
Kempwood
Plaza
|
733
|
1,798
|
903
|
—
|
733
|
2,701
|
3,434
|
|||||||||||||||
|
Lion
Square
|
1,546
|
4,289
|
317
|
—
|
1,546
|
4,606
|
6,152
|
|||||||||||||||
|
Northeast
Square
|
565
|
2,008
|
286
|
—
|
565
|
2,294
|
2,859
|
|||||||||||||||
|
Providence
|
918
|
3,675
|
486
|
—
|
918
|
4,161
|
5,079
|
|||||||||||||||
|
South
Richey
|
778
|
2,584
|
191
|
—
|
778
|
2,775
|
3,553
|
|||||||||||||||
|
South
Shaver
|
184
|
633
|
173
|
—
|
184
|
806
|
990
|
|||||||||||||||
|
SugarPark
Plaza
|
1,781
|
7,125
|
20
|
—
|
1,781
|
7,145
|
8,926
|
|||||||||||||||
|
Sunridge
|
276
|
1,186
|
41
|
—
|
276
|
1,227
|
1,503
|
|||||||||||||||
|
Torrey
Square
|
1,981
|
2,971
|
435
|
—
|
1,981
|
3,406
|
5,387
|
|||||||||||||||
|
Town
Park
|
850
|
2,911
|
214
|
—
|
850
|
3,125
|
3,975
|
|||||||||||||||
|
Webster
Point
|
720
|
1,150
|
76
|
—
|
720
|
1,226
|
1,946
|
|||||||||||||||
|
Westchase
|
423
|
1,751
|
242
|
—
|
423
|
1,993
|
2,416
|
|||||||||||||||
|
Windsor
Park
|
2,621
|
10,482
|
—
|
—
|
2,621
|
10,482
|
13,103
|
|||||||||||||||
|
$
|
17,385
|
$
|
58,614
|
$
|
4,536
|
$
|
—
|
$
|
17,385
|
$
|
63,150
|
$
|
80,535
|
|||||||||
|
Warehouse
Properties:
|
||||||||||||||||||||||
|
Brookhill
|
186
|
788
|
156
|
$
|
—
|
186
|
944
|
1,130
|
||||||||||||||
|
Corporate
Park Northwest
|
1,534
|
6,306
|
554
|
—
|
1,534
|
6,860
|
8,394
|
|||||||||||||||
|
Corporate
Park West
|
2,555
|
10,267
|
456
|
—
|
2,555
|
10,723
|
13,278
|
|||||||||||||||
|
Corporate
Park Woodland
|
652
|
5,330
|
742
|
—
|
652
|
6,072
|
6,724
|
|||||||||||||||
|
Dairy
Ashford
|
226
|
1,211
|
78
|
—
|
226
|
1,289
|
1,515
|
|||||||||||||||
|
Holly
Hall
|
608
|
2,516
|
6
|
—
|
608
|
2,522
|
3,130
|
|||||||||||||||
|
Interstate
10
|
208
|
3,700
|
282
|
—
|
208
|
3,982
|
4,190
|
|||||||||||||||
|
Main
Park
|
1,328
|
2,721
|
530
|
—
|
1,328
|
3,251
|
4,579
|
|||||||||||||||
|
Plaza
Park
|
902
|
3,294
|
341
|
—
|
902
|
3,635
|
4,537
|
|||||||||||||||
|
West
Belt Plaza
|
568
|
2,165
|
293
|
—
|
568
|
2,458
|
3,026
|
|||||||||||||||
|
Westgate
|
672
|
2,776
|
143
|
—
|
672
|
2,919
|
3,591
|
|||||||||||||||
|
$
|
9,439
|
$
|
41,074
|
$
|
3,581
|
$
|
—
|
$
|
9,439
|
$
|
44,655
|
$
|
54,094
|
|||||||||
|
Office
Properties:
|
||||||||||||||||||||||
|
9101
LBJ Freeway
|
$
|
1,597
|
$
|
6,078
|
$
|
267
|
$
|
—
|
$
|
1,597
|
$
|
6,345
|
$
|
7,942
|
||||||||
|
Featherwood
|
368
|
2,591
|
535
|
—
|
368
|
3,126
|
3,494
|
|||||||||||||||
|
Royal
Crest
|
509
|
1,355
|
100
|
—
|
509
|
1,455
|
1,964
|
|||||||||||||||
|
Uptown
Tower
|
1,621
|
15,551
|
103
|
—
|
1,621
|
15,654
|
17,275
|
|||||||||||||||
|
Woodlake
Plaza
|
1,107
|
4,426
|
360
|
—
|
1,107
|
4,786
|
5,893
|
|||||||||||||||
|
Zeta
Building
|
636
|
1,819
|
206
|
—
|
636
|
2,025
|
2,661
|
|||||||||||||||
|
$
|
5,838
|
$
|
31,820
|
$
|
1,571
|
$
|
—
|
$
|
5,838
|
$
|
33,391
|
$
|
39,229
|
|||||||||
|
Grand
Totals
|
$
|
32,662
|
$
|
131,508
|
$
|
9,688
|
$
|
—
|
$
|
32,662
|
$
|
141,196
|
$
|
173,858
|
||||||||
F-33
Hartman
Commercial Properties REIT and Subsidiary
Schedule
III - Real Estate and Accumulated Depreciation
December
31, 2006
(Continued)
|
Property
Name
|
Accumulated
Depreciation
(in
thousands)
|
Date
of
Construction
|
Date
Acquired
|
Depreciation
Life
|
|||||
|
Retail
Properties:
|
|||||||||
|
Bellnot
Square
|
$ |
674
|
1/1/2002
|
5-39
years
|
|||||
|
Bissonnet
Beltway
|
710
|
1/1/1999
|
5-39
years
|
||||||
|
Centre
South
|
612
|
1/1/2000
|
5-39
years
|
||||||
|
Garden
Oaks
|
850
|
1/1/2002
|
5-39
years
|
||||||
|
Greens
Road
|
411
|
1/1/1999
|
5-39
years
|
||||||
|
Holly
Knight
|
402
|
8/1/2000
|
5-39
years
|
||||||
|
Kempwood
Plaza
|
970
|
2/2/1999
|
5-39
years
|
||||||
|
Lion
Square
|
1,073
|
1/1/2000
|
5-39
years
|
||||||
|
Northeast
Square
|
617
|
1/1/1999
|
5-39
years
|
||||||
|
Providence
|
727
|
3/30/2001
|
5-39
years
|
||||||
|
South
Richey
|
675
|
8/25/1999
|
5-39
years
|
||||||
|
South
Shaver
|
289
|
12/17/1999
|
5-39
years
|
||||||
|
SugarPark
Plaza
|
464
|
9/8/2004
|
5-39
years
|
||||||
|
Sunridge
|
176
|
1/1/2002
|
5-39
years
|
||||||
|
Torrey
Square
|
756
|
1/1/2000
|
5-39
years
|
||||||
|
Town
Park
|
921
|
1/1/1999
|
5-39
years
|
||||||
|
Webster
Point
|
297
|
1/1/2000
|
5-39
years
|
||||||
|
Westchase
|
357
|
1/1/2002
|
5-39
years
|
||||||
|
Windsor
Park
|
867
|
12/16/2003
|
5-39
years
|
||||||
| $ |
11,848
|
||||||||
|
Warehouse
Properties:
|
|||||||||
|
Brookhill
|
$ |
226
|
1/1/2002
|
5-39
years
|
|||||
|
Corporate
Park Northwest
|
1,059
|
1/1/2002
|
5-39
years
|
||||||
|
Corporate
Park West
|
1,578
|
1/1/2002
|
5-39
years
|
||||||
|
Corporate
Park Woodlands
|
1,544
|
11/1/2000
|
5-39
years
|
||||||
|
Dairy
Ashford
|
368
|
1/1/1999
|
5-39
years
|
||||||
|
Holly
Hall
|
343
|
1/1/2002
|
5-39
years
|
||||||
|
Interstate
10
|
1,334
|
1/1/1999
|
5-39
years
|
||||||
|
Main
Park
|
1,007
|
1/1/1999
|
5-39
years
|
||||||
|
Plaza
Park
|
891
|
1/1/2000
|
5-39
years
|
||||||
|
West
Belt Plaza
|
804
|
1/1/1999
|
5-39
years
|
||||||
|
Westgate
|
441
|
1/1/2002
|
5-39
years
|
||||||
| $ |
9,595
|
||||||||
|
Office
Properties:
|
|||||||||
|
9101
LBJ Freeway
|
$ |
281
|
8/10/2005
|
5-39
years
|
|||||
|
Featherwood
|
898
|
1/1/2000
|
5-39
years
|
||||||
|
Royal
Crest
|
354
|
1/1/2000
|
5-39
years
|
||||||
|
Uptown
Tower
|
551
|
11/22/2005
|
5-39
years
|
||||||
|
Woodlake
Plaza
|
261
|
3/14/2005
|
5-39
years
|
||||||
|
Zeta
Building
|
471
|
1/1/2000
|
5-39
years
|
||||||
| $ |
2,816
|
||||||||
|
Grand
Total
|
$ |
24,259
|
|||||||
(1)
Reconciliations of total real estate carrying value for the three years ended
December 31 follows:
|
(
In thousands)
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Balance
at beginning of period
|
$
|
173,789
|
$
|
141,997
|
$
|
131,721
|
||||
|
Additions
during the period:
|
||||||||||
|
Acquisitions
|
—
|
30,379
|
8,906
|
|||||||
|
Improvements
|
2,055
|
1,413
|
1,370
|
|||||||
|
2,055
|
31,792
|
10,276
|
||||||||
|
Deductions
- cost of real estate sold or retired
|
(1,986
|
)
|
—
|
—
|
||||||
|
Balance
at close of period
|
$
|
173,858
|
$
|
173,789
|
$
|
141,997
|
||||
(2)
The aggregate cost of real estate (in thousands) for federal income tax purposes
is $143,892
F-34
Hartman
Commercial Properties REIT and Subsidiary
Index
to Exhibits
|
Exhibit
No.
|
Description
|
|
|
3.1
|
Declaration
of Trust of Hartman Commercial Properties REIT, a Maryland real estate
investment trust (previously filed as and incorporated by reference
to
Exhibit 3.1 to the Registrant’s Registration Statement on Form S-11/A,
Commission File No. 333-111674, filed on May 24, 2004)
|
|
|
3.2
|
Articles
of Amendment and Restatement of Declaration of Trust of Hartman Commercial
Properties REIT (previously filed as and incorporated by reference
to
Exhibit 3.2 to the Registrant’s Registration Statement on Form S-11/A,
Commission File No. 333-111674, filed on July 29, 2004)
|
|
|
|
|
|
|
3.3
|
|
Articles
Supplementary (previously filed as and incorporated by reference
to
Exhibit 3(i).1 to the Registrant’s Current Report on Form 8-K, Commission
File No. 000-50256, filed on December 6, 2006)
|
|
|
|
|
|
3.4
|
|
Bylaws
(previously filed as and incorporated by reference to Exhibit 3.2
to the
Registrant’s Registration Statement on Form S-11, Commission File No.
333-111674, filed on December 31, 2003)
|
|
|
|
|
|
3.5
|
|
First
Amendment to Bylaws (previously filed as and incorporated by reference
to
Exhibit 3(ii).1 to the Registrant’s Current Report on Form 8-K, Commission
File No. 000-50256, filed on December 6, 2006)
|
|
|
|
|
|
4.1
|
|
Specimen
certificate for common shares of beneficial interest, par value $.001
(previously filed as and incorporated by reference to Exhibit 4.2
to the
Registrant’s Registration Statement on Form S-11, Commission File No.
333-111674, filed on December 31, 2003)
|
|
|
|
|
|
10.1
|
|
Agreement
of Limited Partnership of Hartman REIT Operating Partnership, L.P.
(previously filed as and incorporated by reference to Exhibit 10.1
to the
Registrant’s General Form for Registration of Securities on Form 10, filed
on April 30, 2003)
|
|
|
|
|
|
10.2
|
|
Amended
and Restated Property Management Agreement (previously filed and
incorporated by reference to Exhibit 10.2 to the Registrant’s Form 10-K
Annual Report for the year ended December 31, 2004, filed on March
31,
2005) (terminated on October 2, 2006)
|
|
|
|
|
|
10.3
|
|
Advisory
Agreement (previously filed and incorporated by reference to Exhibit
10.3
to the Registrant’s Annual Report on Form 10-K for the year ended December
31, 2004, filed on March 31, 2005) (terminated on September 30,
2006)
|
|
|
|
|
|
10.4
|
|
Certificate
of Formation of Hartman REIT Operating Partnership II GP, LLC (previously
filed as and incorporated by reference to Exhibit 10.3 to the Registrant’s
General Form for Registration of Securities on Form 10, filed on
April 30,
2003)
|
|
|
|
|
|
10.5
|
|
Limited
Liability Company Agreement of Hartman REIT Operating Partnership
II GP,
LLC (previously filed as and incorporated by reference to Exhibit
10.4 to
the Registrant’s General Form for Registration of Securities on Form 10,
filed on April 30, 2003)
|
|
|
|
|
|
10.6
|
|
Agreement
of Limited Partnership of Hartman REIT Operating Partnership II,
L.P.
(previously filed as and incorporated by reference to Exhibit 10.6
to the
Registrant’s General Form for Registration of Securities on Form 10, filed
on April 30, 2003)
|
|
Exhibit
No.
|
Description
|
|
|
10.7
|
Promissory
Note, dated December 20, 2002, between Hartman REIT Operating Partnership
II, L.P. and GMAC Commercial Mortgage Corporation (previously filed
as and
incorporated by reference to Exhibit 10.7 to the Registrant’s General Form
for Registration of Securities on Form 10, filed on April 30,
2003)
|
|
|
|
|
|
|
10.8
|
|
Deed
of Trust and Security Agreement, dated December 20, 2002, between
Hartman
REIT Operating Partnership II, L.P. and GMAC Commercial Mortgage
Corporation (previously filed as and incorporated by reference to
Exhibit
10.8 to the Registrant’s General Form for Registration of Securities on
Form 10, filed on April 30, 2003)
|
|
|
|
|
|
10.9
|
|
Loan
Agreement between Hartman REIT Operating Partnership, L.P. and Union
Planter’s Bank, N.A. (previously filed as and incorporated by reference to
Exhibit 10.10 to Amendment No. 2 to the Registrant’s General Form for
Registration of Securities on Form 10, filed on August 6,
2003)
|
|
|
|
|
|
10.10+
|
|
Employee
and Trust Manager Incentive Plan (previously filed and incorporated
by
reference to Exhibit 10.9 to the Registrant’s General Form for
Registration of Securities on Form 10, filed on April 30,
2003)
|
|
|
|
|
|
10.11+
|
|
Summary
Description of Hartman Commercial Properties REIT Trustee Compensation
Arrangements (previously filed and incorporated by reference to Exhibit
10.11 of the Registrant’s Annual Report on Form 10-K for the year ended
December 31, 2004, filed on March 31, 2005)
|
|
|
|
|
|
10.12
|
|
Form
of Agreement and Plan of Merger and Reorganization (previously filed
as
and incorporated by reference to the Registrant’s Proxy Statement, filed
on April 29, 2004)
|
|
|
|
|
|
10.13
|
|
Dealer
Manager Agreement (previously filed and as incorporated by reference
to
Exhibit 10.13 to the Registrant’s Annual Report on Form 10-K for the year
ended December 31, 2004, Commission File No. 000-50256, Central Index
Key
No. 0001175535, filed on March 31, 2005)
|
|
|
|
|
|
10.14
|
|
Escrow
Agreement (previously filed as and incorporated by reference to Exhibit
10.14 to the Registrant’s Annual Report on Form 10-K for the year ended
December 31, 2004, filed on March 31, 2005)
|
|
|
|
|
|
10.15
|
|
Form
of Amendment to the Agreement of Limited Partnership of Hartman REIT
Operating Partnership, L.P. (previously filed in and incorporated
by
reference to the Registrant’s Registration Statement on Form S-11,
Commission File No. 333-111674, filed on December 31,
2003)
|
|
|
|
|
|
10.16
|
|
Revolving
Credit Agreement among Hartman REIT Operating Partnership, L.P.,
Hartman
REIT Operating Partnership III LP, and KeyBank National Association
(together with other participating lenders), dated June 2, 2005
(previously filed as and incorporated by reference to Exhibit 10.13
to
Post-Effective Amendment No. 1 to the Registrant’s Registration Statement
on Form S-11, Commission File No. 333-111674, filed on June 17,
2005)
|
|
|
|
|
|
10.17
|
|
Form
of Revolving Credit Note under Revolving Credit Agreement among Hartman
REIT Operating Partnership, L.P., Hartman REIT Operating Partnership
III
LP, and KeyBank National Association (together with other participating
lenders) (previously filed as and incorporated by reference to Exhibit
10.14 to Post-Effective Amendment No. 1 to the Registrant’s Registration
Statement on Form S-11, Commission File No. 333-111674, filed on
June 17,
2005)
|
|
Exhibit
No.
|
Description
|
|
|
10.18
|
Guaranty
under Revolving Credit Agreement among Hartman REIT Operating Partnership,
L.P., Hartman REIT Operating Partnership III LP, and KeyBank National
Association (together with other participating lenders) (previously
filed
as and incorporated by reference to Exhibit 10.15 to Post-Effective
Amendment No. 1 to the Registrant’s Registration Statement on Form S-11,
Commission File No. 333-111674, filed on June 17, 2005)
|
|
|
|
|
|
|
10.19
|
|
Form
of Negative Pledge Agreement under Revolving Credit Agreement among
Hartman REIT Operating Partnership, L.P., Hartman REIT Operating
Partnership III LP, and KeyBank National Association (together with
other
participating lenders) (previously filed as and incorporated by reference
to Exhibit 10.16 to Post-Effective Amendment No. 1 to the Registrant’s
Registration Statement on Form S-11, Commission File No. 333-111674,
filed
on June 17, 2005)
|
|
|
|
|
|
10.20
|
|
Form
of Collateral Assignment of Partnership Interests under Revolving
Credit
Agreement among Hartman REIT Operating Partnership, L.P., Hartman
REIT
Operating Partnership III LP, and KeyBank National Association (together
with other participating lenders) (previously filed as and incorporated
by
reference to Exhibit 10.17 to Post-Effective Amendment No. 1 to the
Registrant’s Registration Statement on Form S-11, Commission File No.
333-111674, filed on June 17, 2005)
|
|
|
|
|
|
10.21
|
|
Modification
Agreement, dated as of February 28, 2006, between Hartman REIT Operating
Partnership II, L.P. and GMAC Commercial Mortgage Corporation (previously
filed and incorporated by reference to Exhibit 10.1 to the Registrant’s
Current Report on Form 8-K, filed March 3, 2006)
|
|
|
|
|
|
10.22
|
|
Interest
Rate Swap Agreement dated as of March 16, 2006, between Hartman REIT
Operating Partnership, L.P., Hartman REIT Operating Partnership III
LP,
and KeyBank National Association (previously filed as and incorporated
by
reference to Exhibit 10.22 to the Registrant’s Annual Report on Form 10-K
for the year ended December 31, 2005, filed on March 31,
2006)
|
|
|
|
|
|
10.23
|
|
Waiver
and Amendment No. 1, dated May 8, 2006, between Hartman REIT Operating
Partnership, L.P., Hartman REIT Operating Partnership III, L.P.,
and
KeyBank National Association, as agent for the consortium of lenders
(previously filed and incorporated by reference to Exhibit 10.23
to the
Registrant’s Quarterly Report on Form 10-Q, filed on May 12,
2006)
|
|
10.24*
|
Amendment
No 2, dated May 19, 2006, between Hartman REIT Operating Partnership,
L.P., Hartman REIT Operating Partnership III, L.P., and KeyBank National
Association, as agent for the consortium of lenders
|
|
|
|
|
|
|
10.25*
|
|
Promissory
Note between HCP REIT Operating Company IV LLC and MidFirst Bank,
dated
March 1, 2007
|
|
|
|
|
|
10.26*
|
Amendment
No 3, dated March 26, 2007, between Hartman REIT Operating Partnership,
L.P., Hartman REIT Operating Partnership III, L.P., and KeyBank National
Association, as agent for the consortium of lenders
|
|
|
14.1
|
|
Code
of Business Conduct (previously filed as and incorporated by reference
to
Exhibit 14.1 to the Registrant’s Annual Report on Form 10-K for the year
ended December 31, 2005, filed on March 31, 2006)
|
|
|
|
|
|
21.1
|
|
List
of subsidiaries of Hartman Commercial Properties REIT (previously
filed as
and incorporated by reference to Exhibit 21.1 to the Registrant’s Annual
Report on Form 10-K for the year ended December 31, 2004, filed on
March
31, 2005)
|
|
|
|
|
|
24.1
|
|
Power
of Attorney (included on the Signatures page hereto)
|
|
|
|
|
|
31.1*
|
|
Certification
of Principal Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
|
|
|
|
31.2*
|
|
Certification
of Principal Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
|
|
|
Exhibit
No.
|
Description
|
|
|
32.1*
|
Certificate
of Chief Executive and Financial
Officers
|
| * |
Filed
herewith.
|
| + |
Denotes
management contract or compensatory plan or arrangement.
|