For the Fiscal Year Ended 11/30/2002

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended November 30, 2002

 

Commission file number 1-13223

 


 

LNR Property Corporation

(Exact name of registrant as specified in its charter)

 

Delaware

 

65-0777234

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1601 Washington Avenue, Suite 800, Miami Beach, Florida 33139

(Address of principal executive offices) (Zip Code)

 

(Registrant’s telephone number, including area code) (305) 695-5500

 


 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class


 

Name of each exchange

on which registered


Common Stock, par value 10¢ per share

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: NONE

 


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  x    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 of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

As of February 14, 2003, 21,927,435 shares of common stock and 9,783,768 shares of Class B common stock (which can be converted into common stock) were outstanding. Of the total shares outstanding, 20,524,909 shares of common stock and 45,938 shares of Class B common stock, having a combined aggregate market value (assuming the Class B shares were converted) on that date of $684,392,080 were held by non-affiliates of the registrant.

 

Documents Incorporated by

Reference Into this Report


  

Part of Form 10-K Into Which

this Document is Incorporated


LNR Property Corporation

2003 Proxy Statement

  

Part III

 



PART I

 

SOME OF THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K ARE “FORWARD LOOKING STATEMENTS” AS THAT TERM IS DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. GENERALLY, THE WORDS “BELIEVE,” “EXPECT,” “INTEND,” “ANTICIPATE,” “WILL,” “MAY” AND SIMILAR EXPRESSIONS IDENTIFY FORWARD LOOKING STATEMENTS. FORWARD LOOKING STATEMENTS INHERENTLY INVOLVE RISKS AND UNCERTAINTIES. THE FACTORS, AMONG OTHERS, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THE FORWARD LOOKING STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K INCLUDE, BUT ARE NOT LIMITED TO (I) CHANGES IN DEMAND FOR COMMERCIAL REAL ESTATE NATIONALLY, IN AREAS IN WHICH THE COMPANY OWNS PROPERTIES, OR IN AREAS IN WHICH PROPERTIES SECURING MORTGAGES DIRECTLY OR INDIRECTLY OWNED BY THE COMPANY ARE LOCATED, (II) INTERNATIONAL, NATIONAL OR REGIONAL BUSINESS CONDITIONS WHICH AFFECT THE ABILITY OF MORTGAGE OBLIGORS TO PAY PRINCIPAL OR INTEREST WHEN IT IS DUE, (III) THE CYCLICAL NATURE OF THE COMMERCIAL REAL ESTATE BUSINESS, (IV) CHANGES IN INTEREST RATES, (V) CHANGES IN THE MARKET FOR VARIOUS TYPES OF REAL ESTATE BASED SECURITIES, (VI) CHANGES IN AVAILABILITY OF CAPITAL OR THE TERMS ON WHICH IT IS AVAILABLE, (VII) CHANGES IN AVAILABILITY OF QUALIFIED PERSONNEL AND (VIII) CHANGES IN GOVERNMENT REGULATIONS, INCLUDING, WITHOUT LIMITATION, ENVIRONMENTAL REGULATIONS.

 

Item 1.    Business.

 

Overview

 

LNR Property Corporation and subsidiaries (the “Company”) is a real estate investment, finance and management company, which structures and makes real estate and real estate related investments and, through its expertise in developing and managing properties and working out underperforming and non-performing commercial loans, seeks to enhance the value of those investments.

 

Our real estate investment activities include:

 

    Real Estate Properties:    acquiring, developing, repositioning, managing and selling commercial and multi-family residential real estate.

 

    Real Estate Loans:    investing in high-yielding real estate loans and acquiring at a discount portfolios of loans backed by commercial or multi-family residential real estate.

 

    Real Estate Securities:    investing in unrated and non-investment grade rated commercial mortgage backed securities (“CMBS”) as to which we have the right to be special servicer (i.e., to oversee workouts of underperforming and non-performing loans).

 

History

 

Lennar Corporation (“Lennar”), one of the nation’s largest homebuilders, began developing, owning and managing commercial and multi-family residential real estate in 1969. In June 1997, Lennar formed our Company to separate Lennar’s real estate investment, finance and management business from its homebuilding business. On October 31, 1997, Lennar distributed our stock to Lennar’s stockholders in a tax-free spin-off (the “Spin-off”).

 

Relationship with Lennar Corporation

 

In connection with the Spin-off, we agreed that until December 2002, we would not engage in homebuilding or related activities (other than purchasing securities backed by residential mortgages and providing financing to homebuilders or land developers) and Lennar agreed that until December 2002, it would not engage in various activities in which we were engaged at the time of the Spin-off (which is most of the principal activities in which we are currently engaged). The delineation between what we could do and what Lennar could do has helped our two companies work cooperatively in partnerships and other joint endeavors. Since we have no current intention of becoming involved in the types of activities in which Lennar engages (primarily related to homebuilding or related activities) and the delineation has been beneficial, our Board and Lennar’s Board are considering having both companies enter into a new agreement regarding our respective activities similar to the one that expired in December 2002.

 

2


We and Lennar are separate publicly-traded companies and neither of us has any financial interest in the other except for partnerships in which we both have investments. Stuart Miller, the Chairman of our Board of Directors and the President and Chief Executive Officer of Lennar, is the sole director and officer of a family-owned corporation which owns stock that gives it voting control of both companies. A Transaction Review Committee, which is entirely comprised of members of our Board who are not directors, officers or employees of Lennar, approves any significant transactions between us and Lennar or any of its subsidiaries.

 

For information about our partnerships with Lennar, see “Partnerships with Lennar” in Item 1.

 

Investment Strategy

 

Our investment and growth strategy focuses on opportunities both in the United States and Europe in the commercial real estate markets. We adjust our investment focus from time to time to adapt to changes in markets and phases of the real estate cycle, and to take advantage of market inefficiencies. As such, we do not have specific policies as to the type of real estate related assets we will acquire, the percentage of our assets we will invest in particular types of real estate related assets or the percentage of the interests in particular entities we will acquire. Instead, we review, at least monthly, the types of real estate related investment opportunities which may at that time be available, the market factors which may affect various types of real estate related investments (including the likelihood of changes in interest rates or availability of investment capital) and other factors which may affect the attractiveness of particular investment opportunities.

 

We will typically not make an investment unless we have control or significant influence over the development and implementation of the strategy for managing risk and enhancing the value of the underlying assets. We look to invest where we can utilize our expertise to manage risk and to add value by increasing recurring cash flows and optimizing asset values.

 

Because our business activities contain elements of market risk, our investment strategy is designed to minimize these risks. We have a unique platform to evaluate, monitor and control risk through our exhaustive due diligence program, our disciplined hands-on approach to managing the underlying assets, and by remaining balance sheet focused.

 

Due Diligence Process

 

We perform extensive due diligence before making any investment in order to evaluate investment risks and opportunities and see whether we will be able to use our skills to enhance the value of the investment. Our formalized procedures enable our professionals to efficiently conduct due diligence on a wide array of potential investments and this exhaustive, methodical due diligence process is strictly adhered to across each of our business segments. While the discipline is the same for every asset, the significance of this process is particularly evident when an acquisition involves a large pool of assets. For example, in CMBS, where a transaction often involves over $1 billion of collateral and a pool of several hundred loans secured by real estate properties, we, among other things, (i) visit each underlying property and at least three other comparable properties in the same sub-market; (ii) project anticipated cash flows from the properties based on leases in place, market information and extensive internal knowledge; (iii) arrive at an independent value for each property; (iv) review all loan documents and any third party reports such as appraisals and environmental reports; (v) evaluate the borrower and its likely ability to make all required loan payments; (vi) re-underwrite the loan and the expected cash flows from the loan; (vii) model the resultant anticipated bond class cash flows; (viii) require the sponsor to remove from the pool individual loans which do not meet our investment standards; and (ix) formally present findings to senior management prior to approval of any investment. Due diligence is conducted by trained associates who have expertise in each asset’s specific market or geography and who posses extensive workout skills.

 

Hands-on Management Process

 

In the past decade, we have invested in properties, loans and securities with a total underlying real estate value of more than $120 billion. After investments are made, we constantly monitor our investments and oversee the value-enhancement process in an effort to ensure that every asset performs in accordance with our underwriting assumptions and is appropriately accounted for. We undertake a comprehensive asset and market review prior to each asset disposition, which is similar to our acquisition process, and attempt to ensure that each sale is correctly priced and timed to achieve optimal values. Careful, timely dispositions are critical to our value-enhancement strategy and our efforts to keep our assets deployed in areas that offer the greatest opportunities.

 

3


 

Because of our extensive experience since the early 1990’s in turning around distressed and underperforming assets, we have a reputation as a leading commercial real estate workout specialist. For the past decade, we have applied a disciplined approach to value-enhancement and have improved the cash flows from dozens of portfolios that we and our partners bought at significant discounts to face value. In addition, we have worked out thousands of loans that have gone into default, returning them to performing status, resolving them through payoffs or enhancing the underlying foreclosed properties before sale. A combination of experience, disciplined methodologies, state-of-the-art systems and advanced warning through our proprietary surveillance and shadow servicing programs enable us to seek to reduce risk and ultimately realize the optimal value from our investments. The major rating agencies rate the capabilities of CMBS special servicers and have recognized our abilities by assigning us their highest ratings.

 

Balance Sheet Focus

 

We believe that managing a prudent, conservative balance sheet establishes a strong foundation for future growth through all phases of the real estate cycle. We focus on methodically diversifying our investments in terms of property type, geography and position in the capital structure, while recycling operating cash flow and proceeds from the sale of matured assets to enhance our financial position.

 

We finance our investment and growth strategies with cash flow generated from operations and with borrowings obtained under credit facilities or other financing arrangements. We focus on diversifying our capital structure and financing sources, matching the maturities of our debt with the expected lives of our assets, managing our liabilities in the proper proportion to our stated equity, retaining our earnings, and maintaining adequate levels of liquidity.

 

Our approach to managing interest rate risk is based primarily on match funding, with the objective that variable-rate assets be primarily financed by variable-rate liabilities and fixed-rate assets be primarily financed by fixed-rate liabilities. To the extent that we have fixed-rate assets financed with variable-rate debt, we periodically enter into interest rate swaps, to manage our interest costs and hedge against risks associated with changing interest rates. We also periodically enter into interest rate swaps to manage the risk associated with unpredictable changes in asset values related to movements in interest rates on our fixed-rate CMBS.

 

At November 30, 2002 our total assets by business segment consist of the following (dollars in millions):

 

LOGO

 

Total Assets—$2.8 billion(1)


(1)   Includes fair value write-up on CMBS of $213 million at November 30, 2002.

 

Real Estate Properties

 

We engage in the acquisition, development, repositioning, management and sale of commercial and residential multi-family rental real estate throughout the United States and Europe.

 

4


 

The management process for every real estate property we own or operate is carried out in accordance with a five-year strategic business plan, comprehensive annual budgets, weekly asset manager meetings and monthly focus reports. In most instances, we leverage our management team by employing local experts to perform on-site management, leasing, maintenance and development activities. Over the years, we have established relationships with a large network of these experts across the country. We often partner with developers to direct the development and repositioning of the properties. In these instances, our associates closely supervise the operation of the properties and the activities of the outside management companies and developers.

 

Market-rate Properties

 

At November 30, 2002, our domestic real estate market-rate property portfolio, which includes stabilized properties and properties in various stages of development, repositioning and/or lease-up, included:

 

Type


    

Number of Properties


  

Square Feet/ Units/ Rooms


Apartment communities

    

3

  

1,500 units

Office buildings

    

21

  

4.8 million square feet

Industrial/warehouse facilities

    

3

  

1.3 million square feet

Hotels

    

9

  

2,100 rooms

Retail centers

    

7

  

1.4 million square feet

Land:

           

Leased

    

21

  

1.6 million square feet (36 acres)

Other

    

  

530 acres

 

Apartment Communities

 

Our three apartment communities range in size from 430 to 536 units. Two are located in Texas and one is located in Georgia.

 

Office Buildings

 

Our 21 office buildings range from one to 36 stories and have an aggregate of 4.8 million square feet of office space. Nine of the office buildings are in California, three are in Florida, two each are in Georgia, Louisiana, and North Carolina, and one is in each of Texas, Utah and Virginia.

 

Industrial/Warehouse Facilities

 

Our three industrial/warehouse facilities range from 203,000 square feet to 747,000 square feet of floor space. These industrial facilities are all located in California.

 

Hotels

 

Our nine hotels have or will have a total of 2,100 rooms. Six of the hotels, representing 1,200 rooms, are stabilized and carry the name of a national chain. The other three hotels have not yet reached stabilized occupancy, are under development or are being repositioned.

 

Retail Centers

 

The retail centers in our portfolio include: (i) two small neighborhood retail centers (sometimes referred to as “strip centers”), with 30,000 square feet and 70,000 square feet of store space, as well as parking areas and public areas, (ii) four larger regional retail centers, with 60,000 square feet to 970,000 square feet of store space and (iii) one single-tenant property with 14,000 square feet. One of the small retail centers and the single-tenant property are located in Florida. The other small retail center is located in Indiana. Of the regional retail centers, three are in California, and one is in Louisiana.

 

Land

 

In addition to our operating properties, we own commercially zoned land, 1.6 million square feet of which is leased to others under long-term ground leases and 530 acres of which will be used for specific development opportunities or sold.

 

5


 

We maintain a program of liability, property loss and damage and other insurance which covers all of our properties and which we believe is adequate to protect us against all reasonably foreseeable material insurable risks.

 

Affordable Housing Communities

 

During 1998, we entered the business of owning, developing and syndicating multi-family and senior housing residential communities which qualify for Low-Income Housing Tax Credits (“affordable housing communities”). We did this by acquiring a group of entities, or partnership interests in entities, known as the Affordable Housing Group (“AHG”). Initially, our strategy was to retain the tax credits generated through owning the majority of the interests in the affordable housing communities and using those credits to reduce our overall effective tax rate. However, the demand for credits has since increased significantly and we found we could generate higher returns on our investments by selling the credits instead of holding them. Accordingly, we have shifted our strategy away from owning the majority of the interests in the affordable housing communities toward syndicating such interests. After a syndication, we continue to hold a small interest (typically ranging from less than 1% to 10%) in the partnerships that were syndicated and continue to manage the communities, for which we earn management fees. As a result of the shift in strategy, we expect our total investment in affordable housing communities, as well as the amount of tax credits we hold and utilize to reduce our tax rate, to decline in future years.

 

As of November 30, 2002, we had direct or indirect ownership interests through partnership arrangements in approximately 9,700 affordable housing apartment units, ranging in size from 20 to 436 units in 82 communities. The apartment communities are located across the U.S. Approximately 90% of the affordable housing communities were constructed by AHG or under its supervision. AHG acquired the other affordable housing communities after they were completed.

 

Europe

 

In 2002, we entered the European commercial real estate market through the formation of a strategic partnership with CDC Ixis Capital Markets (ICM). ICM is a subsidiary of Caisse des Depots et Consignations of France, a AAA-rated global financial institution that is one of the largest investors in Europe. Our initial investment together was in a partnership which owns over 400 stabilized commercial real estate properties located throughout France. Our total investment in Europe, including our investment in one CMBS transaction, was $81.2 million at November 30, 2002.

 

Partnerships With Lennar

 

Lennar Land Partners

 

Before the Spin-off, we, along with Lennar, transferred to a general partnership, which is 50% owned by us and 50% owned by Lennar, parcels of land or interests in land and other assets which had a total book value on Lennar’s books at October 31, 1997 of approximately $372.4 million. Although we, and Lennar, each have our own management teams and our own public shareholders, Stuart Miller, who is the President and Chief Executive Officer of Lennar and our Chairman of the Board (but not our Chief Executive Officer), has voting control of both us and Lennar. In 1999, certain assets and liabilities of this land partnership were contributed at net book value to a second general partnership and we, along with Lennar, received 50% general partnership interests in the second partnership. The two partnerships are collectively referred to as Lennar Land Partners (“LLP”). The land was originally acquired by Lennar primarily to be used for residential home development. The parcels of land or interests in land we contributed had been contributed to us by Lennar so we could contribute them to LLP and receive a 50% interest in LLP. Today, LLP is engaged in the acquisition, development and sale of land and the development and sale of homes. From November 1, 1997 through November 30, 2002, LLP had land sale revenues of $1,007.2 million, of which $502.7 million was from sales to Lennar and $12.4 million was from sales to us. During that period, LLP acquired 9,760 additional home sites, primarily through partnership arrangements. At November 30, 2002, LLP’s land consisted of 7,772 potential home sites in 14 communities, of which 9 communities with 3,984 potential home sites are in Florida, 2 communities with 519 potential home sites are in Texas and 3 communities with 3,269 potential home sites are in California. Approximately 5% of the land was developed and ready to be built upon, 36% of the land was in various stages of development and 59% of the land was totally undeveloped. LLP recently began to develop and sell homes, and recorded $27.6 million of revenue from the sale of homes in 2002 to third party homebuyers.

 

When Lennar contributed land to us and to LLP in 1997, Lennar retained options to purchase up to approximately 22% of the contributed land at pre-established prices. Through November 1999, almost all the options relative to the originally contributed land had either been exercised or terminated. On November 30,

 

6


1999, Lennar obtained options from LLP to purchase an additional 6,300 home sites at prices we agreed to. The agreement also provided for additional options to Lennar as additional home sites were developed by LLP. Since then, additional home sites became available and Lennar obtained options relating to an additional 3,200 home sites. At November 30, 2002, Lennar still had options to purchase 2,600 home sites. The remaining land is available for sale to independent homebuilders or to Lennar at prices determined from time to time, which, as is discussed below, we must approve.

 

LLP has an agreement with Lennar under which Lennar, for a fee, administers all day-to-day activities of LLP, including overseeing planning and development of properties and overseeing sales of land to Lennar and other builders. In addition, LLP has an agreement with Lennar under which Lennar is the general contractor for homes built and sold by LLP and receives a fee for the general contractor services.

 

LLP is governed by an Executive Committee consisting of both our and Lennar’s representatives, with Lennar’s representatives and our representatives each having in total one vote. This, in effect, gives us and Lennar each a veto with regard to matters presented to LLP’s Executive Committee. Our by-laws require that all significant decisions relating to LLP be approved by a Transaction Review Committee, which is entirely comprised of members of our Board who are not directors, officers or employees of Lennar.

 

Lennar may, but is under no obligation to, offer additional properties to LLP. Lennar is free to acquire properties for itself without any consideration of whether those properties might have been appropriate for LLP. We are, in effect, able to veto any proposals that LLP acquire properties proposed by Lennar. Arrangements with regard to particular properties might include, (i) options to Lennar to purchase all or portions of properties, (ii) rights of first refusal for Lennar to acquire lots if other builders propose to acquire them, or (iii) buy/sell arrangements under which, if Lennar wanted to purchase lots on which it did not have an option, it would propose a purchase price and we would have the option to approve the sale to Lennar at that price or to purchase the lots for that price (probably in order to resell them to someone who would be willing to pay a higher price).

 

We have acquired and may continue to seek to acquire commercial portions of properties owned or acquired by LLP or options relating to them. Lennar can, if it wants to do so, veto acquisitions by us.

 

Our unconsolidated investment in LLP, accounted for by the equity method, was $46.1 million at November 30, 2002. LLP’s total assets and liabilities on a combined 100% basis were $234.2 million and $142.0 million, respectively, as of November 30, 2002.

 

The debt of LLP is non-recourse to us, with the exception of one $1.9 million guarantee. However, one of our subsidiaries, which holds our general partner interests in LLP, could be liable as a general partner for LLP’s debt. That subsidiary has essentially no assets other than the general partner interests in LLP. Along with Lennar, we provide limited maintenance guarantees on $35.3 million of LLP’s debt. These limited guarantees only apply if the fair value of the collateral (generally land and improvements thereto) is less than a specified multiple of the loan balance and LLP does not have the ability to paydown the loan balance to the appropriate level. We have also provided debt service guarantees which only apply if the partnership defaults on its loan arrangements. If we are required to make a payment under these guarantees, the payment would be accounted for as a capital contribution to the partnership and increase our share of capital distributed upon the dissolution of the partnership.

 

Other Partnerships

 

We have joint ventured with Lennar in a number of other projects which require both residential and commercial expertise. Our by-laws require that all significant decisions relating to these ventures be approved by a Transaction Review Committee, which is entirely comprised of members of our Board who are not directors, officers or employees of Lennar. These unconsolidated investments, which are accounted for by the equity method, include:

 

    The redevelopment of two closed military facilities in California, as the federal government moves to put these into the hands of public/private partnerships. These facilities are being converted to master planned communities including housing, office, industrial/warehouse, retail, entertainment, etc.

 

    The development and disposition of approximately 585 acres of commercial and residential land in Carlsbad, California, of which 429 acres remained at November 30, 2002.

 

    The development of 240 residential condominiums within a mixed-use project in San Francisco, California.

 

The debt in these partnerships is non-recourse to us, except for $7.3 million of guarantees.

 

7


 

Our total investment in partnerships with Lennar (including LLP) at November 30, 2002 was $81.6 million. Total assets and liabilities of the partnerships were $345.0 million and $186.7 million, respectively, at November 30, 2002. The debt in these partnerships is non-recourse to us, except for the guarantees discussed above.

 

Real Estate Loans

 

High Yielding Real Estate Loans

 

At November 30, 2002, our real estate loan portfolio consisted of:

 

Type of Loan


  

Principal

Amount of

Loans


    

(In thousands)

B-notes

  

$380,403

Other first mortgage loans

  

34,838

Mezzanine loans

  

24,651

    

Total

  

$439,892

    

 

B-notes

 

We invest in structured junior loan participations in institutional quality short- to medium-term variable-rate real estate loans (“B-notes”). We work with leading financial institutions in underwriting and structuring these loans. The senior participations are securitized in many cases by the financial institutions. We are designated as the special servicer for both the securitizations and the junior loan participations, which allows us to provide asset management and resolution services with respect to these loans. As special servicer, we have the authority to deal directly with any borrower that fails to perform under certain terms of its mortgage loan, including the failure to make payments, and to manage any loan workouts and foreclosures. To date, we have not experienced any delinquencies in our B-note portfolio. We had $380.4 million of outstanding principal amount of these investments at November 30, 2002, of which $307.7 million represented participations in first mortgage loans and $72.7 million represented participations in mezzanine loans.

 

Other First Mortgage Loans

 

We invest in fixed- and variable-rate first mortgage loans secured by commercial and multi-family residential real estate properties. Some of these loans represent short-term seller financing provided by us upon the sale of our operating properties.

 

Mezzanine Loans

 

Our mezzanine loans are typically made to developers or builders of residential communities and owners of stabilized operating properties. These loans are usually subordinate to construction loans or other first mortgage loans and often provide us, in addition to interest income, participations in profits after the developers, builders or owners have achieved specified financial targets.

 

The types of real estate loans and collateral held by us at November 30, 2002, follows:

 

Type of Property


  

B-notes


  

Other First Mortgage Loans


  

Mezzanine Loans


  

Total Principal

Amount


    

(In thousands)

Office buildings

  

$

175,318

  

18,575

  

—  

  

193,893

Hotels

  

 

70,435

  

—  

  

—  

  

70,435

Retail centers

  

 

38,674

  

12,190

  

—  

  

50,864

Apartment communities

  

 

28,600

  

2,996

  

9,426

  

41,022

Mixed-use properties

  

 

34,500

  

—  

  

—  

  

34,500

Industrial/warehouse facilities

  

 

18,122

  

—  

  

—  

  

18,122

Convention centers

  

 

14,600

  

—  

  

—  

  

14,600

Residential development and other

  

 

154

  

1,077

  

15,225

  

16,456

    

  
  
  

Total

  

$

380,403

  

34,838

  

24,651

  

439,892

    

  
  
  

 

8


 

The states in which the properties securing our real estate loans were located, follows:

 

Type of State


  

B-notes


  

Other First Mortgage Loans


  

Mezzanine Loans


  

Total Principal

Amount


    

(In thousands)

California

  

$

98,413

  

2,000

  

16,834

  

117,247

New York

  

 

87,439

  

—  

  

—  

  

87,439

Illinois

  

 

37,017

  

—  

  

—  

  

37,017

Massachusetts

  

 

34,500

  

—  

  

—  

  

34,500

Texas

  

 

17,319

  

—  

  

7,817

  

25,136

Georgia

  

 

23,913

  

—  

  

—  

  

23,913

Tennessee

  

 

7,769

  

13,668

  

—  

  

21,437

Florida

  

 

15,758

  

1,077

  

—  

  

16,835

Michigan

  

 

15,952

  

—  

  

—  

  

15,952

Arizona

  

 

—  

  

15,097

  

—  

  

15,097

Virginia

  

 

14,600

  

—  

  

—  

  

14,600

Missouri

  

 

10,286

  

—  

  

—  

  

10,286

Minnesota

  

 

9,290

  

—  

  

—  

  

9,290

Oregon

  

 

—  

  

2,996

  

—  

  

2,996

Ohio

  

 

2,439

  

—  

  

—  

  

2,439

Kentucky

  

 

1,685

  

—  

  

—  

  

1,685

Nevada

  

 

1,599

  

—  

  

—  

  

1,599

North Carolina

  

 

1,283

  

—  

  

—  

  

1,283

Wisconsin

  

 

761

  

—  

  

—  

  

761

Alabama

  

 

380

  

—  

  

—  

  

380

    

  
  
  

Total

  

$

380,403

  

34,838

  

24,651

  

439,892

    

  
  
  

 

Discounted Portfolios of Commercial Mortgage Loans

 

In the early 1990’s, we acquired in partnership with financial institutions or real estate funds, portfolios of non-performing commercial mortgage loans and related pools of owned real estate assets in the United States. Through these partnerships we purchased and handled the workout activities relating to over $5 billion face amount of these distressed commercial assets.

 

In each of the partnerships, one of our subsidiaries acts as the managing general partner and conducts the business of the partnership. We earn management fees and asset disposition fees from the partnerships and have carried interests in cash flow and sales proceeds once the partners have recovered their capital and achieved specified returns. Our original investments ranged from 15% to 50% of the partnerships’ capital and totaled $165 million, out of a total of $684 million invested in the partnerships. By November 30, 2002, the partnerships had distributed a total of $1.4 billion to the partners, of which $418.5 million had been distributed to us. We also received management and asset disposition fees totaling approximately $66.0 million. As the domestic real estate markets strengthened in the mid to late 1990’s, substantially fewer large real estate portfolios became available at what we viewed as attractive prices. We have not, since August 1996, participated in a partnership which acquired a portfolio of non-performing real estate assets in the United States. Today, most of the assets from these domestic portfolios have been liquidated.

 

Beginning in late 1997, we entered into several partnerships to acquire portfolios of non-performing commercial mortgage loans in Japan. In April 2000, we sold our interests in these Japanese real estate loan portfolios and realized a pre-tax gain on sale of $20.3 million.

 

Our principal activity with respect to distressed portfolios is to manage the workout of non-performing loans, including negotiating new or modified financing terms and foreclosing on defaulted loans. The assets generally are held only as long as required to enhance their value and prepare them for sale. We believe our workout and property rehabilitation skills are the principal reasons financial institutions have sought us as a partner in acquiring portfolios of distressed assets and have given us workout rights for assets held by the partnerships.

 

9


 

Debt financing for partnerships’ acquisitions of real estate related asset portfolios has usually been on a non-recourse basis and with no guarantees by us or any other of the partners. In some cases, the lender must be repaid in full before a partnership can make cash distributions to us and our partners.

 

Real Estate Securities

 

Investments in CMBS

 

As a further use of our loan and real estate workout capabilities, we acquire unrated and non-investment grade rated subordinated CMBS and provide “special servicing” (see below) for the mortgage pools to which they relate. CMBS are securities backed by loans on commercial and multi-family residential real estate properties and possess many of the characteristics of large portfolios of performing loans. Default risk is spread over large, diverse portfolios of assets so that no single default has a significant effect on the overall performance of the portfolio. Furthermore, results can be influenced by the success of the special servicer, who attempts to ensure that all principal and interest payments are collected. However, securities representing interests in a CMBS pool are usually issued in series with varying levels of seniority, and generally provide that no principal may be paid with regard to a series until all senior series have been paid in full. Because of that, different series representing interests in the same pool typically will have different credit ratings. We invest only in the most junior, or nearly the most junior series, which generally do not receive principal payments until much of the mortgage debt underlying the CMBS has been paid and disbursed to holders of more senior series.

 

CMBS differ from other asset-backed securities in that CMBS investors have the ability to perform detailed due diligence on each individual component of the underlying collateral (to determine its ability to pay off the CMBS bonds) and the holders of the most junior series have the right to select the special servicer responsible for ensuring that the loans perform properly. We only invest when we can perform detailed due diligence on the properties securing the mortgages in the pool being securitized and can select ourself as the special servicer. Special servicing is the business of managing and working out the problem assets in a pool of commercial mortgage loans or other assets. For example, when a mortgage loan in a securitized pool goes into default, the special servicer negotiates with the borrower on behalf of the pool to resolve the situation. We use, as special servicer, essentially the same workout skills we apply with regard to distressed asset portfolios.

 

Because the holders of the unrated CMBS receive everything that is collected after the more senior levels of CMBS have been paid in full, we and other holders of unrated CMBS are the principal beneficiaries of increased collections, particularly since these bonds are purchased at significant discounts. Therefore, ownership of the unrated CMBS gives us an opportunity to profit from our special servicing activities in addition to receiving fees for being the special servicer.

 

In addition to purchasing the unrated bonds, we also purchase non-investment grade rated securities, but again only when we are the special servicer. Rated bonds also provide an excellent risk-adjusted return as we receive a yield on these securities based on the stated interest and accretion of the purchase discount. As an added benefit of our work as special servicer, ratings are sometimes upgraded by the rating agencies if the performance of the pool exceeds initial expectations. This increases their market values and gives us an opportunity to achieve gains on the sale of the securities, as well as receiving the stated interest while we hold them. Therefore, purchases of non-investment grade rated subordinated securities, like purchases of unrated securities, are a means for us to profit from our workout skills.

 

Fitch IBCA, Inc. and Standard and Poor’s, which rate special servicers of CMBS on the basis of management team, organizational structure, operating history, workout and asset disposition experience and strategies, information systems, investor reporting capabilities and financial resources, have given us their highest servicer ratings. In addition, many in the industry recognize us as the premier special servicer based on our strong track record and experience.

 

Competition in purchasing unrated and non-investment grade rated subordinated CMBS during the past four years has been limited and, as a result, our purchasing power has been significant. We attribute this limited competition to the need for a significant infrastructure and real estate expertise to properly and efficiently complete the detailed due diligence required to purchase less than investment grade CMBS. In addition, the lower rated bonds are not actively traded. Therefore, they are only suitable for those who can afford to hold them for relatively long periods. The limited competition for unrated and non-investment grade rated subordinated CMBS has given us significant bargaining power with sponsors of CMBS, including the ability to convince sponsors to remove loans from CMBS pools which we believe are too risky.

 

10


 

At November 30, 2002, we have investments in or were entitled to be the special servicer with regard to 103 securitized commercial mortgage pools represented by over 13,600 underlying loans in all 50 states. We have investments in subordinated CMBS related to 86 of these pools. At November 30, 2002, the total face amount of our directly owned portfolio was approximately $2.1 billion with an amortized cost of approximately $0.9 billion, or approximately $1.2 billion of discount. Our fixed-rate portfolio is generating a current cash return of 15% (28% on the unrated bonds).

 

Particularly in periods of falling interest rates, there often are prepayments of mortgages underlying CMBS; however, most fixed-rate transactions have call protections that make prepayments expensive and difficult. Because we usually purchase CMBS at significant discounts from their face amounts, prepayments, which do occur, increase our yield on invested capital.

 

Our CMBS investments are collateralized by pools of mortgage loans on commercial and multi-family residential real estate assets located across the country. Concentrations of credit risk with respect to these securities are limited due to the diversity of the underlying loans across geographical areas and diversity among property types.

 

In 2002, we entered into our first CMBS transaction in Europe, purchasing $8.4 million face value of BB-rated bonds backed by collateral located in the United Kingdom for $5.7 million.

 

Resecuritizations

 

We have resecuritized and may continue to resecuritize our non-investment grade CMBS investments in order to realize the value we add to these bonds and to better match our assets and liabilities, reduce our interest rate and refinancing risk, improve our liquidity position and strengthen our financial condition. Over the past several years, we have been acquiring non-investment grade CMBS, and have been able to remove what we consider to be the riskiest assets before the underlying securitizations take place. Utilizing our due diligence expertise to remove risky assets, by re-underwriting each and every property that backs each loan in a transaction, we have been able to add substantial value to the non-investment grade bonds that we buy. In addition, our workout and hands-on real estate expertise as special servicer for each transaction, has enabled these investments to perform exceptionally well. Taking into account the diversification, the quality of the collateral and our involvement in the transaction, rating agencies have rated a significant portion of the face amount of the non-investment grade bonds we resecuritized as investment grade. We can then sell the investment grade bonds to unrelated third parties to realize the added value and to recycle the proceeds to further strengthen our balance sheet.

 

Madison Square Company LLC

 

In March 1999, we entered into a venture, Madison Square Company LLC (“Madison”), to acquire approximately $2.2 billion of high yielding real estate related assets (primarily CMBS). The members include an affiliate of Credit Suisse First Boston (“CSFB”), a company controlled by real estate investor Peter Bren and Sun America Life Insurance Co. The members have total equity commitments of $490 million, $125 million of which we provided.

 

CSFB provided a credit facility to fund up to $1.76 billion of financing to the venture, which is non-recourse to the members.

 

At November 30, 2002, our investment in the venture was approximately $95.8 million, representing a 25.8% ownership interest. We maintain a significant ongoing role in the venture, for which we earn fees, both as the special servicer for the purchased CMBS transactions and as the provider of management services. We also have an effective veto on Madison’s investment decisions.

 

Competition

 

In virtually all aspects of our activities, we compete with a variety of public and private real estate development companies, real estate investment trusts, investment firms, investment funds, financial institutions and others. The principal area of competition is for the purchase of real estate assets and securities at prices which we believe will enable us to achieve our desired risk-adjusted returns.

 

11


 

We believe that our access to investment opportunities through our relationships and presence in markets across the country and Europe, our access to capital for real estate assets, our ability to quickly underwrite and evaluate those opportunities and our expertise in real estate workout and management help us to compete effectively in the purchase of those types of assets. In addition, our experience in adding value to real estate assets and our top rating as a special servicer to CMBS transactions often attract firms which have access to appealing investment opportunities but who do not have our expertise.

 

We believe it is an opportune time for us to expand our franchise into Europe as there is little competition there with the specific value-add real estate and asset management expertise that we have. We see opportunity there in the private to public migration of real estate, and there is an emerging CMBS and B-note business in the European financial markets.

 

Competitive conditions relating to office buildings, apartment communities, industrial/warehouse facilities, hotels and retail centers owned or operated by us vary depending on the locations of particular properties. Most often these facilities compete for tenants or other occupants based on their locations, the facilities provided and the pricing of the leases or room rates. Although general economic conditions continued to weaken in 2002, occupancies remained stable in many of our markets, which helped to reduce the effects of competition on existing properties.

 

We are not a significant national competitor with regard to any of the properties we own. We are a significant national participant in the market for unrated and non-investment grade rated subordinated CMBS.

 

Investment Company Act

 

We intend to conduct our business at all times so as not to become regulated as an investment company under the Investment Company Act of 1940. Accordingly, we do not expect to be subject to the restrictive provisions of the Investment Company Act. Under the Investment Company Act, an investment company is subject to extensive, restrictive and potentially adverse regulation relating to, among other things, operating methods, management, capital structure, dividends, and transactions with affiliates. The Investment Company Act exempts, among others, entities that are “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate” (“Qualifying Interests”). Under the current interpretation of the staff of the Securities and Exchange Commission, to qualify for this exemption, the entity must maintain at least 55% of its assets in Qualifying Interests, and maintain an additional 25% in Qualifying Interests or other real estate related assets. Our investments in real estate and mortgage loans generally constitute Qualifying Interests and we believe our investments in subordinated CMBS constitute Qualifying Interests when we have the right, as special servicer, to foreclose upon properties which secure loans that back the CMBS and to take the other actions a special servicer may take in connection with defaulted loans. Analysis of our assets at November 30, 2002 indicated that (i) more than 55% of our assets were Qualifying Interests and (ii) more than 80% of our assets were Qualifying Interests and other real estate related assets. Therefore, we qualify for this exemption. If, however, due to a change in our assets, or a change in the value of particular assets, we were to become an investment company which is not exempt from the Investment Company Act, either we would have to restructure our assets so we would not be subject to the Investment Company Act, or we would have to change materially the way we conduct our activities. Either of these changes could require us to sell substantial portions of our assets at a time we might not otherwise want to do so, and we could incur significant losses as a result. Further, in order to avoid becoming subject to the requirements of the Investment Company Act, we may be required at times to forego investments we would like to make or otherwise to act in a manner other than that which we believe would maximize our earnings.

 

Regulation

 

Commercial properties we own or partnerships in which we participate must comply with a variety of state and local regulations relating to, among other things, zoning, treatment of waste, construction materials which must be used and some aspects of building design.

 

In our loan workout activities, we sometimes are required to comply with federal and state laws designed to protect debtors against overbearing loan collection techniques. However, most laws of this type apply to consumer level loans (including home mortgages), but do not apply to commercial loans.

 

Our hotels have to be licensed to conduct various aspects of their businesses, including sales of alcoholic beverages.

 

12


 

Employees

 

At November 30, 2002, we had 514 full time and 4 part time employees, of whom 10 were senior management, 83 were corporate staff, 316 were engaged in asset acquisitions, loan workouts and rehabilitation and disposition of properties, and 109 were hotel personnel.

 

None of our employees are represented by a union. We believe our relationships with our employees are good.

 

Some Things Which Could Adversely Affect Us

 

Virtually all of our assets are interests in real estate properties or in financial instruments which are directly or indirectly secured by real estate properties. Because of that, there are some market-driven factors which can significantly affect us, our results of operations and the value of our assets.

 

We could be affected by changes in real estate markets.

 

Prices of real estate, and in particular commercial real estate, tend to fluctuate significantly over time. To some extent this is due to changes in interest rates. However, it can also result from changes in economic conditions, either internationally, nationally or regionally, which affect demand for commercial space, excess capacity created by over-building, changes in tax laws or environmental laws and a variety of other factors. Historically, we have looked upon weak real estate markets as opportunities to acquire at low cost properties which we can enhance and sell when real estate markets strengthen. However, as our portfolio of real estate properties and real estate related securities has increased, we have become increasingly vulnerable to the negative effect weak real estate markets could have on the values of assets we already hold.

 

Weak real estate markets also increase the likelihood of defaults on mortgages, and make it more difficult to sell foreclosed properties for at least the amounts owed on the mortgages they secure. An increase in the rate of mortgage defaults could affect amounts we can realize on the mortgage loans and CMBS we hold.

 

Beginning in mid-2002, there has been a substantial increase in vacant commercial space (including office and retail space) and vacant multi-family residential apartments in a number of cities, including several in which we own properties or in which we have properties securing mortgage loans or CMBS in which we own interests. Weakness in commercial properties and apartment rentals (i) can reduce our operating income from properties we own, (ii) can adversely affect mortgagees’ abilities to make required payments with regard to mortgages underlying B-notes or CMBS in which we own interests, and (iii) could reduce the price at which properties we own can be sold. To date, the sale value of commercial and multi-family residential properties does not appear to have been significantly affected by the weakened rental markets, in part because of low interest rates, which have reduced expenses of operating properties and have reduced the yields potential purchasers of properties are seeking. However, prolonged weakness in the rental markets could have a significant negative impact on us.

 

We are sensitive to changes in interest rates.

 

Most financial instruments we own bear interest at fixed rates, or derive their value from mortgages or other instruments which bear interest at fixed rates. The values of fixed-rate financial instruments are affected significantly by changes in market interest rates (generally falling when market interest rates are high and increasing when market interest rates are low). Further, the value of real estate itself tends to be significantly affected by changes in interest rates, generally increasing when interest rates are low and declining when interest rates are high. Because we invest in financial instruments with an intention to hold some of them at least for most of their lives, and invest in real estate properties with the intention of holding them long enough to enhance their value by developing or repositioning them, our ability to achieve our investment goals is not substantially affected by short-term changes in interest rates. Further, we try to prevent short-term changes in interest rates from materially affecting our financial statements by purchasing derivatives, such as interest rate swaps, to hedge against interest rate changes. However, relatively long lasting changes in interest rates could significantly affect the value of our assets.

 

We borrow substantial portions of the funds we invest in our assets. Most of the borrowings bear interest at variable rates, and therefore our actual interest costs are affected by increases or decreases in market interest rates. We minimize exposure to these changes by acquiring interest rate swaps which have the effect of converting our variable-rate obligations into fixed-rate obligations. However, we continue to be exposed to risks of interest rate changes to the extent that our hedges do not cover all of our borrowings or to the extent counterparties to interest rate swaps might become unable to meet their obligations to us.

 

13


 

We may have difficulty obtaining financing.

 

Weak real estate markets not only affect the prices for which real estate properties can be purchased or sold, but they also affect the availability of financing for real estate investments. During weak real estate markets, lenders are reluctant to make or to renew loans secured by real estate or real estate related securities. Therefore, even if we would like to be purchasing properties or real estate related securities during weak markets, we may have difficulty obtaining the funds with which to do this.

 

We may have difficulty disposing of assets when we have to do so.

 

Our basic investment strategy is to hold real estate assets until we believe it is an optimal time to sell them. Normally, this will be during relatively strong real estate markets. However, factors beyond our control could make it necessary for us to dispose of real estate properties or real estate related securities in a weaker economic environment. For example, we finance many of our CMBS purchases with reverse repurchase obligations which often require that, if the market value of the CMBS falls below specified percentages of the outstanding indebtedness, we must provide additional collateral, reduce the loan balance or liquidate the CMBS position. Therefore, in a period when the market value of our CMBS falls significantly, we could be required (i) to pay down debt with cash flow we need for our business, (ii) to provide additional collateral for the reverse repurchase obligations, or (iii) to sell CMBS at a time when it may be very inopportune for us to do so. Further, markets for many types of real estate related assets are not highly liquid, which can make it particularly difficult to realize acceptable prices when disposing of large quantities of assets during weak markets.

 

We have controlling stockholders

 

We have two classes of stock: common stock, which is entitled to one vote per share, and Class B common stock, which is entitled to ten votes per share. Trusts for the benefit of the family of the late Leonard Miller, which includes Stuart Miller, the Chairman of our Board, indirectly own most of the Class B common stock, and Stuart Miller owns almost all the rest of the Class B common stock. Stuart Miller has the power to direct the voting of the Class B common stock owned by the Miller family trusts, and therefore has the power to cast approximately 81.6% of the combined votes that can be cast by the holders of the common stock and the Class B common stock. That gives Mr. Miller the power to elect all our directors and to approve most matters that are presented to our stockholders, even if no other stockholders vote in favor of them. The Miller family’s ownership might discourage someone from making a significant equity investment in us, even if we needed the investment to meet our obligations or to operate our business.

 

Access to Company Information

 

We electronically file our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K with the Securities and Exchange Commission (the “SEC”). The public may read and copy any of the reports that are filed with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

 

We make available, free of charge, through our website, and by responding to requests addressed to our investor relations department, the annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. These reports are available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Our website address is: http://www.lnrproperty.com. The information contained on our website is not part of this document.

 

Item 2.    Properties.

 

For information about properties we own for use in our commercial activities, see Item 1.

 

We maintain our principal executive offices and our Miami operations at 1601 Washington Avenue, Suite 800, Miami Beach, Florida, in a building that we own. We have additional office space for the rest of our operations in various other office buildings we own (1 office) and lease (6 offices).

 

Item 3.    Legal Proceedings.

 

We are not subject to any legal proceedings other than suits in the ordinary course of our business, most of which are covered by insurance. We believe these suits will not, individually or in the aggregate, have a material adverse effect upon us.

 

Item 4.    Submission of Matters to a Vote of Security Holders.

 

No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2002.

 

14


PART II

 

Item 5.    Market for the Registrant’s Common Stock and Related Security Holder Matters.

 

Our common stock currently is listed on the New York Stock Exchange under the symbol LNR. The following table sets forth the range of the high and low closing prices reported on the New York Stock Exchange composite tape for each fiscal period indicated.

 

    

High


  

Low


    

2002


First Quarter

  

$

33.80

  

$

28.00

Second Quarter

  

$

38.38

  

$

33.25

Third Quarter

  

$

35.68

  

$

27.75

Fourth Quarter

  

$

36.60

  

$

32.82

    

2001


First Quarter

  

$

30.25

  

$

20.63

Second Quarter

  

$

32.85

  

$

25.50

Third Quarter

  

$

35.26

  

$

31.04

Fourth Quarter

  

$

33.45

  

$

26.45

 

At February 14, 2003, there were approximately 6,300 holders of record of our common stock. During each of the four quarters in 2002 and 2001, we declared and paid cash dividends of $.0125 per common share and $.01125 per Class B common share.

 

Item 6.    Selected Financial Data.

 

The following table contains selected consolidated financial information about us. The selected financial data should be read in conjunction with the consolidated financial statements, the notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K.

 

    

Years Ended November 30,


 
    

2002


    

2001


    

2000


    

1999


    

1998


 
    

(In thousands, except per share amounts)

 

Results of Operations

                                    

Revenues:

                                    

Real estate properties

  

$

202,014

 

  

211,240

 

  

215,828

 

  

195,202

 

  

149,428

 

Real estate loans

  

 

44,848

 

  

52,150

 

  

80,507

 

  

45,483

 

  

43,056

 

Real estate securities

  

 

225,206

 

  

214,290

 

  

176,435

 

  

107,315

 

  

58,273

 

    


  

  

  

  

Total revenues

  

$

472,068

 

  

477,680

 

  

472,770

 

  

348,000

 

  

250,757

 

    


  

  

  

  

Interest expense

  

$

96,610

 

  

110,494

 

  

121,487

 

  

83,909

 

  

53,850

 

Net earnings

  

$

143,878

 

  

135,113

 

  

115,871

 

  

95,560

 

  

73,323

 

Per share amounts:

                                    

Earnings—basic

  

$

4.30

 

  

4.05

 

  

3.46

 

  

2.68

 

  

2.04

 

Earnings—diluted

  

$

4.15

 

  

3.87

 

  

3.32

 

  

2.63

 

  

2.02

 

Cash dividends—common stock

  

$

0.05

 

  

0.05

 

  

0.05

 

  

0.05

 

  

0.05

 

Cash dividends—Class B common stock

  

$

0.045

 

  

0.045

 

  

0.045

 

  

0.045

 

  

0.045

 

Financial Data

                                    

EBITDA(1)

  

$

340,414

 

  

347,332

 

  

329,246

 

  

242,964

 

  

174,700

 

Ratio of earnings to fixed charges

  

 

3.3

x

  

2.7

x

  

2.2

x

  

2.2

x

  

2.9

x

Cash flows provided by (used in):

                                    

Operating activities

  

$

69,590

 

  

115,207

 

  

114,113

 

  

107,356

 

  

87,882

 

Investing activities

  

$

64,915

 

  

(83,143

)

  

(146,269

)

  

(404,415

)

  

(524,946

)

Financing activities

  

$

(135,372

)

  

(27,472

)

  

25,555

 

  

277,229

 

  

431,422

 

 

15


    

As of November 30,


    

2002


  

2001


  

2000


  

1999


  

1998


    

(In thousands, except per share amounts)

Financial Position

                          

Total assets

  

$

2,834,874

  

2,836,647

  

2,348,856

  

2,283,001

  

1,743,805

Assets by business segment

                          

Real estate properties

  

$

1,123,214

  

1,037,098

  

1,153,608

  

1,290,149

  

1,006,621

Real estate loans

  

$

441,652

  

398,614

  

314,162

  

274,694

  

214,494

Real estate securities

  

$

1,248,709

  

1,355,923

  

826,092

  

640,791

  

465,514

Total debt

  

$

1,485,464

  

1,417,207

  

1,404,374

  

1,403,401

  

1,017,199

Stockholders’ equity

  

$

1,126,156

  

1,119,169

  

778,444

  

710,332

  

618,979

Stockholders’ equity per share

  

$

34.15

  

32.54

  

22.75

  

20.18

  

17.39

Shares outstanding:

                          

Common stock

  

 

23,189

  

24,445

  

24,215

  

25,142

  

24,852

Class B common stock

  

 

9,784

  

9,949

  

9,999

  

10,058

  

10,748

    

  
  
  
  

Total

  

 

32,973

  

34,394

  

34,214

  

35,200

  

35,600

    

  
  
  
  

 

(1)   EBITDA is defined as earnings before interest, taxes, depreciation and amortization and is calculated as follows:

 

    

Years Ended November 30,


    

2002


  

2001


  

2000


  

1999


  

1998


    

(In thousands)

Net earnings

  

$

143,878

  

135,113

  

115,871

  

95,560

  

73,323

Add back:

                          

Income tax expense

  

 

69,275

  

71,230

  

52,057

  

35,340

  

34,223

Interest expense

  

 

96,610

  

110,494

  

121,487

  

83,909

  

53,850

Depreciation expense

  

 

24,986

  

25,267

  

36,138

  

27,393

  

13,014

Amortization expense

  

 

5,665

  

5,228

  

3,693

  

762

  

290

    

  
  
  
  

EBITDA

  

$

340,414

  

347,332

  

329,246

  

242,964

  

174,700

    

  
  
  
  

We consider EBITDA a supplemental measure for making decisions and believe it provides relevant information about our operations and our ability to service debt, to make investments and to fund other items as needed and, along with net earnings, is useful in understanding our operating results. Because of the nature of our business, we believe net earnings is the measure of financial performance, calculated in accordance with generally accepted accounting principles, that is most nearly comparable to EBITDA. EBITDA should not be interpreted as an alternative measure of net earnings or cash flows from operating activities, both as determined in accordance with generally accepted accounting principles. Additionally, EBITDA is not necessarily indicative of cash available to fund cash needs. Trends or changes in items excluded from EBITDA (including income tax expense, interest expense, depreciation expense and amortization expense) are not captured in EBITDA. These excluded items must also be considered when assessing or understanding our financial performance. EBITDA as calculated by us may not be comparable to similarly titled measures employed by other companies.

 

16


Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

SOME OF THE STATEMENTS CONTAINED IN THE FOLLOWING MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ARE “FORWARD LOOKING STATEMENTS” AS THAT TERM IS DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. GENERALLY, THE WORDS “BELIEVE,” “EXPECT,” “INTEND,” “ANTICIPATE,” “WILL,” “MAY” AND SIMILAR EXPRESSIONS IDENTIFY FORWARD LOOKING STATEMENTS. FORWARD LOOKING STATEMENTS INHERENTLY INVOLVE RISKS AND UNCERTAINTIES. THE FACTORS, AMONG OTHERS, THAT COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THE FORWARD LOOKING STATEMENTS IN THIS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INCLUDE, BUT ARE NOT LIMITED TO (I) CHANGES IN DEMAND FOR COMMERCIAL REAL ESTATE NATIONALLY, IN AREAS IN WHICH WE OWN PROPERTIES, OR IN AREAS IN WHICH PROPERTIES SECURING MORTGAGES DIRECTLY OR INDIRECTLY OWNED BY US ARE LOCATED, (II) INTERNATIONAL, NATIONAL OR REGIONAL BUSINESS CONDITIONS WHICH AFFECT THE ABILITY OF MORTGAGE OBLIGORS TO PAY PRINCIPAL OR INTEREST WHEN IT IS DUE, (III) THE CYCLICAL NATURE OF THE COMMERCIAL REAL ESTATE BUSINESS, (IV) CHANGES IN INTEREST RATES, (V) CHANGES IN THE MARKET FOR VARIOUS TYPES OF REAL ESTATE BASED SECURITIES, (VI) CHANGES IN AVAILABILITY OF CAPITAL OR THE TERMS ON WHICH IT IS AVAILABLE, (VII) CHANGES IN AVAILABILITY OF QUALIFIED PERSONNEL AND (VIII) CHANGES IN GOVERNMENT REGULATIONS, INCLUDING, WITHOUT LIMITATION, ENVIRONMENTAL REGULATIONS.

 

OVERVIEW

 

LNR Property Corporation is a real estate investment, finance and management company. We engage primarily in (i) acquiring, developing, repositioning, managing and selling commercial and multi-family residential real estate properties, (ii) investing in high-yielding real estate loans and acquiring at a discount portfolios of loans backed by commercial or multi-family residential real estate and (iii) investing in unrated and non-investment grade rated commercial mortgage-backed securities (“CMBS”) as to which we have the right to be special servicer (i.e., to oversee workouts of underperforming and non-performing loans). For the following discussion, these businesses are grouped as follows: (a) real estate properties, (b) real estate loans and (c) real estate securities.

 

17


 

The following is a summary of our results of operations for the years ended November 30, 2002, 2001 and 2000 after allocating among the core business segments certain non-corporate general and administrative expenses:

 

    

2002


    

2001


    

2000


 
    

(In thousands)

 

Revenues:

                      

Real estate properties

  

$

202,014

 

  

211,240

 

  

215,828

 

Real estate loans

  

 

44,848

 

  

52,150

 

  

80,507

 

Real estate securities

  

 

225,206

 

  

214,290

 

  

176,435

 

    


  

  

Total revenues

  

 

472,068

 

  

477,680

 

  

472,770

 

    


  

  

Operating expenses:

                      

Real estate properties

  

 

110,759

 

  

114,150

 

  

137,296

 

Real estate loans

  

 

5,614

 

  

7,399

 

  

9,060

 

Real estate securities

  

 

20,590

 

  

15,271

 

  

11,777

 

Corporate and other

  

 

25,342

 

  

24,023

 

  

25,222

 

    


  

  

Total operating expenses

  

 

162,305

 

  

160,843

 

  

183,355

 

    


  

  

Operating earnings:

                      

Real estate properties

  

 

91,255

 

  

97,090

 

  

78,532

 

Real estate loans

  

 

39,234

 

  

44,751

 

  

71,447

 

Real estate securities

  

 

204,616

 

  

199,019

 

  

164,658

 

Corporate and other

  

 

(25,342

)

  

(24,023

)

  

(25,222

)

    


  

  

Total operating earnings

  

 

309,763

 

  

316,837

 

  

289,415

 

    


  

  

Interest expense

  

 

96,610

 

  

110,494

 

  

121,487

 

Income tax expense

  

 

69,275

 

  

71,230

 

  

52,057

 

    


  

  

Net earnings

  

$

143,878

 

  

135,113

 

  

115,871

 

    


  

  

 

RESULTS OF OPERATIONS

 

Year ended November 30, 2002 compared to year ended November 30, 2001

 

Net earnings for the year ended November 30, 2002 were $143.9 million, a 7% increase over prior year net earnings of $135.1 million. Diluted earnings per share for the year ended November 30, 2002 were $4.15, a 7% increase over prior year diluted earnings per share of $3.87. The increase in earnings was primarily due to (i) a higher level of gains on asset sales primarily due to a $45.6 million pre-tax gain recognized on the sale of non-investment grade CMBS through a resecuritization transaction, (ii) a decrease in interest expense primarily due to lower interest rates, and (iii) an increase in net rents (rental income less cost of rental operations), reflecting the contribution to net rents from our development and repositioned properties which are now stabilized or completed and have tenants that are starting to pay rent. These increases were partially offset by (i) a decrease in equity in earnings of unconsolidated partnerships, primarily due to lower earnings from Madison Square Company LLC (“Madison”) (see Real Estate Securities segment below) and (ii) a decrease in management and servicing fees.

 

Overall, total revenues remained relatively flat, decreasing 1% in 2002, compared to 2001. This was primarily due to a decrease in equity in earnings of unconsolidated partnerships as discussed above, offset in part by higher gains on sales of assets.

 

Operating earnings were generated from our three main business segments in the following proportions: 27% from real estate properties, 12% from real estate loans and 61% from real estate securities. This compares with 29%, 13% and 58%, respectively, for the prior year. The shift in the percentage related to real estate properties from 2001 to 2002 was primarily the result of lower gains on sales of real estate property assets, offset in part by higher net rents and an increase in equity in earnings of unconsolidated partnerships. The increase in the percentage related to real estate securities from 2001 to 2002 was primarily due to higher gains on sales of CMBS and interest income, offset in part by lower equity in earnings of unconsolidated partnership investments and higher operating expenses.

 

18


 

Year ended November 30, 2001 compared to year ended November 30, 2000

 

Net earnings for the year ended November 30, 2001 were $135.1 million, a 17% increase over prior year net earnings of $115.9 million. Diluted earnings per share for the year ended November 30, 2001 were $3.87, a 17% increase over prior year diluted earnings per share of $3.32. The increase in earnings was primarily due to (i) an increase in interest income and servicing fees derived from our growing CMBS portfolio, (ii) an increase in interest income from our mortgage loan portfolio, (iii) a decrease in depreciation expense primarily due to the timing of stabilized property sales relative to new stabilized properties coming on line in 2001 and (iv) a decrease in interest expense due primarily to lower interest rates. These increases were partially offset by (i) a decrease in equity in earnings of unconsolidated partnerships from both our domestic and Japanese discount loan portfolio businesses, (ii) a decrease in net rents, primarily due to the timing of stabilized property sales relative to new properties coming on line in 2001 and (iii) an increase in general and administrative expenses from our growing business segments.

 

Overall, total revenues remained relatively flat, increasing 1% in 2001, compared to 2000. This was primarily due to the timing of asset sales, reduced interest income on variable-rate assets and a shift in the mix of our investments. Lower interest income is related to transactions that are match-funded with variable-rate debt, and therefore had minimal impact on net earnings. The shift in the mix of investments relates primarily to moving investment dollars to asset classes that are currently yielding higher margins such as loans and securities.

 

Operating earnings were generated from our three main business segments in the following proportions: 29% from real estate properties, 13% from real estate loans and 58% from real estate securities. This compares with 25%, 23% and 52%, respectively, for the prior year. The shift in these percentages from 2000 to 2001 was primarily the result of higher gains from the sales of real estate in 2001, the gain on sale of our interests in Japanese real estate loan portfolios in 2000 and higher earnings in 2001 from our growing CMBS portfolio.

 

Real Estate Properties

 

    

2002


  

2001


  

2000


    

(In thousands)

Rental income

  

$

115,426

  

111,669

  

139,264

Equity in earnings of unconsolidated partnerships

  

 

29,383

  

25,796

  

30,810

Interest income

  

 

1,571

  

2,017

  

1,050

Gains on sales of real estate

  

 

48,088

  

63,535

  

38,522

Gains on sales of unconsolidated partnership interests

  

 

3,428

  

746

  

3,335

Management fees

  

 

4,042

  

7,477

  

2,847

Other, net

  

 

76

  

—  

  

—  

    

  
  

Total revenues

  

 

202,014

  

211,240

  

215,828

    

  
  

Cost of rental operations

  

 

58,816

  

58,642

  

78,682

Other operating expenses(1)

  

 

26,860

  

29,998

  

22,052

Depreciation

  

 

24,986

  

25,267

  

36,138

Minority interests

  

 

97

  

243

  

424

    

  
  

Total operating expenses(1)

  

 

110,759

  

114,150

  

137,296

    

  
  

Operating earnings

  

$

91,255

  

97,090

  

78,532

    

  
  

Balance sheet data:

                

Operating properties and equipment, net

  

$

765,627

  

719,662

  

818,486

Land held for investment

  

 

56,980

  

42,229

  

52,969

Investments in unconsolidated partnerships

  

 

250,351

  

226,708

  

234,219

Other assets

  

 

50,256

  

48,499

  

47,934

    

  
  

Total segment assets

  

$

1,123,214

  

1,037,098

  

1,153,608

    

  
  

(1)   Operating expenses do not include interest expense.

 

Real estate properties include office buildings, rental apartment communities (market-rate and affordable housing communities, substantially all of which qualify for Low-Income Housing Tax Credits under Section 42 of the Internal Revenue Code), industrial/warehouse facilities, hotels, retail centers and land that we acquire and

 

19


develop, redevelop or reposition. These properties may be wholly-owned or owned through partnerships that are either consolidated or accounted for by the equity method, and therefore reflected on our balance sheet only as an investment in unconsolidated partnerships. Real estate properties also include our 50% interest in Lennar Land Partners (“LLP”), a non-consolidated partnership accounted for under the equity method which is engaged in the acquisition, development and sale of land, and our interest in an unconsolidated partnership that has investments in properties in Europe. Total revenues from real estate properties include rental income from operating properties, equity in earnings of unconsolidated partnerships that own and operate real estate properties, gains on sales of properties or those unconsolidated partnership interests, and fees earned from managing those partnerships. Operating expenses include the direct costs of operating the real estate properties, the related depreciation and the overhead associated with managing the properties and managing some of the partnerships.

 

We continued to take advantage of the strong investor demand for high quality properties, selling a number of matured assets during 2002. Despite those sales, net rents have continued to grow as properties that were previously under development or repositioning are now stabilized or completed and tenants have started paying rent. For the past two years, we have initiated very few new development or repositioning projects, focusing instead on completing and leasing up our existing portfolio. As of November 30, 2002, approximately 49% of our remaining property portfolio is still undergoing development or repositioning, the majority of which has already been pre-leased.

 

We also entered the European commercial real estate market by investing in a portfolio of real estate properties in the second quarter of 2002 through an unconsolidated partnership with CDC Ixis Capital Markets.

 

Year ended November 30, 2002 compared to year ended November 30, 2001

 

Overall, operating earnings from real estate properties were $91.3 million for the year ended November 30, 2002, compared to $97.1 million in 2001. This decrease was primarily due to lower gains on sales of real estate property assets, offset in part by higher net rents and an increase in equity in earnings of unconsolidated partnerships.

 

Total rental income increased to $115.4 million in 2002 from $111.7 million in 2001. The increase in rental income was primarily due to the contribution from development and repositioning properties that are now stabilized or completed and have some tenants that are starting to pay rent. In 2002 and 2001, respectively, rental income consisted of $84.9 million and $82.5 million from commercial properties (office, industrial/warehouse and retail), $5.8 million and $2.0 million from market-rate rental apartment communities, $10.3 million and $12.5 million from affordable housing communities, and $14.4 million and $14.7 million from hotels and other properties. Cost of rental operations were $58.8 million for the year ended November 30, 2002, relatively flat compared to 2001.

 

Equity in earnings of unconsolidated partnerships increased to $29.4 million in 2002 from $25.8 million in 2001, primarily due to higher earnings from LLP and earnings from our European investment. LLP primarily sells land to homebuilders, including Lennar, our former parent company and our partner in LLP. Equity in earnings from LLP may vary from period to period depending on the timing of housing starts. These increases in earnings, relating to LLP and our European investment, were partially offset by lower gains from sales of assets held by our domestic partnerships and a decrease in equity in earnings associated with our investments in affordable housing partnerships.

 

Gains on sales of real estate and unconsolidated partnership interests decreased to $51.5 million in 2002 from $64.3 million in 2001. Gains on sales of real estate in 2002 include $39.4 million from sales of stabilized market-rate operating properties, $8.1 million from sales of land, $3.4 million from the sale of interests in unconsolidated partnerships and $0.6 million from syndications of affordable housing communities, as compared to $51.5 million, $8.8 million, $0.8 million and $3.2 million, respectively, in 2001. Gains on sales of real estate fluctuate from period to period based on the timing of asset sales.

 

20


 

The net book value of operating properties and equipment with regard to various types of properties we own at November 30, 2002, together with the yield and the occupancy for the stabilized operating properties follows:

 

    

Net Book Value


  

Occupancy Rate(1)


    

Yield on Net

Book Value(2)


    

(In thousands, except percentages)

Market-rate operating properties

                  

Stabilized operating properties:

                  

Office

  

$

249,306

  

93%

    

13%

Retail

  

 

14,088

  

90%

    

15%

Industrial/warehouse

  

 

52,634

  

100%

    

14%

Ground leases

  

 

11,073

  

100%

    

19%

    

  
    

Commercial

  

 

327,101

  

97%

    

14%

Hotel

  

 

16,121

  

45%

    

4%

    

         
    

 

343,222

         

13%

    

           

Under development or repositioning:

                  

Office

  

 

220,540

           

Retail

  

 

62,555

           
    

           

Commercial

  

 

283,095

           

Hotel

  

 

55,699

           
    

           
    

 

338,794

           
    

           

Total market-rate operating properties

  

 

682,016

           
    

           

Affordable housing communities

  

 

68,668

           

Furniture, fixtures and equipment

  

 

14,943

           
    

           

Total

  

$

765,627

           
    

           

(1)   Occupancy rate at November 30, 2002
(2)   Yield for purposes of this schedule is rental income less cost of rental operations before commissions and non-operating expenses for the year ended November 30, 2002.

 

As of November 30, 2002, approximately 50% of our market-rate operating properties, based on net book value, had reached stabilized occupancy levels and were yielding in total 13% on net book value.

 

Occupancy levels for our stabilized commercial real estate properties remained at 97% at the end of 2002 and at the end of 2001.

 

Approximately 50% of our market-rate properties are in various stages of development or redevelopment. Our investment in these properties decreased to $338.8 million at November 30, 2002, from $398.5 million at November 30, 2001, primarily reflecting the stabilization of several development/repositioning properties in 2002. These properties were yielding 4.2% on net book value at November 30, 2002, compared to 2.5% at November 30, 2001. The increased yield reflects a larger number of properties in this portfolio which have been completed and where some tenants are paying rent. These properties were over 50% pre-leased at November 30, 2002.

 

We entered the business of owning, developing and syndicating affordable housing communities in 1998. In this business, we create or enter into partnerships that hold interests in multi-family real estate properties that are eligible for affordable housing tax credits granted under Section 42 of the Internal Revenue Code. Initially our strategy was to retain the tax credits generated through owning the majority of the partnership interests in the affordable housing communities and then using those credits to reduce our overall effective tax rate. However, the demand for credits has since increased significantly and we found we could generate higher returns on our investment by selling the credits instead of using them. We therefore have shifted our strategy away from owning the majority of the partnership interests in the affordable housing communities toward syndicating those interests. After such syndications, we continue to hold a small interest (typically ranging from less than 1% to 10%) in these partnerships and provide certain limited guarantees to the investors. We may also continue to manage the communities and/or provide tax compliance and other services on behalf of the investors, for which we receive fees. As a result of the shift in strategy, our total investment in affordable housing communities, as well as the amount of tax credits we hold and utilize to reduce our tax rate, declined further in 2002. Pre-tax

 

21


operating margins for the affordable housing communities are generally lower than for market-rate rentals. However, we receive our desired yield from these investments after adding in (i) the impact of lower income taxes as a result of the tax credits and other related tax deductions and (ii) profits from sales of tax credits to others.

 

We follow the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 66, “Accounting for Sales of Real Estate,” when accounting for syndications of partnership interests related to affordable housing communities. Interests in these partnerships are sold either while the property is in development, or after it is fully developed and leased. The total proceeds from the sale of partnership interests related to fully developed properties are received at the time of sale, and therefore profit is recognized at that time to the extent that proceeds exceed our basis in the partnership interests sold plus any required reserves for guarantees. Proceeds from the sale of partnership interests related to properties in development may be subject to minor modification after the date of sale, because proceeds to be received generally depend on the amount of tax credits granted, which is only determined once the property is fully developed. Since the total proceeds to be received by us for these partnership interests are not definite at the date of sale, we apply the cost recovery method in accounting for these sales. Gains are recognized to the extent that cash receipts exceed our basis in the partnership interests sold plus any required reserves for guarantees.

 

We provide certain limited guarantees to the purchasers of these partnership interests. In accordance with Paragraph 25 of SFAS No. 66, we recognize profit as outlined above because our loss of profit from guarantees is limited by the terms of the sales contracts. In those instances where we provide operating guarantees that are of limited duration, the profit we recognize on sale is reduced by our expected exposure to loss, calculated in accordance with SFAS No. 66. In those instances where we provide non-operating guarantees, or provide operating guarantees for an extended duration, the profit we recognize on sale is reduced by our maximum exposure to loss as specified in the agreements, regardless of the likelihood that we will have to perform under these guarantees.

 

The net investment in our affordable housing communities at November 30, 2002 follows:

 

    

(In thousands)

 

Operating properties

  

$

68,668

 

Investments in unconsolidated partnerships

  

 

56,201

 

Debt and other

  

 

(53,341

)

    


Net investment in affordable housing communities

  

$

71,528

 

    


 

As of November 30, 2002, we had been awarded and held rights to approximately $90 million in gross tax credits, compared with $140 million at November 30, 2001. The decrease in tax credits primarily reflects the syndication of partnership interests, as well as the utilization of tax credits in 2002. Our net investment in affordable housing communities decreased by $10.8 million in 2002, which is not fully reflective of the value of the partnership interests sold. For syndications of affordable housing communities under development, we receive a substantial portion of the proceeds after the syndication occurs as the properties are completed and leased up. Our net investment is expected to decrease further as the properties in the syndicated partnerships are completed and leased up.

 

Year ended November 30, 2001 compared to year ended November 30, 2000

 

Overall, operating earnings from real estate properties were $97.1 million for the year ended November 30, 2001, compared to $78.5 million in 2000. This increase was primarily due to higher gains on sales of real estate, higher management fees and lower depreciation expense. These increases were partially offset by a decline in net rents, lower equity in earnings of unconsolidated partnerships, and higher other operating expenses.

 

Total rental income decreased to $111.7 million in 2001 from $139.3 million in 2000. In 2001 and 2000, respectively, rental income consisted of $82.5 million and $75.8 million from commercial properties (office, industrial/warehouse and retail), $2.0 million and $15.6 million from market-rate rental apartment communities, $12.5 million and $20.2 million from affordable housing communities, and $14.7 million and $27.7 million from hotels and other properties. Cost of rental operations decreased to $58.6 million for the year ended November 30, 2001 from $78.7 million in 2000. The decreases in rental income and cost of rental operations were primarily due to the timing of stabilized property sales relative to new stabilized properties coming on line in 2001.

 

22


 

Equity in earnings of unconsolidated partnerships decreased to $25.8 million in 2001 from $30.8 million in 2000, primarily due to lower earnings from LLP and a decrease in partnership earnings from our stabilized affordable housing partnerships, partially offset by partnership earnings from the sale of the properties held by two unconsolidated single-asset partnerships.

 

Gains on sales of real estate and unconsolidated partnership interests increased to $64.3 million in 2001 from $41.9 million in 2000. Gains on sales of real estate in 2001 included $51.5 million from sales of stabilized market-rate operating properties, $3.2 million from syndications of affordable housing communities, $8.8 million from sales of land and $0.8 million from the sale of investments in unconsolidated partnerships. Gains on sales of real estate fluctuate from period to period based on the timing of asset sales.

 

Management fees increased to $7.5 million in 2001 from $2.8 million in 2000. This increase was primarily due to developer and other fees we received for managing the properties for our partners.

 

Other operating expenses increased to $30.0 million in 2001 from $22.1 million in 2000. This increase was due to additional personnel and administrative costs necessary to support the growth in the overall real estate portfolio we manage, including wholly-owned real estate and real estate owned by unconsolidated partnerships.

 

Depreciation expense decreased to $25.3 million in 2001 from $36.1 million in 2000. Since we have not been replacing stabilized properties as quickly as they have been sold, this has resulted in a lower investment in stabilized operating properties and a corresponding lower depreciation expense.

 

The net book value of operating properties and equipment with regard to various types of properties we own at November 30, 2001, together with the yield and the occupancy for the stabilized operating properties follows:

 

    

Net Book Value


  

Occupancy Rate(1)


    

Yield on Net

Book Value(2)


    

(In thousands, except percentages)

Market-rate operating properties

                  

Stabilized operating properties:

                  

Office

  

$

167,737

  

94%

    

14%

Retail

  

 

15,791

  

94%

    

14%

Industrial/warehouse

  

 

49,312

  

100%

    

13%

Ground Leases

  

 

11,135

  

100%

    

19%

    

  
    

Commercial

  

 

243,975

  

97%

    

14%

Hotel

  

 

16,360

  

40%

    

8%

    

         
    

 

260,335

         

14%

    

           

Under development or repositioning:

                  

Office

  

 

256,160

           

Retail

  

 

32,900

           
    

           

Commercial

  

 

289,060

           

Multi-family

  

 

80,132

           

Hotel

  

 

29,290

           
    

           
    

 

398,482

           
    

           

Total market-rate operating properties

  

 

658,817

           
    

           

Affordable housing communities

  

 

55,843

           

Furniture, fixtures and equipment

  

 

5,002

           
    

           

Total

  

$

719,662

           
    

           

(1)   Occupancy rate at November 30, 2001
(2)   Yield for purposes of this schedule is rental income less cost of rental operations before commissions and non-operating expenses for the year ended November 30, 2001.

 

As of November 30, 2001, approximately 40% of our market-rate operating properties, based on net book value, had reached stabilized occupancy levels and were yielding in total 14% on net book value.

 

23


 

Hotel occupancy decreased from 59% at November 30, 2000 to 40% at November 30, 2001 on our two wholly-owned operating hotels primarily due to the tragic events of September 11, 2001 and general economic conditions. Both of these factors resulted in lower levels of occupancy in 2001 by a major customer at one of the wholly-owned operating hotels.

 

Our investment in market-rate properties under development or repositioning was $398.5 million at November 30, 2001, compared with $340.3 million at November 30, 2000. The increase primarily reflects continued expenditures on projects already under development at the beginning of 2001. These properties were yielding 2.5% on net book value at November 30, 2001, slightly higher than at November 30, 2000. These properties were over 50% pre-leased at November 30, 2001.

 

The net investment in our affordable housing communities at November 30, 2001 follows:

 

    

(In thousands)

 

Operating properties

  

$

55,843

 

Investments in unconsolidated partnerships

  

 

70,646

 

Debt and other

  

 

(44,170

)

    


Net investment in affordable housing communities

  

$

82,319

 

    


 

As of November 30, 2001, we had been awarded and held rights to approximately $140 million in gross tax credits, with approximately 60% relating to apartment communities that have not yet reached stabilized occupancy levels.

 

Real Estate Loans

 

    

2002


  

2001


  

2000


    

(In thousands)

Interest income

  

$

39,594

  

43,728

  

35,708

Equity in earnings of unconsolidated partnerships

  

 

3,861

  

4,554

  

19,370

Gains on sales of unconsolidated partnership interests

  

 

—  

  

—  

  

20,336

Management fees

  

 

1,347

  

3,732

  

4,656

Other, net

  

 

46

  

136

  

437

    

  
  

Total revenues

  

 

44,848

  

52,150

  

80,507

    

  
  

Operating expenses(1)

  

 

4,504

  

5,167

  

6,665

Minority interests

  

 

1,110

  

2,232

  

2,395

    

  
  

Total operating expenses(1)

  

 

5,614

  

7,399

  

9,060

    

  
  

Operating earnings

  

$

39,234

  

44,751

  

71,447

    

  
  

Balance sheet data:

                

Mortgage loans, net

  

$

430,255

  

331,517

  

243,987

Investments in unconsolidated partnerships

  

 

9,501

  

8,917

  

14,184

Other investments

  

 

—  

  

55,504

  

52,274

Other assets

  

 

1,896

  

2,676

  

3,717

    

  
  

Total segment assets

  

$

441,652

  

398,614

  

314,162

    

  
  

(1)   Operating expenses do not include interest expense.

 

Real estate loans include our direct investments in high yielding loans, as well as our domestic and foreign discount loan portfolio investments, owned primarily through unconsolidated partnerships, and related loan workout operations. Total revenues include interest income, equity in earnings of unconsolidated partnerships and management fees earned from those partnerships. Operating expenses include the overhead associated with servicing the loans and managing the partnerships.

 

Over the past three years, the majority of investing activity within the real estate loan segment has been in structured junior participations in short- to medium-term variable-rate real estate loans (“B-notes”), most of which represent participations in first mortgage loans. Most of our B-note investments are match-funded with variable-rate debt of similar term. To-date, we have not experienced any delinquencies in our B-note portfolio.

 

 

24


Year ended November 30, 2002 compared to year ended November 30, 2001

 

Operating earnings from real estate loans were $39.2 million for the year ended November 30, 2002, compared to $44.8 million in 2001. This decrease was primarily due to lower interest income and management fees.

 

Interest income decreased to $39.6 million for the year ended November 30, 2002 from $43.7 million in 2001. This decrease was partially due to $4.2 million of interest income realized in 2001 from the early payoff of a discounted mortgage loan and the impact during 2002 of lower interest rates on our variable-rate loans. These decreases were offset in part by a higher level of loan investments during 2002 compared with 2001.

 

During the year ended November 30, 2002, we funded ten new B-note investments for $142.5 million. Our B-note investments at November 30, 2002 totaled $378.4 million, net and had a face amount of $380.4 million. These investments contributed $26.3 million to interest income in 2002, compared to $24.8 million in 2001.

 

Management fees decreased to $1.3 million for the year ended November 30, 2002 from $3.7 million in 2001. This decrease was primarily due to fees earned in the first quarter of 2001 from the disposition of certain assets in one of our domestic discount loan portfolios.

 

Year ended November 30, 2001 compared to year ended November 30, 2000

 

Operating earnings from real estate loans were $44.8 million for the year ended November 30, 2001, compared to $71.4 million in 2000. This decrease was primarily due to the sale of our investment interests in our Japanese discount loan portfolios in 2000 and lower earnings from our domestic discount loan portfolio business. These decreases were partly offset by an increase in interest income.

 

Interest income increased to $43.7 million for the year ended November 30, 2001 from $35.7 million in 2000. Interest income primarily includes interest earned on B-notes. During the year ended November 30, 2001, we funded seven new B-note investments for $124.9 million. Our B-note investments at November 30, 2001 had a face amount of $244.0 million. These investments contributed $24.8 million to interest income in 2001, compared to $22.2 million in 2000. Interest income in 2001 also included $4.2 million from the early payoff of a discounted mortgage loan. These increases in interest income were partially offset by lower variable interest rates.

 

For the year ended November 30, 2001, equity in earnings of unconsolidated partnerships decreased to $4.6 million from $19.4 million in 2000. This decrease was due to a decline in earnings from our Japanese discount loan portfolios, which were sold in April 2000, and a decline in earnings from our domestic discount loan portfolios, as expected, due to the liquidation of most of the assets in these portfolios in prior periods.

 

Gains on sales of unconsolidated partnership interests in 2000 reflect the sale of our investment interests in our Japanese discount loan portfolios.

 

Operating expenses decreased to $5.2 million for the year ended November 30, 2001 from $6.7 million in 2000, primarily due to the sale of our Japanese discount loan portfolios in April 2000, partially offset by increased general and administrative expenses to support the growth in our mortgage loan portfolio.

 

25


 

Real Estate Securities

 

    

2002


    

2001


    

2000


    

(In thousands)

Interest income

  

$

139,654

 

  

135,594

 

  

110,988

Equity in earnings of unconsolidated partnerships

  

 

13,117

 

  

44,802

 

  

36,852

Gains on sales of investment securities

  

 

47,221

 

  

9,717

 

  

13,134

Management and servicing fees

  

 

26,593

 

  

25,131

 

  

15,461

Other, net

  

 

(1,379

)

  

(954

)

  

—  

    


  

  

Total revenues

  

 

225,206

 

  

214,290

 

  

176,435

    


  

  

Operating expenses(1)

  

 

20,575

 

  

15,210

 

  

10,797

Minority interests

  

 

15

 

  

61

 

  

980

    


  

  

Total operating expenses(1)

  

 

20,590

 

  

15,271

 

  

11,777

    


  

  

Operating earnings

  

$

204,616

 

  

199,019

 

  

164,658

    


  

  

Balance sheet data:

                    

Investment securities

  

$

1,127,313

 

  

1,215,121

 

  

696,402

Investments in unconsolidated partnerships

  

 

101,129

 

  

116,517

 

  

105,572

Other assets

  

 

20,267

 

  

24,285

 

  

24,118

    


  

  

Total segment assets

  

$

1,248,709

 

  

1,355,923

 

  

826,092

    


  

  

(1)   Operating expenses do not include interest expense.

 

Real estate securities include unrated and non-investment grade rated subordinated CMBS which are collateralized by pools of mortgage loans on commercial and multi-family residential real estate properties. It also includes our investment in Madison, as well as investments in entities in related businesses. Total revenues from real estate securities include primarily interest income, equity in the earnings of Madison, gains on sales of securities, servicing fees from acting as special servicer for CMBS transactions and fees earned from managing Madison. Operating expenses include the overhead associated with managing the investments and Madison and costs of the special servicing responsibilities.

 

Year ended November 30, 2002 compared to year ended November 30, 2001

 

Overall operating earnings from real estate securities increased to $204.6 million for the year ended November 30, 2002 from $199.0 million in 2001. Earnings were higher primarily due to a $45.6 million gain recognized on the sale of non-investment grade CMBS through a resecuritization transaction and an increase in interest income. These increases were partially offset by lower earnings from Madison and an increase in operating expenses.

 

For the year ended November 30, 2002, interest income increased $4.1 million, or 3% to $139.7 million, compared to the same period in 2001, primarily due to greater recognition of earnings as actual CMBS performance continued to exceed expectations as well as a higher average level of CMBS investments during the year, offset in part by lower interest rates.

 

In recording CMBS interest income, we recognize the amount by which cash flows over the life of a security are expected to exceed our initial investment as interest income to achieve a level yield. To date, this has resulted in less recognition of interest income than the amount of interest actually received. The excess interest received is applied to reduce our CMBS investment. Our initial and ongoing estimates of cash flows from CMBS investments are based on a number of assumptions that are subject to various business and economic factors. Changes in cash flow estimates could materially affect the interest income that is recognized in future periods, the most significant of which is the timing and magnitude of credit losses on the underlying mortgages.

 

Since we invest in subordinated classes of CMBS, we generally do not receive principal payments until the principal of the senior classes of that issue are paid in full. However, we have already begun to receive principal payments from 15 classes of our CMBS securities, and 22 classes (excluding securities sold in the resecuritization transaction described below) have reached economic maturity either through the collection of principal, liquidation of the trust, or sale. Through the resecuritization transaction described below, an additional 18 classes of securities and portions of 116 other classes were also sold. Actual loss experience to date,

 

26


particularly for older transactions (3 to 9 years in age), is significantly lower than we originally underwrote. Therefore, changes to original estimated yields have resulted in improved earnings from these transactions. We believe these improvements resulted primarily from our conservative due diligence and success in managing and working out the underlying loans and stable real estate fundamentals. However, the positive experience on these older transactions will not necessarily translate into yield improvements on newer investments.

 

During the year ended November 30, 2002, we acquired $726.7 million face amount of fixed-rate CMBS for $379.8 million and $39.6 million face amount of short-term floating-rate CMBS for $30.8 million. The following is a summary of the CMBS portfolio we held at November 30, 2002:

 

    

Face Amount


  

Weighted Average Interest Rate


  

Book

Value


  

% of Face Amount


  

Weighted

Average

Cash

Yield(1)


  

Weighted

Average

Book

Yield(2)


    

(In thousands, except percentages)

Fixed-rate:

                                 

BB rated or above

  

$

428,851

  

6.30%

  

$

317,851

  

74.1%

  

7.6%

  

10.2%

B rated

  

 

416,969

  

6.35%

  

 

212,548

  

51.0%

  

11.1%

  

12.7%

Unrated

  

 

1,119,840

  

6.48%

  

 

239,194

  

21.4%

  

28.3%

  

27.4%

    

  
  

  
  
  

Total

  

 

1,965,660

  

6.41%

  

 

769,593

  

39.2%

  

15.0%

  

16.2%

Floating-rate/short-term:

                                 

BB rated or above

  

 

21,151

  

4.89%

  

 

17,551

  

83.0%

  

5.9%

  

5.0%

B rated

  

 

25,270

  

8.43%

  

 

24,291

  

96.1%

  

8.8%

  

10.3%

Unrated

  

 

127,015

  

14.00%

  

 

102,817

  

80.9%

  

17.4%

  

18.0%

    

  
  

  
  
  

Total

  

 

173,436

  

12.02%

  

 

144,659

  

83.4%

  

14.5%

  

15.2%

Total amortized cost

  

 

2,139,096

  

6.85%

  

 

914,252

  

42.7%

  

14.9%

  

16.1%

Excess of fair value over amortized cost

  

 

—  

       

 

213,061

              
    

       

              

Total CMBS portfolio(3)

  

$

2,139,096

       

$

1,127,313

              
    

       

              

(1)   Cash yield is determined by annualizing the actual cash received during the month of November 2002, and dividing the result by the book value at November 30, 2002.
(2)   Book yield is determined by annualizing the interest income recorded during the month of November 2002, and dividing the result by the book value at November 30, 2002.
(3)   This table excludes CMBS owned through unconsolidated partnerships.

 

Equity in earnings of unconsolidated partnerships decreased to $13.1 million for the year ended November 30, 2002 from earnings of $44.8 million for the same period in 2001. The decline in earnings was primarily due to reduced income from Madison due to lower interest income resulting from the timing and amount of expected principal collections related to short-term floating-rate securities owned by the venture. Madison, which was formed in March 1999, owned approximately $1.6 billion face amount of CMBS at November 30, 2002. Our investment in the venture as of that date was $95.8 million, representing a 25.8% ownership interest. In addition to our investment, we maintain a significant ongoing role in the venture, for which we earn fees, both as the special servicer for the purchased CMBS transactions and as a provider of management services. Since its inception, we have received $141.1 million in cash distributions and fees from Madison, on an original investment of $90.1 million.

 

Gains on sales of securities were $47.2 million for the year ended November 30, 2002, compared to $9.7 million for the same period in 2001. This increase was primarily due to the gain recognized in the third quarter of 2002 on the sale of non-investment grade CMBS through a resecuritization transaction. In this transaction, we transferred $800.6 million in face value of non-investment grade CMBS to a qualifying special purpose entity. Those CMBS were securitized into various classes of non-recourse fixed- and floating-rate bonds comprised of $416.3 million face value of investment grade rated bonds and approximately $94.1 million face value of non-investment rated bonds, as well as $290.2 million face value of preferred shares in the issuing entity. The qualifying special purpose entity sold the investment grade rated bonds to unrelated third parties for net proceeds of $402.3 million, which was used to pay us for the CMBS collateral securities. We used the proceeds to repay short-term debt, the majority of which can be reborrowed. In accordance with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” we recognized a pre-tax gain on the sale of the CMBS collateral securities of $45.6 million. We retained the non-investment grade rated notes and preferred equity (the “retained interests”). The aggregate face amount of the retained

 

27


interests at the date of transfer and at November 30, 2002 was $384.3 million, respectively. At November 30, 2002, the amortized cost of the retained interest was $78.7 million, with an estimated fair value of $99.7 million. This transaction provided us with significant liquidity for the purchase of new investments, for other general corporate purposes or for the repurchase of stock under our ongoing share repurchase program.

 

Operating expenses increased to $20.6 million in 2002 compared to $15.2 million in 2001, primarily due to increases in personnel and out-of-pocket expenses directly related to the growth of our CMBS business activity.

 

Year ended November 30, 2001 compared to year ended November 30, 2000

 

Overall operating earnings from real estate securities increased to $199.0 million for the year ended November 30, 2001 from $164.7 million in 2000. Earnings were higher primarily due to (i) increased interest income and fees resulting from the growth of our CMBS portfolio, (ii) greater recognition of earnings due to actual CMBS performance continuing to exceed original expectations and (iii) increased equity in earnings from our investment in Madison. These increases were partially offset by (i) a decrease in gains on sales of investment securities and (ii) an increase in operating expenses.

 

During the year ended November 30, 2001, we acquired $471.1 million face amount of fixed-rate CMBS for $214.7 million and $100.1 million face amount of short-term floating-rate CMBS for $84.7 million. The following is a summary of the CMBS portfolio we held at November 30, 2001:

 

    

Face Amount


  

Weighted Average Interest Rate


  

Book

Value


  

% of Face Amount


  

Weighted

Average

Cash

Yield(1)


  

Weighted Average Book

Yield(2)


    

(In thousands, except percentages)

Fixed-rate:

                                 

BB rated or above

  

$

370,324

  

6.74%

  

$

262,304

  

70.8%

  

9.5%

  

12.3%

B rated

  

 

509,884

  

6.56%

  

 

275,929

  

54.1%

  

11.6%

  

12.5%

Unrated

  

 

886,048

  

7.01%

  

 

203,088

  

22.9%

  

29.1%

  

33.3%

    

  
  

  
  
  

Total

  

 

1,766,256

  

6.82%

  

 

741,321

  

42.0%

  

15.7%

  

18.1%

Floating-rate/short-term:

                                 

BB rated or above

  

 

12,789

  

3.81%

  

 

11,329

  

88.6%

  

4.3%

  

9.4%

B rated

  

 

22,345

  

8.56%

  

 

20,880

  

93.4%

  

9.2%

  

12.5%

Unrated

  

 

108,261

  

12.86%

  

 

87,917

  

81.2%

  

15.8%

  

13.2%

    

  
  

  
  
  

Total

  

 

143,395

  

11.33%

  

 

120,126

  

83.8%

  

13.5%

  

12.7%

Total amortized cost

  

 

1,909,651

  

7.15%

  

 

861,447

  

45.1%

  

15.3%

  

17.4%

Excess of fair value over amortized cost

  

 

—  

       

 

353,674

              
    

       

              

Total CMBS portfolio(3)

  

$

1,909,651

       

$

1,215,121

              
    

       

              

(1)   Cash yield is determined by annualizing the actual cash received during the month of November 2001, and dividing the result by the book value at November 30, 2001.
(2)   Book yield is determined by annualizing the interest income recorded during the month of November 2001, and dividing the result by the book value at November 30, 2001.
(3)   This table excludes CMBS owned through unconsolidated partnerships.

 

Equity in earnings of unconsolidated partnerships primarily represents our participation in Madison. Our investment in the venture as of the end of the year was $109.8 million, representing a 25.8% ownership interest. Madison contributed $44.8 million of equity in earnings of unconsolidated partnerships to the real estate securities line of business for the year ended November 30, 2001.

 

In 2001, we sold six CMBS investments, which had been upgraded from non-investment grade to investment grade status for a gain of $5.0 million. These bonds were originally purchased as non-investment grade securities at substantial discounts and were sold at or above par. Additionally, we sold all classes of bonds we owned in one seasoned CMBS pool at close to par for a gain of $4.9 million. Over 93% of the original pool had paid off prior to this sale, which allowed the securitization to be terminated through a “clean-up call.” The underlying loans were then sold to three financial institutions. There are a number of CMBS pools in which we own unrated bonds that have had significant principal paydowns, leaving only a small percentage of the bonds remaining. As a result, we are able to sell some of these bonds (or the underlying loans after executing a clean-up

 

28


call) for significant profits prior to stated maturity, maximizing our return on investment. The gains on sales of investment securities in 2000 resulted from the sale of our remaining investment in the common stock of Bank United Corporation.

 

During 2001, we reclassified our held-to-maturity CMBS securities to available-for-sale in accordance with SFAS No. 115. Although we have the financial ability to hold these bonds to their stated maturities, it sometimes is advantageous for us to sell the bonds as the CMBS pools to which they relate pay down significantly and the bonds get close to economic maturity. Because we may choose to do this, SFAS No. 115 requires all of our CMBS to be classified as available-for-sale and also requires the bond values to be adjusted to fair market value, net of tax, through stockholders’ equity. As a result, at November 30, 2001, all of our directly owned securities were classified as available-for-sale and their book value was written up to include unrealized appreciation.

 

Management and servicing fees increased to $25.1 million for the year ended November 30, 2001 from $15.5 million in 2000. This increase was primarily due to the increase in the number of CMBS mortgage pools (83 at November 30, 2001 versus 65 at November 30, 2000) for which we act as a special servicer.

 

Operating expenses increased to $15.2 million in 2001 compared to $10.8 million in 2000, primarily due to increases in personnel and out-of-pocket expenses directly related to the growth of our CMBS portfolio.

 

Corporate, Other, Interest and Income Tax Expenses

 

Year ended November 30, 2002 compared to year ended November 30, 2001

 

Interest expense decreased to $96.6 million in 2002 from $110.5 million in 2001. This decrease was primarily due to a decrease in interest rates. Weighted average borrowing rates were 6.1% at November 30, 2002, compared to 6.8% at November 30, 2001. Average borrowing levels were $1,495.3 million in 2002 compared to $1,457.0 million in 2001. See further detail below under “Financial Condition, Liquidity and Capital Resources.”

 

Income tax expense decreased to $69.3 million in 2002 from $71.2 million in 2001. The effective tax rate in 2002, including state income taxes, was 33% compared to 35% in 2001. This decrease reflects lower state income taxes related to our CMBS investments in 2002.

 

Year ended November 30, 2001 compared to year ended November 30, 2000

 

Interest expense decreased to $110.5 million in 2001 from $121.5 million in 2000. This decrease was primarily due to a decrease in interest rates and, to a lesser extent, lower borrowing levels. Weighted average borrowing rates were 6.8% at November 30, 2001, compared to 8.6% at November 30, 2000. Average borrowing levels were $1,457.0 million in 2001 compared to $1,501.1 million in 2000.

 

Income tax expense increased to $71.2 million in 2001 from $52.1 million in 2000. This increase was primarily due to an increase in pre-tax earnings, and to a lesser extent, a lower level of Low-Income Housing Tax Credits utilized. Because the level of tax credits was lower in 2001 and pre-tax earnings increased, the effective tax rate in 2001, including state income taxes, was 35% compared to 31% in 2000.

 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

Our operating activities provided $69.6 million and $115.2 million of cash in 2002 and 2001, respectively. The decrease in cash provided by operating activities is primarily due to a greater reduction in accounts payable and accrued liabilities, partially offset by a decrease in other assets and higher net earnings after adjusting for the effects of non-cash items, whose contributions to cash flow are reflected in cash from investing activities below.

 

Our investing activities provided $64.9 million in 2002 and used $83.1 million in 2001. This increase in cash provided by investing activities is primarily due to (i) net proceeds received on the sale of non-investment grade CMBS through the resecuritization transaction completed during the third quarter of 2002, as previously discussed, (ii) a decrease in restricted cash resulting from the release of a cash collateralized letter of credit and (iii) higher proceeds from the sale of operating properties and unconsolidated partnership interests. These increases in cash provided by investing activities were partially offset by (i) a higher level of purchases of investment securities, operating properties, land and mortgage loans, (ii) a higher level of investments in unconsolidated partnerships, primarily related to our investment in European properties, (iii) lower proceeds

 

29


from the syndication of affordable housing partnership interests, and (iv) lower proceeds from collections on mortgage loans.

 

Our financing activities used $135.4 million and $27.5 million in 2002 and 2001, respectively. The increase in cash used in financing activities was primarily due to (i) lower borrowings under our mortgage notes and other debts payable, (ii) more purchases of treasury stock under our stock buy-back program and (iii) higher net distributions to minority partners in consolidated entities. These increases in cash used in financing activities were partially offset by lower net payments under repurchase agreements and revolving credit lines.

 

Our investment activities consist primarily of purchasing real estate related financial instruments and commercial and multi-family residential properties, in part with borrowed funds. The value of all financial instruments, or the earnings from them, is affected by changes in interest rates. However, real estate related financial instruments are particularly sensitive to interest rate changes, because the value of the real estate which collateralizes the instruments, as well as the purely financial aspects of the instruments themselves, are affected by changes in interest rates. Similarly, the cost of borrowing is affected by changes in interest rates, and the willingness of lenders to finance purchases of real estate related financial instruments is affected by factors, including changes in interest rates, which affect the value of the real estate. To a substantial extent, conditions which reduce the value of our assets increase the cost of owning them. Because we borrow significant sums in connection with our investing activities, we could be adversely affected by reluctance of lenders to make loans to companies in real estate related businesses. Difficulty obtaining financing can reduce our ability to take advantage of investment opportunities.

 

We use interest rate swaps to reduce the extent to which we will be affected by changes in interest rates, which affect the value of the assets we hold or the cost of debt we have incurred (see below). However, we cannot protect ourselves against the effect changes in interest rates, or other occurrences which affect real estate values, may have on our ability to borrow funds with which to finance new investments. We also cannot fully protect ourselves against losses we would suffer if, because of declines in real estate values, we were unable to realize expected returns from our real estate related assets or to dispose of those assets for prices at least equal to our investment in them.

 

We continue to diversify our capital structure and to manage our debt position with a combination of short-, medium- and long-term financings with a goal of matching the maturities of our debt with the expected lives of our assets.

 

At November 30, 2002, we had approximately $1.07 billion of available liquidity, which included approximately $1.03 billion of cash and availability under credit facilities, and approximately $45 million under committed project level term financing. Additionally, subsequent to the end of the year, we entered into multi-year reverse repurchase (“repo”) lines with two financial institutions for a total of $135 million, and received a financing commitment for a repo line from another financial institution for $100 million. These facilities will finance future loan and CMBS investments and expire through February 2006.

 

During the fourth quarter of 2002, we amended our $350.0 million unsecured revolving credit facility, increasing the total facility to $380.0 million and extending its term, including a one-year extension option, to July 2006. At November 30, 2002, $89.7 million was outstanding under this facility, and we had $35.7 million of outstanding standby letters of credit utilizing the facility. The facility contains certain financial tests and restrictive covenants, none of which are currently expected to restrict our activities.

 

We have various secured revolving lines of credit with an aggregate commitment of $355.0 million, of which $201.5 million was outstanding at November 30, 2002. These lines are collateralized by CMBS and mortgage loans and mature through July 2007.

 

We have financed some of our purchases of CMBS under repo facilities, which are in effect borrowings secured by the CMBS. These repo agreements contain provisions which may require us to repay amounts or post additional collateral prior to the scheduled maturity dates if the market value of the bonds which collateralize them significantly decline. Therefore, if the market value of our CMBS falls significantly, we could be required to either use cash flow we need to operate and grow our business or to sell assets at a time when it may not be most advantageous for us to do so, to generate cash needed to repay amounts under repo obligations.

 

At November 30, 2002, we had five repo facilities through which we financed selected CMBS. The first facility had a commitment and outstanding balance of $36.7 million and is required to be paid in full by June

 

30


2004. The second facility had a commitment of $50.0 million with no outstanding balance at November 30, 2002, and matures in June 2003. We guaranteed the obligations of our subsidiaries for these two facilities. The third facility is a $150.0 million non-recourse facility, which matures in April 2005, and had an outstanding balance of $61.0 million at November 30, 2002. The fourth facility is a $100.0 million non-recourse facility, which matures in April 2007, and had an outstanding balance of $29.0 million at November 30, 2002. We do not guarantee the third or fourth facility. The fifth facility is a $430.0 million financing structured as a repo line with a leading financial institution to finance the acquisition of securities and loans. At November 30, 2002, there was $46.6 million outstanding under this facility. This facility has limited recourse to us and matures in January 2005.

 

Additionally, we received seller financing in the form of term repos for three specific CMBS transactions. These agreements had an aggregate commitment and outstanding balance of $25.2 million and expire through August 2004. We have guaranteed $21.5 million of the obligations of our subsidiaries for these facilities.

 

We received seller financing in the form of term loans for three specific CMBS transactions. We do not guarantee these loans. We also received seller financing in the form of a term loan for one mortgage loan investment, which we have guaranteed. These term loans had an outstanding balance of $34.7 million at November 30, 2002 and expire through September 2003.

 

We have $450.0 million of long-term unsecured senior subordinated notes outstanding. $200 million of these notes bear interest at 9.38% and are due in March 2008. $250 million of these notes bear interest at 10.5% and are due in January 2009. Subsequent to year-end, Standard & Poor’s, which rates our senior unsecured credit rating at BB and our senior subordinated debt rating at B+, revised our outlook to positive from stable. Additionally, subsequent to year end, Fitch Ratings assigned us a senior unsecured credit rating of BB+ and affirmed our senior subordinated debt rating of BB-.

 

Approximately 63% of our existing indebtedness bears interest at variable rates. However, most of our investments generate interest or rental income at essentially fixed rates. We have entered into derivative financial instruments, primarily interest rate swaps, to manage our interest costs and hedge against risks associated with changing interest rates on our debt portfolio. We believe our interest rate risk management policy is generally effective. Nonetheless, our profitability may be adversely affected during particular periods as a result of changing interest rates. Additionally, hedging transactions using derivative instruments involve risks such as counterparty credit risk. The counterparties to our arrangements are major financial institutions, rated A- or better, with which we and our affiliates may also have other financial relationships. These counterparties potentially expose us to loss in the event of their non-performance.

 

At November 30, 2002, 26% of our variable-rate debt had been swapped to fixed rates and 48% was match-funded against variable-rate assets. After considering the variable-rate debt that had been swapped or was match-funded, 16% of our debt remained variable-rate and 84% of our debt was fixed-rate or match-funded. As of November 30, 2002, we estimate that a 100 basis point change in LIBOR would impact our net earnings by $0.8 million, or $0.02 per share diluted.

 

The weighted average interest rate on our outstanding debt, after giving consideration to the interest rate swap agreements mentioned above, was 6.1% at November 30, 2002.

 

Our Board of Directors approved a stock repurchase plan authorizing us to buy back up to 9.5 million shares of our common stock, including 4.0 million shares of common stock authorized in the fourth quarter of 2002. During the years ended November 30, 2002, 2001 and 2000, we purchased 1.7 million shares, 0.3 million shares and 1.9 million shares, respectively, under this program, bringing the inception-to-date total through November 30, 2002 under our buy-back program to 5.0 million shares.

 

31


 

Contractual Obligations

 

Our significant contractual obligations as of November 30, 2002 follows:

 

    

Payments Due by Period


    

Total


  

Less Than 1 Year


  

1-3 Years


  

4-5 Years


  

After 5 Years


    

(In millions)

Contractual obligations:

                          

Long-term debt

  

$

1,485.5

  

47.5

  

483.8

  

465.9

  

488.3

Operating leases

  

 

3.1

  

1.5

  

1.1

  

0.5

  

—  

    

  
  
  
  

Total contractual cash obligations

  

$

1,488.6

  

49.0

  

484.9

  

466.4

  

488.3

    

  
  
  
  

 

At November 30, 2002, we had scheduled maturities on existing debt of $47.5 million through November 30, 2003, assuming we take advantage of extensions which are exercisable at our option. Our ability to make scheduled payments of principal or interest on or to refinance this indebtedness depends on our future performance, which to a certain extent, is subject to general economic, financial, competitive and other factors beyond our control. We believe our borrowing availability under existing credit facilities, our operating cash flow and unencumbered asset values, and our ability to obtain new borrowings and/or raise new capital, should provide the funds necessary to meet our working capital requirements, debt service and maturities and short- and long-term needs based upon currently anticipated levels of growth. However, limitations on access to financing constrain our ability to take advantage of opportunities that might lead to more significant growth.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

From time to time in the normal course of our business, we enter into various types of transactions and arrangements which are not recorded on our balance sheet. These off-balance sheet arrangements include certain commitments and contingent obligations, retained interests in assets transferred to unconsolidated entities, and investments in certain unconsolidated entities.

 

Commitments and Contingent Obligations

 

We are committed, under various types of agreements, to provide certain guarantees which are not otherwise reflected in the financial statements. Standby letters of credit (“LOCs”), guarantees, performance/surety bonds and other commitments under these arrangements at November 30, 2002 follows:

 

           

Amount of Commitment

Expiration Per Period


      

Outstanding Commitments


  

Less Than 1 Year


  

1-3 Years


  

4-5 Years


  

After 5 Years


      

(In millions)

Standby letters of credit

    

$

40.3

  

39.7

  

0.6

  

—  

  

—  

Guarantees of debt

    

 

35.7

  

20.4

  

9.4

  

1.9

  

4.0

Limited maintenance guarantees

    

 

39.3

  

5.0

  

34.3

  

—  

  

—  

Committed capital contributions

    

 

21.8

  

12.3

  

9.5

  

—  

  

—  

Performance/surety bonds

    

 

37.8

  

21.6

  

0.3

  

—  

  

15.9

Affordable housing communities—other

    

 

28.2

  

14.0

  

3.3

  

10.0

  

0.9

      

  
  
  
  

Total commitments

    

$

203.1

  

113.0

  

57.4

  

11.9

  

20.8

      

  
  
  
  

 

32


 

Standby Letters of Credit

 

We provide LOCs for the benefit of third parties generally to enhance credit or guarantee our performance under certain contractual obligations. LOCs are issued by financial institutions for a fee. We guarantee the reimbursement of any amounts the financial institutions pay to the third party beneficiaries. To date, financial institutions that have issued LOCs on our behalf have not made any payments to beneficiaries, nor do we anticipate any payments will be made in the future. The following are the primary types of LOCs we provide:

 

    Specific Performance—issued to guarantee our performance under various development and construction agreements, typically when the beneficiaries will not accept a third party surety bond.

 

    Credit Enhancement—issued to provide the beneficiaries a higher rated credit to look to for the repayment of debt. In most situations, we would not be able to obtain the debt without providing the LOCs, or the terms of the debt arrangement would be significantly different.

 

    Deposits—issued in lieu of cash to satisfy deposit requirements under certain lease and loan agreements.

 

    Collateral—issued to provide collateral or excess collateral under certain derivative transactions and debt agreements.

 

The amount of issued and outstanding LOCs as of November 30, 2002 was $40.3 million.

 

Guarantees of Debt

 

In order for certain of our partnerships to obtain financing for the acquisition and development of their properties, we may need to provide a repayment guarantee to their lenders. Without our guarantee, the partnership may not be able to obtain financing, which would result in additional capital contributions from our partners and us. To date, we have not made any payments under guarantees of debt, nor do we expect to make any payments in the future. The amount of outstanding debt guaranteed by us at November 30, 2002 was $35.7 million.

 

Limited Maintenance Guarantees

 

For certain partnerships, we provide limited maintenance guarantees to their lenders. These guarantees require us to fund partnership debt obligations to maintain an established loan to value ratio. To the extent the value of the collateral for the financing declines to an amount that would cause the partnership to no longer meet such a ratio, we and our partners would be required to reduce the outstanding loan balance by the amount needed to maintain the ratio. In addition, to certain lenders we have provided a debt service payment guarantee upon an event of default by the borrower. These guarantees are provided by our partners and us to enable the partnership to obtain third-party financing for its projects. These guarantees also limit the amount of capital we must contribute to the partnership. To date, we have not made any payments under these limited guarantees, nor do we expect to make any payments in the future. At November 30, 2002 the amount of outstanding debt related to these limited guarantees was $39.3 million.

 

Committed Capital Contributions

 

In the ordinary course of business, we enter into various partnership arrangements. These arrangements are governed by partnership agreements that describe the partners’ obligations. These obligations include making capital contributions from time to time. The majority of our non-affordable housing partnerships contain provisions for an initial capital contribution and future capital contributions as required. These future contributions are typically not quantifiable, and are therefore not included in the total committed capital contributions provided in the preceding table.

 

A few of our non-affordable housing partnerships contain provisions for capital contributions to be made as defined in the partnership agreements or pursuant to approved annual business plans. These capital contributions totaled $6.9 million at November 30, 2002.

 

Due to the nature of the affordable housing business, the majority of our affordable housing partnerships are subject to agreements which require specified capital contributions. These contributions are typically included on schedules which specify the amount and the date or the event that triggers each contribution. These capital contributions amounted to $8.8 million at November 30, 2002.

 

33


 

In order to receive affordable housing tax credits, we must prepare applications to the respective jurisdictions where we intend to build affordable housing communities prior to their development. As part of this tax credit application process, we are required to provide both loan commitments and capital contribution commitments related to the underlying affordable housing community. These types of commitments are usual and customary for the affordable housing business. These commitments amounted to $6.1 million at November 30, 2002.

 

We have in the past and plan to continue to fund capital contribution commitments as necessary to conduct our business.

 

Performance/Surety Bonds

 

We obtain surety bonds to support our development obligations under certain development agreements with various municipalities. Surety bonds are customary in the real estate development business. Similar to the LOCs, we guarantee to the surety provider reimbursement of any amounts they may pay under the surety. In addition to surety bonds we provide related to our development operations, we also provide surety bonds related to the syndication of affordable housing tax credits. When tax credits are syndicated, we are required to provide to the Internal Revenue Service bonds with a face amount equal to the amount of income tax recapture we would become subject to if the properties to which the tax credits apply no longer complied with the tax credit requirements. To-date, our bond providers have not made any payments on our behalf under performance or surety bonds, nor do we expect any payments to be made in the future. At November 30, 2002 we had provided $37.8 million of surety bonds to third parties.

 

Affordable Housing Communities—Other

 

In connection with our syndication of affordable housing tax credits, we provide various guarantees to the investor which are customary in the affordable housing business. These include agreements to provide additional funding to cover operating cash flow deficiencies, maintain specified debt service coverage ratios and cover financing shortfalls to projects upon completion when the project’s permanent financing is insufficient to pay off the project’s construction loan. These commitments amounted to $28.2 million at November 30, 2002.

 

Construction Completion Guarantees

 

As is customary in the real estate development business, we have provided guarantees to construction lenders that construction of properties we develop will be completed. We cannot estimate the maximum exposure on these guarantees because the amount of any obligations we might incur would depend on the extent to which costs of completing construction exceeded amounts provided by committed borrowings and capital contributions. We are not currently aware of any reason to expect we will be required to make payments under any of our outstanding construction completion guarantees.

 

Retained Interests in Assets Transferred to Unconsolidated Entities

 

In July 2002 we completed our second resecuritization transaction. We transferred $800.6 million in face value of non-investment grade CMBS to a qualifying special purpose entity. Those CMBS were securitized into various classes of non-recourse fixed-and floating-rate bonds comprised of $416.3 million face value investment grade rated bonds. The qualifying special purpose entity sold the investment grade rated bonds to unrelated third parties for net proceeds of $402.3 million, which was used to pay us for the CMBS collateral securities. We used these proceeds to repay short-term debt, the majority of which can be re-borrowed. We recognized a $45.6 million gain on the sale, realizing the value we added to the resecuritized bonds. We recovered most of our entire original purchase price on the $800.6 million portfolio from the sale of the investment grade bonds. We retained the non-investment grade rated bonds and the preferred equity in the qualifying special purpose entity.

 

We have resecuritized and may continue to resecuritize our non-investment grade CMBS investments in order to realize the value we add to these bonds and to better match our assets and liabilities, reduce our interest rate and refinancing risk, improve our liquidity position and strengthen our financial condition. Over the past several years, we have been acquiring non-investment grade CMBS, and have been able to remove what we consider to be the riskiest assets before the underlying securitizations take place. Utilizing our due diligence expertise to remove risky assets, by re-underwriting each and every property that backs each loan in a

 

34


transaction, we have been able to improve the quality of the assets underlying the portfolio, which adds substantial value to the non-investment grade bonds that we buy. In addition, our workout and hands-on real estate expertise as special servicer for each transaction has enabled these investments to perform exceptionally well. Taking into account the diversification, the quality of the collateral and our involvement in the transaction, rating agencies have rated a significant portion of the face amount of the non-investment grade bonds we resecuritized as investment grade. We can then sell the investment grade bonds to unrelated third parties to realize the added value and to further strengthen our balance sheet.

 

Investments in Unconsolidated Entities

 

We frequently make investments jointly with others, through partnerships and joint ventures. This (i) allows us to further diversify our investment portfolio, spreading risk over a wider range of investments, (ii) provides access to transactions which are brought to us by other participants, (iii) provides access to capital and (iv) enables us to participate in investments which are larger than we are willing to make on our own. In many instances, we have a less than controlling interest in the partnership or venture, or control is shared, and therefore we account for our interest by the equity method, rather than consolidating the assets and liabilities of the partnership or venture on our balance sheet.

 

Typically, we either invest on a non-recourse basis, such as by acquiring a limited partnership interest or an interest in a limited liability company, or we acquire a general partner interest, but hold that interest in a subsidiary which has few, if any, other assets. In those instances, our exposure to partnership liabilities is essentially limited to the amounts we invest in the partnerships. However, in some instances we are required to give limited guarantees of debt incurred or other obligations undertaken by the partnerships or ventures. For certain partnerships, typically those involving real estate property development, we may commit to invest certain amounts in the future based on the partnerships’ business plan.

 

On January 17, 2003, the Financial Accounting Standards Board issued FASB Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities.” FIN No. 46 will require us to consolidate variable interest entities (“VIEs”) in which we have a controlling financial interest. Under the provisions of FIN No. 46, we must consolidate VIEs in which we are the primary beneficiary, which is the entity that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both, as a result of holding variable interests, which are the ownership, contractual, or other pecuniary interests in an entity. An entity is considered to be a VIE subject to consolidation if either (i) the total equity investment at risk is not greater than the expected losses of the entity or (ii) as a group, the other equity holders lack (a) the ability to make decisions about the entity’s activities through voting or similar rights, (b) the obligation to absorb the expected losses of the entity, or (c) the right to receive the residual returns of the entity. FIN No. 46 is effective immediately for variable interests in VIEs created after January 31, 2003, and is effective on September 1, 2003 for variable interests in VIEs created before February 1, 2003.

 

We are in the process of evaluating all of our investments and other interests in entities that may be deemed VIEs under the provisions of FIN No. 46. These include (i) interests in CMBS pools in which we have invested or act as special servicer, the face amount of which amounted to approximately $66.0 billion, (ii) real estate related joint ventures with assets totaling approximately $2.5 billion, and (iii) investments in mezzanine loans with underlying assets totaling approximately $120.4 million, at November 30, 2002. Our maximum exposure to loss as a result of our involvement with VIEs only represents our recorded investment in these assets of approximately $1.3 billion and the guarantees we provided to these entities of approximately $130 million (included in the Commitments and Contingent Obligations discussion above) at November 30, 2002. Although, we believe that many of these entities will not be consolidated and may not ultimately fall under the provisions of FIN No. 46, we cannot make any definitive conclusion until we complete our evaluation.

 

35


 

At November 30, 2002, we had investments in unconsolidated partnerships of $361.0 million. Summarized financial information on a combined 100% basis related to our investments in unconsolidated partnerships accounted for by the equity method at November 30, 2002 follows:

 

    

LNR Investment


  

LNR Financial Interest(1)


  

Total Partnership Assets


  

Total Partnership Liabilities


 
    

(In thousands, except percentages)

 

Properties:

                         

Single-asset partnerships

  

$

34,185

  

33%–94%

  

$

237,846

  

182,341

 

Partnerships with Lennar

                         

LLP

  

 

46,110

  

50%

  

 

234,194

  

141,974

 

Other

  

 

35,514

  

50%

  

 

110,815

  

44,744

 

Affordable housing communities

  

 

56,201

  

1%–99%

  

 

554,125

  

391,356

 

Other

  

 

2,828

  

5%–35%

  

 

21,200

  

16,651

 

    

       

  

    

 

174,838

       

 

1,158,180

  

777,066

 

International

  

 

75,513

  

100%

  

 

75,902

  

389

 

    

       

  

    

 

250,351

       

 

1,234,082

  

777,455

 

Loans:

                         

Domestic non-performing loan pools

  

 

9,501

  

15%–50%

  

 

53,369

  

24,880

 

Securities:

                         

Madison

  

 

95,772

  

25.8%

  

 

1,149,994

  

775,203

 

Other

  

 

5,357

  

69.5%

  

 

46,625

  

38,165

 

    

       

  

    

 

101,129

       

 

1,196,619

  

813,368

 

    

       

  

Total

  

$

360,981

       

$

2,484,070

  

1,615,703

(2)

    

       

  


  (1)   Although we may own a majority financial interest in certain partnerships, we do not consolidate those partnerships in which control is shared or in which less than a controlling interest is held. See further discussion under the heading of Basis of Presentation and Consolidation within Note 1 to our consolidated financial statements.
  (2)   Debt is non-recourse to us except for the $35.7 million noted in the commitments table discussed above.

 

Single-Asset Partnerships

 

We have investments in single-asset partnerships established to acquire, develop, reposition, manage and sell real estate assets. Our investment in these partnerships at November 30, 2002 was $34.2 million. Assets of these partnerships at November 30, 2002 include 138,000 square feet of office space, 138,000 square feet of retail space, 1,028 hotel rooms and 1,468 apartment units. Approximately 44% of these properties are not yet stabilized. Our ownership interests range from 33% to 94%. Total partnership debt at November 30, 2002 is $170.1 million, and only $5.4 million is with recourse to us.

 

Partnerships with Lennar

 

In connection with our Spin-off from Lennar in 1997, Lennar transferred parcels of land to us and we transferred these parcels to a general partnership in exchange for a 50% partnership interest in this partnership. In 1999, certain assets and liabilities of this land partnership were contributed at net book value to a second general partnership and both we and Lennar each received 50% general partnership interests in the second partnership. The two partnerships are collectively referred to as Lennar Land Partners (“LLP”). LLP is engaged in the acquisition, development and sale of land and the development and sale of homes. The land was originally acquired by Lennar primarily to be used for residential home development. Lennar can purchase land from LLP at prices we have agreed to. LLP also sells land to unrelated developers. During 2002, LLP had land sale revenues of $194.0 million of which $83.0 million was from sales to Lennar and $12.4 million was from sales to us. All major decisions with respect to LLP are made on an equal basis between us and Lennar. Our by-laws require that all significant decisions with respect to LLP be approved by a Transaction Review Committee, which is entirely comprised of members of our Board who are not directors, officers or employees of Lennar. Lennar manages the day-to-day activities of LLP under a management agreement. We recorded $34.7 million of pre-tax earnings, made contributions of $12.5 million and received $69.4 million in cash distributions from LLP in 2002.

 

36


 

The debt of LLP is non-recourse to us, with the exception of one $1.9 million guarantee. However, a subsidiary of ours, which holds our general partner interests in LLP, could be liable as a general partner for LLP’s debt. That subsidiary has essentially no assets other than the general partner interests in LLP. Along with Lennar, we provide limited maintenance guarantees on $35.3 million of LLP debt. These limited maintenance guarantees only apply if the fair value of the collateral (generally land and improvements thereto) is less than a specified multiple of the loan balance and LLP does not have the ability to reduce the loan balance to the appropriate level. We have also provided debt service guarantees which only apply if the partnership defaults on its loan arrangements. If we are required to make a payment under these guarantees, the payment would be accounted for as a capital contribution to the partnership and increase our share of capital distributed upon the dissolution of the partnership.

 

We have joint ventured with Lennar in a number of other projects which require both residential and commercial expertise. These projects include:

 

    The redevelopment of two closed military facilities in California, as the federal government moves to put these into the hands of public/private partnerships. These facilities are being converted to master planned communities including housing, office, industrial/warehouse, retail, entertainment, etc.

 

    The development and disposition of approximately 585 acres of commercial and residential land in Carlsbad, California, of which 429 acres remained at November 30, 2002.

 

    The development of 240 residential condominiums within a mixed-use project in San Francisco, California.

 

The debt on these ventures is non-recourse to us, except for $7.3 million of guarantees.

 

Our total investment in all partnerships with Lennar (including LLP) at November 30, 2002 was $81.6 million. Total assets and liabilities of the partnerships were $345.0 million and $186.7 million, respectively, at November 30, 2002. The debt in these partnerships is non-recourse to us, except for the guarantees discussed above.

 

Affordable Housing Communities

 

During 1998, we entered the business of owning, developing and syndicating partnership interests in affordable housing communities. Our ownership interests typically approximate 99% in partnerships we have not yet syndicated. We continue to hold a small interest (typically ranging from less than 1% to 10%) in the communities we have syndicated and continue to manage those communities for which we earn management fees. Our investment in unconsolidated affordable housing partnerships was $56.2 million at November 30, 2002. Total unconsolidated affordable housing partnership debt was $344.2 million at November 30, 2002, and only $21.1 million is with recourse to us. Additionally, we have other commitments and contingent liabilities related to our affordable housing investments, which were previously discussed in the section entitled “Commitments and Contingent Obligations.”

 

International Partnerships

 

During 2002, we entered the European commercial real estate market through an investment in an unconsolidated partnership. The assets of this partnership include a note receivable from our partner and an investment in an unconsolidated partnership which owns a pool of over 400 commercial real estate properties located throughout France. The underlying partnership has properties with a net book value of $2.6 billion and non-recourse debt of $2.2 billion as of November 30, 2002. Although we are entitled to 100% of the economic benefits from the partnership in which we have a direct investment, acquiring less than 50% of the partnership’s voting rights was a condition of the transaction. Because our partner effectively participates through substantive participative rights as defined in Emerging Issues Task Force (“EITF”) No. 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholders Have Certain Approval or Veto Rights,” we do not consolidate this partnership. Our investment in this partnership was $75.5 million at November 30, 2002 and we recorded $4.1 million of pre-tax earnings from this partnership in 2002. There is no debt in our direct partnership and the debt of the underlying partnership is non-recourse to us.

 

Domestic Non-Performing Loan Pools

 

In the early to mid 1990’s, we acquired a number of portfolios of non-performing commercial mortgage loans and related pools of owned real estate assets in partnerships with financial institutions or other entities. In

 

37


each of these partnerships, we are a minority limited partner, but one of our subsidiaries acts as the managing general partner. We earn management fees and asset disposition fees from the partnerships and have carried interests in cash flows and sales proceeds once the partners have recovered their capital and achieved specified returns. Our investment in the non-performing loan pool partnerships at November 30, 2002 was $9.5 million. Our pre-tax earnings and distributions from these partnerships for the year ended November 30, 2002 were $3.8 million and $3.2 million, respectively. The partnership’s debt is non-recourse to us.

 

Madison

 

Formed in March 1999, Madison invests in real estate securities, primarily CMBS. Our investment in Madison as of November 30, 2002 was $95.8 million, representing a 25.8% ownership interest. We maintain a significant ongoing role in the venture for which we earn fees, both as the special servicer for the purchased CMBS transactions and for providing services for the management of the venture. We recorded $14.5 million of pre-tax earnings and received $28.5 million in cash distributions from Madison in 2002. The debt of Madison is non-recourse to us.

 

ACCOUNTING POLICIES

 

In the preparation of our financial statements, we select and apply accounting principles generally accepted in the United States of America. The application of some of these generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying results. The accounting policies that include significant estimates and assumptions are in the areas of valuing our investment securities and determining if any are impaired, recognizing interest income on those securities and determining if any of our operating properties are impaired.

 

As discussed in Note 13 to the consolidated financial statements, our investment securities are carried at fair value. We determine fair value through quoted market prices if available. Where quoted market prices are not available, we estimate fair value based on the present value of estimated future cash flows using our best estimate of certain key assumptions including credit losses, prepayment rates and discount rates. Interest income on these securities is recognized on the level yield method, using the yield that equates the future cash flows, estimated by us as described above, to the amortized cost. To the extent estimated future cash flows change, the yield on the security is increased or decreased prospectively to the new yield. A loss is recognized to the extent by which the fair value of the investment security has declined below its amortized cost and the decline in fair value is other than a temporary impairment. Impairment is considered to be other than temporary if the present value of the currently estimated total cash flows related to the security is less than the present value of the previous quarter’s estimated total cash flows of that security.

 

We also review our operating properties for impairment of value. This includes considering certain indications of impairment such as significant declines in occupancy, other significant changes in property operations, significant deterioration in the surrounding economy or environmental problems. If such indications are present, we estimate the total future cash flows from the property and compare the total future cash flows to the carrying value of the property. If the total future cash flows are less than the carrying value, we adjust the carrying value down to its estimated fair value. Fair value may be based on third-party appraisals or our estimate of the property’s fair value.

 

NEW ACCOUNTING PRONOUNCEMENTS

 

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142, and that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment. SFAS No. 142 is effective for the fiscal year ending November 2003 and the interim periods within fiscal year 2003. The adoption of SFAS No. 142 is not expected to have a material effect on our results of operations or financial position.

 

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for legal obligations associated with the retirement of tangible

 

38


long-lived assets. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The fair value of the liability is added to our amount of the related asset and depreciated over the life of the asset. The liability is accreted each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, we will recognize a gain or loss on settlement. We are required and plan to adopt the provisions of SFAS No. 143 for the quarter ending February 28, 2003. The adoption of SFAS No. 143 is not expected to have a material effect on our results of operations or financial position.

 

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” and the accounting and reporting provisions of Accounting Practices Bulletin Opinion (“APB”) No. 30, “Reporting the Results of Operations—Reporting the Effects of a Disposal of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business. This Statement also amends Accounting Research Bulletin (“ARB”) No. 51, “Consolidated Financial Statements,” to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. SFAS No. 144 is effective for the fiscal year ending November 30, 2003, and the interim periods within fiscal 2003, with early application encouraged. The provisions of this statement generally are to be applied prospectively. SFAS No. 144 will require us to present all operating properties classified as held for sale separately on our balance sheet and all properties sold or classified as held for sale as discontinued operations in our statement of earnings. Prior periods will be restated for comparative purposes. We have determined that adoption of this statement will not have a material impact on our net earnings. It will, however, have an impact on the presentation of our financial position and operating results. Specifically, each time we sell a property or classify it as held for sale, we will be required to restate our income statement for the current year, as well as prior years, for comparability purposes. In order to allow readers of our financial statements to better understand our financial position and operating results, we plan to provide financial information in all of our future filings showing what the operating results would have been without the application of SFAS No. 144.

 

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145, among other items, updates and clarifies existing accounting pronouncements related to gains and losses from the extinguishment of debt and certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of SFAS No. 145 were generally effective as of May 15, 2002. The adoption of SFAS No. 145 did not have a material impact on our results of operations or financial position.

 

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires companies to recognize costs associated with exit (including restructuring) or disposal activities at fair value when the related liability is incurred rather than at the date of a commitment to an exit or disposal plan under prior practice. Costs covered by the standard include certain contract termination costs, certain employee termination benefits and other costs to consolidate or close facilities and relocate employees that are associated with an activity being exited or long-lived assets being disposed. The new requirements are effective prospectively for exit or disposal activities initiated after December 31, 2002, and were adopted by us on December 1, 2002. The adoption of SFAS No. 146 is not expected to have a material effect on our results of operations or financial position.

 

In November 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees of Indebtedness of Others.” FIN No. 45 requires certain guarantees to be recorded at fair value and also requires significant new disclosures related to guarantees, even when the likelihood of making any payments under the guarantee is remote. FIN No. 45 generally applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party based on changes in an underlying variable that is related to an asset, liability, or an equity security of the guaranteed party. We are required and plan to adopt the new disclosure requirements of FIN No. 45 for the quarter ending February 28, 2003. The initial recognition and measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. We are currently evaluating whether the adoption of the initial recognition and measurement provisions of FIN No. 45 will have a material effect on our results of operations or financial position.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based

 

39


Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition and disclosure provisions of SFAS No. 148 are effective for financial statements for interim and fiscal years ending after December 15, 2002, with early application permitted for entities with a fiscal year ending prior to December 15, 2002. We have adopted the disclosure provisions of SFAS No. 148 as of November 30, 2002. As we have not changed our method of accounting for stock-based employee compensation, the adoption of SFAS No. 148 did not have a material effect on our results of operations or financial position.

 

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities,” which is intended to clarify the application of ARB No. 51, “Consolidated Financial Statements” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. FIN No. 46 requires us to consolidate variable interest entities (“VIEs”) in which we have a variable interest or a combination of variable interests that will absorb a majority of the entity’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both. We are required to assess whether or not we are required to consolidate the VIE at the time we become involved with the entity. Reconsideration of this assessment is required only if we sell or otherwise dispose of all or part of our variable interest to unrelated third parties, acquire additional interests in the entity, or if the entity’s governing documents or the contractual arrangements among the parties involved change. We are required and plan to adopt the provisions of FIN No. 46 immediately for variable interests in VIEs created after January 31, 2003, and in the quarter ending November 30, 2003 for variable interests in VIEs created before February 1, 2003. We have determined that it is reasonably possible that we will be required to consolidate or disclose information about certain VIEs when FIN No. 46 becomes effective, and accordingly have made certain transitional disclosures required by FIN No. 46 in Note 18 to our consolidated financial statements.

 

Item 7a.    Quantitative and Qualitative Disclosures About Market Risk.

 

Our business activities contain elements of market risk. The primary market risks we are subject to include: (i) exposure to changes in demand for commercial real estate space in areas in which we own properties, or in areas in which properties securing mortgages directly or indirectly owned by us are located, (ii) declines in the value of real estate assets due to changes in real estate markets or the economy in general, (iii) the ability of mortgagors to meet debt obligations and (iv) interest rate risk.

 

The first three risk factors noted above are affected primarily by general economic conditions and to some extent by the interest rate environment. Because these factors are not under our control, our attempts to minimize these risks may not always be effective. We attempt to manage these market risks (i) through our exhaustive underwriting program, (ii) through hands-on management of the underlying assets and (iii) by maintaining a portfolio of assets that is diverse by segment, geographic area and property type. We do not make any investment before extensive hands-on property level due diligence is performed. For each asset, we evaluate the local market, rental rates, vacancy rates and, if applicable, loan and borrower characteristics. Cash flows are evaluated at the property level and loan levels, if applicable, and downside scenario assumptions are stressed. Before any investment is made, it must be approved by corporate senior management through a formal process. We do not make passive investments, only investing when we have control over the development and implementation of the strategy for enhancing the value of the underlying assets. We do not invest in disproportionately large assets. No single asset we own at November 30, 2002 accounted for more than 3% of our total assets.

 

Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political conditions, and other factors beyond our control. We have an interest rate risk management policy with the objective of (i) managing our interest costs and (ii) reducing the effect of unpredictable changes in asset values related to movements in interest rates on our available-for-sale securities. As more fully discussed in Note 5 to our consolidated financial statements, we employ hedging strategies to limit the effects of changes in interest rates on our operating income and cash flows and on the value of our available-for-sale securities.

 

Our approach to managing interest rate risk is based primarily on match funding, with the objective that variable-rate assets be primarily financed by variable-rate liabilities and fixed-rate assets be primarily financed

 

40


by fixed-rate liabilities. Most of our variable-rate assets are financed with variable-rate debt. To the extent that we have fixed-rate assets financed with variable-rate debt, we periodically enter into derivative financial instruments, primarily interest rate swap agreements, to manage our interest costs and hedge against risks associated with changing interest rates. At November 30, 2002, 63% of our existing consolidated indebtedness had interest at variable rates. Approximately 48% of this debt was match-funded against variable-rate assets and 26% was swapped to fixed-rate. As a result, at year-end, we estimate that a 100 basis point change in LIBOR would have impacted our net earnings by $0.8 million or by $0.02 per share diluted.

 

To manage the risk associated with unpredictable changes in asset values related to movements in interest rates on our fixed-rate available-for-sale securities, we periodically use derivative financial instruments, primarily interest rate swap agreements.

 

We believe our interest rate risk management policy is generally effective. Nonetheless, our profitability may be adversely affected during particular periods as a result of changing interest rates. In addition, hedging transactions using derivative instruments involve risks such as counterparty credit risk. The counterparties to our arrangements are lenders of the hedged debt instruments or are major financial institutions, rated A– or better, with which we and our affiliates may also have other financial relationships. These counterparties potentially expose us to credit loss in the event of non-performance.

 

41


 

Item 8.    Financial Statements and Supplementary Data.

 

REPORT OF INDEPENDENT AUDITORS

 

To the Board of Directors and Stockholders of LNR Property Corporation and Subsidiaries:

 

We have audited the accompanying consolidated balance sheets of LNR Property Corporation and subsidiaries (the “Company”) as of November 30, 2002 and 2001 and the related consolidated statements of earnings, comprehensive earnings, stockholders’ equity and cash flows for each of the three years in the period ended November 30, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LNR Property Corporation and subsidiaries at November 30, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended November 30, 2002, in conformity with accounting principles generally accepted in the United States of America.

 

 

 

DELOITTE & TOUCHE LLP

Certified Public Accountants

 

Miami, Florida

January 15, 2003

 

42


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

    

As of November 30,


 
    

2002


    

2001


 
    

(In thousands, except per share amounts)

 

Assets

               

Cash and cash equivalents

  

$

5,711

 

  

6,578

 

Restricted cash

  

 

2,524

 

  

81,955

 

Investment securities:

               

Investment securities pledged to creditors which can be repledged or sold by creditors

  

 

497,295

 

  

719,605

 

Other investment securities

  

 

630,018

 

  

495,516

 

    


  

Total investment securities

  

 

1,127,313

 

  

1,215,121

 

Mortgage loans, net

  

 

430,255

 

  

331,517

 

Operating properties and equipment, net

  

 

765,627

 

  

719,662

 

Land held for investment

  

 

56,980

 

  

42,229

 

Investments in unconsolidated partnerships

  

 

360,981

 

  

352,142

 

Other assets

  

 

85,483

 

  

87,443

 

    


  

Total assets

  

$

2,834,874

 

  

2,836,647

 

    


  

Liabilities and stockholders’ equity

               

Liabilities:

               

Accounts payable

  

$

14,087

 

  

20,914

 

Accrued expenses and other liabilities

  

 

164,413

 

  

174,023

 

Deferred income taxes

  

 

43,032

 

  

79,646

 

Mortgage notes and other debts payable

  

 

1,485,464

 

  

1,417,207

 

    


  

Total liabilities

  

 

1,706,996

 

  

1,691,790

 

    


  

Minority interests

  

 

1,722

 

  

25,688

 

Commitments and contingent liabilities (Note 16)

               

Stockholders’ equity

               

Common stock, $.10 par value, 150,000 shares authorized, 23,189 and 24,445 shares issued and outstanding in 2002 and 2001, respectively

  

 

2,319

 

  

2,444

 

Class B common stock, $.10 par value, 40,000 shares authorized, 9,784 and 9,949 shares issued and outstanding in 2002 and 2001, respectively

  

 

978

 

  

995

 

Additional paid-in capital

  

 

489,948

 

  

513,977

 

Retained earnings

  

 

510,204

 

  

404,611

 

Unamortized value of restricted stock grants

  

 

(7,077

)

  

(10,273

)

Accumulated other comprehensive earnings

  

 

129,784

 

  

207,415

 

    


  

Total stockholders’ equity

  

 

1,126,156

 

  

1,119,169

 

    


  

Total liabilities and stockholders’ equity

  

$

2,834,874

 

  

2,836,647

 

    


  

 

See accompanying notes to consolidated financial statements.

 

43


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF EARNINGS

 

    

Years Ended November 30,


    

2002


    

2001


    

2000


    

(In thousands,

except per share amounts)

Revenues

    

Rental income

  

$

115,426

 

  

111,669

 

  

139,264

Equity in earnings of unconsolidated partnerships

  

 

46,361

 

  

75,152

 

  

87,032

Interest income

  

 

180,819

 

  

181,339

 

  

147,746

Gains on sales of:

                    

Real estate

  

 

48,088

 

  

63,535

 

  

38,522

Unconsolidated partnership interests

  

 

3,428

 

  

746

 

  

23,671

Investment securities

  

 

47,221

 

  

9,717

 

  

13,134

Management and servicing fees

  

 

31,982

 

  

36,340

 

  

22,964

Other, net

  

 

(1,257

)

  

(818

)

  

437

    


  

  

Total revenues

  

 

472,068

 

  

477,680

 

  

472,770

    


  

  

Costs and expenses

                    

Cost of rental operations

  

 

58,816

 

  

58,642

 

  

78,682

General and administrative

  

 

77,281

 

  

74,398

 

  

64,736

Depreciation

  

 

24,986

 

  

25,267

 

  

36,138

Minority interests

  

 

1,222

 

  

2,536

 

  

3,799

    


  

  

Total costs and expenses

  

 

162,305

 

  

160,843

 

  

183,355

    


  

  

Operating earnings

  

 

309,763

 

  

316,837

 

  

289,415

Interest expense

  

 

96,610

 

  

110,494

 

  

121,487

    


  

  

Earnings before income taxes

  

 

213,153

 

  

206,343

 

  

167,928

Income taxes

  

 

69,275

 

  

71,230

 

  

52,057

    


  

  

Net earnings

  

$

143,878

 

  

135,113

 

  

115,871

    


  

  

Earnings per share:

                    

Basic

  

$

4.30

 

  

4.05

 

  

3.46

    


  

  

Diluted

  

$

4.15

 

  

3.87

 

  

3.32

    


  

  

Weighted average common and common equivalent shares outstanding:

                    

Basic

  

 

33,460

 

  

33,364

 

  

33,464

    


  

  

Diluted

  

 

34,649

 

  

34,916

 

  

34,875

    


  

  

 

 

See accompanying notes to consolidated financial statements.

 

44


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

 

    

Years Ended November 30,


 
    

2002


    

2001


    

2000


 
    

(In thousands)

 

Net earnings

  

$

143,878

 

  

135,113

 

  

115,871

 

Other comprehensive earnings, net of tax:

                      

Unrealized gain (loss) on available-for-sale securities, net and other

  

 

(48,133

)

  

226,491

 

  

(1,071

)

Unrealized gain (loss) on derivative financial instruments

  

 

1,500

 

  

(4,859

)

  

—  

 

Transition adjustment related to accounting for derivative financial instruments and hedging activities

  

 

—  

 

  

4,388

 

  

—  

 

Reclassification adjustment for gains included in net earnings

  

 

(30,998

)

  

(17,534

)

  

(13,796

)

    


  

  

Other comprehensive earnings (loss), net of tax

  

 

(77,631

)

  

208,486

 

  

(14,867

)

    


  

  

Comprehensive earnings

  

$

66,247

 

  

343,599

 

  

101,004

 

    


  

  

 

 

 

See accompanying notes to consolidated financial statements.

 

45


 

LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

    

Years Ended November 30,


 
    

2002


    

2001


    

2000


 
    

(In thousands)

 

Common stock

                      

Beginning balance

  

$

2,444

 

  

2,422

 

  

2,514

 

Purchase and retirement of treasury stock

  

 

(191

)

  

(30

)

  

(189

)

Restricted stock grants

  

 

—  

 

  

1

 

  

87

 

Stock option exercises

  

 

44

 

  

46

 

  

4

 

Stock issued under Senior Officers Stock Purchase Plan

  

 

5

 

  

—  

 

  

—  

 

Conversion of Class B common stock to common stock

  

 

17

 

  

5

 

  

6

 

    


  

  

Balance at November 30

  

 

2,319

 

  

2,444

 

  

2,422

 

    


  

  

Class B common stock

                      

Beginning balance

  

 

995

 

  

1,000

 

  

1,006

 

Conversion of Class B common stock to common stock

  

 

(17

)

  

(5

)

  

(6

)

    


  

  

Balance at November 30

  

 

978

 

  

995

 

  

1,000

 

    


  

  

Additional paid-in capital

                      

Beginning balance

  

 

513,977

 

  

516,516

 

  

529,042

 

Purchase and retirement of treasury stock

  

 

(28,355

)

  

(4,509

)

  

(28,454

)

Restricted stock grants

  

 

—  

 

  

267

 

  

15,627

 

Stock option exercises

  

 

2,999

 

  

1,703

 

  

301

 

Stock issued under Senior Officers Stock Purchase Plan

  

 

1,327

 

  

—  

 

  

—  

 

    


  

  

Balance at November 30

  

 

489,948

 

  

513,977

 

  

516,516

 

    


  

  

Retained earnings

                      

Beginning balance

  

 

404,611

 

  

272,772

 

  

163,974

 

Net earnings

  

 

143,878

 

  

135,113

 

  

115,871

 

Purchase and retirement of treasury stock

  

 

(36,628

)

  

(1,611

)

  

(5,421

)

Cash dividends—common stock

  

 

(1,215

)

  

(1,214

)

  

(1,202

)

Cash dividends—Class B common stock

  

 

(442

)

  

(449

)

  

(450

)

    


  

  

Balance at November 30

  

 

510,204

 

  

404,611

 

  

272,772

 

    


  

  

Unamortized value of restricted stock grants

                      

Beginning balance

  

 

(10,273

)

  

(13,195

)

  

—  

 

Restricted stock grants

  

 

—  

 

  

(268

)

  

(15,714

)

Amortization

  

 

3,196

 

  

3,190

 

  

2,519

 

    


  

  

Balance at November 30

  

 

(7,077

)

  

(10,273

)

  

(13,195

)

    


  

  

Accumulated other comprehensive earnings (loss)

                      

Beginning balance

  

 

207,415

 

  

(1,071

)

  

13,796

 

Change in accumulated other comprehensive earnings (loss), net

  

 

(77,631

)

  

208,486

 

  

(14,867

)

    


  

  

Balance at November 30

  

 

129,784

 

  

207,415

 

  

(1,071

)

    


  

  

Total stockholders’ equity

  

$

1,126,156

 

  

1,119,169

 

  

778,444

 

    


  

  

 

See accompanying notes to consolidated financial statements.

 

46


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

    

Years Ended November 30,


 
    

2002


    

2001


    

2000


 
    

(In thousands)

 

Cash flows from operating activities:

                      

Net earnings

  

$

143,878

 

  

135,113

 

  

115,871

 

Adjustments to reconcile net earnings to net cash provided by operating activities:

                      

Depreciation

  

 

24,986

 

  

25,267

 

  

36,138

 

Deferred income tax provision (benefit)

  

 

3,989

 

  

(24,575

)

  

7,904

 

Minority interests

  

 

1,222

 

  

2,536

 

  

3,799

 

Accretion of discount on CMBS and mortgage loans

  

 

(37,194

)

  

(24,318

)

  

(12,002

)

Amortization of deferred costs

  

 

6,237

 

  

5,744

 

  

3,936

 

Equity in earnings of unconsolidated partnerships

  

 

(46,361

)

  

(75,152

)

  

(87,032

)

Distributions of earnings from unconsolidated partnerships

  

 

74,601

 

  

90,478

 

  

98,380

 

Interest received on CMBS in excess of income recognized

  

 

21,383

 

  

25,192

 

  

19,085

 

Gains on sales of real estate

  

 

(48,088

)

  

(63,535

)

  

(38,522

)

Gains on sales of unconsolidated partnership interests

  

 

(3,428

)

  

(746

)

  

(23,671

)

Gains on sales of investment securities

  

 

(47,221

)

  

(9,717

)

  

(13,134

)

Losses on derivative financial instruments

  

 

1,053

 

  

954

 

  

—  

 

Changes in assets and liabilities:

                      

Decrease (increase) in other assets

  

 

31

 

  

(7,812

)

  

(44,426

)

(Decrease) increase in accounts payable and accrued liabilities

  

 

(25,498

)

  

35,778

 

  

47,787

 

    


  

  

Net cash provided by operating activities

  

 

69,590

 

  

115,207

 

  

114,113

 

    


  

  

Cash flows from investing activities:

                      

Operating properties and equipment:

                      

Additions

  

 

(181,410

)

  

(159,521

)

  

(339,856

)

Sales

  

 

209,943

 

  

158,445

 

  

117,418

 

Land held for investment:

                      

Additions

  

 

(53,902

)

  

(5,046

)

  

(27,277

)

Sales

  

 

34,594

 

  

29,662

 

  

76,655

 

Investments in unconsolidated partnerships

  

 

(124,834

)

  

(84,870

)

  

(51,334

)

Proceeds from sales of unconsolidated partnership interests

  

 

11,979

 

  

—  

 

  

77,990

 

Distributions of capital from unconsolidated partnerships

  

 

56,383

 

  

61,624

 

  

23,092

 

Purchase of mortgage loans held for investment

  

 

(113,203

)

  

(72,062

)

  

(50,990

)

Proceeds from mortgage loans held for investment

  

 

87,770

 

  

108,969

 

  

74,651

 

Purchase of investment securities

  

 

(411,137

)

  

(270,884

)

  

(141,012

)

Proceeds from principal collections on and sales of investment securities

  

 

444,051

 

  

86,994

 

  

65,943

 

Decrease (increase) in restricted cash

  

 

79,431

 

  

(107

)

  

(5,677

)

Proceeds from syndications of affordable housing partnership interests

  

 

25,250

 

  

63,653

 

  

34,128

 

    


  

  

Net cash provided by (used in) investing activities

  

 

64,915

 

  

(83,143

)

  

(146,269

)

    


  

  

Cash flows from financing activities:

                      

Proceeds from stock option exercises and stock purchase plan sales

  

 

4,375

 

  

1,749

 

  

304

 

Purchase and retirement of treasury stock

  

 

(65,174

)

  

(6,150

)

  

(34,064

)

Payment of dividends

  

 

(1,657

)

  

(1,663

)

  

(1,652

)

Net distributions to minority partners in consolidated entities

  

 

(25,188

)

  

(3,224

)

  

(7,852

)

Net payments under repurchase agreements and revolving credit lines

  

 

(11,177

)

  

(211,704

)

  

(88,924

)

Mortgage notes and other debts payable:

                      

Proceeds from borrowings

  

 

114,017

 

  

352,230

 

  

257,210

 

Principal payments

  

 

(150,568

)

  

(158,710

)

  

(99,467

)

    


  

  

Net cash (used in) provided by financing activities

  

 

(135,372

)

  

(27,472

)

  

25,555

 

    


  

  

Net (decrease) increase in cash and cash equivalents

  

 

(867

)

  

4,592

 

  

(6,601

)

Cash and cash equivalents at beginning of year

  

 

6,578

 

  

1,986

 

  

8,587

 

    


  

  

Cash and cash equivalents at end of year

  

$

5,711

 

  

6,578

 

  

1,986

 

    


  

  

 

See accompanying notes to consolidated financial statements.

 

47


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued

 

    

Years Ended November 30,


 
    

2002


    

2001


    

2000


 
    

(In thousands)

 

Supplemental disclosures of non-cash investing and financing activities:

                      

Purchases of investment securities financed by seller

  

$

—  

 

  

28,508

 

  

98,498

 

Purchases of mortgage loans financed by seller

  

$

55,375

 

  

73,280

 

  

113,670

 

Mortgage loans received on sales of operating properties

  

$

12,190

 

  

50,488

 

  

—  

 

Note receivable on sale of unconsolidated partnership interests

  

$

8,685

 

  

—  

 

  

—  

 

Mortgage note assumed on purchase of operating property

  

$

6,479

 

  

—  

 

  

—  

 

Supplemental disclosure of non-cash transfers:

                      

Transfer of land held for investment to operating properties

  

$

12,745

 

  

—  

 

  

31,640

 

Transfer of operating properties to land held for investment

  

$

—  

 

  

5,114

 

  

—  

 

Transfer of investment securities to mortgage loans

  

$

4,310

 

  

—  

 

  

—  

 

Transfer of other assets to investments in unconsolidated partnerships

  

$

3,785

 

  

—  

 

  

—  

 

Transfer of certain assets and liabilities to investments in unconsolidated partnerships:

                      

Investment securities

  

$

—  

 

  

49,169

 

  

—  

 

Operating properties

  

 

—  

 

  

—  

 

  

385,711

 

Mortgage notes and other debts payable

  

 

—  

 

  

(39,490

)

  

(269,681

)

Other

  

 

—  

 

  

(2,987

)

  

(20,068

)

    


  

  

Total net transfers to investments in unconsolidated partnerships

  

$

—  

 

  

6,692

 

  

95,962

 

    


  

  

Supplemental disclosure of cash flow information:

                      

Cash paid for interest, net of amounts capitalized

  

$

96,892

 

  

116,334

 

  

132,174

 

Cash paid for taxes

  

$

80,569

 

  

68,564

 

  

38,681

 

Purchase of partnership interests and consolidation of entities previously accounted for under the equity method:

                      

Operating properties

  

$

60,504

 

  

—  

 

  

—  

 

Other assets

  

 

4,173

 

  

—  

 

  

—  

 

Mortgage notes and other debts payable

  

 

(48,187

)

  

—  

 

  

—  

 

Investment in unconsolidated partnership

  

 

(6,560

)

  

—  

 

  

—  

 

    


  

  

Cash paid

  

$

9,930

 

  

—  

 

  

—  

 

    


  

  

 

 

See accompanying notes to consolidated financial statements.

 

48


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.   Summary of Organization, Business and Significant Accounting Policies

 

Description of Business

 

LNR Property Corporation, a Delaware corporation, was formed in June 1997. Including our subsidiaries, we operate a real estate investment, finance and management business which engages primarily in (i) acquiring, developing, repositioning, managing and selling commercial and multi-family residential real estate, (ii) investing in high-yielding real estate loans and acquiring at a discount portfolios of loans backed by commercial and multi-family residential real estate and (iii) investing in unrated and non-investment grade rated commercial mortgage-backed securities (“CMBS”) as to which we have the right to be the special servicer (i.e., to oversee workouts of underperforming and non-performing loans).

 

Basis of Presentation and Consolidation

 

The accompanying consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. We consolidate the assets, liabilities, and results of operations of entities (both corporations and partnerships) in accordance with Accounting Research Bulletin (“ARB”) No. 51, “Consolidated Financial Statements” and Statement of Financial Accounting Standards (“SFAS”) No. 94, “Consolidation of All Majority-Owned Subsidiaries—an amendment of ARB No. 51, with related amendments of Accounting Principles Board (“APB”) Opinion No. 18 and ARB No. 43, Chapter 12.” Therefore, we consolidate those entities in which we own a majority of the voting securities or interests, except in those instances in which the minority voting interest owner effectively participates through substantive participative rights, as discussed in Emerging Issues Task Force (“EITF”) 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights.” Substantive participative rights include the ability to select, terminate, and set compensation of the investee’s management, and the ability to make capital and operating decisions of the investee, including budgets, in the ordinary course of business.

 

We also invest in organizations with varying structures, many of which do not have voting securities or interests, such as general partnerships, limited partnerships, and limited liability companies. In many of these structures, control of the partnership generally rests with the general partners or managing members, while other members hold passive interests. The general partner or managing member can hold anywhere from a relatively small percentage of the total financial interests to a majority of the financial interests. Where we serve as a general partner or managing member, we are considered to have the controlling financial interest and therefore that investee is consolidated, regardless of our financial interest percentage, unless there are other limited partners or investing members that effectively participate through substantive participative rights as outlined in EITF 96-16. When we consolidate these entities, the ownership interests of the minority party are reflected as minority interests. In those circumstances where we, as majority owner, cannot cause the entity to take actions that are significant in the ordinary course of business, because such actions were vetoed by the minority owner, we do not consolidate the entity.

 

Since many of the entities in which we invest are single purpose entities that hold real estate properties and have no employees, participative rights over management selection and compensation are not applicable. However, in instances in which the minority voting interest owner, minority general partner or managing member, limited partner, or investing member is permitted or required to effectively participate through substantive participation in capital and operating budget decisions for the entity, those rights are considered to be effective participation through substantive participative rights and accordingly, we do not consolidate the entity. Entities which are not consolidated are accounted for by the equity method (when significant influence can be exerted by us), or the cost method. All significant intercompany transactions and balances among consolidated entities and intercompany profits and/or losses with unconsolidated partnerships have been eliminated.

 

Earnings Per Share

 

We report earnings per share in accordance with SFAS No. 128, “Earnings per Share.” Under SFAS No. 128, basic earnings per share is computed by dividing our earnings attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per

 

49


share is computed by dividing our earnings attributable to common stockholders for the period by the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares reflect the dilution that would occur if the issuance of common stock shared in our earnings for the following: incremental common shares issuable upon the exercise of stock options and the issuance of stock under stock purchase plans, and unvested restricted common stock. The dilutive impact of common stock equivalents is determined by applying the treasury stock method. See Note 8 for the reconciliation of the numerator and denominator of the basic and diluted earnings per share calculations for the years ended November 30, 2002, 2001 and 2000.

 

Comprehensive Earnings

 

We report our comprehensive earnings in accordance with SFAS No. 130, “Reporting Comprehensive Income,” which establishes standards for reporting and presenting comprehensive earnings and its components in a full set of financial statements. Comprehensive earnings consist of net income and other comprehensive earnings (losses), which are primarily unrealized gains and losses on available-for-sale securities and derivative financial instruments. Comprehensive earnings are presented separately in our consolidated statements of comprehensive earnings, net of taxes. The change in accumulated other comprehensive earnings (loss) is reflected in our consolidated statements of stockholders’ equity. SFAS No. 130 requires only additional disclosures in the consolidated financial statements; it does not affect our results of operations or financial position.

 

Business Segments

 

We report business segment information under the provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” This statement establishes standards for reporting information about our operating segments and related disclosures about our products, services, geographic areas of operations and major customers. See Note 17 which provides further information.

 

Cash and Cash Equivalents

 

We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Due to the short maturity period of cash equivalents, the carrying amount of these instruments approximates fair value.

 

Investment Securities

 

Investment securities, which consist principally of CMBS, are accounted for in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” This standard requires that debt and equity securities be classified as either trading, available-for-sale or held-to-maturity. At November 30, 2002 and 2001, none of our securities were held for trading purposes or held-to-maturity; all were classified as available-for-sale. At November 30, 2001, we reclassified our held-to-maturity securities to available-for-sale. Although we have the financial ability to hold our securities to their stated maturities, it is often advantageous for us to sell our securities as they get upgraded, or as the CMBS pools to which they relate pay down significantly and the securities get closer to economic maturity. Because we may choose to sell our securities prior to stated maturity, SFAS No. 115 requires that they be classified as available-for-sale. On the date of transfer, these securities had an amortized cost of $160.8 million and a net unrealized gain of $182.4 million.

 

Securities classified as available-for-sale are recorded at fair value. Unrealized gains or losses, net of the related tax effects, on available-for-sale securities are excluded from earnings and are reported in stockholders’ equity as a component of accumulated other comprehensive earnings (loss) until realized. The cost of securities sold is based on the specific identification method.

 

Unrealized losses that are other than temporary are recognized in earnings. A loss is recognized to the extent to which the fair value of the investment security has declined below its amortized cost and the decline in fair value is other than a temporary impairment. For investment securities, impairment is considered to be other than temporary if the present value of the currently estimated total cash flows related to the security is less than the present value of the previous quarter’s estimated total cash flows of that security.

 

We finance selected CMBS through reverse repurchase obligations (“repos”) with various financial institutions. These agreements allow the lender by contract or custom to repledge or sell the collateral. We are exposed to risk of loss in the event the counterparties fail to perform under the terms of the agreement. The

 

50


counterparties to our transactions are major financial institutions. Accordingly, we believe our risk of loss is limited and therefore, we only require an agreement, without requiring collateral or other security. We separately disclosed on the face of our consolidated balance sheet the investment securities that are pledged under repo agreements which allow the lender to repledge or sell the collateral.

 

We typically seek to be the special servicer on CMBS transactions in which we invest. When we are called on to serve in this capacity, we earn special servicing fees from the related activities performed (primarily overseeing the workout of underperforming and non-performing loans). Special servicing fees are recognized when services have been rendered. We do not pay any consideration for the right to act as special servicer and we purchase the related CMBS at their fair value. Accordingly, we have not assigned a value to our special servicing rights. Consistent with SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” these servicing rights are reflected in our consolidated financial statements at a zero basis. On an ongoing basis, we monitor the level of fees related to these special servicing rights to ascertain that a liability is not created.

 

Mortgage Loans, Net

 

Mortgage loans are accounted for in accordance with Statement of Position (“SOP”) No. 01-06, “Accounting by Certain Entities (Including Entities With Trade Receivables) That Lend to or Finance the Activities of Others.” Under the provisions of SOP No. 01-06, loans for which we have the intent and ability to hold for the foreseeable future or until maturity or payoff should be recorded on the balance sheet as held for investment at outstanding principal adjusted for any chargeoffs, allowances, deferred fees or costs on originated loans and any unamortized premiums or discounts on purchased loans. Loans held for sale should be separately classified on the balance sheet and carried at the lower of cost or fair value. Since we have the intent and ability to hold our loans for the foreseeable future, we classify all of our mortgage loans as held for investment. These mortgage loans are accordingly carried at outstanding principal net of unaccreted discounts, which are accreted to income utilizing a methodology that results in a level yield. In the event that we decide to sell a loan previously classified as held for investment, that loan is reclassified to held for sale at the lower of cost or fair value, with the excess of cost over fair value, if any, recorded as a valuation allowance. If loans are reclassified to held for sale in the future, the determination of fair value will be based on discounting future cash flows using the current interest rates at which similar loans would be made, or will be estimated by us on the basis of financial or other information.

 

We provide an allowance for credit losses for mortgage loans that are considered to be impaired in accordance with SFAS No. 114 “Accounting by Creditors for Impairment of a Loan.” The allowance for losses is based on our evaluation of various factors, including our historical loss experience, the fair value of the collateral and other factors. Realized credit losses on loans are deducted from the allowance when they occur, and related loan balances are charged off as a component of interest income in the period in which the loan is determined to be uncollectible, with loan recoveries recorded in earnings as a component of interest income when received. Loan acquisition costs, such as costs incurred in conducting our due diligence, are capitalized and amortized to earnings over the life of the loan.

 

Operating Properties and Equipment, Net and Land Held for Investment

 

Operating properties and equipment and land held for investment are recorded at cost. Depreciation for operating properties and equipment is calculated to amortize the cost of depreciable assets over their estimated useful lives using the straight-line method. The range of estimated useful lives for operating properties is 10 to 30 years and for furniture and fixtures is 2 to 5 years.

 

We account for long-lived assets in accordance with the provisions of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” This statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets is measured by comparing the carrying amount of an asset to the undiscounted future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the carrying amount of the asset is reduced to its fair value. Beginning December 1, 2002 we will account for long-lived assets in accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which supersedes SFAS No. 121. See New Accounting Pronouncements.

 

Derivative Financial Instruments

 

On December 1, 2000, we adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 137 and SFAS No. 138. Since the adoption of SFAS No. 133, we record all

 

51


derivative instruments as either an asset or liability on the balance sheet at their fair value, and recognize changes in the fair value in earnings unless specified criteria are met.

 

We periodically enter into derivative financial instruments, primarily interest rate swap agreements, to hedge unpredictable changes in asset values related to movements in interest rates on a portion of our available-for-sale securities. These derivative instruments are reported on the consolidated balance sheet at fair value, and changes in the fair value of these derivative instruments are recognized in earnings. Changes in the fair value of the hedged available-for-sale securities attributable to movements in interest rates are also recognized in earnings. Prior to the implementation of SFAS No. 133, gains or losses on these derivative instruments were deferred and amortized through earnings over the remaining lives of the securities being hedged. The deferred gains or losses were reported net of the related tax effect in stockholders’ equity as a component of accumulated other comprehensive earnings (loss).

 

We also periodically enter into interest rate swap agreements to manage our interest costs and hedge against risks associated with changing interest rates on certain of our debt obligations. These derivative instruments are reported on the consolidated balance sheets at fair value. The effective portion of the unrealized gain or loss on these derivatives is reported in other comprehensive earnings (loss) in the consolidated statements of comprehensive earnings, and the ineffective portion is recognized in earnings in the consolidated statements of earnings.

 

In accordance with SFAS No. 133, certain criteria must be met before an interest rate swap or other derivative instrument is accounted for as a hedge. This includes formal documentation at hedge inception of (i) the hedging relationship and our risk management objective and strategy for undertaking the hedge and (ii) an indication that the hedging relationship is expected to be highly effective in hedging the designated risk during the term of the hedge. Effectiveness is tested periodically, and at least quarterly.

 

Our derivative instruments are not leveraged or held-for-trading purposes. See Note 5 for further discussion of derivative financial instruments and hedging activities.

 

Foreign Currency

 

The assets and liabilities held by our foreign investments with a functional currency other than U.S. dollars are translated into U.S. dollars at exchange rates in effect at the end of each reporting period. Foreign entity revenue and expenses are translated into U.S. dollars at the average rates that prevailed during the period. The resulting net translation gains and losses are reported as foreign currency translation adjustments, net of tax, in stockholders’ equity as a component of accumulated other comprehensive earnings (loss). Realized foreign currency gains and losses and changes in the value of foreign currency monetary assets and liabilities are included in the determination of net earnings and are reported as other revenue, net.

 

Revenue Recognition

 

In accordance with EITF No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” we estimate all cash flows attributable to an investment security on the date the security is acquired. The amount by which estimated cash flows exceed the initial investment is recognized as interest income over the life of the security using the effective interest method. Changes in expected cash flows result in prospective adjustments to interest income, in accordance with APB Opinion No. 20.

 

Interest income for mortgage loans held for investment is comprised of interest received plus the accretion of discount between the carrying value and unpaid principal balance using a methodology that results in a level yield.

 

Rental income is recognized when rent is due from tenants. For leases that provide rent concessions or fixed escalations over the lease term, rental income is recognized on a straight-line basis over the terms of the respective leases. Contingent rents are not recognized until realized.

 

Revenues from sales of real estate (including operating properties and land held for investment) and unconsolidated partnership interests are recognized in accordance with the provisions of SFAS No. 66, “Accounting for Sales of Real Estate,” when the profit is determinable and the earnings process is virtually complete.

 

52


 

Transfers of investment securities are accounted for as sales under the provisions of SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” providing that we have surrendered control over the transferred securities and to the extent that we received consideration other than beneficial interests in the transferred securities.

 

Management fees are recognized in income in the period in which the services are performed and collectibility is reasonably assured.

 

Income Taxes

 

Income taxes are accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between the financial reporting carrying values and tax bases of assets and liabilities, and are measured by using enacted tax rates expected to apply to taxable income in the years in which those differences are expected to reverse.

 

Stock-Based Compensation

 

At November 30, 2002, we had one stock-based employee compensation plan, which is described more fully in Note 14. We grant stock options and restricted stock to certain officers, employees and directors. Stock options are granted for a fixed number of shares with an exercise price not less than the fair value of the shares at the dates of grant. We account for the stock option grants under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. An illustration of the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” is presented in Note 14.

 

Upon the issuance of restricted stock, we record deferred compensation expense as a reduction of stockholders’ equity equal to the number of shares granted multiplied by the fair value of the stock at the date of grant. The deferred compensation expense is amortized to earnings over the vesting period.