11/30/2003

 

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, 2003

 

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. ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.) YES x NO ¨

 

The aggregate market value of the common stock and Class B common stock held by non-affiliates of the registrant was $675,497,776 based on the closing price of $38.34 on May 31, 2003, which is the last business day of the registrant’s most recently completed second fiscal quarter.

 

As of January 22, 2004, 19,924,051 shares of common stock and 9,774,568 shares of Class B common stock (which can be converted into common stock) were outstanding.

 

Documents Incorporated by

Reference Into this Report


 

Part of Form 10-K Into Which

this Document is Incorporated


LNR Property Corporation

2004 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 OUR 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 AND INTERNATIONALLY, IN AREAS IN WHICH WE OWN PROPERTIES, OR IN AREAS (INCLUDING AREAS OUTSIDE THE UNITED STATES) IN WHICH PROPERTIES SECURING MORTGAGES DIRECTLY OR INDIRECTLY OWNED BY US ARE LOCATED, (II) CHANGES IN 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, (VIII) CHANGES IN GOVERNMENT REGULATIONS, INCLUDING, WITHOUT LIMITATION, ENVIRONMENTAL REGULATIONS, AND (IX) OTHER FACTORS DESCRIBED UNDER “SOME THINGS WHICH COULD ADVERSELY AFFECT US.”

 

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 under-performing and non-performing commercial loans, seeks to enhance the value of those investments.

 

Our real estate investment activities include the following (see Note 18 of the financial statements for additional details):

 

  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, formed our Company in June 1997 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”).

 

We began developing, owning and managing commercial and multi-family residential real estate in 1969. The decades of experience we gained in developing and managing income producing properties and working out under-performing assets provided us the expertise to capitalize on opportunities and inefficiencies across the broad real estate marketplace.

 

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In the early to mid 1990’s, we leveraged the expertise we gained from managing commercial and multi-family residential real estate by working out large portfolios of non-performing commercial real estate loans. Through partnerships in which we invested and managed that purchased these loans at deep discounts, we worked out over $5 billion face amount of distressed loans during this period.

 

It was also during the early 1990’s that we entered the CMBS market, leveraging these same workout skills to become the special servicer of the CMBS transactions we invested in. Entering the market in its infancy, we established a leadership position by applying our due diligence expertise, our extensive market knowledge and unique workout and real estate value add skills. Today, we have investments in or are special servicer for 112 CMBS transactions, 109 of which relate to U.S. transactions, which represents approximately 20% of the total U.S. CMBS market.

 

In 1997, we entered Japan by investing in and managing several partnerships which acquired non-performing commercial loans, again leveraging the due diligence expertise and workout skills we gained in the U.S. We exited Japan in 2000, realizing a substantial return on our investment there.

 

In the late 1990’s, as opportunities to acquire distressed real estate assets in the U.S. ceased to be readily available, we began to invest in structured junior loan participations in institutional quality short- to medium-term commercial real estate loans (“B-notes”), where we are also designated as special servicer. The B-note market and our B-note portfolio have grown substantially since that time, and B-notes currently make up the majority of our Real Estate Loan business.

 

More recently, in 2002, we entered the European commercial real estate market to take advantage of an opportunity to expand our franchise in an evolving market. The market opportunity is significant as the European Union real estate market is potentially as large as the U.S. real estate market. Additionally, there has been a migration of real estate from the public sector to the private sector and both the CMBS and B-note markets are in their infancy. To date, we have invested in two partnerships with a global financial institution, which hold stabilized commercial real estate properties across Europe, and several CMBS transactions for which we are the special servicer. We are also attempting to market a European real estate private equity venture to invest in CMBS, B-notes and mezzanine debt.

 

Over time, we have proven that we have been able to leverage our due diligence expertise, asset management capabilities and workout skills both geographically and across different product lines, resulting in new investment opportunities and continued growth.

 

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. Because 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, we extended the agreement between Lennar and ourselves regarding our respective activities to November 2005.

 

We and Lennar are separate publicly-traded companies and neither of us has any financial interest in the other except for partnerships and similar entities 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 majority voting control over us and approximately 47% of the voting power of Lennar’s stock. 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 the entities we own jointly with Lennar, see Partnerships with Lennar in Item 1.

 

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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 believe we have a unique ability 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.

 

LNR Business Model

 

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 each 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 $150 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.

 

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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 more than a 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, as well as CMBS for which we are the special servicer. As a result, we have experience working 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 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 sales 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 of similar duration and fixed-rate assets be primarily financed by fixed-rate liabilities of similar duration. 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, 2003, our total assets by business segment consist of the following (dollars in millions):

 

LOGO

 

(1) Includes fair value write-up on CMBS of $114 million at November 30, 2003.

 

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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.

 

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 utilizing 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 sometimes 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, 2003, our domestic real estate market-rate property portfolio, which includes stabilized properties and properties in various stages of development, repositioning and/or lease-up, which we own directly or through partnerships, included:

 

Type


   Number of
Properties


  

Square Feet/Units/Rooms


Apartment communities

   3    1,500 units

Office buildings

   16    4.1 million square feet

Industrial/warehouse facilities

   3    0.6 million square feet

Hotels

   9    2,100 rooms

Retail centers

   7    1.8 million square feet

Land:

         

Leased

   9    0.3 million square feet (8 acres)

Other

   —      700 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 16 office buildings range from one to 36 stories and have an aggregate of 4.1 million square feet of office space. Seven of the office buildings are in California, three are in Florida, two are in Georgia, two are in North Carolina, one is in Texas and one is in Louisiana.

 

Industrial/Warehouse Facilities

 

Our three industrial/warehouse facilities range from 123,000 square feet to 309,000 square feet of floor space. These industrial facilities are all located in California.

 

Hotels

 

Our nine hotels have a total of 2,100 rooms. Two of the hotels are located in Florida. The remaining seven are located in Louisiana, Colorado, New Jersey, Tennessee, Virginia, Texas and New York.

 

Retail Centers

 

The retail centers in our portfolio include: (i) a five story dining and entertainment complex with 58,000 square feet of retail and office space, (ii) two small neighborhood retail centers (sometimes referred to as

 

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“strip centers”), with 30,000 square feet and 70,000 square feet of store space, as well as parking areas and public areas and (iii) four larger regional retail centers, with 102,000 square feet to 974,000 square feet of store space. The entertainment complex is located in Louisiana. One small retail center is located in Florida and the other is located in Indiana. Of the regional retail centers, three are in California, and one is in New York.

 

Land

 

In addition to our operating properties, we own commercially zoned land, 0.3 million square feet of which is leased to others under nine long-term ground leases and 700 acres of which will be used for specific development opportunities or sold. Eight of these ground leases are located in Florida and one is in California. The land held for development is located in California, Florida, Massachusetts, Michigan and Texas.

 

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.

 

Newhall Land Income Producing Commercial Assets

 

In connection with the acquisition of Newhall Land (see Partnerships with Lennar), we purchased income producing assets, which we own directly or through partnerships, which included:

 

Type


   Number of
Properties


  

Square Feet/Rooms


Office buildings

   2    46,000 square feet

Hotels

   2    396 rooms

Retail centers

   6    1,250,000 square feet

Land leases

   4    348,044 square feet (8 acres)

 

Europe

 

At November 30, 2003, our European real estate property investments represented partnership interests in entities that own stabilized properties, which included:

 

Number of Properties


 

Country


 

Type


 

Square Feet


224

  France   Industrial   13.7 million

147

  France   Office   10.6 million

    3

  Spain   Industrial   1.1 million

    1

  Belgium   Industrial   0.2 million

    1

  Switzerland   Office   0.1 million

 

For more information about the European partnerships, see Off Balance Sheet Arrangements, International Partnerships, Item 7.

 

Affordable Housing Communities

 

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. In 2000, we began to shift our strategy away from owning the majority of the partnership interests in the affordable housing communities toward syndicating those interests. After such syndications,

 

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we continue to hold small interests (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, has continued to decline.

 

As of November 30, 2003, we had direct or indirect ownership interests through partnership arrangements in approximately 9,500 affordable housing apartment units, ranging in size from three to 436 units in 82 communities. The apartment communities are located across the U.S.

 

Partnerships With Lennar

 

In November 2003, we and Lennar each contributed our 50% interests in jointly owned entities that had significant assets to a new limited liability company named LandSource Communities Development LLC (“LandSource”), in exchange for 50% interests in LandSource. The most significant entity contributed to LandSource by both us and Lennar was Lennar Land Partners (“LLP”), which is engaged in the acquisition, development and sale of land that is suitable for residential or commercial development, and in the development and sale of homes.

 

In addition, in July 2003, we and Lennar formed, and obtained 50% interests in, NWHL Investment LLC (“NHWL”), which in January 2004 purchased The Newhall Land and Farming Company (“Newhall Land”) for approximately $1.0 billion, in addition to assuming Newhall Land’s debt. Newhall Land’s primary business is developing two master-planned communities in Los Angeles County, California.

 

In order to enable NWHL to pay the acquisition price of Newhall Land, we and Lennar each contributed $200 million, and LandSource and NWHL jointly obtained $600 million of bank financing commitments, of which $400 million was used by NWHL to pay part of the acquisition price of Newhall Land. The remainder of the acquisition price was paid with proceeds from a sale of income producing properties from Newhall Land to us for $217 million. We are not obligated with regard to the borrowings of LandSource and NWHL, except that we and Lennar have committed to complete any property development commitments on which LandSource and NWHL default and have guaranteed that, in the event of fraud or similar unlawful activities by the borrowers, or distributions by the borrowers that are not permitted by the loan documents, we will pay the lenders the amount of any resulting damages they suffer and we will pay anything that is required to reduce the loan balances to specified percentages of the appraised values of the properties that secure the borrowings.

 

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

 

We and Lennar have equal say on all major decisions with respect to our joint ventures. Our by-laws require that transactions between us and Lennar with respect to these entities be approved by our Transaction Review Committee, which is entirely comprised of members of our Board who are not directors, officers or employees of Lennar.

 

Our total investment in partnerships with Lennar (including LandSource, NWHL and other partnerships), accounted for by the equity method, at November 30, 2003 was $163.6 million. Total assets and liabilities of the partnerships were $589.9 million and $217.0 million, respectively, at November 30, 2003.

 

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Real Estate Loans

 

At November 30, 2003, our real estate loan portfolio consisted of:

 

Type of Loan


   Principal Amount
of Loans


     (In thousands)

B-notes

   $443,014

Mezzanine loans

   27,286

Other loans

   7,605
    

Total

   $477,905
    

 

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. In many cases, the senior participations are securitized by the financial institutions. We are designated as the special servicer for the junior loan participations and generally for the securitizations, 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. At November 30, 2003, we had no delinquencies in our B-note portfolio. We had $443.0 million principal amount of these investments at November 30, 2003, of which $373.7 million represented participations in first mortgage loans and $69.3 million represented participations in mezzanine loans.

 

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.

 

Other Loans

 

Other loans typically include loans secured by commercial and multi-family residential real estate properties. Sometimes these loans represent short-term seller financing provided by us upon the sale of our operating properties.

 

The types of real estate loans and collateral held by us at November 30, 2003, follows:

 

Property Type


   B-notes

   Mezzanine
Loans


   Other Loans

   Total
Principal
Amount


     (In thousands)

Office buildings

   $ 198,477    6,259    3,536    208,272

Retail centers

     104,674    —      —      104,674

Hotels

     38,880    —      —      38,880

Apartment communities

     30,450    8,019    —      38,469

Mixed-use properties

     34,500    —      —      34,500

Industrial/warehouse facilities

     17,923    —      3,244    21,167

Residential development and other

     3,510    13,008    825    17,343

Convention centers

     14,600    —      —      14,600
    

  
  
  

Total

   $ 443,014    27,286    7,605    477,905
    

  
  
  

 

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The locations of the properties securing our real estate loans were as follows:

 

Location


   B-notes

   Mezzanine
Loans


   Other Loans

   Total
Principal
Amount


     (In thousands)

New York

   $ 143,058    —      —      143,058

California

     52,267    13,008    —      65,275

Massachusetts

     60,500    —      —      60,500

Texas

     35,718    8,019    —      43,737

Illinois

     37,017    —      —      37,017

Washington

     23,350    —      —      23,350

Virginia

     14,600    6,259    —      20,859

Missouri

     17,166    —      —      17,166

Michigan

     15,753    —      —      15,753

Florida

     13,832    —      669    14,501

Utah

     9,500    —      —      9,500

Minnesota

     8,621    —      —      8,621

International

     —      —      6,936    6,936

Georgia

     3,570    —      —      3,570

Ohio

     2,058    —      —      2,058

Kentucky

     1,685    —      —      1,685

Nevada

     1,087    —      —      1,087

North Carolina

     1,083    —      —      1,083

Tennessee

     1,008    —      —      1,008

Wisconsin

     761    —      —      761

Alabama

     380    —      —      380
    

  
  
  

Total

   $ 443,014    27,286    7,605    477,905
    

  
  
  

 

Discounted Portfolios of Commercial Mortgage Loans

 

In the early 1990’s, we acquired in partnership with financial institutions or real estate funds, several 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, 2003, the partnerships had distributed a total of $1.4 billion to the partners, of which $420.4 million had been distributed to us. We also received management and asset disposition fees totaling approximately $66.0 million. At November 30, 2003, most of the assets from these domestic portfolios had been liquidated and our investment in these partnerships was $10.6 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.

 

Beginning in late 1997, we were approached by a number of global financial institutions and entered into several partnerships to acquire portfolios of non-performing commercial mortgage loans in Japan and to

 

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run the workout operations of the partnerships. In April 2000, we sold our interest in these Japanese real estate loan portfolios and realized a pretax gain on sale of $20.3 million.

 

In late 2003, we were again approached by another major financial institution and entered into a 50%/50% joint venture to invest in performing, sub-performing and non-performing assets, including owned real estate assets, loans and CMBS. One of our subsidiaries acts as the managing member and conducts the business of the venture. We earn management fees, special servicing fees and asset disposition fees from the venture and have a carried interest in cash flow once our partner has recovered their capital and achieved a specified return. Our investment in this venture at November 30, 2003 was $1.7 million. The venture has the capacity to invest up to $425 million in these types of assets.

 

Debt financing for partnerships’ acquisitions of real estate and real estate related assets has usually been on a non-recourse basis and with no guarantees by us or any of our partners. In some cases, the lender must be repaid in full or in part 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. In most transactions, 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 trust 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

 

11


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 & 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 the United States. In addition, many in the industry recognize us as the premier special servicer based on our strong track record and experience. The strength of both our relocated U.S. team and the import/customization of our U.S. platform to Europe, has allowed us to be approved as a special servicer for our European CMBS transactions.

 

Competition in purchasing unrated and non-investment grade rated subordinated CMBS in the United States during the past five years has generally been limited and, as a result, our purchasing power has been significant. Although the subordinated CMBS market has seen some new entrants more recently, competition remains somewhat limited due to the need for a significant infrastructure and the real estate expertise to properly and efficiently complete the detailed due diligence required to purchase less than investment grade CMBS. Therefore, our ability to successfully bid on new deals even with some new entrants remains strong. 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 generally limited competition for unrated and non-investment grade rated subordinated CMBS usually provides us with 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.

 

In Europe, the CMBS market is in its early stages of development and we believe we are well positioned to capitalize on the expansion and evolution of that market.

 

At November 30, 2003, we had investments in or were entitled to be the special servicer with regard to 112 securitized commercial mortgage pools represented by over 15,200 underlying loans in all 50 United States and in the United Kingdom. We had investments in subordinated CMBS related to 101 of these pools. At November 30, 2003, the total face amount of our directly owned portfolio was approximately $2.2 billion with an amortized cost of approximately $0.8 billion, or approximately $1.4 billion of discount. Our fixed-rate portfolio was generating a current cash return of 17% (29% 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 United States and in the United Kingdom. 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.

 

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 five 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. The investment grade

 

12


bonds can then be sold to unrelated third parties to realize the added value and the proceeds can be recycled 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 had 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. This facility expires in March 2004, and the members are in the process of refinancing through a resecuritization.

 

At November 30, 2003, our investment in the venture was $81.8 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.

 

Strategic Growth Alternatives

 

In 2001, we engaged certain investment banking firms to explore strategic alternatives for the growth of our Company. We continue to have an ongoing relationship with these firms.

 

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.

 

We believe our access to investment opportunities through our relationships, presence in markets across the country and Europe, the large portfolio of assets we currently specially service, 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 attracts 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 migration of real estate from the public sector to the private sector, and in the emerging European CMBS and B-note 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 were weak for much of 2003, occupancies remained relatively 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.

 

13


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.

 

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, 2003 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.

 

Employees

 

At November 30, 2003, we had 460 full time and 4 part time employees, of whom 9 were senior management, 91 were corporate staff, and 364 were engaged in asset acquisitions, loan workouts and the management, development, repositioning and sale of properties.

 

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.

 

14


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.

 

Since late 2001, vacant commercial space (including office and retail space) and vacant multi-family residential apartments in a number of cities has been increasing as demand for space has weakened reflecting economic conditions. 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. Some 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.

 

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.

 

15


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 balances or liquidate the CMBS positions. 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 83% 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.

 

Continued investment in European assets can expose us to currency fluctuations.

 

Our investments and operations in Europe use functional currencies other than the U.S. dollar. As a result, changes in currency rates can adversely impact our earnings and the translation of assets and liabilities of our European operations. Based on our current plans to reinvest cash flow generated by our European investments back into our European operations, we have no foreign currency hedges in place at November 30, 2003. Our European assets represent less than 5% of our total assets at November 30, 2003. To the extent our European assets become greater or to the extent cash flow from European investments are repatriated to the U.S., our exposure to changes in foreign currency rates could become realized and will increase.

 

Access to Company Information

 

We electronically file our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all exhibits and amendments to these reports, 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, N.W., Washington, D.C. 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, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all exhibits and amendments to these reports. These reports are available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. In addition, we make available, free of charge, through our website, and by responding to requests addressed to our investor relations department, our Code of Business Conduct and Ethics and our Corporate Governance Guidelines. You can find links to these materials on our website at http://www.lnrproperty.com. The information contained on our website is not part of this document.

 

16


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 (one office) and lease (eight 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 2003.

 

17


PART II

 

Item 5. (a) 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

     2003

First Quarter

   $ 36.40    $ 32.75

Second Quarter

   $ 38.36    $ 32.55

Third Quarter

   $ 41.13    $ 37.40

Fourth Quarter

   $ 44.25    $ 40.70
     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

 

At January 22, 2004, there were approximately 14,612 holders of record of our common stock. During each of the four quarters in 2003 and 2002, we declared and paid cash dividends of $.0125 per common share and $.01125 per Class B common share.

 

18


(b) Issuer Purchases of Equity Securities.

 

Month


   Total
Number of
Shares
Purchased(1)


   Average
Price
Paid per
Share


   Total
Number of
Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs(1)


   Maximum
Number of
Shares that
May Yet Be
Purchased
Under the Plans
or Programs(2)


December 2002

   95,000    $ 36.46    95,000    4,531,245

January 2003

   409,970    $ 33.66    409,970    4,221,275

February 2003

   948,200    $ 33.54    948,200    3,273,075

March 2003

   2,882,700    $ 33.00    2,882,700    390,375

April 2003

   —      $ —      —      3,390,375

May 2003

   —      $ —      —      3,390,375

June 2003

   —      $ —      —      3,390,375

July 2003

   —      $ —      —      3,390,375

August 2003

   —      $ —      —      3,390,375

September 2003

   —      $ —      —      3,390,375

October 2003

   —      $ —      —      3,390,375

November 2003

   —      $ —      —      3,390,375

 

(1) Our Board of Directors approved a stock repurchase program authorizing us to buy back up to 12.5 million shares of our common stock, including 3 million shares of common stock authorized in April 2003. This repurchase program was first authorized in 1998. In January 2001, our Board of Directors approved the Employee Share Repurchase Plan. Under the Employee Share Repurchase Plan, employees can request that we consider purchasing shares of common stock that the employees acquired through the exercise of stock options or whose common stock became non-forfeitable on a restricted stock vesting date. If the purchase is approved by the Board of Directors or a committee designated by the Board of Directors, we will purchase the shares at the market price on the applicable stock purchase date. 95,000 and 100,000 shares were purchased by us during the months of December 2002 and January 2003, respectively, under the Employee Share Repurchase Plan. The remainder of our purchased shares relate to the stock repurchase plan.

 

(2) Excludes the Employee Share Repurchase Plan as each purchase requires approval by the Board of Directors or a committee designated by the Board of Directors.

 

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.

 

19


     Years Ended November 30,

 
     2003

    2002

    2001

    2000

    1999

 
           (In thousands, except per share
amounts)
       

Results of Operations

                                

Revenues and other operating income:

                                

Real estate properties

   $ 190,879     180,252     205,347     211,054     191,828  

Real estate loans

     51,827     44,848     52,150     80,507     45,483  

Real estate securities

     191,932     225,206     214,290     176,435     107,315  
    


 

 

 

 

Total revenues and other operating income

   $ 434,638     450,306     471,787     467,996     344,626  
    


 

 

 

 

Interest expense

   $ 102,254     92,054     109,742     120,722     83,199  

Earnings from continuing operations, net of tax

   $ 81,169     140,192     133,402     114,392     94,608  

Earnings from discontinued operations, net of tax

   $ 28,413     3,686     1,711     1,479     952  

Net earnings

   $ 109,582     143,878     135,113     115,871     95,560  

Earnings per share – basic:

                                

From continuing operations

   $ 2.77     4.19     4.00     3.42     2.66  

From discontinued operations

     0.97     0.11     0.05     0.04     0.02  
    


 

 

 

 

Net earnings per share – basic

   $ 3.74     4.30     4.05     3.46     2.68  
    


 

 

 

 

Earnings per share – diluted:

                                

From continuing operations

   $ 2.64     4.04     3.82     3.28     2.61  

From discontinued operations

     0.93     0.11     0.05     0.04     0.02  
    


 

 

 

 

Net earnings per share – diluted

   $ 3.57     4.15     3.87     3.32     2.63  
    


 

 

 

 

Cash dividends per share:

                                

Common stock

   $ 0.05     0.05     0.05     0.05     0.05  

Class B common stock

   $ 0.045     0.045     0.045     0.045     0.045  

Financial Data

                                

EBITDA (1)

   $ 333,240     340,414     347,332     329,246     242,964  

Ratio of earnings to fixed charges

     2.2 x   3.4 x   2.8 x   2.2 x   2.2 x

Cash flows provided by (used in):

                                

Operating activities

   $ 78,638     71,131     115,907     121,726     110,316  

Investing activities

   $ 265,161     63,374     (83,843 )   (150,619 )   (404,590 )

Financing activities

   $ (319,843 )   (135,372 )   (27,472 )   22,292     274,444  

Financial Position

                                

Total assets

   $ 2,633,014     2,834,874     2,836,647     2,348,856     2,283,001  

Assets by business segment

                                

Real estate properties

   $ 1,053,839     1,123,214     1,037,098     1,153,608     1,290,149  

Real estate loans

   $ 468,394     441,652     398,614     314,162     274,694  

Real estate securities

   $ 1,015,113     1,248,709     1,355,923     826,092     640,791  

Total debt

   $ 1,382,786     1,339,962     1,318,392     1,382,059     1,382,124  

Stockholders’ equity

   $ 1,050,867     1,126,156     1,119,169     778,444     710,332  

Stockholders’ equity per share

   $ 35.36     34.15     32.54     22.75     20.18  

Shares outstanding:

                                

Common stock

     19,941     23,189     24,445     24,215     25,142  

Class B common stock

     9,775     9,784     9,949     9,999     10,058  
    


 

 

 

 

Total

     29,716     32,973     34,394     34,214     35,200  
    


 

 

 

 


(1) EBITDA is defined as earnings before interest, taxes, depreciation, amortization and loss on early extinguishment of debt, and is calculated as follows:

 

20


     Years Ended November 30,

     2003

   2002

   2001

   2000

   1999

     (In thousands)

Continuing operations:

                          

Earnings

   $ 81,169    140,192    133,402    114,392    94,608

Add back:

                          

Income tax expense

     38,285    66,918    70,136    51,112    34,732

Interest expense

     102,254    92,054    109,742    120,722    83,199

Depreciation expense

     21,256    21,395    24,545    35,519    27,018

Amortization expense

     9,465    5,665    5,228    3,693    762

Loss on early extinguishment of debt

     28,672    —      —      —      —  
    

  
  
  
  

EBITDA from continuing operations

     281,101    326,224    343,053    325,438    240,319
    

  
  
  
  

Discontinued operations:

                          

Earnings

     28,413    3,686    1,711    1,479    952

Add back:

                          

Income tax expense

     18,166    2,357    1,094    945    608

Interest expense

     3,093    4,556    752    765    710

Depreciation expense

     2,467    3,591    722    619    375
    

  
  
  
  

EBITDA from discontinued operations

     52,139    14,190    4,279    3,808    2,645
    

  
  
  
  

EBITDA

   $ 333,240    340,414    347,332    329,246    242,964
    

  
  
  
  

 

Our management uses EBITDA as a supplemental measure for making decisions and believes 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. Also, many of our debt instruments have covenants relating to our EBITDA or similar measures. Our management believes investors may find information about our EBITDA helpful, because prices of securities of companies in real estate related businesses often are affected by changes in EBITDA. 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 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, amortization expense and loss on early extinguishment of debt) are not captured in EBITDA. These excluded items must also be considered when assessing or understanding our financial performance. Because EBITDA is not a measure governed by generally accepted accounting principles, there are no required standards for calculating EBITDA. Therefore, EBITDA as calculated by us may not be comparable to similarly titled measures employed by other companies.

 

21


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 AND INTERNATIONALLY, IN AREAS IN WHICH WE OWN PROPERTIES, OR IN AREAS (INCLUDING AREAS OUTSIDE THE UNITED STATES) IN WHICH PROPERTIES SECURING MORTGAGES DIRECTLY OR INDIRECTLY OWNED BY US ARE LOCATED, (II) CHANGES IN 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, (VIII) CHANGES IN GOVERNMENT REGULATIONS, INCLUDING, WITHOUT LIMITATION, ENVIRONMENTAL REGULATIONS, AND (IX) OTHER FACTORS DESCRIBED IN PART I UNDER “SOME THINGS WHICH COULD ADVERSELY AFFECT US.”

 

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 under-performing 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.

 

RESULTS OF OPERATIONS

 

Adoption of SFAS No. 144

 

On December 1, 2002, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 requires that, beginning December 1, 2002, whenever we sell or hold for sale a commercial real estate property that has its own operations and cash flows, which is a frequent occurrence since selling properties is a regular part of our business, we must reclassify the revenues and expenses of that property, including the gain or loss on the sale of that property, both with regard to the current period and with regard to the past, as results of discontinued operations. Primarily because of this, 26% of our net earnings during 2003 were characterized as earnings from discontinued operations. Because selling properties is a regular part of our business, our expectation is that each year we will continue to report a significant portion of our earnings as discontinued operations, and accordingly we will be required to restate prior years for comparability. Because our real estate properties business consists of continuously acquiring properties, enhancing their value and selling them, sales of individual properties are an important part of our real estate property business. Therefore, we believe that reclassifying our operating income from properties we sell or hold for sale and treating our gain or loss from sale of those properties as discontinued operations, makes it difficult to determine and evaluate from our statements of earnings the performance of our real estate properties business. Because of that, in this “Management’s Discussion and Analysis of Financial Condition and

 

22


Results of Operations,” and particularly in the section regarding Real Estate Properties, we provide information that combines revenues, expenses and gains on sales with regard to properties we have sold or hold for sale, which are reflected on our statements of earnings as discontinued operations, with the operating income from commercial properties we continue to own which are not classified as held for sale. Our management uses this combined information in evaluating the performance of the real estate properties business, and believes investors may find the information helpful for this purpose as well.

 

23


The following is a summary of our results of operations on an as reported and combined basis for the years ended November 30, 2003, 2002 and 2001:

 

    

As Reported

Years Ended November 30,


   

Combined(1)

Years Ended November 30,


 
     2003

    2002

    2001

    2003

    2002

    2001

 
                 (In thousands)              

Revenues

                                      

Rental income

   $ 100,058     93,708     105,806     113,353     115,426     111,669  

Management and servicing fees

     41,227     31,982     36,324     41,227     31,982     36,340  
    


 

 

 

 

 

Total revenues

     141,285     125,690     142,130     154,580     147,408     148,009  
    


 

 

 

 

 

Other operating income

                                      

Equity in earnings of unconsolidated partnerships

     51,974     46,361     75,152     51,974     46,361     75,152  

Interest income

     157,893     180,776     181,325     157,936     180,819     181,339  

Gains on sales of:

                                      

Real estate

     13,174     48,088     63,535     56,754     48,088     63,535  

Unconsolidated partnership interests

     3,568     3,428     746     3,568     3,428     746  

Investment securities

     52,667     47,221     9,717     52,667     47,221     9,717  

Lease termination fee

     15,115     —       —       15,115     —       —    

Other, net

     (1,038 )   (1,258 )   (818 )   (1,040 )   (1,257 )   (818 )
    


 

 

 

 

 

Total other operating income

     293,353     324,616     329,657     336,974     324,660     329,671  
    


 

 

 

 

 

Costs and expenses

                                      

Cost of rental operations

     60,431     51,243     57,028     65,227     58,816     58,642  

General and administrative

     87,747     77,281     74,398     87,747     77,281     74,398  

Depreciation

     21,256     21,395     24,545     23,723     24,986     25,267  

Impairment of long-lived asset

     15,050     —       —       15,050     —       —    

Minority interests

     (226 )   1,223     2,536     (245 )   1,222     2,536  

Interest

     102,254     92,054     109,742     105,347     96,610     110,494  

Loss on early extinguishment of debt

     28,672     —       —       28,672     —       —    
    


 

 

 

 

 

Total costs and expenses

     315,184     243,196     268,249     325,521     258,915     271,337  
    


 

 

 

 

 

Earnings from continuing operations before income taxes

     119,454     207,110     203,538     166,033     213,153     206,343  

Income taxes

     38,285     66,918     70,136     56,451     69,275     71,230  
    


 

 

 

 

 

Earnings from continuing operations

     81,169     140,192     133,402     109,582     143,878     135,113  
    


 

 

 

 

 

Discontinued operations:

                                      

Earnings from operating properties sold or held for sale, net of tax

     1,829     3,686     1,711     —       —       —    

Gain on sales of operating properties, net of tax

     26,584     —       —       —       —       —    
    


 

 

 

 

 

Earnings from discontinued operations

     28,413     3,686     1,711     —       —       —    
    


 

 

 

 

 

Net earnings

   $ 109,582     143,878     135,113     109,582     143,878     135,113  
    


 

 

 

 

 


(1) See discussion entitled, “Adoption of SFAS No. 144.”

 

24


The following table summarizes our results of operations by segment for the years ended November 30, 2003, 2002 and 2001, after allocating certain non-corporate general and administrative expenses.

 

    

As Reported

Years Ended November 30,


   

Combined(1)

Years Ended November 30,


 
     2003

    2002

    2001

    2003

    2002

    2001

 
     (In thousands)  

Revenues and other operating income

                                    

Real estate properties

   $190,879     180,252     205,347     247,795     202,014     211,240  

Real estate loans

   51,827     44,848     52,150     51,827     44,848     52,150  

Real estate securities

   191,932     225,206     214,290     191,932     225,206     214,290  
    

 

 

 

 

 

Total revenues and other operating income

   434,638     450,306     471,787     491,554     472,068     477,680  
    

 

 

 

 

 

Costs and expenses

                                    

Real estate properties

   126,891     99,596     111,814     134,135     110,759     114,150  

Real estate loans

   4,329     5,614     7,399     4,329     5,614     7,399  

Real estate securities

   24,081     20,590     15,271     24,081     20,590     15,271  

Corporate and interest

   159,883     117,396     133,765     162,976     121,952     134,517  
    

 

 

 

 

 

Total costs and expenses

   315,184     243,196     268,249     325,521     258,915     271,337  
    

 

 

 

 

 

Earnings from continuing operations before income taxes

                                    

Real estate properties

   63,988     80,656     93,533     113,660     91,255     97,090  

Real estate loans

   47,498     39,234     44,751     47,498     39,234     44,751  

Real estate securities

   167,851     204,616     199,019     167,851     204,616     199,019  

Corporate and interest

   (159,883 )   (117,396 )   (133,765 )   (162,976 )   (121,952 )   (134,517 )

Earnings from continuing operations before income taxes

   119,454     207,110     203,538     166,033     213,153     206,343  

Income taxes

   38,285     66,918     70,136     56,451     69,275     71,230  
    

 

 

 

 

 

Earnings from continuing operations

   81,169     140,192     133,402     109,582     143,878     135,113  
    

 

 

 

 

 

Discontinued operations:

                                    

Earnings from operating properties sold or held for sale, net of tax

   1,829     3,686     1,711     —       —       —    

Gain on sales of operating properties, net of tax

   26,584     —       —       —       —       —    
    

 

 

 

 

 

Earnings from discontinued operations

   28,413     3,686     1,711     —       —       —    
    

 

 

 

 

 

Net earnings

   $109,582     143,878     135,113     109,582     143,878     135,113  
    

 

 

 

 

 


(1) See discussion entitled, “Adoption of SFAS No. 144.”

 

25


Year ended November 30, 2003 compared to year ended November 30, 2002

 

Net earnings for the year ended November 30, 2003 were $109.6 million, compared to $143.9 million in 2002. Diluted earnings per share for the year ended November 30, 2003 were $3.57, compared to $4.15 in 2002. The decrease in earnings was primarily due to (i) lower interest income from our real estate securities business, primarily due to lower overall yields in the current year, write-downs on certain bonds in the current year, and the early collection of purchase discounts in the prior year due to prepayments on seasoned transactions, offset in part by a higher average level of CMBS investments, (ii) a pretax loss of $28.7 million related to the early retirement of our senior subordinated notes, as discussed further in our Financial Condition, Liquidity and Capital Resources below, (iii) higher general and administrative expenses, primarily due to increased personnel and out-of-pocket expenses related to growth in our activities, (iv) higher interest expense, primarily due to higher average debt balances, partially offset by lower average interest rates, and (v) lower net rents (rental income less cost of rental operations), primarily due to a smaller stabilized property portfolio. These decreases in earnings were somewhat offset by (i) higher interest income from our real estate loans business, primarily due to a higher average level of loan investments as well as income in 2003 realized from the early payoff of several loan investments, (ii) higher management and servicing fee income, primarily due to increased activity in our specially serviced portfolio, (iii) higher gains on sales of assets (including gains of $43.6 million in 2003 and $0.0 million in 2002 characterized as earnings from discontinued operations), (iii) higher equity in earnings from unconsolidated partnerships, primarily due to higher earnings from one property partnership that sold 75% of its interest in its land portfolio for a gain, and (iv) lower income tax expense, due to lower pretax earnings offset by a higher effective tax rate. Additionally, during 2003, we recorded a lease termination fee and a $15.1 million asset impairment charge, which offset each other, as discussed in the Real Estate Properties section below.

 

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, compared to $135.1 million in 2001. Diluted earnings per share for the year ended November 30, 2002 were $4.15, compared to $3.87 in 2001. The increase in earnings was primarily due to (i) a higher level of gains on asset sales primarily due to a $45.6 million pretax 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, reflecting the contribution to net rents from our development and repositioned properties which became stabilized or completed and had tenants that were 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”), as discussed in Real Estate Securities below and (ii) a decrease in management and servicing fees.

 

26


Real Estate Properties

 

     Year Ended November 30, 2003

 
     As Reported

   

Discontinued

Operations


    Combined

 
     (In thousands)  

Revenues

                    

Rental income

   $ 100,058     13,295     113,353  

Management fees

     3,732     —       3,732  

Other operating income

                    

Equity in earnings of unconsolidated partnerships

     54,055     —       54,055  

Interest income

     1,144     43     1,187  

Gains on sales of real estate

     13,174     43,580     56,754  

Gains on sales of unconsolidated partnership interests

     3,568     —       3,568  

Lease termination fee

     15,115     —       15,115  

Other, net

     33     (2 )   31  
    


 

 

Total revenues and other operating income

     190,879     56,916     247,795  
    


 

 

Costs and expenses

                    

Cost of rental operations

     60,431     4,796     65,227  

General and administrative

     30,387     —       30,387  

Depreciation

     21,256     2,467     23,723  

Impairment of long-lived assets

     15,050     —       15,050  

Minority interests

     (233 )   (19 )   (252 )
    


 

 

Total costs and expenses (1)

     126,891     7,244     134,135  
    


 

 

Earnings before income taxes

   $ 63,988     49,672     113,660  
    


 

 

Balance sheet data:

                    

Operating properties and equipment, net

   $ 640,942     —       640,942  

Land held for investment

     58,578     —       58,578  

Investments in unconsolidated partnerships

     329,960     —       329,960  

Other assets

     24,359     —       24,359  
    


 

 

Total segment assets

   $ 1,053,839     —       1,053,839  
    


 

 


(1) Costs and expenses do not include interest expense.

 

27


     Year Ended November 30, 2002

     As Reported

   Discontinued
Operations


    Combined

     (In thousands)

Revenues

                 

Rental income

   $ 93,708    21,718     115,426

Management fees

     4,042    —       4,042

Other operating income

                 

Equity in earnings of unconsolidated partnerships

     29,383    —       29,383

Interest income

     1,528    43     1,571

Gains on sales of real estate

     48,088    —       48,088

Gains on sales of unconsolidated partnership interests

     3,428    —       3,428

Other, net

     75    1     76
    

  

 

Total revenues and other operating income

     180,252    21,762     202,014
    

  

 

Costs and expenses

                 

Cost of rental operations

     51,243    7,573     58,816

General and administrative

     26,860    —       26,860

Depreciation

     21,395    3,591     24,986

Minority interests

     98    (1 )   97
    

  

 

Total costs and expenses (1)

     99,596    11,163     110,759
    

  

 

Earnings before income taxes

   $ 80,656    10,599     91,255
    

  

 

Balance sheet data:

                 

Operating properties and equipment, net

   $ 585,086    180,541     765,627

Assets held for sale

     195,363    (195,363 )   —  

Land held for investment

     56,980    —       56,980

Investments in unconsolidated partnerships

     250,351    —       250,351

Other assets

     35,434    14,822     50,256
    

  

 

Total segment assets

   $ 1,123,214    —       1,123,214
    

  

 

(1) Costs and expenses do not include interest expense.

 

28


     Year Ended November 30, 2001

     As Reported

   Discontinued
Operations


    Combined

     (In thousands)

Revenues

                 

Rental income

   $ 105,806    5,863     111,669

Management fees

     7,461    16     7,477

Other operating income

                 

Equity in earnings of unconsolidated partnerships

     25,796    —       25,796

Interest income

     2,003    14     2,017

Gains on sales of real estate

     63,535    —       63,535

Gains on sales of unconsolidated partnership interests

     746    —       746
    

  

 

Total revenues and other operating income

     205,347    5,893     211,240
    

  

 

Costs and expenses

                 

Cost of rental operations

     57,028    1,614     58,642

General and administrative

     29,998    —       29,998

Depreciation

     24,545    722     25,267

Minority interests

     243    —       243
    

  

 

Total costs and expenses (1)

     111,814    2,336     114,150
    

  

 

Earnings before income taxes

   $ 93,533    3,557     97,090
    

  

 

Balance sheet data:

                 

Operating properties and equipment, net

   $ 571,897    147,765     719,662

Assets held for sale

     157,930    (157,930 )   —  

Land held for investment

     41,593    636     42,229

Investments in unconsolidated partnerships

     226,708    —       226,708

Other assets

     38,970    9,529     48,499
    

  

 

Total segment assets

   $ 1,037,098    —       1,037,098
    

  

 

(1) Costs and 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, develop, reposition, manage and sell. These properties may be wholly-owned or owned through partnerships or similar entities that are either consolidated or accounted for by the equity method, and therefore reflected on our balance sheets only as investments in unconsolidated partnerships. Total revenues and other operating income from real estate properties include rental income from consolidated operating properties, equity in earnings of unconsolidated partnerships that own and operate real estate properties, gains on sales of properties or interests in those unconsolidated partnerships, and fees earned from managing those partnerships. Costs and 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.

 

Year ended November 30, 2003 compared to year ended November 30, 2002

 

Earnings before income taxes from real estate properties on an as reported basis were $64.0 million for the year ended November 30, 2003, compared to $80.7 million in 2002. On a combined basis (i.e., including revenues and expenses of properties classified as discontinued operations), earnings before income taxes from real estate properties were $113.7 million for the year ended November 30, 2003, compared to $91.3 million for 2002. The decrease in earnings before income taxes in 2003 on an as reported basis compared to 2002 was primarily due to lower gains, because 77% of our gains on sales of real estate properties were classified as discontinued operations in 2003 as a result of the adoption of SFAS No. 144 and therefore not reflected in earnings before income taxes and an increase in general and administrative

 

29


expenses offset somewhat by higher equity in earnings of unconsolidated partnerships. The increase in earnings before income taxes in 2003 on a combined basis compared to 2002 was primarily due to higher equity in earnings of unconsolidated partnerships and higher gains on sales of real estate properties, partially offset by a decrease in net rents and an increase in general and administrative expenses.

 

On an as reported basis, rental income increased to $100.1 million for the year ended November 30, 2003, from $93.7 million for the same period in 2002. On a combined basis, rental income decreased slightly to $113.4 million for the year ended November 30, 2003, from $115.4 million for the same period in 2002. On an as reported basis, cost of rental operations increased to $60.4 million for the year ended November 30, 2003 from $51.2 million for the same period in 2002. On a combined basis, cost of rental operations increased to $65.2 million for the year ended November 30, 2003, from $58.8 million for the same period in 2002. Net rents decreased on both an as reported and combined basis for the year ended November 30, 2003, compared to the same period in 2002, primarily due to a smaller stabilized property portfolio (see discussion below). In 2003 and 2002, respectively, rental income on a combined basis consisted of $81.5 million and $84.9 million from commercial properties (office, industrial/warehouse and retail), $0.0 million and $5.8 million from market-rate rental apartment communities, $9.9 million and $10.3 million from affordable housing communities, and $22.0 million and $14.4 million from hotels and other properties.

 

Over the past three years, we have limited our new property acquisitions in favor of adding value to our existing portfolio through development, repositioning and leasing. As these properties have come on-line, we have been taking advantage of strong buyer demand for stabilized properties by selling our stabilized properties into a market that has been paying premium prices. As a result, our stabilized property portfolio has declined since the prior year. At November 30, 2003, 39% of our $629.4 million owned property portfolio was stabilized compared to 51% of our $750.7 million owned portfolio at November 30, 2002.

 

On both an as reported and combined basis, equity in earnings of unconsolidated partnerships increased to $54.1 million for the year ended November 30, 2003, from $29.4 million for the same period in 2002. This increase was primarily due to higher earnings from one partnership which is involved in the development of approximately 585 acres of commercial and residential land in Carlsbad, California. The partnership sold 75% of its interest in the land during the first quarter of 2003 for a gain. The increase was also partially due to higher earnings from a partnership in Europe established in mid-2002 and from Lennar Land Partners (“LLP”), a partnership indirectly owned 50% by us and 50% by Lennar, that is primarily engaged in the acquisition, development and sale of land.

 

On an as reported basis, gains on sales of real estate properties decreased to $13.2 million for the year ended November 30, 2003, from $48.1 million for the same period in 2002. On a combined basis, gains on sales of real estate properties increased to $56.8 million for the year ended November 30, 2003, from $48.1 million for the same period in 2002. On a combined basis, gains on sales of real estate in 2003 included $47.8 million from sales of stabilized and development market-rate operating properties, $7.6 million from sales of land and $1.4 million from syndications of affordable housing communities, compared to $39.4 million, $8.1 million, and $0.6 million, respectively, in 2002. Gains on sales of real estate properties fluctuate from period to period based on the timing of asset sales.

 

In 2003, we received a $24.0 million lease termination fee from a tenant that had originally leased 100% of one of our office buildings for ten years. Approximately $8.9 million of that fee was a recovery of capitalized and deferred costs associated with the lease. The remaining $15.1 million was recorded as other operating income. In accordance with SFAS No. 144, a loss provision in the amount of $15.1 million was recorded during the year ended November 30, 2003, for the impairment of this property to reflect the current market value of the building without the tenant. We plan to re-lease the building in the future.

 

On both an as reported and combined basis, general and administrative expenses increased to $30.4 million for the year ended November 30, 2003, from $26.9 million for the same period in 2002. The increase was primarily due to the start-up of the property portion of our European operations and increased personnel and out-of-pocket expenses related to overall growth in the development/repositioning portfolio.

 

30


The net book value of operating properties and equipment with regard to various types of properties we own at November 30, 2003, 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

   $ 118,030    85%    13%

Retail

     11,347    76%    14%

Industrial/warehouse

     33,437    100%    14%

Ground leases

     3,758    100%    19%
    

  
  

Commercial

     166,572    89%    14%

Hotel

     42,297    55%    3%
    

       
       208,869         11%
    

         

Under development or repositioning:

                

Office

     212,577          

Retail

     112,629          

Industrial/warehouse

     9,572          

Ground leases

     368          
    

         

Commercial

     335,146          

Hotel

     28,504          
    

         
       363,650          
    

         

Total market-rate operating properties

     572,519          

Affordable housing communities

     56,872          
    

         

Total operating properties

     629,391          

Furniture, fixtures and equipment

     11,551          
    

         

Total operating properties and equipment

   $ 640,942          
    

         

(1) Occupancy rate at November 30, 2003.

 

(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, 2003.

 

Our market-rate stabilized commercial real estate properties were yielding in total 14% on net book value as of November 30, 2003 and 2002.

 

Occupancy levels for our market-rate stabilized commercial real estate properties were 89% at the end of 2003, compared to 97% at the end of 2002. The decrease primarily reflects the sale of ground leases and a large warehouse in 2003, which were 100% occupied, and the loss of two large tenants in two of our office properties.

 

Approximately 64% of our market-rate properties are in various stages of development or redevelopment. Our investment in these properties increased to $363.7 million at November 30, 2003, from $338.8 million at November 30, 2002, primarily reflecting the acquisition of a retail center under redevelopment and the continuing development of our existing portfolio, offset in part by the stabilization of properties under development/repositioning, some of which have been sold. These properties were yielding 4% on net book value at both November 30, 2003 and November 30, 2002, and were nearly 60% pre-leased at November 30, 2003.

 

31


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. In 2000, we began to shift our strategy away from owning the majority of the partnership interests in the affordable housing communities towards 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, have continued to decline.

 

The net investment in our affordable housing communities at November 30, 2003 was as follows:

 

     (In thousands)

 

Operating properties

   $56,872  

Investments in unconsolidated partnerships

   48,247  

Debt and other

   (66,349 )
    

Net investment in affordable housing communities

   $38,770  
    

 

As of November 30, 2003, we had been awarded and held rights to approximately $59 million in gross tax credits, compared to $90 million at November 30, 2002. The decrease in tax credits primarily reflects the sale and syndication of partnership interests, as well as the utilization by us of tax credits in 2003. Our net investment in affordable housing communities at November 30, 2003 was $38.8 million, compared to $71.5 million at November 30, 2002.

 

In July 2003, an entity, owned 50% by us and 50% by Lennar, entered into an agreement to acquire The Newhall Land and Farming Company (“Newhall Land”). Newhall Land, a premier community planner in north Los Angeles County, is primarily engaged in the planning of the Valencia and Newhall Ranch communities, with over 48,000 acres of land in California, including 34,000 acres in Los Angeles County primarily related to real estate and agricultural operations. At November 30, 2003, the transaction was subject to the approval of the California Public Utilities Commission of the change in control of Valencia Water Company, a wholly-owned subsidiary of Newhall Land, that resulted from the purchase. That approval was received on January 22, 2004. The acquisition was completed on January 27, 2004. Simultaneous with the closing of the transaction, we purchased existing income producing commercial assets from Newhall Land for approximately $217 million and Lennar agreed to purchase 687 homesites and obtained options to purchase 623 homesites from Newhall Land. Although the income producing properties are expected to immediately contribute to our recurring income from net rents, after depreciation and carrying costs, including those within the land venture, the Newhall Land acquisition in total is not anticipated to have much of an impact on our earnings until 2005, when significant homesite sales are planned to commence. Funding for the Newhall Land purchase was made through capital contributions of approximately $200 million from each of the partners, borrowings under a $400 million senior credit facility secured by assets of Newhall Land and another LNR/Lennar joint venture (LandSource), and the $217 million we paid for the income producing commercial assets.

 

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

 

Earnings before income taxes from real estate properties on an as reported basis were $80.7 million for the year ended November 30, 2002, compared to $93.5 million in 2001. On a combined basis (i.e., including revenues and expenses of properties classified as discontinued operations), earnings before income taxes from real estate properties were $91.3 million for the year ended November 30, 2002, compared to $97.1 million in 2001. The decrease for 2002 on an as reported basis compared to 2001 was primarily due to lower gains on sales of real estate property assets and lower net rents, offset in part by an increase in earnings from unconsolidated properties. The decrease for 2002 on a combined basis compared to 2001 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.

 

32


On an as reported basis, rental income decreased to $93.7 million for the year ended November 30, 2002, from $105.8 million for the same period in 2001. On a combined basis, rental income increased to $115.4 million for the year ended November 30, 2002, from $111.7 million for the same period in 2001. The decrease in rental income on an as reported basis reflects the reclassification of rental income from properties sold in 2003 to discontinued operations in accordance with SFAS No. 144. The increase in rental income on a combined basis was primarily due to the contribution from development and repositioning properties that were stabilized or completed and had some tenants that were starting to pay rent. In 2002 and 2001, respectively, rental income on a combined basis 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. On an as reported basis cost of rental operations decreased to $51.2 million for the year ended November 30, 2002 from $57.0 million for the same period in 2001. On a combined basis, cost of rental operations remained flat with $58.8 million for the year ended November 30, 2002, compared to $58.6 million for the same period in 2001.

 

On both an as reported and combined basis, 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 investments, 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.

 

On both an as reported and combined basis, gains on sales of real estate properties decreased to $48.1 million for the year ended November 30, 2002, from $63.5 million for the same period in 2001. Gains on sales of real estate in 2002 included $39.4 million from sales of stabilized market-rate operating properties, $8.1 million from sales of land, and $0.6 million from syndications of affordable housing communities, compared to $51.5 million, $8.8 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.

 

33


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           
    

        

Total operating properties

   750,684           

Furniture, fixtures and equipment

   14,943           
    

        
     765,627           

Assets held for sale

   (180,541 )         
    

        

Total operating properties and equipment

   $585,086           
    

        

(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.

 

Our market-rate stabilized commercial real estate properties were yielding in total 14% on net book value as of November 30, 2002 and 2001.

 

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 were in various stages of development or redevelopment as of November 30, 2002. 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% on net book value at November 30, 2002, compared to 3% 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.

 

34


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

 

     (In thousands)

 

Operating properties (1)

   $ 68,668  

Investments in unconsolidated partnerships

     56,201  

Debt and other

     (53,341 )
    


Net investment in affordable housing communities

   $ 71,528  
    



(1) Includes $16.1 million of assets held for sale.

 

As of November 30, 2002, we had been awarded and held rights to approximately $90 million in gross tax credits, compared to $140 million at November 30, 2001. The decrease in tax credits primarily reflects the sale and syndication of partnership interests, as well as the utilization of tax credits in 2002.

 

Real Estate Loans

 

     Years Ended November 30,

     2003

   2002

   2001

     (In thousands)

Revenues

                

Management fees

   $ 1,836    1,347    3,732

Other operating income

                

Interest income

     49,438    39,594    43,728

Equity in earnings of unconsolidated partnerships

     101    3,861    4,554

Other

     452    46    136
    

  
  

Total revenues and other operating income

     51,827    44,848    52,150
    

  
  

Costs and expenses

                

General and administrative

     4,329    4,504    5,167

Minority interests

     —      1,110    2,232
    

  
  

Total costs and expenses (1)

     4,329    5,614    7,399
    

  
  

Earnings before income taxes

   $ 47,498    39,234    44,751
    

  
  

Balance sheet data:

                

Mortgage loans, net

   $ 462,545    430,255    331,517

Investments in unconsolidated partnerships

     2,902    9,501    8,917

Other investments

     —      —      55,504

Other assets

     2,947    1,896    2,676
    

  
  

Total segment assets

   $ 468,394    441,652    398,614
    

  
  

(1) Costs and expenses do not include interest expense.

 

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

 

Over the past several years, the majority of investing activity within the real estate loans 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. At November 30, 2003, we had no delinquencies in our B-note portfolio.

 

35


Year ended November 30, 2003 compared to year ended November 30, 2002

 

Earnings before income taxes from real estate loans were $47.5 million for the year ended November 30, 2003, compared to $39.2 million in 2002. This increase was primarily due to higher interest income, offset in part by lower equity in earnings of unconsolidated partnerships reflecting lower earnings from the domestic discount loan portfolio business.

 

Interest income from real estate loans was $49.4 million for the year ended November 30, 2003, compared to $39.6 million in 2002. This increase reflects a higher average level of loan investments, as well as income in 2003 realized from the early payoff of several investments, one that had a guaranteed return and others purchased at discounts. This increase was partially offset by the impact of lower interest rates on floating-rate loans.

 

During the year ended November 30, 2003, we funded seventeen new B-note investments for $292.8 million and received $220.7 million for the payoff in full of eleven B-note investments, bringing the total B-note investment balance to a face value of $443.0 million at November 30, 2003. These investments contributed $39.4 million to interest income in 2003, compared to $26.3 million in 2002.

 

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

 

Earnings before income taxes 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 to 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 the domestic discount loan portfolios.

 

36


Real Estate Securities

 

     Years Ended November 30,

 
     2003

    2002

    2001

 
     (In thousands)  

Revenues

                    

Management and servicing fees

   $ 35,659     26,593     25,131  

Other operating income

                    

Interest income

     107,311     139,654     135,594  

Equity (loss) in earnings of unconsolidated partnerships

     (2,182 )   13,117     44,802  

Gains on sales of investment securities

     52,667     47,221     9,717  

Other

     (1,523 )   (1,379 )   (954 )
    


 

 

Total revenues and other operating income

     191,932     225,206     214,290  
    


 

 

Costs and expenses

                    

General and administrative

     24,074     20,575     15,210  

Minority interests

     7     15     61  
    


 

 

Total costs and expenses (1)

     24,081     20,590     15,271  
    


 

 

Earnings before income taxes

   $ 167,851     204,616     199,019  
    


 

 

Balance sheet data:

                    

Investment securities

   $ 900,334     1,127,313     1,215,121  

Investments in unconsolidated partnerships

     93,714     101,129     116,517  

Other assets

     21,065     20,267     24,285  
    


 

 

Total segment assets

   $ 1,015,113     1,248,709     1,355,923  
    


 

 


(1) Costs and 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 non-investment grade notes and preferred shares related to resecuritization transactions which are collateralized by CMBS, our investment in Madison Square Company LLC (“Madison”), a limited liability company that invests primarily in CMBS, as well as investments in entities in similar businesses. Total revenues and other operating income from real estate securities include interest income, equity in the earnings of unconsolidated partnerships, gains on sales of investment securities, servicing fees from acting as special servicer for CMBS transactions and fees earned from managing unconsolidated partnerships. Costs and expenses include the overhead associated with managing the investments and partnerships, and costs to perform our special servicing responsibilities.

 

Year ended November 30, 2003 compared to year ended November 30, 2002

 

Earnings before income taxes from real estate securities were $167.9 million for the year ended November 30, 2003, compared to $204.6 million in 2002. Earnings were lower than in the prior year primarily due to lower interest income, lower equity in earnings of unconsolidated partnership investments and an increase in operating expenses, partially offset by an increase in management and servicing fee income and higher gains on sales of investment securities.

 

Interest income from direct CMBS investments was $107.3 million for the year ended November 30, 2003, compared to $139.7 million for 2002. The decrease was primarily due to (i) lower overall yields in the current year, (ii) $17.8 million of write-downs on certain bonds due to cash flow projections where we utilized the highest level of loss severity among possible outcomes and (iii) the early collection of purchase discounts in the prior year due to prepayments on seasoned transactions, offset in part by a higher average level of CMBS investments.

 

37


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 the basis of our CMBS investment. Our initial and ongoing estimates of cash flows from CMBS investments are estimated by management based on certain assumptions which include, but are not limited to, collectibility of principal and interest on the underlying loans and the amount and timing of projected principal repayments or losses. Changes in cash flow estimates could materially affect the interest income that is recognized in future periods.

 

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 is paid in full. However, we have already begun to receive principal payments from 21 classes of our CMBS securities, and 33 classes (excluding securities sold in the resecuritization transactions in 2003 and 2002) have reached economic maturity either through the collection of principal, liquidation of the trust, or sale. Through the resecuritization transactions completed in 2003 and 2002, an additional 120 classes of securities and portions of 101 other classes were also sold. Aggregate actual loss experience to date, particularly for older transactions (3 to 10 years in age), is lower than we originally underwrote. Therefore, changes to original estimated yields have resulted in overall improved earnings. 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, 2003, we acquired $662.8 million face amount of non-investment grade fixed-rate CMBS for $343.0 million and $66.8 million face amount of non-investment grade short-term floating-rate CMBS for $56.8 million. The following is a summary of the CMBS portfolio we held at November 30, 2003:

 

     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

   $ 336,879    6.74%    $ 245,285    72.8%    8.1%    9.1%

B rated

     415,434    7.00%      191,532    46.1%    12.9%    13.4%

Unrated

     1,283,248    5.81%      233,131    18.2%    29.0%    21.8%
    

  
  

  
  
  

Total

     2,035,561    6.21%      669,948    32.9%    16.8%    14.8%

Floating-rate/short-term:

                                 

BB rated or above

     52,332    5.45%      43,451    83.0%    6.4%    7.0%

B rated

     34,082    9.36%      32,468    95.3%    10.2%    7.6%

Unrated

     68,553    13.11%      40,524    59.1%    22.0%    10.3%
    

  
  

  
  
  

Total

     154,968    9.70%      116,443    75.1%    12.9%    8.3%

Total amortized cost

     2,190,529    6.45%      786,391    35.9%    16.2%    13.8%

Excess of estimated fair value over amortized cost

     —             113,943               
    

       

              

Total CMBS portfolio(3)

   $ 2,190,529         $ 900,334               
    

       

              

(1) Cash yield is determined by annualizing the actual cash received during the month of November 2003, and dividing the result by the book value at November 30, 2003.

 

(2) Book yield is determined by annualizing the interest income recorded during the month of November 2003, and dividing the result by the book value at November 30, 2003.

 

(3) This table excludes CMBS owned through unconsolidated partnerships.

 

38


At November 30, 2003, our overall annualized weighted average cash and book yields were approximately 16% and 14%, respectively, compared to approximately 15% and 16% at November 30, 2002, respectively. The decline in overall annualized book yield in 2003 compared to 2002 was primarily due to reductions in expected future cash flows and due to our migrating to higher-rated and lower loan-to-value positions in our real estate related investments.

 

Equity (loss) in earnings of unconsolidated partnerships was $(2.2) million for the year ended November 30, 2003, compared to $13.1 million in 2002. The decrease was primarily due to reduced income from Madison because of lower interest income resulting from the timing and amount of expected principal collections related to short-term floating-rate securities owned by the venture. At November 30, 2003, our 25.8% investment in Madison, which owned $1.2 billion face amount of CMBS at November 30, 2003, was $81.8 million. 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 the provider of management services. We received $22.6 million in cash distributions and fees from Madison during the year 2003 and, since its inception, have received $163.7 million in cash distributions and fees on an original investment of $90.1 million.

 

Management and servicing fees income were $35.7 million for the year ended November 30, 2003, compared to $26.6 million for 2002. The increase was primarily due to an increase in the number of CMBS mortgage pools for which we act as special servicer (112 at November 30, 2003 versus 103 at November 30, 2002).

 

Gains on sales of securities were $52.7 million for the year ended November 30, 2003, compared to $47.2 million in 2002. During 2003, we completed a resecuritization transaction (LNR CDO 2003-1, the “CDO”). We selected $762.7 million face amount of non-investment grade CMBS from our owned portfolio and sold those bonds to a qualifying special purpose entity (“QSPE”). Those CMBS were resecuritized into various classes of non-recourse bonds. The total of $762.7 million CMBS bonds that were collateral for this transaction were from 35 different CMBS transactions purchased over the past four years. Underlying these CMBS transactions were a total of $34.8 billion of commercial real estate loans, and each of the 4,800 loans comprising this amount had been evaluated in detail during our due diligence process before the CMBS were acquired. During that process, we were able to remove $2.8 billion of loans that did not meet our standards prior to the original securitizations taking place. Taking into account the diversification and the quality of the collateral, as well as our involvement in the transaction, the rating agencies rated $419.5 million of the $762.7 million face amount of non-recourse CDO securities as investment grade. The QSPE sold all of the investment grade rated bonds to unrelated third parties for total cash proceeds of $412.0 million. We used the proceeds to repay senior secured and unsecured debt, the majority of which can be re-borrowed. As a result of the sale of our CMBS collateral securities, we recognized a total pretax gain of $47.7 million in 2003. We retained the remaining $343.2 million of face amount in the form of non-investment grade rated bonds and unrated preferred shares of the QSPE. At November 30, 2003, the amortized costs of the retained interests were $68.1 million, with an estimated fair value of $78.7 million.

 

During 2002, we completed a similar resecuritization transaction. In this transaction, we sold $800.6 million in face amount of non-investment grade CMBS to a QSPE. Those CMBS were securitized into various classes of non-recourse bonds. The rating agencies rated $416.3 million of the $800.6 million face amount of non-recourse CDO securities as investment grade. The QSPE sold all of the investment grade rated bonds to unrelated third parties for total cash proceeds of $402.3 million. We used the proceeds to repay short-term debt, the majority of which could be reborrowed. We recognized a pretax gain on the sale of our CMBS collateral securities of $45.6 million. We retained the remaining $384.3 million face amount in the form of non-investment grade rated bonds and preferred shares of the QSPE. At November 30, 2003, the amortized costs of the retained interests were $73.2 million, with an estimated fair value of $91.0 million.

 

Operating expenses increased to $24.1 million in 2003, from $20.6 million in 2002, primarily due to increases in personnel and out-of-pocket expenses directly related to the growth of our CMBS activity.

 

39


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

 

Earnings before income taxes 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 in 2002 than in 2001 primarily due to a $45.6 million gain recognized in 2002 on the sale of non-investment grade CMBS through the resecuritization transaction discussed above and an increase in interest income. These increases were partially offset by lower earnings from Madison and an increase in operating expenses.

 

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 $45.6 million gain recognized in the third quarter of 2002 on the sale of non-investment grade CMBS through the resecuritization transaction discussed above.

 

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.

 

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 estimated 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.

 

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Operating expenses increased to $20.6 million in 2002, from $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.

 

Corporate and Interest Expense

 

Year ended November 30, 2003 compared to year ended November 30, 2002

 

Corporate costs and expenses, excluding interest expense and loss on early extinguishment of debt, were $29.0 million for the year ended November 30, 2003, compared to $25.3 million in 2002. The increase was primarily due to increased staffing levels and amortization related to restricted stock granted to corporate senior officers in the second quarter of 2003.

 

On an as reported basis, interest expense was $102.3 million for the year ended November 30, 2003, compared to $92.1 million in 2002. On a combined basis, interest expense was $105.3 million for the year ended November 30, 2002, compared to $96.6 million in 2002. These increases were primarily due to higher average debt balances, partially offset by lower average interest rates during 2003. The weighted average interest rate on outstanding debt was 6.5% at November 30, 2003, compared to 6.1% at November 30, 2002. Average borrowing levels (including debt related to assets held for sale) were $1,607.4 million in 2003, compared to $1,495.3 million in 2002.

 

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

 

On an as reported basis, interest expense was $92.1 million for the year ended November 30, 2002, compared to $109.7 million in 2001. On a combined basis, interest expense was $96.6 million for the year ended November 30, 2002, compared to $110.5 million in 2001. These decreases were primarily due to lower average interest rates during 2002. The weighted average interest rate on outstanding debt was 6.1% at November 30, 2002, compared to 6.8% at November 30, 2001. Average borrowing levels (including debt related to assets held for sale) were $1,495.3 million in 2002, compared to $1,457.0 million in 2001.

 

Income Tax Expense

 

Year ended November 30, 2003 compared to year ended November 30, 2002

 

On an as reported basis, income tax expense was $38.3 million for the year ended November 30, 2003, compared to $66.9 million in 2002. On a combined basis, income tax expense was $56.5 million for the year ended November 30, 2003, compared to $69.3 million in 2002. On a combined basis, the effective tax rate for the year ended November 30, 2003 was 34.0%, compared to 32.5% in 2002. The increase in the effective tax rate was primarily due to an increase in state taxes and lower affordable housing tax credits.

 

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

 

On an as reported basis, income tax expense was $66.9 million for the year ended November 30, 2002, compared to $70.1 million in 2001. On a combined basis, income tax expense was $69.3 million for the year ended November 30, 2002, compared to $71.2 million in 2001. On a combined basis, the effective tax rate for the year ended November 30, 2002 was 32.5%, compared to 34.5% in 2001. The decrease in the effective tax rate reflects lower state income taxes related to our CMBS investments in 2002.

 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

Our operating activities provided cash of $78.6 million in 2003 and $71.1 million in 2002. The increase in cash provided by operating activities was primarily due to higher net earnings after adjusting for the effects of non-cash items, the gross cash effects of which are reflected in cash from financing and investing activities, and a greater increase in accounts payable and accrued liabilities, partially offset by a larger increase in other assets in 2003.

 

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Our investing activities provided cash of $265.2 million in 2003 and $63.4 million in 2002. The increase in cash provided by investing activities is primarily due to (i) a higher level of proceeds from loan collections, primarily reflecting the payoff in full of eleven B-notes for $220.7 million during 2003, compared to no B-note loans paid in full in 2002, (ii) a higher level of principal collections on and proceeds from sales of investment securities, (iii) a lower level of investment spending on operating properties and land as we have been focused on adding value to our existing portfolio through development, repositioning and leasing, rather than on new acquisitions, and (iv) a lower level of investment spending in unconsolidated partnerships primarily due to higher investments in European and affordable housing partnerships in 2002. These increases in cash flow were offset by (i) a higher level of mortgage loan investments, primarily due to $292.8 million of B-note purchases in 2003, compared to $142.5 million in 2002, (ii) an increase in restricted cash primarily related to a higher level of funds held in trust for asset purchases and development, and the release of a cash collateralized letter of credit in 2002, and (iii) lower proceeds from the sale of operating properties and land held for sale.

 

Our financing activities used cash of $319.8 million in 2003 and $135.4 million in 2002. The increase in cash used by financing activities is primarily due to (i) higher net payments made under repurchase agreements and revolving credit lines, (ii) the purchase and retirement of more shares of treasury stock in 2003, and (iii) higher net principal paydowns of mortgage notes and other debts payable. These increases in cash used were offset by (i) higher net proceeds from the issuance of senior subordinated notes during 2003, and (ii) a lower level of distributions to minority partners in 2003.

 

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 fully protect ourselves against the effect changes in interest rates, or other occurrences that 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.

 

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At November 30, 2003, we had approximately $2.0 billion of available liquidity, which included approximately $1.88 billion of cash and availability under credit facilities, and approximately $127.7 million under committed project level term financing. A summary of our available liquidity at November 30, 2003, follows:

 

     Commitment

   Outstanding

    Liquidity

     (In millions)

Cash, including Section 1031 funds included in restricted cash

   $     49.2    —       49.2

Secured revolving credit lines

   366.3    —       366.3

Repo facilities

   1,162.9    98.8     1,064.1

CMBS specific term loan

   11.7    —       11.7

Seller financing term loan

   8.1    8.1     —  

Unsecured revolving credit facility

   400.0    15.5 (1)   384.5

Committed project financing

   423.7    296.0     127.7
    
  

 
     $2,421.9    418.4     2,003.5
    
  

 

(1) Represents letters of credit.

 

We and certain of our subsidiaries have entered into an unsecured revolving credit facility, with a maximum commitment of $400.0 million and a maturity date of July 2006, assuming a one-year extension option is exercised. At November 30, 2003, there were no borrowings outstanding and we had $15.5 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 four secured revolving credit lines with an aggregate commitment of $366.3 million, of which there were no borrowings outstanding at November 30, 2003. These lines are collateralized by CMBS and mortgage loans and mature through November 2007.

 

We have financed some of our CMBS and B-notes under reverse repurchase obligation facilities (“repos”), which are in effect borrowings secured by the CMBS and B-notes. 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 or B-notes that collateralize them significantly decline. Therefore, if the market value of our CMBS or B-notes 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.

 

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At November 30, 2003, we had nine repos through which we financed selected CMBS and B-notes. Our repos are summarized below:

 

Commitment
Amount


   Outstanding
Amount


  

Collateral
Type


  

Interest Rate


  

Maturity Date


  

Recourse


(In thousands)                    
$   100,000    $45,970    CMBS    LIBOR + 150-250    April 2007    Non-recourse
150,000    52,816    CMBS    LIBOR + 125-225    April 2005    Non-recourse
37,906    —      CMBS    LIBOR + 125-175    January 2004 - August 2004    Recourse(1)
50,000    —      CMBS    LIBOR + 150    June 2004    Recourse
430,000    —      CMBS    LIBOR + 150-300    January 2006    Limited Recourse(2)
120,000    —      CMBS    LIBOR + 150-190    January 2005    Recourse
75,000    —      B-notes    LIBOR + 150-225    February 2006    Non-recourse
100,000    —      B-notes    LIBOR + 150-225    February 2007    Recourse
100,000    —      B-notes    LIBOR + 175-275    November 2007    Recourse

  
                   
$1,162,906    $98,786                    

  
                   

(1) Except for $3.7 million of the commitment, which is non-recourse.

 

(2) $8.2 million of the commitment is recourse.

 

We have a non-recourse term loan for one specific CMBS transaction through which we finance BB, B and unrated bonds. The commitment amount is $11.7 million and there was no balance outstanding as of November 30, 2003. This facility matures in June 2004. Interest is calculated using a range of LIBOR plus 25 – LIBOR plus 150, which varies based the rating of the collateral pledged to the facility.

 

We have seller financing in the form of a term loan for one mortgage loan investment, which we have guaranteed. This facility had an outstanding balance of $8.1 million at November 30, 2003 and matures in July 2004, which matches the maturity date of the mortgage loan securing the facility. Interest on this term loan is variable at LIBOR plus 125.

 

In March 2003, we issued $235.0 million principal amount of 5.5% convertible senior subordinated notes due March 2023. The proceeds from the sale were used to repurchase shares of our common stock, to repay senior secured and unsecured revolving debt, and for general corporate purposes. The notes can be converted into our common stock at a conversion price per share of $45.28 under certain circumstances, including when the market price of the common stock is more than 120% of the conversion price. We will have the right to redeem the notes beginning in 2008. Holders will have the right to require us to repurchase the notes in 2010 and 2017. If holders require us to repurchase the notes, we will be able to pay the repurchase price in cash or with shares of our common stock. If this were to occur, we currently expect to pay the repurchase price in cash.

 

In July 2003, we issued $350.0 million principal amount of 7.625% senior subordinated notes due July 2013. A portion of the proceeds from the sale were used to redeem $200.0 million principal amount of 9.375% senior subordinated notes due 2008 at a redemption price equal to 104.688% of principal plus accrued interest to the redemption date. The remainder of the proceeds were used to repay senior secured and unsecured debt and for general corporate purposes. Primarily as a result of the redemption of the notes at a premium, we recorded a pretax loss of $10.3 million in 2003.

 

Prior to 2002, we issued at a discount $250 million principal amount of unsecured senior subordinated notes due January 15, 2009, with a stated interest rate of 10.5%, payable semi-annually. During October and November 2003, we retired $204.7 million principal amount of these notes at a premium, including $73.1 million principal amount tendered in response to a tender offer and $131.6 million principal amount purchased in the open market, which resulted in a pretax loss of $18.3 million in 2003. Approximately

 

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$45.3 million principal amount of the notes remained outstanding as of November 30, 2003 and were redeemed in January 2004 at a price equal to 105.375%.

 

In October 2003, we issued $350.0 million principal amount of 7.25% senior subordinated notes due October 2013. A portion of the proceeds from the sale were used to retire the $204.7 million principal amount of 10.5% notes and redeem the $45.3 million principal amount of 10.5% notes discussed above. The remainder of the proceeds were used to repay senior secured debt. In December 2003, we issued an additional $50.0 million principal amount of these 7.25% notes as an add-on to these existing senior subordinated notes, bringing the total principal amount of 7.25% senior subordinated notes due 2013 to $400.0 million.

 

The subordinated notes contain certain financial tests and restrictive covenants, none of which are currently expected to restrict our activities.

 

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, 2003, approximately 24% of our existing indebtedness bears interest at variable rates, of which 3% of our debt was match-funded against variable-rate assets and 13% was swapped to fixed rate. After considering the variable-rate debt that had been swapped or was match-funded, only 8% of our debt remained variable-rate. As of November 30, 2003, because variable-rate assets exceeded variable-rate debt, we estimate that a 100 basis point increase in LIBOR would increase our net earnings by $2.6 million, or $0.08 per share diluted.

 

The weighted average interest rate on our outstanding debt, after giving consideration to the interest rate swap agreements mentioned above, was 6.5% at November 30, 2003, compared to 6.1% at November 30, 2002. The increase in the weighted average interest rate primarily reflects a higher proportion of fixed-rate long-term senior subordinated debt which carries higher interest rates than short-term floating rate debt.

 

Our Board of Directors approved a stock repurchase plan authorizing us to buy back up to 12.5 million shares of our common stock, including 3.0 million shares which were authorized in 2003. During the years ended 2003, 2002 and 2001, we purchased 4.1 million shares, 1.7 million shares and 0.3 million shares, respectively, under this program, bringing the inception-to-date total through November 30, 2003 under our buy-back program to 9.1 million shares. As of November 30, 2003, there were 3.4 million shares remaining that we were authorized to buy back under our ongoing buy-back program.

 

Contractual Obligations

 

Our significant contractual obligations as of November 30, 2003 are as 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

   $ 1,382.8    29.1    238.1    109.9    1,005.7

Operating leases

     9.3    2.2    3.0    2.3    1.8
    

  
  
  
  

Total contractual cash obligations

   $ 1,392.1    31.3    241.1    112.2    1,007.5
    

  
  
  
  

 

The weighted average maturity of our outstanding debt, assuming we take advantage of extensions that are exercisable at our option, was 7.1 years at November 30, 2003, well above the weighted average maturity

 

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of 4.0 years at November 30, 2002. At November 30, 2003, we had scheduled maturities on existing debt of $29.1 million through November 30, 2004, assuming we take advantage of extensions that are exercisable at our option, most of which is secured by assets which are expected to be sold in 2004. 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. Our ability to obtain new borrowings and/or raise new capital is linked to both our short- and long-term credit ratings. Lower ratings generally result in higher borrowing costs as well as reduced access to capital markets.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

From time to time in the normal course of our business, we enter into various types of transactions and arrangements that 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”), payment/debt guarantees, performance/surety bonds and other commitments under these arrangements at November 30, 2003 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

   $  15.9    15.2    0.7    —      —  

Guarantees of debt

   46.2    29.1    1.9    —      15.2

Limited maintenance guarantees

   49.1    16.2    32.9    —      —  

Committed capital contributions

   26.1    14.7    11.4    —      —  

Performance/surety bonds

   33.0    6.6    —      1.0    25.4

Affordable housing communities - other

   23.4    11.9    11.1    0.2    0.2
    
  
  
  
  

Total commitments

   $193.7    93.7    58.0    1.2    40.8
    
  
  
  
  

 

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. If we failed to perform under our contractual obligations secured by such LOCs, those LOCs may be called upon for payment. 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.

 

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  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, 2003 was $15.9 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. Examples of events that would require us to provide a cash payment pursuant to a guarantee include a loan default, which would result from failure of the partnership to service the debt when due, non-compliance of the partnership with regard to financial covenants, or inadequacy of asset collateral due to declines in fair value. The amount of outstanding debt guaranteed by us at November 30, 2003 was $46.2 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, 2003 the amount of outstanding debt related to these limited maintenance guarantees was $49.1 million, primarily Lennar Land Partners (“LLP”) maintenance guarantee of LLP’s debt as discussed in the Investments in Unconsolidated Entities section.

 

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 which include making capital contributions from time to time. The majority of our partnerships, excluding affordable housing, 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 partnerships, excluding affordable housing, 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 $11.5 million at November 30, 2003.

 

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 $6.4 million at November 30, 2003.

 

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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 $8.2 million at November 30, 2003.

 

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, 2003, we had provided $33.0 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 that 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 $23.4 million at November 30, 2003.

 

Construction Completion Guarantees

 

As is customary in the real estate development business, we have provided completion guarantees to our construction lenders that guarantee we will complete the development of the project they are financing. 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

 

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 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. The resecuritized investment grade bonds can then be sold to unrelated third parties to realize the added value and to further strengthen our balance sheet.

 

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In 2003, we sold $762.7 million in face value of non-investment grade CMBS to a qualifying special purpose entity. Those CMBS were resecuritized into various classes of non-recourse bonds comprised of $419.5 million face value investment grade rated bonds and $343.2 million face value of non-investment grade bonds and preferred shares in the qualifying special purpose entity. The qualifying special purpose entity sold the investment grade rated bonds to unrelated third parties for net proceeds of $412.0 million. We used these proceeds to repay senior and unsecured debt, the majority of which can be re-borrowed. We recognized a $47.7 million gain on the sale, realizing the value we added to the resecuritized bonds. We retained the non-investment grade rated bonds and the preferred equity in the qualifying special purpose entity. We also completed a similar resecuritization transaction in 2002. The aggregate face amount and amortized cost of the retained interests in both of these resecuritizations at November 30, 2003 was $720.4 million and $141.3 million, respectively.

 

Although we successfully completed CMBS resecuritization transactions in both 2003 and 2002, which generated significant proceeds and gains, we are not dependent upon the completion of such transactions as a means of generating liquidity or providing cash for us to fund operations or future investments. Although we have the financial ability to hold our CMBS investments to their stated maturities, it may be advantageous for us to sell these investments through such resecuritization transactions, depending upon market conditions. Our ability to effectively complete CMBS resecuritization transactions depends to a great extent on market demand for resecuritized securities, the pricing and interest rate environment, and the portfolio of securities we may own which would be suitable for resecuritization.

 

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.

 

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.

 

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At November 30, 2003, we had investments in unconsolidated partnerships of $426.6 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, 2003 follows:

 

     LNR
Investment


   LNR
Financial
Interest(1)


   Total
Partnership
Assets


    Total
Partnership
Liabilities


 
     (In thousands, except percentages)  

Properties:

                          

Single-asset partnerships

   $ 28,966    33% - 98%    $ 226,581     180,377  

Partnerships with Lennar:

                          

LandSource

     112,628    50%      347,541     122,285  

Other

     50,938    13% -50%      242,318     94,736  

Affordable housing communities

     48,247    1% - 99%      584,189     414,188  

Other

     124    35%      718     738  
    

       


 

       240,903           1,401,347     812,324  

International

     89,057    50% - 100%      263,720 (3)   170,850  
    

       


 

       329,960           1,665,067     983,174  

Loans:

                          
                            

Discounted portfolios of commercial mortgage loans

     2,902    15% - 50%      44,778     35,372  

Securities:

                          

Madison

     81,765    26%      826,666     506,619  

Other

     11,949    50% -69%      63,875     38,421  
    

       


 

       93,714           890,541     545,040  
    

       


 

Total

   $ 426,576         $ 2,600,386     1,563,586 (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 $46.2 million noted in the commitments table discussed above.

 

(3) Total partnership assets include an investment in an unconsolidated partnership which in turn has investments in properties with a net book value of $2.7 billion.

 

Single-Asset Partnerships

 

We have investments in single-asset partnerships established to acquire, develop, reposition, manage and sell real estate assets. Assets of these partnerships at November 30, 2003 include 110,000 square feet of office space, 138,000 square feet of retail space, 1,028 hotel rooms and 1,500 apartment units. Approximately 30% of these properties are not yet stabilized. Our ownership interests range from 33% to 98%. Our total investment in single asset partnerships was $29.0 million at November 30, 2003. Total assets and liabilities of the partnerships were $226.6 million and $180.4 million, respectively, at November 30, 2003. The debt in these partnerships is non-recourse to us, except for $5.5 million of debt guarantees and $8.1 million of limited maintenance guarantees.

 

Partnerships with Lennar

 

In November 2003, we and Lennar each contributed our 50% interests in jointly owned entities that had significant assets to a new limited liability company named LandSource Communities Development LLC (“LandSource”), in exchange for 50% interests in LandSource. In addition, in July 2003, we and Lennar formed, and obtained 50% interest in, NWHL Investment LLC (“NWHL”), which in January 2004 purchased The Newhall Land and Farming Company. LandSource and NWHL jointly obtained bank financing which was used for a portion of the acquisition price of Newhall Land.

 

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The most significant property entity contributed to LandSource by both us and Lennar was Lennar Land Partners (“LLP”). LLP is engaged in the acquisition, development and sale of land that is suitable for residential or commercial development, which it sells to homebuilders and commercial developers, including us and Lennar. LLP is also engaged in the development and sale of homes. During 2003, LLP had land sale revenues of $112.2 million of which $68.0 million was from sales to Lennar and $0.0 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 transactions between us and Lennar with respect to LLP be approved by our 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.

 

The other property entities owned by LandSource include Mare Island, a closed naval shipyard located in California which is being converted to a master planned community, and an office property located in California which is being redeveloped into for-sale residential units. In 2003, Lennar purchased from us a 50% interest in the entity owning the office property for $12.8 million. Also in 2003, a joint venture in which both we and Lennar have a non-controlling interest purchased residential land from a LandSource entity for $71.0 million. As with LLP, all major decisions with respect to these entities are made on an equal basis between us and Lennar, and transactions between us and Lennar related to these ventures are approved by our Transaction Review Committee.

 

We recorded $55.6 million of pretax earnings, made contributions of $53.9 million and received $57.3 million in cash distributions from the LandSource entities in 2003.

 

At November 30, 2003, the debt of LandSource and its subsidiaries is non-recourse to us, with the exception of one $1.4 million guarantee. Along with Lennar, we provide limited maintenance guarantees on $35.4 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.

 

Other Partnerships with Lennar

 

We have joint ventured with Lennar in a number of other projects, which require both residential and commercial expertise. As with the LandSource entities, both us and Lennar have equal say on all major decisions and transactions between us and Lennar relating to these ventures are required to be approved by our Transaction Review Committee. These unconsolidated investments, which are accounted for by the equity method, include:

 

  The redevelopment of Hunters Point, a closed naval shipyard in California, which is being converted to a master planned community 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, 2003.

 

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

 

The debt on these partnerships is non-recourse to us except for $5.6 million of limited maintenance guarantees.

 

Our total investment in all partnerships with Lennar (including LandSource and other partnerships) at November 30, 2003 was $163.6 million and we recorded $55.5 million of pretax earnings from the partnerships in 2003. Total assets and liabilities of the partnerships were $589.9 million and $217.0 million, respectively, at November 30, 2003. The debt in these partnerships is non-recourse to us, except for the guarantees discussed above.

 

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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 $48.2 million at November 30, 2003. These partnerships contributed $1.7 million to our after tax earnings for the year ended November 30, 2003. Total unconsolidated affordable housing partnership debt was $360.9 million at November 30, 2003, of which only $39.2 million was 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 approximately 362 commercial real estate properties located throughout France. Our investment in this partnership was $81.7 million at November 30, 2003. In 2003, we invested in a second real estate partnership in Europe, which owns 14 office and industrial properties located in France, Switzerland, Spain and Belgium. Our investment in this partnership was $7.4 million at November 30, 2003. We recorded $7.1 million in pretax earnings from our international partnerships in 2003. At November 30, 2003, the total assets and liabilities of these partnerships were $263.7 million and $170.9 million respectively. The partnerships underlying our European investments had assets and liabilities of $3.3 billion and $3.1 billion, respectively.

 

Discounted Portfolios of Commercial Mortgage Loans

 

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 through partnerships with financial institutions or other entities. In late 2003, we entered into a 50%/50% joint venture with a major financial institution to invest in performing, sub-performing and non-performing assets, including owned real estate assets, loans and CMBS. In each of these partnerships, one of our subsidiaries acts as the managing general partner or managing member and conducts the business of the venture. We earn management fees and asset disposition fees from these ventures and have carried interests in cash flows and sales proceeds once the partners have recovered their capital and achieved specified returns. Our investment in these ventures at November 30, 2003 was $2.9 million. The debt of these ventures is non-recourse to us.

 

Madison Square Company LLC

 

Formed in March 1999, Madison invests in real estate securities, primarily CMBS. Our investment in Madison as of November 30, 2003 was $81.8 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 $2.9 million of pretax losses and received $22.6 million in cash distributions and fees from Madison in 2003. The debt of Madison is non-recourse to us and expires in March 2004. The members of the venture are currently in the process of refinancing through a resecuritization.

 

CRITICAL ACCOUNTING POLICIES

 

In the preparation of our financial statements, we follow 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 investment securities, derivative financial instruments, long-lived assets, income taxes and allowance for loan losses. Management periodically reviews the application and disclosure of these critical accounting policies with our Audit Committee.

 

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Investment Securities

 

Interest income on our investment securities is recognized on the level yield method, using the yield that equates the future cash flows, estimated by us as described below, to the amortized cost (including any other than temporary impairments recognized to date). To the extent estimated future cash flows change, the yield on the security is increased or decreased prospectively to the revised yield. If the projected cash flows on a particular security become subject to significant uncertainty, the security is accounted for on a cost recovery method. Under the cost recovery method, all cash received is applied to amortized cost until such time as we are able to project cash flows with greater certainty, resulting in no income recognition during the period of uncertainty.

 

As discussed in Note 3 to the consolidated financial statements, our investment securities are classified as available-for-sale and are recorded at fair value with unrealized gains and losses reported in stockholders’ equity as a component of accumulated other comprehensive earnings (loss) until realized. 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. Due to the uncertainty inherent in the valuation process, estimates of fair value may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. Changes in the valuations do not affect reported income or cash flows, but impact unrealized gains and losses reported in stockholders’ equity as a component of accumulated other comprehensive income.

 

Management must assess whether unrealized losses on securities reflect a decline in fair value that is other than temporary. If the decline is determined to be other than temporary, a loss is recognized in earnings. For investment securities accounted for under the level yield method, a decline in fair value 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, and the decline in the present value is due to adverse changes in the projected cash flows. For these securities a loss is recognized to the extent by which the fair value of the investment security has declined below its amortized cost. For investment securities accounted for under the cost recovery method, a loss is recognized to the extent that the total projected cash flows do not exceed the amortized cost of the security. Significant management judgment is required in this analysis, which includes but is not limited to making assumptions about the collectibility of the principal and interest, net of related expenses, on the underlying loans, and about the amount and timing of projected principal repayments or losses.

 

Derivative Financial Instruments

 

In accordance with our risk management policy, we utilize derivative financial instruments, primarily interest rate swaps, to manage our exposure to interest rate risk on variable-rate debt instruments (cash flow hedges) and to changes in fair value due to movements in interest rates on our fixed-rate investments in CMBS (fair value hedges). All derivatives are carried in our balance sheets at fair value, which is determined based on estimated net payments or receipts of interest. Changes in fair value on cash flow hedges are recorded in stockholders’ equity as a component of other comprehensive income to the extent that the hedges are effective, with any ineffectiveness recorded currently in earnings. Changes in fair value on fair value hedges are recorded in earnings, and are offset by changes in fair value on the hedged CMBS that arise due to changes in interest rates. As discussed in Note 5 to our consolidated financial statements, certain of our derivative financial instruments do not qualify for hedge accounting, although they were entered into in accordance with our risk management policy to hedge against cash flow or fair value exposures on financial instruments that we hold. Changes in fair value of these derivatives are recorded currently in earnings.

 

Changes in short- and long-term interest rates could have a significant impact on the fair value of derivative financial instruments we have entered into. Because these derivative instruments hedge specific exposures, their changes in value should approximately offset the changes in value of the items they hedge.

 

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Long-Lived Assets

 

We 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 issues. If such indications are present, we estimate the total undiscounted future cash flows from the property and compare the total undiscounted future cash flows to the carrying amount of the property. If the total undiscounted future cash flows are less than the carrying amount, we adjust the carrying amount of the asset down to its estimated fair value. For stabilized operating properties, fair value is determined by applying capitalization rates appropriate for the property’s age, type, condition and market to annualized property net operating income (rental income less cost of rental operations before commissions and non-operating expenses). For operating properties under development or repositioning, fair value is determined using discounted expected future cash flows. The determination of future expected cash flows, discount rates and capitalization rates requires significant judgment and assumptions, including estimates and timing of sales proceeds and operating cash flows. Significant adverse changes in local or regional economic conditions, market capacity, interest rates, or property performance (including occupancy, rent rollovers, rental rates and tenant defaults) could affect these judgments and assumptions in future periods, and could cause a significant decline in the fair value of these assets.

 

Income Taxes

 

As part of the process of preparing our consolidated financial statements, significant management judgment is required to estimate our income taxes. Our estimates are based on interpretation of tax laws. We estimate our actual current tax due and assess temporary differences resulting from differing treatment of items for tax and accounting purposes. The temporary differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. Adjustments may be required due to a change in our assessment of our deferred tax assets and liabilities, changes resulting from audit adjustments by Federal and State tax authorities, and changes in tax laws. Adjustments required in any given period would be included within the tax provision in the statements of earnings and/or balance sheets. These adjustments could materially impact our financial position and results of operations.

 

We record a valuation allowance for deferred income tax assets to reduce the assets to amounts we expect to realize. In determining the required level of the valuation allowance, we consider whether it is more likely than not that all or some portion of the deferred tax assets will not be realized. This assessment is based on management’s expectations as to whether sufficient taxable income of an appropriate character will be realized within tax carryback and carryforward periods. Should we change our estimate of the amount of deferred tax assets that we would be able to realize, an adjustment to the valuation allowance would result in an increase or decrease to the tax provision in the period the change in estimate was made. At November 30, 2003, we believe that it is more likely than not that our deferred tax assets will be realized through future taxable income.

 

Allowance for Loan Losses

 

The allowance for loan losses is established and maintained at levels we deem adequate to cover losses resulting from the inability of borrowers to make contractually required loan payments. Management periodically evaluates each loan in our portfolio for impairment by comparing the fair value of the underlying collateral to the carrying value of the loan. The determination of the fair value of the underlying collateral is based on judgments and assumptions about future performance of the asset and market conditions affecting the asset’s value. This evaluation also considers several other factors, including the historical and current performance of the underlying collateral (including loan-to-value ratios, occupancy, debt service coverage and lease terms), the strength of the borrower and current market conditions. If our evaluation indicates that all of the interest or principal on the specific loan may not be collectible, we record an impairment loss in the amount by which book value exceeds our estimate of fair value.

 

While we have experienced minimal actual losses on investments in loans, management considers it prudent to reflect provisions for loan losses on a portfolio basis based upon our assessment of our historical loss experience, current trends in delinquencies and charge offs, industry loss experience and trends and

 

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changes in the size and composition of the loan portfolio. When such assessment indicates that an allowance may be prudent for loans not subject to specific impairment charges as discussed above, an allowance is recorded.

 

Our assessment of probable loan losses at the specific loan and portfolio levels requires significant judgment in estimating future market conditions and the impact of economic events, the outcomes of which are uncertain. These events may include, but are not limited to, deterioration in general economic conditions, changes in economic conditions affecting our borrowers or tenants, availability and supply of commercial real estate, legislation that directly or indirectly affects the real estate industry, and regional economic conditions affecting specific geographical areas in which our underlying loan collateral is located. At November 30, 2003, our allowance for loan losses was $7.5 million. Actual losses, if any, could ultimately differ significantly from these estimates.

 

NEW ACCOUNTING PRONOUNCEMENTS

 

In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires that the cost of an acquired enterprise allocated to 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. Additionally, SFAS No. 142 requires that the costs of an acquired enterprise be allocated to intangible assets, including above-market, below-market and in-place leases of operating properties, and that such costs be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment. We adopted the provisions of SFAS No. 142 in 2003. The adoption of SFAS No. 142 did not 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 long-lived assets. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized as an asset with an offsetting liability in the period in which it is incurred if a reasonable estimate of fair value can be made. We adopted the provisions of SFAS No. 143 in 2003. The adoption of SFAS No. 143 did not 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 Principles Board (“APB”) Opinion 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. As indicated in Note 20 to the consolidated financial statements, we adopted the provisions of SFAS No. 144 effective December 1, 2002. SFAS No. 144 requires us to present all operating properties classified as held for sale after November 30, 2002, separately on our consolidated balance sheets, and the earnings from all properties sold or classified as held for sale after November 30, 2002, as results of discontinued operations in our consolidated statements of earnings. Prior periods are to be restated for comparative purposes. The adoption of this statement did not impact our net earnings. It did, however, impact the presentation of our financial position and operating results. Specifically, each time we sell a property or classify it as held for sale, which is a frequent occurrence since selling properties is a regular part of our business, we are required to restate our consolidated statements of earnings for the current year, as well as prior years, for comparability purposes. Our expectation is that each year we will continue to report a significant portion of our earnings as discontinued operations, and accordingly each year we will be required to reclassify prior years for comparative purposes because selling properties is a regular part of our business.

 

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

 

55


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 did not have a material effect on our results of operations or financial position.

 

In November 2002, the FASB issued Financial 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 guarantees 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, a liability, or an equity security of the guaranteed party. We adopted the new disclosure requirements of FIN No. 45 in 2003 (see Note 17 to the consolidated financial statements). The initial recognition and measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of the initial recognition and measurement provisions of FIN No. 45 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 a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. In December 2003, the FASB issued a revision to FIN No. 46. FIN No. 46 requires us to consolidate variable interest entities (“VIEs”) of which we are the primary beneficiary – those in which we have a variable interest or a combination of variable interests that will absorb a majority of each entity’s expected losses, receive a majority of each entity’s expected residual returns, or both, based on an assessment performed at the time we become involved with each entity. Reconsideration of this assessment is required under certain circumstances, which are outlined in Note 1 to the consolidated financial statements. 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 equity holders lack (a) the ability to participate in decisions about the entity’s activities through voting or similar rights, including proportionate voting and economic rights, (b) the obligation to absorb the expected losses of the entity, or (c) the right to receive the residual returns of the entity. We have adopted the provisions of FIN No. 46 for variable interests in VIEs created after January 31, 2003. The adoption of FIN No. 46 for variable interests in VIEs created after January 31, 2003 did not have a material effect on our results of operations or financial position. The FASB has deferred the effective date for variable interests in VIEs created before February 1, 2003, to our quarter ending May 31, 2004. We have made certain transitional disclosures required by FIN No. 46 in Note 19 to our consolidated financial statements.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 requires that contracts with comparable characteristics be accounted for similarly. The Statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The provisions of this Statement generally are to be applied prospectively only. We have adopted the provisions of SFAS No. 149 effective July 1, 2003. The adoption of SFAS No. 149 did not have a material effect on our results of operations or financial position.

 

In May 2003, the FASB issued SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or asset in some circumstances). This Statement is effective for financial instruments created or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. In November 2003, the FASB indefinitely deferred the effective date for the classification and measurement provisions of certain mandatorily redeemable

 

56


noncontrolling interests under SFAS No. 150. We have adopted the provisions of SFAS No. 150 that are effective for the year ending November 30, 2003. The adoption of SFAS No. 150 did not have a material effect on our results of operations or financial position.

 

In November 2003, the Emerging Issues Task Force (“EITF”) reached a consensus on the disclosure provisions of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF No. 03-1 requires that certain quantitative and qualitative disclosures be made for certain debt securities classified as available-for-sale under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. Debt securities within the scope of EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” are not subject to these disclosure provisions. The disclosures are required for fiscal years ending after December 15, 2003, and accordingly we plan to adopt the disclosure provisions of EITF No. 03-1 for the year ending November 30, 2004.

 

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, 2003 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 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 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, 2003, 24% of our existing consolidated indebtedness had interest at variable rates. Approximately 3% of our debt was match-funded against variable-rate assets and 13% was swapped to fixed-rate. As a result, at year-end, because our variable-rate assets exceeded our variable-rate debt, we estimate that a 100 basis point increase in LIBOR would have increased our net earnings by $2.6 million, or $0.08 per share diluted.

 

57


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.

 

58


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, 2003 and 2002 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, 2003. 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, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended November 30, 2003, in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 20 to the consolidated financial statements, in connection with the adoption of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, effective December 1, 2002, the accompanying consolidated financial statements have been reclassified to conform to the provisions of such standard.

 

DELOITTE & TOUCHE LLP
Certified Public Accountants

Miami, Florida

February 25, 2004

 

59


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

(In thousands, except per share amounts)

 

     As of November 30,

 
     2003

    2002

 

Assets

              

Cash and cash equivalents

   $ 29,667     5,711  

Restricted cash

     23,732     2,524  

Investment securities

     900,334     1,127,313  

Mortgage loans, net

     462,545     430,255  

Operating properties and equipment, net

     640,942     585,086  

Land held for investment

     58,578     56,980  

Investments in unconsolidated partnerships

     426,576     360,981  

Assets held for sale

     —       195,363  

Deferred income taxes

     20,686     —    

Other assets

     69,954     70,661  
    


 

Total assets

   $ 2,633,014     2,834,874  
    


 

Liabilities and stockholders’ equity

              

Liabilities:

              

Accounts payable

   $ 11,249     13,276  

Accrued expenses and other liabilities

     187,056     158,750  

Deferred income taxes

     —       43,032  

Liabilities related to assets held for sale

     —       151,976  

Mortgage notes and other debts payable

     1,382,786     1,339,962  
    


 

Total liabilities

     1,581,091     1,706,996  
    


 

Minority interests

     1,056     1,722  
    


 

Commitments and contingent liabilities (Note 16)

              

Stockholders’ equity:

              

Common stock, $.10 par value, 150,000 shares authorized, 19,941 and 23,189 shares issued and outstanding in 2003 and 2002, respectively

     1,994     2,319  

Class B common stock, $.10 par value, 40,000 shares authorized, 9,775 and 9,784 shares issued and outstanding in 2003 and 2002, respectively

     977     978  

Additional paid-in capital

     459,378     489,948  

Retained earnings

     538,799     510,204  

Unamortized value of restricted stock grants

     (28,890 )   (7,077 )

Accumulated other comprehensive earnings

     78,609     129,784  
    


 

Total stockholders’ equity

     1,050,867     1,126,156  
    


 

Total liabilities and stockholders’ equity

   $ 2,633,014     2,834,874  
    


 

 

See accompanying notes to consolidated financial statements.

 

60


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF EARNINGS

 

(In thousands, except per share amounts)

 

     Years Ended November 30,

 
     2003

    2002

    2001

 

Revenues

                    

Rental income

   $ 100,058     93,708     105,806  

Management and servicing fees

     41,227     31,982     36,324  
    


 

 

Total revenues

     141,285     125,690     142,130  
    


 

 

Other operating income

                    

Equity in earnings of unconsolidated partnerships

     51,974     46,361     75,152  

Interest income

     157,893     180,776     181,325  

Gains on sales of:

                    

Real estate

     13,174     48,088     63,535  

Unconsolidated partnership interests

     3,568     3,428     746  

Investment securities

     52,667     47,221     9,717  

Lease termination fee

     15,115     —       —    

Other, net

     (1,038 )   (1,258 )   (818 )
    


 

 

Total other operating income

     293,353     324,616     329,657  
    


 

 

Costs and expenses

                    

Cost of rental operations

     60,431     51,243     57,028  

General and administrative

     87,747     77,281     74,398  

Depreciation

     21,256     21,395     24,545  

Impairment of long-lived asset

     15,050     —       —    

Minority interests

     (226 )   1,223     2,536  

Interest

     102,254     92,054     109,742  

Loss on early extinguishment of debt

     28,672     —       —    
    


 

 

Total costs and expenses

     315,184     243,196     268,249  
    


 

 

Earnings from continuing operations before income taxes

     119,454     207,110     203,538  

Income taxes

     38,285     66,918     70,136  
    


 

 

Earnings from continuing operations

     81,169     140,192     133,402  
    


 

 

Discontinued operations:

                    

Earnings from operating properties sold or held for sale, net of tax

     1,829     3,686     1,711  

Gains on sales of operating properties, net of tax

     26,584     —       —    
    


 

 

Earnings from discontinued operations

     28,413     3,686     1,711  
    


 

 

Net earnings

   $ 109,582     143,878     135,113  
    


 

 

 

(continued)

 

See accompanying notes to consolidated financial statements.

 

61


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF EARNINGS—Continued

 

(In thousands, except per share amounts)

 

     Years Ended November 30,

     2003

   2002

   2001

Weighted average shares outstanding:

                

Basic

     29,289    33,460    33,364
    

  
  

Diluted

     30,718    34,649    34,916
    

  
  

Earnings per share from continuing operations:

                

Basic

   $ 2.77    4.19    4.00
    

  
  

Diluted

   $ 2.64    4.04    3.82
    

  
  

Earnings per share from discontinued operations:

                

Basic

   $ 0.97    0.11    0.05
    

  
  

Diluted

   $ 0.93    0.11    0.05
    

  
  

Net earnings per share:

                

Basic

   $ 3.74    4.30    4.05
    

  
  

Diluted

   $ 3.57    4.15    3.87
    

  
  

 

See accompanying notes to consolidated financial statements.

 

62


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

 

(In thousands)

 

     Years Ended November 30,

 
     2003

    2002

    2001

 

Net earnings

   $ 109,582     143,878     135,113  
    


 

 

Other comprehensive earnings (loss), net of tax:

                    

Unrealized gains (losses) on available-for-sale securities arising during the period

     (42,099 )   (50,088 )   213,513  

Less: reclassification adjustment for gains on available-for-sale securities included in net earnings

     (21,919 )   (33,586 )   (4,436 )

Unrealized gains (losses) on foreign currency translation

     10,951     4,543     (120 )

Unrealized gains (losses) on derivative financial instruments

     1,892     1,500     (4,859 )

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

     —       —       4,388  
    


 

 

Other comprehensive earnings (loss), net of tax

     (51,175 )   (77,631 )   208,486  
    


 

 

Comprehensive earnings

   $ 58,407     66,247     343,599  
    


 

 

 

See accompanying notes to consolidated financial statements.

 

63


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

(In thousands)

 

     Common Stock

   

Class B Common

Stock


   

Additional

Paid-in

Capital


   

Retained

Earnings


   

Unamortized

Value of

Restricted

Stock

Grants


   

Accumulated

Other

Comprehensive

Earnings

(Loss)


    Total

 
     Shares

    Amount

    Shares

    Amount

           

Balance at November 30, 2000

   24,215     $2,422     9,999     $1,000     $516,516     $272,772     $(13,195 )   $(1,071 )   $  778,444  

Purchase and retirement of treasury stock

   (300 )   (30 )   —       —       (4,509 )   (1,611 )   —       —       (6,150 )

Restricted stock grants

   15     1     —       —       267     —       (268 )   —       —    

Stock option exercises

   465     46     —       —       1,703     —       —       —       1,749  

Conversion of Class B common stock to common stock

   50     5     (50 )   (5 )   —       —       —       —       —    

Cash dividends - common stock

   —       —       —       —       —       (1,214 )   —       —       (1,214 )

Cash dividends - Class B common stock

   —       —       —       —       —       (449 )   —       —       (449 )

Amortization of unamortized value of restricted stock grants

   —       —       —       —       —       —       3,190     —       3,190  

Net earnings

   —       —       —       —       —       135,113     —       —       135,113  

Change in accumulated other comprehensive earnings (loss), net

   —       —       —       —       —       —       —       208,486     208,486  
    

 

 

 

 

 

 

 

 

Balance at November 30, 2001

   24,445     2,444     9,949     995     513,977     404,611     (10,273 )   207,415     1,119,169  

Purchase and retirement of treasury stock

   (1,909 )   (191 )   —       —       (28,355 )   (36,628 )   —       —       (65,174 )

Restricted stock grants

   —       —       —       —       —       —       —       —       —    

Stock option exercises

   442     44     —       —       2,999     —       —       —       3,043  

Stock issued under Senior Officers Stock Purchase Plan

   46     5     —       —       1,327     —       —       —       1,332  

Conversion of Class B common stock to common stock

   165     17     (165 )   (17 )   —       —       —       —       —    

Cash dividends - common stock

   —       —       —       —       —       (1,215 )   —       —       (1,215 )

Cash dividends - Class B common stock

   —       —       —       —       —       (442 )   —       —       (442 )

Amortization of unamortized value of restricted stock grants

   —       —       —       —       —       —       3,196     —       3,196  

Net earnings

   —       —       —       —       —       143,878     —       —       143,878  

Change in accumulated other comprehensive earnings (loss), net

   —       —       —       —       —       —       —       (77,631 )   (77,631 )
    

 

 

 

 

 

 

 

 

Balance at November 30, 2002

   23,189     2,319     9,784     978     489,948     510,204     (7,077 )   129,784     1,126,156  

Purchase and retirement of treasury stock

   (4,358 )   (436 )   —       —       (64,768 )   (79,559 )   —       —       (144,763 )

Restricted stock grants

   825     82     —       —       28,628     —       (28,710 )   —       —    

Stock option exercises

   219     22     —       —       3,808     —       —       —       3,830  

Stock issued under Senior Officers Stock Purchase Plan

   57     6     —       —       1,762     —       —       —       1,768  

Conversion of Class B common stock to common stock

   9     1     (9 )   (1 )   —       —       —       —       —    

Cash dividends - common stock

   —       —       —       —       —       (988 )   —       —       (988 )

Cash dividends - Class B common stock

   —       —       —       —       —       (440 )   —       —       (440 )

Amortization of unamortized value of restricted stock grants

   —       —       —       —       —       —       6,897     —       6,897  

Net earnings

   —       —       —       —       —       109,582     —       —       109,582  

Change in accumulated other comprehensive earnings (loss), net

   —       —       —       —       —       —       —       (51,175 )   (51,175 )
    

 

 

 

 

 

 

 

 

Balance at November 30, 2003

   19,941     $1,994     9,775     $977     $459,378     $538,799     $(28,890 )   $78,609     $1,050,867  
    

 

 

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

64


LNR PROPERTY CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(In thousands)

 

     Years Ended November 30,

 
     2003

    2002

    2001

 

Cash flows from operating activities:

                  

Net earnings

   $109,582     143,878     135,113  

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

                  

Depreciation

   23,723     24,986     25,267  

Deferred income tax provision (benefit)

   (37,434 )   3,989     (24,575 )

Minority interests

   (245 )   1,222     2,536  

Accretion of discount on investment securities and mortgage loans, net of writedowns

   (1,856 )   (35,653 )   (23,618 )

Amortization of deferred costs

   9,954     6,237     5,744  

Equity in earnings of unconsolidated partnerships

   (51,974 )   (46,361 )   (75,152 )

Distributions of earnings from unconsolidated partnerships