AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 5, 2002
REGISTRATION NO. 333-98571
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 1
TO
FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
BERKSHIRE INCOME REALTY, INC.
(Exact Name of Registrant as Specified in its Governing Instruments)
ONE BEACON STREET,
SUITE 1500
BOSTON, MASSACHUSETTS 02108
(617) 523-7722
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
SCOTT D. SPELFOGEL, ESQ.
GENERAL COUNSEL
BERKSHIRE INCOME REALTY, INC.
ONE BEACON STREET, SUITE 1500
BOSTON, MASSACHUSETTS 02108
(617) 523-7722
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
WITH COPIES TO:
JAMES M. DUBIN, ESQ.
PAUL, WEISS, RIFKIND, WHARTON & GARRISON
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019-6064
(212) 373-3000
APPROXIMATE DATE OF COMMENCEMENT OF THE PROPOSED SALE OF THE SECURITIES TO
THE PUBLIC: As soon as practicable after this Registration Statement becomes
effective. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE AS PROVIDED IN SECTION 8(a) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING UNDER SAID SECTION 8(a), MAY
DETERMINE.
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PRELIMINARY PROSPECTUS, DATED , 2002
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. BERKSHIRE
INCOME REALTY, INC. MAY NOT COMPLETE THE EXCHANGE OFFERS UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
PRELIMINARY PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND BERKSHIRE
INCOME REALTY, INC. IS NOT SOLICITING OFFERS TO BUY THESE SECURITIES IN ANY
STATE WHERE THE EXCHANGE OFFER OR SALE IS NOT PERMITTED.
OFFERS TO EXCHANGE SHARES OF
% SERIES A CUMULATIVE REDEEMABLE PREFERRED STOCK OF
BERKSHIRE INCOME REALTY, INC.
FOR INTERESTS IN
KRUPP GOVERNMENT INCOME TRUST (GIT)
KRUPP GOVERNMENT INCOME TRUST II (GIT II)
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP (KIM)
KRUPP INSURED PLUS LIMITED PARTNERSHIP (KIP)
KRUPP INSURED PLUS II LIMITED PARTNERSHIP (KIP II)
KRUPP INSURED PLUS III LIMITED PARTNERSHIP (KIP III)
THE OFFERS AND WITHDRAWAL RIGHTS WILL EXPIRE AT 12:00 MIDNIGHT, NEW YORK CITY
TIME, ON , 2002, UNLESS EXTENDED. INTERESTS TENDERED IN AN OFFER MAY
BE WITHDRAWN AT ANY TIME BEFORE THE EXPIRATION OF THE OFFER.
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We are a newly formed company whose primary goal will be to acquire, own and
operate multi-family residential properties. We are affiliated with The
Berkshire Group, a group of affiliated diversified real estate companies whose
businesses include real estate acquisitions, property management, investment
sponsorship and mortgage banking.
We are offering to exchange up to 2,563,147 shares of our % Series A
Cumulative Redeemable Preferred Stock, having a liquidation preference of $25.00
per share (the Preferred Shares), which are expected to be listed on the
American Stock Exchange under the symbol "BIR," for the following Interests,
subject, in each case, to the proration procedures and other terms described in
this prospectus and the related letter of transmittal:
- up to 3,913,815 Interests of GIT
- up to 4,776,584 Interests of GIT II
- up to 3,888,766 Interests of KIM
- up to 1,950,025 Interests of KIP
- up to 3,810,433 Interests of KIP II
- up to 3,320,267 Interests of KIP III
For each Interest in the mortgage fund identified below that is validly
tendered and not withdrawn, we will issue the corresponding number of Preferred
Shares shown in the table below:
MORTGAGE FUND PREFERRED SHARE MORTGAGE FUND PREFERRED SHARE
------------- --------------- ------------- ---------------
GIT.................. share KIP............ share
GIT II............... share KIP II......... share
KIM.................. share KIP III........ share
There is no requirement that holders of Interests participate in the offers.
If a holder elects to participate, the holder may elect to tender some or all of
the holder's Interests in exchange for Preferred Shares. Any holder electing not
to participate in the offers will continue to own Interests in the holder's
mortgage fund.
The Preferred Shares will entitle holders to receive cumulative preferential
cash distributions at an annual rate of % of the liquidation preference of
$25.00 per Preferred Share. Cash distributions will accrue from the date of
original issuance of the Preferred Shares and will be payable quarterly.
Consistent with Maryland law, which governs our charter, distributions may be
paid only when authorized by our board of directors and declared by us out of
legally available funds. Cash distributions on the Preferred Shares will
accumulate without interest. At any time after February 15, 2010, we will have
the right to redeem the Preferred Shares for $25.00 per share plus accumulated
and unpaid distributions. Holders will have the right as a class to elect two
directors if distributions are not paid for six consecutive quarterly periods.
The consent of holders of 66 2/3% of the Preferred Shares is required for
changes to our charter that materially and adversely affect the terms of, or
authorize, create or increase the number of authorized shares of a security that
ranks senior to, the Preferred Shares. We intend to conduct our business to
qualify as a REIT under the Internal Revenue Code of 1986. To ensure that we
maintain our qualification, limitations on ownership and transfer will apply to
the Preferred Shares.
Our obligation to exchange Preferred Shares for Interests requires that
several conditions be met first, including the condition that Interests
resulting in at least 1,000,000 Preferred Shares to be issued in exchange for
Interests in the offers be validly tendered and not withdrawn.
SEE "RISK FACTORS" BEGINNING ON PAGE 17, FOR A DISCUSSION OF MATERIAL RISK
FACTORS, INCLUDING THE FACT THAT:
- The offer consideration was determined without arm's-length negotiations
and may not reflect the fair market value of the Interests.
- By tendering their Interests, investors will be changing the nature of
their investment from primarily guaranteed mortgage loans to primarily
uninsured investments in real estate.
- If we do not have legally available funds, distributions actually paid on
the Preferred Shares may be less than the stated preferential amount, and
distributions received by holders who retain their Interests could be
greater than this stated preferential amount.
- The trading prices of the Preferred Shares may be less than the value
assigned for purposes of determining the offer consideration.
- Tendering holders will relinquish their right to share in future
appreciation, if any, in the value of the mortgage funds' assets. Only
holders who retain their Interests and KRF Company, our sole common
stockholder, will be able to share in this future appreciation.
- Unlike the mortgage funds, which have no outstanding indebtedness, we
intend to incur indebtedness to finance the acquisition of additional
properties.
- Tendering holders will not be able to determine in advance what portion of
their tendered Interests will be accepted in the offers.
- Our advisor and some of our directors are subject to conflicts of interest
as a result of their affiliation with The Berkshire Group.
- We have no operating history or established financing sources.
- Holders of the Preferred Shares will have limited voting rights.
- The exchange will generally be a taxable event for federal income tax
purposes that may result in gain to tendering holders.
- There may be adverse tax consequences if we fail to qualify as a REIT.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
SELLING PROCEEDS TO THE
PRICE TO PUBLIC(1) COMMISSIONS COMPANY(3)
Per Share..................................... $25 (2) $25
Total Minimum (1,000,000)..................... $25,000,000 (2) $25,000,000
Total Maximum (2,563,147)..................... $64,078,675 (2) $64,078,675
(1) Based on the liquidation preference of the Preferred Shares.
(2) We will pay a base fee of $100,000 to our dealer manager for its services in
connection with the offers plus reimbursement of its expenses. We will also
pay $4.50 per completed call made by it plus an additional $25,000 per
mortgage fund if at least 25% of the Interests in that fund has been
tendered.
(3) Proceeds are calculated before deducting organization, dealer manager and
other offering expenses payable by us, estimated to be approximately
$2,860,000.
The dealer manager for this offer is:
GEORGESON SHAREHOLDER SECURITIES CORPORATION
The date of this prospectus is , 2002.
TABLE OF CONTENTS
PAGE
--------
Additional Information...................................... i
Questions and Answers About the Proposed Transaction........ ii
Prospectus Summary.......................................... 1
Risk Factors................................................ 17
Cautionary Statement Regarding Forward-Looking Statements... 28
Use of Proceeds............................................. 29
Ratios of Earnings and "Adjusted" Earnings to Fixed Charges
and Combined Fixed Charges and Preferred Share
Dividends................................................. 30
Capitalization.............................................. 32
Selected Financial Data..................................... 33
Management's Discussion and Analysis of Financial Condition
and Results of Operations of Berkshire Income Realty
Predecessor Group......................................... 36
Management's Discussion and Analysis of Financial Condition
and Results of Operations of the Mortgage Funds........... 42
Business and Properties..................................... 68
Policies with respect to Certain Activities................. 76
The Offers.................................................. 78
Formation Transactions...................................... 90
Management.................................................. 91
Security Ownership of Beneficial Owners and Management...... 99
Information Relating to Our Common Stock.................... 100
Certain Relationships and Related Transactions.............. 100
Compensation Payable to Our Affiliates...................... 103
Conflicts of Interest....................................... 107
Comparison of the Rights of Holders of Preferred Shares and
the Rights of Holders of Interests........................ 109
Information with respect to the Mortgage Funds.............. 124
Description of the Preferred Shares......................... 145
Summary of Operating Partnership Agreement.................. 153
Description of the Preferred OP Units....................... 156
Important Provisions of Maryland Law........................ 158
Federal Income Tax Considerations........................... 160
Plan of Distribution........................................ 176
Experts..................................................... 177
Legal Matters............................................... 177
Where You Can Find More Information About Us and the
Mortgage Funds............................................ 177
Index to Financial Statements and Financial Statement
Schedules and Supplementary Data.......................... F-1
Index to Unaudited Pro Forma Condensed Consolidated
Financial Information..................................... P-1
Appendix A--Fairness Opinion
ADDITIONAL INFORMATION
This prospectus incorporates important business and financial information
about us and the mortgage funds from documents filed with the Securities and
Exchange Commission that have not been included in or delivered with this
prospectus. This information is available at the Internet Web Site that the SEC
maintains, http://www.sec.gov, or it may be examined at the offices of the SEC
without charge, at the Public Reference Facilities in Washington, D.C. at
Judiciary Plaza, Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549. See
also "Where You Can Find More Information About Us and the Mortgage Funds."
You may also request copies of these documents from us, without charge, upon
written or oral request to us at One Beacon Street, Suite 1500, Boston,
Massachusetts, Attention: Investor Communications, or you can call us or
Georgeson Shareholder Communications, Inc., our information agent, toll-free at
1-866-33-KRUPP (1-866-335-7877). TO RECEIVE TIMELY DELIVERY OF THE DOCUMENTS,
YOU MUST MAKE YOUR REQUESTS NO LATER THAN , 2002 (FIVE BUSINESS DAYS
BEFORE THE INITIALLY SCHEDULED EXPIRATION DATE OF THE OFFERS).
i
QUESTIONS AND ANSWERS ABOUT THE PROPOSED TRANSACTION
QUESTIONS RELATING TO THE OFFERS
WHAT IS THE PRIMARY PURPOSE OF THE OFFERS?
The primary purpose of the offers is to provide holders of interests in the
mortgage funds with an opportunity to exchange some or all of their current
interests for our % Series A Cumulative Redeemable Preferred Stock, which is a
preferred security of a newly organized REIT.
We intend to borrow funds that will be secured by these exchanged mortgage
fund interests, and to use the proceeds of these borrowings, distributions from
these mortgage fund interests consisting of mortgage loan repayments, and income
from our other assets, to acquire additional multi-family residential
properties.
WHAT IS BEING PROPOSED?
We are offering to exchange shares of our % Series A Cumulative Redeemable
Preferred Stock, which will be listed on the American Stock Exchange (subject to
official notice of issuance) and will have a liquidation preference of $25.00
per share (which we refer to as our Preferred Shares), for the following
interests in six mortgage funds:
- shares of beneficial interest of Krupp Government Income Trust, a
Massachusetts trust (which we refer to as GIT),
- shares of beneficial interest of Krupp Government Income Trust II, a
Massachusetts trust (which we refer to as GIT II),
- units of depositary receipts representing units of limited partner
interests of Krupp Insured Mortgage Limited Partnership, a Massachusetts
limited partnership (which we refer to as KIM),
- units of depositary receipts representing units of limited partner
interests of Krupp Insured Plus Limited Partnership, a Massachusetts
limited partnership (which we refer to as KIP),
- units of depositary receipts representing units of limited partner
interests of Krupp Insured Plus II Limited Partnership, a Massachusetts
limited partnership (which we refer to as KIP II), and
- units of depositary receipts representing units of limited partner
interests of Krupp Insured Plus III Limited Partnership, a Massachusetts
limited partnership (which we refer to as KIP III).
We refer to interests in these mortgage funds as the Interests.
The Preferred Shares will entitle you to receive preferential quarterly cash
distributions at an annual rate of % of the liquidation preference of $25.00
per share (or $ per share annualized). All distributions that are
then due must be paid before we may make any distributions on our common stock,
and before we may pay fees to our advisor.
There is no requirement that you participate in the offers. If you elect to
participate, you may tender some or all of your Interests in exchange for
Preferred Shares. If you elect not to participate, you will continue to own
Interests in your mortgage fund.
IS THIS A ROLL-UP?
No, these are exchange offers designed to create a new real estate company.
You may elect to participate or stay with your current investment. A roll-up
generally would require all investors in a mortgage fund to participate if more
than 50% elected to do so. If you do not elect to exchange your Interests for
Preferred Shares, you will continue to own your Interests in your mortgage fund.
WHO IS MAKING THE OFFERS?
We are Berkshire Income Realty, Inc., a newly formed company that is
controlled by Douglas Krupp, Chairman and Chief Executive Officer of The
Berkshire Group, and George Krupp, Vice Chairman of The Berkshire Group. The
Berkshire Group is an integrated real estate and financial services organization
whose businesses include real estate acquisitions, property management,
investment sponsorship and mortgage banking.
ii
WHY SHOULD I PARTICIPATE IN THE OFFERS?
Your mortgage fund is not allowed to reinvest the principal balances it
receives from repayments of its mortgage loan assets, but instead must
distribute these funds to the holders of Interests. The mortgage funds have
experienced significant payoffs of their mortgage loan assets, which results in
ever-decreasing levels of regular distributions by the mortgage funds. By making
the offers, we are providing you with an opportunity to exchange all or part of
your Interests for a preferred security in a newly organized REIT. This
preferred security will be issued by a company having substantially different
assets and investment objectives and a substantially different ownership
structure from your mortgage fund, and will have substantially different
distribution and liquidation rights and trading liquidity from the Interests.
WHAT ARE THE SIGNIFICANT DIFFERENCES BETWEEN MY INTERESTS AND THE PREFERRED
SHARES I WILL RECEIVE FROM YOU IF I TENDER?
Unlike the Interests, the Preferred Shares have a stated annual distribution
rate of %. Although not guaranteed, this means you will be entitled to receive
quarterly cash distributions of $ per share, provided we have the legally
available funds to pay them. Also, the Preferred Shares will be listed on the
American Stock Exchange, which will provide you with greater liquidity. The
Interests in the mortgage funds only have limited liquidity because there is no
established trading market for the Interests.
Unlike holders of Interests, however, upon our liquidation, holders of
Preferred Shares will not be entitled to receive distributions in excess of
their initial investment. Also, as a holder of Preferred Shares, you will have
more limited voting rights than you currently have with respect to your
Interests, including only limited rights to elect or remove directors, amend
organizational documents and approve fundamental corporate transactions. In
addition, we may redeem the Preferred Shares at any time after February 15, 2010
at a redemption price of $25.00 per share plus accumulated and unpaid
distributions, while your Interests do not have a similar redemption feature.
WHAT ARE THE SIGNIFICANT RISKS TO ME IF I TENDER MY INTERESTS?
Participating in the offers may involve certain risks. Some of the material
risks include the following:
- Our offer consideration was determined without arm's-length negotiations
and may not reflect the fair market value of the Interests.
- By tendering your Interests, you will be changing the nature of your
investment from primarily guaranteed mortgage loans to primarily uninsured
investments in real estate.
- If we do not have the legally available funds, distributions actually paid
on the Preferred Shares may be less than the stated preferential amount,
and distributions received by holders who retain their Interests could be
greater than this stated preferential amount.
- The trading prices of the Preferred Shares may be less than the value
assigned for purposes of determining the offer consideration.
- Tendering holders will relinquish their right to share in future
appreciation, if any, in the value of the mortgage funds' assets. Only
holders who retain their Interests and KRF Company, our sole common
stockholder, will be able to share in this future appreciation.
- Unlike the mortgage funds, which have no outstanding indebtedness, we
intend to incur indebtedness to finance the acquisition of additional
properties.
- The exchange will generally be a taxable event for federal income tax
purposes that may result in gain to tendering holders.
- Tendering holders will not be able to determine in advance what portion of
their tendered Interests will be accepted in the offers.
- Our advisor and some of our directors are subject to conflicts of interest
as a result of their affiliation with The Berkshire Group.
- We have no operating history or established financing sources.
- Holders of the Preferred Shares will have limited voting rights.
- There may be adverse tax consequences if we fail to qualify as a REIT.
iii
ARE THERE OTHER DIFFERENCES THAT AFFECT ONLY HOLDERS OF INTERESTS IN KIP II?
Unlike the other mortgage funds, KIP II no longer owns any mortgage loan
assets. Instead, the assets of KIP II consist primarily of mortgage-backed
securities. KIP II has announced that it intends to liquidate its assets and
distribute liquidation proceeds. Accordingly, in deciding to exchange their
Interests for Preferred Shares, tendering holders of KIP II Interests will be
foregoing their right to receive their share of these liquidation proceeds,
potentially in the relatively near future.
HOW MANY PREFERRED SHARES WILL I RECEIVE FOR EACH INTEREST THAT I TENDER?
We are offering to exchange the number of Preferred Shares listed below for
each Interest validly tendered and not withdrawn in the offers. The relationship
between the number of Preferred Shares that you will receive in exchange for
each Interest that you validly tender is referred to as the exchange ratio.
MORTGAGE FUND PREFERRED SHARE
------------- ---------------
GIT..................................................... share
GIT II.................................................. share
KIM..................................................... share
KIP..................................................... share
KIP II.................................................. share
KIP III................................................. share
HOW WAS THE EXCHANGE RATIO DETERMINED?
We valued the Interests in each mortgage fund based on their projected cash
flows over a ten year period, and then divided that value by $25.00 (the
liquidation preference of each Preferred Share). Because the assets of KIP II no
longer include any mortgage loan assets but instead consist primarily of readily
marketable securities, KIP II was valued at net asset value.
To value the Interests of the mortgage funds, we projected the cash flows of
each mortgage fund by first calculating the rate at which each mortgage loan
held by that mortgage fund would amortize based on the terms of the mortgage
loan, such as monthly payment amounts, interest rates and maturity dates. From
these projected cash flows, we deducted expenses of the mortgage fund, such as
contractual asset management fees and estimated ongoing general and
administrative costs. The ongoing general and administrative costs were based on
historical information. Most of the mortgage loans have maturity dates that
extend beyond 2030. However, because we believe it is unlikely that the mortgage
loans will remain outstanding until their actual maturity date, we assumed, for
purposes of determining projected cash flows, that all mortgage loans were paid
off at the earlier of their contractual maturity date or ten years
(December 31, 2012). We assumed that any shared appreciation payments to which
the mortgage funds are entitled would be paid upon the earlier of December 31,
2012 or the maturity date of the mortgage loan in question. We then assumed that
all cash flows of the mortgage fund would be distributed to the holders of
Interests at the end of the quarter in which they were received, which is
consistent with the distribution policy of the mortgage funds.
The mortgage fund values we used to determine the exchange ratio was based
on a methodology that views the Interests as representing an interest in the
future distributions from the mortgage funds over a period of time. This
methodology differs from the methodology used by the mortgage funds in
determining their net asset value estimates, which is intended to represent the
theoretical liquidation value of all of the assets held by the mortgage fund at
a particular point in time. Although we believe that a net asset value
methodology may be an appropriate way of measuring the value of the underlying
assets of the mortgage funds, we believe the methodology we used to determine
our mortgage fund values is a more appropriate methodology for purposes of
determining the exchange ratio. This distinction is discussed in greater depth
in the prospectus under "The Offers--Exchange Ratio."
The exchange ratio, which was determined by our management, is intended to
provide each tendering holder with Preferred Shares having an aggregate
liquidation preference that is generally equal to the aggregate value of the
Interests being tendered by the holder.
Actual cash flows received by the mortgage funds may be greater or less than
the projected cash flows we used to determine the exchange ratio. Holders who
tender their Interests will not be compensated if these actual cash flows
received exceed our projected cash flows.
iv
HAS ANYONE DETERMINED THAT WHAT I WILL RECEIVE IN EXCHANGE FOR MY INTERESTS IS
FAIR?
Yes. The investment banking firm, Sutter Securities Incorporated, has
delivered its opinion to us that, as of the date of the opinion, the
consideration being offered to holders of Interests is fair, from a financial
point of view, to holders of Interests who elect to tender their Interests for
Preferred Shares. This opinion may be found in Appendix A to this prospectus.
Sutter Securities makes no recommendation as to whether or not investors should
tender their Interests in the offers.
WILL I HAVE TO PAY ANY FEES OR COMMISSIONS?
No, you will not have to pay any fees or commissions to tender your
Interests. We will use the cash contributed to us by our common stockholder to
pay the costs related to the exchange of the Interests and the issuance of the
Preferred Shares.
HOW CAN I SELL MY PREFERRED SHARES IF I NEED TO?
The Preferred Shares are expected to be listed on the American Stock
Exchange under the symbol "BIR." The price for the Preferred Shares will be the
price at which they trade on the American Stock Exchange.
WILL THE PREFERRED SHARES TRADE AT THEIR $25.00 PER SHARE LIQUIDATION
PREFERENCE?
There are many factors that affect the trading prices of securities. The
Preferred Shares may trade at a discount from or premium to the $25.00
liquidation preference.
WILL I SHARE IN ANY APPRECIATION IN THE VALUE OF THE REAL ESTATE INTERESTS HELD
OR TO BE ACQUIRED BY YOU?
No. You will receive Preferred Shares that will entitle you to receive cash
distributions at an annual rate of %, payable quarterly. Although this
distribution rate is not guaranteed, all distributions on the Preferred Shares
will be preferential in relation to our common stock. We are a Maryland
corporation and, consistent with Maryland law, distributions on the Preferred
Shares and our common stock may be paid only if authorized by our board of
directors and declared by us out of legally available funds.
Any appreciation in our real estate properties will be for the benefit of
the holders of our common stock and common limited partner interests in our
operating partnership, all of which will initially be owned by KRF Company,
L.L.C., an affiliate of The Berkshire Group. However, the holders of our common
stock and common limited partner interests in our operating partnership will be
entitled to this benefit only to the extent the holders of the Preferred Shares
first receive all amounts then due on the Preferred Shares. Payment of
distributions on the Preferred Shares also will have priority over the fees and
expense reimbursements payable to our advisor.
Because you will not share in any appreciation, the % preferential return
on your Preferred Shares will likely be the maximum return you will receive on
your investment. (This may not be the case if you are able to sell the Preferred
Shares on the American Stock Exchange at a premium, but there is no assurance
that you will be able to do so.) However, because of the preference feature of
the Preferred Shares, if the real estate properties owned by us lost value, in
most cases this loss would be borne by the holders of our common stock and
common limited partner interests in our operating partnership before being borne
by the holders of the Preferred Shares. This structure is intended to provide
you with greater protection in preserving your capital investment and a greater
likelihood that you will receive a dependable return.
CAN THE PREFERRED SHARES BE CALLED?
Yes, but they generally cannot be called before February 15, 2010. After
that date, they can be called for a redemption price equal to $25.00 per share
plus accumulated and unpaid distributions.
ARE THE PREFERRED SHARES REQUIRED TO BE REDEEMED?
No. But remember, because the shares will be listed on the American Stock
Exchange, you can sell your shares at any time for the then market value of the
shares.
v
WHAT WILL HAPPEN TO MY INTERESTS IF I DO NOT EXCHANGE THEM IN THE OFFERS?
Nothing. You will continue to own the Interests in your mortgage fund. Our
offers are not expected to affect the operation of the mortgage funds in any
way, including their continued payment of distributions.
IS THIS A GOING PRIVATE TRANSACTION INVOLVING THE MORTGAGE FUNDS?
No. Because we are not seeking to exchange Preferred Shares for all of the
outstanding Interests of the mortgage funds, after completion of the offers each
mortgage fund will continue to be required to comply with SEC rules relating to
publicly held companies, including being required to file periodic reports and
make other filings with the SEC.
WHAT DO THE GENERAL PARTNERS AND THE BOARD OF TRUSTEES OF THE MORTGAGE FUNDS
THINK OF THE OFFER?
Information about the recommendation of the mortgage funds' general partner
or board of trustees is described in the Schedule 14D-9 of each of the mortgage
funds, which they are required to file with the SEC. Copies of the
Schedule 14D-9 of KIM, KIP, KIP II and KIP III are included with this
prospectus. The Schedule 14D-9's of GIT and GIT II are required to be mailed to
you shortly by those mortgage funds.
QUESTIONS RELATING TO OUR BUSINESS AND ITS MANAGEMENT
WHAT IS OUR BUSINESS PLAN?
We intend to acquire, own and operate multi-family residential properties.
We will own all of our operating assets through Berkshire Income Realty-OP,
L.P., which we refer to as our operating partnership. Upon completion of the
offers, we will own interests in five multi-family residential properties as
well as the Interests that have been tendered to us in the offers. We intend to
acquire additional real estate properties meeting certain objectives described
in this prospectus under "Policies with respect to Certain
Activities--Investment Policies." We intend to finance the acquisition of these
additional properties through bank borrowings secured by a pledge of the
Interests, distributions from the Interests consisting of mortgage loan
repayments, and income from our real estate investments. We have not entered
into any agreements or received commitments from any lenders with respect to a
credit facility at this time.
TELL ME MORE ABOUT THE REAL ESTATE INTERESTS THAT YOU WILL OWN AT THE COMPLETION
OF THE OFFERS.
KRF Company, L.L.C., an affiliate of The Berkshire Group and the owner of
all of our common stock, will be contributing its interests in five residential
properties to us at the time we complete the offers in exchange for common
limited partner interests in our operating partnership. Four of these properties
are located in the Baltimore/Washington D.C. metropolitan areas, which we
believe comprise one of the strongest rental markets in the country. The fifth
property is located in Houston, Texas. The properties are each garden style
apartment communities and collectively consist of 2,539 apartment units. Each of
these properties has been managed by an affiliate of The Berkshire Group for
over 15 years.
HOW WERE THESE FIVE REAL ESTATE PROPERTIES SELECTED?
The Berkshire Group and its affiliates (including KRF Company) own, and have
the unilateral right to sell to us, interests in six multi-family real estate
properties. Of these six properties, five were considered by KRF Company and us
to be attractive investments. The sixth was not consistent with our investment
policies due to its existing level of indebtedness and other financing terms
affecting the property.
WHO WILL MANAGE BERKSHIRE INCOME REALTY?
Berkshire Property Advisors, L.L.C. (which we refer to as Berkshire
Advisor), an affiliate of The Berkshire Group, will be responsible for managing
our day-to-day activities, subject to the control and supervision of our board
of directors. Berkshire Advisor will be authorized to make multi-family
residential property investments on our behalf within investment guidelines
approved by our board of directors. We will rely on BRI OP Limited Partnership
to provide on-site property management services. BRI OP is owned by affiliates
of The Berkshire Group in joint venture with unaffiliated third parties.
vi
ARE THERE ANY SIGNIFICANT RELATIONSHIPS BETWEEN YOU AND THE MORTGAGE FUNDS?
Yes. The general partners of each of KIM, KIP, KIP II and KIP III are
controlled by Douglas and George Krupp, who also control the advisor to GIT and
GIT II. Douglas Krupp also is the chairman of the board as well as an officer of
both GIT funds. In addition, Douglas and George Krupp control KRF Company, the
company that owns all of our common stock and that will be contributing
interests in the initial real estate properties in exchange for common limited
partner interests in our operating partnership at the completion of the offers.
George Krupp is also a member of our board of directors. Douglas and George
Krupp also control our advisor and are affiliated with other entities that will
be paid fees by us for managing our assets.
HOW WILL YOU DEAL WITH POTENTIAL CONFLICTS OF INTEREST?
We will be governed by a board of directors, which will have a majority of
directors unaffiliated with us or our affiliates (including any affiliates of
Douglas and George Krupp). Our board of directors will have established an audit
committee, consisting exclusively of independent directors, whose approval will
be required with respect to any transactions involving our advisor or any of its
affiliates, including affiliates of Douglas and George Krupp. However, we cannot
tell you that this structure will be successful in eliminating the influence of
any conflicts of interest.
Our advisor, which is an affiliate of The Berkshire Group, will face
conflicts of interest relating to the allocation of investment opportunities
among us and other affiliates of The Berkshire Group. Although our advisor is
not required to present us with all investment opportunities that come to its
attention, we expect that, to the extent possible, the resolution of conflicting
opportunities between us and affiliates of our advisor will be based upon
differences in investment objectives and policies, the make-up of investment
portfolios, the amount of cash and financing available for investment and the
length of time the funds have been available, the estimated income tax effects
of the investment, policies relating to leverage and cash flow, the effect of
the investment on diversification of investment portfolios and any regulatory
restrictions on investment policies.
In terms of conflicts relating to the allocation of management and staff
time, services and functions among us and other affiliates of The Berkshire
Group, we have provided in our advisory agreement that our advisor is required
to devote sufficient resources as may be required to discharge its obligations
to us under that agreement.
QUESTIONS RELATING TO PROCEDURAL AND OTHER MATTERS
HOW DO I ACCEPT AN OFFER?
All you need to do is complete, sign and return the letter of transmittal
that is accompanying this prospectus. You do not need to surrender a stock
certificate representing your Interests.
WILL I BE RECEIVING A STOCK CERTIFICATE?
No. Similar to your current mortgage fund Interest, all Preferred Shares
will be issued by book-entry only.
IS THERE A MINIMUM NUMBER OF INTERESTS I AM REQUIRED TO TENDER IN THE OFFERS?
No, there is not a minimum number of Interests you are required to tender.
However, we are not required to accept ANY Interests in the offers unless
Interests resulting in at least 1,000,000 Preferred Shares to be issued in
exchange for them are tendered to us.
DO I HAVE TO TENDER ALL THE INTERESTS THAT I OWN IN THE OFFERS?
No. You do not have to tender all of the Interests that you own.
WHAT HAPPENS IF THERE IS A CASH DISTRIBUTION ON MY INTERESTS BEFORE THE
COMPLETION OF THE OFFERS?
Until we have accepted your Interests at the completion of the offers, you
will continue to be entitled to receive cash distributions on your Interests
that have been tendered to us. Note, however, that, with respect to KIP II, our
offer is subject to the condition that there may not have been any distributions
by KIP II consisting of proceeds in liquidation of the KIP II Interests.
vii
WHAT ARE THE MOST SIGNIFICANT CONDITIONS TO THE OFFERS?
The offers require that a number of conditions be met before they are
completed, including the condition that there must be validly tendered and not
properly withdrawn Interests resulting in an aggregate of at least 1,000,000
Preferred Shares being issued in exchange for Interests in all the offers. This
condition and other conditions to the offers are discussed in this prospectus
under "The Offer to Exchange Preferred Shares for Interests--Conditions to the
Offers."
HOW LONG DO I HAVE TO DECIDE WHETHER TO TENDER MY INTERESTS IN THE OFFERS?
You will have until 12:00 midnight, New York City time, on , 2002 to
decide whether to tender your Interests in the offers, unless we decide to
extend the expiration date as described below.
CAN THE EXPIRATION DATE OF AN OFFER BE EXTENDED, AND UNDER WHAT CIRCUMSTANCES?
Yes. The expiration date of an offer may be extended at our option if, in
our opinion, any of the conditions to the offer have not been satisfied or if
the aggregate number of Interests we are seeking to exchange for Preferred
Shares in the offers has not been validly tendered and not withdrawn by the
expiration date.
DO YOU CURRENTLY INTEND TO EXTEND THE EXPIRATION DATE OF THE OFFERS?
We are seeking to accept Interests up to an amount such that the total
number of Preferred Shares to be issued by us in the offers will equal, but not
exceed, 2,563,147 shares. If this amount has not been tendered to us by the
expiration date, we currently intend to extend the expiration date of the
offers, although we reserve the right not to do so. However, based on the number
of Interests of each mortgage fund that has been tendered to us by the
expiration date, we will likely also amend each offer either to increase or
decrease the aggregate number of Interests we are seeking in that offer in order
to meet our goal of issuing a total of 2,563,147 Preferred Shares.
HOW WILL I BE NOTIFIED IF THE EXPIRATION DATE OF AN OFFER IS EXTENDED?
If we extend the expiration date of an offer, we will issue a press release,
announcing the number of Interests that have been tendered as of that time and
giving the new expiration date, no later than 9:00 a.m., New York City time, on
the day after the day on which the offer was previously scheduled to expire. If
we also decide to amend an offer to either increase or decrease the aggregate
number of Interests we are seeking in that offer, we will also include that
information in the press release and otherwise comply with our obligations under
applicable law relating to material changes in an offer.
UNTIL WHAT TIME CAN I WITHDRAW PREVIOUSLY TENDERED INTERESTS?
You may withdraw Interests previously tendered in an offer any time before
the expiration of the offer, and, unless we have accepted the Interests tendered
in the offer, you may also withdraw any tendered Interests at any time after
, 2003. After we have accepted your Interests tendered in the offer, your
tender becomes irrevocable.
HOW DO I WITHDRAW PREVIOUSLY TENDERED INTERESTS?
You must deliver a written notice of withdrawal with the required
information to us while you still have the right to withdraw.
WILL YOU ACCEPT ALL OF THE INTERESTS THAT I TENDER?
It depends. We are only seeking to exchange Preferred Shares for up to
approximately 26% of the outstanding Interests in each of the mortgage funds. If
the number of Interests in your mortgage fund that is tendered is equal to or
less than the number of Interests in your mortgage fund that we are seeking to
exchange for Preferred Shares, then all of the Interests tendered by you will be
accepted. If the number of Interests in your mortgage fund that is tendered is
greater than the number of Interests in your mortgage fund that we are seeking
to exchange for Preferred Shares, our proration procedures will apply, which are
described below.
HOW DO THE PRORATION PROCEDURES WORK?
With respect to each offer, we are seeking to exchange Preferred Shares for
up to approximately 26% of the outstanding Interests of a mortgage fund. We
refer to this 26% ceiling as the tender ceiling. If the number of
viii
Interests of a mortgage fund that is tendered in an offer is greater than the
tender ceiling applicable to that mortgage fund, we will accept Interests of
that mortgage fund on a pro rata basis, based on the number of Interests of that
mortgage fund validly tendered and not properly withdrawn prior to the
expiration date.
WHEN WILL I KNOW HOW MANY OF MY INTERESTS WERE ACCEPTED?
Because of the complexity of determining the number of Interests validly
tendered and not withdrawn in an offer, if proration is required, we do not
expect we will be able to announce the final results of proration until
approximately three business days after the expiration of the offer. The
preliminary results of any proration will be announced by press release as
promptly as practicable after the time we accept Interests in an offer.
HOW MANY PREFERRED SHARES WILL BE OUTSTANDING AT THE COMPLETION OF THE OFFER?
The amount of outstanding shares will be a function of the number of holders
that have exchanged their Interests for Preferred Shares. Unless we waive our
minimum tender condition, the minimum number of outstanding Preferred Shares
will be 1,000,000 shares. The maximum number of outstanding Preferred Shares
will be 2,563,147 shares.
WHEN WILL DISTRIBUTIONS BE PAID ON THE PREFERRED SHARES?
Distributions are payable on February 15, May 15, August 15 and November 15
of each year. The first distribution payment will be made in 2003 on the first
of those dates following the completion of the offers, and will be prorated from
the date of completion of the offers through the first distribution payment
date. Although we intend to pay distributions on a quarterly basis, the
distributions on the Preferred Shares are not guaranteed and may be paid only
when authorized by our board of directors and declared by us out of legally
available funds. Distributions will accrue whether or not they are authorized or
declared by us.
WHAT IS THE TAX TREATMENT OF THE EXCHANGE OF INTERESTS FOR PREFERRED SHARES?
The receipt by you of Preferred Shares in exchange for your Interests
generally will be a taxable event for United States federal income tax purposes
and may also be taxable under applicable state, local and foreign tax laws. See
"Federal Income Tax Considerations--United States Federal Income Tax
Considerations Applicable to the Exchange of Preferred Shares for Interests."
WILL THE DISTRIBUTIONS I WILL RECEIVE ON THE PREFERRED SHARES BE TAXABLE AS
ORDINARY INCOME?
It depends. Generally, distributions that you receive will be taxed as
ordinary dividend income to the extent they are from current or accumulated
earnings and profits. Amounts distributed to you in excess of our earnings and
profits will reduce the tax basis of your Preferred Shares and distributions in
excess of tax basis will be taxable as an amount realized from the sale of your
Preferred Shares. This, in effect, would defer a portion of your tax until your
Preferred Shares are disposed of or redeemed, at which time you might be taxed
at capital gain rates. However, because each investor's tax considerations are
different, we suggest that you consult with your tax advisor. You also should
review the section of this prospectus entitled "Federal Income Tax
Considerations."
WHO WILL BE THE TRANSFER AGENT?
The Bank of New York.
WHO CAN I CALL WITH QUESTIONS ABOUT THE OFFERS?
You can call our information agent, Georgeson Shareholder, at 1-866-33-KRUPP
(1-866-335-7877) and they will be glad to answer any questions.
ix
PROSPECTUS SUMMARY
This summary highlights information more fully described elsewhere in this
prospectus. This summary is not complete and does not contain all the
information you should consider in connection with our offer. You should read
this entire prospectus carefully, including "Risk Factors," before deciding to
accept our offer.
BERKSHIRE INCOME REALTY, INC.
Berkshire Income Realty, Inc. is a Maryland corporation formed on July 19,
2002. We have had no operating history to date, but we are an affiliate of The
Berkshire Group, a group of affiliated companies whose businesses include real
estate acquisitions, property management, investment sponsorship and mortgage
banking. The Berkshire Group is controlled by Douglas and George Krupp, who also
control the general partners of and advisor to the mortgage funds. See
"Management--Berkshire Advisor" and "--Executive Officers and Directors."
By initiating this offer, we are seeking to create a real estate company
whose primary goal will be to acquire, own and operate multi-family residential
properties. Our initial assets will consist primarily of interests in five of
such properties, which will be transferred to us by our affiliate, KRF Company,
L.L.C., at the time we complete the offer. See "Formation Transactions." We will
also own the Interests that have been tendered to us in the offer, which will
represent our indirect interests in the insured or guaranteed mortgage loans,
mortgage-backed securities, other loans and related assets that are currently
held by the mortgage funds. We intend to own all of our operating assets through
Berkshire Income Realty-OP, L.P., our operating partnership, and to qualify as a
REIT for federal income tax purposes. Our address is One Beacon Street, Suite
1500, Boston, Massachusetts 02108 and our telephone number is (617) 523-7722.
The following is an organizational chart showing the general ownership
relationships between us and the affiliates of The Berkshire Group that are
highlighted in this prospectus. Except for our property manager and Berkshire
Realty Holdings, L.P., which is the parent of our property manager, all of the
entities shown in the organizational chart are substantially owned, and entirely
controlled, indirectly by Douglas and George Krupp and trusts for the benefit of
their immediate families. Berkshire Realty Holdings, L.P. is owned indirectly by
Douglas and George Krupp (and such family trusts) in joint venture with
unaffiliated third parties.
[GRAPHIC]
PURPOSE OF THE OFFERS
We are seeking to provide holders of Interests with an opportunity to
exchange some or all of their Interests for Preferred Shares, which bear a %
annual distribution rate and are expected to be listed on the American Stock
Exchange.
We intend to borrow funds that will be secured by these Interests, and to
utilize the proceeds of these borrowings, distributions from the Interests
consisting of mortgage loan repayments, and income from our real properties to,
among other things, acquire additional multi-family residential properties.
A summary of some of the anticipated benefits and risk factors of the offers
are highlighted below.
ANTICIPATED BENEFITS OF THE OFFERS
LIQUIDITY. Unlike the Interests, the Preferred Shares are expected to be
listed on the American Stock Exchange, under the symbol "BIR." As a result, the
Preferred Shares will have a public trading market and will have a readily
determinable market value. The Interests in the mortgage funds only have limited
liquidity because there is no established trading market for the Interests.
QUARTERLY CASH DISTRIBUTIONS. Holders of the Preferred Shares will be
entitled to receive cash distributions at an annual rate of %, payable
quarterly in the amount of $ per Preferred Share ($ annualized).
This % distribution rate was determined by us after reviewing dividend yields
payable on preferred stocks issued by publicly traded REITs that we believed to
be comparable to the Preferred Shares, and then selecting a distribution rate
that was comparable to the current yields payable on those preferred stocks.
2
PREFERRED RETURN. The Preferred Shares will entitle the holder to receive
regular quarterly cash distributions in the amount of $ per share
($ annualized) before any distributions may be made to the holders of our
common stock and common limited partner interests in our operating partnership.
In addition, if we were liquidated, after payment of our debts and other
obligations, holders of the Preferred Shares would be entitled to receive,
subject to our having available funds, a return of their capital investment plus
all accrued but unpaid distributions, before any of our assets would be
available for distribution to the holders of our common stock or common limited
partner interests in our operating partnership. Although any unpaid
distributions on the Preferred Shares will accumulate, no interest will be
payable with respect to them.
LOWER ASSET MANAGEMENT FEES. The asset management fees to be paid to our
advisor, Berkshire Property Advisors L.L.C., which are based on total assets
under management, will be at a lower rate than the asset management fees that
are payable to the GIT and GIT II advisor and to the general partners of KIM,
KIP, KIP II and KIP III. In addition, unlike the asset management fees payable
to these general partners, the fees and expense reimbursements payable to
Berkshire Advisor may not be paid unless all distributions then payable on the
Preferred Shares have been paid in full. This effectively means that the holders
of our common stock and common limited partner interests in our operating
partnership will generally bear the cost of these fees. However, the payment of
these fees in one quarter will still reduce the cash available for distribution
on the Preferred Shares in future quarters. Accordingly, it is possible that the
payment of these fees could reduce future distributions payable on the Preferred
Shares.
A chart comparing the fees and other compensation payable to our advisor and
other affiliates of The Berkshire Group in connection with the offers, with the
fees and other compensation payable to The Berkshire Group affiliates by the
mortgage funds, can be found in this summary under "Significant Differences
Between Preferred Shares and Interests."
SIMPLIFIED TAX RETURN PREPARATION. Holders of the Preferred Shares will not
be required to use complex Schedule K-1s currently being provided to holders of
Interests in the KIM, KIP, KIP II and KIP III mortgage funds to prepare their
tax returns.
RISK FACTORS
Exchanging your Interests for Preferred Shares involves some risks. In
deciding whether to tender your Interests in the offers, you should read this
prospectus carefully, including "Risk Factors" beginning on page , and the
other documents to which we refer you. The material risks include the following:
- The exchange ratio, which is the number of Preferred Shares that will be
issued in exchange for Interests, was determined without any arm's-length
negotiations and may not reflect the fair market value of the Interests.
- By tendering Interests, a holder will be changing the nature of the
holder's investment from primarily guaranteed mortgage loans to primarily
uninsured investments in real estate.
- If our business plan is not realized, distributions actually paid on the
Preferred Shares may be less than the stated preferential amount. This
would likely have an adverse effect on the trading value of the Preferred
Shares.
- Unlike the Interests, the value of the Preferred Shares will be determined
by the trading price of the shares on the American Stock Exchange. We
cannot assure you that the Preferred Shares will not trade at a discount
to the liquidation preference of $25.00 per share, or that the discount
will not be significant.
- Unlike holders of Interests, who have the right to share in any future
appreciation of the value of certain assets held by the mortgage funds,
holders of Preferred Shares will not be entitled to participate in any
future appreciation of our assets. KRF Company, as our sole common
stockholder, will be entitled to receive the entire benefit of any such
future appreciation.
- Unlike the mortgage funds, which have no outstanding indebtedness, we
intend to incur indebtedness to finance the acquisition of additional
properties.
- Holders who tender their Interests will not be able to determine in
advance what portion of their tendered Interests will be accepted in the
offers.
3
- Our advisor and some of our directors are subject to conflicts of interest
as a result of their affiliation with The Berkshire Group.
- We have no operating history or established financing sources.
- Unlike holders of Interests, who have the right to elect or remove their
general partner or board of trustees, amend organizational documents and
approve fundamental corporate transactions, holders of Preferred Shares
will have more limited voting rights. Holders of Preferred Shares will
only have the right to elect directors if distributions are not paid for
six consecutive quarterly periods, and they generally will not have the
right to vote on fundamental corporate transactions.
- Because we are a perpetual entity that may reinvest the proceeds of any
sales of properties, we will not necessarily be liquidated at any
particular date in the future. Holders of the Preferred Shares will not be
able to force a liquidation of the company or a redemption of the
Preferred Shares, particularly because of the lack of voting rights
associated with the Preferred Shares. Accordingly, unless we voluntarily
elect to redeem the Preferred Shares, holders of Preferred Shares may only
be able to liquidate their investment by selling their shares in the
public market at prevailing prices, and those prices may be significantly
less than the $25.00 liquidation preference of the Preferred Shares.
- The exchange of Interests for Preferred Shares will generally be a taxable
event for federal income tax purposes that may result in gain to tendering
holders of those Interests.
- There may be adverse tax consequences if we fail to qualify as a REIT.
- Because KIP II is in a liquidation stage, tendering holders of KIP II
Interests will be foregoing their right to receive their share of
liquidation proceeds, potentially in the relatively near future.
- The ratio at which Preferred Shares will be issued in exchange for
tendered Interests was based on estimates of the projected cash flows of
the mortgage funds. These estimates may turn out to have been less than
actual future cash flows. Accordingly, investors who tender their
Interests in exchange for Preferred Shares may in fact receive
distributions from us that are less than the distributions they would have
received had they retained their Interests.
BUSINESS PLAN
We intend to acquire, own and operate multi-family residential properties.
As of the completion of the offer, we will own interests in five of such
properties, which we refer to as the initial properties. Four of the five
initial properties are located in the Baltimore/Washington D.C. metropolitan
areas, which, based on occupancy data compiled by a third party real estate
information company, we believe comprise one of the strongest rental markets in
the country. Each of the initial properties has been managed by affiliates of
The Berkshire Group for more than 15 years.
We intend to acquire additional multi-family residential properties in the
future to provide portfolio diversification and an investment presence in other
strong metropolitan markets. Specifically, our plan is to acquire, and in some
cases renovate, middle income apartment complexes in selected targeted markets,
primarily in the Mid-Atlantic, Southeast and Southwest areas of the United
States.
Our primary business objective is to deliver strong, consistent returns to
our stockholders, while enhancing the long-term growth in value of our real
estate portfolio. We believe we are well positioned to meet this objective,
given the strengths of the economic regions in which the initial properties are
located, the quality of the initial properties, and the opportunities for new
investments within our selected targeted markets. Through adherence to specific
operating and renovation-related strategies, we will seek to achieve stability
and growth through maximization of cash flow from our interests in the initial
properties and investment in other multi-family residential properties. Our
policy with respect to renovations and capital improvements is to provide for
reserves and utilize sufficient capital to maintain each property's competitive
position within its rental market and, whenever possible, to capitalize on
market opportunities that can be realized through targeted capital expenditures.
See "Business and Properties--Business Strategy."
We intend to borrow funds that will be secured by the Interests, and to
utilize the proceeds of these borrowings, distributions from the Interests
consisting of mortgage loan repayments, and income from our real properties to,
among other things, acquire additional multi-family residential properties.
Under our current
4
investment guidelines, we may not incur indebtedness such that at the time we
incur the indebtedness our ratio of debt to total assets exceeds 75%. We have
not entered into any agreements or received commitments from any lenders with
respect to a credit facility at this time. We do not intend to dispose of the
Interests that have been tendered to us in the offers.
Interests in the initial properties will be contributed to us by our
affiliate, KRF Company, in exchange for common limited partner interests in our
operating partnership. See "Formation Transactions." Although The Berkshire
Group and its affiliates (including KRF Company) own interests in many
multi-family residential properties, there are only six such properties that
such entities have the right to sell to us without obtaining the consent of
third parties. Of the six properties, five are consistent with our investment
guidelines, while the sixth property is not, due to its existing level of
indebtedness and other financing terms affecting the property.
The five initial properties are described below:
CENTURY II APARTMENTS. Century II Apartments is located at 307 Fox Fire
Place, Cockeysville, Maryland. This garden style apartment community consists of
468 units within 16 buildings. The units consist of one, two and three-bedroom
apartments. The property is located on approximately 29 acres of land. Other
improvements include a swimming pool, fitness center, tennis courts, an exercise
facility and a clubhouse. Century II Apartments was built in 1971 and is in good
condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own a 75.82% interest in Century II Apartments. The remaining
24.18% interest will be held by affiliates of Equity Resources Group, Inc., an
unaffiliated third party. Our arrangements with the Equity Resources affiliates
relating to the management and control of the property are currently being
negotiated, but are expected to be comparable to those described below with
respect to the Dorsey's Forge and Hannibal Grove properties.
DORSEY'S FORGE APARTMENTS. Dorsey's Forge Apartments is located at 9650
White Acre Road, Columbia, Maryland. This garden style apartment community
consists of 251 units within 13 buildings. The units consist of one, two and
three-bedroom apartments. The property is located on approximately 17 acres of
land. Dorsey's Forge Apartments was built in 1970 and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own a 91.382% beneficial interest as tenant-in-common in
Dorsey's Forge Apartments. The remaining 8.618% interest will be held by
ERG/DFHG, LLC, an affiliate of Equity Resources Group, Inc. Under our
tenancy-in-common agreement, we will have control over the management, operation
and disposition of the property, except that the tenancy-in-common agreement
will give ERG/DFHG, LLC the option to require us to use our good faith efforts
to sell the property during a 180-day period beginning on April 27, 2005. We
believe that if ERG/DFHG, LLC exercises this option, it would be willing to
allow us to retain the property and instead accept a cash payment from us equal
to what it would have received in an arm's-length sale, if we decided to make
that proposal to ERG/DFHG, LLC.
HANNIBAL GROVE APARTMENTS. Hannibal Grove Apartments is located at 5361
Brookway, Columbia, Maryland. This garden style apartment community consists of
316 units within 23 buildings. The units consist of one, two and three-bedroom
apartments and three, four and five-bedroom townhouses. The property is located
on approximately 23 acres of land. Hannibal Grove Apartments was built in 1970
and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own a 91.382% beneficial interest as tenant-in-common in
Hannibal Grove Apartments. The remaining 8.618% interest will be held by
ERG/DFHG, LLC. Under our tenancy-in-common agreement, we will have control over
the management, operation and disposition of the property, except that the
tenancy-in-common agreement will give ERG/DFHG, LLC the option to require us to
use our good faith efforts to sell the property during a 180-day period
beginning on April 27, 2005. We believe that if ERG/DFHG, LLC exercises this
option, it would be willing to allow us to retain the property and instead
accept a cash payment from us equal to what it would have received in an arm's-
length sale, if we decided to make that proposal to ERG/DFHG, LLC.
We are currently evaluating the costs and anticipated benefits of doing
renovation and capital improvement projects at Hannibal Grove Apartments in a
small sample of test units. If after this evaluation we believe that there is a
sufficient return on the investment in the proposed projects, we may proceed
with the preparation of a formal plan for renovations and improvements on a
broader scale after we acquire the property.
5
SEASONS APARTMENTS. Seasons Apartments is located at 9220 Old Lantern Way,
Laurel, Maryland. This garden style apartment community consists of 1,088 units
within 70 buildings. The units consist of one and two-bedroom apartments and one
and three-bedroom townhouses. The property is located on approximately 68.5
acres of land. Other improvements include two swimming pools, six playgrounds,
two tennis courts, two clubrooms and approximately 1,700 parking spaces. Seasons
Apartments was built between 1972 and 1978 and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own 100% of this property.
We are currently evaluating the results of the renovation and capital
improvement projects conducted at Seasons Apartments in an initial group of 31
test units to determine the feasibility and benefits of a broader renovation and
improvement plan. The renovations and improvements made on the test units
included the replacement of kitchen cabinets and counters and bathroom vanities
and the modification of kitchens to provide for breakfast bars and a more open
environment between the kitchen and the main living area. The average cost of
the renovations and improvements for each test unit was approximately $4,500,
and the average annual rental increase on a renovated and improved unit was
approximately $1,200. It is anticipated that any future renovations would
initially be financed out of funds generated by operations and refinancings.
WALDEN POND APARTMENTS. Walden Pond Apartments is located at 12850
Whittington, Houston, Texas. This garden style community contains 416 one and
two-bedroom apartment units and is located on approximately 12 acres of land.
Walden Pond Apartments was built in 1982 and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own 100% of this property.
For further information regarding the initial properties, see "Business and
Properties--Initial Properties."
MANAGEMENT
We will be governed by a board of directors, which will be responsible for
the management and control of our operations. Our board will retain Berkshire
Advisor to manage our day-to-day affairs. Our board will control and supervise
Berkshire Advisor. Berkshire Advisor is part of The Berkshire Group, which
together with its affiliates collectively have over $1.1 billion of real estate
assets under management. Berkshire Advisor's address is One Beacon Street, Suite
1500, Boston, Massachusetts 02108 and its telephone number is (617) 523-7722.
Under our advisory agreement with Berkshire Advisor, Berkshire Advisor is
obligated to manage our portfolio and identify investment opportunities
consistent with our investment policies and objectives, as our board of
directors may adopt from time to time. Berkshire Advisor will be authorized to
follow these investment guidelines in determining the types of assets it decides
to recommend to our board of directors as proper investments for us. In
addition, Berkshire Advisor, based on its investment committee's
recommendations, may make investments in multi-family residential properties on
our behalf within the board approved guidelines without the approval of our
board of directors. Berkshire Advisor will receive the acquisition and asset
management fees summarized below under "Compensation to our Affiliates" and
described under "Management--Summary of Advisory Services Agreement" as
compensation for its services under the advisory services agreement. The initial
term of the advisory services agreement is two years and will be automatically
extended for subsequent one-year periods unless notice of termination or
non-renewal is provided by either party.
The individuals on the investment committee of Berkshire Advisor are Frank
Apeseche, Peter Donovan, George Krupp and David Quade. They will be responsible
for making investment decisions for us which, except for decisions regarding
investments in multi-family residential properties within board approved
guidelines, must be approved by our board of directors. See
"Management--Berkshire Advisor" and "--Executive Officers and Directors" for
biographical information relating to these investment committee members and the
members of our board of directors.
6
Our board of directors will have established an audit committee, consisting
exclusively of independent directors, whose approval will be required with
respect to all transactions involving us, on the one hand, and Berkshire Advisor
and its affiliates, on the other hand, such as the acquisition of additional
properties from The Berkshire Group or any of its affiliates. Unless modified by
our board, we will follow the policies on investments and borrowings described
under "Policies with respect to Certain Activities."
BRI OP Limited Partnership currently acts as property manager with respect
to the initial properties and, upon the completion of the offers, will continue
to do so under its existing property management agreements. The parent of the
property manager is owned by The Berkshire Group in joint venture with
unaffiliated third parties.
Under the existing property management agreements, the property manager is
obligated to perform property management services, including those relating to
rental and maintenance. The property management agreements may be terminated at
any time by either party upon notice. The property manager receives management
fees of 5% of the gross rental receipts for its services under these existing
property management agreements. See "Management--Summary of Property Management
Agreements."
FORMATION TRANSACTIONS
Our corporate structure is as follows. We are a Maryland corporation. All of
our common stock is owned by KRF Company. Until we issue the Preferred Shares at
the completion of the offers, we will have no other outstanding securities. We
intend to own all of our operating assets through our operating partnership,
Berkshire Income Realty-OP, L.P., a Delaware limited partnership. Our wholly
owned subsidiary, BIR GP, L.L.C., is the general partner of our operating
partnership, and we are the special limited partner of our operating
partnership. Through our ownership of the general partner, we effectively
control the operating partnership and its assets.
At the completion of the offers, the following will occur:
- we will issue Preferred Shares to holders who have validly tendered and
not withdrawn their Interests to us in the offers,
- we will transfer those Interests to our operating partnership in exchange
for preferred limited partner interests in the operating partnership,
having the same economic terms as the Preferred Shares (which we refer to
as the preferred OP units). The preferred OP units will have the same
relative ranking with respect to common limited partner interests as the
Preferred Shares will have with respect to our common stock. The preferred
OP units to be issued to us in exchange for Interests will equal the
number of Preferred Shares being issued by us,
- KRF Company will contribute its interests in the initial properties to our
operating partnership in exchange for common limited partner interests in
the operating partnership, having the same economic terms as our common
stock (which we refer to as the common OP units). The common OP units will
have the same relative ranking with respect to the preferred OP units as
our common stock will have with respect to the Preferred Shares, and
- KRF Company will make a capital contribution to us, in exchange for our
common stock, in an amount equal to 1% of the fair value of the total net
assets of our operating partnership, taking into account any cash
contributed to us by KRF Company prior to the completion of the offers. We
will contribute this amount to BIR GP, which in turn will contribute this
amount to our operating partnership in exchange for general partner
interests in our operating partnership (which we refer to as general
partner OP units).
SUMMARY OF THE OFFERS
We are offering, upon the terms and subject to the conditions described in
this prospectus and the related letter of transmittal, to exchange our Preferred
Shares for Interests that are validly tendered on or before the expiration date
and not properly withdrawn.
The term "expiration date" means 12:00 midnight, New York City time, on
, , 2002, unless we extend the period of time during
which an offer is open, in which case the term "expiration date" means the
latest time and date on which the offer, as so extended, expires.
7
CONDITIONS TO EACH OFFER
Our obligation to exchange our Preferred Shares for Interests in each offer
requires that several conditions be met first, including the conditions that:
- there must be validly tendered in the offers and not properly withdrawn
Interests resulting in an aggregate of at least 1,000,000 Preferred Shares
being issued in exchange for Interests in all the offers (we refer to this
as the minimum tender condition),
- the fairness and tax opinions described in this prospectus shall not have
been withdrawn,
- with respect to the offers for GIT and GIT II only, the waiver referred to
under "Certain Relationships and Related Transactions--GIT Funds Ownership
Limit Waiver" shall not have been withdrawn,
- there shall not have been a decline in any of the Dow Jones Industrial
Average, the Standard & Poors Index of 500 Industrial Companies or the
NASDAQ Composite Index in excess of 15% measured from the close of
business on the date of this prospectus,
- there shall not have been a material adverse effect on our business,
condition, operations or prospects,
- there shall not have been any material change in the business, condition,
operations or prospects of any of the mortgage funds or the initial
properties, and
- with respect to the offer for KIP II Interests only, there shall not have
been any distributions by KIP II consisting of proceeds in liquidation of
the KIP II Interests.
These are only some of the conditions to the offers. For a complete list of
conditions, see "The Offers--Conditions to the Offers." Except as described in
"The Offers--Conditions to the Offers," any of the conditions to the offers may
be waived by us, in whole or in part, in our sole discretion.
NUMBER OF PREFERRED SHARES TO BE EXCHANGED
The following table shows, with respect to each mortgage fund, the number of
Preferred Shares to be issued in exchange for an Interest in a mortgage fund:
PREFERRED SHARES
TO BE EXCHANGED
PER INTEREST
----------------
GIT.................................................... share
GIT II................................................. share
KIM.................................................... share
KIP.................................................... share
KIP II................................................. share
KIP III................................................ share
See "The Offers--Exchange Ratio."
FAIRNESS OPINION
Our financial advisor, Sutter Securities Incorporated, has delivered its
opinion to us, dated , 2002, that, as of such date, the
consideration being offered to holders of Interests is fair, from a financial
point of view, to holders of Interests who elect to tender their Interests for
Preferred Shares. A copy of this opinion is attached to this prospectus as
Appendix A. See "The Offers--Fairness Opinion." Sutter Securities makes no
recommendation as to whether or not investors should tender their Interests in
the offers.
TIMING OF THE OFFERS
Our offers are currently scheduled to expire at 12:00 midnight, New York
City time, on , , 2002. However, we may decide to extend an offer
from time to time if any conditions to the offer have not been satisfied or
waived before this time or if the aggregate number of Interests we are seeking
to exchange for Preferred Shares has not been validly tendered before this time.
See "The Offers--Extension, Termination and Amendment."
8
EXTENSION, TERMINATION AND AMENDMENT
We reserve the right to extend the period of time during which an offer
remains open if any condition to the offer has not been satisfied or if the
aggregate amount of Interests we are seeking to exchange for Preferred Shares
have not been validly tendered to us by the expiration date.
We also reserve the right to waive any of the conditions to an offer and to
make any change in the terms of or conditions to an offer, if allowed under the
SEC's applicable rules and regulations.
We will follow any extension, termination, amendment or delay, as promptly
as practicable, with a public announcement. Any announcement of an extension
will be issued no later than 9:00 a.m., New York City time, on the next business
day after the previously scheduled expiration date. Subject to applicable law,
including Rules 14d-4(d), 14d-6(c) and 14e-1 under the Securities Exchange Act
of 1934, which we refer to as the Exchange Act, which require that any material
change in the information published, sent or given to the holders of Interests
in connection with an offer be promptly sent to the holders in a manner
reasonably designed to inform them of such change, and, without limiting the
manner in which we may choose to make any public announcement, we assume no
obligation to publish, advertise or otherwise communicate any such public
announcement other than by making a release to the Dow Jones News Service or the
PR Newswire Association, Inc. During any such extension of an offer, all
Interests previously tendered and not properly withdrawn will remain subject to
the offer, unless properly withdrawn by you.
We are seeking to accept Interests up to an amount such that the total
number of Preferred Shares to be issued by us in the offers will equal, but not
exceed, 2,563,147 shares. If this amount has not been tendered to us by the
expiration date, we currently intend to extend the expiration date of the
offers, although we reserve our right not to do so. However, based on the number
of Interests of each mortgage fund that has been tendered to us, we will also
likely amend each offer either to increase or decrease the aggregate number of
Interests we are seeking in that offer in order to meet our goal of issuing a
total of 2,563,147 Preferred Shares. See "The Offers--Extension, Termination and
Amendment."
EXCHANGE OF INTERESTS
Upon the terms and conditions of our offers, including, if an offer is
extended or amended, the terms and conditions of any extension or amendment, we
will accept for exchange, and will exchange, up to the specified number of
Interests described under "The Offers--Exchange of Interests" that are validly
tendered and not properly withdrawn as promptly as practicable after the
expiration date. However, our proration procedures may apply, in which case we
may not accept for exchange all of your Interests that have been validly
tendered. Our proration procedures are described under "The Offers--Proration
Procedures."
CASH INSTEAD OF FRACTIONAL SHARES
We will not issue fractional Preferred Shares. Instead, each tendering
holder who would otherwise be entitled to receive fractional Preferred Shares in
exchange for Interests will receive cash in an amount equal to that fraction
multiplied by $25.00.
EFFECT OF CASH DISTRIBUTIONS ON INTERESTS
One or more of the mortgage funds are expected to make one or more cash
distributions before the completion of the offers. Until we have accepted your
Interests at the completion of the offers, you will continue to be entitled to
receive any cash distributions on your Interests that have been tendered to us.
Note, however, that with respect to KIP II, our offer is subject to the
condition that there may not have been any distributions by KIP II consisting of
proceeds in liquidation of the KIP II Interests.
WITHDRAWAL RIGHTS
Interests tendered in an offer may be withdrawn at any time before the
expiration date of the offer, and, unless we have previously accepted and issued
Preferred Shares in exchange for them in the offer, may also be withdrawn at any
time after , 2003. Once we have accepted Interests for exchange in an
offer, all tenders not previously withdrawn become irrevocable. See "The
Offers--Withdrawal Rights."
9
PROCEDURE FOR TENDERING INTERESTS
For you to validly tender Interests in an offer, you must, before the
expiration of the offer, deliver to us a properly completed and duly executed
letter of transmittal, or a manually signed facsimile of that document, and any
other required documents. See "The Offers--Procedure for Tendering."
PRORATION PROCEDURES
With respect to each offer, we are seeking to exchange Preferred Shares for
up to the specified number of Interests described under "The Offers--Exchange of
Interests," which represents approximately 26% of the Interests of each of the
mortgage funds. We refer to this 26% ceiling as the tender ceiling. If the
number of Interests of a mortgage fund validly tendered and not properly
withdrawn in an offer is greater than the tender ceiling applicable to that
mortgage fund, our proration procedures will apply. In that event, we will, upon
the terms and conditions of the offer, accept Interests of that mortgage fund on
a pro rata basis, with adjustments to avoid purchases of fractional Interests,
based on the number of Interests of that mortgage fund validly tendered and not
properly withdrawn prior to the expiration date. Because of the time required to
determine the precise number of Interests validly tendered and not properly
withdrawn, if proration is required, we do not expect to announce the final
results of proration until approximately three business days after the
expiration date. Preliminary results of proration will be announced by press
release as promptly as practicable after the expiration date.
TERMS OF PREFERRED SHARES
The following is a summary of the principal terms of the Preferred Shares.
For a more complete description, see "Description of the Preferred Shares."
ISSUER......................... Berkshire Income Realty, Inc., a Maryland corporation.
SECURITIES OFFERED............. % Series A Cumulative Redeemable Preferred Stock.
USE OF PROCEEDS................ The Preferred Shares are being issued by us in exchange for
Interests. We will not receive any cash proceeds from this
offering. To the extent we receive distributions from these
Interests that consist of mortgage loan repayments, we
intend to use them, together with cash from other sources,
primarily for the purpose of acquiring additional
multi-family residential properties. We intend to use other
distributions from these Interests for general corporate
purposes. We also plan to use the Interests as collateral
for a credit facility to be entered into primarily for the
purpose of funding additional residential property
acquisitions. No agreements or commitments have been
obtained from any lender for such a facility at this time.
DISTRIBUTIONS.................. Distributions on the Preferred Shares will accrue from their
date of issuance and will be payable at an annual rate of %
of the liquidation preference of $25.00 per share.
Distributions will be payable quarterly in arrears on
February 15, May 15, August 15 and November 15 of each
year. See "Description of the Preferred
Shares--Distributions."
LIQUIDATION PREFERENCE......... Upon our dissolution, liquidation, winding-up or
termination, holders of Preferred Shares will be entitled to
receive, after payment or provision for payment of our debts
and other liabilities and subject to the rights of holders
(if any) of other series of preferred stock ranking senior
to or on a parity with the Preferred Shares, $25.00 per
share plus accumulated and unpaid distributions on the
Preferred Shares. See "Description of the Preferred
Shares--Liquidation."
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OPTIONAL REDEMPTION............ Except as described below, the Preferred Shares are not
redeemable before February 15, 2010. On or after
February 15, 2010, the Preferred Shares may be redeemed at
our option, in whole or from time to time in part, at a
redemption price of $25.00 per share plus accumulated and
unpaid distributions, if any, to the redemption date. The
Preferred Shares may also be redeemed in whole but not in
part at any time upon the occurrence and continuance of a
"tax event" or "Investment Company Act event." See
"Description of the Preferred Shares--Redemption."
NO CONVERSION RIGHTS; NO
SINKING FUND................... The Preferred Shares will not be subject to any sinking fund
and, except as described under "Description of the Preferred
Shares--Restrictions on Ownership and Transfer of Preferred
Shares," the Preferred Shares will not be convertible into
any of our securities.
VOTING RIGHTS.................. Holders of Preferred Shares will have the right as a class
to elect two directors if distributions are not paid for six
consecutive quarterly periods. The consent of holders of
66 2/3% of the Preferred Shares is required for changes to
our charter that would materially and adversely affect the
preferences, rights, voting powers, restrictions,
limitations as to distributions, qualifications and terms
and conditions of redemption of the Preferred Shares, or the
authorization, creation or increase in the number of
authorized shares of any series of stock that would rank
senior to the Preferred Shares. See "Description of the
Preferred Shares--Voting Rights."
RANKING........................ The Preferred Shares will, with respect to distributions and
rights upon our liquidation, dissolution, winding-up or
termination, rank senior to our common stock. With respect
to any other series of our preferred stock that may
hereafter be issued by us, the Preferred Shares will rank
(1) senior to any such preferred stock whose terms
specifically provide that it ranks junior to the Preferred
Shares, (2) on a parity with any such preferred stock,
unless the terms of such preferred stock specifically
provide that it ranks junior or senior to the Preferred
Shares and (3) junior to any such preferred stock whose
terms specifically provide that it ranks senior to the
Preferred Shares. As described above under "Voting Rights,"
we may not issue preferred stock that ranks senior to the
Preferred Shares without the consent of the holders of
66 2/3% of the Preferred Shares. See "Description of the
Preferred Shares--Ranking."
PROPOSED AMERICAN STOCK
EXCHANGE SYMBOL................ "BIR"
SIGNIFICANT DIFFERENCES BETWEEN PREFERRED SHARES AND INTERESTS
The Preferred Shares have a stated annual distribution rate of %. Although
not guaranteed, this means holders will be entitled to receive quarterly cash
distributions in the amount of $ per share ($ annualized), provided our
board of directors has authorized their payment out of legally available funds.
The Interests do not have a stated distribution rate.
The Preferred Shares will be listed on the American Stock Exchange, which
will provide greater liquidity than the Interests in the mortgage funds, for
which there is no established trading market.
While holders of Interests in a mortgage fund are entitled to participate in
any net assets of that fund available for distribution upon liquidation, holders
of Preferred Shares will only be entitled to receive their initial investment of
$25.00 per share plus accumulated and unpaid distributions upon our liquidation.
Holders of Preferred Shares will have more limited voting rights than
holders of Interests. Holders of Interests have the right to elect and remove
the trustees or general partners of the applicable mortgage fund, while, in
general, holders of Preferred Shares will have no right to elect or remove our
directors. However, if we fail to make distributions in full with respect to the
Preferred Shares for six consecutive quarters, holders of Preferred Shares will
be entitled to elect two special directors to serve on the board of directors
until all accumulated dividends have been paid or declared and will have the
right to remove any special director without
11
cause. Amendments to the organizational documents of the mortgage funds
generally require the approval of the holders of Interests, while holders of
Preferred Shares will have the right to approve only those amendments that would
have a material and adverse effect on the preferences, rights and privileges of
the Preferred Shares or any amendments authorizing or creating, or increasing
the authorized amount of, any series of stock that would rank senior to the
Preferred Shares.
We may redeem the Preferred Shares at any time after February 15, 2010 at a
redemption price of $25.00 per share plus accumulated and unpaid dividends. The
Interests in the mortgage funds do not have a similar redemption feature, though
GIT and GIT II may redeem Interests in excess of the applicable ownership
percentage limit.
The Preferred Shares do not have a stated maturity, as we are a corporation
having a perpetual life, and so you will be able to liquidate your investment in
the Preferred Shares only by selling your Preferred Shares in the public market
at prevailing market prices or upon the exercise of our redemption option. In
contrast, each of the mortgage funds is a finite entity that will dissolve as of
a fixed date, the earliest being December 31, 2025, unless earlier dissolved.
An investment in the Preferred Shares will be subject to the risks
highlighted above in this summary and in the prospectus under "Risk Factors."
For more information regarding the differences between the terms of the
Preferred Shares and the terms of the Interests, see "Comparison of the Rights
of Holders of Preferred Shares and the Rights of Holders of Interests."
The following is a chart comparing the fees and other compensation payable
to Berkshire Advisor and other affiliates of The Berkshire Group in connection
with the offers, with the fees and other compensation payable to affiliates of
The Berkshire Group by the mortgage funds. For more information regarding the
compensation payable to Berkshire Advisor and its affiliates, see "Compensation
Payable to Our Affiliates."
12
COMPENSATION PAYABLE COMPENSATION PAYABLE COMPENSATION PAYABLE
TO BERKSHIRE ADVISOR AND ITS AFFILIATES TO THE GENERAL PARTNERS OF KIM, KIP, KIP II TO THE ADVISOR OF GIT AND GIT II
IN CONNECTION WITH OFFERS AND KIP III AND THEIR AFFILIATES AND ITS AFFILIATES
--------------------------------------- ------------------------------------------- --------------------------------
ACQUISITIONS
ACQUISITION FEE: After all ACQUISITION FEE: One-time fee was paid ACQUISITION FEE: One-time fee
distributions then due on the Preferred equal to 2.9% of the gross proceeds of the was paid equal to 2.5% of the
Shares have been paid in full, a offering. gross proceeds of the offering.
transactional fee equal to 1% of the ACQUISITION EXPENSES: Expenses were ACQUISITION EXPENSES: Expenses
purchase price of any new property reimbursed on an accountable basis up to an were reimbursed on an
acquired directly or indirectly by us. amount equal to 0.5% of the gross proceeds accountable basis up to an
ACQUISITION EXPENSES: After all of the offering (1.0% for KIP), and amount equal to 0.5% of the
distributions then due on the Preferred reimbursed for non-accountable expenses up gross proceeds of the offering,
Shares have been paid in full, all to an amount equal to 1.5% (1.0% for KIP) and reimbursed for
acquisition expenses will be reimbursed of the gross proceeds of the offering. non-accountable expenses up to
at cost. PARTICIPATION SERVICING FEE: One-time fee an amount equal to 1.5% of the
was paid equal to 1.6% of the gross gross proceeds of the offering.
proceeds of the offering for the servicing PARTICIPATION SERVICING FEE:
of the participation features of the One-time fee was paid equal to
partnership's PIM and PIMI investments. 1.5% of the gross proceeds of
the offering for the servicing
of the participation features of
the trust's PIM and PIMI
investments.
OPERATIONS
ASSET MANAGEMENT FEES: After all ASSET MANAGEMENT FEES: 0.75% per annum of ASSET MANAGEMENT FEES: Beginning
distributions then due on the Preferred the value of the total invested assets of in the second year, 0.75% per
Shares have been paid in full, an the partnership, payable quarterly. annum of the value of the
annual fee equal to 0.40% of the SUBORDINATED INCENTIVE MANAGEMENT FEE:After average invested assets of the
purchase price of real estate investors have received a return of capital partnership, payable quarterly.
properties, as adjusted from time to and their cumulative return on invested OPERATING EXPENSES:
time to reflect the then current fair capital, an incentive fee equal to 0.3% per Reimbursement of certain
market value of the properties. annum of the partnership's total invested operating expenses at the lesser
OPERATING EXPENSES: After all assets. of (1) actual cost or (2), with
distributions then due on the Preferred OPERATING EXPENSES: Reimbursement of respect to costs for certain
Shares have been paid in full, certain operating expenses at the lesser of administrative services, the
reimbursement of certain operating (1) actual cost or (2), with respect to amount the trust would be
expenses at cost. costs for certain administrative services, required to pay to unaffiliated
PROPERTY MANAGEMENT FEES: 5% of the 90% of the amount the partnership would be parties, all reimbursements and
gross rental receipts with respect to required to pay to unaffiliated parties. other expenses of the trust not
the initial properties. DISTRIBUTIONS OF DISTRIBUTABLE CASH FLOW to exceed, in any fiscal year,
DISTRIBUTIONS: KRF Company, an AND NET CASH PROCEEDS OF CAPITAL the greater of (1) 2% of the
affiliate of Berkshire Advisor and the TRANSACTIONS OTHER THAN TERMINATING CAPITAL average invested assets of the
owner of all of our common stock, will TRANSACTIONS: The general partner receives trust and (2) 25% of the net
be entitled to receive distributions on 3% of the partnership's annual income of the trust.
our common stock, subject to the distributable cash flow, and net cash PROPERTY MANAGEMENT FEES: On
preferential rights to distributions on proceeds of capital transactions are terms customary for comparable
the Preferred Shares. distributed as follows--(1) after the properties in the locality, not
The advisor of GIT and GIT II will be investors have received the return of their to exceed 5% of the gross
entitled to receive distributions on invested capital, the general partner will receipts of the property.
the Preferred Shares it will receive in receive the return of its invested capital, DISTRIBUTIONS: The advisor of
exchange for the 10,000 Interests in (2) net cash proceeds distributed 99% to GIT and GIT II, as the holder of
GIT and 10,000 Interests in GIT II that 10,000 Interests in GIT and
the GIT advisor intends to tender in 10,000 Interests in GIT II, is
the offers. entitled to receive its pro rata
share of distributions on the
Interests of each trust.
13
COMPENSATION PAYABLE COMPENSATION PAYABLE COMPENSATION PAYABLE
TO BERKSHIRE ADVISOR AND ITS AFFILIATES TO THE GENERAL PARTNERS OF KIM, KIP, KIP II TO THE ADVISOR OF GIT AND GIT II
IN CONNECTION WITH OFFERS AND KIP III AND THEIR AFFILIATES AND ITS AFFILIATES
--------------------------------------- ------------------------------------------- --------------------------------
investors and 1% to the general partner
until the investors have received their
cumulative return on invested capital per
annum, (3) net cash proceeds until the
general partner has received 4% of net cash
proceeds and (4) thereafter, 96% to the
investors and 4% to the general partner.
LIQUIDATION
DISTRIBUTIONS ON LIQUIDATION: KRF DISTRIBUTIONS OF NET CASH PROCEEDS FROM DISTRIBUTIONS ON LIQUIDATION:
Company, an affiliate of Berkshire TERMINATING CAPITAL TRANSACTIONS: Net cash The advisor of GIT and GIT II,
Advisor and the owner of all of our proceeds from a terminating capital as the holder of 10,000
common stock, will be entitled to transaction to be distributed in the same Interests in GIT and 10,000
receive all liquidation proceeds, manner as distributions of net cash Interests in GIT II, is entitled
subject to the preferential rights of proceeds from capital transactions to receive its pro rata share of
holders of Preferred Shares to receive described above, except that the general any liquidation proceeds on the
their liquidation amount plus accrued partner and the investors first will Interests of each trust.
and unpaid distributions. receive an amount equal to the positive SUBORDINATED INCENTIVE FEE ON
The advisor of GIT and GIT II, as the balance, if any, of their capital accounts. DISPOSITION OF MORTGAGES: After
holder of Preferred Shares to be holders of Interests have
received in exchange for its 10,000 received a return of capital and
Interests of GIT and 10,000 Interests their cumulative return on
of GIT II, will be entitled to receive invested capital, an incentive
the liquidation preference plus accrued fee equal to 4% of the cash from
and unpaid distributions payable on the the disposition of the trust's
Preferred Shares. mortgage investments.
OUR REIT TAX STATUS
We will elect to be taxed as a REIT under the Internal Revenue Code of 1986
(which we refer to as the Code), beginning with the taxable year during which
the offers are consummated, and we intend to operate so as to qualify as a REIT.
If we qualify for taxation as a REIT, then under current federal income tax laws
we generally will not be subject to federal corporate income tax on our net
income that is currently distributed to holders of our stock. REITs are subject
to numerous organizational and operational requirements under the Code,
including a requirement that they distribute at least 90% of their taxable
income to their stockholders. If we fail to qualify for taxation as a REIT for
any year, our income will be taxed at regular corporate rates, we will not be
allowed a deduction for distributions to our stockholders in computing our
taxable income and we may be prevented from qualifying as a REIT for the
four-year period following the year of our failure to qualify. Even if we
qualify for federal income taxation as a REIT, we may still be subject to state
and local taxes on our income and property and to federal income and excise
taxes on our undistributed income. See "Federal Income Tax Considerations."
CONFLICTS OF INTEREST
Due to relationships among us and affiliates of The Berkshire Group,
including Berkshire Advisor, KRF Company and the mortgage funds, the offers and
the operation of our business will involve conflicts of interest. The Berkshire
Group and its affiliates, including our executive officers and some of our
directors, and the executive officers and directors of Berkshire Advisor and
other affiliates of The Berkshire Group are engaged in a wide range of real
estate activities, including activities with investment objectives and policies
which are, in some respects, similar to ours. Conflicts of interest that may
arise include, but are not limited to:
- Conflicts relating to competition for investment opportunities. By this we
mean that Berkshire Advisor and its affiliates are engaged and may in the
future engage in business activities that may compete with us.
14
- Competition for management services. By this we mean that Berkshire
Advisor and our property manager will have conflicts of interest in the
allocation of management and staff time, services and functions among us
and other investment entities in existence or which may be organized in
the future.
- Conflicts relating to management compensation. By this we mean that
agreements between us and Berkshire Advisor, and us and the property
manager, were not the result of arm's-length negotiations.
- Conflicts relating to the offers. By this we mean that the offer
consideration was determined without any arm's-length negotiations and may
not reflect the fair market value of the Interests.
- Conflicts relating to control by KRF Company. By this we mean that because
of KRF Company's exclusive ability to benefit from the net appreciation of
our assets, the substantial influence by KRF Company over our affairs
might not be consistent with the interests of the holders of the Preferred
Shares.
COMPENSATION TO OUR AFFILIATES
Berkshire Advisor and other affiliates of The Berkshire Group will receive
fees and compensation from us in connection with the acquisition and management
of our assets. See "Compensation Payable to Our Affiliates." We are not
permitted to pay fees or expense reimbursements to Berkshire Advisor until all
distributions then due have been paid on the Preferred Shares.
The following table summarizes the types of compensation, fees, profits or
distributions that have been, may or will be received by Berkshire Advisor and
other affiliates of The Berkshire Group in connection with the offers, our
operation, and the management of our properties and other investments.
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION AMOUNT OF COMPENSATION
-------------------------------- -------------------------------- --------------------------------
Berkshire Advisor (our advisor) - Acquisition fees. Transactional fee equal to 1% of
the purchase price of any new
property acquired by us.
- Asset management fees. Annual fee equal to 0.40% of the
purchase price of real estate
properties, as adjusted from
time to time to reflect the then
current fair market value of the
properties.
-Reimbursement of expenses All expenses reimbursed at cost.
incurred in connection with
managing our assets.
-Indemnification against Full indemnification to the
liabilities and related expenses extent permitted under Maryland
incurred in connection with law.
duties as advisor.
BRI OP (our property manager) - Property management fees. Monthly fee equal to 5% of gross
rental receipts.
-Reimbursement of expenses All expenses reimbursed at cost.
incurred in connection with the
management of our properties.
-Indemnification against Full indemnification unless
liabilities and related expenses liability occurred as a result
incurred in connection with of BRI OP's gross negligence or
duties as property manager. willful malfeasance.
KRF Company (the owner of our -Distributions and liquidation All distributions and
common stock and common OP proceeds on our common stock. liquidation proceeds to holders
units) of common stock, subject to the
preferential rights of holders
of Preferred Shares to receive
distributions or the liquidation
amount of $25 per share plus
accrued and unpaid
distributions.
15
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION AMOUNT OF COMPENSATION
-------------------------------- -------------------------------- --------------------------------
-Distributions and liquidation All distributions to holders of
proceeds on common OP units of common OP units, subject to our
operating partnership. preferential rights, as holder
of preferred OP units, to
receive distributions or
liquidation proceeds up to the
amount required to pay
distributions or liquidation
proceeds to the holders of
Preferred Shares.
Berkshire Mortgage Advisors -Distributions on and Pro rata share of distributions
Limited Partnership (the advisor liquidation preference with to holders of Preferred Shares
to GIT and GIT II) respect to its Preferred on the Preferred Shares it will
Shares. receive in exchange for the
10,000 Interests in GIT and
10,000 Interests in GIT II it
intends to tender in the offers,
and the liquidation preference
of $25 per share plus accrued
and unpaid distributions payable
on its Preferred Shares.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The receipt of Preferred Shares and any cash instead of fractional Preferred
Shares in exchange for Interests generally will be a taxable transaction for
United States federal income tax purposes and may also be a taxable transaction
under applicable state, local and foreign tax laws. Consequently, if you tender
your Interests in the offer, you may be required to pay income tax on any gain
you realize on the exchange. See "Federal Income Tax Considerations--United
States Federal Income Tax Considerations Applicable to the Exchange of Preferred
Shares for Interests."
Distributions that you receive on the Preferred Shares generally will be
taxable to you as ordinary dividend income to the extent they are from current
or accumulated earnings and profits. Amounts distributed to you in excess of our
earnings and profits will reduce the tax basis of your Preferred Shares. Amounts
distributed to you in excess of tax basis will be taxable as an amount realized
from the sale of your Preferred Shares. See "Federal Income Tax Considerations."
The federal income tax consequences described above may not apply to all
holders of Interests or Preferred Shares. Your tax consequences, including any
state, local and non-United States tax consequences, will depend on your own
situation. You should consult your tax advisor to determine the particular tax
consequences of the offers to you.
16
RISK FACTORS
You should carefully consider the following information, together with the
other information contained in this prospectus, before accepting the offers. In
connection with the forward-looking statements that appear in this prospectus,
you should also carefully review the cautionary statement referred to under
"Cautionary Statement Regarding Forward-Looking Statements."
RISK FACTORS RELATING TO OUR COMPANY
WE ARE A NEWLY FORMED COMPANY WITH NO OPERATING HISTORY UPON WHICH TO EVALUATE
OUR LIKELY PERFORMANCE.
Although key personnel of Berkshire Advisor have had extensive experience
making real estate investments, we and Berkshire Advisor are newly formed
entities with no operating history upon which to evaluate our likely
performance. We cannot assure you that we will be able to implement our business
plan successfully.
OUR BUSINESS PLAN DIFFERS SIGNIFICANTLY FROM THE BUSINESS PLANS OF THE MORTGAGE
FUNDS, INVOLVING DIFFERENT AND POTENTIALLY GREATER RISKS.
Our business plan is different from that of the mortgage funds. An
investment in the Preferred Shares may entail different and potentially greater
risks than an investment in the mortgage funds. Specifically, we intend to
invest primarily in multi-family residential properties. See "Policies With
Respect to Certain Activities--Investment Policies." In contrast, the mortgage
funds were formed to invest primarily in guaranteed or insured mortgage loans or
mortgage-backed securities. As the portfolio of mortgage loans and
mortgage-backed securities represented by the Interests held by us is reduced
and proceeds from the Interests are invested in real property, the risks
associated with ownership of real estate, as described below, will increase
proportionately.
MAINTENANCE OF OUR INVESTMENT COMPANY ACT EXEMPTION IMPOSES LIMITS ON OUR
OPERATIONS.
We intend to conduct our operations so as not to be required to register as
an investment company under the Investment Company Act of 1940. We believe that
there are exemptions under the Investment Company Act that are applicable to us.
The assets that we may acquire are limited by the provisions of the Investment
Company Act and the exemption on which we rely. In addition, we could, among
other things, be required either to change the manner in which we conduct our
operations to avoid being required to register as an investment company, or to
register as an investment company. Either of these could have an adverse effect
on us and the market price for the Preferred Shares. For example, one exception
from the definition of an "investment company" we believe we could rely on would
require us to manage our assets such that no more than 40% of our total assets
(exclusive of government securities and cash) are invested in "investment
securities." Generally speaking, "investment securities" are all securities
except securities issued by majority-owned operating company subsidiaries and
government securities. To be able to continue to rely on this exception in the
event the value of our investment securities were to increase relative to our
total assets, we may need to sell certain investment securities that we
otherwise would not want to sell. On the other hand, we may be required to hold
other non-investment security assets, such as some of our real property assets,
that we may otherwise want to sell in order to avoid increasing the value of our
investment securities relative to our total assets.
WE ARE DEPENDENT ON CASH DISTRIBUTIONS FROM OUR OPERATING PARTNERSHIP FOR OUR
ABILITY TO MAKE DISTRIBUTIONS ON THE PREFERRED SHARES.
We will own all of our operating assets through our operating partnership.
At the completion of the offers, the Interests tendered to us in the offers will
be contributed by us to our operating partnership in exchange for preferred OP
units in the operating partnership having the same economic terms as the
Preferred Shares. Our assets will consist primarily of the preferred OP units.
Accordingly, our ability to make distributions and other payments on the
Preferred Shares is dependent upon the operating partnership making
distributions and other payments on the preferred OP units. If the operating
partnership does not make distributions or other payments on the preferred OP
units for any reason, we will likely be unable to make payments on the Preferred
Shares. Because we control our operating partnership, it is highly unlikely that
the operating partnership will not make distributions or other payments on the
preferred OP units if it has the means to do so.
17
CERTAIN FEDERAL INCOME TAX RISKS
OUR FAILURE TO QUALIFY AS A REIT WOULD RESULT IN HIGHER TAXES AND REDUCED CASH
AVAILABLE FOR DISTRIBUTION TO OUR STOCKHOLDERS.
We intend to operate in a manner that will allow us to qualify as a REIT for
federal income tax purposes. Although we believe that we will be organized and
will operate in this manner, no assurance can be given that we will be able to
operate so as to qualify as a REIT under the Code or to remain so qualified.
Qualification as a REIT involves the application of highly technical and complex
provisions of the Code for which there are only limited judicial or
administrative interpretations. The determination of various factual matters and
circumstances not entirely within our control may affect our ability to qualify
as a REIT. The complexity of these provisions and of the applicable income tax
regulations under the Code is greater in the case of a REIT that holds its
assets through a partnership, such as we will. Moreover, our qualification as a
REIT will depend upon the qualification of each of GIT and GIT II as REITs. In
addition, we cannot assure you that legislation, new regulations, administrative
interpretations or court decisions will not significantly change the tax laws
with respect to the qualification as a REIT or the federal income tax
consequences of this qualification. However, we are not aware of any proposal
currently being considered by Congress to amend the tax laws in a manner that
would materially and adversely affect our ability to operate as a REIT. See
"Federal Income Tax Considerations--United States Federal Income Tax
Considerations Applicable to Our Status as a REIT."
If for any taxable year we fail to qualify as a REIT, we would not be
allowed a deduction for distributions to our stockholders in computing our
taxable income and would be subject to federal income tax (including any
applicable alternative minimum tax) on our taxable income at regular corporate
rates. In addition, we would normally be disqualified from treatment as a REIT
for the four taxable years following the year of losing our REIT status. This
would likely result in significant increased costs to us. Any corporate tax
liability could be substantial and would reduce the amount of cash available for
distribution to our stockholders and for investment, which in turn could have an
adverse impact on the value of, and trading prices for, the Preferred Shares.
Our taxation as a corporation if we fail to qualify as a REIT would generally
permit us to redeem the Preferred Shares. See "Description of the Preferred
Shares--Redemption."
Although we intend to operate in a manner designed to qualify as a REIT,
future economic, market, legal, tax or other considerations may cause our board
of directors and the holders of our common stock to determine that it is in our
best interest to revoke our REIT election.
We believe that our operating partnership will be treated for federal income
tax purposes as a partnership and not as a corporation or an association taxable
as a corporation. If the Internal Revenue Service were successfully to determine
that our operating partnership were properly treated as a corporation, our
operating partnership would be required to pay federal income tax at corporate
rates on its net income, its partners would be treated as stockholders of the
operating partnership and distributions to partners would constitute dividends
that would not be deductible in computing the operating partnership's taxable
income. In addition, we would fail to qualify as a REIT, with the resulting
consequences described above. See "Federal Income Tax Considerations--United
States Federal Income Tax Considerations Applicable to our Status as a
REIT--Federal Income Tax Aspects of Our Operating Partnership and the Subsidiary
Entities--Classification as Partnerships."
REIT DISTRIBUTION REQUIREMENTS COULD ADVERSELY AFFECT OUR LIQUIDITY.
To obtain the favorable tax treatment for REITs qualifying under the Code,
we generally will be required each year to distribute to our stockholders at
least 90% of our real estate investment trust taxable income, determined without
regard to the deduction for dividends paid and by excluding net capital gains.
We will be subject to a 4% nondeductible excise tax on the amount, if any, by
which distributions paid by us with respect to any calendar year are less than
the sum of:
- 85% of our ordinary income for the calendar year;
- 95% of our capital gain net income for the calendar year, unless we elect
to retain and pay income tax on those gains; and
- 100% of our undistributed amounts from prior years.
Failure to comply with these requirements would result in our income being
subject to tax at regular corporate rates.
18
We intend to pay out our income to our stockholders in a manner intended to
satisfy the distribution requirement and to avoid corporate income tax and the
4% excise tax. Differences in timing between the recognition of income and the
related cash receipts or the effect of required debt amortization payments could
require us to borrow money or sell assets to pay out enough of our taxable
income to satisfy the distribution requirement and to avoid corporate income tax
and the 4% excise tax in a given year.
LEGISLATIVE OR REGULATORY ACTION COULD ADVERSELY AFFECT HOLDERS OF PREFERRED
SHARES.
In recent years, numerous legislative, judicial and administrative changes
have been made to the federal income tax laws applicable to investments in REITs
and similar entities. Additional changes to tax laws are likely to continue to
occur in the future, and we cannot assure you that any such changes will not
adversely affect the taxation of a stockholder. Any such changes could have an
adverse effect on your ownership of Preferred Shares. You are urged to consult
with your own tax advisor with respect to the status of legislative, regulatory
or administrative developments and proposals and their potential effect on your
ownership of Preferred Shares.
RISK FACTORS RELATING TO THE OFFERS AND THE OWNERSHIP OF THE PREFERRED SHARES
OUR OFFER CONSIDERATION MAY NOT REFLECT THE FAIR MARKET VALUE OF THE INTERESTS
AND WAS BASED ON VARIOUS ASSUMPTIONS WHICH MAY NOT BE REALIZED.
Our offer consideration was determined without any arm's-length
negotiations. As a result, it may not reflect the fair market value of the
Interests. In addition, in determining our offer consideration, we assigned
values to the Interests in each mortgage fund. Our assigned values were based on
various assumptions that we believe to be reasonable, however, we cannot tell
you that the amounts realized from a liquidation of the assets held by the
mortgage funds, if they were liquidated today, would not differ from our
estimates of value, and these differences could be material.
THE MARKET VALUE OF THE PREFERRED SHARES IS UNCERTAIN AND COULD DECREASE BASED
ON OUR PERFORMANCE AND MARKET PERCEPTIONS AND CONDITIONS.
The Preferred Shares are a new issue of securities for which there is
currently no active trading market. Although the Preferred Shares have been
approved for listing on the American Stock Exchange, subject to official notice
of issuance, we cannot assure you as to the development of any market, or the
liquidity of any market that may develop, for the Preferred Shares. The
Preferred Shares may trade at a discount, depending upon prevailing interest
rates, the market for similar securities and other factors, including general
economic conditions and our financial condition, performance and prospects.
In addition, because the Interests have been an illiquid investment since
their initial offerings, we believe that a large number of Preferred Shares may
be offered for sale after the offers are completed, which could create an
initial imbalance in the market for the Preferred Shares. Sales of substantial
amounts of Preferred Shares in the public market after the completion of the
offers, or the perception that these sales could occur, could adversely affect
the market price of the Preferred Shares. We cannot predict what effect, if any,
market sales of Preferred Shares will have on the market price of the Preferred
Shares. At the time trading commences, it is possible that the Preferred Shares
will trade below their liquidation preference of $25.00 per share, and that
discount could be significant.
Although as a general matter, preferred stock is not as volatile as common
stock, the stock market in general has recently experienced extreme price
fluctuations. Fluctuations in the trading price of the Preferred Shares may not
be correlated in a predictable way to our performance or operating results. The
trading price of the Preferred Shares will change as interest rates change and
from factors that are beyond our control.
HOLDERS OF PREFERRED SHARES WILL HAVE LIMITED VOTING RIGHTS, RESTRICTING THE
ABILITY OF THE HOLDERS OF PREFERRED SHARES TO INFLUENCE OUR MANAGEMENT AND
OPERATIONS.
Holders of Preferred Shares will have only the following voting rights.
Holders of Preferred Shares will have the right as a class to elect two
directors if distributions are not paid on the Preferred Shares for six
consecutive quarterly periods. The consent of holders of 66 2/3% of the
Preferred Shares is required for changes to our charter that would materially
and adversely affect the preferences, rights, voting powers, restrictions,
limitations as to distributions, qualifications and terms and conditions of
redemption of the Preferred Shares, or the creation of any
19
series of stock that would rank senior to the Preferred Shares as to
distributions or liquidation. Except with respect to the directors referred to
above, holders of Preferred Shares will not be able to elect or remove
directors, as these rights are vested exclusively in the holders of our common
stock. See "Description of the Preferred Shares--Voting Rights" and "Security
Ownership of Beneficial Owners and Management."
WE CAN ISSUE ADDITIONAL SECURITIES RANKING ON A PARITY WITH THE PREFERRED
SHARES, WHICH MAY DILUTE THE INTERESTS OF THE HOLDERS OF PREFERRED SHARES, AND
WE CAN DO THIS WITHOUT OBTAINING THE CONSENT OF THE HOLDERS.
No consent or approval by the holders of the Preferred Shares is required
for the authorization, creation of or increase in the number of authorized
shares of any series of our stock that would rank on a parity with the Preferred
Shares as to distributions or liquidation. The issuance of additional shares of
preferred stock that rank on a parity with the Preferred Shares as to
distributions or liquidation will dilute the interests of the holders of the
Preferred Shares because there will be more claims on our assets with respect to
distributions or liquidation proceeds. In the event we decide to issue a series
of preferred stock that would rank on a parity with the Preferred Shares as to
distributions or liquidation, we will, not later than 20 days prior to such
issuance, issue a press release announcing our intention to do so.
THE TERRORIST ATTACKS ON THE UNITED STATES HAVE NEGATIVELY IMPACTED THE U.S.
ECONOMY AND OTHER ATTACKS, THREATS OF TERRORISM AND THE ONGOING WAR AGAINST
TERRORISM MAY ADVERSELY AFFECT THE MARKETS ON WHICH THE PREFERRED SHARES WILL
TRADE, OUR OPERATIONS AND OUR PROFITABILITY.
The terrorist attacks of September 11, 2001 have disrupted the U.S.
financial markets and have negatively impacted the U.S. economy in general. Any
future terrorist attacks and the anticipation of any such attacks, or the
consequences of the military or other response by the U.S. and its allies, may
have a further adverse impact on the U.S. financial markets and economy. It is
not possible to predict the severity of the effect that any of these future
events would have on the U.S. financial markets and economy.
It is possible that the economic impact of the terrorist attacks may have an
adverse effect on the ability of real estate tenants of the initial properties
to pay rent. In addition, insurance on our real estate may be more costly and
coverage may be more limited because of these events. The instability of the
U.S. economy may also reduce the number of suitable investment opportunities
available to us and the pace at which those investments are made. In addition,
armed hostilities and further acts of terrorism may directly impact our real
estate and real estate collateral. These developments may subject us to
increased risks and, depending on their magnitude, could have a material adverse
effect on our business and your investment.
On May 6, 2002, the Federal Bureau of Investigation issued an alert
regarding potential terrorist threats involving apartment buildings.
Specifically, the FBI announced that there are indications that discussions were
held about the possibility of renting apartment units in various areas of the
United States and rigging them with explosives. The FBI advised that it has no
information indicating these plans had advanced beyond the discussion stage. The
information has been characterized as a non-specific, general threat to the
industry, with no details regarding location, timing or suspects. Threats of
future terrorist attacks, such as the one announced by the FBI on May 6, 2002,
could have a negative impact on rent and occupancy levels at our properties. The
impact that future terrorist activities or threats of these activities could
have on our business cannot presently be determined. If we incur a loss at a
property because of an act of terrorism, we could lose all or a portion of the
capital we have invested in the property, as well as the anticipated future
revenue from the property.
RISK FACTORS RELATING TO OUR BUSINESS
OPERATING RISKS AND LACK OF LIQUIDITY MAY ADVERSELY AFFECT OUR INVESTMENTS IN
REAL PROPERTY.
Varying degrees of risk affect real property investments. The investment
returns available from equity investments in real estate depend in large part on
the amount of income earned and capital appreciation generated by the related
properties as well as the expenses incurred. If the initial properties (together
with distributions payable on the Interests tendered to us in the offers) do not
generate revenue sufficient to meet operating expenses, including debt service
and capital expenditures, our income and ability to service our debt and other
obligations and to pay distributions on the Preferred Shares will be adversely
affected. Some significant expenditures associated with an investment in real
estate, such as mortgage and other debt payments, real estate taxes and
maintenance costs, generally are not reduced when circumstances cause a
reduction in revenue from the
20
investment. In addition, income from properties and real estate values are also
affected by a variety of other factors, such as interest rate levels,
governmental regulations and applicable laws and the availability of financing.
Equity real estate investments, such as the investments in the initial
properties and any additional properties that may be acquired by us, are
relatively illiquid. This illiquidity limits our ability to vary our portfolio
in response to changes in economic or other conditions. We cannot assure you
that we will recognize full value for any property that we are required to sell
for liquidity reasons. Our inability to respond rapidly to changes in the
performance of our investments could adversely affect our financial condition
and results of operations.
The initial properties are subject to all operating risks common to
apartment ownership in general. These risks include:
- our ability to rent units at the initial properties;
- competition from other apartment communities;
- excessive building of comparable properties that might adversely affect
apartment occupancy or rental rates;
- increases in operating costs due to inflation and other factors, which
increases may not necessarily be offset by increased rents;
- increased affordable housing requirements that might adversely affect
rental rates;
- inability or unwillingness of residents to pay rent increases; and
- future enactment of rent control laws or other laws regulating apartment
housing, including present and possible future laws relating to access by
disabled persons or the right to convert a property to other uses, such as
condominiums or cooperatives.
If operating expenses increase, the local rental market may limit the extent to
which rents may be increased to meet increased expenses without decreasing
occupancy rates. If any of the above occurred, our ability to meet our debt
service and other obligations and to pay distributions on the Preferred Shares
could be adversely affected.
WE MAY RENOVATE APARTMENT COMMUNITIES, WHICH WOULD INVOLVE ADDITIONAL OPERATING
RISKS.
We expect to be working on the renovation of apartment communities that may
be acquired in the future from third parties. We may also acquire completed
communities. The renovation of real estate involves risks in addition to those
involved in the ownership and operation of established apartment communities,
including the risks that specific project approvals may take longer to obtain
than expected, that construction may not be completed on schedule or budget and
that the properties may not achieve anticipated rent or occupancy levels.
WE MAY NOT BE ABLE TO PAY THE COSTS OF NECESSARY CAPITAL IMPROVEMENTS ON OUR
PROPERTIES, WHICH COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION.
We anticipate funding any required capital improvements on our properties
using cash flow from operations, cash reserves or additional financing if
necessary. However, the anticipated sources of funding may not be sufficient to
make the necessary improvements. If our cash flow from operations and cash
reserves prove to be insufficient, we might have to fund the capital
improvements by borrowing money. If we are unable to borrow money on favorable
terms, or at all, we may not be able to make necessary capital improvements,
which could harm our financial condition.
OUR TENANTS-IN-COMMON OR FUTURE JOINT VENTURE PARTNERS MAY HAVE INTERESTS OR
GOALS THAT CONFLICT WITH OURS, WHICH MAY RESTRICT OUR ABILITY TO MANAGE SOME OF
OUR INVESTMENTS AND ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
One or more of our properties that we acquire may be owned through
tenancies-in-common or by joint venture partnerships between us and the seller
of the property, an independent third party or another investment entity
sponsored by Berkshire Advisor or its affiliates. See "Business and
Properties--Initial Properties" and "Conflicts of Interest--Competition for
Investments." Our investment through tenancies-in-common or in joint venture
partnerships that own properties may, under certain circumstances, involve risks
that would not otherwise be present. For example, our tenant-in-common or joint
venture partner may experience financial difficulties and may at any time have
economic or business interests or goals that are inconsistent with our economic
or business interests or our policies or goals. In addition, actions by, or
litigation involving, any tenant-in-common or joint
21
venture partner might subject the property owned through a tenancy-in-common or
by the joint venture to liabilities in excess of those contemplated by the terms
of the tenant-in-common or joint venture agreement. Also, there is a risk of
impasse between the parties since generally either party may disagree with a
proposed transaction involving the property owned through a tenancy-in-common or
joint venture and impede any proposed action, including the sale or other
disposition of the property.
Our inability to dispose of a property we may acquire in the future without
the consent of a tenant-in-common or joint venture partner would increase the
risk that we would be unable to dispose of the property, or dispose of it
promptly, in response to economic or other conditions. The inability to respond
promptly to changes in performance of the property could adversely affect our
financial condition and results of operations.
To reduce the potential risks to us that may arise from any future
investment through tenancies-in-common or joint venture interests, Berkshire
Advisor will seek to negotiate agreements that contain provisions designed to
minimize these risks. However, there is no assurance that these provisions, if
included in a particular agreement, will in fact be sufficient to protect us
against the risks described above, particularly if a tenant-in-common or joint
venture partner fails to comply with its contractual obligations to us.
Two of our initial properties, Dorsey's Forge Apartments and Hannibal Grove
Apartments, are owned through tenancies-in-common, and one of our initial
properties, Century II Apartments, is owned through a joint venture with a third
party. Our interest in each of Dorsey's Forge Apartments and Hannibal Grove
Apartments is 91.382% and our interest in Century II Apartments in 75.82%. Our
tenancy-in-common agreement relating to Dorsey's Forge Apartments and Hannibal
Grove Apartments gives us sole control over the management, operation and
disposition of the properties, including the right to cause a sale of the
properties without the consent of our co-tenant. Under the agreement, our
co-tenant has no right to take part in the management or control of the
properties, except for the right to require us to use our good faith efforts to
sell the properties during a 180-day period beginning on April 27, 2005. See
"Business and Properties--Initial Properties." We believe that if our co-tenant
exercised this right, it would be willing to allow us to retain the properties
and instead accept a cash payment from us equal to what it would have received
in an arm's-length sale, if we decided to make that proposal to our co-tenant.
The tenancy-in-common agreement for Dorsey's Forge Apartments and Hannibal
Grove Apartments also gives us the right to determine whether additional capital
is needed for capital improvements or rehabilitation of the properties and to
call for such capital from the co-tenants on a pro rata basis. If our co-tenant
declines or is unable to make the additional capital contribution, then the
agreement allows us to contribute the unfunded amount and to increase our
tenancy-in-common interest to reflect our additional contribution.
The operating agreement with our joint venture partner relating to Century
II Apartments includes provisions similar to those of the tenancy-in-common
agreement for Dorsey's Forge Apartments and Hannibal Grove Apartments.
WE WILL FACE SIGNIFICANT COMPETITION AND WE MAY NOT COMPETE SUCCESSFULLY.
We will face significant competition in seeking investments. We will be
competing with several other companies, including other REITs, insurance
companies and other investors, such as investment funds and entities formed with
investment objectives similar to ours, including companies that may be
affiliated with Berkshire Advisor. Some of our competitors will have greater
financial and other resources than we will have and may have better
relationships with lenders and sellers, and we may not be able to compete
successfully for investments.
OUR DISTRIBUTION REQUIREMENTS MAY AFFECT OUR ABILITY TO ACQUIRE ADDITIONAL
PROPERTIES.
We will be required to pay cumulative distributions on the Preferred Shares.
Because of this, we will be unable to look to the funds necessary to pay these
distributions as a source for acquiring additional properties. However, we
intend to fund the acquisition of additional real estate properties primarily
from distributions on the Interests tendered to us that consist of loan
repayments, and bank borrowings secured by those Interests.
WE PLAN TO BORROW, WHICH MAY ADVERSELY AFFECT OUR RETURN ON OUR INVESTMENTS AND
MAY REDUCE INCOME AVAILABLE FOR DISTRIBUTION.
Where possible, we will seek to borrow funds to increase the rate of return
on our investments and to allow us to make more investments than we otherwise
could. Borrowing by us presents an element of risk if the cash
22
flow from our properties and other investments is insufficient to meet our debt
service and other obligations or to pay distributions with respect to the
Preferred Shares. A property encumbered by debt increases the risk that the
property will operate at a loss and may ultimately be forfeited upon foreclosure
by the lender. Loans that do not fully amortize during the term, such as
"bullet" or "balloon-payment" loans, present refinancing risks. Variable rate
loans increase the risk that the property may become unprofitable in adverse
economic conditions. Loans that require guaranties, including full principal and
interest guaranties, master leases, debt service guaranties and indemnities for
liabilities such as hazardous waste, may result in significant liabilities for
us.
Our return on our investment and cash available to pay distributions on the
Preferred Shares may be reduced to the extent that changes in market conditions
cause the cost of our financing to increase relative to the income that can be
derived from the assets acquired. In addition, any debt service payments we are
obligated to make would reduce the net income available to pay distributions on
the Preferred Shares. All of our debt and other liabilities would rank senior to
the Preferred Shares, with a prior claim on our assets.
Under our current investment policies, we may not incur indebtedness such
that at the time we incur indebtedness our ratio of debt to total assets exceeds
75%. However, we may reevaluate our borrowing policies from time to time, and
our board of directors may change our investment policies. We may make such a
change without the consent of the holders of the Preferred Shares.
OUR INSURANCE ON OUR REAL ESTATE MAY NOT COVER ALL LOSSES.
We carry comprehensive liability, fire, extended coverage and rental loss
insurance covering all of the initial properties, with policy specifications and
insured limits that we believe are adequate and appropriate under the
circumstances. Some types of losses, such as from terrorism, are uninsurable or
not economically insurable. In addition, many insurance carriers are excluding
asbestos-related claims and most mold-related claims from standard policies,
pricing asbestos and mold endorsements at prohibitively high rates or adding
significant restrictions to this coverage. Because of our inability to obtain
specialized coverage at rates that correspond to the perceived level of risk, we
have not obtained insurance for acts of terrorism or asbestos-related claims or
all mold-related risks. We continue to evaluate the availability and cost of
additional insurance coverage from the insurance market. If we decide in the
future to purchase insurance for terrorism, asbestos or mold, the cost could
have a negative impact on our results of operations. If an uninsured loss or a
loss in excess of insured limits occurs on a property, we could lose our capital
invested in the property, as well as the anticipated future revenues from the
property and, in the case of debt that is recourse to us, would remain obligated
for any mortgage debt or other financial obligations related to the property.
Any loss of this nature would adversely affect us. We believe that the initial
properties are adequately insured. No assurance can be given that this will be
the case in the future.
ENVIRONMENTAL COMPLIANCE COSTS AND LIABILITIES WITH RESPECT TO OUR REAL ESTATE
MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Our operating costs may be affected by our obligation to pay for the cost of
complying with existing environmental laws, ordinances and regulations, as well
as the cost of complying with future legislation with respect to the assets, or
loans secured by assets, with environmental problems that materially impair the
value of the assets. Under various federal, state and local environmental laws,
ordinances and regulations, an owner of real property may be liable for the
costs of removal or remediation of hazardous or toxic substances located on or
in the property. These laws often impose liability without regard to whether the
owner knew of, or was responsible for, the presence of the hazardous or toxic
substances. The costs of any required remediation or removal of these substances
may be substantial. In addition, the owner's liability as to any property is
generally not limited under these laws, ordinances and regulations and could
exceed the value of the property and/or the aggregate assets of the owner. The
presence of hazardous or toxic substances, or the failure to remediate properly,
may also adversely affect the owner's ability to sell or rent the property or to
borrow using the property as collateral. Under these laws, ordinances and
regulations, an owner or any entity who arranges for the disposal of hazardous
or toxic substances, such as asbestos, at a disposal facility may also be liable
for the costs of any required remediation or removal of the hazardous or toxic
substances at the facility, whether or not the facility is owned or operated by
the owner or entity. In connection with the ownership of the initial properties
or the disposal of hazardous or toxic substances, we may be liable for any of
these costs.
Other federal, state and local laws may impose liability for the release of
hazardous materials, including asbestos-containing materials, into the
environment, or require the removal of damaged asbestos containing
23
materials in the event of remodeling or renovation, and third parties may seek
recovery from owners of real property for personal injury associated with
exposure to released asbestos-containing materials or other hazardous materials.
We do not currently have insurance for asbestos-related claims. Recently there
has been an increasing number of lawsuits against owners and managers of
multi-family properties alleging personal injury and property damage caused by
the presence of mold in residential real estate. Some of these lawsuits have
resulted in substantial monetary judgments or settlements. We do not currently
have insurance for all mold-related risks. Environmental laws may also impose
restrictions on the manner in which a property may be used or transferred or in
which businesses may be operated, and these restrictions may require additional
expenditures. In connection with the ownership of properties, we may be
potentially liable for any of these costs. The cost of defending against claims
of liability or remediating contaminated property and the cost of complying with
environmental laws could materially adversely affect our results of operations
and financial condition.
Each of the initial properties has been financed or refinanced within the
past 18 months. In connection with this financing or refinancing, an updated
environmental report was prepared by a third party environmental specialist and
delivered to the lender in connection with the financing or refinancing. These
reports noted the presence of asbestos in certain structural elements in each of
the initial properties, which is being addressed in accordance with various
operations and management plans. The asbestos operations and management plans
require that all structural elements that contain asbestos must not be
disturbed. In the event the asbestos containing elements are or will be
disturbed either through accident, such as a fire, or as a result of planned
renovations at the property, those elements would require removal by a licensed
contractor, who would provide for containment and disposal in an authorized
landfill. The property manager of the initial properties has been directed to
work proactively with licensed ablation contractors whenever there is a question
regarding possible exposure. Other than that, no material environmental issues
were reported.
We have not been notified by any governmental authority of any material
noncompliance, liability or other claim in connection with any of the initial
properties. We are not aware of any environmental liability relating to the
initial properties that we believe would have a material adverse effect on our
business, assets or results of operations. Nevertheless, it is possible that
there are material environmental liabilities of which we are unaware with
respect to the initial properties. Moreover, no assurance can be given that
future laws, ordinances or regulations will not impose material environmental
liabilities or that the current environmental condition of the initial
properties will not be affected by residents and occupants of the initial
properties or by the uses or condition of properties in the vicinity of the
initial properties, such as leaking underground storage tanks, or by third
parties unrelated to us.
OUR FAILURE TO COMPLY WITH VARIOUS REGULATIONS AFFECTING OUR PROPERTIES COULD
ADVERSELY AFFECT OUR FINANCIAL CONDITION.
Various laws, ordinances, and regulations affect multi-family residential
properties, including regulations relating to recreational facilities, such as
activity centers and other common areas. We believe that each initial property
will have all material permits and approvals to operate its business. Rent
control laws currently are not applicable to any of the initial properties.
However, we cannot assure you that rent control requirements will not be
initiated in the future.
The initial properties and any newly acquired or developed multi-family
residential properties must comply with Title II of the Americans with
Disabilities Act (the ADA) to the extent that such properties are "public
accommodations" and/or "commercial facilities" as defined by the ADA. Compliance
with the ADA requires removal of structural barriers to handicapped access in
certain public areas of the initial properties where such removal is "readily
achievable." The ADA does not, however, consider residential properties, such as
the initial properties, to be public accommodations or commercial facilities,
except to the extent portions of such facilities, such as a leasing office, are
open to the public. We believe that the initial properties will comply in all
material respects with all present requirements under the ADA and applicable
state laws. Noncompliance with the ADA could result in imposition of fines or an
award of damages to private litigants. The cost of defending against any claims
of liability under the ADA or the payment of any fines or damages could
adversely affect our financial condition.
The Fair Housing Act (the FHA) requires, as part of the Fair Housing
Amendments Act of 1988, apartment communities first occupied after March 13,
1990 to be accessible to the handicapped. Noncompliance with the FHA could
result in the imposition of fines or an award of damages to private litigants.
We believe that the initial
24
properties that are subject to the FHA are in compliance with such law. The cost
of defending against any claims of liability under the FHA or the payment of any
fines or damages could adversely affect our financial condition.
WE FACE RISKS ASSOCIATED WITH PROPERTY ACQUISITIONS.
We intend to acquire additional properties in the future, either directly or
by acquiring entities that own properties. These acquisition activities are
subject to many risks. We may acquire properties or entities that are subject to
liabilities or that have problems relating to environmental condition, state of
title, physical condition or compliance with zoning laws, building codes, or
other legal requirements. In each case, our acquisition may be without any
recourse, or with only limited recourse, with respect to unknown liabilities or
conditions. As a result, if any liability were asserted against us relating to
those properties or entities, or if any adverse condition existed with respect
to the properties or entities, we might have to pay substantial sums to settle
or cure it, which could adversely affect our cash flow and operating results.
However, some of these liabilities may be covered by insurance. In addition, we
intend to perform customary due diligence regarding each property or entity we
acquire. We also intend to obtain appropriate representations and indemnities
from the sellers of the properties or entities we acquire, although it is
possible that the sellers may not have the resources to satisfy their
indemnification obligations if a liability arises. Unknown liabilities to third
parties with respect to properties or entities acquired might include:
- liabilities for clean-up of undisclosed environmental contamination;
- claims by tenants, vendors or other persons dealing with the former owners
of the properties;
- liabilities incurred in the ordinary course of business; and
- claims for indemnification by general partners, directors, officers and
others indemnified by the former owners of the properties.
RISK FACTORS RELATING TO OUR MANAGEMENT
WE ARE DEPENDENT ON BERKSHIRE ADVISOR AND MAY NOT FIND A SUITABLE REPLACEMENT AT
THE SAME COST IF BERKSHIRE ADVISOR TERMINATES THE ADVISORY SERVICES AGREEMENT.
We have entered into a contract with Berkshire Advisor (which we refer to as
the advisory services agreement) under which Berkshire Advisor is obligated to
manage our portfolio and identify investment opportunities consistent with our
investment policies and objectives, as our board of directors may adopt from
time to time. Although our board has continuing exclusive authority over our
management, the conduct of our affairs and the management and disposition of our
assets, our board initially has delegated to Berkshire Advisor, subject to the
supervision and review of our board, the power and duty to make decisions
relating to the day-to-day management and operation of our business. See
"Management--Summary of Advisory Services Agreement." We will generally utilize
officers of Berkshire Advisor to provide our services and will employ only a few
individuals as our officers, none of whom will be compensated by us for their
services to us as our officers. We believe that our success depends to a
significant extent upon the experience of Berkshire Advisor's officers, whose
continued service is not guaranteed. We have no separate facilities and are
completely reliant on Berkshire Advisor, which has significant discretion as to
the implementation of our operating policies and strategies. We face the risk
that Berkshire Advisor will terminate the advisory services agreement and we may
not find a suitable replacement at the same cost with similar experience and
ability. However, we believe that so long as KRF Company, which is an affiliate
of Berkshire Advisor, continues to own a significant amount of our common stock,
it is unlikely that Berkshire Advisor will terminate the advisory services
agreement. Although KRF Company currently owns all of our common stock, we
cannot assure you that KRF Company will continue to do so.
OUR RELATIONSHIP WITH BERKSHIRE ADVISOR MAY LEAD TO GENERAL CONFLICTS OF
INTEREST THAT ADVERSELY AFFECT THE INTERESTS OF HOLDERS OF PREFERRED SHARES.
Berkshire Advisor is an affiliate of KRF Company, which owns all of our
common stock and the common OP units in our operating partnership. All of our
directors and executive officers, other than Messrs. Hawthorne, Kaufman and
Peiser, who are our independent directors, are also officers or directors of
Berkshire Advisor. As a result, the advisory services agreement was not
negotiated at arm's-length and its terms, including the fees payable to
Berkshire Advisor, may not be as favorable to us as if it had been negotiated
with an unaffiliated third party. Asset management fees and acquisition fees for
new investments are payable to Berkshire Advisor under the
25
advisory services agreement regardless of the performance of our portfolio and
may create conflicts of interest. See "Compensation Payable to Our Affiliates."
For example, conflicts of interest may arise because the retention of a
particular property, at a particular time, may be advantageous to Berkshire
Advisor, because it would continue to earn asset management fees attributable to
that property, but may not be in the best interests of the holders of the
Preferred Shares. However, the asset management fees are not payable unless and
until the holders of the Preferred Shares have first received all distributions
then due on their Preferred Shares. Conflicts of interest also may arise in
connection with any decision to renegotiate, renew or terminate our advisory
services agreement, because it may be advantageous to Berkshire Advisor to
continue to earn fees under that agreement, but may not be in the best interests
of the holders of the Preferred Shares to continue to retain Berkshire Advisor
as our advisor. In order to mitigate these conflicts, the renegotiation, renewal
or termination of the advisory services agreement will require the approval of
the audit committee of our board of directors.
Our property manager, an affiliate of Berkshire Advisor, in most cases will
provide on-site management services for our properties. Our directors that are
affiliates of our property manager might be subject to conflicts of interest in
their dealings with our property manager. For example, conflicts of interest may
arise in connection with any decision to renegotiate, renew or terminate the
property management agreements with our property manager, because it may be
advantageous to our property manager to continue to earn fees under those
agreements, but it may not be in the best interests of the holders of the
Preferred Shares to continue to retain the services of our property manager. In
order to mitigate these conflicts, the renegotiation, renewal or termination of
the property management agreements will require the approval of the audit
committee of our board of directors.
Berkshire Advisor and its affiliates may engage in other businesses and
business ventures, including business activities relating to real estate or
other investments, whether similar or dissimilar to those made by us, or may act
as advisor to any other person or entity (including other REITs). The ability of
Berkshire Advisor and its officers and employees to engage in these other
business activities will reduce the time Berkshire Advisor spends managing us.
Berkshire Advisor and its affiliates will have conflicts of interest in the
allocation of management and staff time, services and functions among us and its
other investment entities presently in existence or subsequently formed.
However, under our advisory services agreement with Berkshire Advisor, Berkshire
Advisor is required to devote sufficient resources as may be required to
discharge its obligations to us under the advisory agreement.
Our advisory services agreement with Berkshire Advisor provides that neither
Berkshire Advisor nor any of its affiliates will be obligated to present to us
all investment opportunities that come to their attention, even if any of those
opportunities might be suitable for investment by us. It will be within the sole
discretion of Berkshire Advisor to allocate investment opportunities to us as it
deems advisable. However, it is expected that, to the extent possible, the
resolution of conflicting investment opportunities between us and others will be
based upon differences in investment objectives and policies, the makeup of
investment portfolios, the amount of cash and financing available for investment
and the length of time the funds have been available, the estimated income tax
effects of the investment, policies relating to leverage and cash flow, the
effect of the investment on diversification of investment portfolios and any
regulatory restrictions on investment policies.
We have adopted policies to ensure that Berkshire Advisor does not enter
into investments on our behalf involving its affiliates that could be less
favorable to us than investments involving unaffiliated third parties. For
example, any transaction between us and the operating partnership, on the one
hand, and Berkshire Advisor or any of its affiliates, on the other hand, will
require the prior approval of the audit committee of our board of directors.
Members of the audit committee are required under our bylaws to be unaffiliated
with Berkshire Advisors and its affiliates. See "Management--Board of Directors
Committees--Audit Committee" for a description of the qualifications of the
members of the audit committee. We cannot assure you that these policies will be
successful in eliminating the influence of any conflicts and, if they are not
successful, decisions could be made that might fail to reflect fully the
interests of the holders of the Preferred Shares.
KRF COMPANY WILL HAVE A SIGNIFICANT OPPORTUNITY TO INFLUENCE OR CONTROL US, AND
ITS INTERESTS MIGHT NOT BE CONSISTENT WITH THE INTERESTS OF HOLDERS OF PREFERRED
SHARES.
KRF Company owns all of our common stock and, as a result, will have the
right to elect our directors and to vote on any matter submitted to a vote of
common stockholders. Accordingly, KRF Company will have substantial influence
over our affairs, which influence might not be consistent with the interests of
holders of the Preferred Shares. For example, because holders of Preferred
Shares will not share in the appreciation of our assets, the
26
holders of Preferred Shares may prefer that we make investments that are more
conservative in nature, because their goal is to assure that their capital
investment is preserved. KRF Company, on the other hand, may favor investments
that are riskier in return for the possibility of a greater return because KRF
Company, as the holder of our common stock, will benefit from the appreciation
of our assets.
We have adopted policies with respect to Berkshire Advisor, an affiliate of
KRF Company, designed to eliminate or minimize potential conflicts of interest.
See "Conflicts of Interest" and "Management--Board of Directors
Committees--Audit Committee." For example, our bylaws require that a majority of
the members of our board be unaffiliated with Berkshire Advisor and its
affiliates (including KRF Company and other members of The Berkshire Group).
However, although our board of directors will establish our investment
guidelines, Berkshire Advisor may make investments in multi-family residential
properties on our behalf within the board approved guidelines without the
approval of our board. We cannot assure you that our policies will be successful
in eliminating the influence of any conflicts and, if they are not successful,
decisions could be made that might fail to reflect fully the interests of the
holders of Preferred Shares.
OUR BOARD OF DIRECTORS HAS APPROVED INVESTMENT GUIDELINES FOR BERKSHIRE ADVISOR,
BUT WILL NOT APPROVE EACH MULTI-FAMILY RESIDENTIAL PROPERTY INVESTMENT DECISION
MADE BY BERKSHIRE ADVISOR WITHIN THOSE GUIDELINES.
Berkshire Advisor is authorized to follow investment guidelines adopted from
time to time by our board of directors in determining the types of assets it may
decide to recommend to our board of directors as proper investments for us. Our
board of directors will periodically review our investment guidelines and our
investment portfolio. However, Berkshire Advisor may make investments in
multi-family residential property on our behalf within the board approved
guidelines without the approval of our board of directors. In addition, in
conducting periodic reviews, the board of directors will rely primarily on
information provided by Berkshire Advisor.
WE MAY CHANGE OUR INVESTMENT STRATEGY WITHOUT STOCKHOLDER CONSENT, WHICH COULD
RESULT IN OUR MAKING DIFFERENT AND POTENTIALLY RISKIER INVESTMENTS.
The descriptions in this prospectus of the various types of investments to
be made by us reflect only the current plans of our board of directors and
Berkshire Advisor. We may change our investment strategy at any time without the
consent of our stockholders, which could result in our making investments that
are different from, and possibly riskier than, the investments described in this
prospectus. In addition, the methods of implementing our investment policies may
vary as new investment techniques are developed. A change in our investment
strategy may increase our exposure to interest rate and real estate market
fluctuations.
27
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements. We based these
forward-looking statements on our current expectations and projections about
future events. Our actual results could differ materially from those discussed
in, or implied by, these forward-looking statements. Forward-looking statements
are identified by words such as "believe," "anticipate," "expect," "intend,"
"plan," "will," "may" and other similar expressions. In addition, any statements
that refer to expectations, projections or other characterizations of future
events or circumstances are forward-looking statements. The following factors
could cause our actual results to differ from those implied by the
forward-looking statements in this prospectus:
- changes in economic conditions generally and the real estate and bond
markets specifically,
- legislative/regulatory changes (including changes to laws governing the
taxation of real estate investment trusts),
- availability of capital, interest rates and interest rate spreads, and
- changes in generally accepted accounting principles and policies and
guidelines applicable to REITs.
Other factors that could cause actual results to differ from those implied
by the forward-looking statements in this prospectus are more fully described in
the "Risk Factors" section and elsewhere in this prospectus.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of these statements. We
are under no duty to update any of the forward-looking statements after the date
of this prospectus to conform these statements to actual results.
28
USE OF PROCEEDS
The Preferred Shares are being issued by us in exchange for Interests. We
will not receive any cash proceeds from this offering.
We intend to contribute the Interests tendered to us to our operating
partnership in exchange for preferred OP units having the same economic terms as
the Preferred Shares. To the extent our operating partnership receives
distributions from these Interests that consist of mortgage loan repayments, we
intend, through our operating partnership, to use these distributions, together
with cash from other sources, primarily for the purpose of acquiring additional
multi-family residential properties that are within our investment guidelines.
We intend to use other distributions from these Interests for general corporate
purposes. We also plan to use the Interests as collateral for a credit facility
that would be entered into primarily for the purpose of funding additional
property acquisitions. We have not entered into any agreements or received
commitments from any lenders relating to such a facility at this time.
Our estimated expenses of the offers are expected to be approximately
$2,860,000, all of which will be funded by KRF Company.
29
RATIOS OF EARNINGS AND "ADJUSTED" EARNINGS TO FIXED CHARGES
AND COMBINED FIXED CHARGES AND PREFERRED SHARE DIVIDENDS
The following table shows the ratio of earnings and "adjusted earnings" to
fixed charges and combined fixed charges and preferred share dividends of
Berkshire Income Realty, Inc. (the Company), as adjusted assuming the offer was
completed on June 30, 2002, and of Berkshire Income Realty Predecessor Group
(the Predecessor). See "Management's Discussion and Analysis of Financial
Condition and Results of Operations of Berkshire Income Realty Predecessor
Group" for a discussion of the entities that comprise Berkshire Income Realty
Predecessor Group, which is deemed to be our predecessor for accounting
purposes. You should read this financial data in conjunction with the unaudited
pro forma condensed consolidated financial statements of the Company and the
combined financial statements of Berkshire Income Realty Predecessor Group.
THE COMPANY THE COMPANY PREDECESSOR THE COMPANY THE COMPANY
----------- ----------- ------------------- ------------- -------------
PRO FORMA PRO FORMA HISTORICAL
SIX MONTHS SIX MONTHS SIX MONTHS ENDED PRO FORMA PRO FORMA
ENDED ENDED JUNE 30, YEAR ENDED YEAR ENDED
JUNE 30, JUNE 30, ------------------- DECEMBER 31, DECEMBER 31,
2002 (1) 2002 (2) 2002 2001 2001 (1) 2001 (2)
----------- ----------- -------- -------- ------------- -------------
Ratio of earnings to fixed
charges (3).............. 1.91 2.94 2.86 --(4) 1.90 3.25
Ratio of earnings to
combined fixed charges
and preferred stock
dividends (5)............ 1.40 1.45 --(6) --(6) 1.40 1.62
Ratio of adjusted earnings
to fixed charges (7)
(8)...................... 2.42 3.45 3.50 --(4) 2.76 4.12
Ratio of adjusted earnings
to combined fixed charges
and preferred stock
dividends (7) (9)........ 1.72 1.70 --(10) --(10) 1.97 2.06
PREDECESSOR
----------------------------------------------------
HISTORICAL
YEARS ENDED DECEMBER 31,
----------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
Ratio of earnings to fixed
charges (3).............. --(4) --(4) --(4) --(4) --(4)
Ratio of earnings to
combined fixed charges
and preferred stock
dividends (5)............ --(6) --(6) --(6) --(6) --(6)
Ratio of adjusted earnings
to fixed charges (7)
(8)...................... 1.07 1.14 1.43 1.61 1.14
Ratio of adjusted earnings
to combined fixed charges
and preferred stock
dividends (7) (9)........ --(10) --(10) --(10) --(10) --(10)
------------------------------
(1) Assuming 8.84% of the Interests in the mortgage funds are tendered in
exchange for Preferred Shares and certain other transactions, including the
refinancing of the initial properties and the payoff of the participating
note, respectively, occurred at the beginning of the period presented, and
payment of preferred dividends on the Preferred Shares, occurred as of
January 1, 2001. This financial data should be read in conjunction with the
unaudited pro forma consolidated condensed financial statement of the
Company.
(2) Assuming 25% of the Interests in the mortgage funds are tendered in
exchange for Preferred Shares and certain other transactions, including the
refinancing of the initial properties and the payoff of the participating
note, respectively, occurred at the beginning of the period presented, and
payment of preferred dividends on the Preferred Shares, occurred as of
January 1, 2001. This financial data should be read in conjunction with the
unaudited pro forma consolidated condensed financial statement of the
Company.
(3) The ratio of earnings to fixed charges was computed by dividing earnings by
fixed charges. We defined "earnings" as income before minority interest and
extraordinary items plus fixed charges. We define "fixed charges" as
interest expense including amortization of deferred financing costs.
(4) The ratio is less than "1" due to charges for participating note interest
on the former Seasons of Laurel subordinate note payable, which was paid
off in July 2001.
(5) The ratio of earnings to combined fixed charges and preferred share
dividends was computed by dividing earnings by combined fixed charges and
preferred share dividends. We define "earnings" and "fixed charges" as
described in Note (3) above. We define "preferred share dividends" as the
amount that would be required to cover preferred share dividends.
(6) Historical ratios of earnings to combined fixed charges and preferred
shares dividends have not been presented since the historical presentation
does not reflect payments for preferred share dividends.
(7) We are presenting the ratios of "adjusted" earnings to fixed charges and
"adjusted" earnings to combined fixed charges and preferred share
dividends, for additional information. We do not consider these ratios more
important than the ratios of earnings to fixed charges and earnings to
combined fixed charges and preferred share dividends. We consider
"adjusted" earnings to be an alternative measure of performance of the
Company and the Predecessor which provides potential investors with an
understanding of the ability of the Company to pay fixed charges and
preferred share dividends. We define "adjusted" earnings as earnings as
described in Note (3) above plus depreciation and advisory fees less
capital expenditures. Advisory fees have been added back to earnings
because such fees are subordinate to preferred share dividends.
Depreciation has been added back to earnings because it is a non cash
charge. Capital expenditures have been deducted from earnings because they
represent a cash charge not reflected in earnings. "Adjusted" earnings
should not be considered as an alternative to net income (determined in
accordance with GAAP) as an indication of financial performance or to cash
flows from operating activities (determined in accordance with GAAP) as a
measure of liquidity and the items excluded from "adjusted" earnings are
significant components in understanding and evaluating financial
performance. The computation of "adjusted" earnings may not be comparable
to similarly titled or other alternative performance measures, including
funds from operations, presented by other companies. We believe that in
order to facilitate a clear understanding of the combined historical
results of the Predecessor and the pro forma results of the Company,
"adjusted" earnings should be examined in connection with net income and
cash flows from operating, investing and financing activities in the
combined financial statements and other information included in this
Prospectus.
30
A reconciliation between GAAP earnings and "adjusted" earnings for the
historical results of the Berkshire Income Realty Predecessor Group and the
pro forma results of the Company are as follows:
THE COMPANY THE COMPANY PREDECESSOR THE COMPANY THE COMPANY
------------ ------------ ------------------- ------------- -------------
PRO FORMA PRO FORMA HISTORICAL
SIX MONTHS SIX MONTHS SIX MONTHS ENDED PRO FORMA PRO FORMA
ENDED ENDED JUNE 30, YEAR ENDED YEAR ENDED
JUNE 30, JUNE 30, ------------------- DECEMBER 31, DECEMBER 31,
2002 (A) 2002 (B) 2002 2001 2001 (A) 2001 (B)
------------ ------------ -------- -------- ------------- -------------
(DOLLARS IN THOUSANDS)
Income (loss) before
minority interests and
extraordinary loss...... $2,841 $ 6,044 $ 2,943 $(2,970) $ 5,716 $14,299
Add:
Interest expense........ 3,115 3,115 1,586 6,482 6,347 6,347
Depreciation expense.... 2,215 2,215 2,215 2,826 5,603 5,603
Advisory fees
(subordinate)......... 305 305 610 610
Deduct:
Capital expenditures.... (945) (945) (1,190) (701) (732) (732)
------ ------- ------- ------- ------- -------
"Adjusted" earnings....... $7,531 $10,734 $ 5,554 $ 5,637 $17,544 $26,127
====== ======= ======= ======= ======= =======
Cash flows provided by
(used in) operating
activities (c).......... 6,098 478
Cash flows provided by
(used in) investing
activities (c).......... (1,285) 766
Cash flows provided by
(used in) financing
activities (c).......... (2,125) (5,274)
PREDECESSOR
----------------------------------------------------
HISTORICAL
YEARS ENDED DECEMBER 31,
----------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Income (loss) before
minority interests and
extraordinary loss...... $ (3,179) $ (905) $ (595) $ (46) $(2,422)
Add:
Interest expense........ 12,273 8,217 6,840 5,600 6,814
Depreciation expense.... 4,751 5,011 5,700 6,017 6,197
Advisory fees
(subordinate).........
Deduct:
Capital expenditures.... (732) (2,959) (2,190) (2,534) (2,794)
-------- -------- ------- ------- -------
"Adjusted" earnings....... $ 13,113 $ 9,364 $ 9,755 $ 9,037 $ 7,795
======== ======== ======= ======= =======
Cash flows provided by
(used in) operating
activities (c).......... (6,008) 6,592 6,328 4,306 2,901
Cash flows provided by
(used in) investing
activities (c).......... (33,081) (24,032) (2,458) (1,646) (1,527)
Cash flows provided by
(used in) financing
activities (c).......... 35,180 23,559 (3,349) (2,634) (1,030)
----------------------------------
(a) Assuming 8.84% of the Interests in the mortgage funds are tendered for
Preferred Shares.
(b) Assuming 25% of the Interests in the mortgage funds are tendered for
Preferred Shares.
(c) Pro forma information relating to cash flows from operating, investing
and financing activities has not been included because we believe that
the information would not be meaningful due to the number of
assumptions required in order to calculate this information.
(8) The ratio of "adjusted" earnings to fixed charges was computed by dividing
"adjusted" earnings to fixed charges. We defined "adjusted" earnings as
income before minority interest and extraordinary items less fixed charges,
depreciation and subordinate advisory fees less capital expenditures, and
"fixed charges" as interest expenses including amortization of deferred
financing costs.
(9) The ratio of "adjusted" earnings to combined fixed charges and preferred
share dividends was computed by dividing "adjusted" earnings by combined
fixed charges and preferred share dividends. We define "adjusted earnings"
and "fixed charges" as described in Note (8) above. We defined "preferred
share dividends" as the amount of income that would be required to cover
preferred share dividends.
(10) Historical ratios of "adjusted" earnings to combined fixed charges and
preferred share dividends have not been presented since the historical
presentation does not reflect payments for preferred shares dividends.
31
CAPITALIZATION
The following table shows the capitalization of Berkshire Income Realty,
Inc. (the Company), assuming (1) the Interests in the mortgage funds are
tendered in exchange for Preferred Shares and (2) certain other transactions
were completed on June 30, 2002. These other transactions include an estimated
distribution of the Predecessor excess working capital aggregating $5 million to
KRF Company L.L.C. and the refinancing of the Seasons of Laurel mortgage note
payable which occurred on July 31, 2002. The table also shows the capitalization
of Berkshire Income Realty Predecessor Group based on these same assumptions.
See "Management's Discussion and Analysis of Results of Operations and Financial
Condition of Berkshire Income Realty Predecessor Group" for a discussion of the
entities that comprise the Berkshire Income Realty Predecessor Group, which is
deemed to be our predecessor for accounting purposes.
THE COMPANY THE COMPANY PREDECESSOR
---------------- ---------------- ----------------
PRO FORMA PRO FORMA HISTORICAL
SIX MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30,
2002(3) 2002(4) 2002
---------------- ---------------- ----------------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(DOLLARS IN THOUSANDS)
Mortgage notes payable........................... $106,335 $106,335 $90,167
Minority common interest in operating
partnership.................................... 154(1)(2) 604(1)(2) --
Owners' equity................................... -- -- 4,919(1)
Stockholder's equity:
Preferred stock, $.01 par value liquidation
preference $25.00 per share, 5,000,000 shares
authorized, 1,131,301 (1) and 2,500,000
(2)shares issued and outstanding,
respectively................................. 250(1)(2) 707(1)(2) --
Class A common stock, $.01 par value, 5,000,000
shares authorized, 0 shares issued and
outstanding.................................. -- -- --
Class B common stock, $.01 par value, 5,000,000
shares authorized, 874,692 (3) and 1,336,362
(4) shares issued and outstanding,
respectively................................. -- -- --
Additional paid in capital..................... 24,752(1)(2) 70,012(1)(2)
-------- -------- -------
Total equity..................................... 25,002 70,719 4,919
-------- -------- -------
Total Capitalization............................. $131,491 $177,658 $95,086
======== ======== =======
------------------------
(1) The pro forma balance sheet has been prepared on a historical cost basis and
does not reflect the fair value of the real estate contributed by KRF,
which, based upon independent appraisals, is $62,962 in excess of its net
historical cost, less minority interest.
(2) The Company's preferred stock is senior to the common stock and minority
common interest in the Company's operating partnership.
(3) Assuming 8.84% of the Interests in the mortgage funds are tendered in
exchange for Preferred Shares.
(4) Assuming 25% of the Interests in the mortgage funds are tendered in exchange
for Preferred Shares.
32
SELECTED FINANCIAL DATA
The following tables show selected financial data regarding the financial
position and operating results of (1) Berkshire Income Realty, Inc. (the
Company), as adjusted assuming the offers and certain other transactions were
completed on June 30, 2002 or at the beginning of the periods presented,
including an estimated distribution of the Predecessor excess working capital
aggregating $5 million to KRF Company L.L.C., the refinancing of the Seasons of
Laurel mortgage note payable which occurred on July 31, 2002, the payoff of the
participating note and the payment of preferred share dividends and (2)
Berkshire Income Realty Predecessor Group. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations of Berkshire Income
Realty Predecessor Group" for a discussion of the entities that comprise
Berkshire Income Realty Predecessor Group, which is deemed to be our predecessor
for accounting purposes. You should read the following financial data in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations of Berkshire Income Realty Predecessor Group,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Mortgage Funds" and the unaudited pro forma condensed
consolidated financial statements of the Company and the financial statements of
Berkshire Income Realty Predecessor Group and of each of the mortgage funds
(including the related notes) included in this prospectus.
33
THE COMPANY AND THE BERKSHIRE INCOME REALTY PREDECESSOR GROUP
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THE COMPANY THE COMPANY PREDECESSOR THE COMPANY THE COMPANY
---------------- ---------------- ------------------------- ------------ ------------
PRO FORMA PRO FORMA HISTORICAL PRO FORMA PRO FORMA
SIX MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED JUNE 30, YEAR ENDED YEAR ENDED
JUNE 30, JUNE 30, ------------------------- DECEMBER 31, DECEMBER 31,
2002 (2) 2002 (3) 2002 2001 2001 (2) 2001 (3)
---------------- ---------------- ----------- ----------- ------------ ------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Operating Data:
Revenue......................... $ 14,156 $ 17,359 $ 12,403 $ 11,976 $29,266 $ 37,849
Depreciation.................... 2,215 2,215 2,215 2,826 5,603 5,603
Income (loss) before minority
interest...................... 2,841 6,044 2,943 (2,970) 5,716 14,299
Net income (loss)............... 1,129 3,211 624 (2,856) 2,301 6,534
Net income (loss) available for
common........................ $ 4 $ 29 $ -- $ -- $ 51 $ 170
Earnings per common share....... $ 0.004 $ 0.020 -- -- $ 0.060 $ 0.130
Weighted average number of
common shares outstanding..... 874,692 1,336,362 -- -- 874,692 1,336,362
Balance Sheet Data, at period
end:
Real estate, before accumulated
depreciation.................. $171,557 $ 171,557 $171,557 $107,123 -- --
Real estate, after accumulated
depreciation.................. 86,623 86,623 86,623 55,324 -- --
Cash and cash equivalents....... 18,083 18,544 6,678 3,867 -- --
Total assets.................... 133,675 179,842 97,270 72,514 -- --
Total long term obligations..... 106,335 106,335 90,167 72,201 -- --
Minority Interest............... 154 604 -- 1,002
Stockholders' or owners' equity
(deficit)..................... 25,003(1) 70,719(1) 4,919 (2,066) -- --
Other Data:
"Adjusted" earnings (4)......... $ 7,531 $ 10,734 $ 5,554 $ 5,637 $17,544 $ 26,127
Cash flows provided by (used in)
operating activities (5)...... 6,098 478
Cash flows provided by (used in)
investing activities (5)...... (1,285) 766
Cash flows provided by (used in)
financing activities (5)...... (2,125) (5,274)
PREDECESSOR
----------------------------------------------------------
HISTORICAL
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- ----------- -----------
(UNAUDITED) (UNAUDITED)
Operating Data:
Revenue......................... $ 24,571 $ 23,148 $ 21,760 $ 20,910 $ 20,177
Depreciation.................... 4,751 5,011 5,700 6,017 6,197
Income (loss) before minority
interest...................... (3,179) (905) (595) (46) (2,422)
Net income (loss)............... (3,664) (864) (595) (46) (2,422)
Net income (loss) available for
common........................ $ -- $ -- $ -- $ -- $ --
Earnings per common share....... -- -- -- -- --
Weighted average number of
common shares outstanding..... -- -- -- -- --
Balance Sheet Data, at period
end:
Real estate, before accumulated
depreciation.................. $170,367 $135,072 $110,581 $108,391 $105,899
Real estate, after accumulated
depreciation.................. 87,648 57,104 37,624 41,134 44,547
Cash and cash equivalents....... 3,990 7,899 1,780 1,260 1,507
Total assets.................... 96,613 72,387 44,482 46,829 52,623
Total long term obligations..... 76,799 72,568 57,618 58,554 59,801
Minority Interest............... 619 1,385 -- -- --
Stockholders' or owners' equity
(deficit)..................... 17,352 (11,505) (19,250) (13,512) (9,772)
Other Data:
"Adjusted" earnings (4)......... $ 13,113 $ 9,364 $ 9,755 $ 9,037 $ 7,795
Cash flows provided by (used in)
operating activities (5)...... (6,008) 6,592 6,328 4,306 2,901
Cash flows provided by (used in)
investing activities (5)...... (33,081) (24,032) (2,458) (1,646) (1,527)
Cash flows provided by (used in)
financing activities (5)...... 35,180 23,559 (3,349) (2,634) (1,030)
------------------------------
(1) The pro forma balance sheets have been prepared on a historical cost basis
and does not reflect the fair value of the real estate contributed by KRF,
which, based upon independent appraisals, was $62,962 in excess of its net
historical cost, less minority interest.
(2) Assuming 8.84% of the Interests in the mortgage funds are tendered in
exchange for Preferred Shares.
(3) Assuming 25% of the Interests in the mortgage funds are tendered in exchange
for Preferred Shares.
34
(4) We consider "adjusted" earnings to be an alternative measure of performance
of the Company and the Predecessor which provides potential investors with
an understanding of the ability of the Company to pay fixed charges and
preferred dividends. We define "adjusted" earnings as income before
minority interests and extraordinary loss (determined in accordance with
GAAP) plus interest expense, depreciation and advisory fees less capital
expenditures. Advisory fees have been added back to earnings as such fees
are subordinate to preferred share dividends. Depreciation has been added
back to earnings as it is a non cash charge. Capital expenditures have been
deducted from earnings as they represent a cash charge not reflected in
earnings. "Adjusted" earnings should not be considered as an alternative to
net income (determined in accordance with GAAP) as an indication of
financial performance or to cash flows from operating activities
(determined in accordance with GAAP) as a measure of liquidity and the
items excluded from "adjusted" earnings are significant components in
understanding and evaluating financial performance. The computation of
"adjusted" earnings may not be comparable to similarly titled or other
alternative performance measures, including funds from operations,
presented by other companies. We believe that in order to facilitate a
clear understanding of the combined historical results of the Predecessor
and the pro forma results of the Company, "adjusted" earnings should be
examined in connection with net income and cash flows from operating,
investing and financing activities in the combined financial statements and
other information included in this Prospectus.
A reconciliation between GAAP earnings and "adjusted" earnings for the
historical results of the Berkshire Income Realty Predecessor Group and the
pro forma results of the Company are as follows:
THE COMPANY THE COMPANY PREDECESSOR THE COMPANY THE COMPANY
---------------- ---------------- ------------------------- ------------ ------------
PRO FORMA PRO FORMA HISTORICAL PRO FORMA PRO FORMA
SIX MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED JUNE 30, YEAR ENDED YEAR ENDED
JUNE 30, JUNE 30, ------------------------- DECEMBER 31, DECEMBER 31,
2002 (1) 2002 (2) 2002 2001 2001 (1) 2001 (2)
---------------- ---------------- ----------- ----------- ------------ ------------
(DOLLARS IN THOUSANDS)
Income (loss) before minority
interests and extraordinary
loss........................... $2,841 $ 6,044 $ 2,943 $(2,970) $ 5,716 $14,299
Add:
Interest expense............... 3,115 3,115 1,586 6,482 6,347 6,347
Depreciation expense........... 2,215 2,215 2,215 2,826 5,603 5,603
Advisory fees (subordinate).... 305 305 610 610
Deduct:
Capital expenditures........... (945) (945) (1,190) (701) (732) (732)
------ ------- ------- ------- ------- -------
"Adjusted earnings".............. $7,531 $10,734 $ 5,554 $ 5,637 $17,544 $26,127
====== ======= ======= ======= ======= =======
PREDECESSOR
----------------------------------------------------
HISTORICAL
YEARS ENDED DECEMBER 31,
----------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
Income (loss) before minority
interests and extraordinary
loss........................... $(3,179) $ (905) $ (595) $ (46) $(2,422)
Add:
Interest expense............... 12,273 8,217 6,840 5,600 6,814
Depreciation expense........... 4,751 5,011 5,700 6,017 6,197
Advisory fees (subordinate)....
Deduct:
Capital expenditures........... (732) (2,959) (2,190) (2,534) (2,794)
------- ------- ------- ------- -------
"Adjusted earnings".............. $13,113 $ 9,364 $ 9,755 $ 9,037 $ 7,795
======= ======= ======= ======= =======
(5) Pro forma information relating to cash flows from operating, investing and
financing activities has not been included because we believe that the
information would not be meaningful due to the number of assumptions
required in order to calculate this information.
35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF BERKSHIRE INCOME
REALTY PREDECESSOR GROUP
You should read the following discussion in conjunction with the Berkshire
Income Realty Predecessor Group combined financial statements and their related
notes and other financial information included elsewhere in this prospectus.
The entities comprising Berkshire Income Realty Predecessor Group are deemed
to be our predecessors for accounting purposes. Because we do not yet have any
operations, the following discussion relates to Berkshire Income Realty
Predecessor Group. Please also see the accompanying Berkshire Income Realty
Predecessor Group combined financial statements and related notes for a more
detailed discussion of the accounting methods used in preparing the financial
information for Berkshire Income Realty Predecessor Group. This discussion
contains forward-looking statements. See "Cautionary Statement Regarding
Forward-Looking Statements."
OVERVIEW
At June 30, 2002 and December 31, 2001, KRF Company, an affiliate of
Berkshire Income Realty, Inc., through its subsidiaries, KRF 3 Acquisition
Company, L.L.C. and KR5 Acquisition, L.L.C., which we collectively refer to as
KRF, held controlling interests in five multi-family apartment communities
consisting of 2,539 units, which we refer to as the initial properties. KRF
Company is an affiliate of The Berkshire Group and is controlled by Douglas and
George Krupp. KRF acquired the initial properties during 2000 and 2001 through
the acquisition of limited partner interests from affiliates of The Berkshire
Group also controlled by George and Douglas Krupp, namely, Krupp Realty Limited
Partnership--V (Century), Krupp Realty Fund, Ltd.--III (Dorsey's Forge and
Hannibal Grove), Maryland Associates Limited Partnership (Seasons of Laurel) and
Krupp Realty Fund, Ltd.--IV (Walden Pond), which we refer to collectively as the
Affiliates. The acquisition of the limited partner interests in the Affiliates
has been accounted for using purchase accounting based upon the cash paid for
the interests, which was at fair value and in excess of book value of the
initial properties. The step up in basis for Century, Dorsey's Forge, Hannibal
Grove, Seasons of Laurel and Walden Pond was $12,214,000 $3,404,000, $5,914,000,
$26,241,000, and $8,322,000, respectively.
The activities of the initial properties held by KRF and the Affiliates, the
owners of the initial properties, are collectively referred to as Berkshire
Income Realty Predecessor Group or the Predecessor.
The Predecessor has been engaged in the business of acquiring, owning and
operating multi-family residential real estate, including the initial
properties. Four of the five initial properties are located in the Baltimore/
Washington D.C. metropolitan areas, which we believe comprise one of the
strongest rental markets in the country. Each of the initial properties has been
managed by affiliates of the Predecessor for over 15 years. The initial
properties include Century II Apartments, Dorsey's Forge Apartments, Hannibal
Grove Apartments, Seasons Apartments and Walden Pond Apartments.
CRITICAL ACCOUNTING POLICIES
The discussion below describes what we believe are the critical accounting
policies that affect the Predecessor's more significant judgments and the
estimates used in the preparation of its combined financial statements. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make estimates
and judgments that affect the reported amounts of assets and liabilities,
revenues and expenses, and related disclosures of contingent assets and
liabilities. These estimates include the allowance for depreciation and the fair
value of the accrued participation note interest. We believe that the following
critical accounting policies affect significant judgments and estimates used in
the preparation of the Predecessor's combined financial statements:
PRINCIPLES OF COMBINATION
The combined financial statements include the accounts of the initial
properties extracted from the books and records of the Affiliates. All overhead
costs of KRF and an allocation of the Affiliates' overhead costs, based upon the
number of units in the initial properties to total units owned by the
Affiliates, have been reflected in the Predecessor financial statements for the
periods presented. To the extent parties not affiliated with The Berkshire Group
have an equity interest in the initial properties, this interest is accounted
for as minority interest in the
36
accompanying financial statements. Allocations of income, losses and
distributions are made to each minority shareholder based upon its share of the
allocations. Losses in excess of each minority shareholder's investment basis
are allocated to the Predecessor. Distributions to each minority shareholder in
excess of its investment basis are recorded in the Predecessor's combined
statement of operations as minority interest.
REAL ESTATE
Real estate is stated at depreciated cost. The Predecessor periodically
reviews its properties to determine if their carrying amounts will be recovered
from future operating cash flows. If we determine that an impairment has
occurred, those assets shall be reduced to fair value. No impairment losses of
this kind have been recognized to date.
REVENUE RECOGNITION
The initial properties are leased under terms of leases with terms of
generally one year or less. Rental revenue is recognized when earned.
INCOME TAXES
No provision for income taxes is necessary in the financial statements of
the Predecessor since the Predecessor's financial statements combine the
operations and balances of partnerships, and limited liability companies that
have elected to be treated as partnerships for Federal income tax purposes, none
of which may be directly taxed on its income. The tax effect of the activities
of these partnerships or limited liability companies accrues to the individual
partners or members of the respective entity.
RESULTS OF OPERATIONS
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED
JUNE 30, 2001.
Rental income increased $339,000 or 2.99%, to $11,672,000. The increase was
a result of an increase of 6.62% in weighted average rental rates offset by a
reduction in overall occupancy from 97.46% to 95.91%.
Interest income decreased $108,000, or 60.67%, to $70,000. The decrease was
a result of decreases in the average cash on hand during the six months ended
June 30, 2002 as compared to the same period in 2001 as well as decreases in the
overall interest rates earned by invested cash.
Other income increased $196,000 or 42.15%, to $661,000. The increase was
primarily a result of reimbursements from tenants for water and sewer charges.
Reimbursement for water and sewer charges increased $266,000 or 760%, as a
result of the implementation of a reimbursable utilities billing system for
water and sewer charges. The reimbursable utilities billing system program was
introduced in mid-2001 and stabilized around November of 2001.
Operating expenses decreased $207,000, or 7.17%, to $2,680,000. The decrease
was the result of the elimination of reimbursement of specified management
company costs and utilities partially offset by increases in payroll related
expenses. The reimbursement of specified management company costs component of
the property management agreement was eliminated during the renegotiation of
management agreements effective January 1, 2002. The resulting savings during
the first six months of 2002 was $189,000. Utilities expense decreased $189,000,
or 16.12%, as a result a decline in gas expense, which resulted from the signing
of contracts with local gas utilities to stabilize the seasonal fluctuation of
fuel prices. 2002 was also a mild winter in the Mid-Atlantic region, which
required less gas usage. Payroll expense increased $152,000, or 16.39%, as a
result of increases in overall pay rates for employees as well as increases in
bonuses paid to employees.
Real estate taxes increased $57,000, or 6.94%, to $878,000. Real estate
taxes increased primarily as a result of increases in the tax rates and
revaluations of the properties by local taxing authorities. Management fees
increased $229,000, or 35.34%, to $877,000. Management fees increased as a
result of the implementation of advisory fees payable to an affiliate of The
Berkshire Group on Seasons and Walden Pond Apartments. These fees will result in
an annual increase in advisory fees of $200,000.
Interest expense decreased $1,434,000, or 47.48%, to $1,586,000. Interest
expense decreased primarily as a result of the refinancing of Seasons Apartments
in July of 2001, from an average interest rate of 10%, exclusive of
participating note interest, to a variable rate of approximately 3% as well as
decreases in the overall interest rate
37
market. During the first quarter of 2002, the majority of the Predecessor's
mortgages were under variable interest rates. From January of 2001 through June
of 2002, the overall interest rate market maintained a steady decline in rates.
On April 1, 2002, the Predecessor took advantage of the lower interest rate
market and locked the interest rates on three of its five mortgages. On
July 31, 2002, the Predecessor locked the interest rate on an additional
mortgage. These refinancing transactions resulted in the fixing of interest
rates on a substantial amount of the Predecessor's debt at near historical low
levels. We believe that the decision to fix interest rates in the current market
will mitigate the risk of fluctuations in the interest rate market, which might
otherwise negatively impact net income.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED
DECEMBER 31, 2000.
Rental income increased $1,187,000 or 5.43%, to $23,056,000. The increase
was a result of an increase of 5.28% in the weighted average rental rates, plus
the effect of an increase in overall occupancy from 96.93% to 97.35%.
Interest income decreased $68,000, or 11.31%, to $533,000. The decrease was
a result of lower average cash on hand during 2001 as compared to 2000.
Other income, which consists primarily of reimbursements for water and sewer
charges, income from operation of laundry facilities, late charges,
administrative fees, net profits from corporate apartments, cable revenue, pet
charges and miscellaneous charges to residents increased $304,000, or 44.84%, to
$982,000. The increase was attributable to an increase in the assessments
charged to an unrelated property that borders the Century property for use of
Century's pool and clubhouse facilities, an increase in the reimbursements for
water and sewer charges from tenants and an increase in month-to-month premiums
charged to tenants who have not signed a lease at Seasons.
Operating expenses, which consist primarily of property payroll,
advertising, leasing expenses, utilities and property insurance decreased
$207,000, or 3.86%, to $5,158,000. Operating expenses decreased as a result of
decreases in payroll and utilities expenses, which were partially offset by
increases in advertising and property insurance expense. Payroll expense
decreased $142,000, or 7.02%, primarily as a result of decreases in group
insurance costs. In 2001, the Predecessor consolidated insurance providers,
which resulted in significant savings. Utilities decreased $74,000, or 3.41%,
primarily as a result of decreases in gas prices. Advertising expense increased
$21,000, or 9.56%, as a result of increases in advertisements in real estate
publications. Property insurance expense increased $59,000, or 31.59%, as a
result of increases in insurance premiums. We expect insurance costs to continue
to increase as a result of changes in the insurance industry that resulted from
the terrorist attacks of September 11, 2001. The Predecessor is reviewing
options that may lower the cost of insurance but cannot make any assurances that
these options will be implemented or will result in noticeable changes to
insurance expense.
Maintenance expense increased $147,000, or 8.18%, to $1,944,000. The
increase in maintenance expense was primarily the result of increases in
non-recurring repairs and maintenance. Non-recurring repairs and maintenance
increased $158,000, or 38.91%, as a result of increases in expenditures for
drywall and plumbing repairs. The expenditures were not considered to be capital
expenditures.
Interest expense decreased $1,522,000, or 21.13%, to $5,682,000. Interest
expense decreased primarily as a result of the refinancing of Seasons and Walden
Pond Apartments. The refinancing resulted in a decrease in the interest rate on
Seasons from 10% to a variable interest rate of approximately 3%. The
refinancing of Walden Pond resulted in a significant reduction in the principal
balance outstanding as compared to the previous mortgage.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED
DECEMBER 31, 1999.
Rental income increased $957,000, or 4.58%, to $21,869,000. The increase was
a result of an increase of 3.69% in weighted average rental rates, plus the
effect of an increase in overall occupancy from 96.79% to 96.93%.
Interest income increased $369,000, or 159.05%, to $601,000. The increase
was a result of higher average cash on hand during 2000 as compared to 1999.
38
Other income, which consists primarily of income from operation of laundry
facilities, late charges, administrative fees, net profits from corporate
apartments, cable revenue, pet charges and miscellaneous charges to residents
increased $61,000, or 9.90%, to $677,000. The increase was attributable to
increases in revenue from cable television contracts, damage charges and
month-to-month income. Cable television contract revenue increased $26,000, or
273%, as a result of a new contract being signed with local cable television
providers. Damage charges increased $12,000, or 14.93%, as a result of increases
in damage done by tenants which was subsequently recovered through billings.
Month-to-month income, which results from premiums being charged to tenants who
do not sign leases, increased $21,000, or 36.92%, as a result of an increase in
the number of tenants who chose the flexibility of a month-to-month arrangement.
The Predecessor has generally limited month-to-month occupants and has made
significant efforts to convert these tenants to longer-term arrangements.
Operating expenses, which primarily consist of property payroll,
advertising, leasing expenses, utilities and property insurance, increased
$402,000, or 8.10%, to $5,364,000. Operating expenses increased primarily as a
result of increases in utilities and property insurance expenses. Utilities
expense increased $305,000, or 15.03%, primarily as a result of increases in gas
expense. In 2001, the Predecessor signed contracts with major regional gas
suppliers to minimize the impact on seasonal price fluctuations. Property
insurance expense increased $49,000, or 36.17%, as a result of general increases
in property insurance premiums.
Maintenance expense increased $97,000, or 5.71%, to $1,797,000. The increase
in maintenance expense was primarily the result of increases in non-recurring
repairs and maintenance. Non-recurring repairs and maintenance increased
$97,000, or 34.19%, primarily as a result of increases in maintenance contract
items. Maintenance contract items generally consist of landscaping, pool
maintenance and other maintenance items performed by third parties.
Management fees increased $283,000, or 28.53%, to $1,275,000. The increase
in management fees was primarily the result of the implementation of advisory
fees payable to an affiliate of The Berkshire Group on Dorsey's Forge, Hannibal
Grove and Century Apartments. These advisory fees resulted in an increase of
$200,000 on an annualized basis.
Interest expense increased $1,002,000, or 16.16%, to $7,204,000. Interest
expense increased primarily as a result of the refinancing of Dorsey's Forge,
Hannibal Grove and Century Apartments in 2000. The refinancing resulted in
increases to the outstanding mortgage principal balances, which resulted in
higher overall interest expense.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL EXPENDITURES, DISTRIBUTIONS, CASH FLOW AND INDEBTEDNESS
We expect our principal liquidity demands to be capital improvements and
repairs and maintenance for the initial properties, acquisition of additional
properties, repayment of indebtedness and, after the completion of the offer,
distributions to our preferred stockholders.
We intend to meet our short-term liquidity requirements through net cash
flows provided by operating activities and, after the completion of the offer,
through distributions of income from the mortgage funds. We consider our ability
to generate cash to be adequate to meet all operating requirements and make
distributions to our stockholders in accordance with the provisions of the Code
applicable to REITs.
Upon completion of the offers, we intend to seek a line of credit secured,
at least in part, by the Interests tendered in the offers. We expect to use this
line of credit primarily as a source of capital for the acquisition of new
properties.
To the extent that we do not satisfy our long-term liquidity requirements
through net cash flows provided by operating activities and, upon the completion
of the offers, through distributions of income from the mortgage funds, we
intend to satisfy these requirements through refinancing or establishing
secondary financing on our real estate investments and through advances on our
proposed line of credit.
As of June 30, 2002, approximately 45% of the Predecessor's mortgage
obligations were under variable interest rates. The weighted average rate of
interest on mortgage debt was 2.89%. As described below, the Predecessor has
taken advantage of the low interest rate market to fix rates on the vast
majority of its mortgage debt. As of July 31, 2002, the weighted average rate of
interest on all mortgage debt was 5.75%. Approximately
39
95% of the mortgage debt was at fixed interest rates. We believe that this
limits the exposure to changes in interest rates, minimizing the effect on our
financial condition, results of operations and cash flow.
MORTGAGE DEBT REFINANCING
On April 1, 2002, the mortgage notes payable on Dorsey's Forge and Hannibal
Grove were refinanced with $10,635,000 and $16,145,000 non-recourse mortgage
notes payable, which were collateralized by the related properties. The interest
rates on the notes were fixed at 5.96%. The notes mature on April 1, 2007, at
which time the remaining principal and accrued interest are due. The notes may
be prepaid, with a prepayment penalty, at any time with 30 days notice. The
Predecessor used the proceeds from the refinancing on Dorsey's Forge and
Hannibal Grove to repay the existing mortgage notes and accrued interest of
approximately $6,011,000 and $10,444,000, respectively, to pay closing costs of
approximately $91,000 and $122,000, respectively, and to fund escrows required
by the lender of approximately $15,000 and $54,000, respectively. The
Predecessor also recognized an approximate $323,000 extraordinary loss resulting
from the prepayment penalty upon the early principal repayment and write-off of
unamortized deferred financing costs for Dorsey's Forge and Hannibal Grove. The
remaining proceeds were distributed to the members of the Predecessor.
On April 1, 2002, the mortgage note payable on Century was refinanced with a
$22,800,000 non-recourse mortgage notes payable, which was collateralized by the
property. The interest rate on the note was fixed at 5.96%. The note matures on
April 1, 2007, at which time the remaining principal and accrued interest are
due. The note may be prepaid, with a prepayment penalty, at any time with
30 days notice. The Predecessor used the proceeds from the refinancing on
Century to repay the existing mortgage note and accrued interest of
approximately $19,219,000, to pay closing costs of approximately $162,000 and to
fund escrows required by the lender of approximately $29,000. The Predecessor
also recognized an approximate $287,000 extraordinary loss resulting from the
prepayment penalty upon the early principal repayment and write-off of
unamortized deferred financing costs for Century. The remaining proceeds were
distributed to the members of the Predecessor.
On July 31, 2002, the mortgage note payable on Seasons of Laurel was
refinanced with a $52,500,000 non-recourse mortgage note payable, which was
collateralized by the property. The interest rate on the note was fixed at
5.74%. The mortgage note matures on August 1, 2009, at which time the remaining
principal and accrued interest are due. The note may be prepaid, with a
prepayment penalty, at any time with 30 days notice. The Predecessor used the
proceeds from the refinancing to repay the existing mortgage note and accrued
interest on the property of approximately $36,412,000, to pay closing costs of
approximately $289,000, to fund escrows required by the lender of approximately
$862,000 and to pay a prepayment penalty of approximately $363,000.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At June 30, 2002, approximately $49,439 of the Predecessor's long-term debt
had fixed interest rates. The fair value of these instruments is affected by
changes in market interest rates. The following table presents principal cash
flows based upon maturity dates of the debt obligations and the related
weighted-average interest rates by expected maturity dates for the fixed rate
debt. The interest rate on the variable rate debt as of June 30, 2002 ranged
from FHLMC Reference Bill plus 0.95% to FHLMC Reference Bill plus 1.74%. FHLMC
is the Federal Home Loan Mortgage Corporation. The FHLMC Reference Bills are
unsecured general corporate obligations. As of June 30, 2002, the FHLMC
Reference Bill was 1.741%.
MORTGAGE DEBT, INCLUDING CURRENT PORTION
(IN THOUSANDS)
-----------------------------------------------------------------------------------------------------------------------------
SIX
MONTHS
ENDING FAIR
12/31/2002 2003 2004 2005 2006 2007+ TOTAL VALUE
---------- -------- -------- -------- -------- -------- -------- --------
Fixed Rate.......................... $ 314 $ 657 $ 698 $ 741 $ 786 $46,281 $49,477 $49,477
Average Interest Rate............... 5.96% 5.96% 5.96% 5.96% 5.96% 5.96%
Variable Rate....................... $ 460 $ 939 $ 966 $ 994 $4,917 $32,582 $40,858 $40,858
The table above reflects the mortgage notes payable as of June 30, 2002. It
does not take into consideration the refinancing of Seasons of Laurel on
July 31, 2002 as described above in "Liquidity and Capital Resources--Mortgage
Debt Refinancing."
40
In connection with the financing of Seasons Apartments in July of 2001, the
Predecessor also entered into an interest rate cap agreement in the notional
amount of $37,000 with a termination date of July 20, 2003. The agreement
provides for a rate cap of 6.65%. The Predecessor holds the derivative for the
purposes of hedging against exposure to changes in the future cash flows
attributable to increases in the interest rate. However, the instrument does not
qualify as an effective hedge for accounting purposes. As a result of the
nominal cost and fair value of the interest rate cap, the premium paid for the
interest rate cap agreement is being amortized over the term of the agreement.
ENVIRONMENTAL ISSUES
There are no recorded amounts resulting from environmental liabilities, as
there are no known contingencies with respect to environmental liabilities.
During the past 18 months, the Predecessor has refinanced each of the initial
properties. As part of the refinancing process, the lenders obtained
environmental audits of each of the initial properties. The Predecessor was not
advised by the lenders as to any material liability for site restoration or
other costs that may be incurred with respect to the sale or disposal of any of
the initial properties.
RECENT ACCOUNTING PRONOUNCEMENTS
In August of 2001, the Financial Accounting Standards Board, which we refer
to as the FASB, issued Statement of Financial Accounting Standards No. 144,
ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, which supersedes
SFAS No. 121. SFAS No. 144 requires that long-lived assets that are to be
disposed of by sale be measured at the lower of the book value or fair value
less cost to sell. SFAS No. 144 retains the requirements of SFAS No. 121
regarding impairment loss recognition and measurement. In addition, it requires
that one accounting model be used for long-lived assets to be disposed of by
sale and broadens the presentation of discontinued operations to include more
disposal transactions. SFAS No.144 is effective for fiscal years beginning after
December 15, 2001. We do not expect the impact of adopting this statement to
have a material effect on our financial condition, results of operations or cash
flows.
In May of 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections
as of April 2002, which rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, among others. As a result of the rescission of SFAS
No. 4, gains or losses from extinguishment of debt are not necessarily
considered extraordinary. SFAS No. 145 is effective for fiscal years beginning
after May 15, 2002. The impact of adopting this statement will require the
Predecessor to reclassify its extraordinary loss into interest expense in the
accompanying statement of operations.
In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED
WITH EXIT OR DISPOSAL ACTIVITIES, which nullifies Emerging Issues Task Force
(EITF) Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION
BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED
IN A RESTRUCTURING). SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred and that an entity's commitment to an exit plan, by itself, does not
create a present obligation to others that meets the definition of a liability.
This Statement also establishes that fair value is the objective for initial
measurement of the liability. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002. The impact of adopting
this statement is not expected to be material to the combined financial
statements.
INFLATION AND ECONOMIC CONDITIONS
Substantially all of the leases at the initial properties are for a term of
one year or less, which enables the Predecessor to seek increased rents for new
leases or upon renewal of existing leases. These short-term leases minimize the
potential adverse effect of inflation on rental income, although residents may
leave without penalty at the end of their lease terms and may do so if rents are
increased significantly.
Historically, real estate has been subject to a wide range of cyclical
economic conditions, which affect various real estate sectors and geographic
regions with differing intensities and at different times. In 2001, many regions
of the United States experienced varying degrees of economic recession, and the
tragic events of September 11, 2001 accelerated some recessionary trends, such
as the cost of obtaining sufficient property and liability insurance coverage,
short-term interest rates and a temporary reduction in occupancy. We believe,
however, that these tragic events did not have a material effect on the initial
properties given our property type, garden style residential apartment
communities, and the geographic regions in which we are located. We will
continue to review our business strategy and do not anticipate any changes in
strategy or material effects on our financial performance.
41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF THE MORTGAGE FUNDS
You should read the following discussion in conjunction with the financial
statements of the mortgage funds and their related notes and other financial
information regarding the mortgage funds included elsewhere in this prospectus.
This discussion contains forward-looking statements. See "--Forward-Looking
Statements" below.
KRUPP GOVERNMENT INCOME TRUST
OVERVIEW
Krupp Government Income Trust, or GIT, was formed on November 1, 1989 as a
Massachusetts business trust. GIT raised approximately $300 million through a
public offering of shares of beneficial interest and used the net proceeds
primarily to acquire participating insured mortgages, or PIMs, participating
insured mortgage investments, or PIMIs, and mortgage-backed securities, or MBS.
GIT considers itself to be engaged only in the industry segment of investment in
mortgages. The trust has elected to be treated as a REIT.
CRITICAL ACCOUNTING POLICIES
GIT's critical accounting policies relate primarily to revenue recognition
related to the participation features of the trust's PIM and PIMI investments as
well as the recognition of deferred interest income on its additional loans. The
trust's critical accounting policies are as follows:
Basic interest is recognized based on the stated rate of the Department of
Housing and Urban Development, or HUD, insured mortgage loan, less the
servicer's fee, or the coupon rate of the MBS of the Government National
Mortgage Association, which we refer to as GNMA, or the Federal National
Mortgage Association, which we refer to as Fannie Mae. GIT recognizes interest
related to the participation features when the amount becomes fixed and the
transaction that gives rise to the amount is completed. The trust defers the
recognition of additional loan interest payments as income to the extent these
interest payments were from escrows established with the proceeds of the
additional loan. When the properties underlying the PIMIs generate sufficient
cash flow to make the required additional loan interest payments and the
additional loan value is deemed collectible, the trust recognizes income as
earned and commences amortization of the deferred interest amounts into income
over the remaining estimated term of the additional loan. During periods where
mortgage loans are impaired GIT suspends amortizing deferred interest.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 TO THE THREE AND
SIX MONTHS ENDED JUNE 30, 2001.
Net income of GIT increased for the three and six months ended June 30, 2002
as compared to the same periods in 2001 due to increases in participation income
and interest income on MBS and a decrease in asset management fees. This was
partially offset by decreases in interest income on PIMs and PIMIs, additional
loan interest and other interest income. Participation income increased due to
the collection of participation income from the Riverview Apartments and Lincoln
Green Apartments PIMs during the second quarter of 2002. Interest income on MBS
increased due to the accelerated recognition of the Parkwest Apartments MBS
purchase discount as income upon the prepayment of the MBS and the receipt of
the prepayment premium. Interest income on PIMs and PIMIs decreased due to the
prepayments of the Red Run and River View Apartments PIMIs and the Waterford
Townhomes PIM in 2002 and the Seasons PIMI in July of 2001. Additional loan
interest decreased due to the Red Run and Seasons PIMI payoffs in January of
2002 and July of 2001, respectively. Other interest income decreased due to
lower average interest rates earned on cash balances available for short-term
investing when compared to the same period in 2001. Asset management fees
decreased due to the decline in GIT's asset base as a result of principal
collections and prepayments.
42
The following discussion relates to the operations of GIT during the years
ended December 31, 2001, 2000 and 1999. Dollars are stated in thousands, except
for per share amounts.
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999
-------------------- -------------------- --------------------
AMOUNT PER SHARE AMOUNT PER SHARE AMOUNT PER SHARE
-------- --------- -------- --------- -------- ---------
Interest income on PIMs and PIMIs:
Basic interest................................. $ 7,901 $ .52 $ 8,087 .54 $ 8,789 $ .58
Additional loan interest....................... 1,515 .10 744 .05 1,535 .18
Participation interest......................... 7,603 .51 505 .03 2,269 .15
Interest income on MBS......................... 1,251 .08 1,376 .09 1,531 .10
Interest income on cash and cash equivalents... 262 .02 365 .02 508 .03
Trust expenses................................. (1,671) (.11) (1,618) (.10) (1,595) (.11)
Amortization of prepaid fees and expenses...... (1,353) (.09) (1,030) (.07) (1672) (.11)
Reduction of (provision for) impaired
additional loans............................. 464 .03 -- -- (48) --
------- ----- ------- ----- ------- -----
Net income..................................... $15,972 $1.06 $ 8,429 $ .56 $12,317 $ .82
======= ===== ======= ===== ======= =====
Weighted average shares outstanding............ 15,053,135 15,053,135 15,053,135
==================== ==================== ====================
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED
DECEMBER 31, 2000.
GIT's net income increased in 2001 when compared to 2000 primarily due to
increases in additional loan and participation interest and a decrease in
provision for impaired mortgage loans. This was partially offset by decreases in
basic interest on PIMs and PIMIs, interest income on MBS, interest income on
cash and cash equivalents and by increases in amortization and general and
administrative expenses. Additional loan interest increased primarily due to the
recognition of deferred revenue from the Seasons and the Red Run additional loan
payoffs. Participation interest increased due to the collection of participation
interest from the Seasons and Red Run payoffs. The provision for impaired
mortgage loans decreased due to an improvement in the performance of the
Lifestyles apartments. Basic interest on PIMs and PIMIs decreased primarily due
to the Seasons PIMI payoff in the third quarter of 2001. Interest income on MBS
decreased due to principal collections reducing the asset balance. Interest
income on cash and cash equivalents decreased due to lower average interest
rates earned on cash balances available for short-term investing in 2001 as
compared to 2000. Amortization expense increased due to the payoff of the Red
Run PIMI. General and administrative expenses increased due to an increase in
legal fees associated with the research related to the classification of income
for REIT purposes.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED
DECEMBER 31, 1999.
GIT's net income decreased by approximately $3.9 million for 2000 when
compared to 1999 primarily due to decreases in interest income net of decreases
in amortization expense and asset management fees due to an affiliate. Basic
interest on PIMs and PIMIs, additional loan interest and participation interest
decreased by $4.3 million in 2000 primarily due to the payoff of the Audubon
Villas PIMI in the third quarter of 1999. Interest income on MBS will continue
to decline as principal collections reduce the MBS investment balance. Interest
income on cash and cash equivalents decreased due to lower average cash
balances. Amortization expense decreased due to the payoff of the Audubon Villas
PIMI. The decrease in asset management fees was due to the trust's asset base
declining.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW AND DIVIDENDS
GIT had cash and cash equivalents of approximately $5.7 million at June 30,
2002 and approximately $13.2 million at December 31, 2001. GIT also had cash
inflows provided by PIMs, PIMIs, MBS, cash and cash equivalents. GIT may also
receive additional cash flow from the participation features of its PIMs and
PIMIs. GIT anticipates that these sources will be adequate to provide the trust
with sufficient liquidity to meet its obligations, including providing dividends
to its investors.
43
The most significant demands on GIT's liquidity are quarterly dividends paid
to investors of approximately $2.6 million and special dividends. Funds for
dividends come from interest income received on PIMs, PIMIs, MBS and cash and
cash equivalents net of operating expenses, and the principal collections
received on PIMs, PIMIs and MBS. The portion of dividends funded from principal
collections reduces the capital resources of the trust. As the capital resources
of the trust decrease, the total cash flows to the trust will also decrease,
which may result in periodic adjustments to the dividends paid to the investors.
The advisor of GIT periodically reviews the dividend rate to determine
whether an adjustment is necessary based on projected future cash flows. The
current quarterly dividend rate is $0.17 per share. The trustees, based on the
advisor's recommendations, generally set a dividend rate that provides for level
quarterly dividends. To the extent quarterly dividends do not fully utilize the
cash available for distribution and cash balances increase, the trustees may
adjust the dividend rate or distribute these funds through a special dividend.
In addition to providing guaranteed or insured monthly principal and
interest payments, GIT's investments in PIMs and PIMIs also may provide
additional income through the interest on the additional loan portion of the
PIMIs as well as participation interest based on operating cash flow and an
increase in the value realized upon the sale or refinancing of the underlying
properties. However, these payments are neither guaranteed nor insured and
depend upon the successful operations of the underlying properties.
PAYMENTS RECEIVED FROM INVESTMENTS
On June 28, 2002, GIT received a prepayment of the Lincoln Green Apartments
subordinated promissory note. GIT received $725,000 of shared appreciation
interest and $278,785 of shared income interest and minimum additional interest.
On July 25, 2002, GIT received $13,676,641 representing the principal proceeds
on the first mortgage loan from the Lincoln Green Apartments PIM. The advisor of
GIT expects to pay a special dividend of $0.99 per share during the third
quarter of 2002 from the proceeds of the Lincoln Green Apartments PIM
prepayment.
On May 15, 2002, GIT received $8,884,123 representing the principal proceeds
on the first mortgage loan from the River View Apartments PIM. In addition, GIT
received a prepayment premium of $88,841 from the payoff. On June 4, 2002, the
trust paid a special dividend of $0.61 per share from the proceeds of the River
View Apartments PIM prepayment.
Also on May 15, 2002, GIT received $2,487,447 representing the principal
proceeds on the first mortgage loan from the Parkwest Apartments MBS. In
addition, GIT received a prepayment premium of $49,749 from this payoff. On
June 19, 2002, the trust paid a special dividend of $0.17 per share from the
proceeds of the Parkwest Apartments MBS prepayment.
On January 3, 2002, GIT received $18,330,825 representing the principal
proceeds on the first mortgage loan from the Red Run PIMI. On December 31, 2001,
GIT received a prepayment of the Red Run additional loan and subordinated
promissory note. The trust received $2,900,000 of additional loan principal,
$238,369 of shared appreciation interest, $3,506,952 of preferred interest and
$67,667 of base interest on the additional loan. On January 16, 2002, the trust
paid a special dividend of $1.68 per share from the proceeds of the Red Run PIMI
prepayment.
On January 2, 2002, GIT received a prepayment of the Waterford Apartments
subordinate promissory note. GIT received $379,725 of minimum additional
interest and $425,643 of shared appreciation interest. On January 17, 2002, the
trust received $6,625,742 representing the principal proceeds on the first
mortgage loan. In addition, GIT received a prepayment premium of $66,257 from
the payoff. On March 1, 2002, the trust paid a special dividend of $0.51 per
share from the proceeds of the Waterford Apartments PIM prepayment.
The three remaining PIMI investments all operate under workout agreements
with the trust. Those agreements have modified the borrowers' obligations to
make additional loan interest payments, regardless of whether the property
generated sufficient revenues to do so, to an obligation to pay additional loan
interest only if the property generates surplus cash, as defined by HUD. For the
period ending December 31, 2001, Mountain View did not generate any surplus
cash, although both Windward Lakes and Lifestyles did generate some surplus
cash. However, due to the need to complete capital projects at both properties,
GIT agreed that the surplus cash generated by the two properties will not be
used to pay additional loan interest. Consequently, the trust does not expect to
receive any additional loan interest during 2002. Beginning in 2002, the trust
has amortized and
44
recognized additional loan income previously deferred with respect to Windward
Lakes as the property generated surplus cash during 2001.
Windward Lakes' operating results deteriorated during 1995 and 1996, and in
early 1997 the independent trustees approved a workout with the borrower of the
Windward Lakes PIMI, an affiliate of the advisor of GIT. In the workout, GIT
agreed to reduce the effective basic interest rate on the insured first mortgage
by 2% per annum for 1997 and 1% per annum for 1998, 1999 and 2000. The borrower
made an equity contribution of $133,036 to the property and agreed to cap the
annual management fee paid to an affiliate at 3% of revenues. The trust's
participation in current operations is 50% of any surplus cash, and the
additional loan interest is payable out of its share of surplus cash. Any unpaid
additional loan interest accrues at 7.5% per annum. When the property is sold or
refinanced, GIT will receive 50% of any net proceeds remaining after repayment
of the insured mortgage, the additional loan, the interest rate relief, accrued
and unpaid additional loan interest and the borrower's equity up to the point
that the trust has received a cumulative, non-compounded 10% preferred return on
its investment in the PIMI. The additional loan was scheduled to mature in July
of 2002. However, the advisor of GIT granted a sixty day extension to the
borrower to allow the borrower additional time to finalize a more comprehensive
proposal regarding a longer-term extension of the maturity date.
In May 1998, the borrower on the Lifestyles PIMI defaulted on its debt
service payment on the insured first mortgage. GIT agreed to a new workout that
runs through 2007. Under the terms of the workout, the trust agreed to reduce
the effective interest rate on the insured first mortgage by 1.75% retroactively
for 1998 to clear the default, by 1.75% for 1999, and by 1.5% each year after
that until 2007. An affiliate of the advisor of GIT refunds approximately .25%
per annum to the trust related to the interest reduction. The borrower made a
$550,000 equity contribution, which was escrowed, for the exclusive purpose of
correcting deferred maintenance and making capital improvements to the property.
The escrow has been used up for paint, building repairs, parking lot repairs, a
new fitness facility, clubhouse remodeling and landscaping. Any surplus cash
that is generated by property operations will be split evenly between the trust
and the borrower. When the property is sold or refinanced, the first $1,100,000
of any proceeds remaining after the insured mortgage is paid off will be split
50% / 50% between the trust and the borrower; the next $1,690,220 of proceeds
will be split 75% to the trust and 25% to the borrower; and any remaining
proceeds will be split 50% / 50%. The borrower's new equity and the reduction in
the effective interest rate on the insured first mortgage have provided funds
for repairs and improvements that have helped reposition Lifestyles. As a result
of the performance of the property, GIT had initially established a valuation
allowance of $1,130,346 on the additional loan in 1998. During 2001, the trust
received a payment of $118,968, which was recorded as a reduction in the
principal balance of the additional loan and related impairment provision. Based
on improved market conditions and property operations, the trust further reduced
the impairment provision by $344,839 to $666,539 in the fourth quarter of 2001.
Mountain View is similar to Lifestyles with respect to competitive market
conditions. In June of 1999, GIT approved a second workout that runs through
2004. Under the terms of the workout, the trust agreed to reduce the effective
interest rate on the insured first mortgage by 1.25% retroactively for 1999 and
each year after that until 2004, and to change the participation terms. The
workout eliminated the preferred return feature, forgave $288,580 of previous
accruals of additional loan interest related to the first workout, and changed
the trust's participation in surplus cash generated by the property. GIT will
receive 75% of the first $130,667 of surplus cash and 50% of any remaining
surplus cash on an annual basis to pay additional loan interest. Unpaid
additional loan interest related to the second workout will accrue and be
payable if there are sufficient proceeds from a sale or refinancing of the
property. In addition, the borrower repaid $153,600 of the additional loan and
funded approximately $54,000 to a reserve for property improvements. As a result
of the factors described above, the advisor of GIT determined that the
additional loan collateralized by the Mountain View asset was impaired and
currently maintains a valuation allowance of $1,032,272.
GIT received participation interest based on cash flow generated by property
operations from six of its investments during the twelve months ended
December 31, 2001. Waterford Townhomes paid $60,502, Red Run paid $72,841, The
Seasons paid $50,750, Lifestyles paid $118,968, Rivergreens paid $69,067 and
Lincoln Green paid $223,873.
On July 23, 2001, GIT received a prepayment of the Seasons subordinated
promissory note and the Seasons additional loan. GIT received $1,924,649 of
additional loan principal, $180,916 of surplus cash, $847,450 of preferred
interest, $1,052,455 of contingent interest, $69,129 of base interest on the
additional loan and $1,299,562 which represents GIT's portion of the residual
split. The trust received $8,567,890 representing the principal
45
proceeds on the first mortgage note on July 26, 2001. In addition, the trust
recognized $180,633 of additional loan interest that had been previously
received and recorded in deferred income on additional loans. On August 17,
2001, the advisor of GIT paid a special dividend of $0.93 per share from the
proceeds of the Seasons PIMI prepayment.
The payoff of the Seasons PIMI was a result of the sale of the underlying
property by the borrower, Maryland Associates Limited Partnership, which is an
affiliate of the GIT Adviser, to an affiliate of the borrower's general partner.
Because the sale of the underlying property was to an affiliate, the independent
trustees of GIT were required to approve the transaction, which they did based
upon a number of factors, including an appraisal of the underlying property
prepared by an independent third party Member Appraisal Institute appraiser. The
purchase price paid by the affiliate for the underlying property was
$1.6 million greater than the value indicated by the appraisal.
During the third quarter of 1999, GIT received a prepayment of the Audubon
Villas PIMI when the property was refinanced. GIT received the prepayment of the
principal balance of the insured mortgage of $14,861,957, the principal balance
of the additional loan of $2,691,000 and participation income of $1,966,901.
Also, $1,962,261 was recognized as additional loan interest income that was
previously recorded as deferred income. On August 18, 1999, the advisor of GIT
declared a special dividend of $1.30 per share that was paid on September 17,
1999 from the payoff of the Audubon Villas PIMI.
Whether the operating performance at any of the properties mentioned above
provides sufficient cash flow from operations to pay either the additional loan
interest or participation income will depend on factors that the trust has
little or no control over. If the properties are unable to generate sufficient
cash flow to pay the additional loan interest, it would reduce the trust's
distributable cash flow and could affect the value of the additional loan
collateral.
There are contractual restrictions on the repayment of the PIMs and PIMIs.
During the first five years of the investment, borrowers are prohibited from
repayment. During the second five years, the PIM borrowers can prepay the
insured first mortgage by paying the greater of a prepayment premium or the
participation due at the time of the prepayment. Similarly, the PIMI borrowers
can prepay the insured first mortgage and the additional loan by satisfying the
preferred return obligation. The participation features and additional loans are
neither insured nor guaranteed. If the prepayment of the PIM or PIMI results
from the foreclosure on the underlying property or an insurance claim, the trust
would probably not receive any participation income or any amounts due under the
additional loan.
GIT has the option to call some of the PIMs and all the PIMIs by
accelerating their maturity if the loans are not prepaid by the tenth year after
permanent funding. The advisor of GIT will determine the merits of exercising
the call option for each PIM and PIMI as economic conditions warrant. Factors
such as the condition of the asset, local market conditions, the interest rate
environment and available financing will have an impact on these decisions.
KRUPP GOVERNMENT INCOME TRUST II
OVERVIEW
Krupp Government Income Trust II, or GIT II, was formed as a Massachusetts
business trust on February 8, 1991. GIT II raised approximately $366 million
through a public offering of shares of beneficial interest and used the net
proceeds primarily to acquire PIMs, PIMIs and MBS. GIT II considers itself to be
engaged only in the industry segment of investment in mortgages. The trust has
elected to be treated as a REIT.
CRITICAL ACCOUNTING POLICIES
GIT II's critical accounting policies relate primarily to revenue
recognition related to the participation features of the trust's PIM and PIMI
investments as well as the recognition of deferred interest income on its
additional loans. The trust's policies are as follows:
Basic interest is recognized based on the stated rate of the HUD insured
mortgage loan, less the servicer's fee, or the coupon rate of the Fannie Mae
MBS. The trust recognizes interest related to the participation features when
the amount becomes fixed and the transaction that gives rise to the amount is
completed. The trust defers the recognition of additional loan interest payments
as income to the extent these interest payments are from
46
escrows established with the proceeds of the additional loan. When the
properties underlying the PIMIs generate sufficient cash flow to make the
required additional loan interest payments and the additional loan value is
deemed collectible, the trust recognizes income as earned and commences
amortizing deferred interest amounts into income over the remaining estimated
term of the additional loan. During periods where mortgage loans are impaired
the trust suspends amortizing deferred interest.
The trust also fully reserves the portion of any additional loan interest
payment satisfied through the issuance of an operating loan and any associated
interest due on the operating loan. The trust will recognize the income related
to the operating loan when the borrower repays amounts due under the operating
loan.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2002 TO THE THREE MONTHS ENDED
JUNE 30, 2001.
GIT II's net income decreased in the three months ended June 30, 2002 as
compared to the same period in 2001 primarily due to decreases in basic interest
on PIMs and PIMIs and additional loan interest. This was partially offset by
decreases in amortization expense and asset management fees. Basic interest on
PIMs and PIMIs decreased due to the Norumbega Pointe and Windmill Lakes payoffs
and the payoff of the Seasons PIMI in July of 2001. These prepayments also
caused additional loan interest to decrease. Amortization expense was greater
during the three months ended June 30, 2001 as compared to June 30, 2002 as a
result of the full amortization of the remaining prepaid fees and expenses on
the PIMI prepayments in 2001. Asset management fees decreased due to the
decrease in the trust's investments as a result of principal collections and
payoffs.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED
JUNE 30, 2001.
GIT II's net income increased during the six months ended June 30, 2002 as
compared to the same period in 2001 primarily due to an increase in additional
loan interest and decreases in asset management fees and the provision for
impaired mortgage loan. This was partially offset by an increase in amortization
expense and a decrease in basic interest from PIMs and PIMIs. Additional loan
interest increased primarily due to the recognition of deferred income from the
Norumbega Pointe payoff and base interest recognized from the Windmill Lakes
payoff. The decrease in asset management fees was a result of the trust's asset
base declining from PIM and PIMI prepayments in 2001 and the six months ended
June 30, 2002. These prepayments also caused basic interest on PIMs and PIMIs to
decrease. Amortization expense increased primarily due to the full amortization
of the remaining prepaid fees and expenses related to the Norumbega Pointe and
Windmill Lakes payoffs. The provision for impaired mortgage decreased due to the
reversal of the impairment provision for the Windmill Lakes PIMI as a result of
the additional loan payoff received on March 28, 2002.
The following relates to the operations of GIT II during the years ended
December 31, 2001, 2000, and 1999.
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999
-------------------- -------------------- --------------------
AMOUNT PER SHARE AMOUNT PER SHARE AMOUNT PER SHARE
-------- --------- -------- --------- -------- ---------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Interest on PIMs and PIMIs:
Basic interest................................. $ 9,674 $ .52 $11,260 .61 $11,998 $ .66
Additional loan interest....................... 2,208 .12 1,784 .10 1,712 .09
Participation interest......................... 11,873 .64 1,915 .11 1,592 .08
Interest income on MBS......................... 1,197 .07 1,455 .08 3,251 .18
Interest income on cash and cash equivalents... 378 .02 564 .03 1,060 .06
Trust expenses................................. (2,081) (.11) (2,215) (.12) (2,274) (.12)
Amortization of prepaid fees and expenses...... (2,608) (.14) (2,132) (.12) (2,365) (.13)
Reduction of (provision for) impaired
additional loans............................. 1,500 .09 994 .05 -- --
------- ----- ------- ----- ------- -----
Net income..................................... $22,141 $1.21 $ 8,429 $ .74 $14,974 $ .82
======= ===== ======= ===== ======= =====
Weighted average shares outstanding............ 18,371,477 18,371,477 18,371,477
==================== ==================== ====================
47
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED
DECEMBER 31, 2000.
GIT II's net income increased in 2001 when compared to 2000 primarily due to
increases in additional loan and participation interest on PIMs and PIMIs and
decreases in asset management fees and the provision for impaired mortgage loan.
This was partially offset by a decrease in basic interest from PIMs and PIMIs
and increases in amortization expense and general and administrative expenses.
Additional loan and participation interest increased primarily due to the
Seasons payoff in July 2001 and the Falls at Hunters Pointe payoff in
March 2001. Asset management fees decreased due to the decrease in the trust's
investments as a result of the payoffs mentioned above. The provision for
impaired mortgage decreased due to the reduction of the impairment provision for
the Windmill Lakes additional loan. The payoffs also caused basic interest from
PIMs and PIMIs to decrease and amortization expense to increase as the prepaid
fees and expenses associated with these PIMIs were fully amortized. General and
administrative expenses increased due to an increase in legal fees associated
with the research related to the classification of income for REIT purposes.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED
DECEMBER 31, 1999.
GIT II's net income decreased $1.3 million for 2000 when compared to 1999
primarily due to lower interest income. Basic interest on PIMs and PIMIs
decreased due to the payoff of the Windsor Lake PIMI in January of 2000. MBS
interest decreased due to the payoff of the Estates MBS in 1999 and the receipt
of a $1.0 million prepayment premium at payoff. Amortization expense in 2000
decreased because the trust fully amortized the remaining prepaid acquisition
costs and participating servicing fees related to the Windsor Lake PIMI payoff.
The trust reversed its provision for impaired mortgage loans, associated with
the Oasis additional loan, by $994,000 as a result of improved property
operations.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW AND DIVIDENDS
GIT II had cash and cash equivalents of approximately $4.9 million at
June 30, 2001 and approximately $6.5 million at December 31, 2001. GIT II also
had cash inflows provided by PIMs, PIMIs, MBS, cash and cash equivalents. GIT II
may also receive additional cash flow from the participation features of its
PIMs and PIMIs. The trust anticipates that these sources will be adequate to
provide the trust with sufficient liquidity to meet its obligations, including
providing dividends to its investors.
The most significant demands on GIT II's liquidity are quarterly dividends
paid to investors of approximately $2.6 million and special dividends. Funds for
dividends come from interest income received on PIMs, PIMIs, MBS and cash and
cash equivalents net of operating expenses, and the principal collections
received on PIMs, PIMIs and MBS. The portion of dividends funded from principal
collections reduces the capital resources of the trust. As the capital resources
of the trust decrease, the total cash flows to the trust will also decrease
which may result in periodic adjustments to the dividends paid to the investors.
The advisor of GIT II periodically reviews the dividend rate to determine
whether an adjustment is necessary based on projected future cash flows. The
trustees, based on the advisor's recommendations, generally set a dividend rate
that provides for level quarterly distributions. To the extent quarterly
dividends do not fully utilize the cash available for distribution and cash
balances increase, the trustees may adjust the dividend rate or distribute these
funds through a special dividend. On May 16, 2002, the trustees declared a
quarterly dividend rate of $0.14 per share, reduced from $0.24 per share,
effective with the dividend payable on August 14, 2002.
In addition to providing guaranteed or insured monthly principal and
interest payments, GIT II's investments in the PIMs and PIMIs also may provide
additional income through the interest on the additional loan portion of the
PIMIs as well as participation interest based on operating cash flow and
increase in the value realized upon the sale or refinance of the underlying
properties. However, these payments are neither guaranteed nor insured and
depend on the successful operations of the underlying properties.
PAYMENTS RECEIVED FROM INVESTMENTS
GIT II received the first installment of additional loan interest due in
2002 from all five of its PIMI investments during the six months ended June 30,
2002.
48
During the first quarter of 2002, the trust received $90,334 of
participation interest from the operations of Mequon Trails. In addition, the
trust received and recognized participation interest related to the Norumbega
Pointe payoff, as discussed below.
On March 28, 2002, GIT II received a prepayment of the Windmill Lakes
subordinated promissory note and the Windmill Lakes additional loan. The trust
received $2,000,000 of additional loan principal and $162,500 of additional loan
interest. The trust recognized $562,500 of the additional loan principal as
additional loan interest. Due to the payoff, the remaining impairment provision
of $500,000 was reversed. On April 25, 2002, the trust received $10,727,382
representing the principal proceeds on the first mortgage note from Windmill
Lakes. The trust paid a special dividend of $0.71 per share from the proceeds of
the Windmill Lakes prepayment on May 1, 2002.
On February 13, 2002, GIT II received a prepayment of the Norumbega Pointe
subordinated promissory note and the Norumbega Pointe additional loan. The trust
received $3,063,000 of additional loan principal, $302,877 of shared
appreciation interest and $2,280,362 of preferred interest. On February 25,
2002, the trust received $15,123,167 representing the principal proceeds on the
first mortgage note. In addition, the trust recognized $1,242,282 of additional
loan interest that had been previously received and recorded as deferred income
on the additional loan. The trust paid a special dividend of $1.14 per share
from the proceeds of the Norumbega Pointe prepayment on March 12, 2002.
GIT II received participation interest based on cash flow generated by
property operations from four of its investments during the twelve months ended
December 31, 2001. Sunset Summit paid $113,253, Martin's Landing paid $217,585,
the Lakes paid $380,431 and the Seasons paid $129,872. In addition, GIT II
received and recognized participation interest related to the payoffs of the
Seasons and Hunters Pointe PIMIs. During 2000, property operations at Oasis
improved enough that the trust was able to reverse its allowance for loan loss
of $994,000 on this property.
Windmill Lakes is a twelve-year old, basic apartment community that has not
been able to compete against the influx of new apartment communities that have
extensive amenity packages. Builders use deep marketing concessions to fill the
new properties, lowering the cost of renting a new apartment and making it more
difficult for older properties like Windmill Lakes to attract residents. During
the fourth quarter of 2000, occupancy was in the 70% range. The property's curb
appeal, a critical element in a competitive market, has suffered as well because
there has not been enough cash flow for adequate maintenance. The borrower on
the Windmill Lakes PIMI has been unable to secure a purchaser for the property
at a price high enough to cover all of the ownership entity's outstanding
liabilities and has decided to sell the apartments off as condominiums.
Converting a multifamily property to condominium ownership is often a long
process that requires resources and expertise in marketing, financing, legal
matters and construction. Local and state agencies regulate the conversion of
existing housing into condominium ownership, and there are various compliance
regulations governing the process as well. On July 25, 2001, the borrower
finalized an agreement with GIT II which will allow for the release of the
participation features on the PIMI in the event that the first mortgage, the
additional loan and any accrued but unpaid base interest on the additional loan
are paid in full by September 1, 2002. In addition, the trust required the owner
to pay current and outstanding additional loan base interest as of March 1, 2001
of $512,500. In the event that the required payments are not received, the
participation features will remain in force. As a result of the performance of
the property, the trust had initially established a valuation allowance of
$2,000,000 on the additional loan in 1998. The trust reflected the $512,500
received plus $50,000 previously received as a reduction in the principal
balance of the additional loan and related impairment provision. Additionally,
based upon improved market conditions and property operations, the trust further
reduced the impairment provision by $937,500 to $500,000 in the fourth quarter
of 2001.
On July 23, 2001, GIT II received a prepayment of the Seasons subordinated
promissory note and the Seasons additional loan. GIT II received $4,925,351 of
the additional loan principal, $462,983 of surplus cash, $2,168,701 of preferred
interest, $2,693,326 of contingent interest, $176,908 of unpaid base interest on
the additional loan and $3,325,696 which represents the trust's portion of the
residual split. GIT II received $21,926,006 representing the principal proceeds
on the first mortgage note on July 26, 2001. In addition, the trust recognized
$624,023 of additional loan interest that had been previously received and
recorded in deferred income on additional loans. The advisor of GIT II paid a
special dividend of $1.95 per share on August 17, 2001 from the proceeds of the
Seasons PIMI prepayment.
49
The payoff of the Seasons PIMI was a result of the sale of the underlying
property by the borrower, Maryland Associates Limited Partnership, which is an
affiliate of the adviser of GIT II, to an affiliate of the borrower's general
partner. Because the sale of the underlying property was to an affiliate, the
independent trustees of GIT II were required to approve the transaction, which
they did based upon a number of factors, including an appraisal of the
underlying property prepared by an independent third party Member Appraisal
Institute appraiser. The purchase price paid by the affiliate for the underlying
property was $1.6 million greater than the value indicated by the appraisal.
In November 1999, GIT II notified the borrower on the Falls at Hunters
Pointe PIMI that it was in default for non-payment of participating interest due
to the trust based on 1997 and 1998 operating results. The borrower failed to
cure the default. Consequently, GIT II elected to use a portion of the
borrower's funds held in escrow to cure the 1997 portion of the default. The
borrower remained in default for 1998 and 1999 operating results. The trust
filed a complaint against the partners of the borrowing entity to collect the
delinquent participation interest related to 1998 and 1999 operations along with
late payment penalties and legal fees. In response to this action, the borrower
on the PIMI put the property up for sale. During the first quarter of 2001, GIT
II received a payoff of the Falls at Hunters Pointe PIMI as a result of the sale
of the property. The trust received the outstanding balance on the insured
mortgage of $12,347,267, the outstanding balance on the additional loan of
$650,000, participating income interest on the additional loan of $496,207
(including all of the delinquent amounts), preferred interest on the additional
loan of $492,543, participating appreciation interest under the subordinate loan
agreement of $1,070,304 and late fees on the delinquent participating income
interest of $11,021. In addition, GIT II recognized $196,710 of additional loan
interest and $311,132 of participating income interest that had been previously
received and recorded in deferred income on additional loans. On March 20, 2001,
the trust paid a special dividend of $0.83 per share from the proceeds of the
Falls at Hunters Pointe PIMI payoff.
In addition to the amounts received from the payoffs of the Seasons and
Hunters Pointe PIMIs, GIT II received both installments of additional loan
interest due in 2001 from five of its PIMI investments. During 1999, the advisor
of GIT II determined that the borrower on the Norumbega PIMI had paid additional
loan interest from funds other than surplus cash, which resulted in overpayments
during the previous three years. The overpayment was credited to the borrower
when the loan was prepaid.
On December 16, 1999, GIT II received $2,832,907 from Windsor Lake
consisting of $2,000,000 from the payoff of the additional loan, $40,000 of
additional loan interest and $792,907 of participation interest. The payoff of
the balance on the insured mortgage, $9,172,642, was received on January 26,
2000. The trust paid a special dividend of $0.66 per share from the prepayment
proceeds.
On October 18, 1999, GIT II received a payoff of $12,399,164 from the
Estates MBS consisting of an insured mortgage of $11,375,380 and a prepayment
premium of $1,023,784. During October 1999, the trust paid a special dividend of
$0.68 per share from the proceeds received from the Estates MBS payoff.
There are contractual restrictions on the prepayment of the PIMs and PIMIs.
During the first five years of the investment, borrowers are generally
prohibited from repayment. During the second five years, the PIM borrowers can
prepay the insured mortgage by paying the greater of a prepayment premium or the
participation interest due at the time of the prepayment. Similarly, the PIMI
borrowers can prepay the insured mortgage and the additional loan by satisfying
the preferred return obligation. The participation features and the additional
loans are neither insured nor guaranteed. If the prepayment of the PIM or PIMI
results from the foreclosure on the underlying property or an insurance claim,
the trust generally would not receive any participation interest or any amounts
due under the additional loan.
The trust has the option to call some of the PIMs and all the PIMIs by
accelerating their maturity if the loans are not prepaid by the tenth year after
permanent funding. The advisor of GIT II will determine the merits of exercising
the call option for each PIM and PIMI as economic conditions warrant. Factors
such as the condition of the asset, local market conditions, the interest rate
environment and available financing will have an impact on these decisions.
50
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
OVERVIEW
Krupp Insured Mortgage Limited Partnership, or KIM, was formed on March 21,
1988 as a Massachusetts limited partnership. KIM raised approximately
$299 million through a public offering of limited partner interests evidenced by
units of depositary receipts. The partnership used the net proceeds of the
public offering primarily to acquire PIMs and MBS. KIM considers itself to be
engaged only in the industry segment of investment in mortgages.
CRITICAL ACCOUNTING POLICIES
KIM's critical accounting policies relate primarily to revenue recognition
related to the participation feature of the partnership's PIM investments. The
partnership's policies are as follows:
Basic interest on PIMs is recognized based on the stated rate of the
FHA-insured mortgage loan, less the servicer's fee, or the stated coupon rate of
the GNMA MBS. The partnership recognizes interest related to the participation
features when the amount becomes fixed and the transaction that gives rise to
the amount is completed.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2002 TO THE THREE MONTHS ENDED
JUNE 30, 2001.
Net income decreased in the three months ended June 30, 2002 as compared to
the same period in 2001 primarily due to lower basic interest on PIMs, MBS
interest income and other interest income. This decrease was also due to an
increase in general and administrative expenses and was partially offset by a
decrease in asset management fees. Basic interest on PIMs decreased primarily
due to the reclassification of the Richmond Park PIM to a MBS in May of 2001.
For an explanation of this reclassification, please refer to the discussion
under "Liquidity and Capital Resources--Payments Received from Investments"
below. MBS interest income decreased primarily due to the prepayment of the
single family MBS at speeds greater than previously anticipated. Other interest
income decreased due to significantly lower average cash balances available for
short-term investing and the interest rates earned on those balances in the
three-month period versus the same period last year. General and administrative
expenses were higher in 2002 when compared to 2001 due to the overpayment of
2000 processing costs that were refunded in 2001. Asset management fees
decreased due to the decrease in the partnership's investments as a result of
principal collections from MBS and PIMs.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED
JUNE 30, 2001.
Net income decreased in the six months ended June 30, 2002 as compared to
the same period in 2001 primarily due to lower basic interest on PIMs and other
interest income and an increase in general and administrative expenses. This
decrease was partially offset by an increase in MBS interest income and a
decrease in asset management fees. Basic interest on PIMs decreased primarily
due to the reclassification of the Richmond Park PIM to a MBS in May of 2001.
For an explanation of this reclassification, please refer to the discussion
under "Liquidity and Capital Resources--Payments Received from Investments"
below. Other interest income decreased due to significantly lower average cash
balances available for short-term investing and the interest rates earned on
those balances in the six-month period versus the same period last year. General
and administrative expenses were higher in 2002 when compared to 2001 due to the
overpayment of 2000 processing costs that were refunded in 2001. MBS interest
income increased due to the Richmond Park reclassification. Asset management
fees decreased due to the decrease in the partnership's investments as a result
of principal collections from MBS and PIMs.
51
The following discussion relates to the operations of KIM during the years
ended December 31, 2001, 2000 and 1999.
2001 2000 1999
-------- -------- --------
(AMOUNTS IN THOUSANDS)
Interest income on PIMs:
Basic interest............................................ $2,069 $2,773 $ 6,325
Participation interest.................................... 19 941 1,666
Interest income on MBS...................................... 902 550 1,206
Other interest income....................................... 130 427 609
Partnership expenses........................................ (536) (674) (1,006)
Amortization of prepaid fees and expenses................... (73) (138) (1,298)
------ ------ -------
Net income................................................ $2,511 $3,879 $ 7,502
====== ====== =======
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED
DECEMBER 31, 2000.
Net income decreased in 2001 when compared to 2000 primarily due to lower
basic interest and participation interest on PIMs and other interest income.
This was partially offset by an increase in MBS interest income and decreases in
general and administrative expenses, asset management fees and amortization
expense. Basic interest on PIMs decreased primarily due to the payoffs of the
Enclave, Bell Station and Brookside PIMs in 2000 and the reclassification of the
Richmond Park PIM to a MBS in May 2001. Participation interest was higher during
2000 due to amounts collected in connection with the PIM payoffs received. Other
interest income decreased due to significantly lower average interest rates
earned on cash balances available for short-term investing in 2001 versus 2000.
MBS interest income increased due to the Richmond Park reclassification. General
and administrative expenses were greater during 2000 due to higher processing
costs. The decrease in asset management fees was a result of the partnership's
asset base declining from the PIM prepayments. Amortization expense was greater
during 2000 as compared to 2001 as a result of the full amortization of the
remaining prepaid fees and expenses on the PIM prepayments in 2000.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED
DECEMBER 31, 1999.
Net income decreased in 2000 as compared to 1999 primarily due to lower
interest income on PIMs and MBS. Basic interest on PIMs decreased due to the
payoffs of the Enclave, Bell Station and Brookside PIMs in 2000 and the
Salishan, Saratoga, Marina Shores and Valley Shores PIMs in 1999. Participation
interest decreased due to the PIM payoffs mentioned above. MBS interest income
decreased primarily due to the payoff of the Patrician MBS in 1999. Expenses
decreased in 2000 compared with 1999 primarily due to lower asset management
fees and amortization expenses. The decrease in asset management fees was a
result of the partnership's asset base declining. Amortization expense was
greater in 1999 as compared to 2000 as a result of the full amortization of the
remaining prepaid fees and expenses on the 1999 PIM prepayments being greater
than the 2000 PIM prepayments.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW AND DIVIDENDS
KIM had cash and cash equivalents of approximately $11.4 million at
June 30, 2002 and approximately $3.6 million at December 31, 2001. KIM also had
cash flow provided by its investments in PIMs and MBS. KIM anticipates that
these sources will be adequate to provide the partnership with sufficient
liquidity to meet its obligation as well as to provide distributions to its
investors.
The most significant demand on the partnership's liquidity is the quarterly
distribution paid to investors of approximately $900,000. Funds for the
quarterly distributions come from monthly principal and interest payments
received on the PIMs and MBS, the principal prepayments of the MBS and interest
earned on the partnership's cash and cash equivalents. The portion of
distributions attributable to the principal collections and cash reserves
reduces the capital resources of the partnership. As the capital resources
decrease, the total cash flows to the partnership will also decrease and over
time will result in periodic adjustments to the distributions paid to investors.
The general partners of KIM periodically review the distribution rate to
determine whether an adjustment is necessary based on projected future cash
flows. In general, the general partners try to set a
52
distribution rate that provides for level quarterly distributions. To the extent
that quarterly distributions do not fully utilize the cash available for
distributions and cash balances increase, the general partners may adjust the
distribution rate and distribute these funds through a special distribution.
Based on current projections, the general partners have determined that the
partnership will continue to pay a distribution of $0.06 per limited partner
interest per quarter for the near future.
PAYMENTS RECEIVED FROM INVESTMENTS
KIM received a payoff of the Richmond Park Apartments MBS on June 17, 2002
for $8,796,086. KIM intends to pay a special distribution of $0.59 per limited
partner interest from the proceeds of the Richmond Park prepayment in the third
quarter of 2002.
On March 1, 2002, the partnership paid a special distribution of $0.10 per
limited partner interest due to prepayment of the single family MBS at speeds
greater than previously anticipated.
In addition to providing insured or guaranteed monthly principal and basic
interest payments, the partnership's PIM investments also may provide additional
income through its participation interest in the underlying properties. The
partnership may receive a share in any operating cash flow that exceeds debt
service obligations and capital needs or a share in any appreciation in value
when the properties are sold or refinanced. However, this participation is
neither guaranteed nor insured, and it is dependent upon whether property
operations or its terminal value meet specified criteria.
KIM agreed in December of 2000 to provide debt service relief for the
Wildflower PIM due to the property's poor operating performance in the
competitive Las Vegas market. Occupancy had fallen as low as 80%, and the
property had been unable to generate sufficient revenues to adequately maintain
the property. Consequently, a loan modification agreement between KIM, the
borrower entity under the PIM, the principals of the borrower entity and the
affiliated property management agent will provide operating funds for property
repairs. Under the modification, the principals of the borrower entity converted
$105,000 of cash advances to a long-term non-interest-bearing loan. In addition,
an escrow account to be used exclusively for property repairs was established
and is under the control of KIM. The management agent made an initial deposit
into the escrow equal to 30% of the management fees it received during 2000 and
will continue to deposit a similar amount until December of 2002. KIM made an
initial deposit into the escrow account to match the $105,000 principals' loan
and the management agent's initial deposit and will continue to match additional
deposits until December of 2002. KIM's contributions to the escrow account will
be considered an interest rebate. The principals' loan and the escrow deposits
made by the management agent and the partnership can be repaid exclusively out
of any surplus cash that the property may generate in future years. Any
repayments will be made on a pro rata basis among the parties.
KIM's other remaining PIM investment is backed by the underlying first
mortgage loan on Creekside. Located in the Portland, Oregon area, the property
has maintained occupancy in the mid- to high-90% range over the past several
years. However, with flat rental rates and increasing expenses, it does not
generate any cash flow that can be distributed as participation interest, nor
has the value of the property increased sufficiently for the partnership to
share in any participation interest based on value. Furthermore, Clackamas
County is undertaking an extensive road improvement project adjacent to
Creekside. The borrower has learned that the design of the new road interchange
will require a significant portion of the property be taken by eminent domain,
possibly including some of the apartment buildings. The borrower is contesting
the condemnation action on the basis that the compensation award will not fully
compensate ownership for the adverse effects the road widening will have on the
remaining portion of the property. The borrower expects that the legal
proceedings will be complicated and lengthy, particularly since the property is
security for a participating mortgage insured by the Federal Housing
Administration, which we refer to as the FHA. Consequently, during the second
quarter of 2002 the borrower gave notice to the partnership that it will pay off
the first mortgage loan by utilizing the ownership entity's short-term credit
lines. The partnership does not expect to receive any participation interest as
a result of this payoff transaction.
During May of 2001, KIM received $19,231 from the borrowers of the Richmond
Park PIM as a settlement to release the loan's participation features. The
property was not generating sufficient cash flow to pay any participation from
property operations nor did it have sufficient appreciation in value to meet the
threshold to pay any participation based on value if the property was sold or
refinanced. Considering the property's physical condition, there was little
likelihood that its status would improve. Rental rate increases and occupancy
levels had
53
been difficult to achieve. Consequently, all of the cash flow generated by the
property went back into operations. While the borrower had assured that the
insured first mortgage debt was serviced, no major capital improvements were
undertaken to enhance the property's leasing efforts. Furthermore, routine
maintenance and repairs were beginning to be prioritized according to need and
available cash. The condition of the property and its inability to generate
sufficient cash flow seriously impaired the ability of the borrower to either
sell the property or refinance it without taking a loss. The borrower's business
plan was to make a significant investment in the property to correct deferred
maintenance and functional obsolescence and to market it for leasing in order to
reposition the property for a successful sale or refinance. The borrower was
unwilling to make the significant investments necessary while the property was
encumbered with the PIM's participation features. As a result, the borrower
requested a release of the participation features while keeping the insured
first mortgage in place until operations improve and the property can be sold or
refinanced. The general partners of KIM agreed to this request in return for the
settlement because there was no expectation that the partnership would be
entitled to any participation proceeds now or in the future in the property's
physical condition. Upon this settlement, the insured first mortgage loan on
Richmond Park was reclassified from a PIM to a MBS as the only remaining portion
of the investment is a GNMA MBS. The partnership also reclassified this
investment to available for sale concurrent with the release of the
participation feature.
On June 2, 2000, the partnership paid a special distribution of $0.93 per
limited partner interest from the Bell Station and Enclave PIM payoffs along
with the shared appreciation interest proceeds from the Brookside PIM, as
discussed below. On March 30, 2000, the partnership received $190,239 of shared
appreciation interest and $5,973 of shared income interest from the Bell Station
PIM. During April of 2000, the partnership received the principal proceeds of
$4,901,863 from the Bell Station PIM. During May of 2000, the partnership
received the principal proceeds of $8,508,892 from the Enclave PIM. The
underlying first mortgage loan matured on May 1, 2000; however, the borrower was
unable to close on its refinancing of the property in time to payoff the loan on
its maturity date. Consequently, Fannie Mae paid off the MBS under its guarantee
obligation. Subsequent to the payoff of the MBS portion of the PIM, the
partnership received $178,854 of shared appreciation interest and $200,398 of
shared income interest.
On March 30, 2000, KIM paid a special distribution of $0.31 per limited
partner interest from the principal proceeds in the amount of $4,531,910
received from the Brookside Apartments PIM payoff in February of 2000. The
underlying first mortgage loan matured on February 1, 2000; however, the
borrower was unable to close on its refinancing of the property in time to
payoff the loan on its maturity date. Consequently, Fannie Mae paid off the MBS
under its guarantee obligation. Subsequent to the payoff of the MBS portion of
the PIM, the partnership received $130,000 of shared appreciation interest and
$176,513 of shared income interest.
In addition to the payoffs mentioned above, the partnership received shared
income interest of $24,233 from the Enclave PIM during February of 2000 and
$34,793 from the Creekside PIM during June of 2000.
On January 11, 2000, KIM paid a special distribution of $2.37 per limited
partner interest from the prepayment proceeds received during December of 1999
from the Salishan, Saratoga and Marina Shores Apartments PIMs and the Patrician
MBS. In addition to the principal proceeds from the Salishan PIM of $14,666,235,
the partnership received $146,662 of prepayment premium income and $311,650 of
shared income interest and minimum additional interest. The partnership received
$6,008,565 of principal proceeds from the Marina Shores PIM along with $176,679
of shared appreciation interest and prepayment premium income. The principal
proceeds from the Saratoga PIM and the Patrician MBS prepayments were $6,204,895
and $7,830,263, respectively. The partnership did not receive any participation
interest on the Saratoga prepayment.
In October of 1999, the partnership received a prepayment of the Valley
Manor Apartments PIM of $4,425,993. The partnership did not receive any
additional interest as a result of this prepayment because the underlying
property's appraised value did not exceed the threshold required to realize
additional interest. In November of 1999 the partnership paid a special
distribution of $0.30 per limited partner interest from the Valley Manor
proceeds.
In February of 1999, KIM received a payoff of the Pope Building PIM in the
amount of $3,176,761. In addition, the partnership received $703,860 of shared
appreciation and prepayment premium income and $218,578 of shared income and
minimum additional interest upon the payoff of the underlying mortgage. During
March of 1999, the partnership received a payoff of the Remington PIM in the
amount of $12,199,298. The payoff was the result of a default on the underlying
loan, which resulted in the partnership receiving all of the outstanding
principal balance under the insurance feature of the PIM. However, due to the
default the partnership did not
54
receive any participation income from this PIM. During May of 1999, the
partnership paid a special distribution of $1.08 per limited partner interest
from the principal proceeds received from the Remington and Pope Building
PIMs and the shared appreciation and prepayment premium proceeds received from
the Pope Building PIM.
During January of 1999, the partnership paid a special distribution of $0.66
per limited partner interest from the principal proceeds and prepayment premium
received from the Cross Creek PIM in 1998. The prepayment of the Cross Creek PIM
remaining principal balance amounted to $9,414,586 with additional income (in
lieu of a prepayment premium) of approximately $318,000 was received along with
shared income of approximately $60,000.
KIM has the option to call these PIMs by accelerating their maturity if they
are not prepaid by the tenth year after permanent funding. The partnership will
determine the merits of exercising the call option for each PIM as economic
conditions warrant. Factors such as the condition of the asset, local market
conditions, the interest rate environment and availability of financing will
affect those decisions.
KRUPP INSURED PLUS LIMITED PARTNERSHIP
OVERVIEW
Krupp Insured Plus Limited Partnership, or KIP, was formed on December 20,
1985 as a Massachusetts limited partnership. KIP raised approximately
$149 million through a public offering of limited partner interests evidenced by
units of depositary receipts. The partnership used the net proceeds of the
public offering primarily to acquire PIMs and MBS. KIP considers itself to be
engaged only in the industry segment of investment in mortgages.
CRITICAL ACCOUNTING POLICIES
KIP's critical accounting policies relate primarily to revenue recognition
related to the participation feature of the partnership's PIM investments. The
partnership's policies are as follows:
Basic interest on PIMs is recognized at the stated rate of the FHA-insured
mortgage loan, less the servicer's fee, or the stated coupon rate of the Fannie
Mae MBS. The partnership recognizes interest related to the participation
features when the amount becomes fixed and the transaction that gives rise to
the amount is completed.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2002 TO THE THREE MONTHS ENDED
JUNE 30, 2001.
Net income decreased during the three months ended June 30, 2002 when
compared to the same period in 2001 primarily due to decreases in basic interest
income on PIMs, interest income on MBS, other interest income and an increase in
general and administrative expense. This was partially offset by a decrease in
asset management fees. Basic interest income on PIMs decreased due to the payoff
of the Royal Palm Place PIM during the first quarter of 2002. Interest income on
MBS decreased due to the payoff of the Boulders Apartments MBS in July of 2001
and principal collections received on the single family MBS. Other interest
income decreased due to lower average cash balances available for short-term
investing and lower interest rates earned on those balances in the three-month
period when compared to the same period in 2001. Asset management fees decreased
due to the prepayments mentioned above. General and administrative expense
increased due to higher processing costs in 2002 due to the overpayment of 2000
processing costs that were refunded in 2001.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED
JUNE 30, 2001.
Net income decreased during the six months ended June 30, 2002 when compared
to the same period in 2001 primarily due to decreases in basic interest income
on PIMs, interest income on MBS, other interest income and a increase in general
and administrative expense. This was partially offset by an increase in
participation interest and an decrease in asset management fees. Participation
interest increased and basic interest income on PIMs decreased due to the payoff
of the Royal Palm Place PIM during the first quarter of 2002. Interest income on
MBS decreased due to the payoff of the Boulders Apartments MBS in July of 2001
and principal collections received on the single family MBS. Other interest
income decreased due to lower average cash balances available for short-term
investing and lower interest rates earned on those balances in the six-month
period when compared to the same period in 2001. Asset management fees decreased
due to the prepayments mentioned above. General
55
and administrative expense increased due to higher processing costs in 2002 due
to the overpayment of 2000 processing costs that were refunded in 2001.
The following discussion relates to the operations of KIP during the years
ended December 31, 2001, 2000 and 1999.
2001 2000 1999
-------- -------- --------
(AMOUNTS IN THOUSANDS)
Interest income on PIMs:
Basic interest............................................ $1,446 $1,423 $2,085
Participation interest.................................... 306 214 --
Interest income on MBS...................................... 1,171 1,702 1,900
Other interest income....................................... 100 249 231
Partnership expenses........................................ (390) (449) (505)
Amortization of prepaid fees and expenses................... (92) (101) (101)
------ ------ ------
Net income................................................ $2,541 $3,038 $3,610
====== ====== ======
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED
DECEMBER 31, 2000.
Net income decreased for 2001 when compared with 2000 primarily due to
decreases in interest income on MBS and other interest income. This was
partially offset by an increase in participation interest and a decrease in
asset management fees. Interest income on MBS decreased in 2001 when compared to
2000 primarily due to the payoffs of the Boulders Apartments MBS in July of 2001
and the Chateau Bijou MBS in September of 2000. Other interest income decreased
due to lower average interest rates earned on cash balances available for
short-term investing in 2001 as compared with 2000. Participation interest
increased due to the collection of a prepayment premium from the Boulders
Apartments MBS payoff in July of 2001. The decrease in asset management fees was
due to the partnership's asset base declining.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED
DECEMBER 31, 1999.
Net income decreased for 2000 when compared with 1999 primarily due to the
decrease in interest income on PIMs and MBS. Basic interest on PIMs decreased in
2000 as compared to 1999 primarily due to the prepayment of the LaCosta PIM in
December of 1999. MBS interest income decreased in 2000 as compared to 1999
primarily due to principal collections received on the remaining MBS investments
and the Chateau Bijou MBS payoff in September of 2000. Participation interest
increased in 2000 compared with 1999 due to the Chateau Bijou MBS prepayment
premium and shared appreciation interest from the LaCosta PIM payoff received in
2000. Expenses decreased in 2000 as compared with 1999 primarily due to lower
asset management fees caused by a declining asset base.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW AND DIVIDENDS
KIP had cash and cash equivalents of approximately $1.1 million at June 30,
2002 and approximately $1.4 million at December 31, 2001. KIP also had cash flow
provided by its investments in PIMs and MBS. KIP anticipates that these sources
will be adequate to provide the partnership with sufficient liquidity to meet
its obligations as well as to provide distributions to its investors.
The most significant demand on KIP's liquidity is the quarterly
distributions paid to investors, which are approximately $750,000 per quarter.
Funds for the quarterly distributions come from the monthly principal and basic
interest payments received on the remaining PIM and MBS, the principal
prepayments of the PIM and MBS, interest earned on the partnership's cash and
cash equivalents and cash reserves. The portion of distributions attributable to
the principal collections and cash reserves reduces the capital resources of the
partnership. As the capital resources decrease, the total cash flows to the
partnership also will decrease and over time will result in periodic adjustments
to the distributions paid to investors. The general partners of KIP periodically
review the distribution rate to determine whether an adjustment is necessary
based on projected future cash flows. In general, the general partners try to
set a distribution rate that provides for level quarterly distributions. To the
extent that quarterly distributions do not fully utilize the cash available for
distributions and
56
cash balances increase, the general partners may adjust the distribution rate or
distribute these funds through a special distribution. Based on current
projections, the general partners have determined that KIP can maintain its
current distribution rate of $0.10 per limited partner interest per quarter
through the November of 2002 distribution.
PAYMENTS RECEIVED FROM INVESTMENTS
KIP received a prepayment of the Royal Palm Place PIM. On January 2, 2002,
KIP received $378,480 of shared appreciation interest and $126,159 of minimum
additional interest. On February 27, 2002, the partnership received $5,563,531
representing the principal proceeds on the first mortgage. On March 19, 2002,
the partnership paid a special distribution of $0.80 per limited partner
interest from the principal proceeds and shared appreciation interest received.
In addition to providing insured or guaranteed monthly principal and basic
interest payments, KIP's investment in the remaining PIM also may provide
additional income through a participation interest in the underlying property.
The partnership may receive a share in any operating cash flow that exceeds debt
service obligations and capital needs or a share in any appreciation in value
when the property is sold or refinanced. However, this payment is neither
guaranteed nor insured and is dependent upon whether property operations or its
terminal value meet specified criteria.
KIP's only remaining PIM investment is backed by the first mortgage loan on
Vista Montana. Presently, the general partners of KIP do not expect Vista
Montana to pay the partnership any participation interest or to be sold or
refinanced during 2002. However, if favorable market conditions provide the
borrower an opportunity to sell the property, there are no contractual
obligations remaining that would prevent a prepayment of the underlying first
mortgage. Vista Montana operates under a long-term restructure program. KIP
agreed in 1993 to change the original participation terms and to permanently
reduce the rate on the first mortgage loan to 7.375% per annum when construction
was significantly delayed. The borrower also raised additional equity at the
time of the modification by selling investment tax credits. These funds have
been held in escrow and are used to fund operating deficits. Although occupancy
in the Phoenix sub-market is generally in the low 90% range, the property is
currently 80% occupied because of a fire. Repairs to the property are underway
and will be covered by the borrower's property insurance.
KIP has the option to call its remaining PIM by accelerating the maturity
date of the loan. The partnership will determine the merits of exercising the
call option as economic conditions warrant. Factors such as the condition of the
asset, local market conditions, interest rates and available financing will have
an impact on this decision.
KIP received a payoff of the Boulders Apartments MBS on July 9, 2001 for
$9,045,042. The partnership also received a prepayment premium of $306,000 from
this payoff. On August 17, 2001, the partnership paid a special distribution of
$1.25 per limited partner interest from the proceeds received.
KIP received a payoff from the Chateau Bijou MBS on September 19, 2000 for
$2,266,064. During October of 2000 the partnership received a 9% prepayment
premium of $203,946 from this payoff. The partnership paid a special
distribution in November of 2000 of $0.33 per limited partner interest from the
proceeds received.
In December of 1999, KIP received a prepayment in the amount of $9,746,923
representing the outstanding principal balance due on the La Costa PIM. The
borrower defaulted on the first mortgage loan underlying the PIM in June of
1999. The partnership continued to receive its full principal and interest
payments until the default was resolved as GNMA guaranteed those payments to the
partnership. KIP did not receive any participation interest as a result of this
default. However, the partnership received $10,000 from the borrower to release
the subordinated promissory note. This payment was classified as shared
appreciation interest. On January 11, 2000, the partnership paid a special
distribution to the investors of $1.30 per limited partner interest.
57
KRUPP INSURED PLUS II LIMITED PARTNERSHIP
OVERVIEW
Krupp Insured Plus II Limited Partnership, or KIP II, was formed on
October 29, 1986 as a Massachusetts limited partnership. KIP II raised
approximately $292 million through a public offering of limited partner
interests evidenced by units of depositary receipts. The partnership used the
net proceeds of the public offering primarily to acquire PIMs and MBS. KIP II
considers itself to be engaged only in the industry segment of investment in
mortgages.
CRITICAL ACCOUNTING POLICIES
KIP II's critical accounting policies relate primarily to revenue
recognition related to the participation feature of the partnership's PIM
investment. The partnership's policies are as follows:
Basic interest on the PIM is recognized based on the stated coupon rate of
the GNMA MBS. The partnership recognizes interest related to the participation
feature when the amount becomes fixed and the transaction that gives rise to the
amount is completed.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2002 TO THE THREE MONTHS ENDED
JUNE 30, 2001.
Net income decreased in the three months ended June 30, 2002 as compared to
the same period in 2001 primarily due to lower basic and participation interest
on PIMs, MBS interest income and other interest income. This decrease was also
due to an increase in general and administrative expenses and was partially
offset by decreases in asset management fees and amortization expense. The
reduction in basic interest on PIMs was primarily due to the reclassification of
the Richmond Park PIM to a MBS in May of 2001. For an explanation of this
reclassification, please refer to the discussion under "Liquidity and Capital
Resources--Payments Received from Investments" below. Basic interest on
PIMs also decreased due to the payoff of the Denrich Apartments PIM in May of
2002. MBS interest decreased due to the payoff of the Orchard Landing MBS in May
of 2001, but this decrease was partially offset by the Richmond Park
reclassification. Participation interest was greater in 2001 due to the
settlement to release the Richmond Park PIM's participation features. Other
interest income decreased due to significantly lower average interest rates
earned on cash balances available for short-term investing in the three-month
period ended June 30, 2002 versus the same period last year. General and
administrative expense was higher in 2002 when compared to 2001 due to the
overpayment of 2000 processing costs refunded in 2001. Asset management fees
decreased due to the decrease in the partnership's investments as a result of
principal collections and payoffs. Amortization expense was greater during the
three months ended June 30, 2001 as compared to the same period in 2002 as a
result of the remaining prepaid fees and expenses on the PIM prepayments being
fully amortized as of September of 2001.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED
JUNE 30, 2001.
Net income decreased in the six months ended June 30, 2002 as compared to
the same period in 2001 primarily due to lower basic interest on PIMs and other
interest income, and an increase in general and administrative expenses. This
decrease was partially offset by an increase in MBS interest income and
decreases in asset management fees and amortization expense. The reduction in
basic interest on PIMs was primarily due to the reclassification of the Richmond
Park PIM to a MBS in May of 2001. For an explanation of this reclassification,
please refer to the discussion under "Liquidity and Capital Resources--Payments
Received from Investments" below. Basic interest on PIMs also decreased due to
the payoff of the Denrich Apartments PIM in May of 2002. MBS interest increased
due to the Richmond Park reclassification, but this increase was partially
offset by the payoff of the Orchard Landing MBS in May of 2001. General and
administrative expense was higher in 2002 when compared to 2001 due to the
overpayment of 2000 processing costs refunded in 2001. Other interest income
decreased due to significantly lower average cash balances available for
short-term investing and the interest rates earned on those balances in the
six-month period ended June 30, 2002 versus the same period last year. Asset
management fees decreased due to the decrease in the partnership's investments
as a result of principal collections and payoffs. Amortization expense was
greater during the six months ended June 30, 2001 as compared to the same period
in 2002 as a result of the remaining prepaid fees and expenses on the PIM
prepayments being fully amortized as of September of 2001.
58
The following discussion relates to the operations of KIP II during the
years ended December 31, 2001, 2000 and 1999.
2001 2000 1999
-------- -------- --------
(AMOUNTS IN THOUSANDS)
Interest income on PIMs:
Basic interest............................................ $ 613 $1,360 $3,682
Participation interest.................................... 31 -- 1,635
Interest income on MBS...................................... 2,022 1,685 1,826
Other interest income....................................... 125 475 680
Partnership expenses........................................ (553) (628) (778)
Amortization of prepaid fees and expenses................... (66) (122) (898)
------ ------ ------
Net income................................................ $2,172 $2,770 $6,147
====== ====== ======
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED
DECEMBER 31, 2000.
Net income decreased during 2001 as compared to 2000 primarily due to lower
basic interest on PIMs and other interest income. This decrease was partially
offset by an increase in interest income on MBS and decreases in general and
administrative expenses, asset management fees and amortization expense. The
reduction in basic interest on PIMs was primarily due to the reclassification of
the Richmond Park PIM to an MBS in May of 2001. Interest income on MBS increased
due to the reclassification, but was partially offset by the payoff of the
Orchard Landing MBS in May of 2001. Other interest income decreased due to
significantly lower average interest rates earned on cash balances available for
short-term investing in 2001 versus 2000. General and administrative expenses
were greater during 2000 due to higher processing costs. Asset management fees
decreased due to the decrease in the partnership's investments as a result of
principal collections and payoffs. Amortization expense was greater during 2000
as compared to 2001 as a result of the full amortization of the remaining
prepaid fees and expenses on the PIM prepayments in 2000.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED
DECEMBER 31, 1999.
Net income decreased during 2000 as compared to 1999 primarily due to lower
basic and participation interest on PIMs. This was partially offset by a
decrease in amortization. The reduction in basic interest on PIMs was due to the
payoff of the Greenhouse PIM in 2000 and the payoffs of the Saratoga, Le Coeur
du Monde, Country Meadows, Stanford Court, Hillside Court, Carlyle Court and
Waterford Court PIMs in 1999. Participation interest was higher in 1999 than
2000 as the loans that paid off in 1999 generated higher shared appreciation
interest and prepayment premiums than the Greenhouse PIM that paid off in 2000.
The decrease in amortization was also related to the payoff activity in 1999,
which resulted in the write-off of the remaining deferred expenses attributed to
those loans.
As the partnership distributes principal collections on MBS and
PIMs through quarterly or special distributions, the invested assets of the
partnership will decline, which should result in a continuing decline in net
income.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW AND DIVIDENDS
KIP II had cash and cash equivalents of approximately $15.9 million at
June 30, 2002 and approximately $933 at December 31, 2001. KIP II also had cash
flow provided by its investment in PIMs and MBS. KIP II anticipates that these
sources will be adequate to provide the partnership with sufficient liquidity to
meet its obligations as well as to provide distributions to its investors.
The most significant demand on KIP II's liquidity is the quarterly
distribution paid to investors of approximately $733,000. Funds for the
quarterly distributions come from the monthly principal and interest payments
received on the MBS, the principal prepayments of the MBS and interest earned on
the partnership's cash and cash equivalents. The portion of distributions
attributable to the principal collections reduces the capital resources of the
partnership. As the capital resources decrease, the total cash flows to the
partnership also will decrease and over time will result in periodic adjustments
to the distributions paid to investors. The general
59
partners of KIP II periodically review the distribution rate to determine
whether an adjustment is necessary based on projected future cash flows. In
general, the general partners try to set a distribution rate that provides for
level quarterly distributions. To the extent that quarterly distributions do not
fully utilize the cash available for distribution and cash balances increase,
the general partners may adjust the distribution rate or distribute these funds
through a special distribution. The partnership will pay its current
distribution rate of $0.05 per limited partner interest per quarter in August
and November of 2002. With the payoff of the Denrich PIM, the partnership will
determine the market value of the remaining assets in the partnership and
anticipates that a final liquidating distribution will be made prior to year
end.
PAYMENTS RECEIVED FROM INVESTMENTS
KIP II received a payoff of the Richmond Park Apartments MBS on June 17,
2002 for $14,073,943. The partnership intends to pay a special distribution of
$0.97 per limited partner interest from the proceeds of the Richmond Park
prepayment in the third quarter of 2002.
On May 15, 2002, the partnership received $3,084,121 representing the
principal proceeds on the first mortgage loan from the Denrich Apartments PIM.
In addition, the partnership received $100,625 from an affiliate to compensate
the fund for the inability to collect the accumulated but unpaid interest that
resulted from the interest rate reduction agreement entered into in June of
1995. On June 19, 2002, the partnership paid a special distribution of $0.22 per
limited partner interest from the principal proceeds received.
During May of 2001, KIP II received a payoff of the Orchard Landing MBS in
the amount of $4,440,315. On July 18, 2001 the partnership paid a special
distribution of $0.31 per limited partner interest from the principal proceeds.
Also during May of 2001, KIP II received $30,769 from the borrowers of the
Richmond Park PIM as a settlement to release the loan's participation features.
The property was not generating sufficient cash flow to pay any participation
from property operations nor did it have sufficient appreciation in value to
meet the threshold to pay any participation based on value if the property was
sold or refinanced. Considering the property's physical condition, there was
little likelihood that its status would improve. Rental rate increase and
occupancy levels had been difficult to achieve. Consequently, all of the cash
flow generated by the property went back into operations. While the borrower had
assured that the insured first mortgage debt was serviced, no major capital
improvements were undertaken to enhance the property's leasing efforts.
Furthermore, routine maintenance and repairs were beginning to be prioritized
according to need and available cash. The condition of the property and its
inability to generate sufficient cash flow seriously impaired the ability of the
borrower to either sell the property or refinance it without taking a loss. The
borrower's business plan was to make a significant investment in the property to
correct deferred maintenance and functional obsolescence and to market it for
leasing in order to reposition the property for a successful sale or refinance.
The borrower was unwilling to make the significant investments necessary while
the property was encumbered with the PIM's participation features. As a result,
the borrowers requested a release of the participation features while keeping
the insured first mortgage in place until the property turns around. The general
partners of KIP II agreed to this request in return for the settlement because
there was no expectation that the partnership would be entitled to any
participation proceeds now or in the future in the property's physical
condition. Upon this settlement, the insured first mortgage loan on Richmond
Park was reclassified from a PIM to a MBS as the only remaining portion of the
investment is a GNMA MBS. The partnership also reclassified this investment to
available for sale concurrent with the release of the participation feature.
On March 30, 2000, the partnership paid a special distribution of $0.58 per
limited partner interest from the prepayment proceeds received during February
of 2000 on the Greenhouse Apartments PIM in the amount of $8,428,984. The
underlying property was foreclosed on by the first mortgage lender during
January of 1999. The partnership continued to receive its full principal and
basic interest payments due on the PIM while the underlying mortgage was in
default because those payments were guaranteed by GNMA. The partnership did not
receive any participation interest from this transaction.
On January 11, 2000, KIP II paid a special distribution of $0.43 per limited
partner interest from the Saratoga Apartments PIM prepayment proceeds received
in December of 1999 in the amount of $6,204,960. The underlying property value
had not increased sufficiently to meet the criteria for the partnership to earn
any participation interest.
60
On November 22, 1999, the partnership paid a special distribution of $0.72
per limited partner interest from the Le Coeur du Monde Apartments PIM
prepayment proceeds received in October of 1999 in the amount of $9,422,001. The
partnership also received $472,587 of accrued and unpaid participation interest
attributable to property operations from its Le Coeur du Monde PIM investment
and $1,102,701 of participation interest attributable to the partnership's share
in the increase in the property's value.
On June 18, 1999, KIP II paid a special distribution of $0.83 per limited
partner interest from the Country Meadows Apartments PIM prepayment proceeds
received in May of 1999 in the amount of $12,015,224. The underlying property
value had not increased sufficiently to meet the criteria for the partnership to
earn any participation interest. The partnership did receive a $60,076
prepayment premium for the early payoff of the Country Meadows PIM.
On February 26, 1999, the partnership paid a special distribution of $1.97
per limited partner interest from the prepayments of the Stanford Court,
Hillside Court, Carlyle Court and Waterford Court Apartments PIMs. On
January 25, 1999, the partnership received prepayments of the Stanford Court,
Hillside Court, Carlyle Court and Waterford Court Apartments PIMs in the amounts
of $6,609,242, $4,266,759, $7,696,897 and $9,394,386, respectively. In addition
to the prepayments, the partnership received $860,052 of shared appreciation
interest and prepayment penalties and $432,877 of minimum additional interest
and shared income interest during December of 1998.
KRUPP INSURED PLUS III LIMITED PARTNERSHIP
OVERVIEW
Krupp Insured Plus III Limited Partnership, or KIP III, was formed on
March 21, 1988 as a Massachusetts limited partnership. KIP III raised
approximately $255 million through a public offering of limited partner
interests evidenced by units of depositary receipts. The partnership used the
net proceeds of the public offering primarily to acquire PIMs and MBS. KIP III
considers itself to be engaged only in the industry segment of investment in
mortgages.
CRITICAL ACCOUNTING POLICIES
KIP III's critical accounting policies relate primarily to revenue
recognition related to the participation feature of the partnership's PIM
investments. The partnership's policies are as follows:
Basic interest on PIMs is recognized based on the stated coupon rate of the
GNMA MBS. The partnership recognizes interest related to the participation
features when the amount becomes fixed and the transaction that gives rise to
the amount is completed.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2002 TO THE THREE MONTHS ENDED
JUNE 30, 2001.
Net income decreased for the three months ending June 30, 2002 as compared
to the same period in 2001. This decrease was primarily due to decreases in
basic interest income on PIMs, interest income on MBS, other interest income and
participation income and an increase in general and administrative expenses net
of decreases in asset management fees and amortization expense. Basic interest
income on PIMs decreased due to the payoff of the Royal Palm Place PIM in the
first quarter of 2002 and the payoff of the Casa Marina PIM in June of 2001.
Interest income on MBS decreased due to lower principal balances. Other interest
income decreased due to lower average cash balances available for short-term
investing and lower interest rates earned on those balances in the three-month
period when compared to the same period in 2001. Participation income was
greater in 2001 due to the payoff of the Casa Marina PIM mentioned above. Asset
management fees decreased due to the decline in the partnership's asset base as
a result of principal collections and prepayments. Amortization expense
decreased due to the full recognition of prepaid fees and expenses associated
with the Royal Palm Place PIM in April of 2001. General and administrative
expense was higher in 2002 when compared to 2001 due to the overpayment of 2000
processing costs that were refunded in 2001.
61
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED
JUNE 30, 2001.
Net income increased for the six months ended June 30, 2002 as compared to
the same period in 2001 primarily due to an increase in participation income and
decreases in asset management fees and amortization expense. This was partially
offset by a decrease in basic interest income on PIMs and an increase in general
and administrative expense. Participation income increased due to the payoff of
the Royal Palm Place PIM in the first quarter of 2002. Asset management fees
decreased due to the decline in the partnership's asset base as a result of
principal collections and prepayments. Amortization expense decreased due to the
full recognition of prepaid fees and expenses associated with the Royal Palm
Place PIM in April of 2001. Basic interest income on PIMs decreased due to the
payoff of the Royal Palm Place PIM mentioned above and the Casa Marina PIM in
July of 2001. General and administrative expense was higher in 2002 when
compared to 2001 due to the overpayment of 2000 processing costs that were
refunded in 2001.
The following discussion relates to the operations of KIP III during the
years ended December 31, 2001, 2000 and 1999.
2001 2000 1999
-------- -------- --------
(AMOUNTS IN THOUSANDS)
Interest income on PIMs:
Basic interest............................................ $2,511 $2,755 $4,210
Participation interest.................................... 25 -- 1,001
Interest income on MBS...................................... 894 965 1,071
Other interest income....................................... 101 278 488
Partnership expenses........................................ (553) (624) (732)
Amortization of prepaid fees and expenses................... (214) (380) (1,107)
Net income................................................ $2,764 $2,994 $4,931
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2001 TO THE YEAR ENDED
DECEMBER 31, 2000.
Net income decreased during 2001 as compared to 2000 primarily due to
decreases in basic interest on PIMs, interest income on MBS and other interest
income net of decreases in asset management fees, amortization expense and
general and administrative expenses. Basic interest on PIMs decreased primarily
due to the payoff of the Casa Marina PIM in the second quarter of 2001. The
decrease was partially offset by an increase in the interest rate for the Royal
Palm Place PIM as specified in the workout agreement. Interest income on MBS
decreased due to principal collections reducing the MBS investment portfolio.
Other interest income decreased due to lower average interest rates earned on
cash balances available for short-term investing during 2001, when compared to
2000. Asset management fees decreased due to the decline in the asset base.
Amortization expense decreased due to the full recognition of prepaid expenses
relating to the Casa Marina and Royal Palm Place PIMs during the second quarter
of 2001. General and administrative expenses decreased due to lower processing
costs during 2001 when compared to 2000.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED
DECEMBER 31, 1999.
Net income decreased during 2000 as compared to 1999 primarily due to lower
basic and participation interest on PIMs and lower MBS and other interest income
net of lower amortization expense. Basic interest on PIMs decreased due to the
payoffs of the Windsor Court, Mill Ponds Apartments and Marina Shores PIMs in
1999. Participation income decreased in 2000 as a result of the PIM prepayments
mentioned above. MBS income decreased due to the principal collections made on
MBS investments. The decrease in other interest income was primarily due to the
partnership having lower average short-term investment balances during the year
ended December 31, 2000 when compared to the same period in 1999. Amortization
expense decreased due to the partnership's fully amortizing the costs associated
with the PIMs that were prepaid in 1999.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW AND DIVIDENDS
KIP III had cash and cash equivalents of approximately $1.7 million at
June 30, 2002 and approximately $1.9 million at December 31, 2001. KIP III also
had cash flow provided by its investments in PIMs and MBS. KIP
62
III anticipates that these sources will be adequate to provide the partnership
with sufficient liquidity to meet its obligations as well as to provide
distributions to its investors.
The most significant demand on KIP III's liquidity is the quarterly
distributions paid to investors, which are approximately $1.0 million. Funds for
the quarterly distributions come from the monthly principal and basic interest
payments received on the remaining PIM and MBS, the principal prepayments of MBS
and interest earned on the partnership's cash and cash equivalents. The portion
of distributions attributable to the principal collections and cash reserves
reduces the capital resources of the partnership. As the capital resources
decrease, the total cash flows to the partnership also will decrease and over
time will result in periodic adjustments to the distributions paid to investors.
The general partners of KIP III periodically review the distribution rate to
determine whether an adjustment is necessary based on projected future cash
flows. In general, the general partners try to set a distribution rate that
provides for level quarterly distributions. To the extent that quarterly
distributions do not fully utilize the cash available for distributions and cash
balances increase, the general partners may adjust the distribution rate or
distribute these funds through a special distribution. Based on current
projections, the general partners have determined that the partnership can
maintain its current distribution rate of $0.08 per limited partner interest per
quarter through the November of 2002 distribution.
PAYMENTS RECEIVED FROM INVESTMENTS
KIP III received a prepayment of the Royal Palm Place PIM. On January 2,
2002, the partnership received $1,004,379 of shared appreciation interest and
$334,793 of minimum additional interest. On February 25, 2002, the partnership
received $14,764,062 representing the principal proceeds on the first mortgage.
On March 19, 2002, the partnership paid a special distribution of $1.24 per
limited partner interest from the principal proceeds and shared appreciation
interest received.
During June of 2001, KIP III received a payoff of the Casa Marina PIM in the
amount of $6,727,016. In addition, the partnership received $15,000 of shared
appreciation interest and $10,000 of minimum additional interest upon the payoff
of the underlying mortgage. On July 18, 2001, the partnership paid a special
distribution of $0.53 per limited partner interest from the principal proceeds
and shared appreciation received from Casa Marina.
During January of 2000, the partnership paid a special distribution of $1.17
per limited partner interest consisting of principal proceeds and shared
appreciation interest in the amounts of $14,491,746 and $426,321, respectively
from the Marina Shores Apartments PIM payoff in December of 1999.
The partnership made two special distributions during 1999 as a result of
the following PIM prepayments: In February of 1999, an $0.88 per limited partner
interest special distribution consisting of the prepayment proceeds in the
amount of $10,876,051 and shared appreciation interest and prepayment premium of
$243,620 from the Windsor Court PIM that were received in January of 1999. In
September of 1999, an $0.80 per limited partner interest special distribution
was made consisting of the prepayment proceeds in the amount of $9,751,550 and
shared appreciation interest of $402,508 from the Mill Ponds PIM that were
received during the third quarter of 1999.
The partnership's only remaining PIM investment is backed by the first
mortgage loan on Harbor Club. Presently, the general partners of KIP III do not
expect Harbor Club to pay the partnership any participation interest or to be
sold or refinanced during 2002. However, if favorable market conditions provide
the borrower an opportunity to sell the property, there are no contractual
obligations remaining that would prevent a prepayment of the underlying first
mortgage. Harbor Club operates successfully in Ann Arbor, Michigan, which is a
very competitive market with many newer apartment properties. Although Harbor
Club has maintained occupancy rates in the mid-90% range for the past two years,
most cash flow generated by the property is used for capital replacements and
improvements that help it maintain its strong market position.
In addition to providing insured or guaranteed monthly principal and basic
interest payments, the partnership's remaining PIM investment also may provide
additional income through a participation interest in the underlying property.
The partnership may receive a share in any operating cash flow that exceeds debt
service obligations and capital needs or a share in any appreciation in value
when the property is sold or refinanced. However, this participation is neither
guaranteed nor insured, and it is dependent upon whether property operations or
its terminal value meet specified criteria.
63
The partnership has the option to call its remaining PIM by accelerating the
maturity of the loan. The partnership will determine the merits of exercising
the call option as economic conditions warrant. Factors such as the condition of
the asset, local market conditions, the interest rate environment and
availability of financing will affect this decision.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK WITH RESPECT TO THE
MORTGAGE FUNDS
ASSESSMENT OF CREDIT RISK
Each mortgage fund's investments in insured mortgages and MBS are guaranteed
or insured by Fannie Mae, FHLMC, GNMA or HUD. Therefore, the certainty of their
cash flows and the risk of material loss of the amounts invested depend on the
creditworthiness of these entities.
Fannie Mae is a federally chartered private corporation that guarantees
obligations originated under its programs. However, obligations of Fannie Mae
are not backed by the U.S. government. Fannie Mae is one of the largest
corporations in the United States and the Secretary of the Treasury of the
United States has discretionary authority to lend up to $2.25 billion to Fannie
Mae at any time. FHLMC is a federally chartered corporation that guarantees
obligations originated under its programs and is wholly owned by the twelve
Federal Home Loan Banks. These obligations are not guaranteed by the U.S.
government or the Federal Home Loan Bank Board. GNMA guarantees the full and
timely payment of principal and basic interest on the securities it issues,
which represents interest in pooled mortgages insured by HUD. Obligations
insured by HUD, an agency of the U.S. government, are backed by the full faith
and credit of the U.S. government.
Collection of principal and interest on the additional loans and collection
of interest on the participation features have similar risks as those associated
with higher risk debt instruments, including reliance on the owner's operating
skills and ability to maintain occupancy levels, control operating expenses,
maintain the properties and obtain adequate insurance coverage. Operations also
may be effected by adverse changes in general economic conditions, adverse local
conditions and changes in governmental regulations, real estate zoning laws or
tax laws, and other circumstances over which a mortgage fund may have little or
no control.
U.S. GOVERNMENT AGENCY PAPER AND COMMERCIAL PAPER
GIT had cash and cash equivalents of approximately $4.4 million at June 30,
2002 and approximately $6.2 million at December 31, 2002, of U.S. government
agency paper, which is issued by U.S. government-sponsored enterprises with a
credit rating equal to the top rating category of a nationally recognized
statistical rating organization.
GIT II had cash and cash equivalents of approximately $4.6 million at
June 30, 2002 and approximately $6.2 million at December 31, 2002, of U.S.
government agency paper.
KIM had cash and cash equivalents of approximately $11 million at June 30,
2002 and approximately $3.4 million at December 31, 2001, of commercial paper,
which is issued by entities with a credit rating equal to one of the top two
rating categories of a nationally recognized statistical rating organization.
KIP had cash and cash equivalents of approximately $900,000 at June 30,
2002, and approximately $1.1 million at December 31, 2001, of commercial paper.
KIP II had cash and cash equivalents of approximately $15.6 million at
June 30, 2002 and approximately $699,000 at December 31, 2001, of commercial
paper.
KIP III had cash and cash equivalents of approximately $1.4 million at
June 30, 2002 and approximately $1.6 million at December 31, 2001, of commercial
paper.
INTEREST RATE RISK
Each mortgage fund's primary market risk exposure is to interest rate risk,
which can be defined as the exposure of the mortgage fund's net income,
comprehensive income or financial condition to adverse movements in interest
rates. PIMs, PIMIs and MBS comprise the majority of the assets of GIT and GIT
II, and PIMs and MBS comprise the majority of the assets of KIM, KIP, KIP II and
KIP III. Decreases in interest rates may accelerate the prepayment of the
mortgage fund's investments. None of the mortgage funds utilize any derivatives
or other instruments to manage this risk as each plans to hold all of its
investments to expected maturity.
64
Each mortgage fund monitors prepayments and considers prepayment trends, as
well as distribution requirements of the mortgage fund, when setting regular
dividend policy. For MBS, each mortgage fund forecasts prepayments based on
trends in similar securities as reported by statistical reporting entities such
as Bloomberg. For PIMs and PIMIs, each mortgage fund incorporates prepayment
assumptions into planning as individual properties notify the mortgage fund of
the intent to prepay or as they mature.
INTEREST RATE SENSITIVITY OF FINANCIAL INSTRUMENTS
The following tables provide information about each mortgage fund's
financial instruments that are sensitive to changes in interest rates. For
mortgage investments, the tables present principal cash flows and related
weighted average interest rates, or WAIR, by expected maturity dates. The
expected maturity date is contractual maturity adjusted for expectations of
prepayments.
The methodology used by the mortgage funds to estimate the fair value of
each class of financial instruments is described in the notes to the respective
financial statements of each of the mortgage funds included in this prospectus.
For GIT, please see note J on page F-31, for GIT II, please see note I on page
F-51, for KIM, please see note H on page F-68, for KIP, please see note H on
pages F-82 and F-83, for KIP II, please see note H on page F-98, and for KIP
III, please see note H on page F-113. As described in those notes, the mortgage
funds' share of participating interest is not included in these valuations.
KRUPP GOVERNMENT INCOME TRUST
EXPECTED MATURITY DATES ($ IN THOUSANDS)
TOTAL FACE
2002 2003 2004 2005 2006 2007+ VALUE FAIR VALUE
-------- -------- -------- -------- -------- -------- ---------- ----------
Interest-sensitive assets:
MBS............................... $ 900 $ 744 $ 621 $ 524 $ 448 $11,354 $ 14,591 $ 15,299
WAIR.............................. 8.17% 8.17% 8.17% 8.17% 8.17% 8.17% 8.17%
PIMs.............................. 29,467 133 144 157 170 16,345 46,416 47,803
WAIR.............................. 8.07% 8.07% 8.07% 8.07% 8.07% 8.07% 7.67%
PIMIs............................. 18,556 245 266 290 315 31,140 50,812 51,828
WAIR.............................. 7.59% 7.59% 7.59% 7.94% 7.94% 7.94% 7.69%
Additional loans.................. -- -- -- -- -- 5,689 5,689 3,871
WAIR.............................. 4.98% 4.98% 4.98% 4.98% 4.98% 4.98% 4.98%
Total interest-sensitive assets... $48,923 $1,122 $1,031 $ 971 $ 933 $64,528 $117,508 $118,801
KRUPP GOVERNMENT INCOME TRUST II
EXPECTED MATURITY DATES ($ IN THOUSANDS)
TOTAL FACE
2002 2003 2004 2005 2006 2007+ VALUE FAIR VALUE
-------- -------- -------- -------- -------- -------- ---------- ----------
Interest-sensitive assets:
MBS............................ $ 1,821 $1,557 $1,334 $1,146 $ 989 $ 8,254 $ 15,101 $ 15,601
WAIR........................... 7.60% 7.60% 7.60% 7.60% 7.60% 7.60% 7.60%
PIMs........................... 422 455 491 529 570 34,823 37,290 37,978
WAIR........................... 7.05% 7.05% 7.05% 7.06% 7.06% 7.06% 7.06%
PIMIs
Insured mortgages.............. 16,301 1,257 1,361 1,472 1,593 63,641 85,625 86,664
WAIR........................... 6.71% 6.71% 6.71% 6.71% 6.71% 6.71% 6.83%
Additional loans............... 6,963 4,864 2,290 4,600 -- -- 18,717 17,655
WAIR........................... 7.00% 7.00% 7.00% 7.00% 0.00% 0.00% 7.04%
Total interest-sensitive
assets....................... $25,507 $8,133 $5,476 $7,747 $3,152 $106,718 $156,733 $157,898
65
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
EXPECTED MATURITY DATES ($ IN THOUSANDS)
TOTAL FACE
2002 2003 2004 2005 2006 2007+ VALUE FAIR VALUE
-------- -------- -------- -------- -------- -------- ---------- ----------
Interest-sensitive assets:
MBS............................... $ 917 $ 817 $ 734 $ 666 $ 611 $10,111 $13,856 $14,308
WAIR.............................. 7.63% 7.63% 7.63% 7.63% 7.63% 7.63% 7.63%
PIMs.............................. 309 335 363 393 426 21,898 23,724 24,767
WAIR.............................. 7.94% 7.94% 7.94% 7.94% 7.94% 7.94% 7.94%
Total interest-sensitive assets... $1,226 $1,152 $1,097 $1,059 $1,037 $32,009 $37,580 $39,075
KRUPP INSURED PLUS LIMITED PARTNERSHIP
EXPECTED MATURITY DATES ($ IN THOUSANDS)
TOTAL FACE
2002 2003 2004 2005 2006 2007+ VALUE FAIR VALUE
-------- -------- -------- -------- -------- -------- ---------- ----------
Interest-sensitive assets:
MBS................................... $ 256 $ 231 $ 211 $ 194 $ 181 $ 7,844 $ 8,917 $ 9,411
WAIR.................................. 8.41% 8.41% 8.41% 8.41% 8.41% 8.41% 8.41%
PIMs.................................. 5,667 111 120 129 139 12,613 18,779 19,649
WAIR.................................. 7.38% 7.38% 7.38% 7.38% 7.38% 7.38% 7.67%
Total interest-sensitive assets....... $5,923 $ 342 $ 331 $ 323 $ 320 $20,457 $27,696 $29,060
KRUPP INSURED PLUS II LIMITED PARTNERSHIP
EXPECTED MATURITY DATES ($ IN THOUSANDS)
TOTAL FACE
2002 2003 2004 2005 2006 2007+ VALUE FAIR VALUE
-------- -------- -------- -------- -------- -------- ---------- ----------
Interest-sensitive assets:
MBS................................... $1,059 $ 984 $ 929 $ 891 $ 868 $24,876 $29,607 $30,575
WAIR.................................. 7.56% 7.56% 7.56% 7.56% 7.56% 7.56% 7.56%
PIM................................... 3,101 -- -- -- -- -- 3,101 3,247
WAIR.................................. 8.00% 0.00% 0.00% 0.00% 0.00% 0.00% 8.00%
Total interest-sensitive assets....... $4,160 $ 984 $ 929 $ 891 $ 868 $24,876 $32,708 $33,822
KRUPP INSURED PLUS III LIMITED PARTNERSHIP
EXPECTED MATURITY DATES ($ IN THOUSANDS)
TOTAL FACE
2002 2003 2004 2005 2006 2007+ VALUE FAIR VALUE
-------- -------- -------- -------- -------- -------- ---------- ----------
Interest-sensitive assets:
MBS.................................. $ 595 $ 515 $ 449 $ 394 $ 349 $ 8,992 $11,294 $11,629
WAIR................................. 7.51% 7.51% 7.51% 7.51% 7.51% 7.51% 7.51%
PIMs................................. 14,869 114 124 134 146 12,376 27,763 28,376
WAIR................................. 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.2%
Total interest-sensitive assets...... $15,464 $ 629 $ 573 $ 528 $ 495 $21,368 $39,057 $40,005
FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE MORTGAGE FUNDS
Some of the statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations of the Mortgage Funds constitute
forward-looking statements. These forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause the actual results
of the mortgage funds to be different from any future results expressed or
implied by these forward-looking statements. These factors include, among other
things:
- federal, state or local regulations,
- adverse changes in general economic or local conditions,
66
- the inability of borrowers to meet financial obligations on additional
loans,
- the prepayments of mortgages,
- the failure of borrowers to pay participation interests due to poor
operating results at properties underlying the mortgages,
- uninsured losses, and
- potential conflicts of interests between a mortgage fund and its
affiliates, including the trustees or general partners of the mortgage
fund.
Other factors that could cause actual results to differ from those expressed
or implied in this discussion are more fully described in "Cautionary Statement
Regarding Forward-Looking Statements" and elsewhere in this prospectus.
67
BUSINESS AND PROPERTIES
GENERAL
We intend to engage in the business of acquiring, owning and operating
multi-family residential real estate. We intend to grow by acquiring and
renovating middle income apartment communities in selected targeted markets,
primarily in the Mid-Atlantic, Southeast and Southwest areas of the United
States. Concurrently with the completion of the offers, we will own interests in
five multi-family residential real properties, which we refer to as the initial
properties. Four of the five initial properties are located in the
Baltimore/Washington D.C. metropolitan areas, which, based on occupancy data
compiled by a third party real estate information company, we believe comprise
one of the strongest rental markets in the country. Each of the initial
properties has been managed by our affiliates for over 15 years. We intend to
acquire additional properties in the future to provide portfolio diversification
and an investment presence in other strong metropolitan markets.
Our day-to-day operations will be conducted by Berkshire Advisor. See
"Management--Berkshire Advisor" and "--Summary of Advisory Services Agreement."
Berkshire Advisor, which is a newly formed company that has no previous advisory
experience, is an affiliate of The Berkshire Group, a diversified real estate
and financial services organization. Since 1969, The Berkshire Group, together
with its affiliates, have acquired over 30,000 apartment units and provided over
$15 billion of apartment financings. Its advisory experience includes acting as
the advisor to Berkshire Realty Company, Inc., a multi-family residential REIT
whose publicly held shares of common stock were listed on the New York Stock
Exchange until this REIT was acquired in 1999. An investment committee of
Berkshire Advisor will be required to approve all acquisitions, financings and
dispositions made on our behalf. The investment committee members collectively
have over 110 years of professional real estate experience and judgment. See
"Management--Berkshire Advisor."
Our on-site property management and other real estate operating service
needs with respect to the initial properties will be provided by BRI OP Limited
Partnership (which we refer to as BRI OP). Subject to the approval by our audit
committee, BRI OP will provide these management services with respect to
acquisitions of other properties that do not otherwise have a property manager.
See "Management--The Property Manager." We believe that the strength of BRI OP's
management team of apartment community specialists will provide a significant
competitive advantage towards achieving our business goals. BRI OP's management
team has strong capabilities in apartment community management, acquisition,
renovation, leasing and disposition. We believe that these capabilities will put
us in a strong position to allow value to be created in all phases of the real
estate cycle. BRI OP currently manages an approximately $1.1 billion portfolio,
which includes over 21,000 apartment units, from its regional offices in the
Baltimore, Carolinas, Mid-Atlantic, Southeast and Texas markets. BRI OP strives
to provide institutional quality property management services, and, through its
parent, Berkshire Realty Holdings, L.P., is owned by affiliates of The Berkshire
Group in joint venture with unaffiliated third parties, including Whitehall
Street Real Estate XI Limited Partnership (an affiliate of Goldman Sachs) and
affiliates of Blackstone Real Estate Advisors. See "Management--The Property
Manager."
BUSINESS STRATEGY
Our primary business objective is to deliver strong, consistent returns to
our stockholders, while enhancing the long-term growth in value of our real
estate portfolio. We believe we are well positioned to meet this objective,
given the strength of the economic regions in which the initial properties are
located, the quality of the initial properties and the opportunities for new
investments within our selected targeted markets. By following specific
operating and renovation-related strategies, we will seek to achieve stability
and growth through maximization of cash flow from our initial properties and
investment in multi-family properties to be acquired in the future. New
acquisitions are intended to be made within a well-defined strategy of acquiring
middle income properties exhibiting upside potential, in carefully selected
metropolitan markets that we are familiar with.
Through Berkshire Advisor, we will employ an asset management group to
assume overall responsibility for each asset in our real estate portfolio. The
goal of the asset management group will be to develop an annual business plan
for each property, including revenue enhancement strategies, line item expense
control, capital improvement plans, financing strategies, future
disposition/exit strategies, and to insure that the business plan is executed.
68
Through Berkshire Advisor and BRI OP, we will employ the following operating
strategies:
PROPERTY MANAGEMENT AND LEASING. We believe that much of the opportunity to
create value for stockholders exists in the day-to-day property management and
leasing operations. We intend to maximize current and future cash flows through
BRI OP's in-depth knowledge of its markets, its emphasis on customer
satisfaction, and the economies of scale we expect to achieve from BRI OP's
large property management portfolio.
Through utilization of industry research and its local market knowledge, BRI
OP determines the rent growth potential in its markets by analyzing a variety of
factors, including employment growth, vacancy rates and competition from
existing and future apartment communities. This analysis enables BRI OP, in each
of its markets, to formulate and implement strategies for rent and occupancy
growth. BRI OP currently employs a leasing methodology which focuses on future
availability of apartment units in addition to analysis of current vacancies,
thereby allowing a more scientific method for increasing rents while maintaining
high occupancy levels. The leasing strategy also captures additional rent growth
by quickly adjusting rents depending on the supply and demand for certain
specific unit types.
In addition, BRI OP's property management teams focus on providing superior
service to residents of the apartments under management in an effort to ensure
customer satisfaction. These efforts have historically resulted in low turnover
rates with existing tenants and a good reputation in the local markets for
attracting new tenants.
We believe that well-maintained properties will provide attractive and
dependable yields over time. Thus, our strategy is to make continual capital
investments in our apartment communities, in order to ensure resident
satisfaction, remain competitive, and enhance each property's living
environment.
RENOVATIONS AND IMPROVEMENTS. Our affiliates have historically grown the
value of their apartment portfolios using a value-added approach. They have
found that properties over time can benefit by renovation and capital
improvement plans that make the properties more competitive with newly built
properties, and allow the properties to better satisfy renters' changing
expectations and needs. Our strategy is to incorporate general physical
improvement plans in each year's property business plan, and then over longer
periods of time, when needed, to implement a major renovation and capital
improvement plan where rental rate increases can generate a desirable return on
investment.
ACQUISITION STRATEGY
We will seek opportunities to purchase well-located, moderate income
apartment communities which we believe are underperforming, but could benefit
from improved property management operations, minor capital improvement plans or
major renovation plans. We will seek properties that can be upgraded to an
institutional quality level with improvements. We intend to acquire properties
in selective targeted metropolitan markets that exhibit the proper desired
trends in projected supply/demand of apartments, job growth, population growth
and economic growth. We believe that the strategy of acquiring and renovating
middle income apartment communities is a safer strategy than buying or
developing higher income rental communities whose affordability appeals to a
much smaller rental market. Our affiliates have had success throughout most
market cycles with this strategy, and it allows them better control of events
because they control the decision on the timing of capital programs.
We believe we will have a competitive advantage when making acquisitions due
to:
- BRI OP's knowledge of multiple local markets gained from years of
operating in those markets,
- the opportunity to choose among many of BRI OP's existing markets to
invest in, and
- the knowledge of macro-economic and supply/demand trends that we have
access to from Berkshire Mortgage Finance (BMF), whose chairman will be an
initial member of Berkshire Advisor's investment committee. See "Berkshire
Advisor." BMF, an affiliate of The Berkshire Group, financed approximately
$3.5 billion in 2001 of apartment loans and has experience in most major
market areas.
FINANCING STRATEGIES
We intend to pay particular attention to the financing strategy for each of
our properties to insure that:
- the financing term is compatible with the property's exit strategy,
- the financing structure is compatible with the property's capital
improvement plan,
69
- the financing takes advantage of locking in low interest rates at the
appropriate point of the economic cycle, and
- the amount of leverage is conservatively measured against each property's
operating cash flow prospects.
We may seek to acquire additional properties in joint ventures with
institutional investors. The advantage of this strategy is to increase the
return on our investment by earning additional income from managing the assets
held by the joint venture, and also to gain additional diversification of our
capital by investing in a larger number of properties, although through a
smaller investment in each property. We believe the quality control and due
diligence required for entering into joint ventures with institutional capital
is consistent with the historical operating standards of our affiliates.
DISPOSITION STRATEGY
We intend to hold each of our properties for long-term investment. However,
our strategy for determining any particular property's holding period and exit
strategy is based upon the future expectations for that property at any time. We
intend to review, on an annual basis, the expectations of a particular property
during the annual property business plan process. The future expectations for
each property will be based upon a thorough review of many factors including:
- projected economic and job growth prospects in the market area,
- projected apartment supply/demand trends,
- the market competitiveness of our property, and
- the future projected return of the property (referred to as a rebuy
analysis) compared to alternative investment opportunities.
If we decide that a particular property should be disposed of, we believe we
will have a competitive advantage in disposing of that property due to market
knowledge and broker contacts.
We do not intend to dispose of the Interests that have been tendered to us
in the offers.
INITIAL PROPERTIES
Concurrently with the completion of the offers, we will own interests in
five multi-family residential real properties.
The Berkshire Group and its affiliates (including KRF Company) own interests
in a number of multi-family real estate properties. However, other than with
respect to six of these properties, the properties are owned by entities in
which the consent of other parties are required for the transfer of the
properties to us. The substantial majority of these multi-family real estate
properties are owned by BRI OP and its wholly owned subsidiaries. The parent of
BRI OP is owned by The Berkshire Group affiliates in joint venture with
unaffiliated third parties, and The Berkshire Group affiliates do not have the
unilateral right to sell these other properties to us. Of the six properties,
five are consistent with our investment guidelines, while the sixth property is
not, due to its existing level of indebtedness and other financing terms
affecting the property.
CENTURY II APARTMENTS
Century II Apartments is located at 307 Fox Fire Place, Cockeysville,
Maryland. This garden style apartment community consists of 468 units within 16
buildings. The units consist of one, two and three-bedroom apartments. The
property is located on approximately 29 acres of land. Other improvements
include a swimming pool, fitness center, tennis courts, an exercise facility and
a clubhouse. Century II Apartments was built in 1971 and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own a 75.82% interest in Century II Apartments. The remaining
24.18% interest will be held by Equity Resources Group, Inc. or an entity
affiliated with Equity Resources Group, Inc. Our arrangements with Equity
Resources Group, Inc. or its affiliate relating to the management and control of
the property are currently being negotiated, but are expected to be comparable
to those described below with respect to the Dorsey's Forge and Hannibal Grove
properties.
70
As of December 31, 2001, the adjusted federal income tax basis of all of the
property of Century II Apartments was approximately $19,913,770. Of this amount,
approximately $16,983,827 is the basis of depreciable property, of which
$15,512,898 is allocated to the building and building improvements,
approximately $801,915 is allocated to the land improvements and approximately
$669,014 is allocated to all other depreciable assets.
DORSEY'S FORGE APARTMENTS
Dorsey's Forge Apartments is located at 9650 White Acre Road, Columbia,
Maryland. This garden style apartment community consists of 251 units within 13
buildings. The units consist of one, two and three-bedroom apartments. The
property is located on approximately 17 acres of land. Dorsey's Forge Apartments
was built in 1970 and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own a 91.382% beneficial interest as tenant-in-common in
Dorsey's Forge Apartments. The remaining 8.618% interest will be held by
ERG/DFHG, LLC, an affiliate of Equity Resources Group, Inc. Under our
tenancy-in-common agreement with ERG/DFHG, LLC, we will have control over the
management, operation and disposition of the property, although ERG/DFHG, LLC
has the option to require us to use our good faith efforts to sell the property
during the 180-day period beginning on April 27, 2005. We believe that if
ERG/DFHG, LLC exercises this option, it would be willing to allow us to retain
the property and instead accept a cash payment from us equal to what it would
have received in an arm's-length sale, if we decided to make that proposal to
ERG/DFHG, LLC. The tenancy-in-common agreement also will give us the right to
determine whether additional capital is needed for capital improvements to or
renovation of the property. If such a determination is made, each of the two
co-owners may contribute its proportionate share of the necessary additional
capital contribution. If a co-owner declines to make the additional capital
contribution, then the other co-owner may elect to contribute the unfunded
amount and the tenancy-in-common interests will be adjusted to reflect the
changes in each co-owner's capital contribution.
As of December 31, 2001, the adjusted federal income tax basis of all of the
property of Dorsey's Forge Apartments was approximately $6,100,470. Of this
amount, approximately $5,261,964 is the basis of depreciable property, of which
approximately $4,560,451 is allocated to the building, building improvements and
site improvements, approximately $115,460 is allocated to the land improvements
and approximately $586,053 is allocated to all other depreciable assets.
HANNIBAL GROVE APARTMENTS
Hannibal Grove Apartments is located at 5361 Brookway, Columbia, Maryland.
This garden style apartment community consists of 316 units within 23 buildings.
The units consist of one, two and three-bedroom apartments and three, four and
five-bedroom townhouses. The property is located on approximately 23 acres of
land. Hannibal Grove Apartments was built in 1970 and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own a 91.382% beneficial interest as tenant-in-common in
Hannibal Grove Apartments. The remaining 8.618% interest will be held by
ERG/DFHG, LLC. Under our tenancy-in-common agreement with ERG/DFHG, LLC, we will
have control over the management, operation and disposition of the property,
although ERG/DFHG, LLC has the option to require us to use our good faith
efforts to sell the property during the 180-day period beginning on April 27,
2005. We believe that if ERG/DFHG, LLC exercises this option, it would be
willing to allow us to retain the property and instead accept a cash payment
from us equal to what it would have received in an arm's-length sale, if we
decided to make that proposal to ERG/DFHG, LLC. The tenancy-in-common agreement
also will give us the right to determine whether additional capital is needed
for capital improvements or renovation of the property. If such a determination
is made, each of the two co-owners may contribute its proportionate share of the
necessary additional capital contribution. If a co-owner declines to make the
additional capital contribution, then the other co-owner may elect to contribute
the unfunded amount and the tenancy-in-common interests will be adjusted to
reflect the changes in each co-owner's capital contribution.
We are currently evaluating the costs and anticipated benefits of doing
renovation and capital improvement projects at Hannibal Grove Apartments in a
small sample of test units. If after this evaluation we believe that there is a
sufficient return on the investment in the proposed projects, we may proceed
with the preparation of a formal plan for renovations and improvements on a
broader scale after our acquisition of the property.
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As of December 31, 2001, the adjusted federal income tax basis of the all of
the property of Hannibal Grove Apartments was approximately $9,194,914. Of this
amount, approximately $7,919,252 is the basis of depreciable property, of which
approximately $6,997,725 is allocated to the building, building improvements and
site improvements, approximately $197,831 is allocated to the land improvements
and approximately $723,696 is allocated to all other depreciable assets.
SEASONS APARTMENTS
Seasons Apartments is located at 9220 Old Lantern Way, Laurel, Maryland.
This garden style apartment community consists of 1,088 units within 70
buildings. The units consist of one and two-bedroom apartments and one and
three-bedroom townhouses. The property is located on approximately 68.5 acres of
land. Other improvements include two swimming pools, six playgrounds, two tennis
courts, two clubrooms and approximately 1,700 parking spaces. Seasons Apartments
was built between 1972 and 1978 and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own 100% of this property.
We are currently evaluating the results of the renovation and capital
improvement projects conducted at Seasons Apartments in an initial group of 31
test units to determine the feasibility and benefits of a broader renovation and
improvement plan. The renovations and improvements made on the test units
included the replacement of kitchen cabinets and counters and bathroom vanities
and the modification of kitchens to provide for breakfast bars and a more open
environment between the kitchen and the main living area. The average cost of
the renovations and improvements for each test unit was approximately $4,500,
and the average annual rental increase on a renovated and improved unit was
approximately $1,200. It is anticipated that any future renovations would
initially be financed out of funds generated by operations and refinancings.
As of December 31, 2001, the adjusted federal income tax basis of all of the
property of Seasons Apartments was approximately $34,511,172. Of this amount,
approximately $29,749,639 is the basis of depreciable property, of which
approximately $29,456,506 is allocated to the building and building
improvements, approximately $17,323 is allocated to land improvements and
approximately $275,810 is allocated to all other depreciable assets.
WALDEN POND APARTMENTS
Walden Pond Apartments is located at 12850 Whittington, Houston, Texas. This
garden style community contains 416 one and two-bedroom apartment units and is
located on approximately 12 acres of land. Walden Pond Apartments was built in
1982 and is in good condition.
Upon KRF Company's contribution to us at the completion of the offers, we
will indirectly own 100% of this property.
As of December 31, 2001, the adjusted federal income tax basis of the all of
the property of Walden Pond Apartments was approximately $7,007,307. Of this
amount, approximately $6,031,362 is the basis of depreciable property, of which
approximately $6,027,826 is allocated to the building and approximately $3,536
is allocated to all other depreciable assets.
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OWNERSHIP INTEREST
The following is a tabular description of our proposed ownership interests
in, and the appraised value of, the initial properties:
GROSS PROPORTIONATE SHARE
PROPERTY OWNERSHIP INTERESTS APPRAISED VALUE OF APPRAISED VALUE
-------- -------------------- ---------------- --------------------
Century II Apartments................................. Fee Simple (1) $31,010,000 $ 23,511,782
Dorsey's Forge Apartments............................. Fee Simple(2) $14,600,000 $ 13,341,772
Hannibal Grove Apartments............................. Fee Simple(3) $22,360,000 $ 20,433,015
Seasons Apartments.................................... Fee Simple $71,000,000 $ 71,000,000
Walden Pond Apartments................................ Fee Simple $13,500,000 $ 13,500,000
------------
$141,786,569
============
------------------------
(1)We will indirectly own a 75.82% interest in a limited liability company which
will own a fee simple interest in the property. Based on this ownership
interest, our proportionate share of the appraised value of this property is
$23,511,782.
(2) We will indirectly own a 91.382% beneficial tenancy-in-common interest in
the property. Based on this ownership interest, our proportionate share of
the appraised value of this property is $13,341,772.
(3) We will indirectly own a 91.382% beneficial tenancy-in-common interest in
the property. Based on this ownership interest, our proportionate share of
the appraised value of this property is $20,433,015.
MORTGAGES
The following is a tabular description of the mortgages on the initial
properties. Except as noted, all information is as of June 30, 2002.
MORTGAGES
CURRENT PREPAYMENT
PRINCIPAL INTEREST RESTRICTION AND MATURITY BALANCE DUE AT
AMOUNT RATE AMORTIZATION PREMIUM DATE MATURITY
Century II $22,734,833 5.96% 360-month amortization No restrictions; yield 4/01/07 $21,651,501
Apartments schedule over 5-year term maintenance until 3/31/05, 1%
prepayment fee thereafter
Dorsey's $10,604,603 5.96% 360-month amortization No restrictions; yield 4/01/07 $10,099,286
Forge schedule over 5-year term maintenance until 3/31/05, 1%
Apartments prepayment fee thereafter
Hannibal $16,098,854 5.96% 360-month amortization No restrictions; yield 4/01/07 $15,331,732
Grove schedule over 5-year term maintenance until 3/31/05, 1%
Apartments prepayment fee thereafter
Seasons $52,500,000 5.74% 360-month amortization No restrictions; yield 8/01/09 $46,805,910
Apartments(1) schedule over 7-year term maintenance until 3/01/09--1%
prepayment fee
Walden Pond $ 4,450,954 3.50% 360-month amortization No restrictions; 1% prepayment 12/01/08 $ 3,835,124
Apartments(2) schedule over 5-year term fee
(1) Seasons Apartments' mortgage was refinanced on July 31, 2002, and the
information shown is as of that date.
(2) Walden Pond Apartments' mortgage provides for a variable interest rate. The
interest rate shown is the rate effective as of June 30, 2002. The balance
due at maturity is an estimated amount.
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OCCUPANCY RATES
The following is a tabular description of the physical occupancy rates at
the initial properties:
PHYSICAL OCCUPANCY RATES
2001 2000 1999 1998 1997
Century II Apartments 98% 97% 96% 100% 100%
Dorsey's Forge Apartments 98% 97% 97% 100% 99%
Hannibal Grove Apartments 97% 97% 97% 100% 100%
Seasons Apartments 98% 98% 97% 96% 96%
Walden Pond Apartments 98% 89% 94% 97% 98%
AVERAGE ANNUAL RENTAL INCOME
The following is a tabular description of the average annual rental income
per unit for the initial properties, which was determined by dividing the annual
effective gross rental income by the number of apartment units:
AVERAGE ANNUAL RENTAL INCOME PER UNIT
2001 2000 1999 1998 1997
Century II Apartments $ 9,212 $8,772 $8,280 $7,973 $7,718
Dorsey's Forge Apartments $ 8,880 $8,227 $7,814 $7,767 $7,451
Hannibal Grove Apartments $10,060 $9,336 $8,885 $8,636 $8,377
Seasons Apartments $10,015 $9,517 $9,087 $8,693 $8,382
Walden Pond Apartments $ 5,865 $5,756 $5,725 $5,612 $5,464
REAL ESTATE TAX RATES
The following is a tabular description of the real estate tax rates
pertaining to the initial properties:
REAL ESTATE TAX
RATE/$100
Century II Apartments 1.908227
Dorsey's Forge Apartments 1.253500
Hannibal Grove Apartments 1.253500
Seasons Apartments 1.253500
Walden Pond Apartments 2.962603
TAX DEPRECIATION
For each of the initial properties, the building, building improvements and
site improvements are depreciated using the straight-line method of depreciation
with an applicable recovery period or life of 27.5 years. All land improvements
are depreciated using a 150 percent declining balance method of depreciation
with an applicable recovery period or life of 15 years. All other depreciable
assets are depreciated using a 200 percent declining balance method of
depreciation with an applicable recovery period or life of either 5 or 7 years.
INSURANCE
We believe that each of the initial properties is adequately covered by
insurance.
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COMPETITION
The initial properties are located in developed areas. There are numerous
other rental apartment properties within and around the market area of each
initial property. The number of competitive rental properties in the area could
have a material adverse effect on our ability to attract and retain residents
and to increase rental rates. Virtually all of the leases for units in the
initial properties are short-term leases (generally one year or less).
Our business, and the residential housing industry in general, are cyclical.
Our operations and markets are affected by local and regional factors such as
local economies, demographic demand for housing, population growth, property
taxes, energy costs, and by national factors such as short and long-term
interest rates, federal mortgage financing programs, federal income tax
provisions and general economic trends. Occupancy varies only slightly on a
seasonal basis, with the lowest occupancy typically occurring in the summer
months.
LEGAL PROCEEDINGS
We may be subject to various claims and legal actions in the ordinary course
of our business. We are not aware of any pending or threatened litigation that
we believe is reasonably likely to have a material adverse effect on us.
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POLICIES WITH RESPECT TO CERTAIN ACTIVITIES
GENERAL
The following is a discussion of our investment policies, financing
policies, disposition policies and policies with respect to other activities.
The policies with respect to these activities have been determined by our board
of directors, and may be amended or revised from time to time at the discretion
of our board of directors, and without a vote of our common or preferred
stockholders. Holders of the Preferred Shares will not be able to change any of
our investment policies without the approval of our board of directors.
INVESTMENT POLICIES
INVESTMENTS IN REAL ESTATE OR INTERESTS IN REAL ESTATE. Our business will
focus on the acquisition, ownership and operation of multi-family residential
real properties. Our investment objective is to acquire well located properties
that have been neglected, and to increase the profitability of those properties
through various improvement strategies. We intend to pursue these objectives by
providing superior on-site property management, improving the physical
appearance and living environment of the properties, and implementing renovation
strategies in those instances where rental rate increases justify the costs. We
may expand, improve or renovate the initial properties or sell such properties
in whole or in part at such time as we believe market conditions so warrant. See
"Business and Properties--Business Strategy."
Initially our primary focus will be in markets our affiliates currently
operate in, within the Mid-Atlantic, Southeast and Southwest markets of the
United States. Over time we will consider investments in other cities, primarily
east of the Mississippi, where favorable economic growth factors are indicated.
It is our policy to acquire assets primarily for growing our operating
income and cash flow. Over time, those properties that have been renovated or
otherwise improved will be considered for sale once future growth prospects are
not as strong as other investment alternatives. Our objective in some instances
will include attempting to structure tax-free exchanges for the acquisition of
new properties.
We expect to pursue our investment objectives through the direct ownership
of interests in the initial properties and the acquisition of additional
multi-family residential properties. We have not identified any such properties
for acquisition at this time. Future investment activities will not be limited
to any specified percentage of our assets. However, investments in any one
property we acquire in the future may not exceed 25% of the value of our total
assets at the time of its acquisition.
INVESTMENTS IN OTHERS. We may also invest in other equity real estate
interests, including securities of other REITs. While we do not intend to invest
a significant amount in these securities, we may invest in common or preferred
stock of selected REITs that we believe offer good value. We may also
participate with other entities in property ownership, through joint ventures or
other types of co-ownership. Equity investment may be subject to existing
mortgage financing and other indebtedness which have priority over the equity of
the operating partnership. As a result of the offers, we will also own the
Interests, which are securities of REITs (in the case of GIT and GIT II) and
limited partnerships (in the case of KIM, KIP, KIP II and KIP III).
INVESTMENTS IN REAL ESTATE MORTGAGES. We do not currently intend to invest
in mortgage loans.
OTHER INVESTMENT POLICIES. Other than to joint venture partners, we do not
intend to make loans to other persons, including our officers and directors
(other than ordinary course travel advances and similar reimbursable advances).
In all events we intend to make investments in such a way that we will not be
treated as an "investment company" under the Investment Company Act of 1940.
FINANCING POLICIES
Under our current investment guidelines, we may not incur indebtedness such
that at the time we incur the indebtedness our ratio of debt to total assets
exceeds 75%. We, however, may from time to time reevaluate our borrowing
policies in light of then current economic conditions, relative costs of debt
and equity capital, market values of properties, growth and acquisition
opportunities and other factors.
We have established a debt policy relative to the fair market value of our
assets, rather than to the book value of our assets, because we believe that the
book value of our assets (which to a large extent is the depreciated value of
our properties) does not accurately reflect our ability to borrow and to meet
debt service
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requirements. This ratio is commonly employed by REITs. Although we will
consider factors other than fair market value in making decisions regarding the
incurrence of debt (such as the estimated market value of such properties upon
refinancing, and the ability of particular properties and us as a whole to
generate cash flow to cover expected debt services), we cannot assure you that
we will maintain the ratio of debt to fair market value of our assets (or to any
other measure of asset value) described above.
To the extent that our board of directors determines to seek additional
capital to finance acquisitions or otherwise, we may raise such capital through
additional equity offerings, including the issuance of additional series of
preferred stock, common stock, limited partnership units in our operating
partnership, or debt securities, or by the retention of cash flow (after
consideration of provisions of the Code requiring that a REIT distribute 90% of
its taxable income each year to remain qualified as a REIT and taking into
account taxes that would be imposed on undistributed taxable income), or through
a combination of these sources. We currently anticipate that any additional
borrowings will be made through the operating partnership. Borrowings may be
unsecured or may be secured by any or all of our assets or any existing or new
property and may have full or limited recourse to all or any portion of all of
our assets or any existing or new property. Any financing we obtain will be
structured in a manner so that neither our operating partnership nor any portion
of our operating partnership will be treated as a taxable mortgage pool for
federal tax purposes. See "Federal Income Tax Considerations--Federal Income Tax
Aspects of Our Operating Partnership and the Subsidiary Entities--Classification
as Partnerships."
We have not established any limit on the number or amount of mortgages that
may be placed on any single property or on our portfolio as a whole.
Although we have not entered into agreements or received commitments from
any lenders, we plan to enter into a credit facility that will be collateralized
by the Interests tendered to us in the offer. We plan to seek to obtain a credit
facility that will provide funds in an amount initially equal to 50% of the
value of the Interests tendered and that will be available to fund property
acquisitions and for general corporate purposes.
Either we or the operating partnership can raise additional equity capital
if we decide we need to. Our board of directors has the authority, with the
approval of our common stockholders, to issue additional shares of common stock
or other stock in any manner (and on such terms and for such consideration) as
it deems appropriate, including in exchange for property. However, without the
consent of the holders of Preferred Shares representing 66 2/3% in liquidation
preference of the outstanding Preferred Shares, we may not authorize, create or
increase the number of authorized shares of any series of preferred stock that
would rank senior to the Preferred Shares as to distributions or upon
liquidation, dissolution, winding-up or termination.
DISPOSITION POLICY
We intend to hold each of our properties for long-term investment. We have
no current intention to dispose of any of the initial properties or of any of
the Interests that may be tendered to us, although we reserve the right to do
so.
POLICIES WITH RESPECT TO OTHER ACTIVITIES
We may offer shares of our stock or other securities and repurchase or
otherwise reacquire such stock or any other securities. We have no outstanding
loans to other entities or persons, including any of our officers and directors.
We may in the future make loans to joint ventures in which we are a partner to
meet working capital needs. We have not engaged in trading, underwriting or
agency distribution or sale of securities of other issuers, and we have not
invested in the securities of other issuers (other than of our operating
partnership) for the purpose of exercising control, and we do not intend to do
so.
At all times, we intend to make and hold investments in such a manner as to
be consistent with the requirements of the Code for us to qualify as a REIT
unless, because of changing circumstances or changes in the Code (or in Treasury
regulations promulgated under the Code), our board determines that it is no
longer in our best interests to qualify as a REIT.
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THE OFFERS
BASIC TERMS
EXCHANGE OF THE INTERESTS. We are offering to exchange Preferred Shares for
up to the specified number of Interests described under "--Exchange of
Interests" below that are validly tendered in an offer on or before the
expiration date of the offer and not withdrawn, subject in each case to the
proration procedures described in this prospectus and the related letter of
transmittal.
EXPIRATION DATE. Each offer is scheduled to expire at 12:00 midnight, New
York City time, on , , 2002, unless we extend the period
during which the offer is open, in which case the term "expiration date" means
the latest time and date at which the offer, as so extended, expires.
TRANSFER CHARGES. All transfer taxes and fees on the exchange of Interests
under the offers will be paid by us.
CONDITIONS TO THE OFFERS. Our obligation to exchange Preferred Shares for
Interests under an offer is subject to several conditions referred to below
under "Conditions to the Offers," including the minimum tender condition.
EXCHANGE RATIO
The relationship between the number of Preferred Shares to be issued in
exchange for an Interest tendered in the offers is referred to as the exchange
ratio.
We determined the exchange ratio as follows. First, to determine the value
of an Interest in each mortgage fund, we valued each mortgage fund, based on the
methodology described below, and divided that value by the number of Interests
of that mortgage fund that were outstanding as of June 30, 2002. We then divided
the value of each Interest by $25.00 (the liquidation preference of each
Preferred Share) to determine the number of Preferred Shares to be issued in
exchange for each Interest tendered in the offer. The exchange ratio is intended
to provide each tendering holder with an amount of Preferred Shares having an
aggregate liquidation value that is generally equal to the aggregate value of
the Interests being tendered by the holder.
The following table sets forth information relating to our determination of
the exchange ratio, including the number of Preferred Shares to be issued in
exchange for an Interest in each mortgage fund. Fractional shares will not be
issued. See "--Cash Instead of Fractional Shares" below.
NET ASSET
VALUE PREFERRED SHARES
MORTGAGE INTERESTS OUTSTANDING VALUE PER PER TO BE EXCHANGED
FUND VALUE AS OF , 2002 INTEREST INTEREST* PER INTEREST
---------- --------------------- --------- --------- ----------------
GIT..................
GIT II...............
KIM..................
KIP..................
KIP II...............
KIP III..............
------------------------
* As estimated by the mortgage funds. See discussion in sixth paragraph below.
The mortgage fund values were determined using the discounted cash flow
method, which applies a discount rate to projected future distributable cash
flows over the estimated life of an investment to arrive at an estimate of the
present value of the investment. Because the assets of KIP II no longer include
any mortgage loan assets but instead consist primarily of readily marketable
securities, we valued KIP II at net asset value.
We estimated the projected future distributable cash of the mortgage funds
by projecting amortization schedules for each of the underlying mortgage loans
and mortgage-backed securities held by each of the mortgage funds. For the
mortgage loans, the amortization schedules were projected based on the
contractual terms of each mortgage loan, including monthly payments, contractual
interest rates and maturity dates. For the mortgage-backed securities,
distributable cash was projected by taking the weighted average interest rates
on the mortgages within the pool and projecting an annual amortization equal to
a fixed percentage of the outstanding principal at the beginning of each year.
We used rates of between 10% and 15%, depending on the pool. These amortization
78
schedules were intended to reflect the projected monthly principal and interest
payments to be received by the relevant mortgage fund. We assumed that each
mortgage loan would be repaid on the earlier of its maturity date or ten years
(December 31, 2012). Most of the mortgage loans have maturity dates that extend
beyond 2030. However, we believe it is unlikely that the mortgage loans will
remain outstanding until their actual maturity date because refinancing of
mortgages on commercial real estate is a common method of providing cash for
significant capital improvements and cash distributions to owners. From the
estimated cash flows to be received by each mortgage fund, we deducted an
estimate of the ongoing expenses associated with operating the mortgage fund,
including contractual asset management fees of 0.75% of total invested assets
and general administrative expense that we estimated at 0.75% of total invested
assets, based on historical costs and growth patterns. The resulting net cash
flows of each mortgage fund were then assumed to be distributed, in whole, at
the end of the quarter in which they were received, which is consistent with the
distribution policy of the mortgage funds.
Each of the mortgage funds, other than KIP II, has the right to share in the
appreciation of the properties underlying the mortgage loan assets held by the
mortgage funds. The value of these shared appreciation rights are inherently
difficult to estimate. This is because the value is contingent on a number of
variables, including the timing of the repayment of the relevant mortgage loan,
and the value of the underlying property, which is subject to negotiation and
general real estate market conditions at the time of the repayment of the
mortgage loan. Small fluctuations in property values will have a dramatic effect
on the amounts that may be realized by the mortgage funds in connection with
these shared appreciation rights. However, we believe it is likely that some
amount of shared appreciation value will be realized by the mortgage funds in
the future, and therefore estimated a value which was factored into our
determination of the exchange ratio for each mortgage fund. The actual value
that may be realized by the mortgage funds from their shared appreciation rights
cannot be determined with any degree of certainty, and may be substantially
greater than or less than the value that we have ascribed to these rights.
We estimated the value of these shared appreciation rights based on the
historical returns realized by the mortgage loans that have been repaid. For
each mortgage fund, we calculated the average return, relative to the first
mortgage on each property, realized for each mortgage loan that has been repaid.
We then projected a return on each of the remaining outstanding mortgage loans
held by the mortgage fund based on the historical average return for that
mortgage fund. We then reduced the historical average return by a 20% to 50%
discount, based on the number of loans remaining in that mortgage fund, to
reflect the contingent nature of the shared appreciation, which we refer to as
the adjusted historical average return. In determining this discount, we assumed
that the fewer loans that a mortgage fund held, the higher the likelihood that
the historical average return would not be realized. We then assumed that the
adjusted historical average return would be realized at the earlier of the
maturity date of the associated mortgage loan or ten years (December 31, 2012).
The value of the shared appreciation rights was factored into the exchange ratio
by applying a discount rate to the lump sum payment projected to be realized in
the future.
Our determination of the mortgage fund values was based on various
assumptions that we believe to be reasonable, however, we cannot tell you that
the amounts realized from a liquidation of the assets held by the mortgage
funds, if they were liquidated today, would not differ from our estimates, and
these differences could be material. In addition, actual cash flows received by
the mortgage funds may be greater or less than the projected cash flows we used
to determine the exchange ratio. Holders who tender their Interests will not be
compensated if these actual cash flows received exceed our projected cash flows.
Our mortgage fund values are different from, and lower than, the mortgage
fund net asset value estimates as of June 30, 2002, as determined by the
mortgage funds and published on their websites. These net asset values are shown
on the above table. The net asset value estimates as determined by the mortgage
funds represent the theoretical liquidation value of all of the assets held by
the mortgage fund that could reasonably be expected to be realized at a
particular point in time. We use the term "theoretical" because the mortgage
funds cannot, by virtue of the structure and terms of the underlying mortgages,
cause their mortgage assets to be liquidated into cash other than over an
extended period of time and, in any event, the liquidation would not necessarily
result in the realization of the mortgage fund net asset value estimates. In
addition, unlike our mortgage fund values, in determining their net asset value
estimates, the mortgage funds do not factor in any shared appreciation in the
real properties underlying their mortgage loan investments, because the
appreciated value of these properties cannot be ascertained until the mortgages
are refinanced by the borrower or the properties are sold, or unless the
mortgage loan is called.
79
The mortgage fund values we used to determine the exchange ratio was based
on a methodology that views the Interests as representing an interest in the
future distributions from the mortgage funds over a period of time, rather than
an interest in the underlying assets of the mortgage funds as of a particular
point in time. As described above, our mortgage fund values represent the value
of the projected future cash flows from the Interests, including any cash flows
that may be derived from the shared appreciation in the real properties
underlying the mortgages held by the mortgage funds, given various assumptions
that we believe to be reasonable. As described above, we also took into
consideration the expenses of operating the mortgage funds, as well as how we
believe the mortgage funds will apply their cash available for distribution. Our
mortgage fund values do not make any assumptions about the ability of the
mortgage funds to liquidate their assets into cash at any particular point in
time, but rather make assumptions about what would happen if the mortgage funds
were left to wind down their operations under their normal course of operations.
Although we believe that net asset value as reported by the mortgage funds
may be an appropriate measure to value their underlying assets, we do not
believe it is an appropriate measure to value the Interests for purposes of
determining the exchange ratio. By way of example, if two mortgage funds each
owned only one asset consisting of a mortgage loan having the same principal,
prepayment and other terms, but one mortgage loan had an annual interest rate of
4% while the other had an annual interest rate of 6%, the net asset values of
each of the mortgage funds--that is, the liquidation value realizable by those
mortgage funds if the loans were repaid on a particular day--would be identical.
However, from the perspective of someone who owned an interest in both mortgage
funds, the fund owning the mortgage loan bearing the 6% interest rate would have
greater value because that fund would distribute more cash on an annual basis to
that interest holder. Thus, based on the projected cash flow methodology, an
interest in that fund would have more value. This is the methodology we used to
determine the exchange ratio. We believe that the methodology we used to
determine our mortgage fund values is a more appropriate methodology for
purposes of determining the exchange ratio than are the net asset value
estimates determined by the mortgage funds.
Our exchange ratio is premised on the assumption that the value of the
Preferred Shares approximates its liquidation preference, which is $25.00 per
share. We determined the terms of the Preferred Shares with this as our goal. To
do this, we reviewed dividend yields payable on comparable preferred stock
issued by publicly traded REITs. We reviewed the coverage of interest and
preferred dividends of these REIT securities for the twelve months ended
June 30, 2002, as well as the ratios of debt plus equity and of debt plus
preferred stock to debt plus equity. Based on this analysis, we selected a
distribution rate for the Preferred Shares that was comparable to the current
dividend yields on these comparable REIT preferred stocks.
FAIRNESS OPINION
Sutter Securities Incorporated was retained, under an engagement letter
dated March 21, 2002, to advise us with respect to the offers and to render such
opinions as may be reasonably requested by us in connection with the offers. On
, 2002, Sutter Securities delivered its written opinion to us that
the consideration being offered to holders of Interests is fair, from a
financial point of view, to holders of Interests who elect to tender their
Interests for Preferred Shares.
Sutter Securities, as part of its investment banking business, is regularly
engaged in rendering financial advisory services to companies, underwriting and
distributing securities, and providing valuations of businesses and securities.
Sutter Securities was engaged as our financial advisor because of the experience
of the principals of Sutter Securities in providing financial advisory services,
conducting valuation and financial analysis of transactions and rendering
fairness opinions. In requesting Sutter Securities' fairness opinion, we did not
give any special instructions to Sutter Securities or impose any limitations on
the scope of the investigations that Sutter Securities deemed necessary to
enable it to deliver its opinion. Neither Sutter Securities nor any affiliate of
Sutter Securities has performed any investment banking or other financial
services for, or had any other material relationship with us or any of our
affiliates.
The following information has been obtained from Sutter Securities, and we
assume no responsibility for the accuracy or completeness of this information.
Sutter Securities' opinion addresses only the fairness, from a financial
point of view, of the consideration being offered to the holders of Interests in
the offers, and does not constitute a recommendation as to whether or not
holders should tender their Interests in an offer. Moreover, Sutter Securities
was engaged by The Berkshire Group (our affiliate) on our behalf, and we will
pay all of the fees and expenses relating to the Sutter Securities
80
opinion. The summary of Sutter Securities' opinion set forth in this prospectus
is qualified in its entirety by reference to the full text of such opinion,
which is attached as Appendix A to this prospectus. HOLDERS OF INTERESTS ARE
URGED TO, AND SHOULD, READ SUTTER SECURITIES' OPINION CAREFULLY IN ITS ENTIRETY,
TOGETHER WITH THIS PROSPECTUS, FOR ASSUMPTIONS MADE, MATTERS CONSIDERED AND
LIMITS OF THE REVIEW BY SUTTER SECURITIES.
In connection with rendering its opinion, Sutter Securities, among other
things:
- reviewed this prospectus in substantially final form;
- reviewed the annual reports of each of the mortgage funds for the fiscal
years ended December 31, 2001, and their quarterly reports for the periods
ended March 31 and June 30, 2002;
- met with members of The Berkshire Group's senior management to discuss the
operations and financial statements of the mortgage funds and our intended
operations, financial data and future prospects, including the initial
properties;
- reviewed certain operating and financial information, including
projections, relating to our business and prospects and the business and
prospects of the initial properties, all of which was provided to Sutter
Securities by The Berkshire Group's management;
- reviewed publicly available financial information relating to each of the
mortgage funds and The Berkshire Group's management's estimates of the
future financial performance and prospects of each of the mortgage funds;
- reviewed the methodology and assumptions used by management in valuing the
Interests for purposes of establishing the exchange ratio;
- reviewed appraisals of the initial properties;
- visited the initial properties that are located in Maryland;
- reviewed the historical trading activity of the Interests;
- reviewed publicly available information with respect to the preferred
stock of other real estate investment trusts which Sutter Securities
deemed generally comparable to us;
- reviewed publicly available income and balance sheet data of those other
real estate investment trusts; and
- conducted such other studies, analyses, inquiries and investigations as
Sutter Securities deemed appropriate.
GENERAL COMPARISON OF ATTRIBUTES
Sutter Securities compared various attributes of the Preferred Shares to
those of the Interests. In making this comparison, Sutter Securities noted that
the mortgage funds are self-liquidating--that is, their assets are reduced over
time as the mortgage loans owned by the mortgage funds are repaid--which means
the Interests eventually will no longer be outstanding. Sutter Securities noted
that, because the Preferred Shares have no stated maturity, the offers give
holders of Interests the opportunity to continue to own interests in an
investment vehicle, should they desire to do so, subject to our ability to
redeem the Preferred Shares commencing in 2010. Sutter Securities also noted
that by virtue of being listed on the American Stock Exchange, the Preferred
Shares will have greater liquidity than the Interests. In addition, Sutter
Securities also noted that an investment in the Preferred Shares will involve
somewhat greater risk than an investment in the Interests, with no guaranteed
return of principal.
VALUATION
In rendering its opinion, Sutter Securities considered the fair market value
of the Preferred Shares being offered to holders of Interests as well as the
fair market value of the Interests that are sought to be exchanged for the
Preferred Shares. Sutter Securities concluded that because the fair market value
of the Preferred Shares is at least equal to the value of the Interests sought
to be exchanged for Preferred Shares in accordance with the exchange ratios
established for each mortgage fund, the consideration being offered to holders
of Interests is fair, from a financial point of view, to holder of Interests who
elect to tender their interests for Preferred Shares. The exchange ratios
reflect the number of Preferred Shares that will be issued in exchange for each
Interest tendered
81
in an offer or, stated alternatively, the number of Interests required to be
tendered in order to receive one Preferred Share, as set forth in the following
table:
PREFERRED SHARES INTERESTS PER
MORTGAGE FUND PER INTEREST PREFERRED SHARE
------------- ---------------- ---------------
GIT...................................................... -- --
GIT II................................................... -- --
KIM...................................................... -- --
KIP...................................................... -- --
KIP II................................................... -- --
KIP III.................................................. -- --
VALUE OF PREFERRED SHARES. In determining the value of the Preferred
Shares, Sutter Securities first compared the dividend rate payable on the
Preferred Shares of % per annum to the current yields on publicly traded
preferred stock of REITs deemed by Sutter Securities to be generally comparable
to us. The "current yield" of a dividend-paying preferred stock is equal to the
amount of dividends payable per year on each share divided by the value, or
market price, of each such share. For purposes of its analysis, Sutter
Securities calculated the yields in respect of publicly traded non-convertible
preferred stock of companies that Sutter Securities regarded as generally
comparable to our company. The eleven income-oriented REITs considered by Sutter
Securities that invest primarily in residential properties included: Apartment
Investment and Management Company, Archstone-Smith Trust, Associated Estates
Realty Corporation, AvalonBay Communities, Inc., BRE Properties, Inc., Equity
Residential Properties Trust, Home Properties of New York, Inc., Irvine
Apartment Communities, L.P., Mid-America Apartment Communities, Inc., Post
Properties, Inc., and United Dominion Realty Trust, Inc.
Sutter Securities also considered the yields in respect of the following
thirty-three REITs that invest primarily in non-residential properties: AMB
Property Corporation, CarrAmerica Realty Corporation, CBL & Associates
Properties, Inc., CenterPoint Properties Trust, Chelsea Property Group, Inc.,
Colonial Properties Trust, Corporate Office Properties Trust, Crescent Real
Estate Equities Company, Crown American Realty Trust, Developers Diversified
Realty Corporation, Duke Realty Corporation, EastGroup Properties, Inc.,
Entertainment Properties Trust, Equity Inns, Inc., Equity Office Properties
Trust, Felcor Lodging Trust Incorporated, Glimcher Realty Trust, Highwoods
Properties, Inc., Host Marriott Corporation, JDN Realty Corporation, Kimco
Realty Corporation, Kramont Realty Trust, LTC Properties, Inc., New Plan Excel
Realty Trust, Inc., Parkway Properties, Inc., ProLogis Trust, PS Business
Parks, Inc., Realty Income Corporation, Shurgard Storage Centers, Inc., Simon
Property Group, Inc., Taubman Centers, Inc., Vornado Realty Trust and Weingarten
Realty Investors.
The current yields of these comparable companies ranged from % to % as
of the date immediately preceding the date of the Sutter Securities opinion.
Sutter Securities reviewed certain publicly available financial data of
these comparable companies, including the coverage of interest and preferred
dividends for each of these REITs for the twelve months ended June 30, 2002, as
well as the ratios of debt to debt plus equity and of debt plus preferred stock
to debt plus equity, and compared these coverages and ratios to the coverages
and ratios we expect for our company on a pro forma basis.
Based on Sutter Securities' analysis of the financial data and yields of the
comparable companies, it arrived at an imputed value for the Preferred Shares of
approximately $ per share as of the date of its opinion. Sutter Securities
noted that the foregoing value reflected its estimate of the value of the
Preferred Stock resulting from its analysis of yields on preferred stock issued
by comparable companies as described above, and does not necessarily represent
an estimate of the anticipated initial market or trading price for the Preferred
Shares.
VALUE OF INTERESTS. Sutter Securities reviewed the methodology and
assumptions underlying management's determination of the value of the Interests
of each of the mortgage funds as discussed under "The Offers--Exchange Ratio"),
and noted the following:
Management determined the value of the mortgage funds utilizing a discounted
cash flow methodology. This methodology determines value by applying a discount
rate to projected future distributable cash flows over the estimated life of an
investment to arrive at an estimate of the present value of the investment.
Management projected the future cash distributions from each of the mortgage
funds other than KIP II (discussed separately below) based on the terms of the
underlying mortgages using an estimated life of ten years. Management then
reduced the amount of such future cash distributions (a) by 0. % to reflect
expenses (other
82
than management fees) payable by these mortgage funds and (b) by 0.75% of the
average assets under management to reflect management fees payable by these
mortgage funds. Management then applied a discount rate to the adjusted cash
flows based on the ten-year AAA Fin/Bank interest rate ( % as of ,
2002), and increased that rate (a) by 2% to reflect the lack of market liquidity
of the mortgage loans, (b) by an additional 7% to reflect the increased risks
associated with certain second mortgage loans owned by the mortgage funds that
are not government insured or guaranteed (representing approximately 4.5% and
10% of all mortgage loans owned by GIT and GIT II, respectively), such 7%
increase applicable only to the cash flows attributable to such second mortgage
loans and (c) by % to reflect the risk that the mortgage loans, because of
their maturity dates, would not be repaid within the predicted time frame.
Certain of the insured loans held by the mortgage funds also have a shared
appreciation feature, which provides the mortgage funds with a contingent right
to share in the incremental appreciation in the value of the real properties
underlying the mortgages upon disposition of the mortgaged properties or upon
the maturity or refinancing of the insured loan. Management advised Sutter
Securities that it is inherently difficult to value the contingent rights
because the value is contingent on a number of variables, including the timing
of the repayment of the relevant mortgage loan, and the value of the underlying
property, which is subject to negotiation and general real estate market
conditions at the time of the repayment of the mortgage loan. Small fluctuations
in property values will have a dramatic effect on the amounts that may be
realized by the mortgage funds in connection with these shared appreciation
rights. However, management believes it is likely that some amount of shared
appreciation value will be realized by the mortgage funds in the future, and
therefore estimated a value which was factored into its determination of the
exchange ratio for each mortgage fund. In deriving the value of the Interests,
management increased the discounted cash flow amounts for GIT, GIT II, KIM, KIP
and KIP III by %, %, %, % and %, respectively, to reflect the value of
these appreciation rights.
In valuing the Interests of KIP II, management concluded that because of the
short remaining life of this mortgage fund, and the fact that substantially all
of its assets have been liquidated, net asset value was the most appropriate
measure of the value of KIP II.
Finally, management obtained the value for each outstanding Interest of the
mortgage funds by dividing the aggregate discounted cash flow amount, adjusted
as described above (or in the case of KIP II, its net asset value), by the
number of outstanding Interests in each fund.
In rendering its opinion, Sutter Securities concurred with and adopted the
methodology and assumptions utilized by management in valuing the Interests
except as noted below.
First, in its calculation of the discount rate, Sutter Securities used a 5%
increase to reflect risks associated with the uninsured second mortgage loans
rather than the 7% income adopted by management. Second, in its valuation
methodology, Sutter Securities did not adjust the discount rate to reflect the
lack of market liquidity. Instead, Sutter Securities calculated the value of the
Interests pursuant to the discounted cash flow approach as described above
(except for the increase in the discount rate account for the illiquid nature of
the loans) and then applied a marketability discount factor to reduce the value
of such Interests.
Sutter Securities noted that the Interests are not listed on any securities
exchange or quoted on any inter-dealer quotation system, but trade sporadically
from time to time in private transactions. The mortgage funds also periodically
redeem their Interests through a Dutch auction for the account of investors in
connection with their dividend reinvestment plans. Sutter Securities reviewed
the average discounts to net asset value at which interests in privately held
mortgage funds have historically traded (as reported by THE PARTNERSHIP
SPECTRUM, a trade publication), and the average discounts to net asset value at
which Interests have been purchased in connection with the mortgage funds'
dividend reinvestment plans. Based on this review, Sutter Securities determined
that an appropriate discount rate to apply to the anticipated cash flows of the
mortgage funds to reflect the lack of market liquidity of the Interests was in
the range of 15% to 20%.
CALCULATED VALUE PER INTEREST
LIQUIDITY DISCOUNT GIT GIT II KIM KIP KIP III
------------------ -------- -------- -------- -------- --------
15%...................................
20%...................................
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Sutter Securities applied the exchange ratio to the calculated values in the
table above to derive the following:
CALCULATED VALUE OF INTERESTS TO BE EXCHANGED FOR ONE PREFERRED SHARE
LIQUIDITY DISCOUNT GIT GIT II KIM KIP KIP III
------------------ -------- -------- -------- -------- --------
15%...................................
20%...................................
Based on the foregoing, Sutter Securities concluded that, as of the date of
its opinion, the consideration being offered to holders of Interests is fair,
from a financial point of view, to holders of Interests who elect to tender
their Interests for Preferred Shares.
Sutter Securities relied upon and assumed the accuracy and completeness of
the financial and other information provided by The Berkshire Group for purposes
of its opinion. Sutter Securities assumed that the projected financial results
of our operations and those of the mortgage funds were reasonably prepared on
bases reflecting the best currently available estimates and judgment of the
management of The Berkshire Group. Sutter Securities relied upon the assurances
of the management of The Berkshire Group that management was unaware of any
facts that would make the information or projections provided to Sutter
Securities incomplete or misleading. Sutter Securities did not assume any
responsibility for the information or projections provided to it. Sutter
Securities assumed that we would continue to qualify as a REIT. In arriving at
its opinion, Sutter Securities did not perform any independent appraisal of the
initial properties or of the assets of the mortgage funds. Sutter Securities'
opinion is necessarily based on economic, market and other conditions, and the
information made available to it, as of the date of its opinion.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to partial analysis or summary description. Selecting
portions of the analyses or of the summary set forth above, without considering
the analysis as a whole, could create an incomplete view of the processes
underlying Sutter Securities' opinion. In arriving at its opinion, Sutter
Securities considered the results of all such analyses. In rendering its
opinion, Sutter Securities performed such additional analyses as it deemed
appropriate (which also supported its view as to fairness), and the foregoing
summary does not purport to be a complete description of the analyses performed
by Sutter Securities.
Pursuant to our engagement letter with Sutter Securities, we agreed to pay
Sutter Securities a fee of $185,000, of which $85,000 has been paid and $100,000
became payable upon the mailing of this prospectus. We also agreed to reimburse
Sutter Securities for its reasonable out-of-pocket expenses and to indemnify
Sutter Securities against specified liabilities in connection with the
engagement of Sutter Securities, including liabilities under federal securities
laws.
PURPOSE OF THE OFFERS
We are making the offers to provide holders of Interests with the
opportunity to exchange some or all of their Interests for Preferred Shares.
We intend to borrow funds that will be secured by the Interests, and to
utilize distributions from the Interests consisting of mortgage loan repayments,
together with income from our real properties, to, among other things, acquire
additional multi-family residential properties.
As of the date of this prospectus, neither we nor, to our knowledge, our
directors and executive officers own any Interests. Our affiliate, Berkshire
Mortgage Advisors Limited Partnership, is the advisor to GIT and GIT II (the GIT
Advisor). The GIT Advisor owns 10,000 Interests in GIT and 10,000 Interests in
GIT II. The GIT Advisor has advised us that it intends to tender all of those
Interests in the applicable offers.
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EXTENSION, TERMINATION AND AMENDMENT
We reserve the right to extend an offer in the following circumstances for
one or more periods:
- for any period required by any rule, regulation, interpretation or
position of the SEC or the SEC's staff applicable to the offer or any
period required by applicable law,
- if any condition to the offer has not been satisfied, or
- if the aggregate number of Interests we are seeking to exchange for
Preferred Shares has not been validly tendered by the expiration date.
If we decide, or are required, to extend an offer as described above, we
will issue a press release, announcing the number of Interests that have been
tendered as of that time and giving the new expiration date, no later than
9:00 a.m., New York City time, on the next business day after the previously
scheduled expiration date.
During any such extension, all Interests previously tendered in an offer and
not properly withdrawn will remain subject to the offer, unless properly
withdrawn by you. See "Withdrawal Rights" below for more details.
We reserve the right to waive any of the conditions to an offer and to make
any change in the terms of or conditions to the offer, if allowed under the
SEC's applicable rules and regulations.
We will make a public announcement of any extension, termination, amendment
or delay of an offer as promptly as practicable. In the case of an extension,
any announcement will be issued no later than 9:00 a.m., New York City time, on
the next business day after the previously scheduled expiration date. Subject to
applicable law, including Rules 14d-4(c), 14d-6(c) and 14e-1 under the Exchange
Act, which require that any material change in the information published, sent
or given to the holders of Interests in connection with the offer be promptly
sent to the holders in a manner reasonably designed to inform them of such
change, and without limiting the manner in which we may choose to make any
public announcement, we assume no obligation to publish, advertise or otherwise
communicate any such public announcement other than by making a release to the
Dow Jones News Service or the PR Newswire Association, Inc.
If we make a material change in the terms of an offer or the information
concerning the offer, or if we waive a material condition of the offer, we will
extend the offer to the extent required by Rule 14e-1 under the Exchange Act.
If, before the expiration date, we change the number of Interests being sought
or the consideration we are offering, that change will apply to all of the
holders of Interests whose Interests are accepted for exchange in the offer. If,
at the time notice of that change is first published, sent or given to you, the
offer is scheduled to expire at any time earlier than the tenth business day
from and including the date that the notice is first so published, sent or
given, we will extend the offer until the expiration of that ten business day
period.
For purposes of the offers, a "business day" means any day other than a
Saturday, Sunday or federal holiday and consists of the time period from
12:01 a.m. through 12:00 midnight, New York City time.
We are seeking to accept Interests up to an amount such that the total
number of Preferred Shares to be issued by us in the offers will equal, but not
exceed, 2,563,147 shares (which we refer to as the maximum number of Interests
to be accepted). We have established this maximum number because the number of
Interests we can exchange for Preferred Shares is limited by, among other
things, the percentage (in terms of value) of a specified category of assets we
must own so that we will not be deemed an "investment company" under the
Investment Company Act of 1940, and the number of Interests of GIT and GIT II
that we are permitted to own under the ownership limit waiver granted by the
board of trustees of GIT and GIT II. See "Relationships and Related
Transactions--GIT Funds Ownership Limit Waiver."
If the maximum number of Interests to be accepted has not been validly
tendered and not withdrawn in the offers by the expiration date, we currently
intend to extend the expiration date of the offers, and, subject to the limits
imposed by the Investment Company Act and the GIT and GIT II ownership limit
waiver described above, do the following:
- with respect to each mortgage fund where Interests have been validly
tendered and not withdrawn in an amount that is in excess of the tender
ceiling applicable to that mortgage fund, we intend to extend the
expiration date and increase the aggregate number of Interests we are
seeking with respect to that mortgage fund,
- with respect to each mortgage fund where Interests have been validly
tendered and not withdrawn in an amount that is below the tender ceiling
applicable to that mortgage fund, we intend to extend the
85
expiration date and reduce the number of Interests of that mortgage fund
being sought (but not less than the number of Interests that have been
validly tendered and not withdrawn as of the initial expiration date), and
- with respect to each mortgage fund where Interests have been validly
tendered and not withdrawn in an amount that is equal to the tender
ceiling applicable to that mortgage fund, we intend to extend the
expiration date but not change the number of Interests of that mortgage
fund being sought.
The purpose of the extensions and amendments described above is to accept
that number of Interests that will be as close as possible to the maximum number
of Interests to be accepted. Although we currently intend to extend and amend
the offers as described above, we reserve the right not to do so.
If we extend and amend an offer as described above, we currently intend to
mail a prospectus supplement to the holders of Interests describing the
extension of the expiration date and the changes to the offer. Assuming that we
amended the offers as described above and accepted Interests of each mortgage
fund up to an amount such that the total number of Preferred Shares to be issued
by us in the offers equaled 2,563,147 shares, we expect that our total revenue
and total expenses, on a pro forma basis, for the six months ended June 30, 2002
and for the year ended December 31, 2001 would not be materially different from
"total revenue" and "total expenses" included in our unaudited pro forma
condensed consolidated statement of operations assuming 25% investment in
mortgage funds for the six months ended June 30, 2002, or our unaudited pro
forma condensed consolidated statement of operations assuming 25% investment in
mortgage funds for the year ended December 31, 2001, respectively, included in
this prospectus. We also expect that our assets, liabilities and stockholders'
equity, on a pro forma basis, as of June 30, 2002 and as of December 31, 2001
would not be materially different from the information presented in our
unaudited pro forma condensed consolidated balance sheet assuming 25% investment
in mortgage funds as of June 30, 2002, or our unaudited pro forma condensed
consolidated balance sheet assuming 25% investment in mortgage funds as of
December 31, 2001, respectively.
PROCEDURE FOR TENDERING
VALID TENDER. For you to validly tender the Interests in an offer, you
must, before the expiration of the offer, deliver to us at One Beacon Street,
Suite 1500, Boston, Massachusetts 02108, Attention: Krupp Funds Group, a
properly completed and duly executed letter of transmittal, or a manually signed
facsimile of that document, and any other required documents.
TO PREVENT UNITED STATES FEDERAL INCOME TAX BACKUP WITHHOLDING WITH RESPECT
TO THE PREFERRED SHARES, YOU MUST PROVIDE US WITH YOUR CORRECT TAXPAYER
IDENTIFICATION NUMBER AND CERTIFY THAT YOU ARE NOT SUBJECT TO BACKUP WITHHOLDING
OF UNITED STATES FEDERAL INCOME TAX BY COMPLETING THE SUBSTITUTE FORM W-9
INCLUDED IN THE LETTER OF TRANSMITTAL. SOME OF THE HOLDERS OF INTERESTS
(INCLUDING CORPORATIONS AND SOME FOREIGN INDIVIDUALS) MAY BE EXEMPT FROM THESE
BACKUP WITHHOLDING REQUIREMENTS. IN ORDER FOR A FOREIGN INDIVIDUAL STOCKHOLDER
TO QUALIFY AS AN EXEMPT RECIPIENT, THE STOCKHOLDER MUST SUBMIT AN APPLICABLE
INTERNAL REVENUE SERVICE FORM W-8, SIGNED UNDER PENALTIES OF PERJURY, ATTESTING
TO THAT INDIVIDUAL'S EXEMPT STATUS.
APPOINTMENT OF ATTORNEYS-IN-FACT AND PROXIES. By executing a letter of
transmittal as described above, you irrevocably appoint our designees as your
attorneys-in-fact and proxies, each with full power of substitution, to the full
extent of your rights with respect to your Interests tendered and accepted for
exchange by us and with respect to any and all cash distributions payable or
distributable in respect of the Interests on or after the expiration date. That
appointment is effective, and voting rights will be affected, when and only to
the extent that we accept for exchange the Interests that you have tendered to
us. All such proxies will be considered coupled with an interest in the tendered
Interests and therefore will not be revocable. Upon the effectiveness of such
appointment, all prior proxies that you have given will be revoked, and you may
not give any subsequent proxies (and, if given, they will not be deemed
effective). Our designees will, with respect to the Interests for which the
appointment is effective, be empowered, among other things, to exercise all of
your voting rights as they, in their sole discretion, deem proper at any annual,
special or adjourned meeting of the holders of Interests or otherwise, and to
receive all benefits and cash distributions and otherwise exercise all rights of
beneficial ownership of, the tendered Interests.
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DETERMINATION OF VALIDITY. We will determine questions as to the validity,
form, eligibility (including time of receipt) and acceptance for exchange of any
tender of Interests, in our sole discretion, and our determination will be final
and binding. We reserve the absolute right to reject any and all tenders of
Interests that we determine are not in proper form or the acceptance or exchange
for which may, in the opinion of our counsel, be unlawful. We also reserve the
right to waive any defect or irregularity in the tender of Interests, whether or
not similar defects or irregularities are waived in the case of other holders of
Interests. Subject to the SEC's applicable rules and regulations, we also
reserve the right to waive any of the conditions to an offer and to make any
change in the terms of or conditions to the offer. We will give oral or written
notice of any such delay, termination or amendment by making a public
announcement. No tender of Interests will be deemed to have been validly made
until all defects and irregularities in the tender of any Interests have been
cured or waived. Neither we nor Georgeson, in its capacity as information agent
or dealer manager, nor any other person will be under any duty to give
notification of any defects or irregularities in the tender of any Interests or
will incur any liability for failure to give any such notification. Our
interpretation of the terms and conditions of the offers (including the letter
of transmittal and instructions thereto) will be final and binding.
BINDING AGREEMENT. By executing a letter of transmittal to tender Interests
in an offer as described above, you will be expressly acknowledging that you
have read and agree to all of the terms of the offer contained in this
prospectus, including your acknowledgement that we may authorize, create or
increase the number of authorized shares of any series of our stock that would
rank on a parity with the Preferred Shares as to distributions or liquidation
without a vote by the holders of the Preferred Shares. You will also be
expressly acknowledging that the tender of Interests in an offer under the
procedures described above will constitute a binding agreement between us and
you upon the terms and conditions of the offer.
WITHDRAWAL RIGHTS
Interests tendered in an offer may be withdrawn at any time before the
expiration of the offer, and, unless we have previously accepted them in the
offer, may also be withdrawn at any time after , 2003. Once we
accept Interests in the offer, your tender is irrevocable.
For your withdrawal to be effective, we must receive from you a written or
facsimile transmission notice of withdrawal at One Beacon Street, Suite 1500,
Boston, Massachusetts 02108, Attention: Krupp Funds Group, and your notice must
include your name, address, social security number, and the number of Interests
to be withdrawn, as well as the name of the registered holder, if it is
different from that of the person who tendered those Interests.
WE WILL DECIDE ALL QUESTIONS AS TO THE FORM AND VALIDITY (INCLUDING TIME OF
RECEIPT) OF ANY NOTICE OF WITHDRAWAL, IN OUR SOLE DISCRETION, AND OUR DECISION
SHALL BE FINAL AND BINDING. NEITHER WE, THE INFORMATION AGENT, THE DEALER
MANAGER NOR ANY OTHER PERSON WILL BE UNDER ANY DUTY TO GIVE NOTIFICATION OF ANY
DEFECTS OR IRREGULARITIES IN ANY NOTICE OF WITHDRAWAL OR WILL INCUR ANY
LIABILITY FOR FAILURE TO GIVE ANY NOTIFICATION.
Any Interests properly withdrawn from an offer will be deemed not to have
been validly tendered for purposes of the offer. However, you may re-tender
withdrawn Interests by following one of the procedures discussed under the
caption entitled "Procedure for Tendering" at any time prior to the expiration
date of the offer.
EXCHANGE OF INTERESTS
Upon the terms and conditions of an offer (including, if the offer is
extended or amended, the terms and conditions of the extension or amendment),
and subject to the proration procedures described below under "--Proration
Procedures," we will accept for exchange:
- up to 3,913,815 Interests in GIT,
- up to 4,776,584 Interests in GIT II,
- up to 3,988,766 Interests in KIM,
- up to 1,950,025 Interests in KIP,
- up to 3,810,433 Interests in KIP II, and
- up to 3,320,267 Interests in KIP III
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that are validly tendered, and not properly withdrawn, before the expiration
date of the offer, as promptly as practicable after the expiration date.
Notwithstanding the immediately preceding sentence, subject to applicable rules
of the SEC, we may, among other things, increase the number of Interests we will
accept for exchange or delay acceptance for exchange, or the exchange of,
Interests to comply with any applicable law or obtain any government or
regulatory approvals.
In all cases, exchange of Interests tendered and accepted for exchange in an
offer will be made only after timely receipt by us of a properly completed and
duly executed letter of transmittal, or a manually signed facsimile of that
document, and any other required documents.
PRORATION PROCEDURES
With respect to each offer, we are seeking to exchange Preferred Shares for
up to the specified number of Interests described above under "--Exchange of
Interests," which represents approximately 26% of the Interests of each of the
mortgage funds. If the number of Interests of a mortgage fund validly tendered
and not withdrawn in an offer is greater than the tender ceiling applicable to
that mortgage fund, our proration procedures will apply. In that event, we will,
upon the terms and conditions of the offer, accept the Interests of that
mortgage fund on a pro rata basis, with adjustments to avoid purchases of
fractional Interests, based on the number of Interests of that mortgage fund
validly tendered and not withdrawn prior to the expiration date. Because of the
time required to determine the precise number of Interests validly tendered and
not withdrawn, if proration is required, we do not expect to announce the final
results of proration until approximately three business days after the
expiration date. Preliminary results of proration will be announced by press
release as promptly as practicable after the expiration date.
CASH INSTEAD OF FRACTIONAL SHARES
We will not issue certificates representing fractional Preferred Shares.
Instead, each tendering holder who would otherwise be entitled to fractional
Preferred Shares will receive cash in an amount equal to that fraction
multiplied by $25.00.
DISTRIBUTIONS ON INTERESTS
One or more of the mortgage funds are expected to make one or more cash
distributions before the completion of the offers. Until we have accepted your
Interests at the completion of the offers, you will continue to be entitled to
receive any cash distributions on your Interests that have been tendered to us.
Note, however, that with respect to KIP II, our offer is subject to the
condition that there not have been any distributions by KIP II consisting of
proceeds in liquidation of the KIP II Interests.
CONDITIONS TO THE OFFERS
Each offer is subject to a number of conditions. These conditions are
described below:
MINIMUM TENDER CONDITION. There must be validly tendered and not properly
withdrawn before the expiration of the offer the number of Interests resulting
in at least 1,000,000 Preferred Shares to be issued in exchange for them.
FAIRNESS OPINION CONDITION. The fairness opinion described under "The Offer
to Exchange Preferred Shares for Interests--Fairness Opinion" shall not have
been withdrawn.
TAX OPINION CONDITION. The tax opinion referred to under "Federal Income
Tax Considerations" shall not have been withdrawn.
WAIVER BY TRUSTEES OF GIT AND GIT II. With respect to the offers for GIT
and GIT II Interests only, the waiver referred to under "Certain Relationships
and Related Transactions--GIT Funds Ownership Limit Waiver" shall not have been
withdrawn.
OTHER CONDITIONS TO THE OFFERS. Each offer is also subject to the condition
that, at the time of the expiration date of the offer, there will not be
existing and continuing any of the following events or circumstances:
1. there shall have been instituted or threatened, or shall be pending, any
action or proceeding before or by any court or governmental, regulatory
or administrative agency or instrumentality, or by any other person,
which challenges the making of the offer, the acceptance for exchange or
ownership by us of the
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Interests in the offer, the acquisition by us of the interests in the
initial properties, or otherwise directly or indirectly relates to the
offer.
2. there shall have been any action threatened or taken, or approval
withheld, or any statute, rule or regulation proposed, enacted,
promulgated, amended or deemed to be applicable to the offer, any of the
mortgage funds, the initial properties or us, by any governmental,
regulatory or administrative authority or agency or tribunal, which, in
our reasonable judgment, would or might directly or indirectly: delay or
restrict our ability, or render us unable, to accept for exchange some or
all of the Interests or acquire the interests in the initial properties,
or materially affect the business, condition (financial or otherwise),
operations or prospects of any of the mortgage funds, the initial
properties or us or otherwise materially impair in any way the
contemplated future conduct of our business.
3. there shall have occurred: the declaration of any banking moratorium or
suspension of payments in respect of banks in the United States, any
general suspension of trading in, or limitation on prices for, securities
on any United States national securities exchange or in the
over-the-counter market, the commencement of war, armed hostilities or
any other national or international calamity directly or indirectly
involving the United States which is material to the offer, any
limitation, whether or not mandatory, by any governmental, regulatory or
administrative agency or authority that materially and adversely affects
the extension of credit by banks or other lending institutions, a decline
in any of the Dow Jones Industrial Average, the Standard & Poors Index of
500 Industrial Companies or the NASDAQ Composite Index in excess of 15%
measured from the close of business on the date of this prospectus, or
any change in the general political, market, economic or financial
conditions in the United States or abroad that could have a material
adverse effect on our business, condition (financial or otherwise),
operations or prospects, or in the case of the foregoing existing at the
time of the commencement of the offer, in our reasonable judgment, a
material acceleration or worsening thereof.
4. any change shall occur or be threatened in the business, condition
(financial or otherwise), operations or prospects of any of the mortgage
funds or the initial properties that, in our reasonable judgment, is or
may be material to our business, condition (financial or otherwise),
operations or prospects.
5. any material casualty or condemnation affecting any of the initial
properties shall occur.
6. there is a reasonable likelihood that completion of the offer would
result in termination of KIM, KIP, KIP II or KIP III as a partnership
under Section 708 of the Code (this condition would only apply to the
Interests of the relevant mortgage fund).
7. there is a reasonable likelihood that completion of the offer would
result in termination of the status of KIM, KIP, KIP II or KIP III as a
partnership for federal income tax purposes under Section 7704 of the
Code (this condition would only apply to the Interests of the relevant
mortgage fund).
8. there would be fewer than 300 holders of record, within the meaning of
Rule 13e-3 under the Exchange Act, of a mortgage fund because of the
offer (this condition would only apply to the Interests of the relevant
mortgage fund because of the offer).
9. with respect to the offer for KIP II Interests only, there may not have
been any distributions by KIP II consisting of proceeds in liquidation of
the KIP II Interests.
The conditions to the offers described above are solely for our benefit and
we may assert them regardless of the circumstances giving rise to any such
conditions. We may, in our sole discretion, waive these conditions in whole or
in part. However, we may not waive the condition in item 8 above relating to
there being fewer than 300 holders of record in any mortgage fund.
REGULATORY APPROVALS
We are not aware of any non-routine approvals or other consents by or from
any governmental authority or administrative or regulatory agency that would be
required to complete the offers. Should any such approval or other action be
required, we expect to seek such approval or take such action.
FEES AND EXPENSES
We have retained Sutter Securities Incorporated to provide financial
advisory services to us in connection with the offers, including the rendering
of a fairness opinion. Sutter will receive $185,000 for these services and will
be reimbursed for out-of-pocket expenses. In addition, we have agreed to
indemnify Sutter Securities against specified
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liabilities and expenses in connection with its services as financial advisor,
including specified liabilities and expenses under the United States federal
securities laws.
We have retained Georgeson Shareholder Communications Inc. and Georgeson
Shareholder Securities Corporation (together, Georgeson) as information agent
and dealer manager in connection with the offers. In that capacity, Georgeson
may contact holders of Interests by mail, telephone, facsimile and personal
interview and may request brokers, dealers and other nominee stockholders to
forward material relating to the offers to beneficial owners of Interests. We
will pay Georgeson $100,000 for these services plus $4.50 per completed call, in
addition to reimbursing Georgeson for its reasonable out-of-pocket expenses. We
have also agreed to pay Georgeson an additional $25,000 per mortgage fund in the
event Interests representing 25% or more of the outstanding Interests of that
mortgage fund are validly tendered and not properly withdrawn in the applicable
offer. We also have agreed to indemnify Georgeson against specified liabilities
and expenses in connection with the offers, including specified liabilities
under the United States federal securities laws.
Georgeson Shareholder Securities Corporation will act as an agent on our
behalf in soliciting Interests and facilitating the exchange of our Preferred
Shares for Interests. Georgeson has no commitment or obligation to purchase any
of the Preferred Shares and will act as an underwriter merely in connection with
its "best efforts" arrangement with us to facilitate the exchange of the
Preferred Shares for Interests.
Except as described above, we will not pay any fees or commissions to any
broker, dealer or other person for soliciting tenders of Interests in the
offers.
STOCK EXCHANGE LISTING
Application has been made to list the Preferred Shares on the American Stock
Exchange under the symbol "BIR."
FORMATION TRANSACTIONS
Our corporate structure is as follows. We are a Maryland corporation. All of
our common stock is owned by KRF Company. Until we issue Preferred Shares at the
completion of the offer, we will have no other outstanding securities. We intend
to own all of our operating assets through our operating partnership, Berkshire
Income Realty-OP, L.P., a Delaware limited partnership. Our wholly owned
subsidiary, BIR GP, L.L.C., is the general partner of our operating partnership,
and we are the special limited partner of our operating partnership. Through our
ownership of the general partner, we effectively control the operating
partnership and its assets.
At the completion of the offer, the following will occur:
- we will issue Preferred Shares to holders who have validly tendered and
not withdrawn their Interests to us in the offers,
- we will transfer those Interests to our operating partnership in exchange
for preferred OP units having the same economic terms as the Preferred
Shares, and having the same relative ranking with respect to common
limited partner interests as the Preferred Shares have with respect to our
common stock. The preferred OP units to be issued to us in exchange for
Interests will equal the number of Preferred Shares being issued by us,
- KRF Company will contribute its interests in the initial properties to our
operating partnership in exchange for common OP units, having the same
economic terms as our common stock, and having the same relative ranking
with respect to the preferred OP units as our common stock will have with
respect to the Preferred Shares, and
- KRF Company will make a capital contribution to us, in exchange for our
common stock, in an amount equal to 1% of the fair value of the total net
assets of our operating partnership, taking into account any cash
contributed to us by KRF Company before the completion of the offers. We
will contribute this amount to BIR GP which in turn will contribute this
amount to our operating partnership in exchange for general partner OP
units.
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MANAGEMENT
GENERAL
As provided in our charter and bylaws, the responsibility for the management
and control of our operations will be vested in our board of directors. Our
board will retain Berkshire Advisor to manage our day-to-day affairs, subject to
the control and supervision of our board of directors. Our board will initially
be composed of five directors, three of whom will be unaffiliated with Berkshire
Advisor and its affiliates and will qualify as independent directors under our
bylaws. We refer to these persons as independent directors. See "--Board of
Directors Committees--Audit Committee" below for a description of how our bylaws
define the qualifications of an independent director. Absent our failure to pay
distributions, which under specified circumstances gives the holders of
Preferred Shares certain rights to elect and remove directors, KRF Company, an
affiliate of The Berkshire Group and the sole holder of our common stock, will
have the sole right to elect and remove members of our board of directors,
including the members who qualify as independent directors. We will generally
utilize officers of Berkshire Advisor to provide our services and will employ
only a few individuals as our officers, none of whom will be compensated by us
for their services to us as our officers.
Berkshire Advisor will be responsible for locating and presenting investment
opportunities to us. Berkshire Advisor is authorized to follow investment
guidelines adopted from time to time by our board of directors in determining
the types of assets it decides to recommend to our board of directors as proper
investments for us. Our board of directors will periodically review our
investment guidelines and our investment portfolio. However, the board of
directors will not be required to approve particular investment decisions made
by Berkshire Advisor in multi-family residential properties within our
investment guidelines. An investment committee of Berkshire Advisor will be
required to approve all acquisitions, financings and dispositions made on our
behalf. The investment committee members of Berkshire Advisor initially will be
Frank Apeseche, Peter Donovan, George Krupp and David Quade. See "--Berkshire
Advisor" below. We have not identified any properties for acquisition at this
time. Any investments made with an affiliate of Berkshire Advisor will require
the prior approval of the audit committee of our board.
As with most corporate boards of directors, our directors will be employed
by various entities on other full-time activities and will not be required to
devote substantial portions of their time to the discharge of their duties as
our directors. The directors will only be required to devote so much of their
time to us as their duties require.
Our directors will be responsible for reviewing our investment policies,
which review will occur not less frequently than annually. The audit committee
of our board also will be responsible for reviewing the performance of Berkshire
Advisor and determining that the provisions of the advisory services agreement
described under "--Summary of Advisory Services Agreement" are being fulfilled.
Members of our audit committee will be entitled to receive compensation from us
for serving as directors in the amount of $30,000 per year. This amount may be
increased in future years with the prior approval of our board. Our other
directors will not be paid compensation for their services to us as directors.
The directors are not precluded from engaging in activities similar to ours,
but are required to disclose any interest held directly or indirectly by them,
or by any of their affiliates, in an investment presented to us.
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EXECUTIVE OFFICERS AND DIRECTORS
Our executive officers and directors as of the date of this prospectus are
as follows:
NAME AGE POSITION OR OFFICES HELD
---- -------- -------------------------------------------
George D. Krupp............................ 58 Chairman of the Board of Directors
David C. Quade............................. President, Chief Financial Officer and
59 Director
Randolph G. Hawthorne...................... 52 Director
Robert M. Kaufman.......................... 53 Director
Richard B. Peiser.......................... 54 Director
Frank Apeseche............................. 45 Vice President, Treasurer
Wayne H. Zarozny........................... 44 Vice President, Controller
Christopher M. Nichols..................... 38 Vice President
Scott D. Spelfogel......................... 41 Vice President, Secretary
The following is a biographical summary of the experience of our executive
officers and directors:
GEORGE D. KRUPP Director of Berkshire Income Realty since July 19, 2002.
Mr. Krupp is also the co-founder and Vice-Chairman of our affiliate, The
Berkshire Group, an integrated real estate and financial services firm engaged
in real estate acquisitions, property management, investment sponsorship,
mortgage banking, financial management and ownership of three operating
companies through private equity investments. Mr. Krupp has held the position of
Vice-Chairman and previously, Co-Chairman, since The Berkshire Group was
established as The Krupp Companies in 1969. Mr. Krupp has been an instructor of
history at the New Jewish High School in Waltham, Massachusetts since September
of 1997. Mr. Krupp attended the University of Pennsylvania and Harvard
University Extension School and holds a Master's degree in History from Brown
University. Mr. Krupp also serves on the Board of Directors of Boston Symphony
and Combined Jewish Philanthropies.
DAVID C. QUADE Director, President and Chief Financial Officer of Berkshire
Income Realty since July 19, 2002. Since December of 1998, Mr. Quade has been
Executive Vice President and Chief Financial Officer of The Berkshire Group, an
affiliate of Berkshire Income Realty. During that period, he led the efforts to
acquire, finance and asset manage the initial properties being contributed by
KRF Company in connection with the offer. Previously, Mr. Quade was a Principal
and Executive Vice President and Chief Financial Officer of Leggat McCall
Properties from 1981-1998, where he was responsible for strategic planning,
corporate and property financing and asset management. Before that, Mr. Quade
worked in senior financial capacities for two New York Stock Exchange listed
real estate investment trusts, North American Mortgage Investors and Equitable
Life Mortgage and Realty Investors. He also worked at Coopers & Lybrand. He has
a Professional Accounting Program degree from Northwestern University Graduate
School of Business. Mr. Quade also holds a Bachelor of Science degree and a
Master of Business Administration degree from Central Michigan University.
Mr. Quade also serves as Chairman of the Board of Directors of the
Marblehead/Swampscott YMCA and Director of the North Shore YMCA.
RANDOLPH G. HAWTHORNE Director of Berkshire Income Realty since
October 15, 2002. Mr. Hawthorne is currently the Principal of a private
investment and consulting firm known as RGH Ventures and has served as such
since January of 2001. Mr. Hawthorne is also the Development Vice Chair of the
Multi-Family Council Gold Flight and the National Multi Housing Council which he
led as the Chairman from 1996-1997. He also presently serves on the Board of
Directors of the National Housing Conference and The Boston Home and currently
serves as an independent member of the Advisory Board of Berkshire Mortgage
Finance, an affiliate of Berkshire Income Realty. Mr. Hawthorne has previously
served as President of the National Housing and Rehabilitation Association and
served on the Editorial Board of the Tax Credit Advisor and Multi-Housing News.
From 1973-2001, Mr. Hawthorne was a Principal and Owner of Boston Financial, a
full service real estate firm which was acquired in 1999 by Lend Lease, a major
global real estate firm which continues to be the largest U.S. manager of
tax-exempt real estate assets. During his 28 years with Boston Financial and
then Lend Lease, Mr. Hawthorne served in a variety of senior leadership roles
including on the Boston Financial Board of
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Directors. Mr. Hawthorne holds a Master of Business Administration degree from
Harvard University and a Bachelor of Science degree from the Massachusetts
Institute of Technology. In addition, Mr. Hawthorne was a Trustee of The
Berkshire Theatre Festival and the Austen Riggs Foundation.
ROBERT M. KAUFMAN Director of Berkshire Income Realty since October 15,
2002. Mr. Kaufman is currently the President and Chief Operating Officer of
Phoenix Ltd., a private investment firm, and has held this position since
October of 2002. Mr. Kaufman was a founder and the Chief Executive Officer of
Medeview, Inc., a healthcare technology company, from 2000-2002. From 1996-1999,
Mr. Kaufman served as Chief Executive Officer of a senior housing company known
as Carematrix Corp. and in 1999 served as a consultant to Carematrix Corp. Prior
to that, Mr. Kaufman worked for Coopers & Lybrand, LLP (now known as
PricewaterhouseCoopers, LLP), an international accounting and consulting firm,
from 1972-1996. During his tenure at Coopers & Lybrand, he was a partner from
1982-1996 primarily servicing real estate and heathcare industry clients and
served as a member of the National Board of Partners. In addition, while a
partner at Coopers & Lybrand, Mr. Kaufman was a member of the Mergers and
Acquisitions and Real Estate Groups, the Associate Chairman of the National
Retail and Consumer Products Industry Group and was a National Technical
Consulting Partner. Mr. Kaufman received his Bachelor of Arts from Colby College
and his Master of Business Administration degree from Cornell University.
RICHARD B. PEISER Director of Berkshire Income Realty since October 15,
2002. Mr. Peiser is currently the Michael D. Spear Professor of Real Estate
Development at Harvard University and has worked in that position since 1998.
Mr. Peiser is also a member of the Department of Urban Planning and Design in
the Harvard University Graduate School of Design and has served as such since
1998. Before joining the faculty of Harvard University in 1998, Mr. Peiser
served as Director of the Lusk Center for Real Estate Development from 1987-1998
as well as Founder and Academic Director of the Master of Real Estate
Development Program at the University of Southern California from 1986-1998.
Mr. Peiser has also worked as a real estate developer and consultant since 1978.
In addition, Mr. Peiser has published numerous articles relating to various
aspects of the real estate industry. Mr. Peiser taught at Southern Methodist
University from 1978-1984, the University of Southern California from 1985-1998
and at Stanford University in the fall of 1981. Mr. Peiser has been a trustee of
the Urban Land Institute since 1997, a Faculty Associate of the Eliot House
since 1998 and a Director of the firm American Realty Advisors since 1998.
Additionally, Mr. Peiser served as a faculty representative on the Harvard
University Board of Overseer's Committee on Social Responsibility from 1999-2002
and has been a co-editor of the Journal of Real Estate Portfolio Management
during 2002. Mr. Peiser holds a Bachelor of Arts degree from Yale University, a
Master of Business Administration degree from Harvard University and a Ph.D. in
land economics from Cambridge University.
FRANK APESECHE Vice President and Treasurer of Berkshire Income Realty
since July 19, 2002. He is also President and Managing Partner of The Berkshire
Group, an affiliate of Berkshire Income Realty. Mr. Apeseche was President and
Chief Executive Officer of our affiliate, BG Affiliates, from 1995-2000.
Mr. Apeseche was Chief Financial Officer of The Berkshire Group from 1993-1995
and Vice President and Treasurer of Berkshire Realty Income, Inc. from
1993-1994. Mr. Apeseche was the Chief Planning Officer of the Berkshire Group
from 1986-1993. Before joining The Berkshire Group in 1986, Mr. Apeseche was a
manager with ACCENTURE (formerly Anderson Consulting) where he specialized in
providing technology solutions to Fortune 500 clients. He received a Bachelor of
Arts degree with distinction from Cornell University and a Master of Business
Administration degree with Honors from the University of Michigan.
WAYNE H. ZAROZNY Vice President and Corporate Controller of Berkshire
Income Realty since July 19, 2002. He currently serves and has served as the
Vice President and Corporate Controller of The Berkshire Group, an affiliate of
Berkshire Income Realty, since 1997. Mr. Zarozny has held several positions
within The Berkshire Group since joining the company in 1986 and is currently
responsible for accounting, financial reporting and treasury activities. Before
joining The Berkshire Group, he was an audit supervisor for Pannell Kerr Forster
International and on the audit staff of Deloitte, Haskins and Sells in Boston.
He received a Bachelor of Science degree from Bryant College, a Master of
Business Administration degree from Clark University and is a Certified Public
Accountant.
CHRISTOPHER M. NICHOLS Vice President of Berkshire Income Realty since
July 19, 2002. He currently holds the position of Senior Financial Analyst and
Asset Manager for The Berkshire Group, an affiliate of Berkshire Income Realty.
Mr. Nichols joined The Berkshire Group in 1999 as the Assistant Corporate
Controller. Before joining the company, Mr. Nichols served as the Accounting
Manager and then as the Corporate Controller for Mac-Gray Corporation from
1997-1999, a New York Stock Exchange listed company. At Mac-Gray, Mr. Nichols
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had primary oversight of the accounting and financial reporting systems.
Mr. Nichols worked as a Senior Staff Auditor for Mullen & Company from
1994-1997. He has Associate Degrees in Computer Information Systems and in
Electrical Engineering, a Bachelor of Science degree in Accountancy from Bentley
College and is a Certified Public Accountant.
SCOTT D. SPELFOGEL Vice President and Secretary of Berkshire Income Realty
since July 19, 2002. He currently serves and has served as Senior Vice President
and General Counsel to The Berkshire Group, an affiliate of Berkshire Income
Realty, since 1996. Before that, he served as Vice President and Assistant
General Counsel. Before joining The Berkshire Group in November of 1988, he was
in private practice in Boston. He received a Bachelor of Science degree in
Business Administration from Boston University, a Juris Doctor degree from
Syracuse University's College of Law and a Master of Laws degree in Taxation
from Boston University Law School. He is admitted to the bar in Massachusetts
and New York.
BOARD OF DIRECTORS COMMITTEES
Our board of directors will have the following standing committee as of the
date we complete the offer:
AUDIT COMMITTEE. The audit committee is responsible for making
recommendations concerning the engagement of independent public accountants, for
reviewing with the independent public accountants the plans and results of the
audit engagement, for approving professional services provided by the
independent public accountants, for reviewing the independence of the
independent public accountants, for considering the range of audit and non-audit
fees, for engaging independent counsel and other advisors, for resolving
disagreements between management and the independent public accountants
regarding financial reporting, for reviewing the adequacy of our accounting
controls, for establishing procedures for the receipt, retention and treatment
of complaints regarding accounting, internal accounting controls or auditing
matters and for establishing procedures for the confidential, anonymous
submissions by employees of concerns regarding questionable accounting and
auditing matters. The audit committee also is responsible for approving all
transactions between us and the operating partnership, on the one hand, and
Berkshire Advisor or its affiliates, on the other hand.
As required by our bylaws, the audit committee will consist of three
directors, each of whom must qualify as an "independent" director and at least
one of whom must be a financial expert, as defined under the applicable rules
promulgated by the SEC.
Our bylaws provide that in order to be considered an independent director,
the director may not:
- be or have been employed by us or our affiliates for the current year or
any of the past three years,
- receive compensation from us or our affiliates in excess of $60,000 during
the previous fiscal year,
- receive any consulting, advisory or compensatory fee from us other than in
his or her capacity as a member of our board or any board committee,
- be a partner, controlling shareholder or an executive officer of a company
to which we made or received payments for the greater of 5% of our
consolidated gross revenues for that year or $200,000 in any of the past
three years, or
- be employed as an executive officer of another entity if any of our
executives serve on the compensation committee of that entity.
In addition, members of the director's immediate family may not have been
employed by us or our affiliates as an executive officer in any of the past
three years.
The initial members of the audit committee will be Messrs. Hawthorne,
Kaufman and Peiser.
The Company does not have a nominating committee.
The Company does not pay compensation to its officers for their services to
us and, accordingly, the Company does not have a compensation committee.
BERKSHIRE ADVISOR
Berkshire Advisor will manage our day-to-day activities, subject to the
control and supervision of our board. Berkshire Advisor was formed on July 22,
2002, as a Delaware limited liability company. Berkshire Advisor is an
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affiliate of The Berkshire Group, a diversified real estate and financial
services organization. Since 1969, The Berkshire Group, together with its
affiliates, has acquired over 30,000 apartment units and provided over
$15 billion of apartment financings. The address of Berkshire Advisor is One
Beacon Street, Suite 1500, Boston, Massachusetts 02108.
Berkshire Advisor will be paid fees and other compensation from us under an
advisory services agreement. See "--Summary of Advisory Services Agreement"
below and "Compensation Payable to Our Affiliates." All of our directors and
executive officers, other than Messrs. Hawthorne, Kaufman and Peiser, who are
our independent directors, are also officers or directors of Berkshire Advisor.
None of the employees of Berkshire Advisor will receive remuneration from us.
An investment committee of Berkshire Advisor will be required to approve all
of our acquisitions, financings and dispositions. The investment committee
members initially will be Frank Apeseche, Peter Donovan, George Krupp and David
Quade, who collectively have over 120 years of professional real estate
experience and judgment. The following is a biographical summary of the
experience of these initial members of the Berkshire Advisor investment
committee:
PETER F. DONOVAN (Age 49) Member of the investment committee of Berkshire
Advisor since its formation on July 22, 2002. Mr. Donovan is Chief Executive
Officer of our affiliate, Berkshire Mortgage Finance, which position he has held
since January of 1998, and in this capacity he oversees the strategic growth
plans of this mortgage banking firm. Berkshire Mortgage Finance is the 10th
largest mortgage banking firm in the United States based on servicing and asset
management of a $15.2 billion loan portfolio. Previously Mr. Donovan served as
President of Berkshire Mortgage Finance from January of 1993 to January of 1998
and in that capacity he directed the production, underwriting, servicing and
asset management activities of the firm. Prior to that, he was Senior Vice
President of Berkshire Mortgage Finance and was responsible for all
participating mortgage originations. Before joining the firm in 1984,
Mr. Donovan was Second Vice President, Real Estate Finance for Continental
Illinois National Bank & Trust, where he managed a $300 million construction
loan portfolio of commercial properties. Mr. Donovan received a B.A. from
Trinity College and an M.B.A. degree from Northwestern University. He is also
currently a member of the Advisory Council for Fannie Mae.
Messrs. Apeseche, Krupp and Quade have been members of the investment
committee of Berkshire Advisor since its formation on July 22, 2002. See
"--Executive Officers and Directors" above for information relating to
Messrs. Apeseche, Krupp and Quade.
THE PROPERTY MANAGER
BRI OP Limited Partnership (BRI OP) currently provides day-to-day on-site
management services with respect to the initial properties and, upon the
completion of the offer, will continue to do so under existing property
management agreements with BRI OP. See "--Summary of Property Management
Agreements" below. BRI OP, through its parent, Berkshire Realty Holdings, L.P.
(BRH), is owned by affiliates of The Berkshire Group in joint venture with
unaffiliated third parties, including Whitehall Street Real Estate XI Limited
Partnership (an affiliate of Goldman Sachs) and affiliates of Blackstone Real
Estate Advisors. Under the terms of an agreement among the principal partners of
BRH, The Berkshire Group affiliates that own interests in BRI OP have agreed to
cause us to offer BRI OP the opportunity to act as property manager for each
multi-family property owned by us that is not being managed by a property
manager unaffiliated with The Berkshire Group, for a management fee that is
market at the time. Subject to approval by our audit committee, we intend to
enter into agreements with BRI OP to manage any additional multi-family
residential properties that we may acquire in the future. Our property
management services needs also may be provided for one or more of our properties
by an unaffiliated property management firm selected by Berkshire Advisor or
designated by a joint venture agreement under which we acquire an interest in a
property.
BRI OP and its predecessors have been providing property management services
since 1969 and have had considerable experience in managing multi-family
residential properties, retail, office and other types of properties. BRI OP
currently manages over 21,000 apartment units in seven states, valued at over
$1.1 billion in the aggregate, from its regional offices in the Baltimore,
Carolinas, Mid-Atlantic, Southeast and Texas markets. BRI OP has expertise in
all phases of property management, including on-site property operation and
maintenance, negotiation and review of leases, and preparation of market
surveys, budgets, cash flow projections, monthly operating statements and
related reports. BRI OP will be paid fees and other compensation under property
management agreements. See "--Summary of Property Management Agreements" below
and
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"Compensation Payable to Our Affiliates." The address of BRI OP is One Beacon
Street, Suite 1500, Boston, Massachusetts 02108.
SUMMARY OF ADVISORY SERVICES AGREEMENT
We have entered into a contract with Berkshire Advisor (which we refer to as
the advisory services agreement) under which Berkshire Advisor is obligated to
manage our portfolio and identify investment opportunities consistent with our
investment policies and objectives, as our board may adopt from time to time.
Although our board has continuing exclusive authority over our management, the
conduct of our affairs, and the management and disposition of our assets, the
directors initially have delegated to Berkshire Advisor the power and duty to:
- obtain or provide such services as may be required to administer our daily
operations;
- identify investment opportunities for us which are consistent with our
investment objectives and policies;
- serve as our investment and financial advisor and provide reports with
respect to our portfolio of investments, including, but not limited to,
the making of investments in real property and other real estate
investments consistent with our investment policies;
- on our behalf, investigate, select, retain and conduct relationships with
such persons as Berkshire Advisor deems necessary to the proper
performance of its obligations, including, but not limited to,
consultants, investors, builders, developers, borrowers, lenders,
mortgagors, brokers, accountants, attorneys, appraisers and others,
including our or the Advisor's affiliates;
- provide advice and recommendations concerning the making of investments
consistent with our investment policies and objectives;
- structure and negotiate the terms of investments in properties and other
assets and obtain our board's approval of investments, where required,
consistent with our investment policies and objectives as they may be
adopted from time to time by our board;
- obtain from its affiliates or from third parties, property management
services for our investments in real property;
- obtain for or provide to us such services as may be required in acquiring,
managing and disposing of investments, including, but not limited to, the
negotiation of purchase contracts and services related to the acquisition
of real properties by us, disbursing and collecting our funds, paying our
debts and fulfilling our obligations, and handling, prosecuting and
settling any of our claims, and such other services as we may require;
- do all things necessary to assure its ability to fulfill its obligations
to us, including providing the office space, furnishings and personnel
necessary for the performance of the foregoing services;
- from time to time, or at any time reasonably requested by our board, make
reports to our board of its performance of the foregoing services;
- within 30 days after the end of each of our fiscal quarters, submit to our
board a statement of our sources of income during such fiscal quarter and
make recommendations concerning changes, if any, in our investments to
permit us to satisfy the requirements of Sections 856(c)(2), 856(c)(3) and
856(c)(4) of the Code (such statement of income may be based upon
information supplied by independent contractors of ours, to the extent
applicable); and
- consult with our board and, at the request of our board, furnish advice
and recommendations with respect to other aspects of our business and
affairs.
Berkshire Advisor is also authorized to make investments in multi-family
residential properties on our behalf that are consistent with the investment and
other policies adopted by our board from time to time without obtaining the
approval of our board.
Notwithstanding the foregoing, Berkshire Advisor must act in accordance with
our charter and bylaws. Our board will supervise and review all actions of
Berkshire Advisor.
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The initial term of the advisory services agreement is two years. The
advisory services agreement automatically extends for a one-year period at the
end of the initial term and at the end of each subsequent one-year period unless
notice of termination or non-renewal is provided by either party upon 60 days'
prior written notice.
The initial two-year term of the advisory services agreement will commence
upon the completion of the offer. Following the initial term, the audit
committee of our board will evaluate the performance of Berkshire Advisor to
determine if subsequent renewals are in order.
Berkshire Advisor may engage in other business activities relating to real
estate or other investments, whether similar or dissimilar to those made by us,
or act as advisor to any other person or entity (including other REITs).
Berkshire Advisor will receive the following compensation for its services
under the advisory services agreement. See also "Compensation Payable to Our
Affiliates."
ACQUISITION FEES. Berkshire Advisor will receive an acquisition fee equal
to 1.0% of the "purchase price" (which is defined as the capitalized basis of an
asset under GAAP including renovation or new construction costs, costs of
acquisition, or other items paid or received which would be considered an
adjustment to basis; but acquisition fees and capital expenditures of a
recurring nature are excluded from this definition) of any new property. In
addition, Berkshire Advisor will be entitled to reimbursement from us for
acquisition expenses actually incurred by them. However, no acquisition fee will
be paid in connection with our acquisition of KRF Company's interests in the
initial properties or the Interests acquired by us in the offer. The acquisition
fee will not be payable unless and until all distributions then due on the
Preferred Shares have been paid in full.
ASSET MANAGEMENT FEES. For its services to us, Berkshire Advisor will
receive an annual asset management fee equal to 0.40% of the purchase price (as
defined under "Acquisition Fees" above) of real estate properties, as adjusted
from time to time to reflect the then current fair market value of the property.
It is expected that Berkshire Advisor will propose annual adjustments to its
annual asset management fees based on the then current market values of the
managed properties. The current fair market value will be based on such factors
as comparable sales, local market conditions and other factors relevant to a
fair and reasonable valuation. Any such proposed adjustment to this fee will
require the approval of the audit committee. There will be an asset management
fee payable on the initial properties, however, there will be no asset
management fee payable on the Interests acquired by us in the offer. The asset
management fee will be payable on a quarterly basis, in arrears. However, the
fee will not be payable unless and until all distributions then due on the
Preferred Shares have been paid in full.
REIMBURSEMENT OF EXPENSES. Berkshire Advisor will be reimbursed at cost for
all out-of-pocket expenses incurred by it, including the actual cost of goods,
materials and services that are used in connection with the management of our
assets. Berkshire Advisor also will be reimbursed for administrative services
rendered by it that are necessary for our prudent operation, including legal,
accounting, data processing, transfer agent and other necessary services. There
is no set limit on the amount of expenses that may be reimbursed. However,
Berkshire Advisor will not be entitled to reimbursement of these expenses unless
and until all distributions then due on the Preferred Shares have been paid in
full.
SUMMARY OF PROPERTY MANAGEMENT AGREEMENTS
BRI OP currently acts as property manager with respect to the initial
properties and, upon the completion of the offer, will continue to do so under
its existing property management agreements.
Under the existing property management agreements, BRI OP is obligated to
process the applications of prospective tenants; prepare, negotiate and enforce
the leases; perform periodic market surveys of the market area in which the
property is located; and maintain the property in good repair and in compliance
with local codes by doing the following:
- performing periodic physical inspections;
- collecting the rental income and paying the operating expenses associated
with the property;
- hiring, managing and compensating, at our expense, on-site management and
maintenance personnel;
- making arrangements for all necessary utilities for the property;
97
- establishing a comprehensive system of books and records; and
- preparing and reviewing budgets and cash flow projections and furnishing
monthly statements of cash flow to us with respect to the performance of
the property.
The property management agreements may be terminated at any time by either
party, without penalty, upon notice ranging from 30 to 60 days.
BRI OP receives a management fee of 5% of the gross rental receipts for its
services under the existing property management agreements relating to the
initial properties. Gross rental receipts are the total revenue amounts
collected on a property for all services related to the rental of units and
maintenance of the property. It is not expected that management fees that may be
payable to BRI OP under property management agreements with respect to
properties that may be acquired by us in the future will exceed 5%. Such fees
will be based on comparable market rates for similar services in the region in
which the property is located. BRI OP is also entitled to be reimbursed at cost
for all out-of-pocket expenses incurred by it, including the actual cost of
goods, materials and services that are used in connection with the management of
our properties.
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SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information regarding the beneficial
ownership of our equity securities as of October 15, 2002 by (1) each person who
is known by us to beneficially own five percent or more of any class of our
equity securities, (2) each of our directors and executive officers and (3) all
of our directors and executive officers as a group. The address for each of the
persons named in the table is One Beacon Street, Suite 1500, Boston,
Massachusetts 02108.
SHARES OF CLASS B PERCENTAGE AND CLASS OF
NAME OF BENEFICIAL OWNER COMMON STOCK OWNED COMMON STOCK OWNED(1)
------------------------ ------------------ ------------------------------------
George Krupp........................ 100(2) 100% of Class B common stock
Douglas Krupp....................... 100(3) 100% of Class B common stock
The Douglas Krupp 1980 Family 100% of Class B common stock
Trust............................. 100(4)
The George Krupp 1980 Family 100% of Class B common stock
Trust............................. 100(5)
Krupp Family Limited 100% of Class B common stock
Partnership--94................... 100(6)
KRF Company, L.L.C.................. 100 100% of Class B common stock
All directors and officers as a 100% of Class B common stock
group............................. 100(7)
------------------------
(1) No shares of our Class A common stock or any other class of our equity
securities were issued and outstanding as of October 15, 2002.
(2) Includes 100 shares owned by KRF Company, L.L.C. The Krupp Family Limited
Partnership--94 owns 100% of the limited liability company interests in KRF
Company, L.L.C. The general partners of Krupp Family Limited Partnership--94
are George Krupp and Douglas Krupp, who each own 50% of the general
partnership interests in Krupp Family Limited Partnership--94. By virtue of
their interests in The Krupp Family Limited Partnership--94, George Krupp
and Douglas Krupp may each be deemed to beneficially own the 100 shares of
Class B common stock owned by KRF Company. George Krupp is also a director
of Berkshire Income Realty, Inc.
(3) Includes 100 shares owned by KRF Company, L.L.C. that may be deemed to be
beneficially owned by Douglas Krupp, as described in footnote (2).
(4) Includes 100 shares owned by KRF Company, L.L.C. The Krupp Family Limited
Partnership--94 owns 100% of the limited liability company interests in KRF
Company. The Douglas Krupp 1980 Family Trust owns 50% of the limited
partnership interests in Krupp Family Limited Partnership--94. By virtue of
its interest in The Krupp Family Limited Partnership--94, The Douglas Krupp
1980 Family Trust may be deemed to beneficially own the 100 shares of
Class B common stock owned by KRF Company, L.L.C. The trustees of the
Douglas Krupp 1980 Family Trust are Paul Krupp, Lawrence Silverstein and
Vincent O'Reilly. The trustees share control over the power to dispose of
the assets of the trust and thus each may be deemed to beneficially own the
100 shares of Class B common stock owned by KRF Company, L.L.C.; however,
each of the trustees disclaims beneficial ownership of all of those shares
that are or may be deemed to be beneficially owned by Douglas Krupp or
George Krupp.
(5) Includes 100 shares owned by KRF Company, L.L.C. The Krupp Family Limited
Partnership--94 owns 100% of the limited liability company interests in KRF
Company. The George Krupp 1980 Family Trust owns 50% of the limited
partnership interests in Krupp Family Limited Partnership--94. By virtue of
its interest in The Krupp Family Limited Partnership--94, The George Krupp
1980 Family Trust may be deemed to beneficially own the 100 shares of
Class B common stock owned by KRF Company, L.L.C. The trustees of the George
Krupp 1980 Family Trust are Paul Krupp and Lawrence Silverstein. The
trustees share control over the power to dispose of the assets of the trust
and thus each may be deemed to beneficially own the 100 shares of Class B
common stock owned by KRF Company, L.L.C.; however, each of the trustees
disclaims beneficial ownership of all of those shares that are or may be
deemed to be beneficially owned by Douglas Krupp or George Krupp.
(6) Includes 100 shares owned by KRF Company, L.L.C. Krupp Family Limited
Partnership--94 owns 100% of the limited liability company interests in KRF
Company, L.L.C. By virtue of its interest in KRF Company, L.L.C., Krupp
Family Limited Partnership--94 is deemed to beneficially own the 100 shares
of Class B common stock owned by KRF Company, L.L.C.
(7) Includes 100 shares owned by KRF Company, L.L.C. that may be deemed to be
beneficially owned by George Krupp, as described in footnote (2).
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INFORMATION RELATING TO OUR COMMON STOCK
Under our charter, we are authorized to issue 10,000,000 shares of our
common stock, of which 5,000,000 shares have been classified as Class A Common
Stock and 5,000,000 shares have been classified as Class B Common Stock. As of
October 15, 2002, we had 100 shares of our Class B common stock outstanding, all
of which were owned by KRF Company, and no outstanding shares of Class A Common
Stock. At or before the completion of the offer, we intend to issue additional
shares of our Class B common stock to KRF Company, at a price of $1.00 per
share. See "Formation Transactions." There is no established public trading
market for our common stock.
Each share of Class B Common Stock entitles the holder to ten votes per
share, and each share of Class A Common Stock entitles the holder to one vote
per share, on all matters to be submitted to the stockholders for vote. Each
share of Class B Common Stock is convertible, at the option of the holder at any
time, into one share of Class A Common Stock. The exclusive voting power for all
purposes (including amendments to the charter) is vested in the holders of our
common stock, except as otherwise provided in our charter with respect to the
holders of Preferred Shares or any series of preferred stock that is hereafter
established. We may not issue shares of our Class A Common Stock unless the
issuance has been approved by the affirmative vote of the holders of a majority
of the shares of our outstanding Class B Common Stock.
The holders of our common stock are entitled to receive ratably such
distributions as may be authorized from time to time on our common stock by our
board of directors in its discretion from funds legally available for such
distribution, except as otherwise provided in our charter with respect to the
holders of Preferred Shares or any series of preferred stock that is hereafter
established. In the event of our liquidation, dissolution, winding-up or
termination, after payment of all debt and other liabilities and any liquidation
preference with respect to outstanding series of preferred stock, each holder of
our common stock is entitled to receive, ratably with each other holder of our
common stock, all our remaining assets available for distribution to the holders
of our common stock. Holders of our common stock have no subscription,
redemption, appraisal or preemptive rights.
Under Maryland law, a Maryland corporation generally cannot dissolve, amend
its charter, merge, sell all or substantially all of its assets, engage in a
share exchange or engage in similar transactions outside the ordinary course of
business, unless approved by the affirmative vote of stockholders holding at
least two thirds of the shares entitled to vote on the matter. However, a
Maryland corporation may provide in its charter for approval of these matters by
a lesser percentage, but not less than a majority of all of the votes entitled
to be cast on the matter. Our charter provides for approval of these matters by
the affirmative vote of a majority of the votes entitled to be cast on the
matter.
The holders of our common stock have the exclusive right (except as
otherwise provided in our charter) to elect or remove directors, except that
holders of the Preferred Shares (and any other series of preferred securities
having a similar right which is then exercisable) have the right to elect two
directors upon the occurrence of certain distribution payment defaults, and to
remove these directors, as described under "Description of the Preferred
Shares--Voting Rights." The outstanding shares of our common stock are fully
paid and nonassessable.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We have entered into agreements with some of our affiliates, which are
described below.
CONTRIBUTION AGREEMENT
KRF Company has entered into a contribution and sale agreement with our
operating partnership and a subsidiary of our operating partnership under which
our operating partnership will acquire all of KRF Company's interests in the
initial properties in exchange for common OP units. For this purpose, KRF
Company's interests in the initial properties were valued based on third party
appraisals and after deducting all indebtedness on the properties. See "--Other
Relationships" below for the appraised values of the initial properties.
Although the initial properties were valued based on third party appraisals, the
initial properties are to be recorded at historical cost by us as a result of
the common control of the parties. The obligations of the parties under the
contribution and sale agreement are conditioned upon the completion of the
offers.
100
KRF COMPANY CONTRIBUTIONS
On August 12, 2002, we issued an aggregate of 100 shares of our Class B
common stock to KRF Company at a price of $1.00 per share. At the completion of
the offers, we intend to issue additional shares of our Class B common stock to
KRF Company, at the same per share price, in an amount representing 1% of the
fair value of the total net assets of our operating partnership as of the
completion of the offer, taking into account any cash contributed to us before
the completion of the offers. This cash amount will be contributed by us to the
general partner of our operating partnership, which in turn will contribute the
cash to our operating partnership to acquire general partner OP units.
MANAGEMENT FEES
As described under "Management--Summary of Advisory Services Agreement," we
have entered into the advisory services agreement with Berkshire Advisor. George
Krupp, one of our directors, together with his brother Douglas Krupp, indirectly
owns all of the membership interests in Berkshire Advisor. As described under
"Compensation Payable to Our Affiliates," Berkshire Advisor will be paid fees
and be entitled to reimbursed expenses under the advisory services agreement.
As described under "Management--Summary of Property Management Agreements,"
BRI OP currently acts as property manager with respect to the initial properties
and, upon the completion of the offers, will continue to do so under its
existing property management agreements. George Krupp, one of our directors,
together with his brother, Douglas Krupp, indirectly owns general and limited
partner interests in BRH, the parent of BRI OP, which is owned in joint venture
with unaffiliated third parties. The total amount of property management fees
paid to BRI OP under the property management agreements relating to the initial
properties was $1,041,730 for 2000, $1,102,047 for 2001 and $1,253,306
(projected) for 2002. In addition, The Berkshire Group, which is indirectly
owned by Douglas and George Krupp, received advisory fees for asset management
services relating to the initial properties aggregating approximately $233,300
for 2000, $186,000 for 2001 and $662,200 (projected) for 2002.
OTHER RELATIONSHIPS
We are affiliated with The Berkshire Group, which is controlled by Douglas
and George Krupp. George Krupp is one of our directors. He and Douglas Krupp may
be considered to be promoters of our company. See "Compensation Payable To Our
Affiliates" for a description of the compensation that may be received by
affiliates of Douglas and George Krupp in connection with the offers.
KRF Company, which is owned indirectly by Douglas and George Krupp, will be
contributing its interests in the initial properties to our operating
partnership in exchange for common OP units. The initial properties were
acquired in 2000 and 2001 by entities in which KRF Company holds ownership
interests. The following table shows information regarding (1) the acquisition
by these entities of the initial properties and (2) the current appraised value
of the initial properties. The appraised values were determined by Robert D.
Wright, MAI, with respect to Century II, Dorsey's Forge and Hannibal Grove,
Cushman & Wakefield of Washington, D.C., Inc., with respect to Seasons, and
Cushman & Wakefield of Texas, Inc., with respect to Walden Pond. Each of these
companies is an independent third party appraisal firm.
CURRENT GROSS
PROPERTY NAME ACQUISITION DATE(1)(2) APPRAISED VALUE(3)
------------- ---------------------- ------------------
Century II Apartments............................. April 27, 2000 $31,010,000
Dorsey's Forge Apartments......................... April 27, 2000 $14,600,000
Hannibal Grove Apartments......................... April 27, 2000 $22,360,000
Seasons Apartments................................ July 23, 2001 $71,000,000
Walden Pond Apartments............................ November 14, 2001 $13,500,000
------------------------
(1) Seasons and Walden Pond were each acquired during the past two years for
purchase prices of $61,600,000 and $12,800,000, respectively.
(2) As of the date of acquisition of the property, the KRF Company affiliates
owned an indirect 69.775% interest in Century II, an indirect 89.2275%
interest in Dorsey's Forge and Hannibal Grove, and an indirect 100% interest
in Seasons and Walden Pond.
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(3) Appraised values are as of July 2, 2002 with respect to Century II, Dorsey's
Forge and Hannibal Grove, as of June 28, 2002 with respect to Seasons, and
June 20, 2002 with respect to Walden Pond. As of the respective dates of the
appraisals, the KRF Company affiliates owned an indirect 75.82% interest in
Century II, an indirect 91.382% interest in Dorsey's Forge and Hannibal
Grove, and an indirect 100% interest in Seasons and Walden Pond. The
increases in ownership percentages in Century II, Dorsey's Forge and
Hannibal Grove occurred as a result of meeting specified performance targets
in the agreements governing the ownership and operation of these properties.
KRF Company will be receiving common OP units in our operating partnership
in exchange for the contribution of its interests in the initial properties to
our operating partnership. The common OP units will be valued in an aggregate
amount equal to KRF Company's proportionate share of the appraised values of the
initial properties less its proportionate share of all indebtedness on the
initial properties. See "Business and Properties--Initial Properties--Mortgages"
for a summary of the mortgage debt on the initial properties.
Berkshire Mortgage Advisors Limited Partnership, the GIT Advisor, is the
advisor to GIT and GIT II. The GIT Advisor owns 10,000 Interests in GIT and
10,000 Interests in GIT II. The GIT Advisor has advised us that it intends to
tender all of those Interests in the offer. The GIT Advisor is owned and
controlled indirectly by Douglas and George Krupp. Douglas Krupp is also a
member of the board of trustees of each of GIT and GIT II.
GIT FUNDS OWNERSHIP LIMIT WAIVER
In order for GIT and GIT II to qualify as REITs under the Code, they must
each comply with technical requirements of the Code, including a requirement
that not more than 50% in value of each of those mortgage funds' outstanding
shares be owned, directly or indirectly through the application of applicable
attribution rules under the Code, by five or fewer individuals (as defined in
the Code to include specified entities) during the last half of any calendar
year. To ensure compliance with this requirement, the governing instruments of
each of GIT and GIT II prohibit any person from owning, directly or indirectly,
more than 9.8% of the outstanding Interests of that mortgage fund.
In February 2002, representatives of The Berkshire Group met with the board
of trustees of each of GIT and GIT II to advise them that The Berkshire Group
was considering proposing a transaction to the holders of Interests in GIT and
GIT II that would be designed to provide the holders with an attractive
investment opportunity which would be available to them on a voluntary basis.
These representatives further informed the GIT and GIT II board of trustees that
no determination had yet been made as to whether or not to propose such a
transaction, but that the 9.8% ownership limit contained in the governing
instruments of GIT and GIT II (which we refer to as the GIT ownership limit)
would prevent The Berkshire Group from doing so. The representatives requested
that the GIT and GIT II boards consider amending the governing instruments of
those mortgage funds to provide their boards with the flexibility to consider,
on a case-by-case basis, whether to grant waivers from the GIT ownership limit
to permit a person to acquire Interests in situations that would not jeopardize
the REIT status of those mortgage funds. The boards were not asked at that time
to consider granting a waiver in connection with a possible transaction.
On March 29, 2002, the GIT and GIT II board of trustees proposed to their
shareholders, and recommended approval of, an amendment to the governing
instruments of those mortgage funds that would permit the GIT and GIT II board
of trustees, in their sole discretion, to exempt a person from the GIT ownership
limit if the mortgage fund received a ruling from the Internal Revenue Service
or an opinion of counsel, in each case in form and substance satisfactory to the
trustees in their sole discretion, to the effect that the exemption will not
cause the mortgage fund to lose its status as a REIT. On May 16, 2002, the GIT
and GIT II shareholders approved these amendments, which became effective on
that date.
On June 13, 2002, representatives of The Berkshire Group advised members of
the GIT and GIT II board of trustees of their intention to request a waiver from
the GIT ownership limit. Each board of trustees subsequently formed a special
committee of independent trustees to consider the waiver request, and the
special committees then retained separate legal counsel to provide advice in
connection with the waiver request.
On June 28, 2002, The Berkshire Group representatives formally made a
request to the GIT and GIT II special committees that the GIT and GIT II board
of trustees waive the GIT ownership limit with respect to this offer to permit
us to own Interests of GIT and GIT II in excess of the GIT ownership limit.
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On August 15, 2002, the GIT and GIT II board of trustees agreed to waive the
ownership limit waiver to permit us to own up to 55% of the Interests of each of
GIT and GIT II, and we delivered an opinion of counsel to the effect that the
waiver will not cause those mortgage funds to lose their status as a REIT. In
connection with this waiver, we agreed that we would not take any action to
cause GIT or GIT II to cease to be a reporting company under the Exchange Act or
to cause a majority of the GIT or GIT II board of trustees to no longer be
comprised of independent trustees. We also agreed not to solicit, seek to
effect, negotiate with or provide any information to any other party with the
intent of effecting a business combination with GIT or GIT II without the
approval of a majority of the GIT or GIT II board of trustees. The term business
combination includes:
- any merger of GIT or GIT II with us or our affiliates or any other entity
if the merger is caused by us or our affiliates,
- any sale, lease, exchange, mortgage, pledge, transfer or other disposition
of assets, in one transaction or a series of transactions, except
proportionally as a holder of GIT or GIT II Interests,
- any transaction that results in the issuance by GIT or GIT II of Interests
of GIT or GIT II to us or our affiliates, other than specified exceptions
which would not increase our proportionate ownership of those Interests,
- any transaction by GIT or GIT II which has the effect of increasing the
proportionate ownership of the GIT or GIT II Interests which are owned by
us, except as a result of a purchase or redemption of Interests not caused
by us or our affiliates, or
- any receipt by us or our affiliates of the benefit, except proportionally
as a holder of Interests of GIT or GIT II, of any loans, advances,
guarantees, pledges or other financial benefits provided by or through GIT
or GIT II.
On November 1, 2002, to address a concern that might be raised by holders of
Interests in GIT or GIT II who decide not to tender their Interests that we
might use the voting power of the Interests of GIT and GIT II that may be
tendered to us in a manner that may not be consistent with the interests of such
holders, we agreed that, subject to the completion of the offers, we will vote
any GIT or GIT II Interests acquired by us in the offers in proportion to the
votes cast by the non-tendering Interest holders of GIT and GIT II, as
applicable, with respect to any matter brought before them.
COMPENSATION PAYABLE TO OUR AFFILIATES
The following tables show the types of compensation, fees, profits or
distributions that have been, may or will be received by Berkshire Advisor and
other affiliates of The Berkshire Group in connection with our operation and the
management of our properties and other investments. The maximum dollar amounts
of certain fees will depend on the results of our future operations, and thus
the maximum dollar amounts of those fees are not now determinable. No
compensation is payable to Berkshire Advisor or other affiliates of The
Berkshire Group in connection with our organization or the offers.
ACQUISITION STAGE
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
Berkshire Advisor........... Acquisition fees Cannot be determined at
this time
METHOD OF DETERMINING COMPENSATION
Berkshire Advisor will be entitled to receive an acquisition fee equal to 1%
of the purchase price of any new property acquired directly or indirectly by us.
The purchase price is defined as the capitalized basis of an asset under GAAP,
including renovation or new construction costs, costs of acquisition or other
items paid or received that would be considered an adjustment to basis. The
purchase price does not include acquisition fees and capital costs of a
recurring nature.
Berkshire Advisor will not be entitled to receive acquisition fees unless
and until all distributions then due on the Preferred Shares have been paid in
full. In addition, Berkshire Advisor will not receive any acquisition fees in
103
connection with the acquisition of KRF Company's interests in the initial
properties or the Interests acquired by us in the offers.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
Berkshire Advisor........... Reimbursement of Cannot be determined at
acquisition expenses this time
METHOD OF DETERMINING COMPENSATION
Berkshire Advisor will be reimbursed at cost for all acquisition expenses
incurred by it in connection with any new property or investment acquired
directly or indirectly by us. Berkshire Advisor will not be entitled to
reimbursement of acquisition expenses unless and until all distributions then
due on the Preferred Shares have been paid in full.
OPERATIONAL STAGE
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
Berkshire Advisor........... Asset management fees Cannot be determined at
this time
METHOD OF DETERMINING COMPENSATION
Berkshire Advisor will be entitled to receive an annual asset management fee
equal to 0.40% of the purchase price of real estate properties, as adjusted from
time to time to reflect the then current fair market value of the properties.
The purchase price is defined as the capitalized basis of an asset under GAAP,
including renovation or new construction costs, costs of acquisition or other
items paid or received that would be considered an adjustment to basis. The
purchase price does not include acquisition fees and capital costs of a
recurring nature. Berkshire Advisor may propose adjustments to the acquisition
fee, subject to the approval of the audit committee. The asset management fee
will be payable with respect to the initial properties but not with respect to
the Interests acquired by us in the offers. Berkshire Advisor will not be
entitled to receive the asset management fee unless and until all distributions
then due on the Preferred Shares have been paid in full.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
Berkshire Advisor and BRI OP, Reimbursement of Cannot be determined at
as property manager....... operational expenses this time
METHOD OF DETERMINING COMPENSATION
Berkshire Advisor and BRI OP, as property manager, will be reimbursed at
cost for all out-of-pocket expenses incurred by them, including the actual cost
of goods, materials and services that are used in connection with the management
of us and our properties. Berkshire Advisor also will be reimbursed for
administrative services rendered by it that are necessary for our prudent
operation, including legal, accounting, data processing, transfer agent and
other necessary services. There is no set limit on the amount of expenses that
may be reimbursed. However, Berkshire Advisor will not be entitled to
reimbursement of expenses unless and until all distributions then due on the
Preferred Shares have been paid in full. This is not the case with
reimbursements to BRI OP, which is owned by affiliates of The Berkshire Group in
joint venture with unaffiliated third parties. Similar to our debt obligations,
payments on the Preferred Shares are not subordinated to our expense
reimbursement obligations under the existing property management agreements with
BRI OP.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
Berkshire Advisor........... Indemnification against Cannot be determined at
liabilities and related this time
expenses incurred in
connection with duties as
advisor
104
METHOD OF DETERMINING COMPENSATION
Berkshire Advisor will be fully indemnified by us for all liabilities and
related expenses incurred by it in connection with its role as our advisor, to
the fullest extent permitted by Maryland law.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
BRI OP...................... Property management fees $1,253,306 (projected) for
2002
METHOD OF DETERMINING COMPENSATION
BRI OP will be entitled to receive a property management fee, payable
monthly, equal to 5% of the gross rental receipts, including rentals and other
operating income, received each month under the existing property management
agreements with respect to the initial properties. The total amount of property
management fees paid to BRI OP under the property management agreements relating
to the initial properties was $1,041,730 for 2000, $1,102,047 for 2001 and
$1,253,306 (projected) for 2002. Similar to our debt obligations, distributions
on the Preferred Shares are not subordinated to our expense reimbursement
obligations to BRI OP under the existing property management agreements.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
BRI OP...................... Indemnification against Cannot be determined at
liabilities and related this time
expenses incurred in
connection with duties as
property manager
METHOD OF DETERMINING COMPENSATION
BRI OP will be fully indemnified by us for all liabilities and related
expenses incurred by it in connection with its role as property manager for our
properties, unless the liability occurred as a result of BRI OP's gross
negligence or willful malfeasance.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
KRF Company................. Distributions on our common Cannot be determined at
stock this time
METHOD OF DETERMINING COMPENSATION
KRF Company, by reason of its ownership of our common stock, will be
entitled to receive distributions on our common stock, although the holders of
Preferred Shares will have preferential rights to distributions.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
KRF Company................. Distributions on common OP Cannot be determined at
units of the operating this time
partnership
METHOD OF DETERMINING COMPENSATION
KRF Company, by reason of its contribution of the initial properties to the
operating partnership after completion of the offers, will own common OP units
and will be entitled to receive distributions with respect to its common OP
units from the operating partnership. However, we, as the holder of preferred OP
units in the
105
operating partnership, will have a preferential right to distributions from the
operating partnership, up to the amount required for us to pay distributions on
the Preferred Shares.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
Berkshire Mortgage Advisors Distributions on the Cannot be determined at
Limited Partnership....... Preferred Shares this time
METHOD OF DETERMINING COMPENSATION
Berkshire Mortgage Advisors Limited Partnership, by reason of its ownership
of the Preferred Shares it will receive in exchange for the 10,000 Interests in
GIT and 10,000 Interests in GIT II it intends to tender in the offers, will be
entitled to receive its pro rata share of distributions to the holders of
Preferred Shares.
LIQUIDATION STAGE
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
KRF Company................. Distributions on our common Cannot be determined at
stock this time
METHOD OF DETERMINING COMPENSATION
KRF Company, by reason of its ownership of our common stock, will be
entitled to receive distributions on our common stock upon liquidation, although
the holders of Preferred Shares will have preferential rights to distributions
upon liquidation, up to the amount required to pay the liquidation preference of
$25 per share plus accumulated and unpaid distributions.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
KRF Company................. Distributions on common OP Cannot be determined at
units of the operating this time
partnership
METHOD OF DETERMINING COMPENSATION
KRF Company, by reason of its contribution of the initial properties to the
operating partnership after completion of the offers, will own common OP units
and will be entitled to receive distributions with respect to its common OP
units upon liquidation of the operating partnership. However, we, as the holder
of preferred OP units in the operating partnership, will have a preferential
right to distributions upon liquidation of the operating partnership, up to the
amount required for us to pay liquidation proceeds to the holders of Preferred
Shares.
MAXIMUM $ AMOUNT OF
PERSON RECEIVING COMPENSATION FORM OF COMPENSATION COMPENSATION
----------------------------- --------------------------- ---------------------------
Berkshire Mortgage Advisors Liquidation amount with Cannot be determined at
Limited Partnership....... respect to the Preferred this time
Shares
METHOD OF DETERMINING COMPENSATION
Berkshire Mortgage Advisors Limited Partnership, by reason of its ownership
of the Preferred Shares it will receive in exchange for the 10,000 Interests in
GIT and 10,000 Interests in GIT II it intends to tender in the offers, will be
entitled to receive the liquidation preference of $25 per share plus accrued and
unpaid distributions payable on its Preferred Shares.
CONFLICTS OF INTEREST
Due to relationships among us and affiliates of The Berkshire Group,
including Berkshire Advisor, KRF Company and the mortgage funds, the offers and
the operation of our business will involve various conflicts of
106
interest. The Berkshire Group and its affiliates, including our executive
officers and some of our directors, and the officers and directors of Berkshire
Advisor and other affiliates of The Berkshire Group are engaged in a wide range
of real estate activities, including activities with investment objectives and
policies which are, in some respects, similar to ours.
We have adopted policies and entered into agreements with Berkshire Advisor
designed to eliminate or minimize potential conflicts of interest. For example,
our bylaws require that a majority of the members of our board be unaffiliated
with Berkshire Advisor and its affiliates. In addition, our board of directors
has adopted a policy and has provided in our bylaws that no transaction between
us or our operating partnership, on the one hand, and Berkshire Advisor or its
affiliates, on the other hand, may be entered into without the approval of the
audit committee of our board of directors, which will consist exclusively of
independent directors. See "Management--Board of Directors Committees--Audit
Committee" for a description of the qualifications of an independent director.
The conflicts of interest that may arise include, but are not limited to,
the following:
COMPETITION FOR INVESTMENTS
Affiliates of Berkshire Advisor are engaged, and may in the future engage,
in business activities that may compete with us. Such affiliates currently act
or have acted, and in the future may act, as general partner of, or advisor to,
other public and private partnership and other entities organized to acquire
real estate investments. It is possible that these other entities might sell or
refinance a property under circumstances that would permit the reinvestment of
proceeds of that transaction in one or more additional properties that might
satisfy our investment objectives.
Accordingly, our board and Berkshire Advisor might be subject to conflicts
of interest between us and such other entities in connection with the
acquisition of properties. Our advisory services agreement with Berkshire
Advisor provides that neither Berkshire Advisor nor any of its affiliates will
be obligated to present to us all investment opportunities that come to their
attention, even if such opportunities might be suitable for investment by us. It
will be within the sole discretion of Berkshire Advisor to allocate investment
opportunities to us as it deems advisable. However, it is expected that, to the
extent possible, the resolution of conflicting investment opportunities between
us and others will be based upon:
- differences in investment objectives and policies;
- the makeup of investment portfolios;
- the amount of cash and financing available for investment and the length
of time such funds have been available;
- the estimated income tax effects of the investment;
- policies relating to leverage;
- cash flow;
- the effect of the investment on diversification of investment portfolios;
and
- any regulatory restrictions on investment policies.
COMPETITION FOR MANAGEMENT SERVICES
We will depend primarily on Berkshire Advisor for our daily operation.
Berkshire Advisor's executive officers and directors currently act, have acted
and may in the future act as officers and directors of the general partners of,
or advisor to, other entities. Also, our executive officers and some of our
directors are officers and directors of Berkshire Advisor. In addition, BRI OP,
our property manager, currently performs property management services for other
entities affiliated with Berkshire Advisor. Berkshire Advisor and its affiliates
will have conflicts of interest in the allocation of management and staff time,
services and functions among us and the other investment entities in existence
and which may be organized in the future.
We have provided in our advisory agreement that Berkshire Advisor is
required to devote sufficient resources as may be required to discharge its
obligations to us under that agreement. Subject to this requirement, our board
and Berkshire Advisor and its affiliates will devote only so much of their time
to our business as in their judgment
107
is reasonably required to perform their duties to us. In allocating their time
among us and any future partnerships or other ventures which may be managed by
Berkshire Advisor or its affiliates, Berkshire Advisor and its affiliates will
make such allocations based on their good faith evaluation of our relative needs
and those of such other entities for management services.
MANAGEMENT COMPENSATION
No agreements or arrangements between us and Berkshire Advisor, and us and
our property manager, including those relating to compensation, were the result
of arm's-length negotiations between us and such persons. Management of our
investments and our transactions involving the acquisition of our assets may
result in the immediate realization by Berkshire Advisor of fees and may create
conflicts of interest. See "Compensation Payable to Our Affiliates." For
example, conflicts of interest may arise because the retention of a particular
property, at a particular time, may be advantageous to Berkshire Advisor because
it would continue to earn asset management fees attributable to that property,
but may not be in our best interests or those of the holders of the Preferred
Shares. Conflicts of interest also may arise in connection with any decision to
renegotiate, renew or terminate our advisory services agreement with Berkshire
Advisor or our property management agreements with our property manager because
it may be advantageous to such persons to continue to earn fees under those
agreements, but may not be in our best interest if there is poor performance on
behalf of such persons or because it is in our best interest to sell a
particular property. In order to mitigate these conflicts, the renegotiation,
renewal or termination of the advisory services agreement or our property
management agreements will require the approval of the audit committee of our
board of directors.
PROPERTY ACQUISITIONS
If we decide to acquire any assets from, or sell any assets to, or enter
into any joint ventures or co-tenancy arrangements with, affiliates of Berkshire
Advisor or The Berkshire Group, those arrangements will not be the result of
arm's-length negotiations between us and such persons. In order to mitigate
these conflicts, any such transaction will require the approval of the audit
committee of our board of directors.
CONTROL BY KRF COMPANY
KRF Company owns all of our common stock and, as a result, will have the
right to elect our directors and to vote on any matter submitted to a vote of
common stockholders. Accordingly, KRF Company will have substantial influence
over our affairs, which influence might not be consistent with the interests of
the holders of the Preferred Shares. For example, because holders of Preferred
Shares will not share in the appreciation of our assets, the holders may prefer
that we make investments that are more conservative in nature because their goal
is to make sure that their capital investment is preserved. KRF Company, on the
other hand, may favor investments that are riskier in return for the possibility
of a greater return because KRF Company, as the holder of our common stock, will
benefit from the appreciation of our assets. To mitigate conflicts that may
arise from this influence, our bylaws require that a majority of the members of
our board be unaffiliated with Berkshire Advisor and its affiliates (including
KRF Company and other members of The Berkshire Group). In addition, any
transaction between us or our operating partnership, on the one hand, and
Berkshire Advisor or its affiliates, on the other hand, may not be entered into
without the approval of the audit committee of our board of directors.
However, these procedures may not fully address the potential conflict,
because Berkshire Advisor will be authorized to make multi-family residential
property investments on our behalf, without seeking specific board approval,
provided the investment is within investment guidelines that have been approved
by our board of directors.
108
CONFLICTS RELATING TO THE OFFERS
There are also conflicts relating to the offers. The general partners of
KIM, KIP, KIP II and KIP III, and one of the trustees of GIT and GIT II, are
affiliates of The Berkshire Group. Affiliates of The Berkshire Group, including
Berkshire Advisor and KRF Company, will be entitled to receive payments from us
under our advisory services agreement and will benefit from the appreciation of
our assets, and thus will derive benefits from the completion of the offers.
Because of this, the general partners are subject to a conflict of interest in
deciding whether or not to recommend to holders of the relevant Interests
whether or not to tender into the offers. The GIT and GIT II board of trustees
are also subject to this conflict. It is likely that the board of trustees of
GIT and GIT II will rely on a special committee consisting of trustees who are
not affiliated with The Berkshire Group in deciding whether or not to recommend
that holders of the relevant Interests tender into the offers.
COMPARISON OF THE RIGHTS OF HOLDERS OF PREFERRED SHARES AND
THE RIGHTS OF HOLDERS OF INTERESTS
We are a Maryland corporation. GIT and GIT II are Massachusetts business
trusts and KIM, KIP, KIP II and KIP III are Massachusetts limited partnerships.
If holders of Interests in GIT and GIT II, whose rights are currently governed
by Massachusetts law and the declaration of trust for the applicable trust, and
holders of Interests in KIM, KIP, KIP II and KIP III, whose rights are currently
governed by Massachusetts law and the partnership agreement for the applicable
limited partnership, tender their Interests in the offer, these holders will,
when the offers are completed, become our stockholders, and their rights as such
will be governed by Maryland law and our charter and bylaws. The material
differences between the rights of holders of Preferred Shares and the rights of
holders of Interests in the mortgage funds, resulting from the differences in
their governing documents, are summarized below.
The following summary does not purport to be a complete statement of the
rights of holders of Preferred Shares under the applicable provisions of
Maryland law and our charter and bylaws or the rights of holders of Interests in
the mortgage funds under the applicable provisions of Massachusetts law and
their applicable governing documents, or a complete description of the specific
provisions referred to in this section. In addition, the identification of
specific differences is not meant to indicate that other equally or more
significant differences do not exist. However, the following summary includes a
description of those differences that we consider to be material. You should
read the laws of Maryland and Massachusetts and our governing documents and the
governing documents of the mortgage funds before making an investment decision.
Copies of these governing documents are available, without charge, to any person
by following the instructions listed under "Where You Can Find More Information
About Us and the Mortgage Funds."
SUMMARY OF MATERIAL DIFFERENCES BETWEEN THE RIGHTS OF HOLDERS OF PREFERRED
SHARES AND THE RIGHTS OF HOLDERS OF INTERESTS IN THE MORTGAGE FUNDS.
RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
RIGHTS OF HOLDERS OF PREFERRED SHARES GIT AND GIT II KIM, KIP, KIP II AND KIP III
------------------------------------- --------------------------------- ---------------------------------
ISSUER
We are a Maryland corporation. Krupp Government Income Trust and Krupp Insured Mortgage Limited
Krupp Government Income Trust II Partnership, Krupp Insured Plus
are each organized as a Limited Partnership, Krupp
Massachusetts business trust. Insured Plus II Limited
Partnership and Krupp Insured
Plus III Limited Partnership are
each organized as a Massachusetts
limited partnership.
AUTHORIZED STOCK
We have authorized for issuance: GIT has authorized for issuance KIM has authorized for issuance
--10,000,000 shares of common stock, 17,510,000 shares of beneficial 15,000,000 units of depositary
par value $0.01 per share, of which interest, no par value, of which receipts, representing economic
5,000,000 shares have been 15,053,135 shares were rights attributable to the
outstanding limited
109
RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
RIGHTS OF HOLDERS OF PREFERRED SHARES GIT AND GIT II KIM, KIP, KIP II AND KIP III
------------------------------------- --------------------------------- ---------------------------------
classified as Class A Common Stock, as of June 30, 2002. partner interests of the
none of which were outstanding as of GIT II has authorized for corporate limited partner of KIM,
October 15, 2002, and 5,000,000 issuance 25,000,000 shares of of which 14,956,796 units were
shares have been classified as Class beneficial interest, no par outstanding as of June 30, 2002.
B Common Stock, 100 shares of which value, of which 18,371,477 shares KIP has authorized for issuance
were outstanding as of October 15, were outstanding as of June 30, to unit holders 7,500,000 units
2002; 2002. of depositary receipts,
--5,000,000 shares of preferred representing economic rights
stock, par value $0.01 per share, of attributable to the limited
which 5,000,000 shares have been partner interests of the
classified as Series A Preferred corporate limited partner of KIP,
Stock, none of which was outstanding of which 7,499,999 units were
as of October 15, 2002; and outstanding as of June 30, 2002
--15,000,000 shares of excess stock, and 100 units held by the
par value $0.01 per share, of which corporate limited partner were
5,000,000 shares have been classified outstanding as of June 30, 2002.
as Excess Class A Common Stock, KIP II has authorized for
5,000,000 shares have been classified issuance 15,000,000 units of
as Excess Class B Common Stock and depositary receipts, representing
5,000,000 shares have been classified economic rights attributable to
as Excess Series A Preferred Stock, the limited partner interests of
none of which was outstanding as of the corporate limited partner of
October 15, 2002. KIP II, of which 14,655,512 units
were outstanding as of June 30,
2002.
KIP III has authorized for
issuance 20,000,000 units of
depositary receipts, representing
economic rights attributable to
the limited partner interests of
the corporate limited partner of
KIP III, of which 12,770,261
units were outstanding as of
June 30, 2002.
DIVIDENDS
Holders of Preferred Shares will be The trustees of GIT declare The partnership makes
entitled to receive a cumulative quarterly dividends out of funds distributions of distributable
distribution equal to % of the legally available for cash flow, if any, on a quarterly
stated liquidation preference of $25 distribution, and the trustees of basis, which are distributed 97%
per share, on an annual, non- GIT II declare dividends out of to the limited partners and
compounded basis, paid quarterly, out funds legally available for holders of units and 3% to the
of funds legally available for distribution at least quarterly, general partners. The partnership
distribution. and may declare dividends as makes distributions of the
often as daily. The trustees may, proceeds of capital transactions
in their discretion, set aside from time to time, which are
funds in the amount that they distributed in the priority
deem proper for working capital, described in "--Liquidation
reserves, equalizing dividends or Rights."
any other purpose they deem to be
in the interests of the trust.
Distributions of cash from the
disposition of mortgages are made
in the following order of
priority:
--to the shareholders until they
receive a dividend equal to their
110
RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
RIGHTS OF HOLDERS OF PREFERRED SHARES GIT AND GIT II KIM, KIP, KIP II AND KIP III
------------------------------------- --------------------------------- ---------------------------------
invested capital per share of
$20.00;
--to the shareholders until they
receive a cumulative return equal
to 11.5%, in the case of GIT, and
11%, in the case of GIT II, of
their invested capital, which was
initially deemed $20.00 but
decreases over time based on
return of capital, calculated an
annual, non-compounded basis;
--to the advisor or its affiliate
until it receives an amount equal
to 4% of all cash from the
disposition of mortgages, subject
to a cap; and
--4% to the advisor or its
affiliate, subject to a cap, and
96% to the shareholders.
Upon termination of the trust,
the advisor of GIT is obligated
to pay the excess, if any, of
(1) $20.00 over (2) the total
amount of dividends paid with
respect to each original share,
which is a share that was
acquired from the trust directly
or through the trust's dividend
reinvestment plan during the
initial public offering of the
trust, to the holder of each
original share.
RANKING
The Preferred Shares will, with Each of GIT and GIT II has one Each of KIM, KIP, KIP II and KIP
respect to distributions and rights class of shares with equal III has three classes of
upon our liquidation, dissolution, rights, obligations and interest:
winding up or termination, rank: preferences. --limited partner interests held
--senior to our common stock; by the corporate limited partner
--senior to any series of preferred and, under some circumstances, by
stock hereafter created whose terms holders of units who become
specifically provide that such series investor limited partners, whose
ranks junior to the Preferred Shares; rights with respect to
--on a parity with any series of our distributions upon liquidation or
preferred stock hereafter created, dissolution rank in the priority
unless the terms of such series of described in "--Liquidation
preferred stock specifically provide Rights;"
that the other series ranks junior or --holders of units, who have
senior to the Preferred Shares; and effectively the same rights,
--junior to any other series of obligations and preferences as
preferred stock hereafter created limited partners; and
whose terms specifically provide that --general partners, whose rights
the other series ranks senior to the with respect to distributions
Preferred Shares. upon liquidation or dissolution
rank in the priority described in
"--Liquidation Rights."
111
RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
RIGHTS OF HOLDERS OF PREFERRED SHARES GIT AND GIT II KIM, KIP, KIP II AND KIP III
------------------------------------- --------------------------------- ---------------------------------
LIQUIDATION
Upon our dissolution, liquidation, All shares will participate Upon the liquidation and
winding-up or termination, holders of equally in the assets available dissolution, the limited
Preferred Shares will be entitled to for distribution, after the partners, holders of units and
receive, after payment or provision payment of all liabilities of the general partners will participate
for payment of our debts and other trust and the distribution of all in the assets available for
liabilities and subject to the rights cash from the disposition of distribution, after the payment
of holders of any other series of mortgages in the manner described of all liabilities of the limited
preferred stock ranking senior to or in "--Dividends," upon partnership, in the following
on a parity with the Preferred Shares dissolution and liquidation of priority:
upon our dissolution, liquidation, the trust. --return of any negative balances
winding-up or termination, $25.00 per in capital accounts to each class
share plus any accumulated and unpaid of partners;
distributions to the date of payment --return of invested capital of
and no more. $20.00 per share to the limited
partners and holders of units;
--return of invested capital of
$20.00 per share to the general
partners;
--99% to the limited partners and
holders of units and 1% to the
general partners, until the
limited partners and holders of
units have received their
cumulative return on their
invested capital, which was
initially deemed $20.00 but
decreases over time based on
return of capital, calculated on
an annual, non-compounded basis;
--to the general partners, until
they receive an amount equal to
4% of the net proceeds of all
capital transactions of the
partnership; and
--all remaining amounts will be
distributed 96% to the limited
partners and holders of units and
4% to the general partners.
The cumulative return on invested
capital for the limited partners
and holders of units for each
partnership is as follows: KIM is
11%, KIP is 10%, KIP II is 11%
and KIP III is 11%.
MATURITY OR TERM
The Preferred Shares do not have a GIT's amended declaration of The dates of the partnership
stated maturity. trust was entered into as of agreement and stated dissolution
April 12, 1990 and the trust of KIM, KIP, KIP II and KIP III
will dissolve no later than are as follows:
December 31, 2029, unless earlier KIM: partnership agreement dated
dissolved by a majority in as of July 19, 1988; dissolution
interest of the date
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RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
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------------------------------------- --------------------------------- ---------------------------------
shareholders. GIT II's amended December 31, 2028.
declaration of trust was entered KIP: amended partnership
into as of September 25, 1991 and agreement dated as of June 27,
the trust will dissolve no later 1986; dissolution date
than December 31, 2030, unless December 31, 2025.
earlier dissolved: KIP II: amended partnership
--by the trustees with the agreement dated as of May 29,
consent of a majority in interest 1987; dissolution date
of the shareholders; or December 31, 2026.
--upon final payment of the KIP III: partnership agreement
proceeds of the disposition of dated as of June 22, 1988;
the trust's last remaining dissolution date December 31,
mortgage investment. 2028.
Each of KIM, KIP, KIP II and KIP
III may be dissolved earlier than
its stated dissolution date:
--by the withdrawal of a general
partner, unless the remaining
general partner, or substitute
general partner approved by a
majority in interest of
investors, agrees to continue the
business of the partnership;
--at the election of the general
partners, with the consent of a
majority in interest of the
limited partners and unit
holders;
--by the vote of a majority in
interest of the limited partners
and unit holders, excluding any
interests held by the general
partners or their affiliates;
--upon the sale of all or
substantially all the assets of
the partnership, unless the
general partners elect to
continue the business of the
partnership in order to collect
the consideration to be received
for the sale; or
--any other event that causes
dissolution under Massachusetts
law.
RESTRICTIONS ON OWNERSHIP AND TRANSFER
Because we intend to operate as a Because each of GIT and GIT II Transfers of units are subject to
REIT, our charter prohibits any operates as a REIT, the certain restrictions, including:
holder of Preferred Shares from declaration of trust of each --the transferee must satisfy
owning, directly or indirectly, more trust prohibits any shareholder applicable federal or state
than 4.9% of the outstanding from owning, directly or securities law suitability
Preferred Shares. Our board may waive indirectly, more than 9.8% of the standards;
the ownership limit with outstanding shares. Any shares --no transfers are permitted to
that are issued or transferred to foreign persons, except in the
any
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------------------------------------- --------------------------------- ---------------------------------
respect to a holder in some person that would cause the discretion of the general
circumstances unless the holder's person to own more than 9.8% but partners;
ownership would cause us to fail to less than 80% of the outstanding --any transfer that would cause
qualify as a REIT or cause GIT or GIT shares will constitute excess partnership assets to be "plan
II to violate the requirement under shares, as described in assets" or that would violate
the Code that not more than 50% in "--Conversion Rights." The ERISA is not permitted; and
value of their shares may be owned by trustees may refuse to permit any --transfers of fewer than 100
five or fewer individuals during the transfer of shares, or redeem any units are not permitted, except
last half of any year. shares, that would constitute in some circumstances, and this
Any purported transfer of Preferred excess shares or otherwise restriction may be waived by the
Shares that would violate the jeopardize the status of the general partners in their
ownership limit or would cause us to trust as a REIT. discretion.
be actually owned by fewer than 100 Shareholders of GIT II may not In addition, any transfers that
persons or violate our other transfer shares to foreign would cause the partnership to
REIT-related ownership restrictions persons as defined in the Code. terminate under the Code,
will be null and void and the including any transfers of 50% or
intended transferee will acquire no more of the units in any 12-month
rights in the Preferred Shares. The period and any transfers that
Preferred Shares that, if would change the partnership's
transferred, would result in a tax status or status as a
violation of the 4.9% ownership limit partnership are also not
or the 100 person requirement or permitted.
other ownership restrictions will
automatically be converted into
Excess Preferred Shares, as described
in "--Conversion Rights."
REDEMPTION AND REPURCHASE
On or after February 15, 2010, we The trustees may redeem any KIM, KIP, KIP II and KIP III do
will have the right to redeem the shares held in excess of the 9.8% not have any redemption or
Preferred Shares, in whole or in ownership limit or any shares repurchase provisions.
part, at a redemption price of $25.00 that would otherwise jeopardize
per share, plus all accumulated and the trust's status as a REIT at
unpaid distributions to the date of the fair market value of the
payment. shares, as determined by the
If we exercise our redemption right, trustees in good faith.
we must redeem the Preferred Shares
in whole, and not in part, unless all
accrued and unpaid distributions have
been paid on all Preferred Shares for
all quarterly distribution periods
terminating on or prior to the date
of redemption.
We may redeem the Preferred Shares,
in whole but not in part, if we
receive an opinion of counsel that
there is more than an insubstantial
risk that:
--we do not qualify, or within
90 days of the date of the opinion
would no longer qualify, as a REIT;
or
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RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
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------------------------------------- --------------------------------- ---------------------------------
--we are or will be considered an
investment company that is required
to be registered under the Investment
Company Act.
If a partial redemption of the
Preferred Shares would result in the
delisting of the Preferred Shares by
any national securities exchange or
interdealer quotation system on which
the Preferred Shares are then listed,
we will only redeem the Preferred
Shares in whole.
In addition, we or our designee will
have the right, for a period of
20 days after the later of notice to
us that the Preferred Shares have
been converted into Excess Preferred
Shares and the date we determine that
our Preferred Shares were purportedly
transferred, to redeem the Excess
Preferred Shares from the holder at a
price per share equal to the lesser
of (1) the price per share in the
transaction that created the Excess
Preferred Shares, or, if no value was
given, the closing market price at
the time of the devise or gift, and
(2) the closing market price for the
Preferred Shares at the time we or
our designee exercises our option to
purchase.
CONVERSION
Holders of Preferred Shares do not Shareholders of GIT and GIT II do Holders of units in each of KIM,
have any conversion rights. not have any conversion rights. KIP, KIP II and KIP III have the
right to exchange their units for
an equal number of limited
partner interests, which have
effectively the same rights,
obligations and preferences as
the units. Holders of limited
partner interests are not able to
re-exchange those limited partner
interests for units.
EXCESS SHARES PROVISIONS
Preferred Shares that, if Any shares owned, directly or KIM, KIP, KIP II and KIP III do
transferred, would violate the indirectly by any person in not have any excess shares
ownership restrictions described in excess of the 9.8% ownership provisions.
"--Restrictions on Ownership and limit described in
Transfer" will automatically be "--Restrictions on Ownership and
Transfer" will constitute excess
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RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
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converted into Excess Preferred shares that will be deemed to
Shares that will be transferred to a have been transferred to the
trust for the exclusive benefit of trust and held in escrow until
one or more charitable organizations the excess shares are transferred
designated by our board. to a permitted transferee or
While Excess Preferred Shares are redeemed by the trust, as
held in trust, the trustee of the described in "--Redemption and
trust will have all distribution and Repurchase."
voting rights pertaining to the While the excess shares are held
transferred shares and will hold in escrow, the excess shares will
distributions in trust for the have no right to vote or receive
benefit of the charitable dividends, and any other
beneficiary. distributions in respect of the
shares will be held in escrow for
the benefit of the permitted
transferee to whom the shares are
transferred or, the case of
redemption of the shares, the
share trust.
VOTING
Except for the right to elect The shareholders of each of GIT Except for the right to appoint
directors under some circumstances, and GIT II are entitled to one directors, as described in
as described in "--Election of vote per share on all matters to "--Election of Directors,
Directors, Trustees or General be brought before shareholders as Trustees or General Partners," to
Partners," to remove directors under provided under applicable law. remove directors under certain
some circumstances, as described in circumstances, as described in
"--Removal of Directors, Trustees or "--Removal of Directors, Trustees
General Partners," or to approve some or General Partners," to approve
amendments to our charter, as certain amendments to the
described in "--Amendments to partnership agreement, as
Organizational Documents" or as may described in "--Amendments to
be otherwise required by our charter, Organizational Documents," to
the holders of Preferred Shares will approve the sale of all or
have no voting rights. substantially all of the assets
When entitled to vote, the holders of of the partnership, as described
Preferred Shares are entitled to vote in "--Approval of Fundamental
separately as a class with all other Corporate Transactions" or as may
classes of preferred stock upon which be otherwise required by law,
like voting rights have been holders of units have no voting
conferred and are exercisable. When rights.
entitled to vote, the holders of When entitled to vote, each unit
Preferred Shares are entitled to one of interest in each of KIM, KIP,
vote per share, except that when any KIP II and KIP III is entitled to
other series of preferred stock has one vote, which vote may be made
the right to vote with the Preferred on behalf of and at the direction
Shares as a single class on any of the holder of a unit by the
matter, the holders of Preferred corporate limited partner.
Shares and holders of the other
series of preferred stock will have
one vote per $25 of stated
liquidation preference.
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RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
RIGHTS OF HOLDERS OF PREFERRED SHARES GIT AND GIT II KIM, KIP, KIP II AND KIP III
------------------------------------- --------------------------------- ---------------------------------
ELECTION OF DIRECTORS, TRUSTEES OR GENERAL PARTNERS
In general, holders of Preferred The trustees are elected each The holders of a majority in
Shares have no right to elect year at the annual meeting of interest of the limited partner
directors. This right is held shareholders by plurality vote of interests and units must approve
exclusively by the holders of our the shareholders. Vacancies in any replacement general partner
common stock. Vacancies, including the board of trustees occurring upon the removal or withdrawal of
any vacancy created by an increase in other than because of removal by any general partner. In the case
the number of directors, will be the shareholders will be filled of the removal of a general
filled by a majority of the directors by the vote of a majority of the partner, any interests held by
then in office. Any individual so trustees then in office. the general partners or their
elected as director will serve until Vacancies occurring because of affiliates will be excluded from
the next annual meeting of removal by the shareholders will the requisite vote to approve the
stockholders and until his or her be filled by the shareholders. replacement general partner. In
successor is elected and qualifies. Any individual so elected as the case of the voluntary
Our charter currently authorizes five trustee will serve until the next withdrawal of a general partner,
directors. A majority of the board of annual meeting of shareholders the remaining general partner
directors may increase or decrease and until his or her successor is must also approve the replacement
the number of directors, not to be elected and qualified. general partner.
less than the minimum required under
Maryland law or more than 15. A
majority of the board must consist of
independent directors, which will
affect who may be elected or removed
as directors in connection with any
change in the number of authorized
directors.
However, if we fail to make
distributions in full on the
Preferred Shares for six consecutive
quarterly distribution periods, which
we refer to as an election event, the
holders of the Preferred Shares,
voting separately as a class with all
other series of preferred stock upon
which like voting rights have been
conferred and are then exercisable,
will be entitled, by the vote of
holders of Preferred Shares
representing a majority in aggregate
liquidation preference of the
outstanding preferred stock, to elect
two special directors. Each special
director will have the same rights,
powers and privileges under our
charter as a regular director, except
that one of the special directors, at
such director's request, will be
appointed as an additional member of
the audit committee, if the director
otherwise qualifies as an independent
director. During the term of the
special directors, our
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RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
RIGHTS OF HOLDERS OF PREFERRED SHARES GIT AND GIT II KIM, KIP, KIP II AND KIP III
------------------------------------- --------------------------------- ---------------------------------
board of directors will not be
permitted to increase the number of
directors, except to add the special
directors.
REMOVAL OF DIRECTORS, TRUSTEES OR GENERAL PARTNERS
In general, holders of Preferred A majority in interest of the A majority in interest of the
Shares have no right to remove shareholders may remove one or holders of units and limited
directors. This right is held more of the trustees, with or partner interests, not including
exclusively by the holders of our without cause. A majority of the interests held by the general
common stock. trustees may remove any trustee partners and their affiliates,
However, any special director elected for cause. may remove any general partner
by the holders of Preferred Shares, and select a replacement general
as described in "--Election of partner.
Directors, Trustees or General
Partners," may be removed without
cause at any time by the affirmative
vote of the holders of shares
representing a majority in
liquidation preference of each series
of preferred stock upon which like
voting rights have been conferred and
are then exercisable, voting as a
single class.
If and when all accumulated dividends
and dividends for the current period
have been fully paid or declared and
a sufficient amount set aside for
payment, the holders of Preferred
Shares will no longer have the right
to elect the special directors, the
term of the special directors will
terminate and the number of directors
will be reduced by two.
AMENDMENTS TO ORGANIZATIONAL DOCUMENTS
The holders of Preferred Shares The declaration of trust of GIT The vote of a majority in
generally have no voting rights with provides that the vote of a interest of the holders of
respect to any amendment to our majority in interest of the limited partner interests and
charter. However, 66 2/3% in interest shareholders is required to amend units, excluding any interests
of the the holders of Preferred he declaration of trust. However, held by the general partners or
Shares must approve: the declaration of trust of GIT their affiliates, is required to
--any amendment to our charter that provides that any amendment that amend the partnership agreement.
would have a material and adverse would reduce the amounts payable However, the amendment cannot
effect on the preferences, rights, to the shareholders upon allow the limited partners or
voting powers, restrictions, liquidation or diminish or holders of units to take part in
limitations as to distributions, eliminate any voting rights of the control of the partnership
qualifications and terms and the shareholders requires the and may not increase the
conditions of redemption of the vote of 66 2/3% in interest of liability of any partner or unit
Preferred Shares; or the shareholders. holder or adversely affect its
The declaration of trust of share of distributions or
GIT II allocations of
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RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
RIGHTS OF HOLDERS OF PREFERRED SHARES GIT AND GIT II KIM, KIP, KIP II AND KIP III
------------------------------------- --------------------------------- ---------------------------------
--the authorization or creation of, provides that the vote of a profit or loss without the
or any increase in the authorized majority in interest of the approval of each affected partner
amount of, any series of stock that shareholders is required to amend or unit holder.
would rank senior to the Preferred the declaration of trust. The general partners may amend
Shares. However, the declaration of trust the partnership agreement without
of GIT II provides that any the consent of the limited
amendment that would reduce the partners or unit holders for
amounts payable to the specified purposes, including
shareholders upon liquidation clarifying an ambiguity or
requires the vote of 66 2/3% in correcting an inconsistency, to
interest of the shareholders, and preserve the partnership's tax
that no amendment may be made to status or to conform with
provisions regarding business applicable laws, regulations or
combinations and other material administrative rulings.
transactions without offering the
shareholders the options
described in "--Approval of
Fundamental Corporate
Transactions."
The trustees may amend the
declaration of trust without
shareholder consent to conform
the declaration of trust to
applicable laws, regulations or
administrative rulings or to
clarify an ambiguity or correct
an inconsistency.
BUSINESS COMBINATIONS WITH INTERESTED SECURITY HOLDERS
Under Maryland law, business The declaration of trust of GIT KIM, KIP, KIP II and KIP III do
combinations between a Maryland prohibits any business not have any provisions
corporation and an interested combination with an interested specifically restricting business
stockholder or an affiliate of an shareholder for three years combinations with interested
interested stockholder are prohibited following the date the partners or unit holders.
for five years after the most recent shareholder became an interested
date on which the interested shareholder. The exceptions to
stockholder becomes an interested this rule are:
stockholder. This restriction will --if, before that date, the
not apply to business combinations trustees unanimously approved
with KRF Company or its affiliates, either the business combination
as our board of directors has or the transaction that resulted
specifically exempted them from this in the shareholder becoming an
provision. interested shareholder;
An interested stockholder is defined --if, upon completion of the
as: transaction that resulted in the
--any person who beneficially owns shareholder becoming an
10% or more of the voting power of interested shareholder, the
the corporation's shares; or shareholder owned at least 90% of
--an affiliate or associate of the the outstanding shares, excluding
corporation who, at any time within shares held by the trustees and
the two-year period before the date officers of the trust and certain
in question, was the beneficial owner shares held in employee stock
of 10% or more of the voting power of plans; or
the then outstanding voting stock of --if on or after that date, the
the corporation. business combination is approved
by the trustees and a majority in
interest of the outstanding
shares,
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RIGHTS OF HOLDERS OF INTERESTS IN RIGHTS OF HOLDERS OF INTERESTS IN
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------------------------------------- --------------------------------- ---------------------------------
A person is not an interested excluding shares held by the
stockholder under the statute if the interested shareholder.
board of directors approved in An interested shareholder
advance the transaction by which that generally means any person owning
person otherwise would have become an 5% or more of the outstanding
interested stockholder. However, in shares.
approving a transaction, the board of The declaration of trust of
directors may provide that its GIT II does not have any
approval is subject to compliance, at provisions specifically
or after the time of approval, with restricting business combinations
any terms and conditions determined with interested shareholders.
by the board.
After the five-year prohibition, any
business combination between the
Maryland corporation and an
interested stockholder generally must
be recommended by the board of
directors and approved by at least:
--80% in interest of the holders of
outstanding shares of voting stock;
and
--66 2/3% in interest of the holders
of outstanding shares of voting
stock, excluding shares held by the
interested stockholder with whom or
with whose affiliate the business
combination is to be effected or held
by an affiliate or associate of the
interested stockholder.
These super-majority voting
requirements do not apply if the
corporation's common stockholders
receive a minimum price, as defined
under Maryland law, for their shares
in the form of cash or other
consideration in the same form as
previously paid by the interested
stockholder for its shares. The
statute permits various exemptions
from its provisions, including
business combinations that are
exempted by the board of directors
before the time that the interested
stockholder becomes an interested
stockholder.
APPROVAL OF FUNDAMENTAL CORPORATE TRANSACTIONS
We may, upon the approval of our The declaration of trust of GIT A majority in interest of the
board of directors and the holders of provides that all matters limited partner interests and
our common stock, and without submitted to the shareholders units, representing the rights of
will be decided the
120
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------------------------------------- --------------------------------- ---------------------------------
the approval of the holders of by the vote of a majority in holders of interests not
Preferred Shares, merge with or into interest of the shares entitled affiliated with the general
another entity or consolidate with to vote at the shareholders partners, must approve the sale
one or more other entities into a new meeting, and does not provide for of all or substantially all the
entity, so long as the merger or any special voting requirements assets of the partnership.
consolidation does not materially other than with respect to:
adversely affect the preferences, --the election of trustees, as
rights, voting powers, restrictions, described in "--Election of
limitations as to dividends, Directors, Trustees or General
qualifications and terms and Partners;"
conditions of redemption of the --specified business
Preferred Shares, including any combinations, as described in
successor securities. "--Business Combinations with
The approval of the holders of Interested Security Holders;" and
Preferred Shares is not required to --any amendment to the
approve: declaration of trust that would
--any merger or consolidation in reduce the amounts payable to the
which we are the surviving entity; or shareholders upon liquidation or
--any merger or consolidation in diminish or eliminate any voting
which we are not the surviving rights of the shareholders, as
entity, so long as the holders of described in "--Super-Majority
Preferred Shares receive either cash Voting Provisions."
or securities with preferences, The declaration of trust of GIT
rights and privileges substantially provides that the trust may
similar to those of the Preferred change its legal status as a
Shares in exchange for their Massachusetts business trust to a
Preferred Shares in the merger or different type of legal entity by
consolidation. the vote of a majority in
interest of the shareholders if
the trust maintains separate
existence as a single entity and
the shareholders' participation
in the resulting entity is on the
same terms and conditions as
their investment in the trust.
The declaration of trust of
GIT II provides that the trust
may not take any of the following
actions unless shareholders who
do not consent to the action are
given the option of receiving
either a security having the same
terms and conditions as the
shares or the liquidating value
of their interests in the trust,
as established by an independent
appraisal:
--participate in any roll-up,
merger or other business
combination;
--make a material change to the
compensation of the trust's
advisor and its affiliates;
--amend the voting rights of
shareholders;
--listing the shares on a
national
121
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RIGHTS OF HOLDERS OF PREFERRED SHARES GIT AND GIT II KIM, KIP, KIP II AND KIP III
------------------------------------- --------------------------------- ---------------------------------
securities exchange;
--make a change in the
fundamental investment objectives
of the trust; or
--make a material alteration to
the duration of the trust.
The declaration of trust of GIT
II provides that the trust may
change its legal status as a
Massachusetts business trust to a
different type of legal entity
without offering the shareholders
the options described above if
the trust maintains separate
existence as a single entity and
the shareholders' participation
in the resulting entity is on the
same terms and conditions as
their investment in the trust.
SUPER-MAJORITY VOTING PROVISIONS
The vote of 66 2/3% in interest of The declaration of trust of each KIM, KIP, KIP II and KIP III have
the holders of Preferred Shares is of GIT and GIT II provides that no super-majority voting
required to approve any action that the vote of 66 2/3% in interest provisions.
would materially and adversely affect of the shareholders is required
the preferences, rights, voting to reduce any amounts payable to
powers, restrictions, limitations as the shareholders upon
to dividends, qualifications and liquidation.
terms and conditions of redemption of
the Preferred Shares, whether by way
of amendment to the charter or
otherwise.
PUBLIC TRADING MARKET
The Preferred Shares will be listed No public trading market exists No public trading market exists
on the American Stock Exchange, for the Interests in GIT and GIT for the Interests in KIM, KIP,
subject to notice of issuance. II. KIP II and KIP III.
INDEMNIFICATION OF DIRECTORS, OFFICERS, TRUSTEES OR GENERAL PARTNERS
Our charter authorizes us, and our The declaration of trust of each The partnership agreement for
bylaws obligate us, to indemnify, to of GIT and GIT II provides that each of KIM, KIP, KIP II and KIP
the maximum extent permitted by the trust will indemnify and hold III provides that the general
Maryland law, any person against whom harmless the trustees, the partners and their affiliates
a claim is made by reason of the fact advisor or any affiliate of performing services within the
that the person is or was our theirs who performs services on scope of the general partners'
director or officer or is or was behalf of the trust against any duties are entitled to be
serving, at our request, in a similar expense or liability in any indemnified by the partnership
capacity for any other entity, action arising out of that for any loss or liability arising
against any claim or liability. person's activities on behalf of out of any act or omission
the trust as long as: performed or omitted by the
general partners:
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------------------------------------- --------------------------------- ---------------------------------
Maryland law requires us to indemnify --the trustees or the advisor --in good faith on behalf of the
a director or officer who has been determines in good faith that the partnership; and
successful in the defense of any course of conduct that caused the -- in a manner reasonably
proceeding to which he is made a loss or liability was in the best believed by the general partners
party by reason of his service in interests of the trust; to be within the scope of their
that capacity. --the loss or liability was not authority and in the best
Maryland law permits us to indemnify the result of negligence or interests of the partnership.
our present and former directors and misconduct; and They are not entitled to be
officers, among others, against --the indemnification or indemnified for any loss or
judgments, penalties, fines, agreement to hold harmless is liability that was the result of
settlements and reasonable expenses recoverable only out of the negligence, misconduct or breach
actually incurred by any of them in assets of the trust and not from of fiduciary duty.
connection with any proceeding unless the shareholders. Any indemnification must be paid
it is established that: out of the assets of the
--the act or omission was material to partnership and not by the
the matter giving rise to the partners.
proceeding and was committed in bad
faith or was the result of active and
deliberate dishonesty;
--the director or officer actually
received an improper personal benefit
in money, property or services; or
--in the case of any criminal
proceeding, the director or officer
had reasonable cause to believe that
the act or omission was unlawful.
LIMITATION OF PERSONAL LIABILITY OF DIRECTORS, OFFICERS, TRUSTEES OR GENERAL PARTNERS
Our charter contains a provision that The declaration of trust of each The partnership agreement for
eliminates directors' and officers' of GIT and GIT II provides that each of KIM, KIP, KIP II and KIP
liability to the maximum extent the trustees and their affiliates III provides that the general
permitted by Maryland law. will not be liable for any debt, partners and their affiliates
Maryland law permits us to limit the claim, demand, judgment, decree, performing services within the
liability of our officers and liability or obligation of any scope of the general partners'
directors to us and officers and kind of, against or with respect duties will not be liable,
directors to us our stockholders for to the trust arising out of any responsible or accountable in
money damages, except for liability action taken or omitted for or on damages to any of the partners,
resulting from: behalf of the trust. unit holders or the partnership
--actual receipt of an improper for any act or omission performed
benefit or profit in money, property or omitted by the general
or services; or partners:
--active and deliberate dishonesty --in good faith on behalf of the
established by a final judgment that partnership; and
is material to the cause of action. --within the scope of their
authority and in the best
interests of the partnership.
The general partners and their
affiliates will not be released
from liability for acts or
omissions constituting
negligence, misconduct or breach
of fiduciary duty.
123
INFORMATION WITH RESPECT TO
THE MORTGAGE FUNDS
KRUPP GOVERNMENT INCOME TRUST
The following is information regarding Krupp Government Income Trust, which
we refer to as GIT.
GENERAL. GIT was formed on November 1, 1989. GIT, whose address is One
Beacon Street, Boston, Massachusetts 02108, telephone number 617-523-0066, had
15,053,135 shares of beneficial interest outstanding as of June 30, 2002. There
is no established trading market for these shares.
The following is a discussion of GIT's investment policies, borrowing
policies, disposition policies, reporting policies and policies with respect to
some other activities, which was derived from the public filings of the trust.
The policies with respect to these activities are described in the declaration
of trust or have been determined by the trustees. These policies are reviewed at
least annually by the trustees and may be altered by the trustees without
approval of the shareholders, if the trustees determine that the change is in
the best interests of the trust and the shareholders, except as otherwise
expressly provided in the declaration of trust.
INVESTMENT POLICIES. The investment policy of GIT was to invest primarily
to acquire participating insured mortgages (PIMs), participating insured
mortgage investments (PIMIs) and mortgage-backed securities (MBS). GIT's policy
did not include investing in real estate or interests in real estate or
securities of or interests in persons primarily engaged in real estate
activities. GIT's policy did not include investing in other securities of any
issuer, other than reserves or temporary investments for uninvested assets in
United States government securities, certificates of deposit, money market funds
and similar investments permitted in the declaration of trust. Under the terms
of its declaration of trust, GIT is not permitted to make any new investments
through the end of the term of the trust.
A PIM is a mortgage loan created expressly in reference to a particular
multi-family residential property. GIT's investments in PIMs consist of
(1) either a HUD-insured first mortgage or a Fannie Mae MBS, guaranteed or
insured as to principal and basic interest, and (2) a participating mortgage.
The insured mortgages were issued or originated under or in connection with the
housing programs of the Federal Housing Administration, which we refer to as
FHA, under the authority of the Department of Housing and Urban Development,
which we refer to as HUD. PIMs provide GIT with monthly payments of principal
and basic interest and may also provide for GIT's participation in the current
revenue stream and in residual value, if any, from a sale or other realization
of the underlying property. The borrower conveys the participation rights to GIT
through a subordinated promissory note and mortgage. The participation features
are neither insured nor guaranteed.
GIT's investments in PIMIs on multi-family residential properties consist of
(1) either a HUD-insured first mortgage or a HUD-insured first mortgage
securitized by the Government National Mortgage Association, which we refer to
as GNMA, (2) an additional loan to owners of the borrower in excess of mortgage
amounts insured or guaranteed under GNMA or FHA programs that increases GIT's
total financing with respect to that property and (3) a participating mortgage.
Additional loans associated with insured mortgages issued or originated in
connection with HUD insured programs cannot, under government regulations, be
collateralized by a mortgage on the underlying property. These additional loans
are typically collateralized by a security interest satisfactory to the GIT
advisor and are neither insured nor guaranteed. In addition, the participation
features related to the participating mortgage are neither insured nor
guaranteed. Additional loans provide GIT with semi-annual interest payments and
may provide additional interest in the future while the participating mortgage
provides for GIT's participation in the surplus cash from and residual value, if
any, of the underlying property.
The trust was permitted to invest in PIMs and PIMIs for which the borrower
of the underlying mortgage loan is an affiliated borrower. In no event, however,
was the trust permitted to acquire any PIM or PIMI involving an affiliated
borrower unless a majority of the trustees, including a majority of the
independent trustees, not otherwise interested in the transaction approved the
transaction as being fair, competitive and commercially reasonable and no less
favorable to the trust than a loan to an unaffiliated borrower under the same
circumstances. The trust did make two investments in PIMIs where the borrower of
the underlying mortgage loan was an affiliated borrower. The trust currently
owns one of these investments, while the other was repaid in 2001. The trust was
not permitted to invest more than 10% of its total assets in unimproved real
property or mortgage loans on unimproved real property, and was not permitted to
invest more than 10% of its assets in junior mortgages, with exceptions, and the
declaration of trust prohibits some other types of investments.
124
MBS are created when a financial institution buys one or more multi-family
or single-family mortgages, forms them into a separate and distinct pool
consisting of one or more mortgages, and then sells the instruments that
represent an interest in the individual mortgage or the pool of mortgages. The
interest and principal paid by the property owner are passed through by the
issuer to the holder of the mortgage. GIT has investments in MBS collateralized
by single-family and multi-family mortgage loans issued or originated by GNMA,
FHA, Fannie Mae and the Federal Home Loan Mortgage Corporation, which we refer
to as FHLMC. Fannie Mae and FHLMC guarantee the principal and basic interest of
its MBS. GNMA guarantees the timely payment of principal and interest on its
MBS, and HUD insures the pooled mortgage loans underlying the GNMA MBS and FHA
mortgage loans. Neither the single-family MBS nor the multi-family MBS provide a
participation feature.
125
The following table provides information regarding the investment portfolio
of GIT as of June 30, 2002:
GIT MORTGAGE FUND ASSETS
PARTICIPATING INSURED MORTGAGES
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
Fannie Mae 73023 Lincoln Green NC 616 6.750% October-02 October-92
FHA N/A Mill Pond OH 146 8.150% January-33 May-91
FHA N/A Rivergreens OR 208 8.005% April-33 November-91
CARRYING VALUE--PARTICIPATING INSURED MORTGAGES............................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
Fannie Mae $13,676,641 MBS Guaranteed by Fannie Mae N/A Current
FHA $ 7,458,278 First mortgage fully insured by the First Current
U.S. Government
FHA $ 9,554,301 First mortgage fully in sured by the First Current
U.S. Government
-----------
CARRYING VALUE--PARTIC $30,689,220
PARTICIPATING INSURED MORTGAGE INVESTMENTS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
GNMA 280976 Lifestyles FL 236 7.000% March-32 June-92
GNMA 280839 Windward FL 276 8.500% June-32 July-92
FHA N/A Mountain View AL 256 6.875% January-34 September-93
Additional Loan N/A Lifestyles FL N/A N/A May-07 June-92
Additional Loan N/A Windward FL N/A N/A July-02 July-92
Additional Loan N/A Mountain View AL N/A 7.00% September-03 September-93
TOTAL PARTICIPATING INSURED MORTGAGE INVESTMENTS...........................................................................
PROVISION FOR IMPAIRED MORTGAGE LOANS......................................................................................
CARRYING VALUE--PARTICIPATING INSURED MORTGAGE INVESTMENTS.................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
GNMA $ 9,802,302 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
GNMA $13,389,335 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
FHA $ 9,178,704 First mortgage fully insured by the First Current
U.S. Government
Additional Loan $ 1,698,697 By pledging ownership interests in the N/A Current
borrowing entity, their share of any
distributions received, and the proceeds
realized upon the refinancing or sale of
the property or the sale of the
partnership interests
Additional Loan $ 2,471,294 By pledging ownership interests in the N/A Current
borrowing entity, their share of any
distributions received, and the proceeds
realized upon the refinancing or sale of
the property or the sale of the
partnership interests
Additional Loan $ 1,400,000 By pledging ownership interests in the N/A Current
borrowing entity, their share of any
distributions received, and the proceeds
realized upon the refinancing or sale of
the property or the sale of the
partnership interests
TOTAL PARTICIPATING IN $37,940,332
PROVISION FOR IMPAIRED $(1,698,811)
-----------
CARRYING VALUE--PARTIC $36,241,521
-----------
126
MULTI-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
FHA N/A Rosemont TX N/A 8.750% September-35 October-94
GNMA 439902 Pointe East WA N/A 7.500% April-32 January-00
TOTAL MULTI-FAMILY MBS.....................................................................................................
UNAMORTIZED DISCOUNT.......................................................................................................
UNREALIZED GAIN............................................................................................................
CARRYING VALUE--MULTI-FAMILY MBS...........................................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
FHA $ 4,858,730 First mortgage fully insured by the First Current
U.S. Government
GNMA $ 3,280,325 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
-----------
TOTAL MULTI-FAMILY MBS $ 8,139,055
UNAMORTIZED DISCOUNT.. $ (57,097)
UNREALIZED GAIN....... $ 207,579
-----------
CARRYING VALUE--MULTI- $ 8,289,537
SINGLE-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
GNMA Multiple N/A N/A N/A 8% to 9% N/A N/A
Fannie Mae Multiple N/A N/A N/A 8.000% N/A N/A
FHLMC Multiple N/A N/A N/A 7.5% to 9.5% N/A N/A
TOTAL SINGLE-FAMILY MBS....................................................................................................
UNREALIZED GAIN............................................................................................................
UNAMORTIZED PREMIUM........................................................................................................
CARRYING VALUE--SINGLE-FAMILY MBS..........................................................................................
TOTAL OF CARRYING VALUE OF ALL MORTGAGES...................................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
GNMA $ 193,492 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
Fannie Mae $ 608,861 MBS Guaranteed by Fannie Mae N/A Current
FHLMC $ 2,440,000 MBS Guaranteed by FHLMC N/A Current
-----------
TOTAL SINGLE-FAMILY MB $ 3,242,353
UNREALIZED GAIN....... $ 188,820
UNAMORTIZED PREMIUM... $ 8,410
-----------
CARRYING VALUE--SINGLE $ 3,439,586
-----------
TOTAL OF CARRYING VALU $78,659,861
===========
127
BORROWING POLICIES. GIT anticipates that there will be sufficient cash flow
from the mortgages to meet cash requirements. To the extent that the trust's
cash flow should be insufficient to meet the trust's operating expenses and
liabilities, it will be necessary for the trust to obtain additional funds by
liquidating its investment in one or more mortgages or by borrowing. The trust
may pledge mortgages as security for any permitted borrowing.
The trust may not borrow funds in connection with the acquisition or
origination of mortgages. However, it may borrow funds to meet working capital
requirements of the trust. In this event the trust may borrow funds from third
parties on a short-term basis. The declaration of trust limits the amount that
may be borrowed by the trust. Borrowing agreements between the trust and a
lender may also restrict the amount of indebtedness that the trust may incur.
The declaration of trust prohibits the trust from issuing debt securities to
institutional lenders and banks, and the trust may not issue debt securities to
the public except in some circumstances. The trust, under some circumstances,
may borrow funds from the advisor, a trustee or an affiliate of the trust or any
trustee. However, a majority of the independent trustees, not otherwise
interested in such transaction, must approve the transaction as being fair,
competitive and commercially reasonable and no less favorable to the trust than
loans between unaffiliated lenders and borrowers under the same circumstances.
The trust has not borrowed any funds during the past three years and does not
intend to do so in the future.
DISPOSITION POLICIES. The FHA coinsurance loan programs under
Section 221(d)(4) of the National Housing Act provides for loans with 40 year
terms and Section 223(f) provides for loans with 35 year terms. Both have a call
option at any time after ten years, upon one year's notice. The Fannie Mae
Delegated Underwriting and Servicing program provides for loans with seven, ten
or 15 year terms and an amortization period of 35 years. The subordinated
promissory notes and subordinated mortgages that secure the participation
feature of the insured mortgages and PIMs and the notes that evidence the
additional loans provide for acceleration of maturity at the earlier of the sale
of the underlying property or the call date.
From time to time, the trust expects that it may realize the principal and
participation in residual value, if any, of its mortgages before maturity. It is
expected that the mortgages will be repaid after a period of ownership of
approximately ten years from the dates of the closings of the permanent loans.
Realization of the value of mortgages may, however, be made at an earlier or
later date. During the past three years, the trust has received prepayments with
respect to eight of the trust's investments.
REPORTING POLICIES. GIT furnishes its annual report to shareholders within
120 days after the end of each fiscal year of the trust. The annual report
includes: (1) the trust's audited balance sheet and audited statements of income
and comprehensive income, changes in shareholders' equity and cash flows,
accompanied by the report of the trust's independent certified public
accountants, (2) an estimate by the advisor of the net asset value of the shares
and (3) a statement of distributable cash flow.
GIT furnishes its quarterly report to shareholders within 60 days after the
end of the first three fiscal quarters of each fiscal year of the trust. The
quarterly report includes: (1) the trust's unaudited balance sheet,
(2) unaudited statements of income and comprehensive income and cash flows and
(3) an estimate by the advisor of the net asset value of the shares. Each annual
and quarterly report also includes a narrative description of the trust's
operations and the amount of fees and other compensation paid to the advisor and
its affiliates by the trust.
The trust provides annual tax information on Form 1099-DIV by January 31 of
each year.
OTHER POLICIES. The trust will not underwrite securities of other issuers,
offer securities in exchange for property or invest in securities of other
issuers for the purpose of exercising control and has not engaged in any of
these activities during the past three years. The declaration of trust does not
permit GIT to issue senior securities. The trust has not repurchased or
reacquired any of its shares from shareholders in the past three years and does
not intend to do so in the future, except as described in "Comparison of the
Rights of Holders of Preferred Shares and the Rights of Holders of
Interests--Redemption and Repurchase." The trust may not make loans to the
advisor, any trustee, any affiliate of the advisor or any trustee or any other
person, other than mortgage investments of the type described above. The trust
has not made any loans other than mortgage investments during the past three
years.
RELEVANT AFFILIATIONS. The Berkshire Group is controlled by Douglas and
George Krupp, who also control the GIT Advisor, KRF Company and Berkshire
Advisor. Douglas Krupp is also a director of GIT.
KRUPP GOVERNMENT INCOME TRUST II
The following is information regarding Krupp Government Income Trust II,
which we refer to as GIT II.
GENERAL. GIT II was formed on February 8, 1991. GIT II, whose address is
One Beacon Street, Boston, Massachusetts 02108, telephone number 617-523-0066,
had 18,371,477 shares of beneficial interest outstanding as of June 30, 2002.
There is no established trading market for these shares.
The following is a discussion of GIT II's investment policies, borrowing
policies, disposition policies, reporting policies and policies with respect to
some other activities, which was derived from the public filings of the trust.
The policies with respect to these activities are described in the declaration
of trust or have been determined by the trustees. The policies are reviewed at
least annually by the trustees and may be altered by the trustees without
approval of the shareholders, if the trustees determine that the change is in
the best interests of the trust and the shareholders, except as otherwise
expressly provided in the declaration of trust. However, if the trustees make
any fundamental change in the trust's investment objectives, as described in the
declaration of trust, the trust is required to give to shareholders not
approving the change the option of receiving either a security having the same
terms and conditions as the shares of the trust or the liquidating value of
their interests in the trust.
128
INVESTMENT POLICIES. The investment policy of GIT II was to invest
primarily to acquire PIMs, PIMIs and MBS. GIT II considers itself to be engaged
in only one industry segment, investment in real estate mortgages. GIT II's
policy did not include investing in real estate or interests in real estate or
securities of or interests in persons primarily engaged in real estate
activities. GIT II's policy did not include investing in other securities of any
issuer, other than (1) reserves or temporary investments for uninvested assets
in United States government securities, certificates of deposit, money market
funds and similar investments permitted in the declaration of trust or
(2) temporary investments in nominees, trusts or qualified REIT subsidiaries to
facilitate the acquisition of mortgages by the trust. Under the terms of its
declaration of trust, GIT II is not permitted to make any new investments
through the end of the term of the trust.
GIT II's investments in PIMs consist of (1) either a HUD-insured first
mortgage or a Fannie Mae MBS, guaranteed or insured as to principal and basic
interest, and (2) a participating mortgage. The insured mortgages were issued or
originated under or in connection with the housing programs of the FHA under the
authority of HUD. PIMs provide GIT II with monthly payments of principal and
basic interest and may also provide for trust participation in the current
revenue stream and in residual value, if any, from a sale or other realization
of the underlying property. The borrower conveys the participation rights to GIT
II through a subordinated promissory note and mortgage. The participation
features are neither insured nor guaranteed.
GIT II's investments in PIMIs on multi-family residential properties consist
of (1) a Fannie Mae MBS, (2) an additional loan to the borrower or owners of the
borrower, in excess of mortgage amounts guaranteed under a Fannie Mae program,
that increases GIT II's total financing with respect to that property and which
provides a participating feature. Additional loans associated with Fannie Mae
MBS are collateralized by a subordinated mortgage on the underlying property but
are neither insured nor guaranteed. Additional loans provide GIT II with
semi-annual interest payments and may provide additional interest in the future
from GIT II's participation in the surplus cash from and residual value, if any,
of the underlying property.
The trust was permitted to invest in PIMIs and PIMs for which the borrower
of the underlying mortgage loan was an affiliated borrower. In no event,
however, was the trust permitted to acquire any PIMI or PIM involving an
affiliated borrower unless a majority of the trustees, including a majority of
the independent trustees not otherwise interested in the transaction, approved
the transaction as being fair, competitive and commercially reasonable and no
less favorable to the trust than a loan to an unaffiliated borrower under the
same circumstances. The trust did make one investment in a PIMI where the
borrower of the underlying mortgage loan was an affiliated borrower. This
investment was repaid in 2001. The trust was not permitted to invest more than
10% of its total assets in unimproved real property or mortgage loans on
unimproved real property, and the declaration of trust prohibits some other
types of investments.
GIT II has investments in MBS collateralized by single-family and
multi-family mortgage loans issued or originated by Fannie Mae, GNMA or FHLMC.
Fannie Mae, GNMA and FHLMC guarantee the principal and basic interest of its
MBS. HUD insures the pooled mortgage loans underlying the MBS. Neither the
single-family MBS nor the multi-family MBS provide a participation feature.
129
The following table provides information regarding the investment portfolio
of GIT II as of June 30, 2002:
GIT II MORTGAGE FUND ASSETS
PARTICIPATING INSURED MORTGAGES
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
Fannie Mae 73025 Mequon Trails WI 246 6.500% January-08 December-92
FHA N/A Rivergreens II OR 126 7.375% January-35 August-93
FHA N/A Mill Pond II OR 150 7.125% December-35 July-95
FHA N/A Fountains IA 204 7.500% November-36 May-96
TOTAL PARTICIPATING INSURED MORTGAGES......................................................................................
UNAMORTIZED DISCOUNT.......................................................................................................
CARRYING VALUE--PARTICIPATING INSURED MORTGAGES............................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
Fannie Mae $13,144,647 MBS Guaranteed by Fannie Mae N/A Current
FHA $ 5,896,534 First mortgage fully insured by the First Current
U.S. Government
FHA $ 7,954,710 First mortgage fully insured by the First Current
U.S. Government
FHA $10,087,459 First mortgage fully insured by the First Current
U.S. Government
-----------
TOTAL PARTICIPATING IN $37,083,350
UNAMORTIZED DISCOUNT.. $ (50,437)
-----------
CARRYING VALUE--PARTIC $37,032,913
PARTICIPATING INSURED MORTGAGE INVESTMENTS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
Fannie Mae 73027 Crossings Village OH 286 6.750% October-08 September-93
Fannie Mae 73029 Martin's Landing GA 300 6.500% December-08 November-93
Fannie Mae 73030 Sunset Summit OR 261 6.500% December-08 November-93
Fannie Mae 73043 Oasis @ Springtree FL 276 6.750% September-09 August-94
Fannie Mae 73149 The Lakes GA 464 6.825% July-10 June-95
Additional Loan N/A Crossings Village OH N/A 7.00% October-08 September-93
Additional Loan N/A Martin's Landing GA N/A 7.00% December-08 November-93
Additional Loan N/A Sunset Summit OR N/A 7.00% December-08 November-93
Additional Loan N/A Oasis @ Springtree FL N/A 7.00% September-09 August-94
Additional Loan N/A The Lakes GA N/A 7.00% July-10 June-95
CARRYING VALUE--PARTICIPATING INSURED MORTGAGE INVESTMENTS.................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
Fannie Mae $11,621,539 MBS Guaranteed by Fannie Mae N/A Current
Fannie Mae $10,063,800 MBS Guaranteed by Fannie Mae N/A Current
Fannie Mae $ 9,165,246 MBS Guaranteed by Fannie Mae N/A Current
Fannie Mae $11,341,944 MBS Guaranteed by Fannie Mae N/A Current
Fannie Mae $17,037,276 MBS Guaranteed by Fannie Mae N/A Current
Additional Loan $ 2,584,000 Subordinated Mortgage Second Current
Additional Loan $ 2,280,000 Subordinated Mortgage Second Current
Additional Loan $ 1,900,000 Subordinated Mortgage Second Current
Additional Loan $ 2,290,000 Subordinated Mortgage Second Current
Additional Loan $ 4,600,000 Subordinated Mortgage Second Current
-----------
CARRYING VALUE--PARTIC $72,883,805
130
MULTI-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
GNMA 395486 Fair Oaks TX N/A 8.125% June-31 N/A
Fannie Mae 73057 Willows WA N/A 7.075% December-09 N/A
TOTAL MULTI-FAMILY MBS.....................................................................................................
UNREALIZED GAIN............................................................................................................
CARRYING VALUE--MULTI-FAMILY MBS...........................................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
GNMA $ 569,705 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
Fannie Mae $ 3,315,286 MBS Guaranteed by Fannie Mae N/A Current
-----------
TOTAL MULTI-FAMILY MBS $ 3,884,991
UNREALIZED GAIN....... $ 148,695
-----------
CARRYING VALUE--MULTI- $ 4,033,686
SINGLE-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
Fannie Mae Multiple N/A N/A N/A 7% to 7.5% N/A N/A
FHLMC Multiple N/A N/A N/A 7% to 9% N/A N/A
TOTAL SINGLE-FAMILY MBS....................................................................................................
UNAMORTIZED PREMIUM........................................................................................................
UNREALIZED GAIN............................................................................................................
CARRYING VALUE--SINGLE-FAMILY MBS..........................................................................................
CARRYING VALUE OF ALL MORTGAGES............................................................................................
UNPAID DELINQUENCY
BALANCE AS OF LIEN STATUS OF
AGENCY 6/30/02 COLLATERAL POSITION LOAN
------ ------------- ---------- -------- -----------
Fannie Mae $ 1,978,521 MBS Guaranteed by Fannie Mae N/A Current
FHLMC $ 6,673,987 MBS Guaranteed by FHLMC N/A Current
------------
TOTAL SINGLE-FAMILY MB $ 8,652,508
UNAMORTIZED PREMIUM... $ 172,441
UNREALIZED GAIN....... $ 239,790
------------
CARRYING VALUE--SINGLE $ 9,064,739
------------
CARRYING VALUE OF ALL $123,015,143
============
131
BORROWING POLICIES. GIT II anticipates that there will be sufficient cash
flow from the mortgages to meet cash requirements. To the extent that the
trust's cash flow should be insufficient to meet the trust's operating expenses
and liabilities, it will be necessary for the trust to obtain additional funds
by liquidating its investment in one or more mortgages or by borrowing. The
trust may pledge mortgages as security for any permitted borrowing.
The trust may not borrow funds in connection with the acquisition or
origination of mortgages. However, it may borrow funds in order to meet working
capital requirements of the trust. In this event the trust may borrow funds from
third parties on a short-term basis. The declaration of trust limits the amount
that may be borrowed by the trust. Borrowing agreements between the trust and a
lender may also restrict the amount of indebtedness that the trust may incur.
The declaration of trust prohibits the trust from issuing debt securities to
institutional lenders and banks, and the trust may not issue debt securities to
the public except in some circumstances. The trust, under some circumstances,
may borrow funds from the advisor, a trustee or an affiliate of the trust or any
trustee. However, a majority of the independent trustees, not otherwise
interested in such transaction, must approve the transaction as being fair,
competitive and commercially reasonable and no less favorable to the trust than
loans between unaffiliated lenders and borrowers under the same circumstances.
The trust has not borrowed any funds during the past three years and does not
intend to do so in the future.
DISPOSITION POLICIES. The Fannie Mae Delegated Underwriting and Servicing
program provides for loans with seven, ten or 15 year terms and an amortization
period of 35 years. The subordinated promissory notes and subordinated mortgages
that secure the participation feature of the insured mortgages and PIMs and the
notes that evidence the additional loans provide for acceleration of maturity at
the earlier of the sale of the underlying property or the call date.
From time to time, the trust expects that it may realize the principal and
participation in residual value, if any, of its mortgages before maturity. It is
expected that the mortgages will be repaid after a period of ownership of
approximately ten years from the dates of the closings of the permanent loans.
Realization of the value of mortgages may, however, be made at an earlier or
later date. During the past three years, the trust has received payoffs with
respect to six investments of the trust.
REPORTING POLICIES. GIT II furnishes its annual report to shareholders
within 120 days after the end of each fiscal year of the trust. The annual
report includes: (1) the trust's audited balance sheet and audited statements of
income and comprehensive income, changes in shareholders' equity and cash flows,
accompanied by the report of the trust's independent certified public
accountants, (2) an estimate by the advisor of the net asset value of the shares
and (3) a statement of distributable cash flow.
GIT II furnishes its quarterly report to shareholders within 60 days after
the end of the first three fiscal quarters of each fiscal year of the trust. The
quarterly report includes: (1) the trust's unaudited balance sheet,
(2) unaudited statements of income and comprehensive income and cash flows and
(3) an estimate by the advisor of the net asset value of the shares. Each annual
and quarterly report also includes a narrative description of the trust's
operations and the amount of fees and other compensation paid to the advisor and
its affiliates by the trust.
The trust provides annual tax information on Form 1099-DIV by January 31 of
each year.
OTHER POLICIES. The trust will not underwrite securities of other issuers,
offer securities in exchange for property or invest in securities of other
issuers for the purpose of exercising control and has not engaged in any of
these activities during the past three years. The declaration of trust does not
permit GIT II to issue senior securities. The trust has not repurchased or
reacquired any of its shares from shareholders in the past three years and does
not intend to do so in the future, except as described in "Comparison of the
Rights of Holders of Preferred Shares and the Rights of Holders of
Interests--Redemption and Repurchase." The trust may not make loans to the
advisor, any trustee, any affiliate of the advisor or any trustee or any other
person, other than mortgage investments of the type described above. The trust
has not made any loans during the past three years.
RELEVANT AFFILIATIONS. The Berkshire Group is controlled by Douglas and
George Krupp, who also control the GIT Advisor, KRF Company and Berkshire
Advisor. Douglas Krupp is also a director of GIT II.
132
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
The following is information regarding Krupp Insured Mortgage Limited
Partnership, which we refer to as KIM.
GENERAL. KIM was formed on March 21, 1988. KIM, whose address is One Beacon
Street, Boston, Massachusetts 02108, telephone number 617-523-0066, had
14,956,796 units of depositary receipts representing units of limited partner
interests outstanding as of June 30, 2002. There is no established trading
market for these units.
The following is a discussion of KIM's investment policies, borrowing
policies, disposition policies, reporting policies and policies with respect to
some other activities, which was derived from the public filings of the trust.
Under the partnership agreement of KIM, the general partners may not make any
changes in the policies described below, to the extent that these policies are
incorporated into the partnership agreement, without first obtaining the
approval of a majority in interest of the limited partners and unit holders.
INVESTMENT POLICIES. The investment policy of KIM was to invest primarily
to acquire PIMs and MBS. KIM considers itself to be engaged in only one industry
segment, investment in real estate mortgages. KIM's policy did not include
investing in real estate or interests in real estate or securities of or
interests in persons primarily engaged in real estate activities. KIM's policy
did not include investing in other securities of any issuer, other than
(1) reserves or temporary investments for uninvested assets in United States
government securities, certificates of deposit, money market funds and similar
investments permitted in the partnership agreement or (2) investments made
through nominees, trusts or other agents of the partnership to facilitate the
acquisition of mortgages by the partnership. Under the terms of its partnership
agreement, KIM is not permitted to make any new investments through the end of
the term of the partnership.
KIM's investments in PIMs consist of (1) either a HUD-insured first mortgage
or a HUD-insured first mortgage securitized by GNMA, which are insured or
guaranteed as to principal and basic interest and (2) a participating mortgage.
The insured mortgages were issued or originated under or in connection with the
housing program of the FHA under the authority of HUD. PIMs provide KIM with
monthly payments of principal and basic interest and may also provide for KIM's
participation in the current revenue stream and in residual value, if any, from
a sale or other realization of the underlying property. The borrower conveys the
participation rights to KIM through a subordinated promissory note and mortgage.
The participation feature is neither insured nor guaranteed.
The partnership was permitted to invest in a PIM for which the borrower of
the underlying mortgage loan is an affiliate of the general partners only if the
general partners obtained a written opinion from an independent and qualified
advisor that the transaction was fair and no less favorable to the partnership
than a loan to an unaffiliated borrower under the same circumstances. The
partnership did not make any investments in PIMs where the borrower of the
underlying mortgage loan was an affiliate.
KIM also has investments in MBS collateralized by single-family mortgage
loans issued or originated by Fannie Mae or FHLMC. Fannie Mae and FHLMC
guarantee the principal and basic interest of its MBS. The single-family MBS do
not provide a participation feature.
133
The following table provides information regarding the investment portfolio
of KIM as of June 30, 2002:
KIM MORTGAGE FUND ASSETS
PARTICIPATING INSURED MORTGAGES
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
GNMA 280652 Wildflower NV 540 7.750% January-25 December-89
FHA N/A Creekside OR 172 8.305% November-31 August-92
CARRYING VALUE--PARTICIPATING INSURED MORTGAGES............................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
GNMA $15,653,469 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
FHA $ 7,918,673 First mortgage fully insured by the First Current
U.S. Government
-----------
CARRYING VALUE--PARTIC $23,572,142
SINGLE-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
Fannie Mae Multiple N/A N/A N/A 7% to 9% N/A N/A
FHLMC Multiple N/A N/A N/A 8% to 10% N/A N/A
TOTAL SINGLE-FAMILY MBS....................................................................................................
UNAMORTIZED DISCOUNT.......................................................................................................
UNREALIZED GAIN............................................................................................................
CARRYING VALUE--SINGLE-FAMILY MBS..........................................................................................
CARRYING VALUE OF ALL MORTGAGES............................................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
Fannie Mae $ 2,839,539 MBS Guaranteed by Fannie Mae N/A Current
FHLMC $ 1,291,677 MBS Guaranteed by FHLMC N/A Current
-----------
TOTAL SINGLE-FAMILY MB $ 4,131,216
UNAMORTIZED DISCOUNT.. $ (15,417)
UNREALIZED GAIN....... $ 209,530
-----------
CARRYING VALUE--SINGLE $ 4,325,329
-----------
CARRYING VALUE OF ALL $27,703,357
===========
134
BORROWING POLICIES. KIM anticipates that there will be sufficient cash flow
from the mortgages to meet cash requirements. To the extent that the
partnership's cash flow should be insufficient to meet the partnership's
operating expenses and liabilities, it will be necessary for the partnership to
obtain additional funds by liquidating its investment in one or more mortgages
or by borrowing. The partnership may borrow money on an unsecured or secured
basis to further the purposes of the partnership. The partnership may pledge
mortgages as security for any permitted borrowing. The partnership, under some
circumstances, may borrow funds from any general partner or an affiliate of any
general partner. However, the transaction must include interest rates and other
finance charges and fees not in excess of the amounts that are charged by
unaffiliated lenders for comparable loans and must satisfy other conditions
specified in the partnership agreement. The partnership has not borrowed any
funds during the past three years and does not intend to do so in the future.
DISPOSITION POLICIES. The FHA coinsurance loan programs under
Section 221(d)(4) of the National Housing Act provides for loans with 40 year
terms and Section 223(f) provides for loans with 35 year terms. Both have a call
option at any time after ten years, upon one year's notice. The subordinated
promissory notes and subordinated mortgages that secure the participation
feature of the PIMs provide for acceleration of maturity at the earlier of the
sale of the underlying property or the call date, typically expected to be a
date ten years after the date of final endorsement for mortgage insurance.
From time to time, the partnership expects that it may realize the principal
and participation in residual value, if any, of its mortgages before maturity.
It is expected that the mortgages will be repaid after a period of ownership of
approximately ten years from the dates of the closings of the permanent loans.
Realization of value of mortgages may, however, be made at an earlier or later
date. During the past three years, KIM has received payoffs with respect to nine
investments of the partnership.
REPORTING POLICIES. The general partners furnish copies of KIM's annual
report to the limited partners within 120 days after the end of each fiscal year
of the partnership. The annual report includes: (1) the partnership's audited
balance sheet and audited statements of income and comprehensive income, changes
in partners' equity and cash flows, accompanied by the report of the
partnership's independent certified public accountants, (2) a statement of
distributable cash flow and net cash proceeds from capital transactions and
(3) an estimate by the general partners of the net asset value of the limited
partner interests.
The general partners furnish copies of KIM's quarterly report to the limited
partners within 60 days after the end of the first three fiscal quarters of each
fiscal year of the partnership. The quarterly report includes: (1) the
partnership's unaudited balance sheet, (2) unaudited statements of income and
comprehensive income and cash flows, and (3) an estimate by the general partners
of the net asset value of the limited partner interests. Each annual and
quarterly report also includes the amount of fees and other compensation paid to
any general partner and any affiliates of any general partner by the partnership
for that fiscal period.
The partnership provides to the limited partners all tax information
necessary to prepare their federal income tax returns within 75 days after the
end of each calendar year.
OTHER POLICIES. The partnership will not underwrite securities of other
issuers, offer securities in exchange for property, invest in securities of
other issuers for the purpose of exercising control or issue senior securities,
and the partnership has not engaged in any of these activities during the past
three years. The partnership has not repurchased or reacquired any of the
partner interests from partners or units from unit holders in the past three
years and does not intend to do so in the future. The partnership may not make
loans to any general partner or any affiliate of any general partner and will
not make loans to any other persons, other than mortgage investments of the type
described above. The partnership has not made any loans during the past three
years.
RELEVANT AFFILIATIONS. The Berkshire Group is controlled by Douglas and
George Krupp, who also control the general partners of KIM, KRF Company and
Berkshire Advisor.
135
KRUPP INSURED PLUS LIMITED PARTNERSHIP
The following is information regarding Krupp Insured Plus Limited
Partnership, which we refer to as KIP.
GENERAL. KIP was formed on December 20, 1985. KIP, whose address is One
Beacon Street, Boston, Massachusetts 02108, telephone number 617-523-0066, had
7,500,099 units of depositary receipts representing units of limited partner
interests outstanding as of June 30, 2002. There is no established trading
market for these units.
The following is a discussion of KIP's investment policies, borrowing
policies, disposition policies, reporting policies and policies with respect to
some other activities, which was derived from the public filings of the
partnership. Under the partnership agreement of KIP, the general partners may
not make any changes in the policies described below, to the extent that these
policies are incorporated into the partnership agreement, without first
obtaining the approval of a majority in interest of the limited partners and
unit holders.
INVESTMENT POLICIES. The investment policy of KIP was to invest primarily
to acquire PIMs and MBS. KIP considers itself to be engaged in only one industry
segment, investment in real estate mortgages. KIP's policy did not include
investing in real estate or interests in real estate or securities of or
interests in persons primarily engaged in real estate activities. KIP's policy
did not include investing in other securities of any issuer, other than
(1) reserves or temporary investments for uninvested assets in United States
government securities, certificates of deposit, money market funds and similar
investments permitted in the partnership agreement or (2) investments made
through nominees, trusts or other agents of the partnership in order to
facilitate the acquisition of mortgages by the partnership. Under the terms of
its partnership agreement, KIP is not permitted to make any new investments
through the end of the term of the partnership.
KIP's investments in its PIM consists of (1) a HUD-insured first mortgage
insured as to principal and basic interest and (2) a participating mortgage. The
HUD-insured first mortgage was issued or originated under or in connection with
the housing program of the FHA under the authority of HUD. The PIM provides KIP
with monthly payments of principal and basic interest and may also provide for
KIP's participation in the current revenue stream and in residual value, if any,
from a sale or other realization of the underlying property. The borrower
conveys the participation rights to KIP through a subordinated promissory note
and mortgage. The participation feature is neither insured nor guaranteed.
The partnership was permitted to invest in a PIM for which the borrower of
the underlying mortgage loan is an affiliate of the general partners only if the
general partners obtained a written opinion from an independent and qualified
advisor that the transaction was fair and no less favorable to the partnership
than a loan to an unaffiliated borrower under the same circumstances. The
partnership did not make any investments in PIMs where the borrower of the
underlying mortgage loan was an affiliate.
KIP also has investments in MBS collateralized by single-family or
multi-family mortgage loans issued or originated by Fannie Mae, GNMA or FHLMC.
Fannie Mae and FHLMC guarantee the principal and basic interest of its MBS. GNMA
guarantees the timely payment of principal and interest on its MBS, and HUD
insures the pooled mortgage loans underlying the GNMA MBS. Neither the
single-family MBS nor the multi-family MBS provide a participation feature.
136
The following table provides information regarding the investment portfolio
of KIP as of June 30, 2002:
KIP MORTGAGE FUND ASSETS
PARTICIPATING INSURED MORTGAGES
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
FHA N/A Vista Montana AZ 341 7.375% December-33 December-93
CARRYING VALUE--PARTICIPATING INSURED MORTGAGES............................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
FHA $13,165,307 First mortgage fully insured by the First Current
U.S. Government
-----------
CARRYING VALUE--PARTIC $13,165,307
MULTI-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
GNMA 300196 Briar Woods OR N/A 8.250% July-33 N/A
GNMA 309234 Mission Terrace CA N/A 8.625% April-32 N/A
TOTAL MULTI-FAMILY MBS.....................................................................................................
UNAMORTIZED DISCOUNT.......................................................................................................
UNREALIZED GAIN............................................................................................................
CARRYING VALUE--MULTI-FAMILY MBS...........................................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
GNMA $ 5,593,368 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
GNMA $ 1,880,707 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
-----------
TOTAL MULTI-FAMILY MBS $ 7,474,075
UNAMORTIZED DISCOUNT.. $ (13,618)
UNREALIZED GAIN....... $ 471,860
-----------
CARRYING VALUE--MULTI- $ 7,932,317
SINGLE-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
GNMA Multiple N/A N/A N/A 8% to 9% N/A N/A
Fannie Mae Multiple N/A N/A N/A 9% to 10.25% N/A N/A
FHLMC Multiple N/A N/A N/A 8% to 11.75% N/A N/A
TOTAL SINGLE-FAMILY MBS....................................................................................................
UNAMORTIZED PREMIUM........................................................................................................
UNREALIZED GAIN............................................................................................................
CARRYING VALUE--SINGLE-FAMILY MBS..........................................................................................
CARRYING VALUE OF ALL MORTGAGES............................................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
GNMA $ 616,750 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
Fannie Mae $ 136,877 MBS Guaranteed by Fannie Mae N/A Current
FHLMC $ 405,678 MBS Guaranteed by FHLMC N/A Current
-----------
TOTAL SINGLE-FAMILY MB $ 1,159,305
UNAMORTIZED PREMIUM... $ 10,718
UNREALIZED GAIN....... $ 65,903
-----------
CARRYING VALUE--SINGLE $ 1,235,926
-----------
CARRYING VALUE OF ALL $22,333,550
===========
137
BORROWING POLICIES. KIP anticipates that there will be sufficient cash flow
from the mortgages to meet cash requirements. To the extent that the
partnership's cash flow is insufficient to meet the partnership's operating
expenses and liabilities, it will be necessary for the partnership to obtain
additional funds by liquidating its investment in one or more mortgages or by
borrowing. The partnership may borrow money on an unsecured or secured basis to
further the purposes of the partnership. The partnership may pledge mortgages as
security for any permitted borrowing. The partnership, under some circumstances,
may borrow funds from any general partner or an affiliate of any general
partner. However, the transaction must include interest rates and other finance
charges and fees not in excess of the amounts that are charged by unaffiliated
lenders for comparable loans and must satisfy other conditions specified in the
partnership agreement. The partnership has not borrowed any funds during the
past three years and does not intend to do so in the future.
DISPOSITION POLICIES. The FHA coinsurance loan programs under
Section 221(d)(4) of the National Housing Act provides for loans with 40 year
terms and Section 223(f) provides for loans with 35 year terms. Both have a call
option at any time after ten years, upon one year's notice. The subordinated
promissory note and subordinated mortgage of the PIM provides for acceleration
of maturity at the earlier of the sale of the underlying property or the call
date, typically expected to be a date ten years after the date of final
endorsement for mortgage insurance.
From time to time, the partnership expects that it may realize the principal
and participation in residual value, if any, of its mortgages before maturity.
It was expected that the mortgages would be repaid after a period of ownership
of approximately ten years from the dates of the closings of the permanent
loans. Realization of value of mortgages may, however, be made at an earlier or
later date. During the past three years, KIP has received prepayments payoffs
with respect to four investments of the partnership.
REPORTING POLICIES. The general partners furnish copies of KIP's annual
report to the limited partners within 120 days after the end of each fiscal year
of the partnership. The annual report includes: (1) the partnership's audited
balance sheet and audited statements of income and comprehensive income, changes
in partners' equity and cash flows, accompanied by the report of the
partnership's independent certified public accountants, (2) a statement of
distributable cash flow and net cash proceeds from capital transactions and
(3) an estimate by the general partners of the net asset value of the limited
partner interests.
The general partners furnish copies of KIP's quarterly report to the limited
partners and unit holders within 60 days after the end of the first three fiscal
quarters of each fiscal year of the partnership. The quarterly report includes:
(1) the partnership's unaudited balance sheet, (2) unaudited statements of
income and comprehensive income and cash flows, and (3) an estimate by the
general partners of the net asset value of the limited partner interests. Each
annual and quarterly report also includes the amount of fees and other
compensation paid to any general partner and any affiliates of any general
partner by the partnership for that fiscal period.
The partnership provides to the limited partners all tax information
necessary to prepare their federal income tax returns within 75 days after the
end of each calendar year.
OTHER POLICIES. The partnership will not underwrite securities of other
issuers, offer securities in exchange for property, invest in securities of
other issuers for the purpose of exercising control or issue senior securities,
and the partnership has not engaged in any of these activities during the past
three years. The partnership has not repurchased or reacquired any of the
partner interests from partners or units from unit holders in the past three
years and does not intend to do so in the future. The partnership may not make
loans to any general partner or any affiliate of any general partner and will
not make loans to any other persons, other than mortgage investments of the type
described above. The partnership has not made any loans during the past three
years.
RELEVANT AFFILIATIONS. The Berkshire Group is controlled by Douglas and
George Krupp, who also control the general partners of KIP, KRF Company and
Berkshire Advisor.
138
KRUPP INSURED PLUS II LIMITED PARTNERSHIP
The following is information regarding Krupp Insured Plus II Limited
Partnership, which we refer to as KIP II.
GENERAL. KIP II was formed on October 29, 1986. KIP II, whose address is
One Beacon Street, Boston, Massachusetts 02108, telephone number
(617) 523-0066, had 14,655,512 units of depositary receipts representing units
of limited partner interests outstanding as of June 30, 2002. There is no
established trading market for these units.
The following is a discussion of KIP II's investment policies, borrowing
policies, disposition policies, reporting policies and policies with respect to
some other activities, which was derived from the public filings of the
partnership. Under the partnership agreement of KIP II, the general partners may
not make any changes in the policies described below, to the extent that these
policies are incorporated into the partnership agreement, without first
obtaining the approval of a majority in interest of the limited partners and
unit holders.
INVESTMENT POLICIES. The investment policy of KIP II was to invest
primarily to acquire PIMs and MBS. KIP II considers itself to be engaged in only
one industry segment, investment in real estate mortgages. KIP II's policy did
not include investing in real estate or securities of or interests in persons
primarily engaged in real estate activities. KIP II's policy did not include
investing in other securities of any issuer, other than (1) reserves or
temporary investments for uninvested assets in United States government
securities, certificates of deposit, money market funds and similar investments
permitted in the partnership agreement or (2) investments made through nominees,
trusts or other agents of the partnership in order to facilitate the acquisition
of mortgages by the partnership. Under the terms of its partnership agreement,
KIP II is not permitted to make any new investments through the end of the term
of the partnership.
KIP II has no remaining PIM investments.
The partnership was not permitted to invest in any PIM for which the
borrower of the underlying mortgage loan is an affiliate of the general
partners.
KIP II has investments in single-family MBS and an insured mortgage
collateralized by a multi-family mortgage loan issued or originated by Fannie
Mae, FHLMC or HUD. Fannie Mae and FHLMC guarantee the principal and basic
interest of its MBS. HUD insures the mortgage loan on its own direct mortgage
loans. Neither the single-family MBS nor the multi-family insured mortgage loan
provide a participation feature.
139
The following table provides information regarding the investment portfolio
of KIP II as of June 30, 2002:
KIP II MORTGAGE FUND ASSETS
MULTI-FAMILY MBS
BEGINNING DATE UNPAID
PROJECT COUPON MATURITY OF PERMANENT BALANCE AS
AGENCY POOL NO. NAME STATE RATE DATE LOAN OF 6/30/02
------ -------- ------------------ -------- ------------- ------------ -------------- -----------
FHA N/A Hampton Place GA 7.500% September-28 October-93 $11,456,143
-----------
CARRYING VALUE--MULTI-FAMILY MBS................................................................................ $11,456,143
DELINQUENCY
LIEN STATUS OF
AGENCY COLLATERAL POSITION LOAN
------ ---------- -------- -----------
FHA First mortgage fully insured by the First Current
U.S. government
CARRYING VALUE--MULTI-
SINGLE-FAMILY MBS
BEGINNING DATE UNPAID
PROJECT COUPON MATURITY OF PERMANENT BALANCE AS
AGENCY POOL NO. NAME STATE RATE DATE LOAN OF 6/30/02
------ -------- ------------------ -------- ------------- ------------ -------------- -----------
Fannie Mae Multiple N/A N/A 7% to 8% N/A N/A $ 1,255,704
FHLMC Multiple N/A N/A 7% to 10% N/A N/A $ 1,472,559
-----------
TOTAL SINGLE-FAMILY MBS......................................................................................... $ 2,728,263
UNAMORTIZED DISCOUNT............................................................................................ $ (58,897)
UNREALIZED GAIN................................................................................................. $ 188,006
-----------
CARRYING VALUE--SINGLE-FAMILY MBS............................................................................... $ 2,857,372
-----------
CARRYING VALUE OF ALL MORTGAGES................................................................................. $14,313,515
===========
DELINQUENCY
LIEN STATUS OF
AGENCY COLLATERAL POSITION LOAN
------ ---------- -------- -----------
Fannie Mae MBS Guaranteed by Fannie Mae N/A Current
FHLMC MBS Guaranteed by FHLMC N/A Current
TOTAL SINGLE-FAMILY MB
UNAMORTIZED DISCOUNT..
UNREALIZED GAIN.......
CARRYING VALUE--SINGLE
CARRYING VALUE OF ALL
140
BORROWING POLICIES. KIP II anticipates that there will be sufficient cash
flow from the mortgages to meet cash requirements. To the extent that the
partnership's cash flow should be insufficient to meet the partnership's
operating expenses and liabilities, it will be necessary for the partnership to
obtain additional funds by liquidating its investment in one or more mortgages
or by borrowing. The partnership may borrow money on an unsecured or secured
basis to further the purposes of the partnership. The partnership may pledge
mortgages as security for any permitted borrowing. The partnership, under some
circumstances, may borrow funds from any general partner or an affiliate of any
general partner. However, the transaction must include interest rates and other
finance charges and fees not in excess of the amounts that are charged by
unaffiliated lenders for comparable loans and must satisfy other conditions
specified in the partnership agreement. The partnership has not borrowed any
funds during the past three years and does not intend to do so in the future.
DISPOSITION POLICIES. The partnership expects that it will sell its
remaining assets in the near future, because all of its PIM investments have
been repaid, and then liquidate the partnership. During the past three years,
KIP II has received payoffs with respect to six investments of the partnership.
REPORTING POLICIES. The general partners of KIP II furnish KIP II's annual
report to the limited partners within 120 days after the end of each fiscal year
of the partnership. The annual report includes: (1) the partnership's audited
balance sheet and audited statements of income and comprehensive income, changes
in partners' equity and cash flows, accompanied by the report of the
partnership's independent certified public accountants, (2) a statement of
distributable cash flow and net cash proceeds from capital transactions and
(3) an estimate by the general partners of the net asset value of the limited
partner interests.
The general partners of KIP II furnish KIP II's quarterly report to the
limited partners within 60 days after the end of the first three fiscal quarters
of each fiscal year of the partnership. The quarterly report includes: (1) the
partnership's unaudited balance sheet, (2) unaudited statements of income and
comprehensive income and cash flows, and (3) an estimate by the general partners
of the net asset value of the limited partner interests. Each annual and
quarterly report also includes the amount of fees and other compensation paid to
any general partner and any affiliates of any general partner by the partnership
for that fiscal period.
The partnership provides to the limited partners all tax information
necessary to prepare their federal income tax returns within 75 days after the
end of each calendar year.
OTHER POLICIES. The partnership will not underwrite securities of other
issuers, offer securities in exchange for property, invest in securities of
other issuers for the purpose of exercising control or issue senior securities
and has not engaged in any of these activities during the past three years. The
partnership has not repurchased or reacquired any of the partner interests from
partners or units from unit holders in the past three years and does not intend
to do so in the future. The partnership may not make loans to any general
partner or any affiliate of any general partner and will not make loans to any
other persons, other than mortgage investments of the type described above. The
partnership has not made any loans during the past three years.
RELEVANT AFFILIATIONS. The Berkshire Group is controlled by Douglas and
George Krupp, who also control the general partners of KIP II, KRF Company and
Berkshire Advisor.
141
KRUPP INSURED PLUS III LIMITED PARTNERSHIP
The following is information regarding Krupp Insured Plus III Limited
Partnership, which we refer to as KIP III.
GENERAL. KIP III was formed on March 21, 1988. KIP III, whose address is
One Beacon Street, Boston, Massachusetts 02108, telephone number 617-523-0066,
had 12,770,261 units of depositary receipts representing units of limited
partner interests outstanding as of June 30, 2002. There is no established
trading market for these units.
The following is a discussion of KIP III's investment policies, borrowing
policies, disposition policies, reporting policies and policies with respect to
some other activities, which was derived from the public flings of the
partnership. Under the partnership agreement of KIP III, the general partners
may not make any changes in the policies described below, to the extent that
these policies are incorporated into the partnership agreement, without first
obtaining the approval of a majority in interest of the limited partners and
unit holders.
INVESTMENT POLICIES. The investment policy of KIP III was to invest
primarily to acquire PIMs and MBS. KIP III considers itself to be engaged in
only one industry segment, investment in real estate mortgages. KIP III's policy
did not include investing in real estate or securities of or interests in
persons primarily engaged in real estate activities. KIP III's policy did not
include investing in other securities of any issuer, other than (i) reserves or
temporary investments for uninvested assets in United States government
securities, certificates of deposit, money market funds and similar investments
permitted in the partnership agreement or (ii) investments made through
nominees, trusts or other agents of the partnership in order to facilitate the
acquisition of mortgages by the partnership. Under the terms of its partnership
agreement, KIP III is not permitted to make any new investments through the end
of the term of the partnership.
KIP III's investment in a PIM on multi-family residential property consists
of (1) a HUD-insured first mortgage securitized by GNMA, which is insured
guaranteed as to principal and basic interest and (2) a participating mortgage.
The insured mortgage was issued or originated under or in connection with the
housing programs of the FHA under the authority of HUD. The PIM provides KIP III
with monthly payments of principal and basic interest and may also provide for
KIP III's participation in the current revenue stream and in residual value, if
any, from a sale or other realization of the underlying property. The borrower
conveys the participation rights to KIP III through a subordinated promissory
note and mortgage. The participation feature is neither insured nor guaranteed.
The partnership was not permitted to invest in any PIM for which the
borrower of the underlying mortgage loan is an affiliate of the general
partners.
KIP III also has investments in single-family MBS and an insured mortgage
collateralized by a multi-family mortgage loan issued or originated by Fannie
Mae, FHLMC or the FHA. Fannie Mae and FHLMC guarantee the principal and basic
interest of the Fannie Mae and FHLMC MBS, respectively. HUD insures the FHA
mortgage loans. Neither the single-family MBS nor the multi-family insured
mortgage loan provide a participation feature.
142
The following table provides information regarding the investment portfolio
of KIP III as of June 30, 2002:
KIP III MORTGAGE FUND ASSETS
PARTICIPATING INSURED MORTGAGES
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
GNMA 259238 Harbor Club MI 208 8.000% October-31 July-93
CARRYING VALUE--PARTICIPATING INSURED MORTGAGES............................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
GNMA $12,947,374 MBS Guaranteed by GNMA & Insured by N/A Current
U.S. Government
-----------
CARRYING VALUE--PARTIC $12,947,374
MULTI-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
FHA N/A Signature Point ID N/A 7.375% May-35 N/A
TOTAL MULTI-FAMILY MBS.....................................................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
FHA $ 7,906,082 First mortgage fully insured by the First Current
U.S. government
-----------
TOTAL MULTI-FAMILY MBS $ 7,906,082
SINGLE-FAMILY MBS
BEGINNING DATE
PROJECT RENTAL COUPON MATURITY OF PERMANENT
AGENCY POOL NO. NAME STATE UNITS RATE DATE LOAN
------ -------- ------------------ -------- -------- ------------- ------------ --------------
Fannie Mae Multiple N/A N/A N/A 7% to 10.5% N/A N/A
FHLMC Multiple N/A N/A N/A 7.5% to 10% N/A N/A
TOTAL SINGLE-FAMILY MBS....................................................................................................
UNAMORTIZED DISCOUNT.......................................................................................................
UNREALIZED GAIN............................................................................................................
CARRYING VALUE--SINGLE-FAMILY MBS..........................................................................................
CARRYING VALUE OF ALL MORTGAGES............................................................................................
UNPAID DELINQUENCY
BALANCE AS LIEN STATUS OF
AGENCY OF 6/30/02 COLLATERAL POSITION LOAN
------ ----------- ---------- -------- -----------
Fannie Mae $ 1,458,339 MBS Guaranteed by Fannie Mae N/A Current
FHLMC $ 1,369,819 MBS Guaranteed by FHLMC N/A Current
-----------
TOTAL SINGLE-FAMILY MB $ 2,828,158
UNAMORTIZED DISCOUNT.. $ (15,272)
UNREALIZED GAIN....... $ 146,552
-----------
CARRYING VALUE--SINGLE $ 2,959,438
-----------
CARRYING VALUE OF ALL $23,812,894
===========
143
BORROWING POLICIES. KIP III anticipates that there will be sufficient cash
flow from the mortgages to meet cash requirements. To the extent that the
partnership's cash flow should be insufficient to meet the partnership's
operating expenses and liabilities, it will be necessary for the partnership to
obtain additional funds by liquidating its investment in one or more mortgages
or by borrowing. The partnership may borrow money on an unsecured or secured
basis to further the purposes of the partnership. The partnership may pledge
mortgages as security for any permitted borrowing. The partnership, under some
circumstances, may borrow funds from any general partner or an affiliate of any
general partner. However, the transaction must include interest rates and other
finance charges and fees not in excess of the amounts that are charged by
unaffiliated lenders for comparable loans and must satisfy other conditions
specified in the partnership agreement. The partnership has not borrowed any
funds during the past three years and does not intend to do so in the future.
DISPOSITION POLICIES. The FHA coinsurance loan programs under
Section 221(d)(4) of the National Housing Act provides for loans with 40 year
terms and Section 223(f) provides for loans with 35 year terms. Both have a call
option at any time after ten years, upon one year's notice. The subordinated
promissory note and subordinated mortgage that secure the participation feature
of the PIM provides for acceleration of maturity at the earlier of the sale of
the underlying property or the call date, typically expected to be a date ten
years after the date of final endorsement for mortgage insurance.
From time to time, the partnership expects that it may realize the principal
and participation in residual value, if any, of its mortgage before maturity. It
was expected that the mortgage would be repaid after a period of ownership of
approximately ten years from the date of the closing of the permanent loan.
Realization of the value of the mortgage may, however, be at a later date.
During the past three years, KIP III has received payoffs with respect to four
investments of the partnership.
REPORTING POLICIES. The general partners of KIP III provide copies of KIP
III's annual report to the limited partners within 120 days after the end of
each fiscal year of the partnership. The annual report includes: (1) the
partnership's audited balance sheet and audited statements of income and
comprehensive income, changes in partners' equity and cash flows, accompanied by
the report of the partnership's independent certified public accountants, (2) a
statement of distributable cash flow and net cash proceeds from capital
transactions and (3) an estimate by the general partners of the net asset value
of the limited partner interests.
The general partners of KIP III provide copies of KIP III's quarterly report
to the limited partners within 60 days after the end of the first three fiscal
quarters of each fiscal year of the partnership. The quarterly report includes:
(1) the partnership's unaudited balance sheet, (2) unaudited statements of
income and comprehensive income and cash flows, and (3) an estimate by the
general partners of the net asset value of the limited partner interests. Each
annual and quarterly report also includes the amount of fees and other
compensation paid to any general partner and any affiliates of any general
partner by the partnership for that fiscal period.
The partnership provides to the limited partners all tax information
necessary to prepare their federal income tax returns within 75 days after the
end of each calendar year.
OTHER POLICIES. The partnership will not underwrite securities of other
issuers, offer securities in exchange for property, invest in securities of
other issuers for the purpose of exercising control or issue senior securities
and has not engaged in any of these activities during the past three years. The
partnership has not repurchased or reacquired any of the partner interests from
partners or units from unit holders in the past three years and does not intend
to do so in the future. The partnership may not make loans to any general
partner or any affiliate of any general partner and will not make loans to any
other persons, other than mortgage investments of the type described above. The
partnership has not made any loans during the past three years.
RELEVANT AFFILIATIONS. The Berkshire Group is controlled by Douglas and
George Krupp, who also control the general partners of KIP III, KRF Company and
Berkshire Advisor.
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DESCRIPTION OF THE PREFERRED SHARES
The Preferred Shares will be issued under the terms of our charter. The
following summarizes the material terms and provisions of the Preferred Shares.
You should also read the Maryland General Corporation Law and the charter, which
has been filed as an exhibit to the registration statement of which this
prospectus forms a part.
GENERAL
The charter authorizes us to issue up to 5,000,000 shares of preferred
stock, of which 5,000,000 shares have been designated as % Series A Cumulative
Redeemable Preferred Stock. Our directors have the authority to establish the
terms of any series of preferred stock, including the preferences, conversion
and other rights, voting powers, restrictions, limitations as to distributions,
qualifications and terms and conditions of redemption, if any, by filing
articles supplementary to the charter. The filing of the articles supplementary
does not require any vote or action of the holders of the Preferred Shares
except as otherwise described in the charter or the rules of any stock exchange
or automated quotation system on which the Preferred Shares are listed. However,
the approval of the holders of Preferred Shares is required to authorize, create
or increase the authorized amount of any class or series of preferred stock
ranking senior to the Preferred Shares. Holders of Preferred Shares also are
required to approve any amendment or modification to our charter that would
materially and adversely affect the preferences, rights, voting powers,
restrictions, limitations as to distributions, qualifications and terms and
conditions of redemption of the Preferred Shares. Amendments that are deemed not
to materially and adversely affect the holders of Preferred Shares for purposes
of the charter include the authorization, creation or increase in the authorized
amount of any class or series of stock ranking on a parity with or junior to the
Preferred Shares or any decrease in the number of Preferred Shares, but not
below the number of Preferred Shares then outstanding. For more information
regarding these voting provisions, see the discussion below in "--Voting
Rights."
The Preferred Shares have been approved for listing on the American Stock
Exchange, subject to official notice of issuance, under the symbol "BIR."
RESTRICTIONS ON OWNERSHIP AND TRANSFER OF PREFERRED SHARES
The charter contains restrictions on the number of Preferred Shares that
holders may own. For us to qualify as a REIT under the Code, beginning with the
taxable year following the year during which the offers are consummated, not
more than 50% in value of our outstanding shares may be owned, directly or
indirectly through the application of attribution rules under the Code, by five
or fewer individuals (as defined in the Code to include specified entities)
during the last half of any taxable year (which we refer to as the closely held
requirement). Beginning with the taxable year following the year during which
the offers are consummated, our outstanding shares must also be beneficially
owned by 100 or more persons during at least 335 days of a 12-month taxable year
or during a proportionate part of a shorter taxable year. GIT and GIT II are
subject to these same restrictions on ownership of their outstanding shares,
except that the restrictions also apply to them currently. Because we expect to
own Interests in GIT and GIT II, the restrictions on ownership of outstanding
shares of GIT and GIT II are relevant to us.
In order to qualify as a REIT, we must also meet requirements regarding the
nature of our gross income. One of these requirements is that at least 75% of
our gross income for each calendar year must consist of rents from real property
and income from other real property investments. The rents received by our
operating partnership directly or indirectly from any tenant will not qualify as
rents from real property if we own, actually or constructively within the
meaning of applicable provisions of the Code, 10% or more of the ownership
interests in that tenant. Because we will elect to be a REIT and expect to
qualify as a REIT, and it is our understanding that GIT and GIT II intend to
continue to qualify as REITs, the charter contains restrictions on the ownership
and transfer of our shares, including our Preferred Shares, intended to assist
in complying with these REIT requirements.
From the date on which the offer is completed, no holder may own or acquire,
or be deemed to own or acquire by virtue of the attribution provisions of the
Code, more than 4.9% (which we refer to as the ownership limit) of the issued
and outstanding Preferred Shares, and the beneficial ownership of our shares may
not be held by fewer than 100 persons. Our board may, based upon evidence
satisfactory to it, waive the ownership limit with respect to a holder, other
than any individual holder or specified entity treated as an individual under
applicable provisions of the Code, if such holder's ownership will not cause us
to fail to qualify as a REIT or cause GIT or GIT II to violate the closely held
requirement applicable to them.
145
Our charter provides that unless our board has granted a waiver with respect
to the ownership limit, any transfer of Preferred Shares that would violate the
ownership limit or the 100 person requirement described above is null and void
and the intended transferee will acquire no rights in those Preferred Shares. In
addition, our charter prohibits any transfer of or other event with respect to
our shares that would cause us to own, actually or constructively, 9.9% or more
of the ownership interests in a tenant of our real property or the real property
of our operating partnership or any direct or indirect subsidiary of ours or of
our operating partnership or that would otherwise cause us to fail to qualify as
a REIT. The Preferred Shares that, if transferred, would result in a violation
of the ownership limit or the 100 person requirement or other ownership
restrictions, notwithstanding the two preceding sentences, will automatically be
converted into a separate series of our preferred shares (which we refer to as
the Excess Preferred Shares) that will be transferred to a trust effective on
the day before the purported transfer of those Preferred Shares and held for the
exclusive benefit of one or more charitable organizations designated by our
board. We will designate a trustee of the trust that will not be affiliated with
us or the purported beneficial transferee or record holder. While Excess
Preferred Shares are held in trust, the trustee of the trust will have all
distribution and voting rights pertaining to the transferred shares and will
hold the distributions in trust for the benefit of the charitable beneficiary.
Upon our liquidation, dissolution or winding-up, the intended original
transferee-holder's ratable share of our assets would be limited to the price
paid by the original transferee-holder for the Preferred Shares in the purported
transfer that resulted in the Excess Preferred Shares or, if no value was given,
the price per share equal to the closing market price on the trading day before
the date of the purported transfer that resulted in the Excess Preferred Shares.
The trustee will distribute any remaining amounts to the charitable beneficiary.
The trustee will transfer that number of our Preferred Shares represented by
the Excess Preferred Shares to a person whose ownership of the Preferred Shares
will not violate the ownership limit or the 100 person requirement or other
ownership restrictions. The transfer will be made no earlier than 20 days after
the later of our receipt of notice that shares have been transferred to the
trust or the date we determine that a purported transfer of our Preferred Shares
has occurred. During this 20-day period, we will have the option of redeeming
the Excess Preferred Shares. Upon any transfer or redemption, the purported
transferee-holder will receive a price per share equal to the lesser of the
price per share in the transaction that created the Excess Preferred Shares or
if no value was given, the price per share equal to the closing market price on
the trading day before the date of the transaction, and the market price per
share on the trading day before the date of the redemption, in the case of a
purchase by us, or the price received by the trustee net of any sales
commissions and expenses, in the case of a sale by the trustee. The charitable
beneficiary will receive any excess amounts. Immediately upon transfer of our
Preferred Shares to the permitted transferee, the Excess Preferred Shares will
be cancelled.
Any person who acquires or attempts to acquire our shares in violation of
the foregoing restrictions or who owns shares that were transferred to a trust
based on the foregoing will be required to give immediate written notice to us
of such event or, in the case of a proposed or attempted transfer or
acquisition, will be required to give us 15 days prior written notice.
The ownership limit will not be automatically removed from our charter even
if the REIT provisions of the Code are changed so as to no longer contain any
ownership concentration limitation or if the ownership concentration limitation
is increased. Any change in the ownership limit would require an amendment to
the charter. Such an amendment to the charter would require the approval by our
board of directors and our common stockholders. No vote of holders of Preferred
Shares will be required in connection with any such act.
Any certificate representing Preferred Shares will bear a legend referring
to the restrictions described above. If the Preferred Shares are issued by
book-entry only, as anticipated, we will send each holder of Preferred Shares a
written statement including, among other items, a description of the limits on
ownership and transferability described above.
Each person who owns 5% or more (or another percentage applicable under
Treasury regulations) of our outstanding shares will be asked annually to
deliver a statement containing information regarding their ownership of our
shares. In addition, each holder of Preferred Shares will upon demand, be
required to disclose to us information with respect to the direct, indirect and
constructive ownership of our shares as our board deems necessary to comply with
the provisions of the Code applicable to REITs or to comply with the
requirements of any taxing authority or governmental agency.
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RANKING
The Preferred Shares will, with respect to distributions and rights upon our
liquidation, dissolution, winding-up or termination, rank
- senior to our common stock,
- senior to any series of preferred stock hereafter created whose terms
specifically provide that such series ranks junior to the Preferred
Shares,
- on a parity with any series of preferred stock hereafter created unless
the terms of such other series specifically provide that such other series
ranks junior or senior to the Preferred Shares, and
- junior to any series of preferred stock hereafter created whose terms
specifically provide that such series ranks senior to the Preferred
Shares.
DISTRIBUTIONS
Subject to the rights of holders of other series of preferred stock ranking
senior to or on a parity with the Preferred Shares as to the payment of
distributions which may from time to time be issued by us, holders of Preferred
Shares will be entitled to receive, when, as and if authorized by our board of
directors out of funds legally available therefor, cumulative preferential cash
distributions at the rate per annum of % of the stated liquidation preference
of $25.00 per share. Distributions on the Preferred Shares will be cumulative,
will accrue from the original date of issuance and will be payable quarterly in
arrears, on February 15, May 15, August 15 and November 15 (each referred to as
a distribution payment date) of each year, commencing on the first of such dates
following the completion of the offers. The amount of distributions payable for
any period will be computed on the basis of a 360-day year of twelve 30-day
months, and for any period shorter than a full quarterly period for which
distributions are computed, the amount of the distribution payable will be
computed on the basis of the actual number of days elapsed in such a 30-day
month. If any distribution payment date is not a business day, the payment of
the distribution to be made on such distribution payment date will be made on
the next succeeding day that is a business day (and without any interest or
other payment in respect of any such delay). "Business day" means any day other
than Saturday, Sunday or any other day on which banking institutions in New
York, New York or Boston, Massachusetts are authorized or required by any
applicable law to close. Distributions on the Preferred Shares described in this
paragraph will accrue whether or not we have earnings, whether or not there are
funds legally available for the payment of such distributions and whether or not
such distributions are authorized and declared. Accrued distributions will
accumulate, to the extent they are not paid, as of the distribution payment date
on which they first become payable. Accumulated and unpaid distributions will
not bear interest.
So long as any Preferred Shares are outstanding, no distribution will be
paid or declared on or with respect to our common stock or any other series of
outstanding preferred stock ranking junior as to the payment of distributions to
the Preferred Shares (which we refer to collectively as the junior securities)
or any other series of outstanding preferred stock ranking on a parity with the
Preferred Shares as to the payment of distributions (which we refer to
collectively as the parity securities), nor will any sum or sums be set aside
for or applied to the purchase, redemption or other acquisition for value of any
junior securities or parity securities unless, in each case, full cumulative
distributions accumulated on all Preferred Shares and all other series of parity
securities have been paid in full. The foregoing provision will not prohibit
distributions payable solely in junior securities and the conversion of
preferred stock of any series into Excess Preferred Shares as described under
"--Restrictions on Ownership and Transfer of Preferred Shares." Holders of
Preferred Shares will not be entitled to any distributions, whether payable in
cash, property or otherwise, in excess of the full cumulative distributions
described above.
Distributions on the Preferred Shares will be made to the holders of the
Preferred Shares as they appear on our books and records on the relevant record
dates, which, as long as the Preferred Shares remain in book-entry form, will be
one business day before the relevant distribution payment date. Subject to any
applicable laws and regulations and the provisions of the charter, each such
payment to the holders of Preferred Shares will be made as described under
"--Registrar, Transfer Agent and Paying Agent" below. If the Preferred Shares do
not continue to remain in book-entry only form, our board has the right to
select relevant record dates, which will be more than one business day before
the relevant distribution payment dates.
147
POSSIBLE REDEMPTION
Except in the case of a "tax event" or an "Investment Company Act event"
described below, the Preferred Shares cannot be redeemed before February 15,
2010. On or after such date, we have the right to redeem the Preferred Shares,
in whole or in part, from time to time, upon not less than 30 nor more than
60 days' notice, at a redemption price (which we refer to as the redemption
price) equal to $25 per share, plus all accumulated and unpaid distributions to
the date of payment.
If, at any time, a "tax event" or "Investment Company Act event" shall occur
and be continuing, we have the right to redeem the Preferred Shares in whole but
not in part, as described below. However, if at such time there is available to
us the opportunity to eliminate, within a 90-day period, the event by taking
some ministerial action, such as filing a form or making an election, or
pursuing some other similar reasonable measure, which in our sole judgment, has
or will cause no adverse effect on us or the holders of the Preferred Shares and
will involve no material cost, we will pursue such measure instead of such
redemption, and we will have no right to redeem the Preferred Shares while we
are pursuing any such ministerial action. We will have the right, upon not less
than 30 nor more than 60 days' notice, to redeem the Preferred Shares in whole
for cash as provided in the preceding paragraph within 90 days following the
occurrence of such event (subject to extension for the number of days
ministerial actions are pursued).
"Investment Company Act event" means that we have received an opinion of
nationally recognized independent counsel experienced in practice under the
Investment Company Act of 1940, that because of the occurrence of a change in
law or regulation or a change in interpretation or application of law or
regulation by any legislative body, court, governmental agency or regulatory
authority, there is more than an insubstantial risk that we are or will be
considered an "investment company" which is required to be registered under the
Investment Company Act of 1940, which change in law becomes effective on or
after the date of this prospectus.
"Tax event" means that we have received an opinion of nationally recognized
independent tax counsel experienced in such matters that there is more than an
insubstantial risk that we do not qualify, or within 90 days of the date of such
opinion would no longer qualify, as a REIT under the Code for any reason
whatsoever, but a tax event will not include the voluntary election by our board
to terminate our status as a REIT for federal income tax purposes.
In the event fewer than all outstanding Preferred Shares are to be redeemed,
Preferred Shares will be redeemed as described under "--Registrar, Transfer
Agent and Paying Agent" below.
If a partial redemption of the Preferred Shares would result in the
delisting of the Preferred Shares by any national securities exchange or
interdealer quotation system on which the Preferred Shares are then listed, we
will only redeem the Preferred Shares in whole.
REDEMPTION PROCEDURES
We may not redeem fewer than all the outstanding Preferred Shares unless all
accrued and unpaid distributions have been paid on all Preferred Shares for all
quarterly distribution periods terminating on or before the date of redemption.
If we give a notice of redemption in respect of Preferred Shares (which
notice will be irrevocable) then by 12:00 noon, New York City time, on the
redemption date we will deposit irrevocably with our paying agent funds
sufficient to pay the redemption price and will give irrevocable instructions
and authority to pay the redemption price to the holders of the Preferred Shares
entitled to such redemption price. If notice of redemption shall have been given
as provided above and funds deposited as required, then, on the date of such
deposit, distributions will cease to accrue on the Preferred Shares called for
redemption. Also, such Preferred Shares will no longer be deemed to be
outstanding and all rights of holders of such Preferred Shares so called for
redemption will cease, except the right of the holders of such Preferred Shares
to receive the redemption price but without interest. We shall not be required
to register or cause to be registered the transfer of any Preferred Shares which
have been so called for redemption. If any date fixed for redemption of
Preferred Shares is not a business day, then payment of the redemption price
payable on such date will be made on the next succeeding day that is a business
day (and without any interest or other payment in respect of any such delay)
except that, if such business day falls in the next calendar year, such payment
will be made on the immediately preceding business day, in each case with the
same force and effect as if made on such date fixed for redemption. If payment
of the redemption price in respect of Preferred Shares is improperly withheld or
refused and not paid, distributions on such Preferred Shares will
148
continue to accrue, from the original redemption date to the date of payment, in
which case the actual payment date will be used for purposes of calculating the
portion of the redemption price consisting of accumulated and unpaid
distributions.
We will provide notice of any redemption of the Preferred Shares to the
holders of record of the Preferred Shares not less than 30 nor more than
60 days before the date of redemption. Such notice shall be provided by mailing
notice of such redemption, first class postage prepaid, to each holder of
Preferred Shares to be redeemed, at such holder's address as it appears on our
transfer records. Each notice shall state the following: (1) the redemption
date; (2) the redemption price; (3) the place or places where certificates for
the Preferred Shares (if certificated) may be surrendered for payment; (4) the
number of Preferred Shares to be redeemed from each holder; (5) that payment of
the redemption price will be made upon presentation and surrender of such
Preferred Shares (if certificated); and (6) that on or after the redemption date
distributions on the Preferred Shares to be redeemed will cease to accrue. No
failure to give or defect in a notice of redemption shall affect the validity of
the proceedings for redemption except as to the holder to which notice was
defective or not given.
Subject to the foregoing and applicable law (including, without limitation,
federal securities laws), we or our subsidiaries may at any time and from time
to time purchase outstanding Preferred Shares by tender, in the open market or
by private agreement unless at such time we would be prohibited from purchasing
or redeeming them by the terms of the Preferred Shares.
LIQUIDATION
Subject to the rights of holders of any other series of preferred stock
which we may issue in the future which rank senior to or on a parity with the
Preferred Shares, upon our voluntary or involuntary dissolution, liquidation,
winding-up or termination, the holders of the Preferred Shares will be entitled
to receive upon any such dissolution, liquidation, winding-up or termination,
out of our assets legally available for distribution, after payment or provision
for payment of our debts and other liabilities (to the extent not satisfied by
the operating partnership as provided in the charter), an amount per Preferred
Share equal to $25.00 plus accumulated and unpaid distributions to the date of
payment.
If, upon our liquidation, dissolution, winding-up or termination, there are
insufficient assets to permit full payment to holders of Preferred Shares and
any other series of outstanding preferred stock ranking on a parity with the
Preferred Shares, the holders of Preferred Shares and such other series of
parity securities will be paid ratably in proportion to the full distributable
amounts to which holders of Preferred Shares and such other series of parity
securities are respectively entitled upon liquidation, dissolution, winding-up
or termination. The full preferential amount payable to holders of Preferred
Shares and such other series of parity securities upon any such liquidation,
dissolution, winding-up or termination will be paid in full before any
distribution or payment is made to holders of our common stock or preferred
stock of any series ranking junior to the Preferred Shares upon our liquidation,
dissolution, winding up or termination. Neither our consolidation or merger with
or into any corporation, partnership, limited liability company or other entity
(or of any corporation, partnership, limited liability company or other entity
with or into us) nor the sale, lease or conveyance of all or substantially all
of our property in conformity with the terms of the charter shall be deemed to
constitute a liquidation, dissolution, winding-up or termination of us.
In determining whether a distribution (other than upon voluntary or
involuntary liquidation) by dividend, redemption or other acquisition of our
shares of stock or otherwise is permitted under the Maryland General Corporation
Law, no effect will be given to amounts that would be needed, if we were to be
dissolved at the time of the distribution, to satisfy the preferential rights
upon dissolution of holders of the Preferred Shares.
MERGER OR CONSOLIDATION
So long as the Preferred Shares are outstanding, we may not merge with or
into another entity or consolidate with one or more other entities into a new
entity, except as described below. We may, upon the approval of our board of
directors and the holders of our common stock, and without the approval of the
holders of Preferred Shares, merge with or into another entity or consolidate
with one or more other entities into a new entity, provided that the merger or
consolidation does not materially and adversely affect the preferences, rights,
voting powers, restrictions, limitations as to dividends, qualifications and
terms and conditions of redemption of the Preferred Shares (including any
successor securities) as set forth in the charter.
149
The approval of the holders of the Preferred Shares is not required to
approve:
- any merger or consolidation in which we are the surviving entity, or
- any merger or consolidation in which we are not the surviving entity, so
long as the holders of Preferred Shares receive, as a result of the merger
or consolidation, either cash or securities with preferences, rights and
privileges substantially similar to those of the Preferred Shares in
exchange for their Preferred Shares.
VOTING RIGHTS
Except as provided below, under "--Modification and Amendment of the
Charter" and as otherwise required by Maryland General Corporation Law and the
charter, the holders of the Preferred Shares will have no voting rights.
If we fail to make distributions in full on the Preferred Shares for six
consecutive quarterly distribution periods (referred to as an election event),
then the holders of the Preferred Shares (voting separately as a class with all
other series of preferred stock upon which like voting rights have been
conferred and are then exercisable) will be entitled, by the vote of holders of
such Preferred Shares representing a majority in aggregate liquidation
preference of such outstanding preferred stock, to elect two special directors
(who need not be officers or employees of or otherwise affiliated with us) who
shall have the same rights, powers and privileges under the charter as a regular
director, except that one of the special directors, at such director's request,
will be appointed as an additional member of the audit committee, if the
director otherwise qualifies as an independent director. The special directors
so elected shall, without any further act or vote by the holders of any other
series of preferred stock, be deemed to have been elected to act in such
capacity for all series of preferred stock upon which like voting rights have
been conferred and are, or in the future become, exercisable. Any holder of
Preferred Shares (other than us or any of our affiliates) will have the right to
nominate any person to be elected as a special director. During the term of the
special directors, our board of directors will not be permitted to increase the
number of directors, except to add the special directors.
For purposes of determining whether we have failed to pay distributions in
full for six consecutive quarterly distribution periods, distributions will be
deemed to remain in arrears, notwithstanding any payments of the distributions,
until full cumulative distributions have been or contemporaneously are paid with
respect to all quarterly distribution periods terminating on or before the date
of payment of such cumulative distributions. Not later than 30 days after such
right to elect special directors arises, our board will call a meeting for the
purpose of electing special directors. If our board fails to call such meeting
within such 30-day period, the holders of Preferred Shares and any other series
of preferred stock upon which like voting rights have been conferred and are
then exercisable representing 10% in aggregate liquidation preference of such
outstanding preferred stock will be entitled to call such meeting. The
provisions of the charter relating to calling and conducting the meetings of the
holders will apply with respect to any such meeting. If, at any such meeting,
holders of less than a majority in aggregate liquidation preference of preferred
stock of all series entitled to vote for the election of special directors vote
for such election, no special director will be elected. Any special director may
be removed without cause at any time by vote of the holders of shares
representing a majority in liquidation preference of each series of preferred
stock upon which like voting rights have been conferred and are then exercisable
voting as a single class. The holders of 10% in liquidation preference of the
Preferred Shares will be entitled to call such a meeting. Any special director
elected will cease to be a special director if the election event by which the
special director was elected and all other election events have been cured and
cease to be continuing.
If any proposed amendment or modification of the charter would materially
and adversely affect the preferences, rights, voting powers, restrictions,
limitations as to distributions, qualifications and terms and conditions of
redemption of the Preferred Shares, then the holders of outstanding Preferred
Shares will be entitled to vote on such amendment or proposal as a class, and
such amendment or proposal will not be effective except with the approval of the
holders of Preferred Shares representing 66 2/3% in interest of the outstanding
Preferred Shares. Any amendment or modification that would:
- decrease the authorized number of Preferred Shares but not below the
number of Preferred Shares then outstanding, or
- authorize, create or increase the number of authorized shares of any class
or series of stock ranking on a parity with or junior to the Preferred
Shares as to distributions or upon our liquidation, dissolution,
winding-up or termination
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will be deemed not to materially and adversely affect such preferences, rights,
voting powers, restrictions, limitations as to distributions, qualifications and
terms and conditions of redemption.
Holders of Preferred Shares representing 66 2/3% in interest of the
outstanding Preferred Shares voting as a class must approve the authorization,
creation or increase the number of authorized shares of any series of preferred
stock ranking senior to the Preferred Shares as to distributions or upon our
liquidation, dissolution, winding-up or termination. No consent or approval of
the holders of Preferred Shares is required for the authorization, creation or
increase in the number of authorized shares of any series of preferred stock
ranking on a parity with or junior to the Preferred Shares as to distributions
or upon our liquidation, dissolution, winding-up or termination.
When entitled to vote, the holders of Preferred Shares are entitled to vote
separately as a class with all other classes of preferred stock upon which like
voting rights have been conferred and are exercisable. Any required approval or
direction of holders of Preferred Shares may be given at a separate meeting of
holders of Preferred Shares convened for that purpose, at a meeting of all of
the holders of Preferred Shares or by written consent. We will provide a notice
of any meeting at which holders of Preferred Shares are entitled to vote, or of
any matter upon which action by written consent of such holders is to be taken,
by mail to each holder of record of Preferred Shares. Each such notice will
include a statement setting forth:
- date of the meeting or the date by which the action is to be taken,
- a description of any resolution proposed for adoption at such meeting on
which such holders are entitled to vote or of such matter upon which
written consent is sought, and
- instructions for the delivery of proxies or consents.
No vote or consent of the holders of Preferred Shares will be required for
us to redeem and cancel preferred stock of any series.
Subject to the right of holders of Preferred Shares to elect special
directors upon the occurrence of an election event and to remove these
directors, holders of the Preferred Shares will have no rights to elect or
remove a director. These rights are vested exclusively in the holders of our
common stock.
CONVERSION RIGHTS
The Preferred Shares are not convertible into or exchangeable or exercisable
for any other property or securities of ours by the holder of the Preferred
Shares. As described under "--Restrictions on Ownership and Transfer of
Preferred Shares," under specified circumstances, the Preferred Shares are
automatically convertible into Excess Preferred Shares.
MODIFICATION AND AMENDMENT OF THE CHARTER
The charter may be modified and amended by our board with the approval of a
majority of the votes entitled to be cast by holders of our outstanding common
stock, provided, that, if any proposed modification or amendment provides for
any action that would materially and adversely affect the preferences, rights,
voting powers, restrictions, limitations as to distributions, qualifications and
terms and conditions of redemption of any series of preferred stock, whether by
way of amendment to the charter or otherwise, then the holders of each affected
series of outstanding preferred stock will be entitled to vote on such amendment
or modification and such amendment or modification will not be effective with
respect to such an affected series except with the approval of at least 66 2/3%
in interest of such series, unless the terms of any such series of preferred
stock provides otherwise.
BOOK-ENTRY ONLY ISSUANCE
The Preferred Shares will be issued by book-entry only and will not be
represented by certificates.
The laws of some jurisdictions require that some purchasers of securities
take physical delivery of securities in definitive form. Such laws may impair
the ability to transfer beneficial interests in a Preferred Share.
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REGISTRAR, TRANSFER AGENT AND PAYING AGENT
Payment of distributions and payments on redemption of the Preferred Shares
will be payable, the transfer of the Preferred Shares will be registrable, and
Preferred Shares will be exchangeable for Preferred Shares of other
denominations of a like aggregate liquidation preference, at our principal
office; provided that payment of distributions may be made at our option by
check mailed to the address of the persons entitled to such payment and that the
payment on redemption of any Preferred Share will be made only upon surrender of
such Preferred Share (if certificated).
The Bank of New York will act as registrar and transfer agent for the
Preferred Shares. The Bank of New York will also act as paying agent and, with
the consent of our board, may designate additional paying agents.
In the event of any redemption in part, we will not be required to
- issue, register the transfer of or exchange any Preferred Shares during a
period beginning at the opening of business 15 days before any selection
for redemption of Preferred Shares and ending at the close of business on
the earliest date on which the relevant notice of redemption is deemed to
have been given to all holders of Preferred Shares to be redeemed, or
- register the transfer of or exchange any Preferred Shares so selected for
redemption, in whole or in part, except the unredeemed portion of any
Preferred Shares being redeemed in part. Holders of Preferred Shares to be
redeemed must surrender such Preferred Shares (if certificated) at the
place designated in the notice of redemption and, following such
surrender, will be entitled to the redemption price payable upon such
redemption.
If certificated, upon presentation of any certificate for Preferred Shares
redeemed in part only, we shall execute and deliver, at our expense, a new
certificate equal to the unredeemed portion of the certificate so presented.
GOVERNING LAW
The charter and the Preferred Shares will be governed by, and construed in
accordance with, the internal laws of the State of Maryland.
MISCELLANEOUS
Our board is authorized and directed to take such action as it deems
reasonable in order that we
- will not be deemed to be an "investment company" required to be registered
under the Investment Company Act of 1940, and
- will be classified for United States federal income tax purposes as a
REIT.
In this connection, our board is authorized to take any action, not
inconsistent with applicable law or our charter, that our board determines in
its discretion to be reasonable and necessary or desirable for such purposes, as
long as such action does not materially and adversely affect the interests of
holders of the Preferred Shares.
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SUMMARY OF OPERATING PARTNERSHIP AGREEMENT
We will own all of our operating assets through Berkshire Income Realty-OP,
L.P., our operating partnership. We have entered into an operating partnership
agreement, which governs the rights and obligations of the partners of the
operating partnership. The sole partners of the operating partnership consist of
us, as special limited partner, and our wholly owned subsidiary, BIR GP, L.L.C.,
as general partner. Upon completion of the offers, KRF Company will contribute
its interests in the initial properties to the operating partnership, and will
thereby become a limited partner of the operating partnership.
The following summary of certain provisions of the operating partnership
agreement, including the descriptions of certain provisions set forth elsewhere
in this prospectus, is qualified in its entirety by reference to the operating
partnership agreement, which is filed as an exhibit to the registration
statement of which this prospectus forms a part.
MANAGEMENT
The operating partnership is organized as a Delaware limited partnership.
Our wholly owned subsidiary, BRI GP, L.L.C., is the general partner of the
operating partnership. As a result of our ownership of the general partner, we
generally will have full, exclusive and complete responsibility and discretion
in the management, operation and control of the operating partnership and its
assets.
The general partner will manage the affairs of the operating partnership and
will have the ability to cause the operating partnership to make acquisitions,
dispositions and borrowings and select the property managers for our properties.
The general partner will be permitted to cause the operating partnership to
contribute money to its subsidiaries or entities in which it has made
investments, transfer assets to joint ventures and other entities in which it is
a participant and enter into conflict avoidance agreements with affiliates of
the general partner or the operating partnership on terms and conditions the
general partner deems advisable in its discretion. The general partner also will
be permitted to cause the operating partnership to enter into agreements or
transactions with affiliates of the general partner, the operating partnership
or KRF Company, or cause the transfer or sale of property to the operating
partnership by the general partner or its affiliates, on terms and conditions
the general partner, in good faith, deems fair and reasonable. Under our bylaws,
however, such agreements or transactions may not be entered into without the
prior approval of the audit committee of our board of directors. The general
partner also will be responsible for distributing available cash to the partners
on a quarterly basis in accordance with the provisions of the operating
partnership agreement.
SPECIAL LIMITED PARTNER
Our direct interest in the operating partnership will be as special limited
partner. As of the completion of the offers, the only other limited partner will
be KRF Company, which will receive common OP units in connection with its
contribution to the operating partnership of its interests in the initial
properties. The preferred OP units that we will receive in exchange for the
contribution of the Interests tendered in the offers will rank first in priority
with respect to distributions of available cash and participation in any
liquidation proceeds of the operating partnership after payment of operating
partnership indebtedness, up to the amount required for us to pay quarterly
distributions and the liquidation preference to the holders of Preferred Shares.
In addition, the general partner will be obligated to use reasonable efforts to
cause the operating partnership to distribute sufficient amounts to us as
special limited partner so that we can make distributions to our stockholders,
including holders of Preferred Shares, necessary to satisfy our REIT
distribution requirements and to avoid any federal income or excise tax
liability. As special limited partner, we will be entitled to the reimbursement
by the operating partnership of our expenses incurred in connection with our
operations.
The operating partnership agreement permits the general partner to transfer
its general partnership interests to us or one of our subsidiaries without the
approval of the other limited partners. We will be permitted to transfer our
interests in the operating partnership without the approval of the general
partner or the other limited partners under the following circumstances:
- a transfer through a merger or sale of all or substantially all of our
assets that also includes the merger or sale of all or substantially all
of the assets of the operating partnership in which the partners of the
operating partnership receive consideration equivalent to that received by
the corresponding class of our stockholders, or
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- a transfer through a merger with another entity if immediately after the
merger substantially all of the assets of the surviving entity are
contributed to the operating partnership as a capital contribution.
The other limited partners will not be permitted to transfer their interests in
the operating partnership without the approval of the general partner.
The operating partnership agreement also imposes certain restrictions upon
our activities that will not be applicable to the other limited partners. The
operating partnership agreement prohibits us from engaging in any business other
than the ownership, acquisition and disposition of interests in the operating
partnership, and restricts our ability to own or take title to assets, or to
incur indebtedness except with respect to guarantees of indebtedness of the
operating partnership or loans for which the operating partnership or any of its
subsidiaries are also liable. Under the operating partnership agreement we
generally will not be permitted to issue new shares, including by the exercise
or vesting of stock options unless the net proceeds of the issuance are
contributed to the operating partnership and the operating partnership issues to
us additional partnership interests having distribution rights and other
economic attributes equivalent to those of our new shares.
VOTING RIGHTS OF LIMITED PARTNERS
The consent of a majority of the outstanding common OP units will generally
be required for the consummation of any merger, consolidation, reorganization or
other business combination to which the operating partnership is a party, except
for certain business combinations undertaken in conjunction with a merger or
other combination to which we are a party. Any amendment to the operating
partnership agreement that would adversely affect the rights of any class or
series of OP units disproportionately with respect to the rights of any other
class or series, or alter the rights, preferences and privileges of any class or
series of OP units, will, except in connection with the issuance of additional
operating partnership interests as described below under "Issuance of Additional
OP Units," require the consent of a majority in interest of the class or series
of OP units adversely affected by the amendment. The consent of each partner
adversely affected by certain amendments to, or actions in connection with, the
operating partnership agreement generally will be required if the amendment or
action would have certain adverse affects, including:
- converting a limited partner interest into a general partner interest,
except as a result of the general partner acquiring the interest,
- modifying the limited liability of a limited partner,
- reducing any partner's share of distributions made by the operating
partnership in a manner that is not pro rata with respect to all
partnership interests of the same class or series, or creating any
obligations for any partners or otherwise impairing rights of any partner
under the operating partnership agreement, other than an impairment of
rights that is pro rata with other partners holding the same class or
series of partnership interests,
- adversely altering or modifying any right of a limited partner to effect
an exchange of its OP units for shares of our stock as described under
"Exchange and Cash Tender Rights,"
- causing the termination of the operating partnership other than in
accordance with the provisions of the operating partnership agreement,
which approval right only applies to the holders of common OP units, or
- amending the section of the operating partnership agreement governing
these approval rights.
However, holders of preferred OP units will have the right to approve any
amendment reducing the share of distributions, creating obligations or impairing
the rights of the holders of preferred OP units, as described above, by the vote
of 66 2/3% in stated value of the holders of preferred OP units, rather than by
unanimous vote, and will only have the right to approve any amendment to the
section of the partnership agreement governing the approval rights described
above if the amendment would materially and adversely affect the rights,
privileges and preferences of the holders of preferred OP units. The voting
rights of the holders of preferred OP units are described in more detail under
"Description of the Preferred OP Units--Voting Rights."
TRANSFER OF OP UNITS
The preferred OP units held by us as special limited partner may not be
transferred except to a successor entity as described under "--Special Limited
Partner." The operating partnership agreement provides that the other limited
partners may not transfer their common OP units without the approval of the
general partner, subject to certain limitations. However, all limited partners
and the general partner will have the ability to transfer
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their interests in the operating partnership in connection with the pledge of
their interests to secure any borrowing of the operating partnership that is
guaranteed by them or with respect to which they are also borrowers. Holders of
common OP units or preferred OP units will only be permitted to transfer their
common OP units or preferred OP units to a purchaser who is an accredited
investor within the meaning of Regulation D under the Securities Act.
In addition, no transfer of OP units by other limited partners may be made
in violation of certain regulatory and other restrictions set forth in the
operating partnership agreement.
REDEMPTION
The operating partnership agreement generally does not provide for the
redemption of partnership units except as may be contained in the applicable
designation instrument for any class or series of partnership units. However, to
the extent that we redeem our Preferred Shares, the operating partnership will
redeem an equivalent number of preferred OP units from us so that we will have
sufficient funds to pay the purchase price for such shares and our expenses
incurred in connection with the redemption.
ISSUANCE OF ADDITIONAL LIMITED PARTNER INTERESTS
The general partner of the operating partnership will have the ability to
cause the operating partnership to issue additional limited partner interests in
the operating partnership without the consent of the limited partners, and may
issue limited partner interests in one or more class or series, with
designations, powers, preferences, rights and privileges determined by the
general partner in its discretion, except as may be limited by applicable
Delaware law or as set forth in a designation instrument for any class or series
of limited partner interests. Any such new class or series may, except as set
forth in a designation instrument for an existing class or series of limited
partner interests, be senior to, on a parity with or junior to existing classes
or series of limited partner interests. No additional limited partner interests
will be issued to us unless, in connection with the issuance of those limited
partner interests, we issue stock having economic attributes equivalent to those
of the limited partner interests and unless we contribute to the operating
partnership the net proceeds of that issuance of stock.
EXCHANGE AND CASH TENDER RIGHTS
Some limited partners might be given the right, exercisable once in each
twelve-month period beginning one year after the acquisition of their OP units,
to tender their OP units in exchange for cash. We will have the option to elect
to purchase tendered OP units for cash or shares of the applicable class or
series of our stock, as determined in our sole discretion. The ability of the
tendering limited partner to exercise any exchange right also will be subject to
the applicable ownership limit provisions in our charter and other restrictions
in the operating partnership agreement. The exchange ratio is expected to be one
share of the applicable class or series of our stock for each OP unit, subject
to adjustment in certain events, including any stock dividends or subdivisions
with respect to the applicable shares. The OP units we acquire in connection
with any exchange or cash tender described above will increase the OP units held
by us.
FUNDING OF INVESTMENTS
The operating partnership agreement provides that if the general partner
determines that the operating partnership requires additional funds to acquire
properties or for other purposes, the general partner may raise those funds by
having the operating partnership incur debt or by accepting capital
contributions from the partners, whose partnership interests would increase in
consideration of their capital contributions, or from third parties, who would
be admitted as additional limited partners in consideration of their capital
contributions.
TAX ACCOUNTING
The operating partnership has a taxable year ending on December 31, in
accordance with our taxable year, and the taxable year of KRF Company, and will
use the accrual method of accounting.
TERM
The operating partnership was organized on July 22, 2002 and will continue
in full force and effect until December 31, 2052, or until sooner dissolved by
the election of the general partner, the sale of all or substantially all of the
assets of the operating partnership or certain other events specified in the
operating partnership agreement.
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DESCRIPTION OF THE PREFERRED OP UNITS
The preferred OP units will be issued to us in accordance with the operating
partnership agreement. The following summarizes the material terms and
provisions of the preferred OP units that we will hold and is qualified in its
entirety by reference to the operating partnership agreement, which is filed as
an exhibit to the registration statement of which this prospectus forms a part.
GENERAL
The operating partnership is authorized to issue preferred OP units in one
or more series. The general partner of the operating partnership has the
authority to establish the terms of each series, including the designations,
powers, preferences and relative, participating, optional or other special
rights, powers and privileges, including voting and conversion rights, if any,
by amending the operating partnership agreement. Such an amendment does not
require any vote or action by the holders of limited partner units, except as
provided under applicable law.
The operating partnership agreement does not contain any limitation on the
number of preferred OP units that may be issued or on the number of series that
may be established.
RANKING
The series of preferred OP units issued to us upon the completion of the
offers will, with respect to distributions and rights upon liquidation,
dissolution, winding-up or termination of the operating partnership, rank:
- senior to the general partner units and the common OP units,
- senior to any other series of preferred OP units whose terms provide that
such series ranks junior to our preferred OP units,
- on a parity with all other series of preferred OP units issued by the
operating partnership unless the terms of such other series specifically
provide that such series ranks junior or senior to our preferred OP units
and
- junior to any other series of preferred OP units whose terms provide that
such series ranks senior to our preferred OP units.
DISTRIBUTIONS
Subject to the rights of holders of any other series of preferred OP units
ranking senior to or on a parity with our preferred OP units as to the payment
of distributions, we, as the holder of preferred OP units, will be entitled to
receive on a quarterly basis from available cash of the operating partnership,
up to the amount needed by us to pay required distributions on our Preferred
Shares and, upon liquidation of the operating partnership or a redemption of the
Preferred Shares, an amount up to the sum of unpaid distributions and the
liquidation preference of those shares.
Distributions to us will be made before any distributions are made to the
holders of general partner interests or common OP units. We also will be
reimbursed by the operating partnership for our operating expenses.
LIQUIDATION
Subject to the rights of holders of any other series of preferred OP units
ranking senior to or on a parity with our preferred OP units, upon any
dissolution, liquidation, winding-up or termination of the operating
partnership, we will be entitled to receive out of the assets of the operating
partnership legally available for distribution, after payment or provision for
payment of debts and other liabilities of the operating partnership, an amount
equal to the stated value of $25.00 per preferred OP unit, plus accumulated and
unpaid distributions to the date of payment and no more. If upon any such
liquidation, dissolution, winding-up or termination, there are insufficient
assets to permit full payment to us and the holders of any other series of
outstanding preferred OP units ranking on a parity upon liquidation,
dissolution, winding-up or termination of the operating partnership with our
preferred OP units, we and the holders of such other series of preferred OP
units shall be paid ratably in proportion to the full distributable amount to
which we and the holders of such other series of preferred OP units are
respectively entitled upon liquidation, dissolution, winding-up or termination.
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The full preferential amount payable to us and any other series of
outstanding preferred OP units ranking senior to or on a parity with our
preferred OP units upon any such liquidation, dissolution, winding-up or
termination will be paid in full before any distribution or payment is made to
the holders of common OP units, general partner units or any other series of
outstanding OP units ranking junior to our preferred OP units.
REDEMPTION AND EXCHANGE
The preferred OP units will not be subject to any sinking fund or mandatory
redemption provisions and will not be convertible into any other securities of
the operating partnership.
However, to the extent that we redeem our Preferred Shares, the operating
partnership will redeem an equivalent number of preferred OP units from us so
that we will have sufficient funds to pay the purchase price for such shares and
our expenses incurred in connection with the redemption.
VOTING RIGHTS
Our preferred OP units will not have any voting rights except as set forth
below and as otherwise required by law and the operating partnership agreement.
If any proposed amendment or modification of the operating partnership
agreement would materially and adversely affect the powers, special rights,
preferences or privileges of the preferred OP units, then the holders of
outstanding preferred OP units will be entitled to vote on such amendment or
modification as a class, and such amendment or modification shall not be
effective except with the approval of the holders of at least 66 2/3% in stated
value of the outstanding preferred OP units. However, any such amendment or
modification that would:
- decrease the authorized number of preferred OP units but not below the
number of preferred OP units then outstanding, or
- authorize, create or increase the number of authorized units of any series
of preferred limited partnership units ranking on a parity with or junior
to the preferred OP units as to distributions or upon liquidation,
dissolution, winding-up or termination of the operating partnership
will be deemed not to materially and adversely effect such powers, special
rights, preferences or privileges.
Any amendment to the operating partnership agreement that would adversely
affect the rights of the holders of preferred OP units disproportionately with
respect to the rights of any other class or series, or alter the rights,
preferences and privileges of the holders of preferred OP units, generally will
require the consent of a majority in interest of the holders of preferred OP
units. The consent of each holder of preferred OP units adversely affected by
certain amendments to, or actions in connection with, the operating partnership
agreement generally will be required, including amendments or actions that
would:
- convert the limited partner interest of a holder of preferred OP units
into a general partner interest, except as a result of the general partner
acquiring the interest,
- modify the limited liability of a holder of preferred OP units, or
- amend the section of the operating partnership agreement governing these
approval rights, if such amendment would materially and adversely affect
the rights, privileges and preferences of the preferred OP units.
In addition, holders of preferred OP units will have the right to approve,
by the vote of 66 2/3% in stated value of outstanding preferred OP units, any
amendment reducing the share of distributions made by the operating partnership
to any holder of preferred OP units in a manner that is not pro rata with
respect to all partnership interests of the same series, or creating any
obligations for any holder of preferred OP units or otherwise impairing rights
of any holder of preferred OP units under the operating partnership agreement,
other than an impairment of rights that is pro rata with other partners holding
the same series of partnership interests.
Holders of at least 66 2/3% in stated value of the outstanding preferred OP
units voting as a class must approve the authorization, creation or increase the
number of authorized units of any series of preferred limited partnership units
ranking senior to the preferred OP units as to distributions or upon the
liquidation, dissolution, winding-up or termination of the operating partnership
agreement. No consent or approval of the holders of preferred OP units is
required for the authorization, creation or increase in the number of authorized
units of any
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series of preferred limited partnership units ranking on a parity with or junior
to the preferred OP units as to distributions or upon the liquidation,
dissolution, winding-up or termination of the operating partnership.
MERGERS AND CONSOLIDATIONS
The approval of the holders of the preferred OP units is not required to
approve any merger, consolidation, reorganization or other business combination
otherwise permitted under the operating partnership agreement or approved by the
holders of a majority in interest of the common OP units.
For more information regarding the terms of the preferred OP units, see
"Summary of Operating Partnership Agreement."
IMPORTANT PROVISIONS OF MARYLAND LAW
BUSINESS COMBINATIONS
Under the Maryland General Corporation Law, business combinations between a
Maryland corporation and an interested stockholder or the interested
stockholder's affiliate are prohibited for five years after the most recent date
on which the stockholder becomes an interested stockholder. For this purpose,
the term "business combinations" includes mergers, consolidations, share
exchanges, asset transfers and issuances or reclassifications of equity
securities. An "interested stockholder" is defined for this purpose as:
- any person who beneficially owns ten percent or more of the voting power
of the corporation's shares; or
- an affiliate or associate of the corporation who, at any time within the
two-year period before the date in question, was the beneficial owner of
ten percent or more of the voting power of the then outstanding voting
shares of the corporation.
A person is not an interested stockholder under the business combination
statute if the board of directors approved in advance the transaction by which
the stockholder otherwise would have become an interested stockholder. However,
in approving a transaction, the board of directors may provide that its approval
is subject to compliance, at or after the time of approval, with any terms and
conditions determined by the board.
After the five-year prohibition, any business combination between the
corporation and an interested stockholder generally must be recommended by the
board of directors of the corporation and approved by the affirmative vote of at
least:
- 80% of the votes entitled to be cast by holders of outstanding voting
shares of the corporation, and
- two-thirds of the votes entitled to be cast by holders of voting shares of
the corporation other than shares held by the interested stockholder or
its affiliate with whom the business combination is to be effected, or
held by an affiliate or associate of the interested stockholder voting
together as a single voting group.
These super-majority vote requirements do not apply if the corporation's
common stockholders receive a minimum price, as defined under the Maryland
General Corporation Law, for their shares in the form of cash or other
consideration in the same form as previously paid by the interested stockholder
for its shares. None of these provisions of the Maryland General Corporation Law
will apply, however, to business combinations that are approved or exempted by
the board of directors of the corporation before the time that the interested
stockholder becomes an interested stockholder. Our board of directors has
exempted any business combination involving KRF Company or its affiliates.
Consequently, the five-year prohibition and the super-majority vote requirements
will not apply to business combinations between us and any of them. As a result,
KRF Company or its affiliates may be able to enter into business combinations
with us that may not be in the best interest of our stockholders, without
compliance with the super-majority vote requirements and the other provisions of
the statute.
The business combination statute may discourage others from trying to
acquire control of our company and increase the difficulty of consummating any
offer.
CONTROL SHARE ACQUISITIONS
The Maryland General Corporation Law provides that control shares of a
Maryland corporation acquired in a control share acquisition have no voting
rights except to the extent approved by a vote of two-thirds of the votes
entitled to be cast on the matter. Shares owned by the acquiror, or by officers
or directors who are employees of
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the corporation are not entitled to vote on the matter. "Control shares" are
voting shares which, if aggregated with all other shares owned by the acquiror
or with respect to which the acquiror has the right to vote or to direct the
voting of, other than solely by virtue of revocable proxy, would entitle the
acquiror to exercise voting power in electing directors within one of the
following ranges of voting powers:
- One-tenth or more but less than one-third;
- One-third or more but less than a majority; or
- A majority or more of all voting power.
Control shares do not include shares the acquiring person is then entitled
to vote as a result of having previously obtained stockholder approval. Except
as otherwise specified in the statute, a "control share acquisition" means the
acquisition of control shares. Once a person who has made or proposes to make a
control share acquisition has undertaken to pay expenses and has satisfied other
required conditions, the person may compel the board of directors to call a
special meeting of stockholders to be held within 50 days of demand to consider
the voting rights of the shares. If no request for a meeting is made, the
corporation may itself present the question at any stockholders meeting.
If voting rights are not approved for the control shares at the meeting or
if the acquiring person does not deliver an "acquiring person statement" for the
control shares as required by the statute, the corporation may redeem any or all
of the control shares for their fair value, except for control shares for which
voting rights have previously been approved. Fair value is to be determined for
this purpose without regard to the absence of voting rights for the control
shares, and is to be determined as of the date of the last control share
acquisition or of any meeting of stockholders at which the voting rights for
control shares are considered and not approved.
If voting rights for control shares are approved at a stockholders meeting
and the acquiror becomes entitled to vote a majority of the shares entitled to
vote, all other stockholders may exercise appraisal rights. The fair value of
the shares as determined for purposes of these appraisal rights may not be less
than the highest price per share paid in the control share acquisition.
The control share acquisition statute does not apply to shares acquired in a
merger, consolidation or share exchange if the corporation is a party to the
transaction or to acquisitions approved or exempted by its charter or bylaws.
Our bylaws contain a provision exempting from the control share acquisition
statute any and all acquisitions by a person of shares of our stock. There can
be no assurance that this provision will not be amended or eliminated at any
time in the future.
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FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material United States federal income tax
considerations associated with an investment in our Preferred Shares that may be
relevant to you. The statements made in this section of the prospectus are based
upon current provisions of the Code and Treasury regulations under the Code, as
currently in effect, currently published administrative positions of the
Internal Revenue Service and judicial decisions, which are all subject to
change, either prospectively or retroactively. We cannot assure you that any
changes will not modify the conclusions expressed in counsel's opinions
described in this prospectus. This summary does not address all possible tax
considerations that may be material to an investor and does not constitute legal
or tax advice. Moreover, this summary does not deal with all tax aspects that
might be relevant to you, as a holder of Interests and as a prospective holder
of our Preferred Shares, in light of your personal circumstances, nor does it
deal with particular types of holders that are treated specially under the
federal income tax laws, such as insurance companies, tax-exempt organizations
except as provided below, financial institutions or broker-dealers, or foreign
corporations or persons who are not citizens or residents of the United States
except as provided below.
Paul, Weiss, Rifkind, Wharton & Garrison has acted as our special tax
counsel, has reviewed this summary and is of the opinion that it accurately
describes the material United States federal income tax considerations
applicable to U.S. holders (as defined below) that exchange their Interests for,
and hold for investment, our Preferred Shares. This opinion will be filed as an
exhibit to the registration statement of which this prospectus is a part. The
opinion of Paul, Weiss, Rifkind, Wharton & Garrison is based on various
assumptions, is subject to limitations and is not binding on the Internal
Revenue Service or any court.
WE URGE YOU TO CONSULT YOUR OWN TAX ADVISOR REGARDING THE SPECIFIC TAX
CONSEQUENCES TO YOU OF THE EXCHANGE OF YOUR INTERESTS FOR PREFERRED SHARES, THE
OWNERSHIP AND SALE OF THE PREFERRED SHARES AND OUR ELECTION TO BE TAXED AS A
REIT, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF
THAT EXCHANGE, OWNERSHIP, SALE AND ELECTION AND OF POTENTIAL CHANGES IN
APPLICABLE TAX LAWS.
As used in this summary, the phrase "U.S. holder" means a beneficial owner
of shares of beneficial interest of GIT or GIT II, units of depositary receipts
representing units of limited partner interests in KIM, KIP, KIP II or KIP III,
or our Preferred Shares that for federal income tax purposes is:
- a citizen or resident of the United States;
- a corporation, partnership or other entity treated as a corporation or
partnership for U.S. federal income tax purposes created or organized in
or under the laws of the United States or of any political subdivision
thereof;
- an estate, the income of which is subject to U.S. federal income taxation
regardless of its source; or
- a trust if a U.S. court is able to exercise primary supervision over the
administration of the trust and one or more U.S. persons have the
authority to control all substantial decisions of the trust, or a trust
that has a valid election in effect under applicable Treasury regulations
to be treated as a U.S. person.
As used in this summary, the phrase "U.S. shareholder" means a U.S. holder
of our Preferred Shares.
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO THE EXCHANGE OF
PREFERRED SHARES FOR INTERESTS
This section describes certain material United States federal income tax
considerations generally applicable to the receipt by taxable U.S. holders of
our Preferred Shares in exchange for Interests pursuant to the offers.
The receipt of our Preferred Shares and any cash instead of fractional
Preferred Shares in exchange for Interests will be a taxable transaction for
United States federal income tax purposes. Each U.S. holder will recognize gain
or loss on the exchange in an amount equal to the difference between
- the amount realized by the U.S. holder, which is equal to the sum of the
fair market value of the Preferred Shares received and the amount of cash
received instead of fractional shares by the holder, and
- the holder's adjusted tax basis in the Interests exchanged at the time of
the exchange.
For this purpose, the fair market value of a Preferred Share should be equal
to its liquidation preference of $25.00.
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In general, the adjusted tax basis of a U.S. holder in its shares of
beneficial interest of GIT or GIT II will be equal to the holder's initial tax
basis upon acquisition of those shares minus any subsequent distributions made
by GIT or GIT II, as applicable, that constituted a tax-free return of capital
to that holder. In the case of shares of GIT or GIT II that were purchased by
the holder in the first closing of the initial offering of those shares, the
aggregate amount of distributions that had been designated as a return of
capital with respect to each GIT share as of the end of 2001 was $9.48 and the
aggregate amount of distributions that had been designated as a return of
capital with respect to each GIT II share as of the end of 2001 was $9.20.
The adjusted tax basis of a U.S. holder of depositary receipts representing
units of limited partner interests of KIM, KIP, KIP II or KIP III (which we
refer to as the "Partnership Mortgage Funds" for purposes of this section)
generally will be equal to the holder's initial tax basis upon acquisition of
those Interests that are exchanged, increased or decreased, as applicable, by
the holder's distributive share of the income or loss of the Partnership
Mortgage Fund through the date of the exchange as determined under the
partnership agreement of the applicable Partnership Mortgage Fund and decreased
by distributions made by the Partnership Mortgage Fund to that holder.
Any gain or loss recognized upon the exchange by a U.S. holder that holds
its Interest as a capital asset within the meaning of the Code generally will be
long-term capital gain or loss if the Interest has been held at that time for
more than 12 months and short-term capital gain or loss if the Interest has been
held for 12 months or less. If, however, a U.S. holder of shares of GIT or GIT
II has held those shares for 6 months or less at the time of the exchange, any
loss realized upon the exchange will be treated as long-term capital loss to the
extent of any capital gain dividends included in income with respect to those
shares. In the case of a noncorporate U.S. holder, the federal income tax rate
applicable to capital gains will depend upon the holder's holding period for its
Interests, with a preferential rate available for Interests held for more than
one year, and upon the holder's marginal tax rate for ordinary income. The
deductibility of capital losses is subject to limitations.
A U.S. holder's initial tax basis in its Preferred Shares acquired in the
exchange will be equal to their fair market value and the holder's holding
period for the Preferred Shares will begin on the day after the completion of
the exchange.
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO OUR STATUS AS A
REIT
This section describes the material United States federal income tax issues
that may be relevant to prospective holders of our Preferred Shares due to our
status as a REIT. The Code provisions governing the federal income tax treatment
of REITs and their shareholders are highly technical and complex. This summary
is qualified by the express language of applicable Code provisions, Treasury
regulations under the Code and administrative and judicial interpretations
thereof.
REIT QUALIFICATION
We intend to elect to be taxable as a REIT beginning with the taxable year
during which the offers are consummated. We believe that we will operate in a
manner intended to qualify us as a REIT beginning with that taxable year. This
section of the prospectus discusses the laws governing the tax treatment of a
REIT and its shareholders. These laws are highly technical and complex.
In connection with this offering, Paul, Weiss, Rifkind, Wharton & Garrison
has delivered an opinion to us that:
- beginning with its taxable year during which the offers are consummated,
Berkshire Income Realty, Inc. will be organized in conformity with the
requirements for qualification as a REIT under the Code and Berkshire
Income Realty, Inc.'s proposed method of operation will enable it to
operate in conformity with the requirements for qualification as a REIT
under the Code; and
- from the date on which each of Berkshire Income Realty, Inc., BIR GP,
L.L.C. and KRF Company, L.L.C. make their capital contributions to
Berkshire Income Realty-OP, L.P. in accordance with the operating
partnership agreement of Berkshire Income Realty-OP, L.P., the operating
partnership will be treated for federal income tax purposes as a
partnership and not as a corporation or an association taxable as a
corporation.
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Investors should be aware that an opinion of counsel is not binding upon the
Internal Revenue Service or any court. The opinion of Paul, Weiss, Rifkind,
Wharton & Garrison described above is based on various assumptions and
qualifications and conditioned on representations made by us and by the mortgage
funds or the managers of the mortgage funds as to factual matters, including
representations regarding the intended nature of our properties and the future
conduct of our business and the businesses of the mortgage funds. Moreover, our
continued qualification and taxation as a REIT depends upon our ability and the
ability of each of GIT and GIT II to meet on a continuing basis, through actual
annual operating results, the qualification tests set forth in the federal tax
laws and described below. Paul, Weiss Rifkind, Wharton & Garrison will not
review our compliance or the compliance of GIT or GIT II with those tests.
Therefore, our actual results of operation for any particular taxable year may
not satisfy these requirements. For a discussion of some tax consequences of our
failure to meet these qualification requirements, see "Failure to Qualify as a
REIT" below.
TAXATION OF OUR COMPANY
If we qualify for taxation as a REIT, we generally will not be subject to
federal corporate income taxes on that portion of our ordinary income or capital
gain that we distribute currently to our shareholders, because the REIT
provisions of the Code generally allow a REIT to deduct distributions paid to
its shareholders. This substantially eliminates the federal "double taxation" on
earnings (taxation at both the corporate level and shareholder level) that
usually results from an investment in a corporation. Even if we qualify for
taxation as a REIT, however, we will be subject to federal income taxation as
follows:
- We will be taxed at regular corporate rates on our undistributed REIT
taxable income, including undistributed net capital gains;
- Under some circumstances, we may be subject to "alternative minimum tax;"
- If we have net income from the sale or other disposition of "foreclosure
property" that is held primarily for sale to customers in the ordinary
course of business or other non-qualifying income from foreclosure
property, we will be subject to tax at the highest corporate rate on that
income;
- If we have net income from prohibited transactions (which are, in general,
sales or other dispositions of property, other than foreclosure property,
held primarily for sale to customers in the ordinary course of business),
the income will be subject to a 100% tax;
- If we fail to satisfy either of the 75% or 95% gross income tests
(discussed below) but have nonetheless maintained our qualification as a
REIT because specified conditions have been met, we will be subject to a
100% tax on the greater of the amount by which (1) we fail the 75% gross
income test, or (2) 90% of our gross income exceeds the sources of our
gross income that satisfy the 95% gross income test, multiplied by a
fraction calculated to reflect our profitability;
- If we fail to distribute during each year at least the sum of (1) 85% of
our REIT ordinary income for the year, (2) 95% of our REIT capital gain
net income for such year and (3) any undistributed taxable income from
prior periods, we will be subject to a 4% excise tax on the excess of the
required distribution over the amounts actually distributed;
- If we acquire any asset from a C corporation (i.e., a corporation
generally subject to corporate-level tax) in a transaction in which the C
corporation would not normally be required to recognize any gain or loss
on disposition of the asset and we subsequently recognize gain on the
disposition of the asset during the ten-year period beginning on the date
on which we acquired the asset, then a portion of the gain may be subject
to tax at the highest regular corporate rate, unless the C corporation
made an election to treat the asset as if it were sold for its fair market
value at the time of our acquisition; and
- We could be subject to a 100% excise tax if our dealings with any taxable
REIT subsidiary are not at arm's length.
REQUIREMENTS FOR QUALIFICATION AS A REIT
In order for us to qualify as a REIT, we must meet and continue to meet the
requirements discussed below relating to our organization, sources of income,
nature of assets and distributions of income to our shareholders.
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ORGANIZATIONAL REQUIREMENTS. In order to qualify for taxation as a REIT
under the Code, we must meet tests regarding our income and assets described
below and:
1. Be a corporation, trust or association that would be taxable as a
domestic corporation but for the REIT provisions of the Code;
2. Elect to be taxed as a REIT and satisfy relevant filing and other
administrative requirements;
3. Be managed by one or more trustees or directors;
4. Have our beneficial ownership evidenced by transferable shares;
5. Not be a financial institution or an insurance company subject to
special provisions of the federal income tax laws;
6. Use a calendar year for federal income tax purposes;
7. Have at least 100 shareholders for at least 335 days of each taxable
year of 12 months or during a proportionate part of a taxable year of
less than 12 months; and
8. Not be closely held as defined for purposes of the REIT provisions of
the Code.
We would be treated as closely held if, during the last half of any taxable
year, more than 50% in value of our outstanding shares is owned, directly or
indirectly through the application of attribution rules under the Code, by five
or fewer individuals, as defined in the Code to include specified entities.
Items 7 and 8 above will not apply until after the first taxable year for which
we elect to be taxed as a REIT. If we comply with Treasury regulations that
provide procedures for ascertaining the actual ownership of our shares for each
taxable year and we did not know, and with the exercise of reasonable diligence
could not have known, that we failed to meet item 8 above for a taxable year, we
will be treated as having met item 8 for that year.
We intend to elect to be taxed as a REIT beginning with the taxable year
during which the offers are consummated, and we intend to satisfy the other
requirements described in items 1-6 above at all times during each of our
taxable years beginning with the taxable year for which we elect to be taxed as
a REIT. We believe that we will have sufficient diversity of share ownership
upon the completion of the exchange to satisfy items 7 and 8 above. In addition,
our charter contains restrictions on the ownership and transfer of shares of our
stock, including our Preferred Shares, that are intended to assist us in
continuing to satisfy the share ownership requirements in items 7 and 8 above.
See "Description of The Preferred Shares--Restrictions on Ownership and Transfer
of Preferred Shares."
For purposes of the requirements described herein, any corporation that is a
qualified REIT subsidiary of ours will not be treated as a corporation separate
from us. As a result, all assets, liabilities and items of income, deduction and
credit of our qualified REIT subsidiaries will be treated as our assets,
liabilities and items of income, deduction and credit. A qualified REIT
subsidiary is a corporation, other than a taxable REIT subsidiary (as described
below under "Operational Requirements--Asset Tests"), all of the capital stock
of which is owned by a REIT.
In the case of a REIT that is a partner in an entity treated as a
partnership for federal tax purposes, the REIT is treated as owning its
proportionate share of the assets of the partnership and as earning its
allocable share of the gross income of the partnership for purposes of the
requirements described in this section. In addition, the character of the assets
and gross income of the partnership will retain the same character in the hands
of the REIT for purposes of the REIT requirements, including the asset and
income tests described below. As a result, our proportionate share of the
assets, liabilities and items of income of our operating partnership and of each
other partnership, joint venture, limited liability company or other entity
treated as a partnership for federal tax purposes in which we or our operating
partnership have an interest (which we refer to as the Subsidiary Entities) will
be treated as our assets, liabilities and items of income.
Upon completion of the exchange, our operating partnership expects to own
interests in a number of partnerships, including KIM, KIP, KIP II and KIP III,
and an interest in a limited liability company that will indirectly own the
initial properties. Our operating partnership will be treated for federal tax
purposes as directly acquiring its interest in each of the remaining initial
properties, which it expects to beneficially own through disregarded
partnerships and limited liability companies of which it will be the sole direct
or indirect member.
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OPERATIONAL REQUIREMENTS--GROSS INCOME TESTS. To maintain our qualification
as a REIT, we must satisfy annually the following two gross income requirements:
- At least 75% of our gross income, excluding gross income from prohibited
transactions, for each taxable year must be derived directly or indirectly
from investments relating to real property. Gross income from real
property investments includes in part rents from real property, interest
on obligations secured by mortgages on real property or on interests in
real property, gain from the disposition of real property and
distributions on, gain from the disposition of, transferable shares or
transferable certificates of beneficial interest in other qualifying REITs
and income and gain derived from foreclosure property, but excludes gross
income from dispositions of property held primarily for sale to customers
in the ordinary course of a trade or business. These dispositions are
referred to as "prohibited transactions." This is the 75% Income Test; and
- At least 95% of our gross income, excluding gross income from prohibited
transactions, for each taxable year must be derived from the real property
investments described above and generally from dividends and interest and
gains from the sale or disposition of stock or securities or from any
combination of the foregoing. This is the 95% Income Test.
After the completion of the exchange, our gross income initially will
consist primarily of our share of (1) rents received by our operating
partnership and its Subsidiary Entities under apartment leases,
(2) distributions on the shares of beneficial interest our operating partnership
will hold in GIT and GIT II, (3) interest on obligations secured by mortgages on
real property held by KIM, KIP, KIP II and KIP III and (4) income received by
KIM, KIP, KIP II and KIP III with respect to their participation in the residual
value, if any, from a sale or other realization of the underlying real property
with respect to PIMs. See "Information with Respect to the Mortgage Funds."
The rents we will receive or be deemed to receive with respect to the real
properties to be owned by our operating partnership or its Subsidiary Entities
will qualify as "rents from real property" for purposes of satisfying the gross
income requirements for a REIT only if the following conditions are met:
- The amount of rent received from a tenant must not be based in whole or in
part on the income or profits of any person; however, an amount received
or accrued generally will not be excluded from the term "rents from real
property" solely by reason of being based on a fixed percentage or
percentages of receipts or sales;
- In general, neither we nor an owner of 10% or more of our stock may
directly or constructively own 10% or more of a tenant (which we refer to
as a Related Party Tenant) or a subtenant of the tenant (in which case
only rent attributable to the subtenant is disqualified);
- Rent attributable to personal property leased in connection with a lease
of real property cannot be greater than 15% of the total rent received
under the lease, as determined based on the average of the fair market
values as of the beginning and end of the taxable year; and
- We normally must not operate or manage the property or furnish or render
services to tenants, other than through an "independent contractor" who is
adequately compensated and from whom we do not derive any income or
through a taxable REIT subsidiary of ours. However, a REIT may provide
services with respect to its properties, and the income derived therefrom
will qualify as "rents from real property," if the services are "usually
or customarily rendered" in connection with the rental of space only and
are not otherwise considered "rendered to the occupant." Even if the
services provided by us or by any property manager of ours who does not
qualify as an independent contractor with respect to a property are
impermissible tenant services, the rental income derived from the property
will qualify as "rents from real property" if the income from services
does not exceed one percent of all amounts received or accrued with
respect to that property.
Our share of the distributions constituting gross income that will be
received by our operating partnership on the GIT and GIT II shares will qualify
either as dividends or as gain from the disposition of stock for purposes of the
95% Income Test unless, with respect to gain, we were treated as having held
such shares primarily for sale to customers in the ordinary course of a trade or
business. These distributions also will qualify as distributions on transferable
shares of beneficial interest in other qualifying REITs for purposes of the 75%
Income Test for each
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taxable period in which GIT or GIT II, as applicable, satisfies all of the
requirements necessary to qualify as a REIT. See "REIT Qualification of GIT and
GIT II" below.
The interest we will receive or be deemed to receive with respect to our
share of the assets held by KIM, KIP, KIP II and KIP III will qualify as
"interest" for purposes of satisfying the 95% Income Test only if the following
conditions are met:
1. The amounts received or accrued must represent compensation for the use
or forbearance of money and cannot be a charge for services; and
2. No portion of the interest received or accrued normally can depend, in
whole or in part, on the income or profits of any person.
However, with respect to item 2, an amount received or accrued generally
will not be excluded from the term "interest" solely by reason of being based on
a fixed percentage or percentages of receipts or sales and, if a REIT receives
any amount that would not qualify as "interest" solely because the borrower
receives or accrues any amount that depends, in whole or in part, on the income
or profits of any person, only a proportionate part of the amount received or
accrued by the REIT will be excluded from being treated as interest. In
addition, (1) if the amounts received or accrued are with respect to an
obligation secured by a mortgage on real property from a borrower that derives
substantially all of its gross income with respect to the property from leasing
substantially all of its interests in the property to tenants and (2) the lease
income received or accrued by the borrower would have qualified as "rents from
real property" under the rules described above had those rents been received by
the REIT, the amounts received or accrued by the REIT will qualify as "interest"
to the extent the amounts received are attributable to the rents received or
accrued by the borrower.
In addition to the requirements described above, the interest we will
receive or be deemed to receive with respect to our share of each PIM and MBS
held by KIM, KIP, KIP II and KIP III normally will qualify as interest on
obligations secured by mortgages on real property for purposes of satisfying the
75% Income Test only if:
- with respect to those loans originally extended as construction loans, the
fair market value of the land and the reasonably estimated costs of the
improvements or developments, other than personal property, that secure
the loan and were constructed from the proceeds of the loan, determined as
of the date the commitment to make the applicable construction loan became
binding, is at least equal to the highest principal amount of the loan
outstanding during the taxable year, or
- with respect to those loans that were not originally extended as
construction loans, the fair market value of the real property, determined
as of the date on which the commitment to make the loan became binding, is
at least equal to the highest principal amount of the loan outstanding
during the taxable year. To the extent that the fair market value of the
real property is less than the highest principal amount of the loan
outstanding during the taxable year, only a proportionate part of the
interest on that loan will be treated as qualifying income for purposes of
the 75% Income Test.
However, in the case of any MBS held by KIM, KIP, KIP II or KIP III that is
a regular or residual interest in a REMIC:
- if at least 95 percent of the assets of the REMIC are real estate assets
(as described below under "Operational Requirements--Asset Tests"), all of
the interest we will receive or be deemed to receive will be treated as
qualifying interest for purposes of satisfying the 75% Income Test, and
- if less than 95 percent of the assets of the REMIC are real estate assets,
the amount of qualifying interest for purposes of satisfying the 75%
Income Test will be determined under the rules described above as if we
directly held our proportionate share of the assets of the REMIC and
directly received our proportionate share of the REMIC's income.
Our share of the income received by KIM, KIP, KIP II and KIP III with
respect to their participation in the residual value, if any, from a sale or
other realization of the underlying real property that secures a PIM will be
treated as gain recognized on the sale of the real property securing the loan
that normally will constitute qualifying income for purposes of both the 75%
Income Test and the 95% Income Test if the participation right constitutes a
"shared appreciation provision." A shared appreciation provision is any
provision in connection with an obligation held or treated as held by us that is
secured by an interest in real property and that entitles us to receive a
specified portion of any gain realized on the sale or exchange of the real
property, or gain that would be
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realized if the real property were sold on a specified date, or appreciation in
value of the real property as of any specified date. Our share of this income
will not constitute qualifying income for either the 75% Income Test or the 95%
Income Test, however, if the real property securing the loan either is held
primarily for sale to customers in the ordinary course of a trade or business of
the borrower or would be considered to be so held if we had held the real
property.
If KIM, KIP, KIP II or KIP III were to foreclose on any real property that
secures a PIM or an MBS, our share of the gross income received from that
property usually would be expected to qualify as rents from real property for
purposes of both gross income tests under the rules described above. If,
however, the real property or any related property acquired pursuant to a
foreclosure by one of these mortgage funds did not otherwise constitute
qualifying gross income, we would normally elect to treat that property as
"foreclosure property." "Foreclosure property" is defined for this purpose as
any real property (including interests in real property) and any personal
property incident to that real property, acquired by us as the result of us
having bid in the property at foreclosure, or having otherwise reduced the
property to ownership or possession by agreement or process of law, after there
was default (or default was imminent) on an indebtedness that such property
secured. Although income from foreclosure property is qualifying income under
the 75% Income Test and 95% Income Test, we might be subject to tax on that
income as described above under "Taxation of Our Company."
We expect the bulk of our income to qualify under the 75% Income Test and
95% Income Test, in accordance with the requirements described above, as rents
from real property, dividends and other distributions on transferable shares of
beneficial interest in other qualifying REITs, interest on obligations secured
by mortgages on real property and gain from the disposition of real property. In
this regard, we anticipate that substantially all of the apartment leases on the
five apartment buildings that will be contributed to our operating partnership
upon the completion of the exchange will be for fixed rentals with annual CPI or
similar adjustments and that none of the rentals under those leases will be
based on the income or profits of any person. In addition, none of our tenants
are expected to be Related Party Tenants and the portion of the rent
attributable to personal property is not expected to exceed 15% of the total
rent to be received under any lease. Finally, we anticipate that all or nearly
all of the services to be performed with respect to those properties will be
those usually or customarily rendered in connection with the rental of real
property and not rendered to the occupant of the property.
Our share of the distributions constituting gross income that will be
received by our operating partnership with respect to the GIT and GIT II
Interests will qualify as dividends in part and otherwise should qualify as gain
from the disposition of stock for purposes of the 95% Income Test. They also
will constitute qualifying distributions for purposes of the 75% Income Test for
each taxable period in which GIT and GIT II satisfy all of the requirements
necessary to qualify as a REIT. See "REIT Qualification of GIT and GIT II"
below. None of the interest we will receive or be deemed to receive in respect
of our share of the PIMs and MBS held by KIM, KIP, KIP II and KIP III is
expected to represent a charge for services rendered by us. That interest should
qualify as "interest" for purposes of the 95% Income Test and the 75% Income
Test either because it is computed at a fixed rate on outstanding principal or
otherwise does not depend on the income or profits of the debtor, or, if the
interest on any PIM that is equal to a percentage of periodic surplus cash of
the borrower was treated as interest that does depend on the income or profits
of the borrower, is expected to qualify as interest because substantially all of
the borrower's gross income from the apartment building securing the payment of
such interest is derived from leasing the apartments and those rentals would be
expected to qualify as rents from real property if they had been received
directly by us. In addition, most of the interest we will receive or be deemed
to receive in respect of our share of the PIMs and MBS held by KIM, KIP, KIP II
and KIP III is expected to qualify as interest on obligations secured by
mortgages on real property for purposes of the 75% Income Test because the fair
market value of the real property that secures the PIMs and MBS normally exceeds
the outstanding principal balance of those loans.
Finally, our share of income with respect to participations in residual
value under the PIMs held by KIM, KIP, KIP II and KIP III generally is expected
to constitute qualifying income under both the 75% Income Test and the 95%
Income Test from shared appreciation provisions that will be treated as gain
recognized on the sale of the underlying real property under circumstances in
which that property was not held primarily for sale to customers in the ordinary
course of a trade or business of the borrower and would not have been so treated
if held by us. However, although it is our present expectation that the gross
income we will receive or be deemed to receive will allow us to satisfy the 75%
Income Test and the 95% Income Test, we can give you no assurance that the
actual sources of our gross income will allow us to satisfy either or both of
those tests.
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Notwithstanding our failure to satisfy one or both of the 75% Income Test
and the 95% Income Test for any taxable year, we may still qualify as a REIT for
that year if we are eligible for relief under specific provisions of the Code.
These relief provisions generally will be available if:
- Our failure to meet these tests was due to reasonable cause and not due to
willful neglect;
- We attach a schedule of our income sources to our federal income tax
return; and
- Any incorrect information on the schedule is not due to fraud with intent
to evade tax.
It is not possible, however, to state whether, in all circumstances, we
would be entitled to the benefit of these relief provisions. In addition, as
discussed above in "Taxation of our Company," even if these relief provisions
apply, a tax would be imposed with respect to the excess net income.
OPERATIONAL REQUIREMENTS--ASSET TESTS. At the close of each quarter of our
taxable year, we also must satisfy four tests, which we refer to as the Asset
Tests, relating to the nature and diversification of our assets.
- First, at least 75% of the value of our total assets must be represented
by real estate assets, cash, cash items and government securities. The
term "real estate assets" includes real property such as land, buildings
and other inherently permanent structures, mortgages on real property,
shares or transferable certificates of beneficial interest in other
qualifying REITs, property attributable to the temporary investment of new
capital and a proportionate share of any real estate assets owned by a
partnership in which we are a partner or of any qualified REIT subsidiary
of ours. For this purpose, an obligation that is not fully secured by real
property pursuant to the methodology described under "Operational
Requirements--Gross Income Tests" with respect to interest, taking into
account all senior encumbrances on the real property, will be treated as a
real estate asset only to the extent of the fair market value of the real
property available to secure the loan.
- Second, no more than 25% of our total assets may be represented by
securities other than those in the 75% asset class.
- Third, of the investments included in the 25% asset class, the value of
any one issuer's securities that we own may not exceed 5% of the value of
our total assets. Additionally, we may not own more than 10% of the voting
power or value of any one issuer's outstanding securities. For purposes of
this Asset Test and the second Asset Test, securities do not include the
equity or debt securities of a qualified REIT subsidiary of ours or an
equity interest in any entity treated as a partnership for federal tax
purposes. The third Asset Test does not apply in respect of a taxable REIT
subsidiary.
- Fourth, no more than 20% of the value of our total assets may consist of
the securities of one or more taxable REIT subsidiaries. Subject to
certain exceptions, a taxable REIT subsidiary is any corporation, other
than a REIT, in which we directly or indirectly own stock and with respect
to which a joint election has been made by us and the corporation to treat
the corporation as a taxable REIT subsidiary of ours. It also includes any
corporation, other than a REIT or a qualified REIT subsidiary, in which a
taxable REIT subsidiary of ours owns, directly or indirectly, more than
35 percent of the voting power or value.
The Asset Tests must generally be met for any quarter in which we acquire
securities or other property. We expect that upon the completion of the
exchange, most of our assets will constitute real estate assets, including the
apartment buildings contributed to our operating partnership, qualifying REIT
shares of GIT and GIT II and our share of mortgages on real property held by
KIM, KIP, KIP II and KIP III. In connection with the completion of the exchange,
our operating partnership will acquire all of the stock of a corporation that
will make a joint election with us to be treated as a taxable REIT subsidiary of
ours. This corporation does not presently have any assets other than a nominal
amount of cash and is not expected to acquire any additional assets that would
cause us to violate the fourth Asset Test. We do not expect that we will own any
securities that would cause us to violate the second or third Asset Tests. Based
on the foregoing, we therefore expect to satisfy the Asset Tests. However, if
either GIT or GIT II failed to qualify as a REIT for a year during which we were
treated as owning more than 10% of the outstanding shares of beneficial interest
of that trust or during which the value of the shares of beneficial interest in
that trust that we were treated as owning exceeded 5% of the value of our total
assets, we would not satisfy the third Asset Test and as a result we would fail
to qualify as a REIT. See "REIT Qualification of GIT and GIT II" and "Failure to
Qualify as a REIT" below.
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If we meet the Asset Tests at the close of any quarter, we will not lose our
REIT status for a failure to satisfy the Asset Tests at the end of a later
quarter if such failure occurs solely because of changes in asset values. If our
failure to satisfy the Asset Tests results from an acquisition of securities or
other property during a quarter, we can cure the failure by disposing of a
sufficient amount of non-qualifying assets within 30 days after the close of
that quarter. We intend to maintain adequate records of the value of our assets
to ensure compliance with the Asset Tests and to take other action within
30 days after the close of any quarter as may be required and available to cure
any noncompliance.
OPERATIONAL REQUIREMENTS--ANNUAL DISTRIBUTION REQUIREMENT. In order to be
taxed as a REIT, we are required to make dividend distributions, other than
capital gain dividends, to our shareholders each year in the amount of at least
90% of our REIT taxable income (computed without regard to the dividends paid
deduction and our net capital gain and subject to certain other potential
adjustments) for all tax years. While we must generally pay dividends in the
taxable year to which they relate, we may also pay dividends in the following
taxable year if (1) they are declared before we timely file our federal income
tax return for the taxable year in question, and (2) they are paid on or before
the first regular dividend payment date after the declaration.
Even if we satisfy the foregoing dividend distribution requirement and,
accordingly, continue to qualify as a REIT for tax purposes, we will still be
subject to federal income tax on the excess of our net capital gain and our REIT
taxable income, as adjusted, over the amount of dividends distributed to
shareholders.
In addition, if we fail to distribute during each calendar year at least the
sum of:
- 85% of our ordinary income for that year;
- 95% of our capital gain net income other than the capital gain net income
which we elect to retain and pay tax on for that year; and
- any undistributed taxable income from prior periods;
we will be subject to a 4% nondeductible excise tax on the excess of the amount
of the required distributions over amounts actually distributed during such
year.
We intend to make timely distributions sufficient to satisfy the annual
distribution requirement and to avoid income and excise taxes on undistributed
income and we presently anticipate that our cash receipts will normally be
sufficient to enable us to do so. However, it is possible that we may under some
circumstances experience timing differences between (i) the actual receipt of
income and payment of deductible expenses, and (ii) the inclusion of that income
and deduction of those expenses for purposes of computing our taxable income. In
those circumstances, we may have less cash than is necessary to meet our annual
distribution requirement or to avoid income or excise taxation on undistributed
income. We may find it necessary in those circumstances to arrange for financing
or raise funds through the issuance of additional shares in order to meet our
distribution requirements.
As noted above, we may also elect to retain, rather than distribute, our net
long-term capital gains. The effect of that election would be as follows:
- We would be required to pay federal income tax on these gains;
- Taxable U.S. shareholders, while required to include their proportionate
share of the undistributed long-term capital gains in income, would
receive a credit or refund for their share of the tax paid by us; and
- The basis of the shareholder's shares would be increased by the amount of
our undistributed long-term capital gains (minus its proportionate share
of the amount of capital gains tax we pay) included in the shareholder's
long-term capital gains.
In computing our REIT taxable income, we will use the accrual method of
accounting and intend to depreciate depreciable property under accelerated
methods. We are required to file an annual federal income tax return, which,
like other corporate returns, is subject to examination by the Internal Revenue
Service. Because the tax law requires us to make many judgments regarding the
proper treatment of a transaction or an item of income or deduction, it is
possible that the Internal Revenue Service will challenge positions we take in
computing our REIT taxable income and our distributions.
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Issues could arise, for example, with respect to the allocation of the
purchase price of properties between depreciable or amortizable assets and
nondepreciable or non-amortizable assets such as land and the current
deductibility of fees paid to our advisor. If the Internal Revenue Service
successfully challenges our characterization of a transaction or determination
of our REIT taxable income, we could be found to have failed to satisfy a
requirement for qualification as a REIT. If, we are determined to have failed to
satisfy the distribution requirement for a taxable year, we would be
disqualified as a REIT, unless we were permitted to pay a "deficiency dividend"
to our shareholders in the later year and include that distribution in our
deduction for dividends paid for the earlier year. In that event, we may be able
to avoid being taxed on amounts distributed as deficiency dividends, but we
would be required in those circumstances to pay interest to the Internal Revenue
Service based upon the amount of any deduction taken for deficiency dividends
for the earlier year.
OPERATIONAL REQUIREMENTS--RECORDKEEPING. To avoid a monetary penalty we
must request, on an annual basis, specified information designed to disclose the
ownership of our outstanding shares. We also must maintain required records as
described in applicable Treasury regulations. We intend to comply with these
requirements.
REIT QUALIFICATION OF GIT AND GIT II
As discussed above under "Operational Requirements--Gross Income Tests" and
"Operational Requirements--Asset Tests," our ability to satisfy the 75% Income
Test and the Asset Tests will be dependent upon the qualification of each of GIT
and GIT II as REITs. Each of GIT and GIT II has elected to be a REIT and we
expect that representations will be provided in connection with these
transactions that each of GIT and GIT II intend to continue to qualify for
taxation as a REIT for all taxable years ending after the date of the completion
of the exchange. However, we cannot assure you that either GIT or GIT II has
qualified as a REIT for prior taxable years or that they will continue to so
qualify. If either GIT or GIT II did not qualify as a REIT for any taxable
period, it is probable that we would also fail to qualify as a REIT, which would
have the effects described below under "Failure to Qualify as a REIT."
FAILURE TO QUALIFY AS A REIT
If we fail to qualify as a REIT for any reason in a taxable year and
applicable relief provisions do not apply, we will be subject to tax (including
any applicable alternative minimum tax) on our taxable income at regular
corporate rates. We will not be able to deduct dividends paid to our
shareholders in any year in which we fail to qualify as a REIT. We also will be
disqualified for the four taxable years following the year during which
qualification was lost unless we are entitled to relief under specific statutory
provisions.
TAXATION OF TAXABLE U.S. SHAREHOLDERS
For any taxable year for which we qualify for taxation as a REIT, amounts
distributed to, and gains realized by, taxable U.S. shareholders with respect to
our Preferred Shares generally will be taxed as described below.
DISTRIBUTIONS GENERALLY. Distributions to U.S. shareholders, other than
capital gain dividends discussed below, will constitute dividends up to the
amount of our current or accumulated earnings and profits and will be taxable to
holders of our Preferred Shares as ordinary income. These distributions are not
eligible for the dividends received deduction generally available to
corporations. For purposes of determining whether distributions to holders of
our Preferred Shares are out of our earnings and profits, our current earnings
and profits will be allocated first to our Preferred Shares and then to our
common stock. To the extent that we make a distribution in excess of our current
and accumulated earnings and profits, the distribution will be treated first as
a tax-free return of capital, reducing the tax basis in the U.S. shareholder's
shares, and the amount of each distribution in excess of a U.S. shareholder's
tax basis in its shares will be taxable as gain realized from the sale of its
shares. U.S. shareholders may not include any of our losses on their own federal
income tax returns.
We will be treated as having sufficient earnings and profits to treat as a
dividend any distribution by us up to the amount required to be distributed to
avoid imposition of the 4% excise tax discussed above. Moreover, any "deficiency
dividend" will be treated as an ordinary or capital gain dividend, as the case
may be, regardless of our earnings and profits. As a result, shareholders may be
required to treat as taxable some distributions that would otherwise result in a
tax-free return of capital.
CAPITAL GAIN DIVIDENDS. Distributions to U.S. shareholders that we properly
designate as capital gain dividends normally will be treated as long-term
capital gains, to the extent they do not exceed our actual net
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capital gain, for the taxable year without regard to the period for which the
U.S. shareholder has held his stock. We will generally designate our capital
gain dividends as either 20% or 25% rate distributions with respect to
non-corporate U.S. shareholders, or, to the extent we meet certain holding
period requirements, as distributions at a preferential tax rate. A corporate
U.S. shareholder, however, might be required to treat up to 20% of some capital
gain dividends as ordinary income. See "Operational Requirements--Annual
Distribution Requirement" for the treatment by U.S. shareholders of net
long-term capital gains that we elect to retain and pay tax on.
PASSIVE ACTIVITY LOSS AND INVESTMENT INTEREST LIMITATIONS. Our
distributions and any gain you realize from a disposition of our Preferred
Shares will not be treated as passive activity income, and shareholders may not
be able to utilize any of their "passive losses" to offset this income in their
personal tax returns. Our distributions (to the extent they do not constitute a
return of capital) will generally be treated as investment income for purposes
of the limitations on the deduction of investment interest. Net capital gain
from a disposition of shares and capital gain dividends generally will be
included in investment income for purposes of the investment interest deduction
limitations only if, and to the extent, you so elect. In that case those capital
gains will be taxed as ordinary income.
CERTAIN DISPOSITIONS OF OUR PREFERRED SHARES. In general, any gain or loss
realized upon a taxable disposition of our Preferred Shares by a U.S.
shareholder who is not a dealer in securities will be treated as long-term
capital gain or loss if the shares have been held for more than 12 months and as
short-term capital gain or loss if the shares have been held for 12 months or
less. If, however, a U.S. shareholder has included in income any capital gains
dividends with respect to the shares, any loss realized upon a taxable
disposition of shares held for six months or less, to the extent of the capital
gains dividends included in income with respect to the shares, will be treated
as long-term capital loss.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING FOR U.S.
SHAREHOLDERS. We will report to U.S. shareholders of our Preferred Shares and to
the Internal Revenue Service the amount of distributions made or deemed made
during each calendar year and the amount of tax withheld, if any. Under some
circumstances, U.S. shareholders may be subject to backup withholding on
payments made with respect to, or proceeds of a sale or exchange of, our shares.
Backup withholding will apply only if the shareholder:
- Fails to furnish its taxpayer identification number (which, for an
individual, would be his or her Social Security number);
- Furnishes an incorrect taxpayer identification number;
- Is notified by the Internal Revenue Service that the shareholder has
failed properly to report payments of interest or dividends; or
- Under some circumstances, fails to certify, under penalties of perjury,
that it has furnished a correct taxpayer identification number and has not
been notified by the Internal Revenue Service that the shareholder is
subject to backup withholding for failure to report interest and dividend
payments or has been notified by the Internal Revenue Service that the
shareholder is no longer subject to backup withholding for failure to
report those payments.
Backup withholding will not apply with respect to payments made to some
shareholders, such as corporations and tax-exempt organizations. Backup
withholding is not an additional tax. Rather, the amount of any backup
withholding with respect to a payment to a U.S. shareholder will be allowed as a
credit against the U.S. shareholder's United States federal income tax liability
and may entitle the U.S. shareholder to a refund, if the required information is
furnished to the Internal Revenue Service. U.S. shareholders should consult
their own tax advisors regarding their qualification for exemption from backup
withholding and the procedure for obtaining an exemption.
TREATMENT OF TAX-EXEMPT U.S. SHAREHOLDERS
Tax-exempt entities including employee pension benefit trusts and individual
retirement accounts generally are exempt from United States federal income
taxation. These entities are subject to taxation, however, on any "unrelated
business taxable income," which we refer to as UBTI, as defined in the Code. The
Internal Revenue Service has issued a published ruling that dividend
distributions from a REIT to a tax-exempt pension trust did not constitute UBTI.
Although rulings are merely interpretations of law by the Internal Revenue
Service and may be revoked or modified, based on this analysis, indebtedness
incurred by us or by our operating partnership or its
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Subsidiary Entities in connection with the acquisition of a property should not
cause any income derived from the property to be treated as UBTI upon the
distribution of those amounts as dividends to a tax-exempt U.S. shareholder of
our Preferred Shares. A tax-exempt entity that incurs indebtedness to finance a
purchase of our Preferred Shares offered for cash pursuant to the offer,
however, will be subject to UBTI under the debt-financed income rules. In
addition, social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts and qualified group legal services plans that are
exempt from taxation under specified provisions of the Code are subject to
different UBTI rules, which generally will require them to treat dividend
distributions from us as UBTI. These organizations are urged to consult their
own tax advisor with respect to the treatment of our distributions to them.
In addition, tax-exempt pension and specified other tax-exempt trusts that
hold more than 10 percent by value of our shares may be required to treat a
specified percentage of our dividends as UBTI. This requirement applies only if
our qualification as a REIT depends upon the application of a look-through
exception to the closely held restriction (see "Requirements for Qualification
as a REIT--Organizational Requirements") and we are considered to be
predominantly held by those tax-exempt trusts. It is not anticipated that our
qualification as a REIT will depend upon application of the look-through
exception or that we will be predominantly held by these types of trusts.
SPECIAL TAX CONSIDERATIONS FOR NON-U.S. SHAREHOLDERS
The rules governing United States federal income taxation of non-resident
alien individuals, foreign corporations, foreign partnerships and other foreign
stockholders that hold our Preferred Shares, which we refer to collectively as
Non-U.S. shareholders, are complex. The following discussion is intended only as
a summary of these rules. Non-U.S. shareholders should consult with their own
tax advisors to determine the impact of United States federal, state and local
income tax laws on an investment in our Preferred Shares, including any
reporting requirements and the tax treatment of the investment under the tax
laws of their home country.
INCOME EFFECTIVELY CONNECTED WITH A UNITED STATES TRADE OR BUSINESS. In
general, Non-U.S. shareholders will be subject to regular United States federal
income taxation with respect to their investment in our Preferred Shares if the
income derived from such investment is treated as effectively connected with the
Non-U.S. shareholder's conduct of a trade or business in the United States. A
corporate Non-U.S. shareholder that receives income that is (or is treated as)
effectively connected with a United States trade or business also may be subject
to a branch profits tax under the Code, which is payable in addition to the
regular United States federal corporate income tax.
The following discussion will apply to Non-U.S. shareholders whose income
derived from ownership of our Preferred Shares is deemed to be not effectively
connected with a United States trade or business.
DISTRIBUTIONS NOT ATTRIBUTABLE TO GAIN FROM THE SALE OR EXCHANGE OF A UNITED
STATES REAL PROPERTY INTEREST. A distribution to a Non-U.S. shareholder that is
not attributable to gain realized by us from the sale or exchange of a United
States real property interest and that we do not designate as a capital gain
dividend will be treated as an ordinary income dividend to the extent that it is
made out of our current or accumulated earnings and profits. Generally, any
ordinary income dividend will be subject to a United States federal income
withholding tax equal to 30% of the gross amount of the distribution unless this
tax is reduced or eliminated by the provisions of an applicable tax treaty. A
distribution in excess of our earnings and profits will be treated first as a
return of capital that will reduce a Non-U.S. shareholder's basis in our
Preferred Shares, but not below zero, and then as gain from the disposition of
those shares. This tax treatment is described under the rules discussed below
with respect to sales of shares.
We normally intend to withhold United States income tax on these ordinary
dividends at the rate of 30% on the gross amount of any distribution paid to a
Non-U.S. shareholder, unless the shareholder provides us with an Internal
Revenue Service Form W-8BEN evidencing eligibility for a reduced treaty rate or
an Internal Revenue Service Form W-8ECI claiming that such distribution
constitutes effectively connected income.
DISTRIBUTIONS ATTRIBUTABLE TO GAIN FROM THE SALE OR EXCHANGE OF A UNITED
STATES REAL PROPERTY INTEREST. Distributions to a Non-U.S. shareholder that are
attributable to gain from the sale or exchange of a United States real property
interest will be taxed to a Non-U.S. shareholder under Code provisions enacted
by the Foreign Investment in Real Property Tax Act of 1980, which we refer to as
FIRPTA. Under FIRPTA, these distributions are taxed to a Non-U.S. shareholder as
if the distributions were gains effectively connected with a United States
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trade or business. Accordingly, a Non-U.S. shareholder will be taxed at the
normal capital gain rates applicable to a U.S. shareholder, subject to any
applicable alternative minimum tax and a special alternative minimum tax in the
case of non-resident alien individuals. Distributions subject to FIRPTA also may
be subject to a 30% branch profits tax when made to a corporate Non-U.S.
shareholder that is not entitled to a treaty reduction or exemption.
WITHHOLDING OBLIGATIONS WITH RESPECT TO DISTRIBUTIONS TO NON-U.S.
SHAREHOLDERS. Although tax treaties may reduce our withholding obligations,
based on current law, we will generally be required to withhold from
distributions to Non-U.S. shareholders, and remit to the Internal Revenue
Service:
- 35% of designated capital gain dividends or, if greater, 35% of the amount
of any distributions that could be designated as capital gain dividends;
and
- 30% of ordinary dividends paid out of our earnings and profits.
In addition, if we designate prior distributions as capital gain dividends,
later distributions, up to the amount of the prior distributions not withheld
against, will be treated as capital gain dividends for purposes of withholding.
A distribution in excess of our earnings and profits will be subject to 30%
withholding if at the time of the distribution it cannot be determined whether
the distribution will be in an amount in excess of our current or accumulated
earnings and profits. If the amount of tax we withhold with respect to a
distribution to a Non-U.S. shareholder exceeds the shareholder's United States
tax liability with respect to that distribution, the Non-U.S. shareholder may
file a claim with the Internal Revenue Service for a refund of the excess.
SALE OF OUR PREFERRED SHARES BY A NON-U.S. SHAREHOLDER. A sale of our
Preferred Shares by a Non-U.S. shareholder normally will not be subject to
United States federal income taxation unless our Preferred Shares constitute a
"United States real property interest" within the meaning of FIRPTA or the gain
from the sale is effectively connected with the conduct of a United States trade
or business of the Non-U.S. shareholder. Our Preferred Shares will not
constitute a United States real property interest if we are a
"domestically-controlled REIT." A "domestically-controlled REIT" is a REIT that
at all times during a specified testing period has less than 50% in value of its
shares held directly or indirectly by foreign persons, as defined for purposes
of the Code. We currently anticipate that we will be a domestically-controlled
REIT. Therefore, sales of our Preferred Shares should not be subject to taxation
under FIRPTA. However, we cannot assure you that we will continue to be a
domestically-controlled REIT. If we were not a domestically-controlled REIT, a
Non-U.S. shareholder's sale of our Preferred Shares would not be subject to tax
under FIRPTA as a sale of a United States real property interest if:
- Our Preferred Shares were "regularly traded" on an established securities
market within the meaning of applicable Treasury regulations; and
- The Non-U.S. shareholder did not actually, or constructively under
specified attribution rules under the Code, own more than 5% of our
Preferred Shares at any time during the shorter of the five-year period
preceding the disposition or the holder's holding period.
While our Preferred Shares are listed for trading on the American Stock
Exchange, they will be considered to be regularly traded on an established
securities market for any calendar quarter during which they are regularly
quoted by brokers or dealers that hold themselves out to buy or sell our
Preferred Shares at a quoted price. Consequently, a sale of our Preferred Shares
normally should not be subject to taxation under FIRPTA in the case of Non-U.S.
shareholders owning 5% or less of our Preferred Shares, even if we do not
qualify as a domestically-controlled REIT.
If a gain on the sale of our Preferred Shares were subject to taxation under
FIRPTA, a Non-U.S. shareholder would be subject to the same treatment as a U.S.
shareholder with respect to the gain, subject to any applicable alternative
minimum tax and a special alternative minimum tax in the case of non-resident
alien individuals. In addition, distributions that are treated as gain from the
disposition of Preferred Shares and are subject to tax under FIRPTA also may be
subject to a 30% branch profits tax when made to a corporate Non-U.S.
shareholder that is not entitled to a treaty exemption. Under FIRPTA, a
purchaser of our Preferred Shares from a Non-U.S. shareholder may be required to
withhold 10% of the purchase price and remit this amount to the Internal Revenue
Service.
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Even if not subject to FIRPTA, capital gains will be taxable to a Non-U.S.
shareholder if the Non-U.S. shareholder is a non-resident alien individual who
is present in the United States for 183 days or more during the taxable year and
some other conditions apply, in which case the non-resident alien individual
will be subject to a 30% tax on his or her U.S. source capital gains.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING FOR NON-U.S.
SHAREHOLDERS. Non-U.S. shareholders of our Preferred Shares should consult
their tax advisors with regard to United States information reporting and backup
withholding requirements under the Code.
STATEMENT OF STOCK OWNERSHIP
We are required to demand annual written statements from the record holders
of designated percentages of our Preferred Shares disclosing the actual owners
of the Preferred Shares. Any record shareholder who, upon our request, does not
provide us with required information concerning actual ownership of the
Preferred Shares is required to include specified information relating to those
shares in his federal income tax return. We also must maintain, within the
Internal Revenue District in which we are required to file our federal income
tax return, permanent records showing the information we have received about the
actual ownership of our Preferred Shares and a list of those persons failing or
refusing to comply with our demand.
STATE AND LOCAL TAXATION
We and any entities in which we own a direct or indirect interest may be
subject to state and local tax in states and localities in which we or they do
business or own property. The tax treatment of us, our operating partnership and
the Subsidiary Entities and the tax treatment of the holders of our Preferred
Shares in local jurisdictions may differ from the federal income tax treatment
described above. Consequently, prospective shareholders should consult their own
tax advisors regarding the effect of state and local tax laws on their
investment in our Preferred Shares.
FEDERAL INCOME TAX ASPECTS OF OUR OPERATING PARTNERSHIP AND THE SUBSIDIARY
ENTITIES
The following discussion summarizes some material federal income tax
considerations applicable to our investment in our operating partnership and our
indirect investment in the Subsidiary Entities. The discussion does not cover
state or local tax laws or any federal tax laws other than income tax laws.
CLASSIFICATION AS PARTNERSHIPS. We will be entitled to include in our
income our distributive share of the income and to deduct our distributive share
of the losses of our operating partnership, including the operating
partnership's distributive share of the income and losses of the Subsidiary
Entities, only if the operating partnership and each Subsidiary Entity is
classified for federal tax purposes as a partnership rather than as a
corporation or an association taxable as a corporation. Under applicable
Treasury regulations, an unincorporated domestic entity with at least two
members that was formed on or after January 1, 1997 may elect to be classified
either as an association taxable as a corporation or as a partnership. If the
entity fails to make an election, it usually will be treated as a partnership
for federal tax purposes. An unincorporated domestic entity with at least two
members that was formed prior to January 1, 1997 was treated as a partnership
for federal tax purposes only if it had no more than two of the four corporate
characteristics that Treasury regulations applicable at such time used to
distinguish a partnership from a corporation. Unless one of the Subsidiary
Entities formed prior to January 1, 1997 elects otherwise, the classification
claimed by the entity prior to January 1, 1997 will continue for periods after
January 1, 1997, and that classification will be respected for all prior periods
if (1) the entity had a reasonable basis for the classification, (2) the
organization and all members of the organization recognized the federal tax
consequences of any change in the entity's classification within the 60 months
prior to January 1, 1997 and (3) neither the entity nor any member was notified
in writing on or before May 8, 1996 that the classification of the entity was
under examination.
Our operating partnership intends to be classified as a partnership for
federal tax purposes and will not elect to be treated as an association taxable
as a corporation. Any Subsidiary Entities with two or more members formed on or
after January 1, 1997 are or will be organized as domestic entities. We do not
intend that any of those entities either will elect to be treated as
associations taxable as corporations or will be treated as corporations under
the rules described below. Finally, those Subsidiary Entities interests in which
will be acquired by our operating partnership upon consummation of the exchange
that were formed prior to January 1, 1997 have claimed partnership
classification and it is our understanding that none of those entities either
will elect to be
173
treated as associations taxable as corporations or otherwise should be treated
as corporations under the rules described below.
Even though our operating partnership will not elect to be treated as an
association for federal tax purposes, it may be taxed as a corporation if it is
deemed to be a "publicly traded partnership." A publicly traded partnership is a
partnership whose interests are traded on an established securities market or
are readily tradable on a secondary market or the substantial equivalent of a
secondary market. However, even if the foregoing requirements are met, a
publicly traded partnership will not be treated as a corporation for federal
income tax purposes if at least 90% of the partnership's gross income for each
taxable year consists of "qualifying income" under section 7704(d) of the Code.
With some exceptions, qualifying income generally includes any income that is
qualifying income for purposes of the 95% Income Test described above under
"Requirements for Qualification as a REIT--Operational Requirements--Gross
Income Tests." We refer to this as the Passive Income Exception.
Under applicable Treasury regulations, which we refer to as the PTP
Regulations, limited safe harbors from the definition of a publicly traded
partnership are provided. Under one of those safe harbors, which we refer to as
the Private Placement Exclusion, interests in a partnership will not be treated
as readily tradable on a secondary market or the substantial equivalent thereof
if:
- all interests in the partnership were issued in transactions that were not
required to be registered under the Securities Act of 1933, as amended,
and
- the partnership does not have more than 100 partners at any time during
the partnership's taxable year.
In determining the number of partners in a partnership, a person owning an
interest in a flow-through entity (including a partnership, grantor trust or S
corporation) that owns an interest in the partnership is treated as a partner in
such partnership only if (1) substantially all of the value of the owner's
interest in the flow-through entity is attributable to the flow-through entity's
direct or indirect interest in the partnership and (2) a principal purpose of
the use of the flow-through entity is to permit the partnership to satisfy the
100 partner limitation. Upon the completion of the exchange, our operating
partnership will qualify for the Private Placement Exclusion. However, even if
our operating partnership were considered a publicly traded partnership under
the PTP Regulations because it was deemed to have more than 100 partners, our
operating partnership should not be treated as a corporation because it should
be eligible for the Passive Income Exception described above.
Our operating partnership or a specified portion of our operating
partnership also will be taxed as a corporation if our operating partnership or
that portion is deemed to be a "taxable mortgage pool." With some exceptions, a
taxable mortgage pool is any entity or portion of an entity:
1. substantially all of the assets of which consists of debt obligations
(or interests therein) and more than 50 percent of those debt obligations
(or interests) consist of real estate mortgages (or interests therein);
2. that is the obligor under debt obligations with two or more maturities;
and
3. with respect to which the payments on the debt obligations in item 2
bear a relationship to payments on the debt obligations (or interests) in
item 1.
For purposes of item 1, the operating partnership would treat its adjusted
tax basis in each Subsidiary Entity and in each of GIT and GIT II as having the
same relative asset composition as the assets actually owned by those entities
and if less than 80 percent of the tax bases of the assets of the operating
partnership or any applicable portion of the operating partnership consist of
debt obligations, the operating partnership or that portion, as applicable, will
not be a taxable mortgage pool. For purposes of item 3, payments made on debt
obligations that are liabilities will be treated as bearing a relationship to
payments received on debt obligations that are assets if under the terms of the
liability or an underlying arrangement the timing and amount of payments on the
liability obligations are in large part determined by the timing and amount of
the payments or projected payments on the asset obligations. Upon completion of
the exchange, we expect the debt obligations of our operating partnership
initially to consist primarily of existing nonrecourse indebtedness secured by
the real properties to be contributed to our operating partnership. Payments on
these debt obligations do not bear a relationship to the payments on our
operating partnership's share of the debt obligations that are assets of the
mortgage funds. In addition, we presently expect that less than 80 percent of
the tax bases of the operating partnership's assets will consist of debt
obligations. However, to the extent that the operating partnership obtains
additional financing, we intend to structure that indebtedness in a manner so
that one or more of the above
174
requirements for treatment as a taxable mortgage pool is not satisfied with
respect to an applicable portion of the operating partnership.
We have not requested, and do not intend to request, a ruling from the
Internal Revenue Service that our operating partnership will be classified as a
partnership for federal income tax purposes. As described above under "REIT
Qualification," Paul, Weiss, Rifkind, Wharton & Garrison has delivered an
opinion to us, based on existing law and conditioned on factual assumptions and
representations and subject to specified limitations and qualifications that our
operating partnership will be treated for federal income tax purposes as a
partnership and not as a corporation or an association taxable as a corporation.
Unlike a tax ruling, however, an opinion of counsel is not binding upon the
Internal Revenue Service or the courts, and we can give you no assurance that
the Internal Revenue Service will not challenge the status of our operating
partnership as a partnership for federal tax purposes. If a challenge were
successful, our operating partnership would be treated as a corporation for
federal income tax purposes, as described below.
If for any reason our operating partnership or a portion of our operating
partnership were taxable as a corporation, rather than a partnership, for
federal income tax purposes, we would not be able to qualify as a REIT. See
"Requirements for Qualification as a REIT--Operational Requirements--Gross
Income Tests" and "Requirements for Qualification as a REIT--Operational
Requirements--Asset Tests." In addition, any change in the operating
partnership's status for tax purposes might be treated as a taxable event, in
which case we might incur a tax liability without any related cash distribution.
Further, items of income and deduction of our operating partnership would not
pass through to its partners, and its partners would be treated as shareholders
for tax purposes. Our operating partnership would be required to pay income tax
at corporate tax rates on its net income, and distributions to its partners
would constitute dividends that would not be deductible in computing our
operating partnership's taxable income.
PARTNERS, NOT PARTNERSHIP, SUBJECT TO TAX. A partnership is not a taxable
entity for federal income tax purposes. As a partner in our operating
partnership, we will be required to take into account our allocable share of the
operating partnership's income, gains, losses, deductions, and credits for any
taxable year of the operating partnership ending within or with our taxable
year, without regard to whether we have received or will receive any
distributions from our operating partnership.
PARTNERSHIP ALLOCATIONS. Although a partnership agreement normally
determines the allocation of income and losses among partners, those allocations
will be disregarded for federal income tax purposes if they do not comply with
the provisions of section 704(b) of the Code and the Treasury regulations under
that section. If an allocation is not recognized for federal income tax
purposes, the item subject to the allocation will be reallocated in accordance
with the partners' interests in the partnership, which will be determined by
taking into account all of the facts and circumstances relating to the economic
arrangement of the partners with respect to that item. Our operating
partnership's allocations of taxable income and loss under its partnership
agreement are intended to comply with the requirements of section 704(b) of the
Code and the Treasury regulations under that section.
TAX ALLOCATIONS WITH RESPECT TO CONTRIBUTED PROPERTIES. Under
section 704(c) of the Code, income, gain, loss, and deduction attributable to
appreciated or depreciated property that is contributed to a partnership in
exchange for an interest in the partnership must be allocated for federal income
tax purposes in a manner such that the contributor is charged with, or benefits
from, the unrealized gain or unrealized loss associated with the property at the
time of the contribution. The amount of unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
the property at the time of contribution. Under applicable Treasury regulations,
partnerships are required to use a "reasonable method" for allocating items
subject to section 704(c) of the Code and several reasonable allocation methods
are described in those regulations. Under the operating partnership agreement,
gain or loss on the sale of a property that has been contributed to our
operating partnership will be specially allocated to the contributing partner to
the extent of any built-in gain or loss with respect to the property for federal
income tax purposes
BASIS IN PARTNERSHIP INTEREST. The adjusted tax basis of our partnership
interest in our operating partnership generally will be equal to:
- the amount of cash and the basis of any other property contributed to the
operating partnership by us,
- increased by (1) our allocable share of the operating partnership's income
and (2) our allocable share of indebtedness of the operating partnership,
and
175
- reduced, but not below zero, by (1) our allocable share of the operating
partnership's loss and (2) the amount of cash distributed to us, including
constructive cash distributions resulting from a reduction in our share of
indebtedness of the operating partnership.
If the allocation of our distributive share of our operating partnership's
loss would reduce the adjusted tax basis of our partnership interest in the
operating partnership below zero, the recognition of the loss will be deferred
until such time as the recognition of the loss would not reduce our adjusted tax
basis below zero. If a distribution from our operating partnership or a
reduction in our share of the operating partnership's liabilities would reduce
our adjusted tax basis below zero, that distribution, including a constructive
distribution, will constitute taxable income to us. The gain realized by us upon
the receipt of that distribution or constructive distribution would normally be
characterized as capital gain, and if our partnership interest in the operating
partnership had been held at that time for longer than the long-term capital
gain holding period (currently one year), the distribution would constitute
long-term capital gain.
DEPRECIATION DEDUCTIONS AVAILABLE TO OUR OPERATING PARTNERSHIP. Our
operating partnership expects to use a portion of the distributions it receives
upon payoff of the loan assets held by the mortgage funds, as well as excess
funds from operations and borrowings, to acquire additional interests in real
properties. To the extent that our operating partnership acquires properties for
cash, the operating partnership's initial basis in those properties for federal
income tax purposes generally will be equal to the purchase price paid by the
operating partnership. For federal income tax purposes, the operating
partnership plans to depreciate the depreciable properties it purchases under
accelerated methods of depreciation. To the extent that our operating
partnership acquires properties in exchange for operating partnership units, our
operating partnership's initial basis in each of those properties for federal
income tax purposes should be the same as the transferor's basis in that
property on the date of acquisition by our operating partnership. Although the
law is not entirely clear, our operating partnership generally intends to
depreciate those depreciable properties for federal income tax purposes over the
same remaining useful lives and under the same methods used by the transferors.
SALE OF OUR OPERATING PARTNERSHIP'S PROPERTY. Generally, any gain realized
by our operating partnership on the sale of property held for more than one year
will be long-term capital gain, except for any portion of the gain that is
treated as depreciation or cost recovery recapture. Our share of any gain
realized by our operating partnership on the sale of any property held by the
operating partnership as inventory or other property held primarily for sale to
customers in the ordinary course of the operating partnership's trade or
business will be treated as income from a prohibited transaction that would be
subject to a 100% penalty tax. We, however, do not presently intend to acquire
or hold or allow our operating partnership to acquire or hold any property that
represents inventory or other property held primarily for sale to customers in
the ordinary course of our business or the operating partnership's trade or
business.
PLAN OF DISTRIBUTION
We have retained Georgeson Shareholder Communications Inc. and Georgeson
Shareholder Securities Corporation (together, Georgeson) as information agent
and dealer manager in connection with the offers. In that capacity, Georgeson
may contact holders of Interests by mail, telephone, facsimile and personal
interview and may request brokers, dealers and other nominee stockholders to
forward material relating to the offers to beneficial owners of Interests. We
will pay Georgeson $100,000 for these services plus $4.50 per completed call, in
addition to reimbursing Georgeson for its reasonable out-of-pocket expenses. We
have also agreed to pay Georgeson an additional $25,000 per mortgage fund in the
event Interests representing 25% or more of the outstanding Interests of that
mortgage fund are validly tendered and not properly withdrawn in the applicable
offer. We also have agreed to indemnify Georgeson against specified liabilities
and expenses in connection with the offers, including specified liabilities
under the United States federal securities laws.
Georgeson Shareholder Securities Corporation will act as an agent on our
behalf in soliciting Interests and facilitating the exchange of our Preferred
Shares for Interests. Georgeson has no commitment or obligation to purchase any
of the Preferred Shares and will act as an underwriter merely in connection with
its "best efforts" arrangement with us to facilitate the exchange of the
Preferred Shares for Interests.
176
EXPERTS
The financial statement of Berkshire Income Realty, Inc. at August 12, 2002
and the financial statements and financial statement schedules of Berkshire
Income Realty Predecessor Group, Krupp Government Income Trust, Krupp Government
Income Trust II, Krupp Insured Mortgage Limited Partnership, Krupp Insured Plus
Limited Partnership, Krupp Insured Plus II Limited Partnership and Krupp Insured
Plus III Limited Partnership, as of December 31, 2001 and 2000 and for each of
the three years in the period ended December 31, 2001 included in this
prospectus and registration statement have been so included in reliance on the
reports of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of this firm as experts in auditing and accounting.
LEGAL MATTERS
The legality of the Preferred Shares that we are offering will be passed
upon for Berkshire Income Realty, Inc. by Ballard Spahr Andrews &
Ingersoll, LLP. The statements relating to federal income tax matters under the
caption "Federal Income Tax Considerations" have been reviewed by and the
qualification of Berkshire Income Realty, Inc. as a REIT for federal income tax
purposes and the partnership status of Berkshire Income Realty-OP, L.P. for
federal income tax purposes has been passed upon by Paul, Weiss, Rifkind,
Wharton & Garrison, New York, New York.
WHERE YOU CAN FIND MORE INFORMATION
ABOUT US AND THE MORTGAGE FUNDS
We have filed a registration statement with the SEC (of which this
prospectus forms a part) on Form S-11 under the Securities Act of 1933 with
respect to the securities offered in this prospectus. This prospectus does not
contain all the information provided in the registration statement, including
exhibits and schedules related thereto filed with the SEC. For further
information regarding us and the Preferred Shares that we are offering, you
should review the registration statement and such exhibits and schedules.
Each of the mortgage funds currently is, and following this offering we will
be, subject to the informational requirements of the Securities Exchange Act of
1934 and as such are required to file reports and other information with the
SEC. Reports, proxy statements and other information filed by us or the mortgage
funds with the SEC can be inspected and copied at the public reference
facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549. Copies of such material can be obtained from the Public
Reference Section of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates. In addition, following this offer, reports, proxy statements
and other information concerning us can be inspected at the offices of the
American Stock Exchange, 86 Trinity Place@Thames, New York, New York 10006-1872.
You may also access the above information electronically on the SEC's web site,
which contains reports, proxy and information statements and other information
regarding registrants that file electronically with the SEC. The address of the
SEC's website is http: //www.sec.gov.
177
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES AND
SUPPLEMENTARY DATA
BERKSHIRE INCOME REALTY, INC.
Report of Independent Accountants........................... F-5
Balance Sheet at August 12, 2002............................ F-6
Notes to Balance Sheet...................................... F-7
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
Report of Independent Accountants........................... F-8
Combined Financial Statements:
Combined Balance Sheets at December 31, 2001 and 2000 and
(unaudited) as of June 30, 2002........................... F-9
Combined Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999 and (Unaudited) for the
Six Months Ended June 30, 2002 and June 30, 2001.......... F-10
Combined Statements of Changes in Owners' Equity for the
Years Ended December 31, 2001, 2000 and 1999 and
(Unaudited) for the Six Months Ended June 30, 2002........ F-11
Combined Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 and (Unaudited) for the
Six Months Ended June 30, 2002 and June 30, 2001.......... F-12
Notes to Combined Financial Statements...................... F-13-F-17
Schedule III--Real Estate and Accumulated Depreciation at
December 31, 2001......................................... F-18
KRUPP GOVERNMENT INCOME TRUST
Report of Independent Accountants........................... F-19
Balance Sheets at December 31, 2001 and 2000................ F-20
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999.................... F-21
Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999.................... F-22
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999....................................... F-23
Notes to Financial Statements............................... F-24-F-31
Schedule II--Valuation and Qualifying Accounts.............. F-32
Supplementary Data--Selected Quarterly Financial Data
(Unaudited)............................................... F-33
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)............................................... F-34
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)... F-35
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)................................. F-36
Notes to Financial Statements (Unaudited)................... F-37-F-38
F-1
KRUPP GOVERNMENT INCOME TRUST II
Report of Independent Accountants........................... F-39
Balance Sheets at December 31, 2001 and 2000................ F-40
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999.................... F-41
Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999.................... F-42
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999....................................... F-43
Notes to Financial Statements............................... F-44-F-51
Schedule II--Valuation and Qualifying Accounts.............. F-52
Supplementary Data--Selected Quarterly Financial Data
(Unaudited)............................................... F-53
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)............................................... F-54
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)... F-55
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)................................. F-56
Notes to Financial Statements (Unaudited)................... F-57
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
Report of Independent Accountants........................... F-58
Balance Sheets at December 31, 2001 and 2000................ F-59
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999.................... F-60
Statements of Changes in Partners' Equity for the Years
Ended December 31, 2001, 2000 and 1999.................... F-61
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999....................................... F-62
Notes to Financial Statements............................... F-63-F-68
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)............................................... F-69
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)... F-70
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)................................. F-71
Notes to Financial Statements (Unaudited)................... F-72
All schedules are omitted as they are not applicable or not required, or the
information is provided in the financial statements or the related notes.
F-2
KRUPP INSURED PLUS LIMITED PARTNERSHIP
Report of Independent Accountants........................... F-73
Balance Sheets at December 31, 2001 and 2000................ F-74
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999.................... F-75
Statements of Changes in Partners' Equity for the Years
Ended December 31, 2001, 2000 and 1999.................... F-76
Statements of Cash Flows for the Years Ended December 31,
2001, and 1999............................................ F-77
Notes to Financial Statements............................... F-78-F-82
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)............................................... F-83
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)... F-84
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)................................. F-85
Notes to Financial Statements (Unaudited)................... F-86
All schedules are omitted as they are not applicable or not required, or the
information is provided in the financial statements or the related notes.
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
Report of Independent Accountants........................... F-87
Balance Sheets at December 31, 2001 and 2000................ F-88
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999.................... F-89
Statements of Changes in Partners' Equity for the Years
Ended December 31, 2001, 2000 and 1999.................... F-90
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999....................................... F-91
Notes to Financial Statements............................... F-92-F-96
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)............................................... F-97
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)... F-98
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)................................. F-99
Notes to Financial Statements (Unaudited)................... F-100
All schedules are omitted as they are not applicable or not required, or the
information is provided in the financial statements or the related notes.
F-3
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
Report of Independent Accountants........................... F-101
Balance Sheets at December 31, 2001 and 2000................ F-102
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999.................... F-103
Statements of Changes in Partners' Equity for the Years
Ended December 31, 2001, 2000 and 1999.................... F-104
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999....................................... F-105
Notes to Financial Statements............................... F-106-F-110
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)............................................... F-111
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)... F-112
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)................................. F-113
Notes to Financial Statements (Unaudited)................... F-114
All schedules are omitted as they are not applicable or not required, or the
information is provided in the financial statements or the related notes.
F-4
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholder of
Berkshire Income Realty, Inc.
In our opinion, the accompanying balance sheet presents fairly, in all
material respects, the financial position of Berkshire Income Realty, Inc. (the
"Company") at August 12, 2002 in conformity with accounting principles generally
accepted in the United States of America. This financial statement is the
responsibility of the Company's management; our responsibility is to express an
opinion on this financial statement based on our audit. We conducted our audit
of this statement in accordance with auditing standards generally accepted in
the United States of America, which require that we plan and perform the audit
to obtain reasonable assurance about whether the balance sheet is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the balance sheet, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall balance sheet presentation. We believe that our audit of
the balance sheet provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
August 12, 2002
F-5
BERKSHIRE INCOME REALTY, INC.
BALANCE SHEET
AT AUGUST 12, 2002
ASSETS
Assets:
Cash...................................................... $100
----
Total assets............................................ $100
====
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:................................................ $ --
Stockholder's Equity:
Preferred stock, liquidation preference $25.00 per share,
5,000,000 shares authorized,
0 shares issued and outstanding......................... --
Class A common stock, $.01 par value, 5,000,000 shares
authorized,
0 shares issued and outstanding......................... --
Class B common stock, $.01 par value, 5,000,000 shares
authorized,
100 shares issued and outstanding....................... 1
Additional paid in capital................................ 99
----
Total liabilities and stockholder's equity.............. $100
====
The accompanying notes are an integral part of this balance sheet.
F-6
BERKSHIRE INCOME REALTY, INC.
NOTES TO BALANCE SHEET
1. ORGANIZATION AND FORMATION
Berkshire Income Realty, Inc. (the "Company"), a Maryland corporation, was
organized on July 19, 2002. The Company intends to acquire, own and operate
multi-family residential properties. The Company has no operating history to
date.
The Company has filed a registration statement on Form S-11 with the
Securities and Exchange Commission with respect to the offering (the "Offering")
to exchange Series A Cumulative Redeemable Preferred Shares ("Preferred Shares")
of the Company for interests ("Interests") in the following six mortgage funds:
Krupp Government Income Trust, Krupp Government Income Trust II, Krupp Insured
Mortgage Limited Partnership, Krupp Insured Plus Limited Partnership, Krupp
Insured Plus II Limited Partnership, Krupp Insured Plus III Limited Partnership
(collectively, the "Mortgage Funds"). For each Interest in the Mortgage Funds
that is validly tendered and not withdrawn in the Offering, the Company will
exchange its Preferred Shares based on an exchange ratio applicable to each
Mortgage Fund.
Simultaneous with the completion of the Offering, KRF Company, LLC ("KRF
Company"), an affiliate of the Company, will contribute its ownership interests
in five multi-family residential properties (the "Properties") to Berkshire
Income Realty-OP, L.P. (the "Operating Partnership") in exchange for common
limited partner interests in the Operating Partnership. Prior to the Offering,
KRF Company contributed $100 in exchange for 100 shares of common stock of the
Company. Concurrent with the completion of the Offering, KRF Company will
contribute cash to the Company in exchange for common stock of the Company in an
amount equal to 1% of the fair value of total net assets of the Operating
Partnership. This amount will be contributed to the Company's wholly owned
subsidiary, BIR GP, L.L.C., who will then contribute the cash to the Operating
Partnership in exchange for the sole general partner interest in the Operating
Partnership. The Company will contribute the Interests tendered in the Offering
to the Operating Partnership in exchange for preferred limited partner interests
in the Operating Partnership. The Operating Partnership is the successor to the
Berkshire Income Realty Predecessor Group (the "Predecessor"). The merger of the
separate businesses into the Company and the Operating Partnership is considered
a purchase business combination with the Predecessor being the accounting
acquirer. Accordingly, the acquisition or contribution of the various
Predecessor interests will be accounted for at their historical cost. The
acquisition of the Interests will be accounted for using purchase accounting
based upon the fair value of the Interests acquired.
The Preferred Shares will entitle holders to receive cumulative cash
distributions, accruing from the date of original issuance and payable quarterly
in arrears, commencing on February 15, 2003. The cash distributions will be
preferential to distributions made to the holders of common stock and common
limited partner interests in the Operating Partnership. The Company will have
the right to redeem the Preferred Shares for $25 per share, plus accumulated and
unpaid distributions, at any time after February 15, 2010.
2. INCOME TAXES
Upon completion of the Offering, the Company intends to make an election to
be taxed as a real estate investment trust ("REIT") under the Internal Revenue
Code. As a REIT, the Company is required to distribute at least 90% of its REIT
taxable income to its shareholders to maintain its REIT status. REITs are
subject to a number of organizational and operational requirements. If the
Company fails to qualify as a REIT in any taxable year, the Company will be
subject to Federal income tax on its taxable income at regular corporate tax
rates. Even if the Company qualifies for taxation as a REIT, the Company may be
subject to state and local taxes on its income and property and to Federal
income and excise taxes on its undistributed income.
F-7
REPORT OF INDEPENDENT ACCOUNTANTS
To the Partners and Members of
Berkshire Income Realty Predecessor Group
In our opinion, the combined financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Berkshire Income Realty Predecessor Group (the "Predecessor") at December 31,
2001 and 2000, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related combined financial
statements. These financial statements and financial statement schedule are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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 financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
August 12, 2002
F-8
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
COMBINED BALANCE SHEETS
JUNE 30, DECEMBER 31,
----------- -------------------
2002 2001 2000
----------- -------- --------
(UNAUDITED)
(IN THOUSANDS)
ASSETS
Multi-family apartment communities, net of accumulated
depreciation of $84,934, $82,719 and $77,968,
respectively.............................................. $86,623 $87,648 $57,104
Cash and cash equivalents................................... 6,678 3,990 7,899
Cash restricted for tenant security deposits................ 764 811 617
Replacement reserve escrow.................................. 101 5 2,220
Prepaid expenses and other assets........................... 2,392 1,834 2,128
Accounts receivable affiliates.............................. 63 1,738 --
Deferred expenses, net of accumulated amortization of $73,
$171 and $105, respectively............................... 649 587 393
------- ------- -------
Total assets.............................................. $97,270 $96,613 $70,361
======= ======= =======
LIABILITIES AND OWNERS' EQUITY (DEFICIT)
Liabilities:
Mortgage notes payable...................................... $90,167 $76,799 $72,568
Accrued participating note interest, net of discount of
$2,026 at December 31, 2000............................... -- -- 1,650
Accrued expenses and other liabilities...................... 1,326 1,041 5,531
Tenant security deposits.................................... 858 802 732
------- ------- -------
Total liabilities......................................... 92,351 78,642 80,481
Minority interest........................................... -- 619 1,385
Owners' equity (deficit).................................... 4,919 17,352 (11,505)
------- ------- -------
Total liabilities and owners' equity (deficit)............ $97,270 $96,613 $70,361
======= ======= =======
The accompanying notes are an integral part of these combined financial
statements.
F-9
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
COMBINED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, YEARS ENDED DECEMBER 31,
------------------------- ------------------------------
2002 2001 2001 2000 1999
----------- ----------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
Revenue:
Rental........................................ $ 11,672 $ 11,333 $ 23,056 $ 21,869 $ 20,912
Interest...................................... 70 178 533 601 232
Other......................................... 661 465 982 678 616
-------- -------- -------- -------- --------
Total revenue............................... 12,403 11,976 24,571 23,148 21,760
Expenses:
Operating..................................... 2,680 2,887 5,158 5,365 4,962
Maintenance................................... 900 898 1,944 1,797 1,700
Real estate taxes............................. 878 821 1,679 1,674 1,545
General and administrative.................... 324 384 657 714 616
Management fees............................... 877 648 1,288 1,275 992
Depreciation.................................. 2,215 2,826 4,751 5,011 5,700
Interest...................................... 1,586 3,020 5,682 7,204 6,202
Participating note interest................... -- 3,462 6,591 1,013 638
-------- -------- -------- -------- --------
Total expenses.............................. 9,460 14,946 27,750 24,053 22,355
Income (loss) before minority interest and
extraordinary loss from early extinguishment
of debt....................................... 2,943 (2,970) (3,179) (905) (595)
Minority interest............................... (1,436) 114 228 517 --
-------- -------- -------- -------- --------
Income (loss) before extraordinary loss from
early extinguishment of debt.................. 1,507 (2,856) (2,951) (388) (595)
Extraordinary loss from early extinguishment of
debt.......................................... (883) -- (713) (476) --
-------- -------- -------- -------- --------
Net income (loss)............................... $ 624 $ (2,856) $ (3,664) $ (864) $ (595)
======== ======== ======== ======== ========
The accompanying notes are an integral part of these combined financial
statements.
F-10
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
COMBINED STATEMENTS OF CHANGES IN OWNERS' EQUITY (DEFICIT)
COMBINED
--------
Balance at December 31, 1999................................ $(19,250)
Net loss.................................................... (864)
Contributions............................................... 8,609
--------
Balance at December 31, 2000................................ (11,505)
Net loss.................................................... (3,664)
Distributions............................................... (5,462)
Contributions............................................... 37,983
--------
Balance at December 31, 2001................................ 17,352
Net income (Unaudited)...................................... 624
Distributions (Unaudited)................................... (13,057)
--------
Balance at June 30, 2002 (Unaudited)........................ $ 4,919
========
The accompanying notes are an integral part of these combined financial
statements.
F-11
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
COMBINED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, YEARS ENDED DECEMBER 31,
------------------------- ------------------------------
2002 2001 2001 2000 1999
----------- ----------- -------- -------- --------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
Cash flows from operating activities:
Net income (loss)................................ $ 624 $(2,856) $ (3,664) $ (864) $ (595)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities:
Amortization of deferred financing costs....... 44 47 126 134 80
Non-cash portion of extraordinary loss from
early extinguishment of debt................. 273 -- 713 180 --
Depreciation................................... 2,215 2,826 4,751 5,011 5,700
Minority interest.............................. 1,436 (114) (228) (517) --
Increase (decrease) in cash attributable to
changes in assets and liabilities:
Tenant security deposits, net................ 46 (10) (124) (17) (18)
Prepaid expenses and other assets............ 1,180 (2,078) 294 869 81
Accounts receivable affiliates............... (63) (455) (1,738) -- --
Accrued participating note interest.......... -- 3,462 (1,650) 1,013 638
Accrued expenses and other liabilities....... 343 (344) (4,488) 783 442
------- ------- -------- -------- -------
Net cash provided by (used in) operating
activities..................................... 6,098 478 (6,008) 6,592 6,328
------- ------- -------- -------- -------
Cash flows from investing activities:
Capital improvements............................. (1,190) (701) (732) (2,959) (2,190)
Acquisition of real estate/limited partnership
interests...................................... -- -- (34,563) (19,631) --
Replacement reserve escrow....................... (95) 1,467 2,214 (1,442) (268)
------- ------- -------- -------- -------
Net cash provided by (used in) investing
activities..................................... (1,285) 766 (33,081) (24,032) (2,458)
------- ------- -------- -------- -------
Cash flows from financing activities:
Borrowings on mortgage notes payable............. 49,580 -- 32,500 36,207 --
Principal payments on mortgage notes payable..... (36,212) (367) (28,269) (21,257) (937)
Deferred financing costs......................... (379) (89) (1,034) -- (519)
Contributions from owners........................ -- 644 37,983 8,609 --
Distributions to owners.......................... (13,057) (5,462) (5,462) -- (1,893)
Cash distributions to minority interest.......... (2,057) -- (538) -- --
------- ------- -------- -------- -------
Net cash provided by (used in) financing
activities..................................... (2,125) (5,274) 35,180 23,559 (3,349)
------- ------- -------- -------- -------
Net increase (decrease) in cash and cash
equivalents.................................... 2,688 (4,030) (3,909) 6,119 521
Cash and cash equivalents at beginning of
period......................................... 3,990 7,899 7,899 1,780 1,259
------- ------- -------- -------- -------
Cash and cash equivalents at end of period....... $ 6,678 $ 3,869 $ 3,990 $ 7,899 $ 1,780
======= ======= ======== ======== =======
The accompanying notes are an integral part of these combined financial
statements.
F-12
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
------------------------------
1. ORGANIZATION AND BASIS OF PRESENTATION
KRF Company L.L.C., an affiliate of the Berkshire Group and controlled by
Douglas and George Krupp, through its subsidiaries KRF3 Acquisition Company,
L.L.C. and KR5 Acquisition, L.L.C. ("KRF"), at June 30, 2002 and December 31,
2001 has controlling interests in five multifamily apartment communities
consisting of 2,539 units (the "Properties") as follows:
CONTROLLING
DESCRIPTION LOCATION UNITS INTEREST
----------- ---------------------- -------- -----------
Century..................................................... Cockeysville, Maryland 468 75.82%
Dorsey's Forge.............................................. Columbia, Maryland 251 91.38%
Hannibal Grove.............................................. Columbia, Maryland 316 91.38%
Seasons of Laurel........................................... Laurel, Maryland 1,088 100.00%
Walden Pond................................................. Houston, Texas 416 100.00%
KRF acquired the Properties during 2000 and 2001 through the acquisition of
limited partner units from certain affiliates of the Berkshire Group also
controlled by George and Douglas Krupp (See Note 3) namely, Krupp Realty Limited
Partnership--V (Century), Krupp Realty Fund, Ltd.--III (Dorsey's Forge and
Hannibal Grove), Maryland Associates Limited Partnership (Seasons of Laurel) and
Krupp Realty Fund, Ltd.--IV (Walden Pond); (collectively, the "Affiliates").
The activities of the Properties held by KRF and the Affiliates, the owners
of the Properties, are collectively referred to as the Berkshire Income Realty
Predecessor Group or the "Predecessor". The Properties have been included in the
financial statements of the Predecessor for all periods presented.
The accompanying financial statements have been presented on a combined
basis because KRF and the Affiliates are under common management and control and
because KRF and the Properties are expected to be the subject of a business
combination with Berkshire Income Realty, Inc. which was formed in 2002 and is
expected to qualify as a real estate investment trust under the Internal Revenue
Code of 1986, as amended.
Due to the affiliation of the Predecessor, these financial statements have
been presented as a reorganization of entities under common control which is
similar to the accounting for a pooling of interests. The acquisition or
transfer of the various Predecessor interests has been accounted for at
historical cost. The acquisition of limited partner interests in the Affiliates
has been accounted for using purchase accounting based on the cash paid for the
interests, resulting in an incremental increase in the basis of the
Predecessor's real estate.
During 2000, KRF Company L.L.C., the parent of KR5 Acquisition L.L.C.
("KR5"), obtained a $10,000 term loan facility (the "Loan") and utilized the
proceeds to make a capital contribution to KR5.
The Loan had a term of five years and a variable interest rate of either the
Prime Rate, as defined, or LIBOR, as defined, plus two percent. The Loan was
payable on an interest only basis until the first anniversary of closing;
thereafter; quarterly payments of principal were required based upon a five
year, straight-line amortization schedule. Certain net distributions made to KRF
Company L.L.C. by KR5 related to the sale, refinancing or other disposition of
properties by KR5 were to be used to prepay the Loan.
The Loan was collateralized by a first and only security interest in KRF
Company L.L.C.'s equity interest in KR5. An affiliate of KRF Company L.L.C.
granted a first and only security interest in certain assets, including its
rights and interests in certain advisory agreements. Such advisory agreements
provide for fees in excess of $2,000 per year. In addition, the Loan was
guarantied by Douglas Krupp, George Krupp and an affiliate of KRF Company L.L.C.
The Loan was fully repaid on August 2, 2002. Pursuant to SAB Topic 5-J, the
Loan has not been reflected in the financial statements of the Predecessor.
All overhead costs of KRF and an allocation of the Affiliates' overhead
costs, based upon the number of units in the Properties to total units owned by
the Affiliates, have been reflected in the Predecessor financial statements for
the periods presented. Management believes the basis for allocating overhead
costs is reasonable.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, contingent assets and liabilities at the date of the
financial statements and revenue and expenses during the reporting period. Such
estimates include the allowance for depreciation and the fair value of the
accrued participating note interest. Actual results could differ from those
estimates.
The combined financial statements as of June 30, 2002 and for the six months
ended June 30, 2002 and 2001 are unaudited. In the opinion of management, all
adjustments, consisting only of normal, recurring adjustments, necessary for a
fair presentation of such combined financial statements have been included. The
results, of operations for the six months ended June 30, 2002 are not
necessarily indicative of the Predecessor's future results of operations for the
full year ending December 31, 2002.
F-13
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF COMBINATION
The combined financial statements include the accounts of the Properties
extracted from the books and records of KRF and the Affiliates. To the extent
parties not affiliated with the Berkshire Group have an equity interest in the
Properties, such interest is accounted for as minority interest in the
accompanying financial statements. Allocations of income, losses and
distributions are made to minority shareholders based upon their respective
share of such allocations. Losses in excess of the minority shareholder's
investment basis are allocated to the Predecessor. Distributions to the minority
shareholder in excess of their investment basis are recorded in the
Predecessor's combined statement of operations as minority interest.
REAL ESTATE
Real estate assets are stated at depreciated cost. Pursuant to Statement of
Financial Accounting Standards Opinion No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of", impairment
losses are recorded on long-lived assets used in operations on a property by
property basis, when events and circumstances indicate that the assets might be
impaired and the estimated undiscounted cash flows to be generated by those
assets are less than the carrying amount of those assets. Upon determination
that an impairment has occurred, those assets shall be reduced to fair value. No
such impairment losses have been recognized to date.
The cost of rental property and improvements includes the purchase price of
property, legal fees, and acquisition costs.
Expenditures for ordinary maintenance and repairs are charged to operations
as incurred. Significant renovations and betterments which improve or extend the
useful life of the assets are capitalized. Depreciation is computed on the
straight-line basis over the estimated useful lives of the assets, as follows:
Rental property............................................. 27.5 years
5 to
Improvements................................................ 20 years
Appliances, carpeting, and equipment........................ 3 to 8 years
When property is sold, their costs and related depreciation are removed from
the accounts with the resulting gains or losses reflected in net income or loss
for the period.
CASH AND CASH EQUIVALENTS
The Predecessor invests its cash primarily in deposits and money market
funds with commercial banks. All short-term investments with maturities of three
months or less from the date of acquisition are included in cash and cash
equivalents. The cash investments are recorded at cost, which approximates
current market values. The Predecessor has not experienced any losses to date on
its invested cash.
RESTRICTED CASH
Restricted cash represents security deposits held by the Predecessor under
the terms of certain tenant lease agreements.
ESCROWS
Certain lenders require escrow accounts for capital improvements. The
escrows are funded from operating cash, as needed.
DEFERRED EXPENSES
Fees and costs incurred to obtain long-term financing have been deferred and
are being amortized over the terms of the related loans, on a method which
approximates the effective interest method.
PARTNERS'/MEMBERS' CAPITAL CONTRIBUTIONS, DISTRIBUTIONS AND PROFITS AND
LOSSES
Partners'/Members' capital contributions, distributions and profits and
losses are allocated in accordance with the terms of individual partnership and
or limited liability company agreements.
RENTAL REVENUE
The Properties are leased under terms of leases with terms of generally one
year or less. Rental revenue is recognized when earned.
INCOME TAXES
No provision for income taxes is necessary in the financial statements of
the Predecessor since the Predecessor's statements combine the operations and
balances of partnerships and limited liability companies, which have elected to
be treated as partnerships for federal income tax purposes, therefore, none of
which is directly subject to income tax. The tax effect of its activities
accrues to the individual partners and or members of the respective entity.
F-14
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS
The Predecessor has entered into an interest rate cap agreement to
economically hedge a certain mortgage note payable. The Predecessor has not
designated this instrument as an accounting hedge under SFAS No. 133. Derivative
financial instruments contain an element of risk that counterparties may be
unable to meet the terms of such agreements. The Company minimizes its risk
exposure by limiting the counterparties to major banks and investment bankers
who meet established credit and capital guidelines.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS, which supercedes SFAS No. 121. SFAS No. 144
requires that long-lived assets that are to be disposed of by sale be measured
at the lower of the book value or fair value less cost to sell. SFAS No. 144
retains the requirements of SFAS No. 121 regarding impairment loss recognition
and measurement. In addition, it requires that one accounting model be used for
long-lived assets to be disposed of by sale and broadens the presentation of
discontinued operations to include more disposal transactions. SFAS No.144 is
effective for fiscal years beginning after December 15, 2001. The impact of
adopting this statement is not expected to be material to the combined financial
statements.
In May 2002, the FASB issued SFAS No. 145, RESCISSION OF FASB STATEMENTS
NO. 4, 44 AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS
AS OF APRIL 2002, which rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, among others. As a result of the rescission of SFAS
No. 4, gains or losses from extinguishment of debt are not necessarily
considered extraordinary. SFAS No. 145 is effective for fiscal years beginning
after May 15, 2002. The impact of adopting this statement will require the
Company to reclassify its extraordinary loss into interest expense in the
accompanying statement of operations.
In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR COSTS ASSOCIATED
WITH EXIT OR DISPOSAL ACTIVITIES, which nullifies Emerging Issues Task Force
(EITF) Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION
BENEFITS AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED
IN A RESTRUCTURING). SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred and that an entity's commitment to an exit plan, by itself, does not
create a present obligation to others that meets the definition of a liability.
This Statement also establishes that fair value is the objective for initial
measurement of the liability. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002. The impact of adopting
this statement is not expected to be material to the combined financial
statements.
3. MULTIFAMILY APARTMENT COMMUNITIES
The following summarizes the carrying value of the Predecessor's multifamily
apartment communities:
JUNE 30, DECEMBER 31, DECEMBER 31,
2002 2001 2000
----------- ------------ ------------
(UNAUDITED)
Land.................................... $ 20,071 $ 20,071 $ 12,062
Buildings, improvements and personal
property.............................. 151,486 150,296 123,010
-------- -------- ---------
Multi-family apartment communities...... 171,557 170,367 135,072
Accumulated depreciation................ (84,934) (82,719) (77,968)
-------- -------- ---------
Multi-family apartment communities,
net................................... $ 86,623 $ 87,648 $ 57,104
======== ======== =========
The acquisition of the limited partner interests in the Affiliates, which
was at fair value and in excess of book value of the Properties, has been
accounted for using purchase accounting based upon the cash paid for the
interests. The following is a summary of the incremental increase in the basis
of the Predecessor's real estate as a result of the acquisition of limited
partner interests between the Affiliates during 2001 and 2000:
INCREASE IN REAL ESTATE BASIS
-----------------------------
PROPERTY 2001 2000
-------- ------------- -------------
Century............................................ -- $12,214
Dorsey's Forge..................................... -- 3,404
Hannibal Grove..................................... -- 5,914
Seasons of Laurel.................................. $26,241 --
Walden Pond........................................ 8,322 --
------- -------
Total.......................................... $34,563 $21,532
======= =======
Included in the 2000 increase in real estate basis is $1,901 of non-cash
contributions attributable to the minority interest member.
F-15
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
4. MORTGAGE NOTES PAYABLE
Mortgage notes payable consisted of the following at June 30, 2002 and
December 31, 2001 and 2000:
SECURED JUNE 30, DECEMBER 31, FINAL MATURITY
PROPERTY 2002 ANNUAL INTEREST RATE 2001 2000 ANNUAL INTEREST RATE DATE
-------- ------------ ------------------------ -------- -------- ------------------------ --------------
(UNAUDITED)
Century................. $22,735 5.96% fixed $19,188 $19,399 1.74% plus 3 month LIBOR May 1, 2005
Dorsey's Forge.......... 10,605 5.96% fixed 6,004 6,071 1.59% plus 3 month LIBOR May 1, 2005
Hannibal Grove.......... 16,099 5.96% fixed 10,429 10,548 1.59% plus 3 month LIBOR May 1, 2005
Seasons of Laurel....... 36,277 Reference Bill plus .95% 36,678 30,647 Reference Bill plus Aug 1, 2008
.95%(1)
Walden Pond............. 4,451 Reference Bill plus 4,500 5,903 Reference Bill plus Dec 1, 2008
1.74% 1.74%(2)
------- ------- -------
Total................... $90,167 $76,799 $72,568
======= ======= =======
SECURED MONTHLY
PROPERTY PAYMENT
-------- --------
Century................. $136
Dorsey's Forge.......... $ 63
Hannibal Grove.......... $ 96
Seasons of Laurel....... $152
Walden Pond............. $ 20
Total...................
------------------------------
(1) For the year ended December 31, 2000, the variable interest rate was equal
to the greater of Prime less .5% or 8%.
(2) For the year ended December 31, 2000, the fixed interest rate was equal to
8%.
Combined aggregate principal maturities of mortgage notes payable at
December 31, 2001 are approximately as follows:
2002........................................................ $ 1,210
2003........................................................ 1,262
2004........................................................ 1,316
2005........................................................ 16,708
2006........................................................ 1,122
Thereafter.................................................. 55,181
-------
$76,799
=======
Interest rates on variable rate mortgage notes payable aggregating $40,728,
$76,799 and $72,568 range from 2.81% to 3.51%, 3.37% to 5.26%, and 8% to 9%
above the London Interbank Offered Rate ("LIBOR") at June 30, 2002,
December 31, 2001 and 2000, respectively. The 3 month LIBOR rates as of
June 30, 2002, December 31, 2001 and December 31, 2000 were 1.86%, 1.88% and
6.39%, respectively. The Federal Home Loan Mortgage Corporation Reference Bills
("Reference Bills") are unsecured general corporate obligations. The Reference
Bills rates as of June 30, 2002 and December 31, 2001 were 1.74% and 1.77%,
respectively.
On April 27, 2000, the Predecessor completed the refinancing of the Century
mortgage note payable with a $19,500 non-recourse mortgage note payable. The
Predecessor used the proceeds from the refinancing to repay the existing
mortgage note of $10,657, to pay closing costs of $41, and to purchase the
outstanding limited partnership units of Krupp Realty Limited Partnership-V. The
Predecessor also recognized a $476 extraordinary loss resulting from the
prepayment penalty and the write-off of deferred financing costs upon the early
principal repayment of the mortgage note payable, which is reflected in the
statement of operations for the year ended December 31, 2000.
On April 27, 2000, the Predecessor completed the refinancing of the Dorsey's
Forge and Hannibal Grove mortgage notes payable. Dorsey's Forge and Hannibal
Grove were refinanced with $6,103 and $10,604, respectively, non-recourse
mortgage notes payable. The Predecessor used the proceeds from the refinancing
to repay the existing mortgage notes on Dorsey's Forge and Hannibal Grove of
$4,170 and $5,672, respectively, to pay closing costs of $108 and $149,
respectively, and to purchase the outstanding limited partnership units from
Krupp Realty Fund, Ltd.-III.
On July 23, 2001, the Predecessor obtained a $37,000 non-recourse mortgage
note payable on Seasons of Laurel, which is collateralized by the property. The
Predecessor used the proceeds from the note to purchase the outstanding limited
partnership units of Maryland. The Predecessor also recognized a $713
extraordinary loss resulting from the write-off of deferred financing costs
related to the extinguished debt. In connection with the financing, the
Predecessor also entered into an interest rate cap agreement in the notional
amount of $37,000 with a termination date of July 20, 2003. The agreement
provides for a rate cap of 6.65%. The Predecessor holds the derivative for the
purposes of hedging against exposure to changes in the future cash flows
attributable to increases in the interest rate; however, the instrument does not
qualify as an effective hedge for accounting purposes. As a result of the
nominal cost and fair value of the interest rate cap, the premium paid for its
interest rate cap agreement is being amortized over the term of the interest
rate cap agreement. Such unamortized premium approximating $32 and $35 at
June 30, 2002 and December 31, 2001, respectively, was included in deferred
expenses in the accompanying balance sheets.
F-16
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
4. MORTGAGE NOTES PAYABLE (CONTINUED)
Prior to July 23, 2001, the Predecessor had outstanding a first and second
non-recourse mortgage note payable on Seasons of Laurel, which was
collateralized by the property. At December 31, 2000, the principal balance
outstanding on these mortgage notes payable were $30,959 and $6,850,
respectively. The combined first and second mortgage loans contained a preferred
interest rate of 10%, subject to certain cash flow limitations. Additionally,
the Predecessor had a subordinate promissory note payable that required
participating payments to the holder of the note, subject to cash availability,
as defined. The holder of the first and second mortgage notes payable and
subordinate promissory note was an affiliate of the Berkshire Group. The
Predecessor estimated the fair value of the participation feature in the
subordinate promissory note payable to be $3,676 at December 31, 2000, which was
recorded as accrued participating note interest in the accompanying financial
statements. The fair value of the participating interest in the subordinate
promissory note payable was deferred and amortized into the accompanying
statement of operations over the subordinated promissory note's estimated life
using the effective interest rate method. For the years ended December 31, 2000
and 1999, $1,013 and $638 of deferred interest was amortized into the statement
of operations, respectively, related to this note. On July 23, 2001, concurrent
with the refinancing of Seasons of Laurel, the subordinate promissory note
payable was paid off. As such, the Predecessor recognized an additional $6,589
of interest on the subordinate promissory note.
On November 14, 2001, the Predecessor obtained a $4,500 non-recourse
mortgage note payable, which is collateralized by the property on Walden Pond.
The Predecessor used the proceeds from the note to purchase the outstanding
limited partnership units of Krupp Realty Fund, Ltd.--IV.
On April 1, 2002, the mortgage notes payable on Century, Dorsey's Forge, and
Hannibal Grove were refinanced with $22,800, $10,635, and $16,145, respectively,
non-recourse mortgage notes payable, which are collateralized by the related
properties. The interest rates on the notes are fixed at 5.96%. The notes mature
on April 1, 2007, at which time the remaining principal and accrued interest are
due. The notes may be prepaid, subject to a prepayment penalty, at any time
within 30 days notice.
The Predecessor used the proceeds from the refinancing on Century, Dorsey's
Forge, and Hannibal Grove to repay the existing mortgage notes and accrued
interest of $19,219, $6,011 and $10,444, respectively, to pay closing costs of
$162, $91 and $122, respectively, and to fund escrows required by the lender of
$29, $15 and $54, respectively. The remaining cash of $11,357 was distributed to
the members. The Predecessor also recognized a $883 extraordinary loss resulting
from the prepayment penalty upon the early principal repayment and write-off of
unamortized deferred financing costs for Century, Dorsey's Forge and Hannibal
mortgage notes payable, which is reflected in the statement of operations for
the six months ended June 30, 2002.
On July 31, 2002, the mortgage note payable on Seasons of Laurel was
refinanced with a $52,500 non-recourse mortgage note payable, which is
collateralized by the property. The fixed interest rate on the note is 5.74%.
The mortgage note matures on August 1, 2009, at which time the remaining
principal and accrued interest are due. The note may be prepaid, subject to a
prepayment penalty, at any time with 30 days notice. The Predecessor used the
proceeds from the refinancing to repay the existing mortgage note and accrued
interest of $36,412, to pay closing costs of $280, to fund escrows required by
the lender of $862 and to pay an early prepayment penalty of $363. The remaining
cash of $14,579 has been reserved for future investments.
Interest paid on the mortgage notes payable was $8,967, $6,209 and $5,678
for the years ended December 31, 2001, 2000 and 1999, respectively.
Additionally, interest paid on the mortgage notes payable was $2,138 and $3,145
for the six months ended June 30, 2002 and 2001, respectively.
5. RELATED PARTY TRANSACTIONS
The Predecessor paid property management fees to an affiliate of the
Berkshire Group for management services. The fees are payable monthly at an
annual rate of 5% of the gross receipts from the properties under management.
The Predecessor also reimburses affiliates of the Berkshire Group for certain
expenses incurred in connection with the operation of the properties, including
administrative expenses.
The Predecessor paid asset management fees to an affiliate of the Berkshire
Group for certain asset management services.
Amounts accrued or paid to the Berkshire Group's affiliates during the six
months ended June 30, 2002 and during the years ended December 31, 2001, 2000
and 1999 were as follows:
DECEMBER 31,
JUNE 30, ------------------------------
2002 2001 2000 1999
----------- -------- -------- --------
(UNAUDITED)
Property management fee..................................... $ 673 $1,102 $1,042 $ 992
Expense reimbursements...................................... 254 413 984 946
Asset management fee........................................ 204 186 233 --
------ ------ ------ ------
Charged to operations....................................... $1,131 $1,701 $2,259 $1,938
====== ====== ====== ======
Expense reimbursements due to affiliates of $173, $67 and $2 were included
in accrued expenses and other liabilities at June 30, 2002, December 31, 2001
and 2000, respectively.
Expense reimbursements due from affiliates of $36, $1,664 and $421 were
included in prepaid expenses and other assets at June 30, 2002, December 31,
2001 and 2000, respectively.
F-17
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2001
(DOLLARS IN THOUSANDS)
------------------------------
COSTS
CAPITALIZED
SUBSEQUENT
TO ACQUISITION
INITIAL COST --------------------------------
-------------------- BUILDING AND BASIS
DESCRIPTION LOCATION LAND BUILDINGS IMPROVEMENTS STEP-UP (NOTE 3)
----------- ---------------- -------- --------- ------------ -----------------
Century..................................... Cockeysville, MD $1,050 $13,948 $ 6,992 $12,214
Dorsey's Forge.............................. Columbia, MD 341 4,522 3,522 3,404
Hannibal Grove.............................. Columbia, MD 520 6,884 5,744 5,914
Seasons of Laurel........................... Laurel, MD 3,676 50,802 265 26,241
Walden Pond................................. Houston, TX 906 12,040 3,060 8,322
------ ------- ------- -------
Total..................................... $6,493 $88,196 $19,583 $56,095
====== ======= ======= =======
LAND AND BUILDING AND ACCUMULATED YEAR DEPRECIABLE
DESCRIPTION IMPROVEMENTS IMPROVEMENTS TOTAL DEPRECIATION ACQUIRED LIVES
----------- ------------ ------------ -------- ------------ -------- -----------
Century........................................ $ 4,011 $ 30,193 $ 34,204 $(16,090) 1984 (1)
Dorsey's Forge................................. 1,301 10,488 11,789 (5,936) 1983 (1)
Hannibal Grove................................. 2,167 16,895 19,062 (9,973) 1983 (1)
Seasons of Laurel.............................. 9,673 71,311 80,984 (38,524) 1985 (1)
Walden Pond.................................... 2,919 21,409 24,328 (12,196) 1983 (1)
------- -------- -------- --------
Total........................................ $20,071 $150,296 $170,367 $(82,719)
======= ======== ======== ========
------------------------------
(1) Depreciation of the buildings and improvements are calculated over lives
ranging from 3 to 27.5 years.
A summary of activity for real estate and accumulated depreciation is as
follows:
2001 2000 1999
-------- -------- --------
REAL ESTATE
Balance at beginning of year................................ $135,072 $110,581 $108,391
Acquisition and improvements................................ 35,295 24,491 2,190
-------- -------- --------
Balance at the end of year.................................. $170,367 $135,072 $110,581
======== ======== ========
2001 2000 1999
-------- -------- --------
ACCUMULATED DEPRECIATION
Balance at beginning of year................................ $ 77,968 $ 72,957 $ 67,257
Depreciation expense........................................ 4,751 5,011 5,700
-------- -------- --------
Balance at the end of year.................................. $ 82,719 $ 77,968 $ 72,957
======== ======== ========
The aggregate cost of the Predecessor's multifamily apartment communities
for federal income tax purposes was approximately $90,506 and the aggregate
accumulated depreciation was approximately $13,778 as of December 31, 2001.
F-18
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Trustees and the Shareholders of
Krupp Government Income Trust:
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Krupp
Government Income Trust (the "Trust") at December 31, 2001 and 2000, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the accompanying index presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related financial statements. These financial statements
and financial statement schedule are the responsibility of the Trust's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America which 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 financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 14, 2002
F-19
KRUPP GOVERNMENT INCOME TRUST
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
------------ ------------
ASSETS
Participating Insured Mortgage Investments
("PIMIs") (Notes B, C and J):
Insured Mortgages......................................... $ 50,811,558 $ 59,752,085
Additional Loans, net of impairment provision of
$1,698,811 and $2,162,618, respectively................. 3,871,180 8,350,990
Participating Insured Mortgages ("PIMs") (Notes B, D and
J)...................................................... 46,416,493 46,892,234
Mortgage-Backed Securities and insured mortgage loan ("MBS")
(Notes B, E and J)........................................ 14,971,348 16,536,498
------------ ------------
Total mortgage investments.............................. 116,070,579 131,531,807
Cash and cash equivalents (Notes B and J)................... 13,154,231 5,359,041
Interest receivable and other assets........................ 756,832 1,082,412
Prepaid acquisition fees and expenses, net of accumulated
amortization of $6,249,229 and $6,841,714, respectively
(Note B).................................................. 541,044 1,491,747
Prepaid participation servicing fees, net of accumulated
amortization of $1,999,913 and $2,112,209, respectively
(Note B).................................................. 263,455 665,540
------------ ------------
Total assets............................................ $130,786,141 $140,130,547
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred income on Additional Loans (Note B)................ $ 2,336,154 $ 3,550,485
Other liabilities........................................... 20,485 20,980
------------ ------------
Total liabilities....................................... 2,356,639 3,571,465
------------ ------------
Commitments (Note H)
Shareholders' equity (Notes A, F, H and K):
Common stock, no par value; 17,510,000 Shares authorized;
15,053,135 Shares issued and outstanding................ 127,850,874 136,114,206
Accumulated comprehensive income (Note B)................. 578,628 444,876
------------ ------------
Total Shareholders' equity.............................. 128,429,502 136,559,082
------------ ------------
Total liabilities and Shareholders' equity.............. $130,786,141 $140,130,547
============ ============
The accompanying notes are an integral part of the financial statements.
F-20
KRUPP GOVERNMENT INCOME TRUST
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
----------- ----------- -----------
Revenues:
Interest income--PIMs and PIMIs:
Basic interest.......................................... $ 7,901,086 $ 8,086,930 $ 8,789,439
Additional Loan Interest................................ 1,515,330 744,080 2,534,790
Participation interest.................................. 7,602,737 504,612 2,268,505
Interest income--MBS...................................... 1,251,710 1,375,643 1,531,351
Interest income--cash and cash equivalents................ 261,513 364,803 508,144
----------- ----------- -----------
Total revenues........................................ 18,532,376 11,076,068 15,632,229
----------- ----------- -----------
Expenses:
Asset management fee to an affiliate (Note G)............. 950,966 1,007,651 1,104,431
Expense reimbursements to affiliates (Note G)............. 243,109 256,564 220,657
Amortization of prepaid fees and expenses (Note B)........ 1,352,788 1,029,734 1,672,143
General and administrative (Note G)....................... 477,102 353,007 269,345
(Reduction of) provision for impaired mortgage loans
(Notes B and C)......................................... (463,807) -- 48,272
----------- ----------- -----------
Total expenses........................................ 2,560,158 2,646,956 3,314,848
----------- ----------- -----------
Net income (Note I)......................................... 15,972,218 8,429,112 12,317,381
Other comprehensive income:
Net change in unrealized gain on MBS...................... 133,752 213,560 (641,460)
----------- ----------- -----------
Total comprehensive income.................................. $16,105,970 $ 8,642,672 $11,675,921
----------- ----------- -----------
Basic earnings per Share.................................... $ 1.06 $ .56 $ .82
----------- ----------- -----------
Weighted average Shares outstanding......................... 15,053,135 15,053,135 15,053,135
=========== =========== ===========
The accompanying notes are an integral part of the financial statements.
F-21
KRUPP GOVERNMENT INCOME TRUST
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
ACCUMULATED TOTAL
COMMON RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK EARNINGS INCOME EQUITY
------------ ------------ ------------- -------------
Balance at December 31, 1998.................... $164,742,014 $ -- $ 872,776 $165,614,790
Dividends....................................... (26,820,787) (12,317,381) -- (39,138,168)
Net income...................................... -- 12,317,381 -- 12,317,381
Change in unrealized gain on MBS................ -- -- (641,460) (641,460)
------------ ------------ ------------ ------------
Balance at December 31, 1999.................... 137,921,227 -- 231,316 138,152,543
Dividends....................................... (1,807,021) (8,429,112) -- (10,236,133)
Net income...................................... -- 8,429,112 -- 8,429,112
Change in unrealized gain on MBS................ -- -- 213,560 213,560
------------ ------------ ------------ ------------
Balance at December 31, 2000.................... 136,114,206 -- 444,876 136,559,082
Dividends....................................... (8,263,332) (15,972,218) -- (24,235,550)
Net income...................................... -- 15,972,218 -- 15,972,218
Change in unrealized gain on MBS................ -- -- 133,752 133,752
------------ ------------ ------------ ------------
Balance at December 31, 2001.................... $127,850,874 $ -- $ 578,628 $128,429,502
============ ============ ============ ============
Shares issued and outstanding for each of the three years ended December 31, are
15,053,135
The accompanying notes are an integral part of the financial statements.
F-22
KRUPP GOVERNMENT INCOME TRUST
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
----------- ----------- -----------
Operating activities:
Net income................................................ $15,972,218 $ 8,429,112 $12,317,381
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of (discounts) and premiums................ (110) (2,202) 3,044
(Reduction of) provision for impaired mortgage loans.... (463,807) -- 48,272
Amortization of prepaid fees and expenses............... 1,352,788 1,029,734 1,672,143
Changes in assets and liabilities:
Decrease (increase) in interest receivable and other
assets.............................................. 325,580 (108,921) 83,874
Decrease in deferred income on Additional Loans....... (1,214,331) (367,536) (1,855,648)
Decrease in other liabilities......................... (495) (4,045) (8,205)
----------- ----------- -----------
Net cash provided by operating activities................... 15,971,843 8,976,142 12,260,861
Investing activities:
Principal collections on PIMs and Insured Mortgages....... 9,416,268 816,846 15,662,878
Principal collections on MBS.............................. 1,699,012 1,174,687 3,992,931
Additional Loan prepayments............................... 4,943,617 -- 2,844,600
----------- ----------- -----------
Net cash provided by investing activities................... 16,058,897 1,991,533 22,500,409
----------- ----------- -----------
Financing activity:
Dividends................................................. (24,235,550) (10,236,133) (39,138,168)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents........ 7,795,190 731,542 (4,376,898)
Cash and cash equivalents, beginning of year................ 5,359,041 4,627,499 9,004,397
----------- ----------- -----------
Cash and cash equivalents, end of year...................... $13,154,231 $ 5,359,041 $ 4,627,499
----------- ----------- -----------
Non cash activities:
Increase (decrease) in Fair Value of MBS.................. $ 133,752 $ 213,560 $ (641,460)
=========== =========== ===========
The accompanying notes are an integral part of the financial statements.
F-23
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS
A. ORGANIZATION
Krupp Government Income Trust (the "Trust") was formed on November 1, 1989
by filing a Declaration of Trust in The Commonwealth of Massachusetts. The Trust
is authorized to sell and issue not more than 17,510,000 shares of beneficial
interest (the "Shares"). The Trust was organized for the purpose of investing in
commercial and multi-family loans and mortgage backed securities. Berkshire
Mortgage Advisors Limited Partnership ("BMALP") (the "Advisor"), acquired 10,000
of such Shares for $200,000 and 14,999,999 Shares were sold for $299,480,263 net
of purchase volume discounts of $519,717 under a public offering which commenced
on April 19, 1990 and ended on July 15, 1991. Under the Dividend Reinvestment
Plan ("DRP"), 43,136 Shares were sold for $819,356 during its public offering.
The Trust shall terminate on December 31, 2029, unless earlier terminated by the
affirmative vote of holders of a majority of the outstanding Shares entitled to
vote thereon.
B. SIGNIFICANT ACCOUNTING POLICIES
The Trust uses the following accounting policies for financial reporting
purposes:
BASIS OF PRESENTATION
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with accounting principles generally accepted
in the United States of America ("GAAP").
MBS
The Trust, in accordance with the Financial Accounting Standards Board's
Statement 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("FAS 115"), classifies its MBS portfolio as available-for-sale. As
such, the Trust carries its MBS at fair market value and reflects any unrealized
gains (losses) as a separate component of Shareholders' Equity. The Trust
amortizes purchase premiums or discounts over the life of the underlying
mortgages using the effective interest method.
The Federal Housing Administration ("FHA") insured mortgage is carried at
amortized cost. The Trust holds this loan at amortized cost since it is fully
insured by FHA.
PIMS AND PIMIS
The Trust accounts for its MBS portion of a PIM or PIMI in accordance with
FAS 115 under the classification of held to maturity. The Trust carries those
MBS at amortized cost.
The insured mortgage portion of the FHA PIM or FHA PIMI is carried at
amortized cost. The Trust holds these mortgages at amortized cost since they are
fully insured by FHA.
The Additional Loans are carried at amortized cost unless the Advisor of the
Trust believes there is an impairment in value, in which case a valuation
allowance is established in accordance with FAS 114 and FAS 118.
Basic interest is recognized based on the stated rate of the Department of
Housing and Urban Development ("HUD") Insured Mortgage loan (less the servicer's
fee) or the coupon rate of the Government National Mortgage Association ("GNMA")
or Fannie Mae MBS. The Trust recognizes interest related to the participation
features when the amount becomes fixed and the transaction that gives rise to
such amount is consummated. The Trust defers the recognition of Additional Loan
interest payments as income to the extent these interest payments were from
escrows established with the proceeds of the Additional Loan. When the
properties underlying the PIMI's generate sufficient cash flow to make the
required Additional Loan interest payments and the Additional Loan value is
deemed collectible, the Trust recognizes income as earned and commences
amortization of the deferred interest amounts into income over the remaining
estimated term of the Additional Loan. During periods where mortgage loans are
impaired the Trust suspends amortizing deferred interest.
The Trust also fully reserves the portion of any Additional Loan interest
payment satisfied through the issuance of an operating loan and any associated
interest due on such operating loan. The Trust will recognize the income related
to the operating loan when the borrower repays amounts due under the operating
loan.
IMPAIRED MORTGAGE LOANS
Impaired loans are those loans which the Advisor believes that the
collection of all amounts due in accordance with the contractual terms of the
loan agreement are not likely. Impaired loans are measured based on the fair
value of the underlying collateral. Interest received on the impaired loans is
applied against the loan principal.
CASH EQUIVALENTS
The Trust includes all short-term investments with maturities of three
months or less from the date of acquisition in cash and cash equivalents. The
Trust invests its cash primarily in agency paper and money market funds with a
commercial bank and has not experienced any loss to date on its invested cash.
F-24
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
B. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PREPAID FEES AND EXPENSES
Prepaid fees and expenses represent prepaid acquisition fees and expenses
and prepaid participation servicing fees paid for the acquisition and servicing
of PIMs and PIMIs. The Trust amortizes prepaid acquisition fees and expenses
using a method that approximates the effective interest method over a period of
ten to twelve years, which represents the estimated life of the underlying
mortgage.
The Trust amortizes prepaid participation servicing fees using a method that
approximates the effective interest method over a ten year period beginning at
final endorsement of the loan if a HUD-insured mortgage loan or a GNMA MBS and
at closing if a Fannie Mae MBS.
Upon the repayment of a PIM or PIMI any unamortized acquisition fees and
expenses and unamortized participation servicing fees related to such loan are
expensed.
INCOME TAXES
The Trust has elected to be taxed as a REIT under the Internal Revenue Code
of 1986, as amended, and believes it will continue to meet all such
qualifications. Accordingly, the Trust will not be subject to federal income
taxes on amounts distributed to shareholders provided it distributes annually at
least 90% of its REIT taxable income and meets certain other requirements for
qualifying as a REIT. Therefore, no provision for federal income taxes has been
recorded in the financial statements.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, contingent assets and liabilities and revenues and
expenses during the period. Significant estimates include the net carrying value
of Additional Loans and the unrealized gain on MBS investments. Actual results
could differ from those estimates.
C. PIMIS
The Trust had investments in four PIMIs on December 31, 2001 and five PIMIs
on December 31, 2000 that provide the permanent financing of multi-family
housing. One component of a PIMI is either a securitized HUD-insured first
mortgage loan issued and guaranteed by GNMA or a sole participation interest in
a first mortgage loan originated under the FHA lending program and insured by
HUD (collectively the "Insured Mortgages"). The FHA first mortgage or the first
mortgage underlying the GNMA security provided the borrower (generally a limited
partnership) with a below market interest rate loan in exchange for providing
the Trust with participation in a percentage of the cash generated from property
operations and in a percentage of any appreciation of the underlying property to
a preferred return, then a percentage of any appreciation thereafter. The
borrower conveys these rights to the Trust through a subordinated promissory
note and mortgage. In addition, the Trust made an Additional Loan to the owners
of the borrower to provide additional funds for the construction and permanent
financing of the property. The owners generally collateralize the Additional
Loan through a pledge and security agreement that pledges their ownership
interests in the borrower, and their share of any distributions made from
surplus cash generated by the property and the proceeds realized upon the
refinancing of the property, sale of the property or sale of the partnership
interests. Amounts payable under the Additional Loan are neither guaranteed nor
insured.
The Trust receives level monthly principal and interest ("Basic Interest")
payments amortizing over thirty to forty years, on the Insured Mortgage and is
entitled to receive participation income under the subordinated promissory note
and mortgage, and semi-annual interest payments ("Additional Loan Interest") and
preferred interest under the Additional Loan ("Preferred Interest"). The Trust
receives principal and interest payments on the Insured Mortgages currently,
because these payments are insured or guaranteed; however, there are limitations
to the amount and obligation to pay participation income, Additional Loan
Interest and Preferred Interest.
The subordinated promissory note and mortgage entitles the Trust to receive
(i) Participating Income Interest generally equal to 50% of (a) all
distributable Surplus Cash (as defined in the regulatory agreement of the
HUD-insured first mortgage) generated by the property (b) any unrestricted cash
generated from property operations and (c) to the extent available unexpended
reserves and escrows, and (ii) Participating Appreciation Interest generally
equal to 50% of the net proceeds or value of the property upon the sale,
refinancing, maturity or accelerated maturity, or permitted prepayment of all
amounts due under the Insured Mortgage and Additional Loan less the Outstanding
Indebtedness, as defined. Amounts received by the Trust pursuant to the
subordinated promissory note as Participating Income Interest reduce amounts
payable as Preferred Interest and may reduce amounts payable as Base Interest
under the Additional Loan.
The Insured Mortgage and subordinated promissory note generally have
maturities of 30 to 40 years, however, under the subordinated promissory note
the Trust can generally accelerate these maturity dates at any time after the
tenth anniversary of final endorsement for coinsurance or insurance, but in
certain cases for construction loans after the eleventh or twelfth anniversary
of initial endorsement (commencement of construction) for coinsurance or
insurance, upon giving twelve months written notice for the payment of all
accrued participation interest through the accelerated maturity date. The Trust
can accelerate the maturity date for payment of amounts due under the
subordinated promissory note and the insured mortgage providing the contract of
insurance or coinsurance with the Secretary of HUD on the insured mortgage is
canceled prior to the accelerated maturity date.
Additional Loan Interest is payable from the following sources: (i) any
Surplus Cash received pursuant to the subordinated promissory note as
Participating Income Interest, (ii) amounts conveyed to the Trust by the owners
of the borrowing entity representing distributions of Surplus Cash and
(iii) amounts in reserve accounts established with the Additional Loan proceeds,
if available, and any interest earned on these amounts. If these sources are not
sufficient to make Additional Loan Interest payments the owners of the borrowing
entity must notify
F-25
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMIS (CONTINUED)
the Trust of the amount of the shortfall and at its option the Trust could
require a capital call from the owners of the borrowing entity. The capital call
would be equal to 50% of the Additional Loan Interest shortfall and the Trust in
certain situations could convert the remaining 50% into an operating loan.
In addition to the Additional Loan Interest payments, the Additional Loan
requires the payment of Preferred Interest representing a cumulative,
non-compounded preferred return from the date of final endorsement to the date
of calculation at interest rates ranging from 9.5% to 11% per annum on the
outstanding balance of the Insured Mortgage plus the Additional Loan and any
other funds advanced by the Trust to the borrowing entity or the owners of the
borrowing entity less: (i) interest payments paid to the Trust under the Insured
Mortgage, (ii) Participating Income Interest and (iii) Additional Loan Interest
payments made under the Additional Loan.
The Insured Mortgage and subordinated promissory note generally cannot be
prepaid for a term of five years from the construction completion date or final
endorsement and thereafter may be prepaid in whole without penalty provided all
participation interest and amounts under the Insured Mortgage are paid. Any
prepayment requires not less than ninety nor more than 180 days prior written
notice.
The Additional Loan generally may not be prepaid before the fifth
anniversary of the Agreement or the construction completion date and thereafter
may be prepaid in full without penalty provided Preferred Interest and any
amounts due under the Insured Mortgage and subordinated promissory note are paid
in full.
On December 31, 2001, the Trust received a prepayment of the Red Run
Additional Loan and subordinated promissory note. The Trust received $2,900,000
of Additional Loan principal, $238,369 of Shared Appreciation Interest,
$3,506,952 of preferred interest and $67,667 of Base Interest on the Additional
Loan. In addition, the Trust recognized $702,259 of Additional Loan interest
that had been previously received and recorded in deferred income on additional
loans.
On July 23, 2001, the Trust received a prepayment of the Seasons
Subordinated Promissory Note and the Seasons Additional Loan. The Trust received
$1,924,649 of Additional Loan principal, $180,916 of surplus cash, $847,450 of
preferred interest, $1,052,455 of contingent interest, $69,129 of Base Interest
on the Additional Loan and $1,299,562 which represents the Trust's portion of
the residual split. The Trust received $8,567,890 representing the principal
proceeds on the first mortgage note on July 26, 2001. In addition, the Trust
recognized $180,633 of Additional Loan interest that had been previously
received and recorded in deferred income on additional loans. On August 17,
2001, the Advisor paid a special dividend of $0.93 per share from the proceeds
of the Seasons PIMI prepayment.
The payoff of the Seasons PIMI was a result of the sale of the underlying
property by the borrower, Maryland Associates Limited Partnership ("MALP"),
which is an affiliate of the Adviser, to an affiliate of MALP's general partner.
Because the sale of the underlying property was to an affiliate, the Independent
Trustees of the Trust were required to approve the transaction, which they did
based upon a number of factors, including an appraisal of the underlying
property prepared by an independent third party MAI appraiser. The purchase
price paid by the affiliate for the underlying property was $1.6 million greater
than the value indicated by such appraisal.
During the third quarter of 1999, the Trust received a prepayment of the
Audubon Villas PIMI including the Insured Mortgage with a remaining principal
balance of $14,861,957, the Additional Loan of $2,691,000 and participation
interest of $1,966,901. Also, $1,962,261 was recognized as Additional Loan
interest income which was previously recorded as deferred income. On August 18,
1999, the Advisor declared a special dividend of $1.30 per share that was paid
on September 17, 1999 from the payoff of the mortgage on the Audubon Villas
PIMI.
In June 1999, the Trust entered into a second modification agreement (the
"Agreement") with the borrowers of the Mountain View Apartments PIMI reducing
the interest rate on the Insured Mortgage by 1.25% per annum beginning
January 1, 1999 and continuing through December 31, 2004 and changing the
participation feature. The Agreement eliminated the Preferred Interest required
under the Additional Loan and changed the Trust's participation in the Surplus
Cash generated by the property. Under the Agreement, the Trust will receive 75%
of the first $130,667 of Surplus Cash and 50% of any remaining Surplus Cash on
an annual basis to pay the Additional Loan Interest. Unpaid Additional Loan
Interest will accrue and be payable if there are sufficient proceeds from a sale
or refinancing of the property except that $288,580 of existing accruals related
to the Additional Loan had been forgiven. In addition, the borrower repaid
$153,600 of the Additional Loan and funded approximately $54,000 to a reserve
for property improvements. As a result of the factors described above, the
Advisor determined that the Additional Loan collateralized by the Mountain View
asset was impaired and has recorded and maintains a valuation allowance of
$1,032,272.
In May 1998, the borrower on the Lifestyles PIMI defaulted on its debt
service payment on the insured first mortgage. The Trust agreed to a new workout
that runs through 2007. Under its terms, the Trust agreed to reduce the
effective interest rate on the insured first mortgage by 1.75% retroactively for
1998 to clear the default, by 1.75% for 1999, and by 1.5% each year thereafter
until the property is sold or refinanced. An affiliate of the Advisor refunds
approximately .25% per annum to the Trust related to the interest reduction. The
borrower made a $550,000 equity contribution, which was escrowed, for the
exclusive purpose of correcting deferred maintenance and making capital
improvements to the property. The escrow has been used up for paint, building
repairs, parking lot repairs, a new fitness facility, clubhouse remodeling and
landscaping. Any Surplus Cash that is generated by property operations will be
split evenly between the Trust and the borrower. When the property is sold or
refinanced, the first $1,100,000 of any proceeds remaining after the insured
mortgage is paid off will be split 50% / 50% between the Trust and the borrower;
the next $1,690,220 of proceeds will be split 75% to the Trust and 25% to the
borrower; and any remaining proceeds will be split 50% / 50%. The borrower's new
equity and the reduction in the effective interest rate on the insured first
mortgage have provided funds for repairs and improvements that have helped
reposition Lifestyles. As a result of the factors described above, the Trust
determined that the Additional Loan collateralized by the Lifestyles asset was
impaired, and recorded a valuation allowance of $1,130,346 in the fourth quarter
of 1998. During 2001, the Trust received $118,968 of surplus cash generated by
property operations. The Trust recognized this receipt as a reduction of
principal balance of the Additional Loan and related impairment provision. In
addition, the Trust
F-26
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMIS (CONTINUED)
further determined that the valuation allowance should be reduced by an
additional $344,839 based upon the current estimated fair value of the
underlying property.
At December 31, 2001 and 2000 there are no Insured Mortgage loans within the
Trust's portfolio that are delinquent as to principal or interest.
The Trust's investments in PIMIs consist of the following at December 31,
2001 and 2000:
BALANCE OUTSTANDING AT
ORIGINAL APPROXIMATE DECEMBER 31,
LOAN MONTHLY INTEREST MATURITY ----------------------------
INSURED MORTGAGE AMOUNT PAYMENTS RATE DATE 2001 2000
---------------- ----------- ----------- -------- ---------- ----------- -----------
Lifestyles (GNMA).......................... $10,292,394 $ 63,000 7.000%(a) 05/01/2032 $ 9,837,873 $ 9,904,652
Windward (GNMA)............................ 14,000,778 103,000 8.500%(b) 06/01/2032 13,434,399 13,518,840
Mountain View (FHA)........................ 9,547,700 58,000 6.875%(c) 01/01/2034 9,208,461 9,264,428
Red Run (FHA).............................. 19,019,600 130,000 7.875% 05/01/2034 18,330,825 18,446,243
The Seasons (FHA).......................... 9,075,351 -- -- -- -- 8,617,922
----------- -------- ----------- -----------
$61,935,823 $354,000 $50,811,558(d) $59,752,085
=========== ======== =========== ===========
OUTSTANDING BALANCE BASE PREFERRED
--------------------------- MATURITY INTEREST INTEREST
ADDITIONAL LOAN 2001 2000 DATE RATE RATE
--------------- ---------- ----------- ---------- -------- ---------
Lifestyles(a):
Due Contractually......................................... $1,817,665 $ 1,817,665 05/14/2007 -- --
Interest applied.......................................... (118,968) --
---------- -----------
Carrying Value............................................ 1,698,697 1,817,665
Windward(b)................................................. 2,471,294 2,471,294 07/07/2002 7.5% 10%
Mountain View(c)............................................ 1,400,000 1,400,000 09/16/2003 7.0% --
Red Run..................................................... -- 2,900,000 -- -- --
The Seasons................................................. -- 1,924,649 -- -- --
---------- -----------
$5,569,991(e) $10,513,608
========== ===========
------------------------------
(a) The Trust entered into an Agreement which reduced the interest rate on the
Insured Mortgage by 1.75% per annum effective January 1, 1998 for a period
of twenty-four months and by 1.5% per annum for 2000 though 2007. An
affiliate of the Advisor refunds approximately .25% per annum to the Trust
related to the interest reduction. The Trust will not receive any Additional
Loan interest or Preferred Return due to the workout, but will receive a
share of any cash generated from property operations and from proceeds of a
sale or refinance.
(b) The Trust entered into an agreement which reduced the interest rate on the
Insured Mortgage by 2.0% per annum for 1997 and by 1.0% for 1998 through
2000. In addition, the Preferred Interest was reduced by 1% and Additional
Loan Interest is payable from surplus cash.
(c) The Trust entered into a second modification agreement which reduced the
interest rate on the Insured Mortgage by 1.25% per annum effective
January 1, 1999 and continuing through December 31, 2004. The Agreement
eliminated the Preferred Interest required under the Additional Loan and
changed the Trust's participation in the surplus cash generated by the
property. Furthermore, debt service relief provided by the first
modification was forgiven.
(d) The aggregate cost for federal income tax purposes is $50,811,558.
(e) The aggregate cost for federal income tax purposes is $5,688,959.
F-27
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMIS (CONTINUED)
IMPAIRED ADDITIONAL LOANS
The Advisor of the Trust has determined that the Lifestyles Additional Loan
is impaired. As a result, during 1998, a valuation allowance of $1,130,346 was
established to adjust the carrying amount of the loan to the estimated fair
market value of the collateral less anticipated costs of sale. During 2001, the
Trust received $118,968 of interest on the Additional Loan which was reflected
as a reduction of the carrying amount of the loan and the valuation allowance.
In addition in the fourth quarter of 2001, the Trust further reduced the
valuation allowance by $344,839 to $666,539 based upon the current estimated
fair value of the underlying property. The Trust will continue to reflect
interest receipts as reductions to the carrying amount of the loan and the
valuation allowance until the valuation allowance is zero. The Trust did not
receive any interest payments on the Lifestyles Additional Loan during 2000 or
1999 and did not recognize any interest income during 2001, 2000 or 1999.
The Advisor of the Trust has determined that the Mountain View Additional
Loan is impaired. As a result, during 1998, a valuation allowance of $984,000
was established to adjust the carrying amount of the loan to the then estimated
fair market value of the collateral less anticipated costs of sale. During 1999,
the Trust increased the valuation allowance of Mountain View by $48,272. The
Trust will reflect interest receipts as reductions to the carrying amount of the
loan and the valuation allowance until the valuation allowance is zero. The
Trust did not receive any interest payments or recognize any income on the
Mountain View Additional Loan during 2001, 2000 or 1999.
The activity in the valuation allowance together with the related recorded
and carrying value of the mortgage loans is as follows:
RECORDED VALUATION CARRYING
VALUE ALLOWANCE VALUE
---------- ---------- ----------
Lifestyles.................................................. $1,698,697 $ 666,539 $1,032,158
Mountain View............................................... 1,400,000 1,032,272 367,728
---------- ---------- ----------
Balance at December 31, 2001................................ $3,098,697 $1,698,811 $1,399,886
========== ========== ==========
The Trust also has deferred income related to Lifestyles and Mountain View
of $687,319 and $367,383, respectively.
A reconciliation of activity for each of the three years in the period ended
December 31, is as follows:
INSURED MORTGAGES
2001 2000 1999
----------- ----------- -----------
Balance at beginning of period.............................. $59,752,085 $60,129,492 $75,386,460
Insured Mortgage prepayments.............................. (8,575,180) -- (14,861,957)
Principal collections..................................... (365,347) (377,407) (395,011)
----------- ----------- -----------
Balance at end of period.................................... $50,811,558 $59,752,085 $60,129,492
=========== =========== ===========
ADDITIONAL LOANS
Balance at beginning of period.............................. $ 8,350,990 $ 8,350,990 $11,243,862
Interest received and recognized as
Additional Loan prepayment................................ (118,968) -- --
Additional Loan prepayments............................... (4,824,649) -- (2,844,600)
Adjustment to valuation allowance......................... 463,807 -- (48,272)
----------- ----------- -----------
Balance at end of period.................................. $ 3,871,180 $ 8,350,990 $ 8,350,990
=========== =========== ===========
PROPERTY DESCRIPTIONS:
- Lifestyles Apartments ("Lifestyles") is a 236-unit garden style apartment
complex located in Palm Harbor, Florida.
- Windward Lakes Apartments ("Windward") is a 276-unit garden style
apartment complex located in Pompano Beach, Florida.
- Mountain View Apartments ("Mountain View") is a 256-unit apartment complex
located in Madison, Alabama.
- Red Run Apartments ("Red Run") is a 304-unit apartment complex located in
Owings Mills, Maryland.
D. PIMS
The Trust had investments in five PIMs at December 31, 2001 and 2000. The
Trust's PIMs consist of a GNMA or Fannie Mae MBS or a sole participation
interest in a HUD-insured first mortgage loan originated under the FHA lending
program (collectively the "Insured Mortgages"), and participation interests in
the revenue stream and appreciation of the underlying property above specified
base levels. The borrower conveys these participation features to the Trust
generally through a subordinated promissory note and mortgage (the "Agreement").
The Trust receives guaranteed level monthly payments of principal and
interest, amortized over thirty to forty years. The GNMA and Fannie Mae MBS are
guaranteed by GNMA and Fannie Mae and HUD insures the mortgage loan underlying
the GNMA MBS and the FHA mortgage loan. The borrower usually cannot prepay the
insured mortgage during the first five years but may prepay it thereafter
subject to a
F-28
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
D. PIMS (CONTINUED)
9% prepayment penalty in years six through nine, a 1% prepayment penalty in year
ten and no prepayment penalty thereafter. The Trust may receive income related
to its participation interests in the underlying property, however, these
amounts are neither insured nor guaranteed.
Generally, the participation features consist of the following:
(i) "Minimum Additional Interest" at rates ranging from .5% to .75% per annum
calculated on the unpaid principal balance of the Insured Mortgage on the
underlying property, (ii) "Shared Income Interest" ranging from 25% to 30% of
the monthly gross rental income generated by the underlying property in excess
of a specified base, but only to the extent that it exceeds the amount of
Minimum Additional Interest received during such month, and (iii) "Shared
Appreciation Interest" ranging from 25% to 30% of any increase in value of the
underlying property in excess of a specified threshold.
Payment of participation interest from the operations of the property is
limited to 50% of net revenue or Surplus Cash as defined by Fannie Mae or HUD,
respectively. Payment of participation interest at the time of the prepayment of
the PIM or upon its maturity generally cannot exceed 50% of any increase in
value of the underlying property.
Shared Appreciation Interest is payable when one of the following occurs:
(1) the sale of the underlying property to an unrelated third party on a date
which is later than five years from the date of the Agreement, (2) the maturity
date or accelerated maturity date of the Agreement, or (3) prepayment of amounts
due under the Agreement and the Insured Mortgage.
Under the Agreement, the Trust, upon giving twelve months written notice,
can accelerate the maturity date of the Agreement to a date not earlier than ten
years from the date of the Agreement for (a) the payment of all participation
interest due under the Agreement as of the accelerated maturity date, or
(b) the payment of all participation interest due under the Agreement plus all
amounts due on the first mortgage note on the property.
At December 31, 2001 and 2000 there are no Insured Mortgage loans within the
Trust's portfolio that are delinquent of principal or interest.
The Trust's PIMs consisted of the following at December 31, 2001 and 2000:
BALANCE OUTSTANDING AT
ORIGINAL APPROXIMATE DECEMBER 31,
LOAN MONTHLY INTEREST MATURITY ----------------------------
PIM AMOUNT PAYMENTS RATE DATE 2001 2000
--- ----------- ----------- -------- ---------- ----------- -----------
River View (GNMA)........................... $ 9,284,877 $ 64,500 8.000% 01/15/2033 $ 8,905,107 $ 8,964,717
Mill Pond (FHA)............................. 7,812,100 55,200 8.150% 01/01/2033 7,484,720 7,534,451
Waterford (FHA)............................. 6,935,900 48,800 8.125% 08/01/2032 6,625,742 6,671,434
Rivergreens (FHA)........................... 10,003,000 69,500 8.005% 04/01/2033 9,588,286 9,652,263
Lincoln Green (FNMA)........................ 15,565,000 100,000 6.750% 10/01/2002(a) 13,812,638 14,069,369
----------- -------- ----------- -----------
Total..................................... $49,600,877 $338,000 $46,416,493(b) $46,892,234
=========== ======== =========== ===========
------------------------------
(a) Normal monthly benefit is based on a 30-year amortization. All unpaid
principal of approximately $13,583,000 and accrued interest is due at the
maturity date.
(b) The aggregate cost for federal income tax purposes is $46,416,493.
A reconciliation of activity for each of the three years in the period ended
December 31, is as follows:
2001 2000 1999
----------- ----------- -----------
Balance at beginning of period.............................. $46,892,234 $47,331,673 $47,737,583
Principal collections..................................... (475,741) (439,439) (405,910)
----------- ----------- -----------
Balance at end of period.................................... $46,416,493 $46,892,234 $47,331,673
=========== =========== ===========
PROPERTY DESCRIPTIONS:
- River View Apartments ("River View") is a 220-unit apartment complex
located in Columbia, South Carolina.
- Mill Pond Apartments ("Mill Pond") is a 146-unit apartment complex in
Bellbrook, Ohio.
- Waterford Townhomes Apartments ("Waterford") is a 122-unit apartment
complex in Eagen, Minnesota.
- Rivergreens Apartments ("Rivergreens") is a 208-unit apartment complex in
Gladstone, Oregon.
- Lincoln Green Apartments ("Lincoln Green") is a 616-unit apartment complex
in Greensboro, North Carolina.
F-29
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
E. MBS
At December 31, 2001, the Trust's MBS portfolio had an amortized cost of
$9,546,823 and gross unrealized gains of $578,628, respectively. At
December 31, 2001, the Trust had a FHA insured mortgage loan with an amortized
cost of $4,845,897 and gross unrealized gains of $327,232. At December 31, 2000,
the Trust's MBS portfolio had an amortized cost of $11,224,277 and gross
unrealized gains and losses of $445,617 and $741, respectively. At December 31,
2000, the Trust's FHA insured mortgage loan had an amortized cost of $4,867,345
and a gross unrealized gain of $200,271. The Trust's MBS have maturities ranging
from 2008 to 2035.
UNREALIZED
MATURITY DATE FAIR VALUE GAIN/(LOSS)
------------- ----------- -----------
2002-2006................................................... $ -- $ --
2007-2011................................................... 102,831 1,915
2012-2035................................................... 15,195,749 903,945
----------- --------
Total................................................... $15,298,580 $905,860
=========== ========
F. SHAREHOLDERS' EQUITY
Under the Declaration of Trust and commencing with the initial closing of
the public offering of shares, the Trust has declared and paid dividends on a
quarterly basis. During the period in which the Trust qualifies as a REIT, the
Trust has and will pay quarterly dividends aggregating at least 95% of taxable
income on an annual basis to be allocated to the shareholders in proportion to
their respective number of shares.
In order for the Trust to maintain its REIT status with respect to the
requirements of Share ownership, the Declaration of Trust prohibits any investor
from owning, directly or indirectly, more than 9.8% of the outstanding Shares
and empowers the Trustees to refuse to permit any transfer of Shares which, in
their opinion, would jeopardize the status of the Trust as a REIT.
G. RELATED PARTY TRANSACTIONS
Under the terms of the Advisory Service Agreement, the Advisor receives an
Asset Management Fee equal to .75% per annum of the value of the Trust's actual
and committed invested assets payable quarterly.
The Trust also reimburses affiliates of the Advisor for certain costs
incurred in connection with maintaining the books and records of the Trust, the
preparation and mailing of financial reports, tax information and other
communications to investors and legal fees and expenses. Included in the general
and administrative expenses are legal fees and expenses paid by the Trust to an
affiliate of $12,033, $3,305 and $1,285, for the years ended December 31, 2001,
2000 and 1999, respectively.
During the three years ended December 31, 2001, 2000 and 1999, the Trust
received interest collections on Additional Loans with affiliates of the Advisor
of the Trust of $155,738, $173,544 and $225,156, respectively. In addition, the
Trust received $3,431,133 in 2001, $174,505 in 2000 and $153,499 in 1999 related
to Participating Interest Income.
As discussed in Note C, the Trust received a prepayment of the Seasons PIMI
as a result of a sale of the property to an affiliate.
H. ORIGINAL SHARES
Upon termination of the Trust, an affiliate of the Advisor is committed to
pay to holders of Original Shares the amount (if any) by which (a) the
Shareholders' Original Investments exceed (b) all Dividends (as defined in the
prospectus) paid by the Trust with respect to such Original Shares. Original
Shares are those Shares purchased during the Trust's initial public offering
either through purchase or through the dividend reinvestment program and held
until the last mortgage held by the Trust is repaid or disposed of.
I. FEDERAL INCOME TAXES
Net income per statement of income.......................... $15,972,218
Less: Book to tax difference for Additional Loan interest
income.................................................... (1,297,027)
Less: Reduction of provision for impaired mortgage loans.... (344,839)
Less: Book to tax difference for amortization of prepaid
fees and expenses......................................... (648,593)
-----------
Net income for federal income tax purposes.................. $13,681,759
===========
The Trust paid dividends of $1.61 per share during 2001 which represents
approximately $0.91 from ordinary income and $0.70 represents a non-taxable
distribution for federal income tax purposes.
The basis of the Trust's assets for financial reporting purposes is less
than its tax basis by approximately $7,021,000 and $8,209,000 at December 31,
2001 and 2000, respectively. The basis of the Trust's liabilities for financial
reporting purposes exceeded its tax basis by approximately $2,314,000 and
$3,550,000 at December 31, 2001 and 2000, respectively.
F-30
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
J. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The Trust uses the following methods and assumptions to estimate the fair
value of each class of financial instruments:
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short maturity of
those instruments.
MBS
The Trust estimates the fair value of MBS based on quoted market prices
while it estimates the fair value of insured mortgages based on quoted prices of
MBS with similar interest rates. Based on the estimated fair value determined
using these methods and assumptions the Trust's investments in MBS had gross
unrealized gains of approximately $906,000 at December 31, 2001 and gross
unrealized gains and losses of approximately $646,000 and $1,000 at
December 31, 2000.
PIMS AND PIMIS
There is no active trading market for these investments. Accordingly,
management estimates the fair value of the PIMs and the insured mortgage portion
of the PIMIs using quoted market prices of MBS having the same stated coupon
rate as the Insured Mortgages. Additional Loans are based on the estimated fair
value of the underlying properties as an estimate of the fair value of the loan
is not practicable. Management does not include any participation income in the
Trust's estimated fair values, as Management does not believe it can predict the
time of realization of the feature with any certainty. Based on the estimated
fair value determined using these methods and assumptions, the Trust's
investments in PIMs and PIMIs had gross unrealized gains of approximately
$2,403,000 at December 31, 2001 and gross unrealized gains and losses of
approximately $343,000 and $1,738,000, respectively at December 31, 2000.
At December 31, 2001 and 2000, the Trust estimated the fair value of its
financial instruments as follows:
2001 2000
------------------- -------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
Cash and cash equivalents................................... $ 13,154 $ 13,154 $ 5,359 $ 5,359
MBS......................................................... 15,299 14,971 16,737 16,536
PIMs and PIMIs:
PIMs...................................................... 47,803 46,416 46,594 46,892
Insured mortgages......................................... 51,828 50,812 58,655 59,752
Additional Loans.......................................... 3,871 3,871 8,351 8,351
-------- -------- -------- --------
$131,955 $129,224 $135,696 $136,890
======== ======== ======== ========
K. SUBSEQUENT EVENTS
On January 3, 2002, the Trust received $18,330,825 representing the
principal proceeds on the first mortgage note from the Red Run PIMI. The Advisor
declared a special dividend of $1.68 per share from the proceeds of the Red Run
PIMI prepayment which was paid on January 16, 2002.
On January 2, 2002, the Trust received a prepayment of the Waterford
Apartments Subordinate Promissory note. The Trust received $379,725 of Minimum
Additional Interest and $425,643 of Shared Appreciation Interest. On
January 17, 2002, the Trust received $6,625,742 representing the principal
proceeds on the first mortgage. In addition, the Trust received a prepayment
premium of $66,257 from the payoff. The Advisor has declared a special dividend
of $0.51 per share from the proceeds of the Waterford Apartments PIM prepayment
which will be paid in the first quarter of 2002.
F-31
KRUPP GOVERNMENT INCOME TRUST
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
2001
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES RECOVERIES PERIOD
----------- ---------- ---------- ---------- ----------
Additional Loan
impairment provision........................................ $2,162,618 $ -- $(463,807) $1,698,811
---------- ------- --------- ----------
2000
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES RECOVERIES PERIOD
----------- ---------- ---------- ---------- ----------
Additional Loan
impairment provision........................................ $2,162,618 $ -- $ -- $2,162,618
---------- ------- --------- ----------
1999
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES RECOVERIES PERIOD
----------- ---------- ---------- ---------- ----------
Additional Loan
impairment provision........................................ $2,114,346 $48,272 $ -- $2,162,618
---------- ------- --------- ----------
F-32
KRUPP GOVERNMENT INCOME TRUST
SUPPLEMENTARY DATA
SELECTED QUARTERLY FINANCIAL DATA
(UNAUDITED)
FOR THE QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2001 2001 2001 2001
---------- ---------- ------------- ------------
Total revenues.............................................. $2,795,745 $2,731,138 $6,059,462 $6,946,031
========== ========== ========== ==========
Net income.................................................. $2,140,379 $2,045,187 $5,360,536 $6,426,116
========== ========== ========== ==========
Earnings per Share.......................................... $ .14 $ .14 $ .35 $ .43
========== ========== ========== ==========
FOR THE QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2000 2000 2000 2000
---------- ---------- ------------- ------------
Total revenues.............................................. $2,657,314 $2,660,457 $2,697,284 $3,061,013
========== ========== ========== ==========
Net income.................................................. $2,027,459 $1,964,868 $1,986,007 $2,450,778
========== ========== ========== ==========
Earnings per Share.......................................... $ .13 $ .14 $ .13 $ .16
========== ========== ========== ==========
F-33
KRUPP GOVERNMENT INCOME TRUST
BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED)
ASSETS
Participating Insured Mortgage Investments ("PIMIs") (Note
2)
Insured Mortgages......................................... $32,370,341 $ 50,811,558
Additional Loans, net of impairment provision of
$1,698,811.............................................. 3,871,180 3,871,180
Participating Insured Mortgages ("PIMs")(Note 2).......... 30,689,220 46,416,493
Mortgage-Backed Securities and insured mortgage loan ("MBS")
(Note 3).................................................. 11,729,120 14,971,348
----------- ------------
Total mortgage investments.............................. 78,659,861 116,070,579
Cash and cash equivalents................................... 5,690,643 13,154,231
Interest receivable and other assets........................ 499,770 756,832
Prepaid acquisition fees and expenses, net of accumulated
amortization of $3,198,380 and $6,249,229, respectively... 176,581 541,044
Prepaid participation servicing fees, net of accumulated
amortization of $1,021,992 and $1,999,913, respectively... 102,968 263,455
----------- ------------
Total assets............................................ $85,129,823 $130,786,141
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred income on Additional Loans......................... $ 2,175,972 $ 2,336,154
Other liabilities........................................... 117,278 20,485
----------- ------------
Total liabilities....................................... 2,293,250 2,356,639
----------- ------------
Shareholders' equity (Note 4)
Common stock, no par value; 17,510,000 Shares authorized;
15,053,135 Shares issued and outstanding................ 82,440,175 127,850,874
Accumulated comprehensive income.......................... 396,398 578,628
----------- ------------
Total Shareholders' equity.............................. 82,836,573 128,429,502
----------- ------------
Total liabilities and Shareholders' equity.............. $85,129,823 $130,786,141
=========== ============
The accompanying notes are an integral part of the financial statements.
F-34
KRUPP GOVERNMENT INCOME TRUST
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(UNAUDITED)
Revenues:
Interest income--PIMs and PIMIs:
Basic interest.......................................... $1,248,030 $2,044,820 $2,620,518 $4,119,434
Additional Loan interest (Note 5)....................... 80,091 185,938 160,182 371,877
Participation interest (Note 5)......................... 1,092,626 118,968 1,964,251 251,850
Interest income--MBS...................................... 451,728 317,954 743,714 643,543
Interest income--cash and cash equivalents................ 34,949 63,458 90,569 140,179
---------- ---------- ---------- ----------
Total revenues........................................ 2,907,424 2,731,138 5,579,234 5,526,883
---------- ---------- ---------- ----------
Expenses:
Asset management fee to an affiliate...................... 157,141 247,593 327,625 493,669
Expense reimbursements to affiliates...................... 55,377 65,531 92,188 112,040
Amortization of prepaid fees and expenses................. 248,967 257,434 524,950 514,868
General and administrative................................ 117,574 115,393 219,293 220,740
---------- ---------- ---------- ----------
Total expenses........................................ 579,059 685,951 1,164,056 1,341,317
---------- ---------- ---------- ----------
Net income.................................................. 2,328,365 2,045,187 4,415,178 4,185,566
Other comprehensive income:
Net change in unrealized gain on MBS...................... (199,669) 18,847 (182,230) 70,725
---------- ---------- ---------- ----------
Total comprehensive income.................................. $2,128,696 $2,064,034 $4,232,948 $4,256,291
========== ========== ========== ==========
Basic earnings per Share.................................... $ .15 $ .14 $ .29 $ .28
---------- ---------- ---------- ----------
Weighted average Shares outstanding......................... 15,053,135 15,053,135
The accompanying notes are an integral part of the financial statements.
F-35
KRUPP GOVERNMENT INCOME TRUST
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
2002 2001
------------ -----------
(UNAUDITED)
Operating activities:
Net income................................................ $ 4,415,178 $ 4,185,566
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of (discounts) and premiums................ (150,057) 1,082
Amortization of prepaid fees and expenses............... 524,950 514,868
Changes in assets and liabilities:
Decrease in interest receivable and other assets...... 257,062 137,624
Decrease in deferred income on Additional Loans....... (160,182) (183,768)
Increase in other liabilities......................... 96,793 24,307
------------ -----------
Net cash provided by operating activities........... 4,983,744 4,679,679
------------ -----------
Investing activities:
Principal collections on MBS.............................. 3,210,055 805,417
Principal collections on PIMs and Insured Mortgages....... 34,168,490 433,843
------------ -----------
Net cash provided by investing activities........... 37,378,545 1,239,260
------------ -----------
Financing activity:
Dividends................................................. (49,825,877) (5,118,066)
------------ -----------
Net increase (decrease) in cash and cash equivalents........ (7,463,588) 800,873
Cash and cash equivalents, beginning of period.............. 13,154,231 5,359,041
------------ -----------
Cash and cash equivalents, end of period.................... $ 5,690,643 $ 6,159,914
============ ===========
Non Cash Activities:
Increase (decrease) in Fair Value of MBS.................. $ (182,230) $ 70,725
============ ===========
The accompanying notes are an integral part of the financial statements.
F-36
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. ACCOUNTING POLICIES
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted in this report
pursuant to the Rules and Regulations of the Securities and Exchange Commission.
However, in the opinion of Berkshire Mortgage Advisors Limited Partnership (the
"Advisor"), which is the advisor to Krupp Government Income Trust (the "Trust"),
the disclosures contained in this report are adequate to make the information
presented not misleading. See Notes to Financial Statements in the Trust's
financial statements for the year ended December 31, 2001 for additional
information relevant to significant accounting policies followed by the Trust.
In the opinion of the Advisor of the Trust, the accompanying unaudited
financial statements reflect all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the Trust's financial position
as of June 30, 2002, results of its operations for the three and six months
ended June 30, 2002 and 2001 and its cash flows for the six months ended
June 30, 2002 and 2001.
The results of operations for the three and six months ended June 30, 2002
are not necessarily indicative of the results which may be expected for the full
year. See Management's Discussion and Analysis of Financial Condition and
Results of Operations included in this report.
2. PIMS AND PIMIS
At June 30, 2002, the Trust's PIMs and PIMIs, including Additional Loans,
had a fair value of $69,301,795 and gross unrealized gains of $2,371,054. The
PIMs and PIMIs have maturities ranging from 2002 to 2034. At June 30, 2002,
there are no insured mortgage loans within the Trust's portfolio, that are
delinquent of principal or interest.
Lifestyle and Mountain View have been adversely affected by their
competitive rental housing markets. Based on the Advisor's analysis of market
conditions and property operations, the Trust maintains a valuation allowance of
$1,032,272 for Mountain View and $666,539 for Lifestyles.
On June 28, 2002, the Trust received a prepayment of the Lincoln Green
Apartments Subordinated Promissory Note. The Trust received $725,000 of Shared
Appreciation Interest and $278,785 of Shared Income Interest and Minimum
Additional Interest. On July 25, 2002, the Trust received $13,676,641
representing the principal proceeds on the first mortgage note. The Advisor
expects to pay a special dividend of $0.99 per share from the proceeds of the
Lincoln Green Apartments PIM prepayment.
On May 15, 2002, the Trust received $8,884,123 representing the principal
proceeds on the first mortgage loan from the River View Apartments PIM. In
addition, the Trust received a prepayment premium of $88,841 from the payoff. On
June 4, 2002, the Trust paid a special dividend of $0.61 per share from the
proceeds of the River View Apartments PIM prepayment.
On January 3, 2002, the Trust received $18,330,825 representing the
principal proceeds on the first mortgage loan from the Red Run PIMI. On
December 31, 2001 the Trust received a prepayment of the Red Run Additional Loan
and Subordinated Promissory Note. The Trust received $2,900,000 of Additional
Loan Principal, $238,369 of Shared Appreciation Interest, $3,506,952 of
Preferred Interest and $67,667 of Base Interest on the Additional Loan. On
January 16, 2002, the Trust paid a special dividend of $1.68 per share from the
proceeds of the Red Run PIMI prepayment.
On January 2, 2002, the Trust received a prepayment of the Waterford
Apartments Subordinate Promissory Note. The Trust received $379,725 of Minimum
Additional Interest and $425,643 of Shared Appreciation Interest. On
January 17, 2002, the Trust received $6,625,742 representing the principal
proceeds on the first mortgage loan. In addition, the Trust received a
prepayment premium of $66,257 from the payoff. On March 1, 2002, the Trust paid
a special dividend of $0.51 per share from the proceeds of the Waterford
Apartments PIM prepayment.
3. MBS
At June 30, 2002, the Trust's MBS portfolio, had an amortized cost of
$6,498,286 and unrealized gains of $396,398. At June 30, 2002, the Trust's
insured mortgage loan had an amortized cost of $4,834,436. The portfolio, has
maturities ranging from 2008 to 2035.
On May 15, 2002, the Trust received $2,487,447 representing the principal
proceeds on the first mortgage loan from the Parkwest Apartments MBS. In
addition, the Trust received a prepayment premium of $49,749 from this payoff.
On June 19, 2002, the Trust paid a special dividend of $0.17 per share from the
proceeds of the Parkwest Apartments MBS prepayment.
F-37
KRUPP GOVERNMENT INCOME TRUST
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. CHANGES IN SHAREHOLDERS' EQUITY
A summary of changes in shareholders' equity for six months ended June 30,
2002 is as follows:
TOTAL ACCUMULATED
COMMON RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK EARNINGS INCOME EQUITY
------------ ----------- ------------- -------------
Balance at December 31, 2001................................ $127,850,874 $ -- $ 578,628 $128,429,502
Net income.................................................. -- 4,415,178 -- 4,415,178
Dividends................................................... (45,410,699) (4,415,178) -- (49,825,877)
Change in unrealized gain on MBS............................ -- -- (182,230) (182,230)
------------ ----------- --------- ------------
Balance at June 30, 2002.................................... $ 82,440,175 $ -- $ 396,398 $ 82,836,573
============ =========== ========= ============
5. RELATED PARTY TRANSACTIONS
The Trust received $86,609 of Additional Loan Interest during the six months
ended June 30, 2001 from an affiliate of the Advisor. The Trust also received
participation interest of $50,750 from an affiliate of the Advisor during the
six months ended June 30, 2001.
6. SUBSEQUENT EVENT
On July 1, 2002, the Trust granted a sixty day extension of the maturity
date of the Windward Lakes Additional Loan Agreement and Additional Loan Note.
The new maturity date is September 5, 2002.
F-38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Trustees and Shareholders of
Krupp Government Income Trust II:
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Krupp
Government Income Trust II (the "Trust") at December 31, 2001 and 2000, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the accompanying index presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related financial statements. These financial statements
and financial statement schedule are the responsibility of the Trust's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which 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 financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 14, 2002
F-39
KRUPP GOVERNMENT INCOME TRUST II
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
------------ ------------
ASSETS
Participating Insured Mortgage Investments ("PIMIs")(Notes
B, C and I)
Insured mortgages......................................... $ 85,625,185 $121,208,064
Additional loans, net of impairment provision of $500,000
and $2,000,000, respectively............................ 17,654,500 22,292,351
Participating Insured Mortgages ("PIMs") (Notes B, D and
I)........................................................ 37,239,922 37,631,330
Mortgage-Backed Securities ("MBS") (Notes B, E and I)....... 15,600,964 19,124,031
------------ ------------
Total mortgage investments.............................. 156,120,571 200,255,776
------------ ------------
Cash and cash equivalents (Notes B and I)................... 6,453,663 7,089,453
Interest receivable and other assets........................ 1,174,106 1,552,568
Prepaid acquisition fees and expenses, net of accumulated
amortization of $7,964,938 and $8,957,065, respectively
(Note B).................................................. 2,913,250 4,838,771
Prepaid participation servicing fees, net of accumulated
amortization of $2,420,697 and $2,711,086, respectively
(Note B).................................................. 1,102,473 1,784,633
------------ ------------
Total assets............................................ $167,764,063 $215,521,201
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred income on Additional Loans (Note B)................ $ 1,242,282 $ 2,503,604
Other liabilities........................................... 25,985 53,273
------------ ------------
Total liabilities....................................... 1,268,267 2,656,877
------------ ------------
Shareholders' equity (Notes A, F and J)
Common stock, no par value; 25,000,000 Shares authorized;
18,371,477 Shares issued and outstanding................ 166,214,677 212,783,023
Accumulated comprehensive income (Notes B and E).......... 281,119 81,301
------------ ------------
Total Shareholders' equity.............................. 166,495,796 212,864,324
------------ ------------
Total liabilities and Shareholders' equity.............. $167,764,063 $215,521,201
============ ============
The accompanying notes are an integral part of the financial statements.
F-40
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
----------- ----------- -----------
Revenues:
Interest income--PIMs and PIMIs:
Basic interest.......................................... $ 9,673,656 $11,259,617 $11,998,012
Additional Loan interest................................ 2,207,942 1,783,933 1,712,260
Participation interest.................................. 11,873,054 1,915,557 1,591,932
Interest income--MBS...................................... 1,197,120 1,455,367 3,251,078
Interest income--cash and cash equivalents................ 378,045 563,723 1,059,900
----------- ----------- -----------
Total revenues........................................ 25,329,817 16,978,197 19,613,182
----------- ----------- -----------
Expenses:
Asset management fee to an affiliate (Note G)............. 1,309,430 1,529,418 1,718,942
Expense reimbursements to affiliates (Note G)............. 267,554 300,348 276,901
Amortization of prepaid fees and expenses (Note B)........ 2,607,681 2,131,748 2,365,254
General and administrative (Note G)....................... 504,174 385,879 277,747
Reduction of provision for impaired additional loan (Notes
B and C)................................................ (1,500,000) (994,000) --
----------- ----------- -----------
Total expenses........................................ 3,188,839 3,353,393 4,638,844
----------- ----------- -----------
Net income (Notes B and H).................................. 22,140,978 13,624,804 14,974,338
Other comprehensive income:
Net change in unrealized gain (loss) on MBS............... 199,818 635,251 (1,101,186)
----------- ----------- -----------
Total comprehensive income.................................. $22,340,796 $14,260,055 $13,873,152
=========== =========== ===========
Basic earnings per Share.................................... $ 1.21 $ .74 $ .82
=========== =========== ===========
Weighted average Shares outstanding......................... 18,371,477 18,371,477 18,371,477
=========== =========== ===========
The accompanying notes are an integral part of the financial statements.
F-41
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
ACCUMULATED TOTAL
RETAINED COMPREHENSIVE SHAREHOLDERS'
COMMON STOCK EARNINGS INCOME (LOSS) EQUITY
------------ ------------ ------------- -------------
Balance at December 31, 1998.................... $264,099,856 $ -- $ 547,236 $264,647,092
Dividends....................................... (35,179,844) (14,974,338) -- (50,154,182)
Net income...................................... -- 14,974,338 -- 14,974,338
Change in unrealized loss on MBS................ -- -- (1,101,186) (1,101,186)
------------ ------------ ----------- ------------
Balance at December 31, 1999.................... 228,920,012 -- (553,950) 228,366,062
Dividends....................................... (16,136,989) (13,624,804) -- (29,761,793)
Net income...................................... -- 13,624,804 -- 13,624,804
Change in unrealized gain on MBS................ -- -- 635,251 635,251
------------ ------------ ----------- ------------
Balance at December 31, 2000.................... 212,783,023 -- 81,301 212,864,324
Dividends....................................... (46,568,346) (22,140,978) -- (68,709,324)
Net income...................................... -- 22,140,978 -- 22,140,978
Change in unrealized gain on MBS................ -- -- 199,818 199,818
------------ ------------ ----------- ------------
Balance at December 31, 2001.................... $166,214,677 $ -- $ 281,119 $166,495,796
============ ============ =========== ============
Shares issued and outstanding for each of the three years in the period ended
December 31, are 18,371,477.
The accompanying notes are an integral part of the financial statements.
F-42
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
----------- ----------- ------------
Operating activities:
Net income................................................ $22,140,978 $13,624,804 $ 14,974,338
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of net premium............................. 75,585 58,017 173,055
Amortization of prepaid fees and expenses............... 2,607,681 2,131,748 2,365,254
Reduction of provision for impaired additional loans.... (1,500,000) (994,000) --
Changes in assets and liabilities:
Decrease in interest receivable and other assets...... 378,462 76,981 53,333
Decrease in deferred income on Additional Loans....... (1,261,322) (189,372) (26,367)
(Decrease) increase in other liabilities.............. (127,288) 3,248 106,462
----------- ----------- ------------
Net cash provided by operating activities................. 22,314,096 14,711,426 17,646,075
----------- ----------- ------------
Investing activities:
Principal collections on MBS.............................. 3,647,045 2,580,441 19,432,484
Principal collections on Additional Loans................. 6,137,851 -- 2,000,000
Principal collections on PIMs and Insured Mortgages....... 35,974,542 10,905,706 1,718,718
----------- ----------- ------------
Net cash provided by investing activities................. 45,759,438 13,486,147 23,151,202
----------- ----------- ------------
Financing activity:
Dividends................................................. (68,709,324) (29,761,793) (50,154,182)
Net decrease in cash and cash equivalents................. (635,790) (1,564,220) (9,356,905)
Cash and cash equivalents, beginning of period............ 7,089,453 8,653,673 18,010,578
----------- ----------- ------------
Cash and cash equivalents, end of period.................. $ 6,453,663 $ 7,089,453 $ 8,653,673
=========== =========== ============
Non cash activities:
Increase (decrease) in Fair Value of MBS................ $ 199,818 $ 635,251 $ (1,101,186)
=========== =========== ============
The accompanying notes are an integral part of the financial statements.
F-43
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS
A. ORGANIZATION
Krupp Government Income Trust II (the "Trust") was formed on February 8,
1991 by filing a Declaration of Trust in The Commonwealth of Massachusetts. The
Trust is authorized to sell and issue not more than 25,000,000 shares of
beneficial interest (the "Shares"). The Trust was organized for the purpose of
investing in commercial and multi-family loans and mortgage backed securities.
Berkshire Mortgage Advisors Limited Partnership (the "Advisor") acquired 10,000
of such Shares for $200,000 and 18,315,158 Shares were sold for $365,686,058 net
of purchase volume discounts of $617,102 under a public offering which commenced
on September 11, 1991 and was completed on February 12, 1993. Under the Dividend
Reinvestment Plan ("DRP"), 46,319 Shares were sold for $880,061. The Trust shall
terminate on December 31, 2030, unless earlier terminated by the affirmative
vote of holders of a majority of the outstanding Shares entitled to vote
thereon.
B. SIGNIFICANT ACCOUNTING POLICIES
The Trust uses the following accounting policies for financial reporting
purposes:
BASIS OF PRESENTATION
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with accounting principles generally accepted
in the United States of America ("GAAP").
MBS
The Trust, in accordance with the Financial Accounting Standards Board's
Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("FAS 115"), classifies its MBS portfolio as available-for-sale. The
Trust carries its MBS at fair market value and reflects any unrealized gains
(losses) as a separate component of Shareholders' Equity. The Trust amortizes
purchase premiums or discounts over the life of the underlying mortgages using
the effective interest method.
PIMS AND PIMIS
The Trust accounts for its MBS portion of a PIM or PIMI investment in
accordance with FAS 115, under the classification of held to maturity. The Trust
carries these MBS at amortized cost.
The insured mortgage portion of the Federal Housing Administration ("FHA")
PIM or PIMI is carried at amortized cost. The Trust holds these mortgages at
amortized cost since they are fully insured by FHA.
The Additional Loans are carried at amortized cost unless the Advisor
believes there is an impairment in value, in which case a valuation allowance is
established in accordance with FAS 114 and FAS 118.
Basic interest is recognized based on the stated rate of the Department of
Housing and Urban Development ("HUD") Insured Mortgage loan (less the servicer's
fee) or the coupon rate of the Fannie Mae MBS. The Trust recognizes interest
related to the participation features when the amount becomes fixed and the
transaction that gives rise to such amount is consummated. The Trust defers the
recognition of Additional Loan interest payments as income to the extent these
interest payments are from escrows established with the proceeds of the
Additional Loan. When the properties underlying the PIMIs generate sufficient
cash flow to make the required Additional Loan interest payments and the
Additional Loan value is deemed collectible, the Trust recognizes income as
earned and commences amortizing deferred interest amounts into income over the
remaining estimated term of the Additional Loan. During periods where mortgage
loans are impaired the Trust suspends amortizing deferred interest.
The Trust also fully reserves the portion of any Additional Loan interest
payment satisfied through the issuance of an operating loan and any associated
interest due on such operating loan. The Trust will recognize the income related
to the operating loan when the borrower repays amounts due under the operating
loan.
IMPAIRED MORTGAGE LOANS
Impaired loans are those loans which the Advisor believes that the
collection of all amounts due in accordance with the contractual terms of the
loan agreement are not likely. Impaired loans are measured based on the fair
value of the underlying collateral. Interest received on impaired loans is
generally applied against the loan principal.
CASH EQUIVALENTS
The Trust includes all short-term investments with maturities of three
months or less from the date of acquisition in cash and cash equivalents. The
Trust invests its cash primarily in agency paper, and money market funds with a
commercial bank and has not experienced any loss to date on its invested cash.
PREPAID FEES AND EXPENSES
Prepaid fees and expenses represent prepaid acquisition fees and expenses
and prepaid participation servicing fees paid for the acquisition and servicing
of PIMs and PIMIs. The Trust amortizes prepaid acquisition fees and expenses
using a method that approximates the effective interest method over a period of
ten to twelve years, which represents the estimated life of the underlying
mortgage. The prepaid participation servicing fees are amortized using a method
that approximates the effective interest method over a ten-year period beginning
at final endorsement of the loan if a HUD-insured loan and at closing if a
Fannie Mae loan.
F-44
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
B. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Upon the repayment of a PIM or PIMI, any unamortized acquisition fees and
expenses and unamortized participation servicing fees related to such loan are
expensed.
INCOME TAXES
The Trust has elected to be taxed as a REIT under the Internal Revenue Code
of 1986, as amended, and believes it will continue to meet all such
qualifications. Accordingly, the Trust will not be subject to federal income
taxes on amounts distributed to shareholders provided it distributes annually at
least 90% of its REIT taxable income and meets certain other requirements for
qualifying as a REIT. Therefore, no provision for federal income taxes has been
recorded in the financial statements.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, contingent assets and liabilities and revenues and
expenses during the period. Significant estimates include the net carrying value
of Additional Loans and the unrealized gain on MBS investments. Actual results
could differ from those estimates.
C. PIMIS
The Trust had investments in seven PIMIs at December 31, 2001 and nine at
December 31, 2000 that provide the permanent financing for multi-family housing.
Each PIMI consists of either a Fannie Mae MBS or a sole participation interest
in a HUD-insured first mortgage loan originated under the FHA lending program
(collectively, the "insured mortgages") and an "Additional Loan" made to the
borrower or the owners of the borrower to provide additional funds for the
construction or permanent financing of the property. The FHA first mortgage loan
and the first mortgage underlying the Fannie Mae MBS provide the borrower with a
below market interest rate loan, and in return, the Trust receives a percentage
of the cash generated from the property operations ("Participating Income
Interest") and a percentage of any appreciation thereafter ("Participating
Appreciation Interest") (collectively the "participation interest").
The borrower conveys the participation features to the Trust through a
subordinated promissory note and mortgage or a subordinate loan agreement
(collectively the "Agreements"). The Trust makes the Additional Loan under the
Fannie Mae PIMIs directly to the borrower of the first mortgage loan underlying
the Fannie Mae MBS, and the borrower collateralizes the Additional Loan with a
subordinated mortgage on the property. The owners of the borrower also pledge
their ownership interests in the borrower as additional collateral.
The Trust made the Additional Loans on the FHA PIMIs to the owners of the
entity having the FHA first mortgage loan, and the owners collateralize the
Additional Loan by pledging their ownership interests in the borrowing entity,
their share of any distributions received, and the proceeds realized upon the
refinancing of the property, sale of the property or sale of the partnership
interests. Unlike the insured mortgages, the Additional Loans are neither
guaranteed nor insured.
The Trust receives level monthly payments of principal and interest
payments, amortizing over thirty to forty years on the insured mortgages and is
also entitled to receive participation interest and semi-annual interest
payments ("Additional Loan interest") and preferred interest under the
Additional Loans and Agreements. While principal and interest payments on the
insured mortgages are insured or guaranteed, there are limitations to the amount
and obligation to pay interest under the Additional Loan and Agreements.
The Agreements for Fannie Mae PIMIs entitles the Trust to receive
(i) semi-annual interest payments on the Additional Loan, (ii) Participating
Income Interest, (iii) Participating Appreciation Interest and (iv) Preferred
Interest. Additional Loan interest accrues at the stated interest rate of the
Additional Loan and Participating Income Interest represents the Trust's share
of the net revenue generated by the property at a stated percentage generally
ranging from 25% to 35%. Additional Loan interest and Participating Income
Interest are payable only to the extent there is net revenue available to pay
these amounts. However, should the borrower be unable to make the full
Additional Loan interest payment, the borrower must notify the Trust of the
amount of the shortfall.
The Trust can require the partners of the borrower to make a capital call
contribution to the borrower to fund 50% of this shortfall, and the Trust will
fund the remainder with an Operating Loan. Also, the Trust is generally limited
to receiving no more than 50% of net revenue on any semi-annual payment date.
Participating Appreciation Interest provides the Trust with a stated percentage,
ranging from 25% to 30%, of the excess value of the property over amounts due
under the first mortgage, Additional Loan and any Operating Loans, the repayment
of capital call contributions, and a return of original equity to the partners
of the borrower.
Participating Appreciation Interest is due upon the sale, refinancing,
maturity or accelerated maturity, or permitted prepayment of all amounts due
under the insured mortgage and Additional Loan. Generally, the Trust will not
receive more than 50% of the excess of value over the outstanding indebtedness,
the payment of Preferred Interest, and the return of equity and capital call
contributions to the partners of the borrower.
Preferred Interest refers to a non-compounded cumulative return from the
closing date of the loan to the date of calculation, at a stated interest rate
generally on the original outstanding balance of the insured mortgage plus the
Additional Loan and any other funds advanced to the borrower (reduced by
principal payments received) less: (i) interest payments on the insured
mortgage, (ii) Additional Loan interest, (iii) Participating Income Interest,
and (iv) Participating Appreciation Interest. Generally, the amount of Preferred
Interest owed cannot exceed the excess of value over the outstanding
indebtedness. Amounts due under the Additional Loan and Agreements are neither
insured nor guaranteed.
F-45
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMIS (CONTINUED)
The Agreements for FHA PIMIs entitle the Trust to receive (i) Participating
Income Interest at a stated percentage usually ranging from 25% to 50% of
(a) all distributable Surplus Cash generated by the property as defined in the
regulatory agreement of the HUD-insured first mortgage loan, (b) unrestricted
cash generated by property operations, and (c) unexpended reserves and escrows;
and (ii) Participating Appreciation Interest at a stated percentage usually
ranging from 20% to 50% of the proceeds or value of the property less the
outstanding indebtedness upon the sale, refinancing, maturity or accelerated
maturity, or permitted prepayment of all amounts due under the insured mortgage
and Additional Loan. Amounts received by the Trust pursuant to this Agreement
reduce amounts payable as Base Interest and Preferred Interest under the FHA
PIMI Additional Loan.
The FHA PIMI Additional Loan interest is payable from the following sources:
(i) any Surplus Cash received as Participating Income Interest, (ii) amounts
conveyed to the Trust by the owners of the borrower representing distributions
of Surplus Cash, and (iii) amounts in reserve accounts established with
Additional Loan proceeds, if available, and any interest earned on these
amounts. As with the Fannie Mae PIMIs, the borrower must notify the Trust of the
amount of any Additional Loan interest shortfall. At its option the Trust can
require the owners of the borrower to make a capital call for 50% of the
shortfall and the Trust in certain situations could convert the remaining 50%
into an operating loan or would forego the remainder.
The FHA PIMIs also require the payment of Preferred Interest at a stated
interest rate from the date of final endorsement to the date of calculation on
the original outstanding balance of the insured mortgage plus the Additional
Loan and any other funds advanced by the Trust to the borrower or owners of the
borrowing entity (reduced by principal payments received) less: (i) interest
payments paid to the Trust under the insured mortgage, (ii) Participating Income
Interest, and (iii) Additional Loan interest payments made under the Additional
Loan including amounts foregone by the Trust.
The insured mortgage and Agreements generally have maturities of 15 to
40 years, however, under the Agreements the Trust can accelerate the maturity
dates at any time after the ninth or tenth anniversary of final endorsement for
the FHA PIMIs or the closing date of the Fannie Mae PIMIs, upon giving twelve
months written notice for the payment.
If the Trust accelerates the maturity date, the Trust can require payment of
all amounts due under the Additional Loan and Agreements through the accelerated
maturity date for the payment of amounts due under the Agreement and the
HUD-insured first mortgage loan (providing the contract of insurance with the
Secretary of HUD is canceled prior to the accelerated maturity date) or
prepayment of the first mortgage loan underlying the Fannie Mae MBS.
FHA PIMIs generally cannot be prepaid for a term of five years from the
construction completion date or final endorsement. After the fifth anniversary
of construction completion or final endorsement, the FHA PIMI may be prepaid
without penalty providing that all amounts due under the Agreements, Additional
Loan and FHA insured mortgage are paid. Fannie Mae PIMIs generally cannot be
prepaid during the five years following the closing date of the underlying first
mortgage loan. Thereafter, the Fannie Mae first mortgage loan may be prepaid
subject to a prepayment penalty that declines each year for the next five years
with no prepayment penalty after the tenth year. Any prepayment of a Fannie Mae
PIMI generally requires prepayment of the first mortgage loan underlying the
Fannie Mae MBS and payment of amounts due under the Agreements and Additional
Loan. The Fannie Mae first mortgage loan would not need to be prepaid if there
is a permitted assumption of the first mortgage loan, however, amounts due under
the Agreement and Additional Loan would need to be prepaid. Any prepayment
usually requires not less than 90 nor more than 180 days prior written notice.
On July 25, 2001, the Trust finalized an agreement with the owner of the
Windmill Lakes property which will allow for the release of the participation
features on the PIMI in the event that the first mortgage, the Additional Loan
and any accrued but unpaid base interest on the Additional Loan are repaid by
September 1, 2002. In addition, the Trust required the owner to pay current and
outstanding Additional Loan base interest as of March 1, 2001 of $512,500. In
the event that the required payments are not received by September 1, 2002, the
participation features will remain in force. As a result of the performance of
the property, the Trust had initially established a valuation allowance of
$2,000,000 on the Additional Loan in 1998. The Trust has reflected the $512,500
received plus $50,000 previously received as a reduction in the principal
balance of the Additional Loan and related impairment provision. Additionally,
based upon improved market conditions and property operations, the Trust has
further reduced the impairment provision by $937,500 to $500,000 at
December 31, 2001.
On July 23, 2001, the Trust received a prepayment of the Seasons
Subordinated Promissory Note and the Seasons Additional Loan. The Trust received
$4,925,351 of the Additional Loan principal, $462,983 of surplus cash,
$2,168,701 of Preferred Interest, $2,693,326 of contingent interest, $176,908 of
Base Interest on Additional Loan and $3,325,696 which represents the Trust's
portion of the residual split. The Trust received $21,926,006 representing the
principal proceeds on the first mortgage note on July 26, 2001. In addition, the
Trust recognized $624,023 of Additional Loan interest that had been previously
received and recorded in deferred income on additional loans. The Advisor paid a
special dividend of $1.95 per share on August 17, 2001 from the proceeds of the
Seasons PIMI prepayment.
The payoff of the Seasons PIMI was a result of the sale of the underlying
property by the borrower, Maryland Associates Limited Partnership ("MALP"),
which is an affiliate of the Adviser, to an affiliate of MALP's general partner.
Because the sale of the underlying property was to an affiliate, the Independent
Trustees of the Trust were required to approve the transaction, which they did
based upon a number of factors, including an appraisal of the underlying
property prepared by an independent third party MAI appraiser. The purchase
price paid by the affiliate for the underlying property was $1.6 million greater
than the value indicated by such appraisal.
During the first quarter of 2001, the Trust received a payoff of the Hunters
Pointe PIMI. The Trust received the outstanding balance on the insured mortgage
of $12,347,267, the outstanding balance on the Additional Loan of $650,000,
Participating Income Interest of $496,207 (including all of the delinquent
amounts), Preferred Interest of $492,543, Participating Appreciation Interest of
$1,070,304 and late fees on the delinquent Participating Income Interest of
$11,021. In addition, the Trust recognized $196,710 of additional loan interest
and $311,132 of
F-46
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMIS (CONTINUED)
Participating Income Interest that had been previously received and recorded in
deferred income on additional loans. On March 20, 2001, the Trust paid a special
dividend of $.83 per share from the proceeds of the Hunters Pointe PIMI payoff.
On December 16, 1999, the Trust received $2,832,907 from Windsor Lake consisting
of $2,000,000 from the payoff of the Additional Loan, $40,000 of Additional Loan
interest and $792,907 of participation interest. The payoff of the balance on
the insured mortgage, $9,172,642 was received on January 26, 2000. The Trust
paid a special dividend of $.66 per Share from the prepayment proceeds on
February 18, 2000.
At December 31, 2001 and 2000 there are no insured mortgage loans within the
Trust's portfolio that are delinquent as to principal or interest.
The Trust's investments in PIMIs consists of the following at December 31,
2001 and 2000:
BALANCE OUTSTANDING AT
DECEMBER 31,
APPROXIMATE --------------------------
LOAN MONTHLY INTEREST MATURITY DATE
INSURED MORTGAGES AMOUNT PAYMENTS RATE 2001 2000
------- ------------ ----------- -------- -------- ----------- ------------
FHA
The Seasons....................................... $ 23,224,649 $ -- -- -- $ -- $ 22,054,045
Hunters Pointe.................................... 12,789,100 -- -- -- -- 12,362,037
Norumbega Point................................... 15,598,500 101,100 7.375% 02/01/36 15,139,275 15,231,817
FNMA (A)
Crossings Village................................. 12,907,334 82,500 6.75% 10/01/08 11,722,936 11,913,997
Martin's Landing.................................. 11,200,000 69,600 6.50% 12/01/08 10,153,225 10,322,038
Sunset Summit..................................... 10,192,801 63,400 6.50% 10/01/08 9,246,686 9,400,427
Oasis............................................. 12,401,673 79,100 6.75% 07/01/09 11,432,503 11,603,141
Windmill Lakes.................................... 11,600,000 74,600 6.825% 03/01/10 10,767,647 10,920,913
The Lakes......................................... 18,387,653 118,000 6.825% 07/01/10 17,162,913 17,399,649
------------ -------- ----------- ------------
$128,301,710 $588,300 $85,625,185 $121,208,064(d)
============ ======== =========== ============
BASE PREFERRED
MATURITY INTEREST INTEREST
ADDITIONAL LOANS 2001 2000 DATE RATE RATE
---------------- ----------- ----------- -------- -------- ---------
The Seasons................................................. $ -- $ 4,925,351 -- -- --
Hunters Pointe.............................................. -- 650,000 -- -- --
Norumbega Pointe............................................ 3,063,000 3,063,000 07/02/06 7% 10%
Crossings Village........................................... 2,584,000 2,584,000 10/01/08 7% 9%
Martin's Landing............................................ 2,280,000 2,280,000 12/01/08 7% 12%
Sunset Summit............................................... 1,900,000 1,900,000 12/01/08 7% 9%(b)
Oasis....................................................... 2,290,000 2,290,000 09/01/09 7% 9.25%
Windmill Lakes (c):
Due Contractually......................................... 2,000,000 2,000,000 03/01/10 7.5% 9.5%
Interest applied.......................................... (562,500) --
----------- ----------- -------- --- ----
Carrying Value............................................ 1,437,500 2,000,000
The Lakes................................................... 4,600,000 4,600,000 07/01/10 7% 9%
----------- -----------
$18,154,500(e) $24,292,351
=========== ===========
------------------------------
(a) Monthly principal and interest payments are based on a 30-year amortization.
The unpaid principal balances due at maturity are as follows:
Crossings Village........................................... $ 9,917,000
Martin's Landing............................................ $ 8,524,000
Sunset Summit............................................... $ 7,763,000
Oasis....................................................... $ 9,550,000
Windmill Lakes.............................................. $ 8,907,000
The Lakes................................................... $14,118,000
(b) The Trust will receive its Additional Loan Interest and its GIT
Contingent Interest on Investment (as defined in the Subordinate Loan
Agreement) from net revenue up to the 9% Preferred Interest Rate and,
thereafter is entitled to 25% of net revenue.
(c) The Trust finalized an agreement on July 25, 2001 with the owner which
will allow for the release of the participation features in the event
that the first mortgage, the Additional Loan and any accrued but unpaid
interest on the Additional Loan are all paid off by September 1, 2002. In
the event that the required payments are not received, the participation
features will remain in force.
(d) The aggregate cost for federal income tax purposes is $85,625,185.
(e) The aggregate cost for federal income tax purposes is $18,717,000.
F-47
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMIS (CONTINUED)
IMPAIRED ADDITIONAL LOANS
On December 31, 1998, as a result of continued deterioration in property
operations, the Advisor of the Trust determined that the Windmill Lakes
Additional Loan was impaired. As a result, a valuation allowance of $2,000,000
was established to adjust the carrying amount of the loan to the estimated fair
market value of the collateral less anticipated costs of sale. On July 25, 2001,
the Trust received $512,500 in accrued but unpaid base interest. The Trust
reflected the $512,500 received plus $50,000 previously received as a reduction
in the principal balance of the Additional Loan and related impairment
provision. During the fourth quarter of 2001, based on improved market
conditions and property operations, the Trust reduced the impairment provision
by an additional $937,500 to $500,000. The Trust did not receive interest income
on the Windmill Lakes Additional Loan during 2000 or 1999 and has not recognized
any interest income during 2001, 2000 or 1999.
On December 31, 1998, as a result of continued deterioration in property
operations, the Advisor of the Trust determined that the Oasis Additional Loan
was impaired. As a result, a valuation allowance of $994,000 was established to
adjust the carrying amount of the loan to the estimated fair market value of the
collateral less anticipated costs of sale. During 2000, property operations
improved and, as a result, the Advisor determined that the Oasis Additional Loan
was no longer impaired. Therefore, the valuation allowance was reversed.
The activity in the valuation allowance together with the related recorded
and carrying value of the mortgage loans is as follows as of December 31, 2001:
RECORDED VALUATION CARRYING
VALUE ALLOWANCE VALUE
---------- --------- --------
Windmill Lakes.............................................. $1,437,500 $500,000 $937,500
========== ======== ========
Reconciliations of activity for 2001, 2000 and 1999 are as follows:
INSURED MORTGAGES
2001 2000 1999
------------ ------------ ------------
Balance at beginning of period.............................. $121,208,064 $131,750,452 $133,132,325
Principal collections....................................... (35,582,879) (10,542,388) (1,381,873)
============ ============ ============
Balance at end of period.................................... $ 85,625,185 $121,208,064 $131,750,452
============ ============ ============
ADDITIONAL LOANS
2001 2000 1999
----------- ----------- -----------
Balance at beginning of period.............................. $22,292,351 $21,298,351 $23,298,351
Interest received and recognized as Additional Loan
prepayment................................................ (562,500) -- --
Additional Loan prepayments................................. (5,575,351) -- (2,000,000)
Adjustment to valuation allowance........................... 1,500,000 994,000 --
----------- ----------- -----------
Balance at end of period.................................... $17,654,500 $22,292,351 $21,298,351
=========== =========== ===========
PROPERTY DESCRIPTIONS:
- Norumbega Point is a 93-unit assisted living facility in Weston,
Massachusetts.
- Crossings Village Apartments ("Crossings Village") is a 286-unit apartment
complex located in Westlake, Ohio.
- Martin's Landing Apartments ("Martin's Landing") is a 300-unit apartment
complex in Roswell, Georgia.
- Sunset Summit Apartments ("Sunset Summit") is a 261-unit apartment complex
located in Portland, Oregon.
- Oasis at Springtree ("Oasis") is a 276-unit apartment complex located in
Sunrise, Florida.
- Windmill Lakes Apartments ("Windmill Lakes") is a 264-unit garden style
apartment complex in Pembroke Pines, Broward County, Florida.
- The Lakes at Vinings Apartments ("The Lakes") is a 464-unit garden and
townhouse style apartment complex in Vinings, Georgia.
D. PIMS
The Trust has investments in four PIMs. The Trust's PIMs consist of either a
Fannie Mae MBS or a sole participation interest in a HUD-insured first mortgage
loan originated under the FHA lending program (collectively the "insured
mortgages") and participation interests in the revenue stream and appreciation
of the property above specified levels. The borrower conveys these participation
features to the Trust generally through a subordinated promissory note and
mortgage (the "Agreement"). The Trust receives level monthly principal and
interest payments, amortized over thirty to forty years. The Fannie Mae MBS is
guaranteed by Fannie Mae, and HUD insures payment of principal and interest on
the FHA first mortgage loan.
F-48
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
D. PIMS (CONTINUED)
The borrower generally cannot prepay the insured mortgage during the first
five years but may prepay it thereafter subject to a 9% prepayment premium in
years six through nine, a 1% prepayment premium in year ten and no prepayment
premium thereafter. The Trust may receive interest related to its participation
interests in the underlying property, however, these amounts are neither insured
nor guaranteed.
Generally, the participation features consist of the following:
(i) "Minimum Additional Interest" at rates ranging from .5% to .75% per annum
calculated on the unpaid principal balance of the first mortgage on the
underlying property, (ii) "Shared Income Interest" ranging from 25% to 30% of
the monthly gross rental income generated by the underlying property in excess
of a specified base, but only to the extent that it exceeds the amount of
Minimum Additional Interest received during such month, (iii) "Shared
Appreciation Interest" ranging from 25% to 30% of any increase in value of the
underlying property in excess of a specified threshold. Payment of participation
interest from the operations of the property is limited to 50% of net revenue or
surplus cash as defined by Fannie Mae or HUD, respectively. The total amount of
participation interest payable by the borrower generally cannot exceed 50% of
any increase in value of the property.
Shared Appreciation Interest is payable when one of the following occurs:
(1) the sale of the underlying property to an unrelated third party on a date
which is later than five years from the date of the Agreement, (2) the maturity
date of the Agreement, or (3) prepayment of the Agreement.
Under the Agreement, the Trust, upon giving twelve months written notice,
can accelerate the maturity date of the Agreement and insured mortgage to a date
not earlier than ten years from the date of the Agreement for (a) the payment of
all participation interest due under the Agreement as of the accelerated
maturity date or (b) the payment of all participation interest due under the
Agreement plus all amounts due on the first mortgage note on the property.
At December 31, 2001 and 2000 there are no insured mortgage loans within the
Trust's portfolio that are delinquent of principal or interest.
The Trust's PIMs consisted of the following at December 31, 2001 and 2000:
BALANCE OUTSTANDING AT
APPROXIMATE DECEMBER 31,
ORIGINAL MONTHLY INTEREST MATURITY ----------------------------
PIM AMOUNT PAYMENTS RATE DATE 2001 2000
--- ----------- ----------- -------- -------- ----------- -----------
FNMA
Mequon Trails............................. $14,937,726 $ 93,500 6.50% 01/01/08(a) $13,276,440 $13,525,695
FHA
Rivergreens II............................ 6,137,199 39,800 7.375% 01/01/35 5,917,280 5,956,517
Mill Ponds II............................. 8,245,300 51,900 7.125% 12/01/35 7,982,225 8,034,349
The Fountains............................. 10,336,000 70,800 7.50%(b) 11/01/36 10,063,977 10,114,769
----------- -------- ----------- -----------
Total................................... $39,656,225 $256,000 $37,239,922(c) $37,631,330
=========== ======== =========== ===========
------------------------------
(a) Principal and interest payments are based on a 30-year amortization. Unpaid
principal of approximately $11,267,000 is due at maturity.
(b) Construction-phase interest rate was 7.875%. Received Final Endorsement in
April 1998.
(c) The aggregate cost for federal income tax purposes is $37,239,922.
Reconciliations of activity for 2001, 2000 and 1999 are as follows:
2001 2000 1999
----------- ----------- -----------
Balance at beginning of period.............................. $37,631,330 $37,994,412 $38,331,257
Discount amortization....................................... 255 236 217
Principal collections....................................... (391,663) (363,318) (337,062)
----------- ----------- -----------
Balance at end of period.................................... $37,239,922 $37,631,330 $37,994,412
=========== =========== ===========
PROPERTY DESCRIPTIONS:
- Mequon Trails Townhomes ("Mequon Trails") is a 246-unit apartment complex
located in Mequon, Wisconsin.
- Rivergreens II Apartments ("Rivergreens II") is a 126-unit apartment
complex in Gladstone, Oregon.
- Mill Ponds II Apartments ("Mill Ponds II") is a 150-unit apartment complex
in Bellbrook, Ohio.
- The Fountains Apartments ("The Fountains") is a 204-unit apartment complex
in West Des Moines, Iowa.
F-49
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
E. MORTGAGE BACKED SECURITIES
The Trust received a payoff from The Estates MBS consisting of a first
mortgage of $11,375,380 on October 18, 1999. In addition, the Trust received a
prepayment premium of $1,023,784. The Trust paid a special dividend of $.68 per
Unit from the proceeds on October 27, 1999.
At December 31, 2001 the Trust's MBS portfolio has an amortized cost of
$15,319,845 and gross unrealized gains of $281,119. At December 31, 2000, the
Trust's MBS portfolio had an amortized cost of $19,042,730 and gross unrealized
gains and losses of $134,943 and $53,642, respectively. The MBS have maturities
ranging from 2008 to 2031.
MATURITY DATE FAIR VALUE UNREALIZED GAIN
------------- ----------- ---------------
2002-2006................................................... $ -- $ --
2007-2011................................................... 3,622,586 67,189
2012-2031................................................... 11,978,378 213,930
----------- --------
Total..................................................... $15,600,964 $281,119
=========== ========
F. SHAREHOLDERS' EQUITY
Under the Declaration of Trust, and commencing with the initial closing of
the public offering of Shares, the Trust has declared and paid dividends on a
quarterly basis. During the period in which the Trust qualifies as a REIT, the
Trust has and will pay quarterly dividends aggregating at least 95% of taxable
income on an annual basis to be allocated to the shareholders, in proportion to
their respective number of shares.
In order for the Trust to maintain its REIT status with respect to the
requirements of Share ownership, the Declaration of Trust prohibits any investor
from owning, directly or indirectly more than 9.80% of the outstanding Shares
and empowers the Trustees to refuse to permit any transfer of Shares which, in
their opinion, would jeopardize the status of the Trust as a REIT.
G. RELATED PARTY TRANSACTIONS
Under the terms of the Advisory Service Agreement, the Advisor receives an
Asset Management Fee equal to .75% per annum of the value of the Trust's actual
and committed invested assets payable quarterly.
The Trust also reimburses affiliates of the Advisor for certain expenses
incurred in connection with maintaining the books and records of the Trust, the
preparation and mailing of financial reports, tax information and other
communications to investors and legal fees and expenses. Included in general and
administration expenses are legal fees and expenses paid by the Trust to an
affiliate. During the three years ended December 31, 2001, 2000, and 1999 these
fees totaled $6,276, $1,533 and $778 respectively.
The Trust earned or received $398,549 of base interest from The Seasons in
2001 and $443,282 in 2000 and 1999, respectively (see Note C). In addition, the
Trust received $8,780,579 in 2001, $446,574 in 2000 and $392,816 in 1999 related
to participating interest income.
H. FEDERAL INCOME TAXES
The reconciliation of the income reported in the accompanying statement of
income with the income reported in the Trust's 2001 federal income tax return
follows:
Net income per statement of income.......................... $22,140,978
Less: Book to tax difference for amortization of prepaid
fees and expenses......................................... (1,322,819)
Less: Book to tax difference for Additional Loan interest
income.................................................... (1,037,081)
Less: Reduction of provision for impaired mortgage loans.... (962,500)
-----------
Net income for federal income tax purposes.................. $18,818,578
===========
The Trust paid dividends of $3.74 per share during 2001 which represents
approximately $1.02 from ordinary income and $2.72 represents a non-taxable
dividend for federal income tax purposes.
The basis of the Trust's assets for financial reporting purposes is less
than its tax basis by approximately $7,162,000 and $9,423,000 at December 31,
2001 and 2000, respectively. The basis of the Trust's liabilities for financial
reporting purposes exceeded its tax basis by approximately $1,242,000 and
$2,504,000 at December 31, 2001 and 2000, respectively.
I. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The Trust uses the following methods and assumptions to estimate the fair
value of each class of financial instrument:
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short maturity of
those instruments.
F-50
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
I. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS (CONTINUED)
MBS
The Trust estimates the fair value of MBS based on quoted market prices.
Based on the estimated fair value determined using these methods and
assumptions, the Trust's investments in MBS has gross unrealized gains of
approximately $281,000 December 31, 2001 and gross unrealized gains and losses
of approximately $135,000 and $54,000 at December 31, 2000.
PIMS AND PIMIS
There is no established trading market for these investments. Management
estimates the fair value of the PIMs and the insured mortgage portion of the
PIMIs using quoted market prices of MBS having the same stated coupon rate as
the insured mortgages. Additional Loans are based on the estimated fair value of
the underlying properties as an estimate of the fair value of the loan is not
practicable. Management does not include any participation income in the Trust's
estimated fair values, as Management does not believe it can predict the time of
realization of the feature with any certainty.
Based on the estimated fair value determined using these methods and
assumptions, the Trust's investments in PIMs and PIMIs had gross unrealized
gains of approximately $1,777,000 at December 31, 2001 and gross unrealized
gains and losses of approximately $170,000 and $4,052,000, respectively at
December 31, 2000.
At December 31, 2001 and 2000, the estimated fair values of the Trust's
financial instruments are as follows:
2001 2000
------------------- -------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
Cash and cash equivalents................................... $ 6,454 $ 6,454 $ 7,089 $ 7,089
MBS......................................................... 15,601 15,601 19,124 19,124
PIMs and PIMIs:
PIMs...................................................... 37,978 37,240 36,568 37,631
Insured mortgages......................................... 86,664 85,625 118,389 121,208
Additional loans.......................................... 17,655 17,655 22,292 22,292
-------- -------- -------- --------
$164,352 $162,575 $203,462 $207,344
======== ======== ======== ========
J. SUBSEQUENT EVENT
On February 13, 2002, the Trust received a prepayment of the Norumbega
Subordinated Promissory Note and the Norumbega Pointe Additional Loan note. The
Trust received $3,063,000 of Additional Loan principal, $302,877 of Shared
Appreciation Interest and $2,280,362 of preferred interest. The Trust received
$15,123,167 representing the principal proceeds on the first mortgage note on
February 25, 2002. The Trust intends to pay a special dividend of $1.14 per
share from the proceeds of the Norumbega Pointe prepayment in the first quarter
of 2002.
F-51
KRUPP GOVERNMENT INCOME TRUST II
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
2001
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES RECOVERIES PERIOD
----------- ---------- ---------- ----------- ----------
Valuation Allowance......................................... $2,000,000 $ -- $(1,500,000) $ 500,000
========== ========= =========== ==========
2000
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES RECOVERIES PERIOD
----------- ---------- ---------- ----------- ----------
Valuation Allowance......................................... $2,994,000 $ -- $ (994,000) $2,000,000
========== ========= =========== ==========
1999
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES RECOVERIES PERIOD
----------- ---------- ---------- ----------- ----------
Valuation Allowance......................................... $2,994,000 $ -- $ -- $2,994,000
========== ========= =========== ==========
F-52
KRUPP GOVERNMENT INCOME TRUST II
SUPPLEMENTARY DATA
SELECTED QUARTERLY FINANCIAL DATA
(UNAUDITED)
FOR THE QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2001 2001 2001 2001
---------- ---------- ------------- ------------
Total revenues.............................................. $6,360,137 $3,476,744 $12,808,257 $2,684,679
========== ========== =========== ==========
Net income.................................................. $4,926,015 $2,516,304 $11,911,501 $2,787,158
========== ========== =========== ==========
Earnings per Share.......................................... $ .27 $ .14 $ .64 $ .16
========== ========== =========== ==========
FOR THE QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2001 2001 2001 2001
---------- ---------- ------------- ------------
Total revenues.............................................. $4,908,065 $3,954,856 $4,031,680 $4,083,596
========== ========== ========== ==========
Net income.................................................. $3,585,243 $2,894,895 $3,003,591 $4,141,075
========== ========== ========== ==========
Earnings per Share.......................................... $ .20 $ .15 $ .17 $ .22
========== ========== ========== ==========
F-53
KRUPP GOVERNMENT INCOME TRUST II
BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001
------------ ------------
(UNAUDITED)
ASSETS
Participating Insured Mortgage Investments ("PIMIs")(Note 2)
Insured mortgages......................................... $ 59,229,805 $ 85,625,185
Additional Loans, net of impairment provision of $0 and
$500,000, respectively.................................. 13,654,000 17,654,500
Participating Insured Mortgages ("PIMs")(Note 2)............ 37,032,913 37,239,922
Mortgage-Backed Securities ("MBS")(Note 3).................. 13,098,425 15,600,964
------------ ------------
Total mortgage investments.............................. 123,015,143 156,120,571
Cash and cash equivalents................................... 4,867,553 6,453,663
Interest receivable and other assets........................ 1,038,766 1,174,106
Prepaid acquisition fees and expenses, net of accumulated
amortization of $6,824,434 and $7,964,938, respectively... 1,790,474 2,913,250
Prepaid participation servicing fees, net of accumulated
amortization of $2,107,459 and $2,420,697, respectively... 661,285 1,102,473
------------ ------------
Total assets............................................ $131,373,221 $167,764,063
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred income on Additional Loans (Note 2)................ $ -- $ 1,242,282
Other liabilities........................................... 100,387 25,985
------------ ------------
Total liabilities....................................... 100,387 1,268,267
------------ ------------
Shareholders' equity (Note 4)
Common stock, no par value; 25,000,000 Shares authorized;
18,371,477 Shares issued and outstanding................ 130,884,349 166,214,677
Accumulated comprehensive income.......................... 388,485 281,119
------------ ------------
Total Shareholders' equity.............................. 131,272,834 166,495,796
------------ ------------
Total liabilities and Shareholders' equity.............. $131,373,221 $167,764,063
============ ============
F-54
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(UNAUDITED)
Revenues:
Interest income--PIMs and PIMIs:
Basic interest...................................... $1,655,328 $2,575,956 $3,629,965 $5,301,009
Additional Loan interest............................ 292,378 394,533 2,498,605 1,061,959
Participation interest.............................. -- 113,253 2,673,573 2,624,332
Interest income--MBS.................................. 223,134 316,868 449,141 648,691
Interest income--cash and cash equivalents............ 29,816 76,134 75,638 200,890
---------- ---------- ---------- ----------
Total revenues.................................... 2,200,656 3,476,744 9,326,922 9,836,881
---------- ---------- ---------- ----------
Expenses:
Asset management fee to an affiliate.................. 229,713 349,666 493,300 712,598
Expense reimbursements to affiliates.................. 62,406 75,192 94,381 117,175
Amortization of prepaid fees and expenses............. 278,556 414,521 1,563,964 1,335,809
General and administrative............................ 99,253 121,061 200,063 228,980
Reduction of provision for impaired additional loan
(Note 2)............................................ -- -- (500,000) --
---------- ---------- ---------- ----------
Total expenses.................................... 669,928 960,440 1,851,708 2,394,562
---------- ---------- ---------- ----------
Net income.............................................. 1,530,728 2,516,304 7,475,214 7,442,319
Other comprehensive income:
Net change in unrealized gain (loss) on MBS......... 105,937 (7,500) 107,366 49,184
---------- ---------- ---------- ----------
Total comprehensive income............................ $1,636,665 $2,508,804 $7,582,580 $7,491,503
========== ========== ========== ==========
Basic earnings per share.............................. $ .09 $ .14 $ .41 $ .41
========== ========== ========== ==========
Weighted average Shares outstanding................... 18,371,477 18,371,477
F-55
KRUPP GOVERNMENT INCOME TRUST II
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS
ENDED JUNE 30,
---------------------------
2002 2001
------------ ------------
(UNAUDITED)
Operating activities:
Net income................................................ $ 7,475,214 $ 7,442,319
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of net premium............................. 46,708 28,223
Amortization of prepaid fees and expenses............... 1,563,964 1,335,809
Reduction of provision for impaired additional loan..... (500,000) --
Changes in assets and liabilities:
Decrease in interest receivable and other assets...... 135,340 64,432
Decrease in deferred income on Additional Loans....... (1,242,282) (572,377)
Increase (decrease) in other liabilities.............. 74,402 (101,995)
------------ ------------
Net cash provided by operating activities................... 7,553,346 8,196,411
------------ ------------
Investing activities:
Principal collections on MBS.............................. 2,563,062 1,385,347
Principal collections on Additional Loans................. 4,500,500 650,000
Principal collections on PIMs and Insured Mortgages....... 26,602,524 13,235,507
------------ ------------
Net cash provided by investing activities................... 33,666,086 15,270,854
------------ ------------
Financing activity:
Dividends................................................. (42,805,542) (24,066,636)
------------ ------------
Net decrease in cash and cash equivalents................... (1,586,110) (599,371)
Cash and cash equivalents, beginning of period.............. 6,453,663 7,089,453
------------ ------------
Cash and cash equivalents, end of period.................... $ 4,867,553 $ 6,490,082
============ ============
Non Cash Activities:
Increase in Fair Value of MBS............................. $ 107,366 $ 49,184
============ ============
The accompanying notes are an integral part of the financial statements.
F-56
KRUPP GOVERNMENT INCOME TRUST II
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. ACCOUNTING POLICIES
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted in this report
pursuant to the Rules and Regulations of the Securities and Exchange Commission.
However, in the opinion of Berkshire Mortgage Advisors Limited Partnership (the
"Advisor"), which is the advisor to Krupp Government Income Trust II (the
"Trust"), the disclosures contained in this report are adequate to make the
information presented not misleading. See Notes to Financial Statements in the
Trust's financial statements for the year ended December 31, 2001 for additional
information relevant to significant accounting policies followed by the Trust.
In the opinion of the Advisor of the Trust, the accompanying unaudited
financial statements reflect all adjustments (consisting primarily of normal
recurring accruals) necessary to present fairly the Trust's financial position
as of June 30, 2002 and the results of its operations for the three and six
months ended June 30, 2002 and 2001 and its cash flows for the six months ended
June 30, 2002 and 2001.
The results of operations for the three and six months ended June 30, 2002
are not necessarily indicative of the results which may be expected for the full
year. See Management's Discussion and Analysis of Financial Condition and
Results of Operations included in this report.
2. PIMS AND PIMIS
At June 30, 2002, the Trust's PIMs and PIMIs, including Additional Loans,
had a fair value of $112,673,155 and gross unrealized gains of $2,756,437. The
PIMs and PIMIs had maturities ranging from 2008 to 2036. At June 30, 2002 there
are no insured mortgage loans within the Trust's portfolio, that were delinquent
of principal or interest.
On March 28, 2002, the Trust received a prepayment of the Windmill Lakes
Subordinated Promissory Note and the Windmill Lakes Additional Loan. The Trust
received $2,000,000 of Additional Loan principal and $162,500 of Additional Loan
interest. The Trust recognized $562,500 of the Additional Loan principal as
Additional Loan interest. Due to the payoff, the remaining impairment provision
of $500,000 was reversed. On April 25, 2002, the Trust received $10,727,382
representing the principal proceeds on the first mortgage note from Windmill
Lakes. The Trust paid a special dividend of $.71 per share from the proceeds of
the Windmill Lakes prepayment on May 1, 2002.
On February 13, 2002, the Trust received a prepayment of the Norumbega
Pointe Subordinated Promissory Note and the Norumbega Pointe Additional Loan.
The Trust received $3,063,000 of Additional Loan principal, $302,877 of Shared
Appreciation Interest and $2,280,362 of Preferred Interest. On February 25,
2002, the Trust received $15,123,167 representing the principal proceeds on the
first mortgage note. In addition, the Trust recognized $1,242,282 of Additional
Loan interest that had been previously received and recorded as deferred income
on the additional loan. The Trust paid a special dividend of $1.14 per share
from the proceeds of the Norumbega Pointe prepayment on March 12, 2002.
3. MBS
At June 30, 2002, the Trust's MBS portfolio, had an amortized cost of
approximately $12,709,940 and gross unrealized gains of approximately $388,485.
The MBS portfolio, had maturities ranging from 2008 to 2031.
4. CHANGES IN SHAREHOLDERS' EQUITY
A summary of changes in Shareholders' equity for the six months ended
June 30, 2002 is as follows:
ACCUMULATED TOTAL
COMMON RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK EARNINGS INCOME EQUITY
------------ ----------- ------------- -------------
Balance at December 31, 2001................................ $166,214,677 $ -- $281,119 $166,495,796
Net income.................................................. -- 7,475,214 -- 7,475,214
Dividends................................................... (35,330,328) (7,475,214) -- (42,805,542)
Change in unrealized gain on MBS............................ -- -- 107,366 107,366
------------ ----------- -------- ------------
Balance at June 30, 2002.................................... $130,884,349 $ -- $388,485 $131,272,834
============ =========== ======== ============
5. RELATED PARTY TRANSACTIONS
The Trust received $221,641 of Additional Loan interest during the six
months ended June 30, 2001 from an affiliate of the Advisor. The Trust also
received participation interest of $129,872 from an affiliate of the Advisor
during the six months ended June 30, 2001.
F-57
REPORT OF INDEPENDENT ACCOUNTANTS
To the Partners of
Krupp Insured Mortgage Limited Partnership:
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Krupp
Insured Mortgage Limited Partnership (the "Partnership") at December 31, 2001
and 2000 and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Partnership's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America which
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 financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 22, 2002
F-58
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
----------- -----------
ASSETS
Participating Insured Mortgages ("PIMs")
(Notes B, C and H).......................................... $23,723,593 $33,004,074
Mortgage-Backed Securities ("MBS")
(Notes B, D and H).......................................... 14,308,403 6,640,398
----------- -----------
Total mortgage investments.............................. 38,031,996 39,644,472
Cash and cash equivalents (Notes B, C and H)................ 3,603,846 2,737,740
Interest receivable and other assets........................ 267,672 292,370
Prepaid acquisition fees and expenses, net of accumulated
amortization of $596,986 and $544,434 respectively (Note
B)........................................................ 30,656 83,208
Prepaid participation servicing fees, net of accumulated
amortization of $195,430 and $174,676, respectively (Note
B)........................................................ 12,106 32,860
----------- -----------
Total assets............................................ $41,946,276 $42,790,650
=========== ===========
LIABILITIES AND PARTNERS' EQUITY
Liabilities................................................. $ 17,875 $ 17,650
----------- -----------
Partners' equity (deficit) (Notes A and E):
Limited Partners (14,956,796 Limited Partner interests
outstanding).............................................. 41,833,148 42,986,643
General Partners............................................ (377,115) (373,628)
Accumulated Comprehensive Income (Note B)................... 472,368 159,985
----------- -----------
Total Partners' equity.................................. 41,928,401 42,773,000
----------- -----------
Total liabilities and Partners' equity.................. $41,946,276 $42,790,650
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-59
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
---------- ---------- ----------
Revenues (Note B):
Interest income--PIMs (Note C):
Basic interest............................................ $2,068,652 $2,772,996 $6,324,994
Participation interest.................................... 19,231 941,003 1,665,793
Interest income--MBS (Note D)............................... 902,292 549,802 1,205,925
Other interest income....................................... 130,485 427,056 609,360
---------- ---------- ----------
Total revenues.......................................... 3,120,660 4,690,857 9,806,072
========== ========== ==========
Expenses:
Asset management fee to an affiliate (Note F)............... 231,416 318,118 703,699
Expense reimbursements to affiliates(Note F)................ 118,398 125,247 92,642
Amortization of prepaid fees and expenses (Note B).......... 73,306 138,050 1,298,012
General and administrative.................................. 186,059 230,294 209,402
---------- ---------- ----------
Total expenses.......................................... 609,179 811,709 2,303,755
========== ========== ==========
Net income (Note G)......................................... 2,511,481 3,879,148 7,502,317
Other comprehensive income:
Net change in unrealized gain on MBS........................ 312,383 156,410 (641,612)
---------- ---------- ----------
Total comprehensive income.................................. $2,823,864 $4,035,558 $6,860,705
========== ========== ==========
Allocation of net income (Note E):
Limited Partners............................................ $2,436,137 $3,762,774 $7,277,247
---------- ---------- ----------
Average net income per Limited Partner interest (14,956,796
Limited Partner interests outstanding).................... $ .16 $ .25 $ .49
---------- ---------- ----------
General Partners............................................ $ 75,344 $ 116,374 $ 225,070
========== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-60
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
PARTNERS PARTNERS INCOME EQUITY
------------ --------- ------------- ------------
Balance at December 31, 1998....................... $134,849,373 $(312,060) $ 645,187 $135,182,500
Net income......................................... 7,277,247 225,070 -- 7,502,317
Quarterly distributions............................ (12,563,709) (260,692) -- (12,824,401)
Special distributions.............................. (30,511,863) -- -- (30,511,863)
Change in unrealized gain on MBS................... -- -- (641,612) (641,612)
------------ --------- --------- ------------
Balance at December 31, 1999....................... 99,051,048 (347,682) 3,575 98,706,941
Net income......................................... 3,762,774 116,374 -- 3,879,148
Quarterly distributions............................ (5,833,146) (142,320) -- (5,975,466)
Special distributions.............................. (53,994,033) -- -- (53,994,033)
Change in unrealized gain on MBS................... -- -- 156,410 156,410
------------ --------- --------- ------------
Balance at December 31, 2000....................... 42,986,643 (373,628) 159,985 42,773,000
Net income......................................... 2,436,137 75,344 -- 2,511,481
Quarterly distributions............................ (3,589,632) (78,831) -- (3,668,463)
Change in unrealized gain on MBS................... -- -- 312,383 312,383
------------ --------- --------- ------------
Balance at December 31, 2001....................... $ 41,833,148 $(377,115) $ 472,368 $ 41,928,401
============ ========= ========= ============
The accompanying notes are an integral part of the financial statements.
F-61
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
----------- ------------ ------------
Operating activities:
Net income................................................ $ 2,511,481 $ 3,879,148 $ 7,502,317
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of prepaid fees and expenses............... 73,306 138,050 1,298,012
Shared Appreciation Interest and prepayment premium
income................................................ -- (499,093) (1,027,201)
Changes in assets and liabilities:
Decrease (increase) in interest receivable and other
assets.............................................. 24,698 (105,007) 598,802
Increase (decrease) in liabilities.................... 225 (1,900) (11,244)
----------- ------------ ------------
Net cash provided by operating activities........... 2,609,710 3,411,198 8,360,686
----------- ------------ ------------
Investing activities:
Principal collections on PIMs including
Shared Appreciation Interest and prepayment premiums of
$499,093 in 2000, and $1,027,201 in 1999.............. 330,141 18,885,111 48,587,772
Principal collections on MBS.............................. 1,594,718 976,124 10,705,146
----------- ------------ ------------
Net cash provided by investing activities........... 1,924,859 19,861,235 59,292,918
----------- ------------ ------------
Financing activities:
Quarterly distributions................................... (3,668,463) (5,975,466) (12,824,401)
Special distributions..................................... -- (53,994,033) (30,511,863)
----------- ------------ ------------
Net cash used for financing activities.............. (3,668,463) (59,969,499) (43,336,264)
----------- ------------ ------------
Net increase (decrease) in cash and cash equivalents........ 866,106 (36,697,066) 24,317,340
Cash and cash equivalents, beginning of year................ 2,737,740 39,434,806 15,117,466
----------- ------------ ------------
Cash and cash equivalents, end of year...................... $ 3,603,846 $ 2,737,740 $ 39,434,806
----------- ------------ ------------
Supplemental disclosure of non-cash investing activities:
Reclassification of investment in a PIM to a MBS........ $ 8,950,340 $ -- $ --
----------- ------------ ------------
Non cash activities:
Increase (decrease) in fair value of MBS................ $ 312,383 $ 156,410 $ (641,612)
=========== ============ ============
The accompanying notes are an integral part of the financial statements.
F-62
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
A. ORGANIZATION
Krupp Insured Mortgage Limited Partnership (the "Partnership") was formed on
March 21, 1988 by filing a Certificate of Limited Partnership in The
Commonwealth of Massachusetts. The Partnership was organized for the purpose of
investing in multi-family loans and mortgage backed securities. The Partnership
issued all of the General Partner Interests to two General Partners in exchange
for capital contributions aggregating $3,000. Krupp Plus Corporation and
Mortgage Services Partners Limited Partnership are the General Partners of the
Partnership and Krupp Depositary Corporation is the Corporate Limited Partner.
Except under certain limited circumstances upon termination of the Partnership,
the General Partners are not required to make any additional capital
contributions. The Partnership terminates on December 31, 2028, unless
terminated earlier upon the occurrence of certain events as set forth in the
Partnership Agreement.
The Partnership commenced the public offering of Limited Partner interests
on July 22, 1988 and completed its public offering on May 23, 1990 having sold
14,956,696 Limited Partner interests for $298,678,321 net of purchase volume
discounts of $457,599. In addition, Krupp Depositary Corporation owns one
hundred Limited Partner interests.
B. SIGNIFICANT ACCOUNTING POLICIES
The Partnership uses the following accounting policies for financial
reporting purposes, which may differ in certain respects from those used for
federal income tax purposes (Note G).
BASIS OF PRESENTATION
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with accounting principles generally accepted
in the United States of America ("GAAP").
MBS
The Partnership, in accordance with Financial Accounting Standards Board's
Statement 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("FAS 115"), classifies its MBS portfolio as available-for-sale. As
such the Partnership carries its MBS at fair market value and reflects any
unrealized gains (losses) as a separate component of Partners' Equity. The
Partnership amortizes purchase premiums or discounts over the life of the
underlying mortgages using the effective interest method.
PIMS
The Partnership accounts for its MBS portion of a PIM in accordance with
FAS 115 under the classification of held to maturity. The Partnership carries
the Government National Mortgage Association (GNMA) MBS at amortized cost.
The insured mortgage portion of its Federal Housing Administration (FHA) PIM
is carried at amortized cost. The Partnership holds this FHA insured mortgage at
amortized cost since the loan is fully insured by the FHA.
Basic interest on PIMs is recognized based on the stated rate of the FHA
mortgage loan (less the servicer's fee) or the stated coupon rate of the GNMA
MBS. The Partnership recognizes interest related to the participation features
when the amount becomes fixed and the transaction that gives rise to such amount
is consummated.
CASH AND CASH EQUIVALENTS
The Partnership includes all short-term investments with maturities of three
months or less from the date of acquisition in cash and cash equivalents. The
Partnership invests its cash primarily in commercial paper and money market
funds with a commercial bank and has not experienced any loss to date on its
invested cash.
PREPAID FEES AND EXPENSES
Prepaid fees and expenses represent prepaid acquisition fees and expenses
and prepaid participation servicing fees paid for the acquisition and servicing
of PIMs. The Partnership amortizes prepaid acquisition fees and expenses using a
method that approximates the effective interest method over a period of ten to
twelve years, which represents the estimated life of the underlying mortgage.
Acquisition expenses incurred on potential acquisitions which were not
consummated were charged to operations.
The Partnership amortizes prepaid participation servicing fees using a
method that approximates the effective interest method over a ten-year period
beginning at final endorsement of the loan if a Department of Housing and Urban
Development ("HUD") loan or GNMA loan.
Upon the repayment of a PIM, any unamortized acquisition fees and expenses
and unamortized participation servicing fees related to such loan are expensed.
INCOME TAXES
The Partnership is not liable for federal or state income taxes as
Partnership income is allocated to the partners for income tax purposes. In the
event that the Partnership's tax returns are examined by the Internal Revenue
Service or state taxing authority and the examination results in a change in
Partnership taxable income, such change will be reported to the partners.
F-63
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
B. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, contingent assets and liabilities and revenues and
expenses during the period. Actual results could differ from those estimates.
C. PIMS
At December 31, 2001 and 2000, the Partnership had investments in two and
three PIMs, respectively. The Partnership's PIMs consist of (a) a GNMA MBS
representing the securitized first mortgage loan on the underlying property or a
sole participation interest in the mortgage loan originated under HUD's FHA
lending program (collectively the "insured mortgages"), and (b) participation
interests in the revenue stream and appreciation of the underlying property
above specified base levels. The borrower conveys these participation features
to the Partnership generally through a subordinated promissory note and mortgage
(the "Agreement").
The Partnership receives guaranteed monthly payments of principal and
interest on the GNMA MBS, and HUD insures the FHA mortgage loan. The borrower
usually cannot prepay the first mortgage loan during the first five years and
may prepay the first mortgage loan thereafter subject to a 9% prepayment premium
in years six through nine, a 1% prepayment premium in year ten and no prepayment
premium thereafter. The Partnership may receive interest related to its
participation interests in the underlying property, however, these amounts are
neither insured nor guaranteed.
Generally, the participation features consist of the following:
(i) "Minimum Additional Interest" which is at the rate of .5% to 1% per annum
calculated on the unpaid principal balance of the first mortgage on the
underlying property, (ii) "Shared Income Interest" which is 25% to 35% of the
monthly gross rental income generated by the underlying property in excess of a
specified base, but only to the extent that it exceeds the amount of Minimum
Additional Interest earned during such month and (iii) "Shared Appreciation
Interest" which is 25% to 35% of any increase in the value of the underlying
property in excess of a specified base. Payment of participation interest from
the operations of the property is limited in any year to 50% of net revenue or
Surplus Cash as defined by Fannie Mae or HUD, respectively. The aggregate amount
of Minimum Additional Interest, Shared Income Interest and Shared Appreciation
Interest payable by the underlying borrower on the maturity date generally
cannot exceed 50% of any increase in value of the property above certain
thresholds.
Shared Appreciation Interest is payable when one of the following occurs:
(1) the sale of the underlying property to an unrelated third party on a date
which is later than five years from the date of the Agreement, (2) the maturity
date or accelerated maturity date of the Agreement, or (3) prepayment of amounts
due under the Agreement and the insured mortgage.
The Partnership, upon giving twelve months written notice, can accelerate
the maturity date of the Agreement to a date not earlier than ten years from the
date of the Agreement for (a) the payment of all participation interest due
under the Agreement as of the accelerated maturity date, or (b) the payment of
all participation interest due under the Agreement plus all amounts due on the
first mortgage note on the property.
During May 2001, the Partnership received $19,231 from the borrowers of the
Richmond Park PIM as a settlement to release the loan's participation features.
The property never generated sufficient cash flow to pay any participation from
property operations nor did it have sufficient value to meet the threshold to
pay any participation based on value if the property was sold or refinanced. The
borrowers asked for a release of the participation features while keeping the
insured first mortgage in place until operations improve and the property can be
sold or refinanced. The General Partners agreed to this request in return for
the settlement because there was no expectation that the Partnership would be
entitled to any participation proceeds now or in the future in the property's
current condition. Upon this settlement, the insured first mortgage loan on
Richmond Park was reclassified from a PIM to a MBS as the only remaining portion
of the investment is a GNMA MBS. The Partnership also reclassified this
investment to available for sale concurrent with the release of the
participation feature. The Partnership will continue to receive the scheduled
principal and interest payments on the first mortgage until the property is
refinanced or sold.
On June 2, 2000, the Partnership paid a special distribution of $.93 per
Limited Partner interest from the proceeds of the Bell Station and Enclave
insured mortgage payoffs along with the Shared Appreciation Interest proceeds
from the Brookside PIM (see below), the Bell Station PIM and the Enclave PIM.
On March 30, 2000, the Partnership received $190,239 of Shared Appreciation
Interest and $5,973 of Shared Income Interest from the Bell Station PIM. During
April and May, the Partnership received the principal proceeds of $4,901,863 and
$8,508,892 from the Bell Station and the Enclave PIM, respectively. Subsequent
to the payoff of the MBS portion of the Enclave PIM, the Partnership received
$178,854 of Shared Appreciation Interest and $200,398 of Shared Income Interest.
On March 30, 2000, the Partnership paid a special distribution of $.31 per
Limited Partner interest from the principal proceeds in the amount of
$4,531,910, received from the Brookside Apartments PIM payoff in February of
2000. Subsequent to the payoff of the MBS portion of the Brookside PIM, the
Partnership received $130,000 of Shared Appreciation Interest and $176,513 of
Shared Income Interest.
On January 11, 2000, the Partnership paid a special distribution of $2.37
per Limited Partner interest from the prepayment proceeds received during
December 1999 from the Salishan, Saratoga, and Marina Shores Apartments
PIMs and the Patrician MBS. In addition to the principal proceeds from the
Salishan PIM of $14,666,235, the Partnership received $146,662 of prepayment
premium income and $311,650 of Shared Income Interest and Minimum Additional
Interest. The Partnership also received $6,008,565 of principal proceeds from
the Marina Shores PIM along with $176,679 of Shared Appreciation Interest and
prepayment premium income. The principal proceeds from the Saratoga PIM and the
Patrician MBS prepayments were $6,204,895 and $7,830,263, respectively. The
Partnership did not receive any participation interest on the Saratoga
prepayment.
F-64
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMS (CONTINUED)
During November 1999, the Partnership paid a special distribution of $.30
per Limited Partner interest from the principal proceeds received from the
Valley Manor PIM of $4,425,993. The Partnership did not receive any
participation income from this PIM prepayment.
During May 1999, the Partnership paid a special distribution of $1.08 per
Limited Partner interest from the principal proceeds, Shared Appreciation and
prepayment proceeds received from the Remington and Pope Building PIMs (see
below).
During March 1999, the Partnership received a payoff of the Remington PIM in
the amount of $12,199,298. The payoff was the result of a default on the
underlying loan which resulted in the Partnership receiving all of the
outstanding principal balance under the insurance feature of the PIM. However,
due to the default the Partnership did not receive any participation income from
this PIM.
During February 1999, the Partnership received a payoff of the Pope Building
PIM in the amount of $3,176,761. In addition, the Partnership received $703,860
of Shared Appreciation Interest and prepayment premium income and $218,578 of
Shared Income Interest and Minimum Additional Interest upon the payoff of the
underlying mortgage.
During January 1999, the Partnership paid a special distribution of $.66 per
Limited Partner interest from the principal proceeds and prepayment premium
received from the Cross Creek PIM during 1998. On November 16, 1998, the
Partnership received a prepayment of the Cross Creek PIM in the amount of
$9,414,586. Additional interest in lieu of a prepayment penalty of approximately
$318,000 along with Shared Income Interest of approximately $60,000 was also
received during 1998.
At December 31, 2001 and 2000 there were no loans within the Partnership's
portfolio that were delinquent as to principal or interest.
The Partnership's PIMs consisted of the following at December 31, 2001 and
2000:
INVESTMENT BASIS AT
ORIGINAL APPROXIMATE DECEMBER 31,
FACE INTEREST MATURITY MONTHLY ----------------------------
PIMS AMOUNT RATE(A) DATE(F) PAYMENT(G) 2001 2000
---- ----------- -------- -------- ----------- ----------- -----------
GNMA
Richmond Park Apts.(h)
Richmond Heights, OH........ $10,000,000 -- -- $ -- $ -- $ 8,995,263
Wildflower Apts.
Las Vegas, NV............... 17,600,000 7.75%(b)(e)(i) 1/15/25 121,700 15,774,526 16,002,630
----------- ----------- -----------
27,600,000 15,774,526 24,997,893
----------- ----------- -----------
FHA
Creekside Apts.
Portland, OR................ 8,354,500 8.305%(b)(c)(d) 11/1/31 60,000 7,949,067 8,006,181
----------- ----------- -----------
Total..................... $35,954,500 $23,723,593(j) $33,004,074
=========== =========== ===========
------------------------------
(a) Represents the permanent interest rate of the GNMA MBS or the HUD-insured
first mortgage less the servicers fee. The Partnership may also receive
additional interest which consists of (i) Minimum Additional Interest based
on a percentage of the unpaid principal balance of the first mortgage on the
property, (ii) Shared Income Interest based on a percentage of monthly gross
income generated by the underlying property in excess of a specified base
amount (but only to the extent it exceeds the amount of Minimum Additional
Interest received during such month), (iii) Shared Appreciation Interest
based on a percentage of any increase in the value of the underlying
property in excess of a specified base value.
(b) Minimum additional interest is at a rate of .5% per annum calculated on the
unpaid principal balance of the first mortgage note.
(c) Shared income interest is based on 25% of monthly gross rental income over a
specified base amount.
(d) Shared appreciation interest is based on 25% of any increase in the value of
the project over the specified base value.
(e) Shared income interest is based on 35% of monthly gross rental income over a
specified base amount and shared appreciation interest is based on 35% of
any increase in the value of the project over the specified base value.
(f) The Partnership's GNMA MBS and HUD direct mortgages have call provisions,
which allow the Partnership to accelerate their respective maturity dates.
(g) The normal monthly payment consisting of principal and interest is payable
monthly at level amounts over the term of the GNMA MBS and the HUD direct
mortgage.
(h) During May 2001, the Partnership received $19,231 as a settlement to release
the loan's participation features. The insured first mortgage loan was
reclassified from a PIM to a MBS.
(i) The coupon rate of interest on the Wildflower Apartments PIM is 7.75% per
annum. However, in December 2000 the Partnership agreed to provide debt
service relief for the Wildflower PIM due to the property's poor operating
performance in the competitive Las Vegas market. Occupancy has fallen as low
as 80%, and the property has been unable to generate sufficient revenues to
adequately maintain the property. Consequently, a loan modification
agreement between the Partnership, the borrower entity under the PIM, the
principals of the borrower entity, and the affiliated property management
agent will provide operating funds for property repairs. Under the
modification, the principals of the borrower entity converted $105,000 of
cash advances to a long-term non interest-bearing loan. In addition, an
escrow account to be used exclusively for property repairs has been
established and is under the control of the Partnership. The management
agent made an initial deposit into the escrow equal to 30% of the management
fees it received during 2000 and will continue to deposit a similar amount
until December 2002. The Partnership made an initial deposit into the escrow
to match the $105,000 principals' loan and the management agent's initial
deposit and will continue to match additional deposits until December 2002.
The Partnership's contributions to the escrow account will be considered to
be an interest rebate. The principals' loan and the escrow deposits made by
the management agent and the Partnership can be repaid exclusively out of
any Surplus Cash, as defined by HUD, that the property may generate in
future years. Any repayments will be made on a pro rata basis amongst the
parties. The approximate monthly payment is before the rebate which
fluctuates month to month.
(j) The aggregate cost of PIMs for federal income tax purposes is $23,723,593.
F-65
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMS (CONTINUED)
A reconciliation of the carrying value of PIMs for each of the three years
in the period ended December 31, 2001 is as follows:
2001 2000 1999
----------- ------------- ------------
Balance at beginning of period.............................. $33,004,074 $ 51,390,092 $ 98,950,663
Deductions during period:
Prepayments and principal collections..................... (330,141) (18,386,018) (47,560,571)
Reclass to MBS............................................ (8,950,340) -- --
----------- ------------- ------------
Balance at end of period.................................... $23,723,593 $ 33,004,074 $ 51,390,092
=========== ============= ============
The underlying mortgages of the PIMs are collateralized by multi-family
apartment complexes located in 2 states. The apartment complexes range in size
from 172 to 540 units.
D. MBS
At December 31, 2001, the Partnership's MBS portfolio had an amortized cost
of $13,836,035 and gross unrealized gains of $472,368. At December 31, 2000, the
Partnership's MBS portfolio had an amortized cost of $6,480,413 and gross
unrealized gains and losses of $160,571 and $586 respectively. The portfolio has
maturity dates ranging from 2016 to 2024.
UNREALIZED
MATURITY DATE FAIR VALUE GAIN/(LOSS)
------------- ----------- -----------
2002-2006................................................... $ -- $ --
2007-2011................................................... -- --
2012-2024................................................... 14,308,403 472,368
----------- --------
Total................................................... $14,308,403 $472,368
=========== ========
E. PARTNERS' EQUITY
Profits from Partnership operations and Distributable Cash Flow are
allocated 97% to the Unitholders and Corporate Limited Partner (the "Limited
Partners") and 3% to the General Partners.
Upon the occurrence of a capital transaction, as defined in the Partnership
Agreement, net cash proceeds and profits from the capital transaction will be
distributed first, to the Limited Partners until they have received a return of
their total invested capital, second, to the General Partners until they have
received a return of their total invested capital, third, 99% to the Limited
Partners and 1% to the General Partners until the Limited Partners receive an
amount equal to any deficiency in the 11% cumulative return on their invested
capital that exists through fiscal years prior to the date of the capital
transaction, fourth, to the class of General Partners until they have received
an amount equal to 4% of all amounts of cash distributed under all capital
transactions and fifth, 96% to the Limited Partners and 4% to the General
Partners. Losses from a capital transaction will be allocated 97% to the Limited
Partners and 3% to the General Partners.
Upon the occurrence of a terminating capital transaction, as defined in the
Partnership Agreement, the net cash proceeds and winding up of the affairs of
the Partnership will be allocated among the Partners first, to each class of
Partners in the amount equal to, or if less than, in proportion to, the positive
balance in the Partner's capital accounts, second, to the Limited Partners until
they have received a return of their total invested capital, third, to the
General Partners until they have received a return of their total invested
capital, fourth, 99% to the Limited Partners and 1% to the General Partners
until the Limited Partners have received to any deficiency in the 11% cumulative
return on their invested capital that exists through fiscal years prior to the
date of the capital transaction, fifth, to the General Partners until they have
received an amount equal to 4% of all amounts of cash distributed under all
capital transactions and sixth, 96% to the Limited Partners and 4% to the
General Partners.
F-66
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
E. PARTNERS' EQUITY (CONTINUED)
During 2001, 2000 and 1999 the Partnership made quarterly distributions
totaling $.24, $.39 and $.84 per Limited Partner interest, respectively. The
Partnership made special distributions of $3.61 and $2.04 per Limited interest
in 2000 and 1999, respectively.
As of December 31, 2001, the following cumulative partner contributions and
allocations have been made since inception of the Partnership:
CORPORATE ACCUMULATED
LIMITED GENERAL COMPREHENSIVE
UNITHOLDERS PARTNER PARTNERS INCOME TOTAL
----------- --------- ----------- ------------- -------------
Capital contributions................................... $ 298,678,321 $ 2,000 $ 3,000 $ -- $ 298,683,321
Syndication costs....................................... (20,431,915) -- -- -- (20,431,915)
Quarterly distributions................................. (224,056,957) (1,612) (4,929,066) -- (228,987,635)
Special distributions................................... (159,438,377) (1,066) -- -- (159,439,443)
Net income.............................................. 147,081,731 1,023 4,548,951 -- 151,631,705
Unrealized gains on MBS................................. -- -- -- 472,368 472,368
------------- ------- ----------- ---------- -------------
Balance, December 31, 2001.............................. $ 41,832,803 $ 345 $ (377,115) $ 472,368 $ 41,928,401
============= ======= =========== ========== =============
F. RELATED PARTY TRANSACTIONS
Under the terms of the Partnership Agreement, the General Partners or their
affiliates receive an Asset Management Fee equal to .75% per annum of the value
of the Partnership's invested assets payable quarterly. The General Partners may
also receive an incentive management fee in an amount equal to .3% per annum on
the Partnership's Total Invested Assets providing the Unitholders receive a
specified non-cumulative annual return on their Invested Capital. Total fees
payable to the General Partners as asset management or incentive management fees
shall not exceed 9.05% of distributable cash flow over the life of the
Partnership.
Additionally, the Partnership reimburses affiliates of the General Partners
for certain expenses incurred in connection with maintaining the books and
records of the Partnership, the preparation and mailing of financial reports,
tax information, other communications to investors and legal fees and expenses.
G. FEDERAL INCOME TAXES
The reconciliation of the net income reported in the accompanying statement
of income with the income reported in the Partnership's 2001 federal income tax
return is as follows:
Net income per statement of income.......................... $2,511,481
Less: Book to tax difference for amortization of prepaid
fees and expenses......................................... (180,622)
----------
Net income for federal income tax purposes.................. $2,330,859
==========
The allocation of the 2001 net income for federal income tax purposes is as
follows:
PORTFOLIO
INCOME
----------
Unitholders................................................. $2,260,918
Corporate Limited Partner................................... 15
General Partners............................................ 69,926
----------
$2,330,859
==========
For the years ended December 31, 2001, 2000 and 1999 the average per unit
net income to the Unitholders for federal income tax purposes was $.15, $.25 and
$.36 respectively.
The basis of the Partnership's assets for financial reporting purposes was
less than its tax basis by approximately $1,698,000 and $2,191,000 at
December 31, 2001 and 2000, respectively. The basis of the Partnership's
liabilities for financial reporting purposes were the same as its tax basis at
December 31, 2001 and 2000, respectively.
F-67
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
H. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
The Partnership uses the following methods and assumptions to estimate the
fair value of each class of financial instruments:
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value due to the short maturity of
those instruments.
MBS
The Partnership estimates the fair value of MBS based on quoted market
prices. Based on the estimated fair value determined using these methods and
assumptions, the Partnership's investments in MBS had gross unrealized gains of
approximately $472,000 at December 31, 2001, and gross unrealized gains and
losses of approximately $161,000 and $1,000 at December 31, 2000.
PIMS
As there is no active trading market for these investments, Management
estimates the fair value of the PIMs using quoted market prices of MBS having
the same stated coupon rate. Management does not include any participation
income in the Partnership's estimated fair value arising from appreciation of
the properties, as Management does not believe it can predict the time of
realization of the feature with any certainty. Based on the estimated fair value
determined using these methods and assumptions, the Partnership's investments in
PIMs had gross unrealized gains of approximately $1,043,000 at December 31,
2001, and gross unrealized gains and losses of approximately $98,000 and
$216,000 at December 31, 2000.
At December 31, 2001 and 2000, the estimated fair values of the
Partnership's financial instruments are as follows (amounts rounded to nearest
thousand):
2001 2000
------------------- -------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
Cash and cash equivalents................................... $ 3,604 $ 3,604 $ 2,738 $ 2,738
MBS......................................................... 14,308 14,308 6,640 6,640
PIMS........................................................ 24,767 23,724 32,886 33,004
------- ------- ------- -------
$42,679 $41,636 $42,264 $42,382
======= ======= ======= =======
F-68
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED)
ASSETS
Participating Insured Mortgages ("PIMs") (Note 2)........... $23,572,142 $23,723,593
Mortgage-Backed Securities ("MBS") (Note 3)................. 4,325,329 14,308,403
----------- -----------
Total mortgage investments................................ 27,897,471 38,031,996
Cash and cash equivalents................................... 11,427,809 3,603,846
Interest receivable and other assets........................ 203,115 267,672
Prepaid acquisition fees and expenses, net of accumulated
amortization of $623,262 and $596,986, respectively....... 4,380 30,656
Prepaid participation servicing fees, net of accumulated
amortization of $205,806 and $195,430, respectively....... 1,730 12,106
----------- -----------
Total assets.............................................. $39,534,505 $41,946,276
=========== ===========
LIABILITIES AND PARTNERS' EQUITY
Liabilities................................................. $ 110,478 $ 17,875
----------- -----------
Partners' equity (deficit)(Note 4):
Limited Partners (14,956,796 Limited Partner interests
outstanding).............................................. 39,596,626 41,833,148
General Partners............................................ (382,129) (377,115)
Accumulated Comprehensive Income............................ 209,530 472,368
----------- -----------
Total Partners' equity.................................... 39,424,027 41,928,401
----------- -----------
Total liabilities and Partners' equity.................... $39,534,505 $41,946,276
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-69
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- -----------------------
2002 2001 2002 2001
--------- -------- ---------- ----------
(UNAUDITED)
Revenues:
Interest income--PIMs:
Basic interest........................................ $ 455,462 $513,578 $ 913,108 $1,149,019
Participation interest................................ -- 19,231 -- 19,231
Interest income--MBS.................................... 194,697 230,062 453,228 353,322
Other interest income................................... 19,053 34,000 37,238 76,606
--------- -------- ---------- ----------
Total revenues...................................... 669,212 796,871 1,403,574 1,598,178
--------- -------- ---------- ----------
Expenses:
Asset management fee to an affiliate.................... 44,821 51,897 101,150 117,685
Expense reimbursements to affiliates.................... 33,633 31,098 57,865 56,206
Amortization of prepaid fees and expenses............... 18,326 18,328 36,652 36,655
General and administrative.............................. 73,435 40,332 121,337 88,703
--------- -------- ---------- ----------
Total expenses...................................... 170,215 141,655 317,004 299,249
--------- -------- ---------- ----------
Net income................................................ 498,997 655,216 1,086,570 1,298,929
Other comprehensive income:
Net change in unrealized gain on MBS.................... (287,282) 182,389 (262,838) 204,284
--------- -------- ---------- ----------
Total comprehensive income................................ $ 211,715 $837,605 $ 823,732 $1,503,213
========= ======== ========== ==========
Allocation of net income (Note 4):
Limited Partners........................................ $ 484,027 $635,559 $1,053,973 $1,259,961
========= ======== ========== ==========
Average net income per Limited Partner interest
(14,956,796 Limited Partner interests outstanding) $ .03 $ .04 $ .07 $ .08
========= ======== ========== ==========
General Partners........................................ $ 14,970 $ 19,657 $ 32,597 $ 38,968
========= ======== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-70
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS
ENDED JUNE 30,
-------------------------
2002 2001
----------- -----------
(UNAUDITED)
Operating activities:
Net income................................................ $ 1,086,570 $ 1,298,929
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of prepaid fees and expenses............... 36,652 36,655
Premium amortization.................................... -- 899
Changes in assets and liabilities:
Decrease in interest receivable and other assets...... 64,557 24,232
Increase in liabilities............................... 92,603 18,793
----------- -----------
Net cash provided by operating activities........... 1,280,382 1,379,508
----------- -----------
Investing activities:
Principal collections on PIMs............................. 151,451 184,663
Principal collections on MBS.............................. 9,720,236 679,997
----------- -----------
Net cash provided by investing activities........... 9,871,687 864,660
----------- -----------
Financing activities:
Quarterly distributions................................... (1,832,427) (1,835,433)
Special distribution...................................... (1,495,679) --
----------- -----------
Net cash used for financing activities.............. (3,328,106) (1,835,433)
----------- -----------
Net increase in cash and cash equivalents................... 7,823,963 408,735
Cash and cash equivalents, beginning of period.............. 3,603,846 2,737,740
----------- -----------
Cash and cash equivalents, end of period.................... $11,427,809 $ 3,146,475
=========== ===========
Supplemental disclosure of non-cash investing activities:
Reclassification of investment in a PIM to a MBS.......... $ -- $ 8,950,340
=========== ===========
Non cash activities:
Increase (decrease) in Fair Value of MBS.................. $ (262,838) $ 204,284
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-71
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. ACCOUNTING POLICIES
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted in this report
pursuant to the Rules and Regulations of the Securities and Exchange Commission.
However, in the opinion of the General Partners, Krupp Plus Corporation and
Mortgage Services Partners Limited Partnership, (collectively the "General
Partners"), of Krupp Insured Mortgage Limited Partnership (the "Partnership"),
the disclosures contained in this report are adequate to make the information
presented not misleading. See Notes to Financial Statements included in the
Partnership's financial statements for the year ended December 31, 2001 for
additional information relevant to significant accounting policies followed by
the Partnership.
In the opinion of the General Partners of the Partnership, the accompanying
unaudited financial statements reflect all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the Partnership's
financial position as of June 30, 2002, its results of operations for the three
and six months ended June 30, 2002 and 2001 and its cash flows for the six
months ended June 30, 2002 and 2001.
The results of operations for the three and six months ended June 30, 2002
are not necessarily indicative of the results which may be expected for the full
year. See Management's Discussion and Analysis of Financial Condition and
Results of Operations included in this report.
2. PIMS
At June 30, 2002, the Partnership's PIM portfolio, had a fair market value
of $24,920,873 and gross unrealized gains of $1,348,731. The Partnership's
PIMs had maturity dates ranging from 2025 to 2031.
3. MBS
The Partnership received a payoff of the Richmond Park Apartments MBS on
June 17, 2002 for $8,796,086. The Partnership intends to pay a special
distribution of $.59 per Limited Partner interest from the proceeds of the
Richmond Park prepayment in the third quarter of 2002.
At June 30, 2002, the Partnership's MBS portfolio had an amortized cost of
$4,115,799 and gross unrealized gains of $209,530. The MBS portfolio had
maturity dates ranging from 2016 to 2024.
4. CHANGES IN PARTNERS' EQUITY
A summary of changes in Partners' Equity for the six months ended June 30,
2002 is as follows:
ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
PARTNERS PARTNERS INCOME EQUITY
----------- --------- ------------- -----------
Balance at December 31, 2001................................ $41,833,148 $(377,115) $ 472,368 $41,928,401
Net income.................................................. 1,053,973 32,597 -- 1,086,570
Quarterly distributions..................................... (1,794,816) (37,611) -- (1,832,427)
Special Distribution........................................ (1,495,679) -- -- (1,495,679)
Change in unrealized gain on MBS............................ -- -- (262,838) (262,838)
----------- --------- --------- -----------
Balance at June 30, 2002.................................... $39,596,626 $(382,129) $ 209,530 $39,424,027
=========== ========= ========= ===========
F-72
REPORT OF INDEPENDENT ACCOUNTANTS
To the Partners of
Krupp Insured Plus Limited Partnership:
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Krupp
Insured Plus Limited Partnership (the "Partnership") at December 31, 2001 and
2000 and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Partnership's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America which
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 financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 22, 2002
F-73
KRUPP INSURED PLUS LIMITED PARTNERSHIP
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
----------- -----------
ASSETS
Participating Insured Mortgages ("PIMs") (Notes B, C, H and
I)........................................................ $18,779,477 $18,875,248
Mortgage-Backed Securities and insured mortgage ("MBS")
(Notes B, D and H)........................................ 9,410,920 18,864,480
----------- -----------
Total mortgage investments................................ 28,190,397 37,739,728
Cash and cash equivalents (Notes B and H)................... 1,422,582 1,460,786
Interest receivable and other assets........................ 190,282 260,797
Prepaid acquisition fees and expenses, net of accumulated
amortization of $785,095 and $725,937, respectively (Note
B)........................................................ 59,157 118,315
Prepaid participation servicing fees, net of accumulated
amortization of $292,428 and $259,323, respectively (Note
B)........................................................ 38,624 71,729
----------- -----------
Total assets.............................................. $29,901,042 $39,651,355
=========== ===========
LIABILITIES AND PARTNERS' EQUITY
Liabilities................................................. $ 17,877 $ 17,650
----------- -----------
Partners' equity (deficit) (Notes A, E and I):
Limited Partners.......................................... 29,633,496 39,544,329
(7,500,099 Limited Partner interests outstanding)
General Partners.......................................... (249,219) (247,215)
Accumulated Comprehensive Income (Note B)................. 498,888 336,591
----------- -----------
Total Partners' equity.................................. 29,883,165 39,633,705
----------- -----------
Total liabilities and Partners' equity.................. $29,901,042 $39,651,355
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-74
KRUPP INSURED PLUS LIMITED PARTNERSHIP
STATEMENTS OF INCOME & COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
---------- ---------- ----------
Revenues:
Interest income--PIMs
Basic interest.......................................... $1,446,220 $1,422,912 $2,085,273
Participation interest.................................. 306,000 213,946 --
Interest income--MBS...................................... 1,170,585 1,701,993 1,899,734
Other interest income..................................... 99,649 248,982 230,826
---------- ---------- ----------
Total revenues........................................ 3,022,454 3,587,833 4,215,833
========== ========== ==========
Expenses:
Asset management fee to an affiliate (Note F)............. 243,650 295,192 376,755
Expense reimbursements to affiliates (Note F)............. 53,989 56,015 42,279
Amortization of prepaid fees and expenses (Note B)........ 92,263 101,056 101,059
General and administrative................................ 92,005 97,385 85,508
---------- ---------- ----------
Total expenses........................................ 481,907 549,648 605,601
========== ========== ==========
Net income (Note G)......................................... 2,540,547 3,038,185 3,610,232
Other Comprehensive Income:
Net change in unrealized gain on MBS...................... 162,297 72,745 (599,917)
---------- ---------- ----------
Total Comprehensive Income.................................. $2,702,844 $3,110,930 $3,010,315
Allocation of net income (Notes E and G):
Limited Partners.......................................... $2,464,331 $2,947,039 $3,501,925
---------- ---------- ----------
Average net income per Limited Partner Interest........... $ .33 $ .39 $ .47
---------- ---------- ----------
(7,500,099 Limited Partner interests outstanding)
General Partners.......................................... $ 76,216 $ 91,146 $ 108,307
========== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-75
KRUPP INSURED PLUS LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
PARTNERS PARTNERS INCOME EQUITY
------------ --------- ------------- ------------
Balance at December 31, 1998....................... $ 56,720,679 $(237,028) $863,763 $ 57,347,414
Net income......................................... 3,501,925 108,307 -- 3,610,232
Quarterly distributions............................ (5,700,076) (112,626) -- (5,812,702)
Change in unrealized gain on MBS................... -- -- (599,917) (599,917)
------------ --------- -------- ------------
Balance at December 31, 1999....................... 54,522,528 (241,347) 263,846 54,545,027
Net income......................................... 2,947,039 91,146 -- 3,038,185
Quarterly distributions............................ (5,700,076) (97,014) -- (5,797,090)
Special distributions.............................. (12,225,162) -- -- (12,225,162)
Change in unrealized gain on MBS................... -- -- 72,745 72,745
------------ --------- -------- ------------
Balance at December 31, 2000....................... 39,544,329 (247,215) 336,591 39,633,705
Net income......................................... 2,464,331 76,216 -- 2,540,547
Quarterly distributions............................ (3,000,040) (78,220) -- (3,078,260)
Special distribution............................... (9,375,124) -- -- (9,375,124)
Change in unrealized gain on MBS................... -- -- 162,297 162,297
------------ --------- -------- ------------
Balance at December 31, 2001....................... $ 29,633,496 $(249,219) $498,888 $ 29,883,165
============ ========= ======== ============
The accompanying notes are an integral part of the financial statements.
F-76
KRUPP INSURED PLUS LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
------------ ------------ ------------
Operating activities:
Net income.................................................. $ 2,540,547 $ 3,038,185 $ 3,610,232
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of prepaid fees and expenses............... 92,263 101,056 101,059
Shared Appreciation Interest and prepayment premiums.... (306,000) (213,946) --
Premium amortization.................................... -- 52,528 6,630
Changes in assets and liabilities:
Decrease in interest receivable and other assets........ 70,515 59,197 47,786
Increase (decrease) in liabilities...................... 227 (1,900) (648)
------------ ------------ ------------
Net cash provided by operating activities................... 2,397,552 3,035,120 3,765,059
------------ ------------ ------------
Investing activities:
Principal collections and prepayments on PIMs including
Shared Appreciation Interest of $10,000 in 2000......... 95,771 167,751 10,041,106
Principal collections on MBS including a prepayment
premium of $306,000 in 2001 and $203,946 in 2000........ 9,921,857 3,278,080 1,355,494
------------ ------------ ------------
Net cash provided by investing activities................... 10,017,628 3,445,831 11,396,600
------------ ------------ ------------
Financing activities:
Quarterly distributions................................... (3,078,260) (5,797,090) (5,812,702)
Special distributions..................................... (9,375,124) (12,225,162) --
------------ ------------ ------------
Net cash used for financing activities...................... (12,453,384) (18,022,252) (5,812,702)
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents........ (38,204) (11,541,301) 9,348,957
Cash and cash equivalents, beginning of period.............. 1,460,786 13,002,087 3,653,130
------------ ------------ ------------
Cash and cash equivalents, end of period.................... $ 1,422,582 $ 1,460,786 $ 13,002,087
============ ============ ============
Non cash activities:
Increase (decrease) in Fair Value of MBS.................. $ 162,297 $ 72,745 $ (599,917)
============ ============ ============
The accompanying notes are an integral part of the financial statements.
F-77
KRUPP INSURED PLUS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
A. ORGANIZATION
Krupp Insured Plus Limited Partnership (the "Partnership") is a
Massachusetts Limited Partnership. The Partnership was organized for the purpose
of investing in multi-family loans and mortgage-backed securities. The General
Partners of the Partnership are The Krupp Corporation and The Krupp Company
Limited Partnership-IV and the Corporate Limited Partner is Krupp Depositary
Corporation. The Partnership terminates on December 31, 2025, unless terminated
earlier upon the occurrence of certain events as set forth in the Partnership
Agreement.
The Partnership commenced the public offering of Units on July 7, 1986 and
completed its public offering having sold 7,499,999 Units for $149,489,830 net
of purchase volume discounts of $510,150 as of January 27, 1987. In addition,
Krupp Depositary Corporation owns 100 Units.
B. SIGNIFICANT ACCOUNTING POLICIES
The Partnership uses the following accounting policies for financial
reporting purposes which differ in certain respects from those used for federal
income tax purposes (Note G):
BASIS OF PRESENTATION
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with accounting principles generally accepted
in the United States of America ("GAAP").
MBS
The Partnership, in accordance with Financial Accounting Standards Board's
Statement 115, "Accounting for Certain Investments in Debt and Equity
Securities" (FAS 115), classifies its MBS portfolio as available-for-sale. As
such the Partnership carries its MBS at fair market value and reflects any
unrealized gains (losses) as a separate component of Partners' equity. The
Partnership amortizes purchase premiums or discounts over the life of the
underlying mortgages using the effective interest method.
PIMS
The Partnership accounts for its MBS portion of a PIM in accordance with
FAS 115 under the classification of held to maturity. The Partnership carries
the Fannie Mae MBS at amortized cost. The insured mortgage portion of the
Federal Housing Administration PIM (FHA PIM) is carried at amortized cost. The
Partnership does not establish loan loss reserves as its investments are fully
insured by the FHA.
Basic interest on PIMs is recognized at the stated rate of the Federal
Housing Administration insured mortgage (less the servicer's fee) or the stated
coupon rate of the Fannie Mae MBS. The Partnership recognizes interest related
to the participation features when the amount becomes fixed and the transaction
that gives rise to such amount is consummated.
CASH AND CASH EQUIVALENTS
The Partnership includes all short-term investments with maturities of three
months or less from the date of acquisition in cash and cash equivalents. The
Partnership invests its cash primarily in commercial paper and money market
funds with a commercial bank and has not experienced any loss to date on its
invested cash.
PREPAID FEES AND EXPENSES
Prepaid fees and expenses represent prepaid acquisition fees and expenses
and prepaid participation servicing fees paid for the acquisition and servicing
of PIMs. The Partnership amortizes the prepaid acquisition fees and expenses
using a method that approximates the effective interest method over a period of
ten to twelve years, which represents the estimated life of the underlying
mortgage.
The Partnership amortizes the prepaid participation servicing fees using a
method that approximates the effective interest method over a ten year period
beginning from the acquisition of the Fannie Mae MBS or final endorsement of the
FHA loan.
Upon the repayment of a PIM, any unamortized acquisition fees and expenses
and unamortized participation servicing fees related to such loan are expensed.
INCOME TAXES
The Partnership is not liable for federal or state income taxes because
Partnership income is allocated to the partners for income tax purposes. If the
Partnership's tax returns are examined by the Internal Revenue Service or state
taxing authority and such an examination results in a change in Partnership
taxable income, such change will be reported to the partners.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, contingent assets and liabilities and revenues and
expenses during the period. Actual results could differ from those estimates.
F-78
KRUPP INSURED PLUS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMS
At December 31, 2001 and 2000, the Partnership had investments in two
PIMs. The Partnership's PIMs consist of one Fannie Mae MBS representing the
securitized first mortgage loan on the underlying property and one participation
interest in a first mortgage loan originated under the FHA lending program on
the underlying property (collectively the "insured mortgages"). The Partnership
also has participation interests in the revenue stream and appreciation of the
underlying properties above specified thresholds. The borrower conveys these
participation features to the Partnership generally through a subordinated
promissory note and mortgage (the "Agreement").
The Partnership receives monthly payments of principal and basic interest
that are guaranteed by Fannie Mae on the MBS and insured by HUD on the FHA
mortgage loan. The Partnership may receive income related to its participation
interests in the underlying property, however, these amounts are neither insured
nor guaranteed.
Generally, the participation features consist of the following:
(i) "Minimum Additional Interest" which is at the rate of .5% per annum
calculated on the unpaid principal balance of the first mortgage on the
underlying property, (ii) "Shared Income Interest" which is 30% of the monthly
gross rental income generated by the underlying property in excess of a
specified base, limited to the extent that it exceeds the amount of Minimum
Additional Interest earned during such month or 25% of distributable surplus
cash and (iii) "Shared Appreciation Interest" which is 30% of any increase in
the value of the underlying property in excess of a specified base or 25% of the
net sales proceeds.
Payment of participation interest from the operations of the property is
limited to 50% of net revenue or Surplus Cash as defined by Fannie Mae or HUD,
respectively. The aggregate amount of Minimum Additional Interest, Shared Income
Interest and Shared Appreciation Interest payable by the underlying borrower on
the maturity date generally cannot exceed 50% of any increase in value of the
property over certain thresholds.
Shared Appreciation Interest is payable when one of the following occurs:
(1) the sale of the underlying property to an unrelated third party on a date
which is later than five years from the date of the Agreement, (2) the maturity
date or accelerated maturity date of the Agreement, or (3) prepayment of amounts
due under the Agreement and the insured mortgage.
The borrower may prepay the first mortgage loan subject to a 9% prepayment
premium in years six through nine, a 1% prepayment premium in year ten and no
prepayment premium thereafter.
Under the Agreement, upon giving twelve months written notice, the
Partnership can accelerate the maturity date of the Agreement to a date not
earlier than ten years from the date of the Agreement for (a) the payment of all
participation interest due under the Agreement as of the accelerated maturity
date, or (b) the payment of all participation interest due under the Agreement
plus all amounts due on the first mortgage note on the property.
In December 1999, the Partnership received a prepayment in the amount of
$9,746,923 representing the outstanding principal balance due on the La Costa
PIM. The Borrower defaulted on the first mortgage loan underlying the PIM in
June of 1999. The Partnership continued to receive its full principal and
interest payments until the GNMA mortgagee exercised its right to prepay the
GNMA MBS due to the continuing default of the underlying first mortgage loan.
Subsequent to the payoff, the Partnership received $10,000 from the Borrower to
release the Subordinated Promissory Note. This payment has been classified as
Shared Appreciation Interest. On January 11, 2000, the Partnership paid a
special distribution to the investors of $1.30 per Limited Partner interest.
At December 31, 2001 and 2000 there were no loans within the Partnership's
portfolio that were delinquent as to principal or interest.
The Partnership's PIMs consist of the following at December 31, 2001 and
2000:
INVESTMENT BASIS AT
APPROXIMATE DECEMBER 31,
ORIGINAL INTEREST MATURITY MONTHLY ----------------------------
PIMS FACE AMOUNT RATES (A) DATES PAYMENT 2001 2000
---- ----------- --------- -------- ----------- ----------- -----------
FHA
Vista Montana Apts.
Val Vista Lakes, Az.................. $13,814,400 7.375%(b) 12/1/33 90,000 $13,215,946 $13,311,717
FANNIE MAE
Royal Palm Place Kendall, Fl........... 6,021,258(c) 8.375%(d) 4/1/06 39,000 5,563,531 5,563,531
----------- ------ -------- ------ ----------- -----------
$19,835,658 $18,779,477(e) $18,875,248
=========== =========== ===========
------------------------------
(a) Represents only the stated interest rate of the Fannie Mae MBS or the stated
interest rate of the FHA mortgage loan less the servicing fee. In addition,
the Partnership may receive participation income, consisting of (i) Minimum
Additional Interest, (ii) Shared Income Interest and (iii) Shared
Appreciation Interest.
(b) On November 30, 1993, the Partnership entered into an agreement with the
underlying borrower of the FHA PIM for a permanent interest rate reduction
from 8.875% per annum to 7.375% per annum, retroactive to January 1, 1992.
In exchange for the interest rate reduction, the Partnership received an
increase in Shared Appreciation Interest from 25% in excess of the base
amount of $15,410,000 to 25% of the net sales proceeds over the outstanding
indebtedness at the time of sale. In the event of a refinancing, Shared
Appreciation Interest is 25% of the appraised value over the outstanding
indebtedness at the time of refinancing. In addition, Shared Income Interest
increased from 25% of rental income in excess of the base amount of $175,000
to 25% of all distributable surplus cash.
(c) The total original face amount of the PIM on the underlying property was
$22,000,000 of which 73% or $15,978,742 was acquired by Krupp Insured Plus
III Limited Partnership, an affiliate of the Partnership.
F-79
KRUPP INSURED PLUS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMS (CONTINUED)
(d) During December 1995, the Partnership agreed to a modification of the Royal
Palm PIM. The Partnership received a reissued Fannie Mae MBS and increased
its participation percentage in income and appreciation from 25% to 30%. The
Partnership will receive interest only payments on the Fannie Mae MBS at
interest rates ranging from 8.375% to 8.775% per annum through maturity.
(e) The aggregate cost of PIMs for federal income tax purposes is $18,779,477.
A reconciliation of the carrying value of Mortgages for each of the three
years in the period ended December 31, 2001 is as follows:
2001 2000 1999
----------- ----------- -----------
Balance at beginning of period.............................. $18,875,248 $19,032,999 $29,074,105
Deductions during period:
Prepayment and principal collections........................ (95,771) (157,751) (10,041,106)
----------- ----------- -----------
Balance at end of period.................................... $18,779,477 $18,875,248 $19,032,999
=========== =========== ===========
The underlying mortgages of the PIMs are collateralized by multi-family
apartment complexes located in two states. The apartment complexes range in size
from 341 to 377 units.
D. MBS
The Partnership received a payoff of the Boulders Apartments MBS on July 9,
2001 for $9,045,042. The Partnership also received a prepayment premium of
$306,000 from this payoff. On August 17, 2001, the Partnership paid a special
distribution of $1.25 per Limited Partner interest from the proceeds received.
The Partnership received a payoff from the Chateau Bijou MBS on
September 19, 2000 for $2,266,064. During October, the Partnership received a 9%
prepayment premium of $203,946 from this payoff. The Partnership paid a special
distribution in November of $.33 per Limited Partner interest from the proceeds
received.
At December 31, 2001, the Partnership's MBS portfolio had an amortized cost
of $8,912,032 and gross unrealized gains of $498,888. At December 31, 2000, the
Partnership's MBS portfolio had an amortized cost of $9,458,992 and gross
unrealized gains and losses of $338,073 and $1,482, respectively. At
December 31, 2000, the Partnership's insured mortgage had an amortized cost of
$9,068,897 and an unrealized gain of $351,420. The portfolio has maturities
ranging from 2006 to 2032.
UNREALIZED
MATURITY DATE FAIR VALUE GAIN
------------- ---------- ----------
2002-2006................................................... $ 93,563 $ 7,082
2007-2011................................................... 317,739 22,746
2012-2032................................................... 8,999,618 469,060
---------- --------
Total..................................................... $9,410,920 $498,888
========== ========
E. PARTNERS' EQUITY
Profits and losses from Partnership operations and Distributable Cash Flow
are allocated 97% to the Unitholders and Corporate Limited Partner (the "Limited
Partners") and 3% to the General Partners.
Upon the occurrence of a capital transaction, as defined in the Partnership
Agreement, net cash proceeds will be distributed first, to the Limited Partners
until they have received a return of their total invested capital, second, to
the General Partners until they have received a return of their total invested
capital, third, 99% to the Limited Partners and 1% to the General Partners until
the Limited Partners receive an amount equal to any deficiency in the 10%
cumulative return on their invested capital that exists through fiscal years
prior to the date of the capital transaction, fourth, to the class of General
Partners until they have received an amount equal to 4% of all amounts of cash
distributed under all capital transactions and fifth, 96% to the Limited
Partners and 4% to the General Partners.
Upon the occurrence of a terminating capital transaction, as defined in the
Partnership Agreement, the net cash proceeds and winding up of the affairs of
the Partnership will be allocated among the Partners first, to each class of
Partners in the amount equal to, or if less than, in proportion to, the positive
balance in the Partner's capital accounts, second, to the Limited Partners until
they have received a return of their total invested capital, third, to the
General Partners until they have received a return of their total invested
capital, fourth, 99% to the Limited Partners and 1% to the General Partners
until the Limited Partners have received to any deficiency in the 11% cumulative
return on their invested capital that exists through fiscal years prior to the
date of the capital transaction, fifth, to the General Partners until they have
received an amount equal to 4% of all amounts of cash distributed under all
capital transactions and sixth, 96% to the Limited Partners and 4% to the
General Partners.
Profits arising from a capital transaction will be allocated in the same
manner as related cash distributions. Losses from a capital transaction will be
allocated 97% to the Limited Partners and 3% to the General Partners.
During 2001, 2000 and 1999, the Partnership made quarterly distributions
totaling $.40, $.76 and $.76 per Limited Partner interest annually,
respectively. The Partnership made special distributions of $1.25 and $1.63 per
Limited Partner interest in 2001 and 2000, respectively.
F-80
KRUPP INSURED PLUS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
E. PARTNERS' EQUITY (CONTINUED)
As of December 31, 2001, the following cumulative partner contributions and
allocations have been made since inception of the Partnership:
CORPORATE ACCUMULATED
LIMITED GENERAL COMPREHENSIVE
UNITHOLDERS PARTNER PARTNERS INCOME TOTAL
------------- --------- ----------- ------------- -------------
Capital contributions................................... $ 149,489,830 $ 2,000 $ 3,000 $ -- $ 149,494,830
Syndication costs....................................... (7,906,604) -- -- -- (7,906,604)
Quarterly distributions................................. (126,236,046) (1,727) (2,927,848) -- (129,165,621)
Special distributions................................... (72,224,972) (963) -- -- (72,225,935)
Net income.............................................. 86,510,815 1,163 2,675,629 -- 89,187,607
Unrealized gains on MBS................................. -- -- -- 498,888 498,888
------------- ------- ----------- -------- -------------
Balance at December 31, 2001............................ $ 29,633,023 $ 473 $ (249,219) $498,888 $ 29,883,165
============= ======= =========== ======== =============
F. RELATED PARTY TRANSACTIONS
Under the terms of the Partnership Agreement, the General Partners receive
an Asset Management Fee equal to .75% per annum of the value of the
Partnership's total invested assets payable quarterly. The General Partners may
also receive an incentive management fee in an amount equal to .3% per annum on
the Partnership's Total Invested Assets providing the Unitholders receive a
specified non-cumulative annual return on their Invested Capital. Total fees
payable to the General Partners for asset management and incentive management
fees shall not exceed 10% of distributable cash flow over the life of the
Partnership.
Additionally, the Partnership reimburses affiliates of the General Partners
for certain expenses incurred in connection with maintaining the books and
records of the Partnership, the preparation and mailing of financial reports,
tax information and other communications to investors and legal fees and
expenses.
G. FEDERAL INCOME TAXES
The reconciliation of the net income reported in the accompanying statement
of income with the net income reported in the Partnership's 2001 federal income
tax return is as follows:
Net income from statement of operations..................... $2,540,547
Add: Book to tax difference for amortization of prepaid fees
and expenses.............................................. 63,587
----------
Net income for federal income tax purposes.................. $2,604,134
==========
The allocation of the 2001 net income for federal income tax purposes is as
follows:
PORTFOLIO
INCOME
----------
Unitholders................................................. $2,535,156
Corporate Limited Partner................................... 34
General Partners............................................ 68,944
----------
$2,604,134
==========
For the years ended December 31, 2001, 2000 and 1999 the average per unit
net income to the Unitholders for federal income tax purposes was $.34, $.40 and
$.40, respectively.
The basis of the Partnership's assets for financial reporting purposes was
less than its tax basis by approximately $256,000 and $343,000 at December 31,
2001 and 2000, respectively. The basis of the Partnership's liabilities for
financial reporting purposes was less than its tax basis by approximately
$11,000 at December 31, 2001. At December 31, 2000 the basis of the
Partnership's liabilities for financial reporting purposes was the same as its
tax basis.
H. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The Partnership used the following methods and assumptions to estimate the
fair value of each class of financial instruments:
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short maturity of
those instruments.
MBS
The Partnership estimated the fair value of MBS based on quoted market
prices while it estimated the fair value of insured mortgages based on quoted
prices of MBS with similar interest rates. Based on the estimated fair value
determined using these methods and assumptions,
F-81
KRUPP INSURED PLUS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
H. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS (CONTINUED)
the Partnership's investments in MBS had gross unrealized gains of approximately
$499,000 at December 31, 2001 and gross unrealized gains and losses of
approximately $689,000 and $1,000 at December 31, 2000.
PIMS
As there is no active trading market for these investments, management
estimates the fair value of the PIMs using quoted market prices of MBS having a
similar interest rate. Management does not include any estimate of participation
interest in the Partnership's estimated fair value for the Vista Montana PIM, as
Management does not believe it can predict the time of realization of the
feature with any certainty. Based on the estimated fair value determined using
these methods and assumptions, the Partnership's investments in PIMs had gross
unrealized gains of approximately $870,000 at December 31, 2001, and gross
unrealized gains and losses of approximately $42,000 and $300,000 at
December 31, 2000.
At December 31, 2001 and 2000, the Partnership estimates the fair value of
its financial instruments as follows (amounts rounded to the nearest thousand):
2001 2000
------------------- -------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
Cash and cash equivalents................................... $ 1,423 $ 1,423 $ 1,461 $ 1,461
MBS and insured mortgage.................................... 9,411 9,411 19,216 18,864
PIMs........................................................ 19,649 18,779 18,617 18,875
------- ------- ------- -------
$30,483 $29,613 $39,294 $39,200
======= ======= ======= =======
I. SUBSEQUENT EVENTS
The Partnership received a prepayment of the Royal Palm Place PIM. On
January 2, 2002, the Partnership received $378,480 of Shared Appreciation
Interest and $121,490 of Minimum Additional Interest. On February 27, 2002 the
Partnership received $5,563,531 representing the principal proceeds on the first
mortgage. The Partnership has declared a special distribution of $.80 per
Limited Partner interest consisting of Shared Appreciation Interest and
prepayment proceeds which will be paid in the first quarter of 2002.
F-82
KRUPP INSURED PLUS LIMITED PARTNERSHIP
BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED)
ASSETS
Participating Insured Mortgages ("PIMs")(Note 2)............ $13,165,307 $18,779,477
Mortgage-Backed Securities and insured mortgage ("MBS")
(Note 3).................................................. 9,168,243 9,410,920
----------- -----------
Total mortgage investments.............................. 22,333,550 28,190,397
Cash and cash equivalents................................... 1,117,553 1,422,582
Interest receivable and other assets........................ 146,081 190,282
Prepaid acquisition fees and expenses, net of accumulated
amortization of $814,674 and $785,095 respectively........ 29,578 59,157
Prepaid participation servicing fees, net of accumulated
amortization of $311,740 and $292,428, respectively....... 19,312 38,624
----------- -----------
Total assets............................................ $23,646,074 $29,901,042
=========== ===========
LIABILITIES AND PARTNERS' EQUITY
Liabilities................................................. $ 44,010 $ 17,877
----------- -----------
Partners' equity (deficit)(Note 4):
Limited Partners (7,500,099 Limited Partner interests
outstanding)............................................ 23,307,795 29,633,496
General Partners.......................................... (243,494) (249,219)
Accumulated comprehensive income.......................... 537,763 498,888
----------- -----------
Total Partners' equity.................................. 23,602,064 29,883,165
----------- -----------
Total liabilities and Partners' equity.................. $23,646,074 $29,901,042
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-83
KRUPP INSURED PLUS LIMITED PARTNERSHIP
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- -----------------------
2002 2001 2002 2001
--------- --------- ---------- ----------
(UNAUDITED)
Revenues:
Interest income--PIMs
Basic interest......................................... $242,893 $361,202 $ 525,084 $ 725,155
Participation interest................................. -- -- 504,639 --
Interest income--MBS..................................... 182,935 391,888 367,738 788,568
Other interest income.................................... 6,344 17,839 22,384 40,618
-------- -------- ---------- ----------
Total revenues....................................... 432,172 770,929 1,419,845 1,554,341
-------- -------- ---------- ----------
Expenses:
Asset management fee to an affiliate..................... 40,846 69,435 85,049 138,415
Expense reimbursements to affiliates..................... 15,003 14,163 25,725 25,664
Amortization of prepaid fees and expenses................ 24,446 23,066 48,891 46,132
General and administrative............................... 34,995 22,796 49,460 36,103
-------- -------- ---------- ----------
Total expenses....................................... 115,290 129,460 209,125 246,314
-------- -------- ---------- ----------
Net income................................................. 316,882 641,469 1,210,720 1,308,027
Other comprehensive income:
Net change in unrealized gain on MBS..................... 16,235 67,005 38,875 76,942
-------- -------- ---------- ----------
Total comprehensive income................................. $333,117 $708,474 $1,249,595 $1,384,969
======== ======== ========== ==========
Allocation of net income (Note 4):
Limited Partners......................................... $307,375 $622,225 $1,174,398 $1,268,786
======== ======== ========== ==========
Average net income per Limited Partner interest
(7,500,099 Limited Partner interests outstanding)...... $ .04 $ .08 $ .16 $ .17
======== ======== ========== ==========
General Partners......................................... $ 9,507 $ 19,244 $ 36,322 $ 39,241
======== ======== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-84
KRUPP INSURED PLUS LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS
ENDED JUNE 30,
-------------------------
2002 2001
----------- -----------
(UNAUDITED)
Operating activities:
Net income................................................ $ 1,210,720 $ 1,308,027
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of prepaid fees and expenses............... 48,891 46,132
Shared Appreciation Interest............................ (378,480) --
Changes in assets and liabilities:
Decrease in interest receivable and other assets...... 44,201 3,508
Increase in liabilities............................... 26,133 4,531
----------- -----------
Net cash provided by operating activities................... 951,465 1,362,198
----------- -----------
Investing activities:
Principal collections on MBS.............................. 281,552 294,274
Principal collections on PIMs including Shared
Appreciation Interest of $378,480 in 2002............... 5,992,650 46,991
----------- -----------
Net cash provided by investing activities................... 6,274,202 341,265
----------- -----------
Financing activities:
Quarterly distributions................................... (1,530,617) (1,543,527)
Special distribution...................................... (6,000,079) --
----------- -----------
Net cash used for financing activities...................... (7,530,696) (1,543,527)
----------- -----------
Net increase (decrease) in cash and cash equivalents........ (305,029) 159,936
Cash and cash equivalents, beginning of period.............. 1,422,582 1,460,786
----------- -----------
Cash and cash equivalents, end of period.................... $ 1,117,553 $ 1,620,722
=========== ===========
Non cash activities:
Increase in Fair Value of MBS............................. $ 38,875 $ 76,942
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-85
KRUPP INSURED PLUS LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. ACCOUNTING POLICIES
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted in this report
pursuant to the Rules and Regulations of the Securities and Exchange Commission.
However, in the opinion of the general partners, The Krupp Corporation and The
Krupp Company Limited Partnership-IV (collectively the "General Partners"), of
Krupp Insured Plus Limited Partnership (the "Partnership") the disclosures
contained in this report are adequate to make the information presented not
misleading. See Notes to Financial Statements included in the Partnership's
financial statements for the year ended December 31, 2001 for additional
information relevant to significant accounting policies followed by the
Partnership.
In the opinion of the General Partners of the Partnership, the accompanying
unaudited financial statements reflect all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the Partnership's
financial position as of June 30, 2002, its results of operations for the three
and six months ended June 30, 2002 and 2001 and its cash flows for the six
months ended June 30, 2002 and 2001.
The results of operations for the three and six months ended June 30, 2002
are not necessarily indicative of the results which may be expected for the full
year. See Management's Discussion and Analysis of Financial Condition and
Results of Operations included in this report.
2. PIMS
At June 30, 2002, the Partnership's remaining PIM had a fair market value of
$13,715,617 and gross unrealized gains of $550,310. The PIM matures in 2033.
The Partnership received a prepayment of the Royal Palm Place PIM. On
January 2, 2002, the Partnership received $378,480 of Shared Appreciation
Interest and $126,159 of Minimum Additional Interest. On February 27, 2002, the
Partnership received $5,563,531 representing the principal proceeds on the first
mortgage. On March 19, 2002, the Partnership paid a special distribution of
$0.80 per Limited Partner interest from the principal proceeds and Shared
Appreciation Interest received.
3. MBS
At June 30, 2002, the Partnership's MBS portfolio had an amortized cost of
$8,630,480 and gross unrealized gains of $537,763. The portfolio has maturities
ranging from 2006 to 2032.
4. CHANGES IN PARTNERS' EQUITY
A summary of changes in Partners' Equity for the six months ended June 30,
2002 is as follows:
ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
PARTNERS PARTNERS INCOME EQUITY
----------- --------- ------------- -----------
Balance at December 31, 2001................................ $29,633,496 $(249,219) $498,888 $29,883,165
Net income.................................................. 1,174,398 36,322 -- 1,210,720
Quarterly distributions..................................... (1,500,020) (30,597) -- (1,530,617)
Special Distribution........................................ (6,000,079) -- -- (6,000,079)
Change in unrealized gain on MBS............................ -- -- 38,875 38,875
----------- --------- -------- -----------
Balance at June 30, 2002.................................... $23,307,795 $(243,494) $537,763 $23,602,064
=========== ========= ======== ===========
F-86
REPORT OF INDEPENDENT ACCOUNTANTS
To the Partners of
Krupp Insured Plus-II Limited Partnership:
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Krupp
Insured Plus-II Limited Partnership (the "Partnership") at December 31, 2001 and
2000 and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Partnership's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America which
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 financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 22, 2002
F-87
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
----------- -----------
ASSETS
Participating Insured Mortgages ("PIMs")
(Notes B, C and H).......................................... $ 3,101,005 $17,541,596
Mortgage-Backed Securities and insured mortgage ("MBS")
(Notes B, D and H)........................................ 30,211,162 21,247,646
----------- -----------
Total mortgage investments.............................. 33,312,167 38,789,242
Cash and cash equivalents (Notes B, C and H)................ 933,678 3,125,710
Interest receivable and other assets........................ 221,124 275,591
Prepaid acquisition fees and expenses, net of accumulated
amortization of $0 and $733,572, respectively (Note B).... -- 65,905
----------- -----------
Total assets............................................ $34,466,969 $42,256,448
=========== ===========
LIABILITIES AND PARTNERS' EQUITY
Liabilities................................................. $ 17,875 $ 17,889
----------- -----------
Partners' equity (deficit) (Notes A, C and E):
Limited Partners............................................ 34,084,355 42,383,344
(14,655,512 Limited Partner interest outstanding)
General Partners............................................ (341,667) (337,448)
Accumulated comprehensive income (Note B)................... 706,406 192,663
----------- -----------
Total Partners' equity.................................. 34,449,094 42,238,559
----------- -----------
Total liabilities and Partners' equity.................. $34,466,969 $42,256,448
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-88
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
---------- ---------- ----------
Revenues:
Interest income--PIMs:
Basic interest.......................................... $ 613,152 $1,360,247 $3,681,868
Participation interest.................................. 30,769 -- 1,634,686
Interest income--MBS.................................... 2,021,867 1,685,246 1,826,026
Other interest income..................................... 124,846 474,953 680,085
---------- ---------- ----------
Total revenues........................................ 2,790,634 3,520,446 7,822,665
========== ========== ==========
Expenses:
Asset management fee to an affiliate (Note F)............. 261,650 299,983 496,464
Expense reimbursement to affiliates (Note F).............. 119,166 125,209 94,160
Amortization of prepaid fees and expenses (Note B)........ 65,905 122,275 898,457
General and administrative................................ 172,342 202,601 186,866
---------- ---------- ----------
Total expenses........................................ 619,063 750,068 1,675,947
========== ========== ==========
Net income (Notes E and G).................................. 2,171,571 2,770,378 6,146,718
Other Comprehensive Income:
Net change in unrealized gain on MBS...................... 513,743 87,582 (435,431)
---------- ---------- ----------
Total Comprehensive Income.................................. $2,685,314 $2,857,960 $5,711,287
========== ========== ==========
Allocation of net income (Notes E and G):
Limited Partners.......................................... $2,106,424 $2,687,267 $5,962,316
Average net income per Limited Partner
Interest (14,655,512 Limited Partner interests
outstanding)............................................ $ .14 $ .18 $ .41
---------- ---------- ----------
General Partners.......................................... $ 65,147 $ 83,111 $ 184,402
========== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-89
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
PARTNERS PARTNERS INCOME EQUITY
------------ --------- ------------- ------------
Balance at December 31, 1998....................... $117,123,621 $(290,140) $ 540,512 $117,373,993
Net income......................................... 5,962,316 184,402 -- 6,146,718
Quarterly distributions............................ (11,138,189) (217,645) -- (11,355,834)
Special distributions.............................. (51,587,401) -- -- (51,587,401)
Change in unrealized gain on MBS................... -- -- (435,431) (435,431)
------------ --------- --------- ------------
Balance at December 31, 1999....................... 60,360,347 (323,383) 105,081 60,142,045
Net income......................................... 2,687,267 83,111 -- 2,770,378
Quarterly distributions............................ (5,862,204) (97,176) -- (5,959,380)
Special distributions.............................. (14,802,066) -- -- (14,802,066)
Change in unrealized gain on MBS................... -- -- 87,582 87,582
------------ --------- --------- ------------
Balance at December 31, 2000....................... 42,383,344 (337,448) 192,663 42,238,559
Net income......................................... 2,106,424 65,147 -- 2,171,571
Quarterly distributions............................ (5,862,204) (69,366) -- (5,931,570)
Special distributions.............................. (4,543,209) -- -- (4,543,209)
Change in unrealized gain on MBS................... -- -- 513,743 513,743
------------ --------- --------- ------------
Balance at December 31, 2001....................... $ 34,084,355 $(341,667) $ 706,406 $ 34,449,094
============ ========= ========= ============
The accompanying notes are an integral part of the financial statements.
F-90
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
------------ ------------ ------------
Operating activities:
Net income................................................ $ 2,171,571 $ 2,770,378 $ 6,146,718
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of prepaid fees and expenses............... 65,905 122,275 898,457
Premium Amortization.................................... 22,153 -- --
Shared Appreciation Interest and prepayment premiums.... -- -- (1,162,777)
Changes in assets and liabilities:
Decrease in interest receivable and other assets...... 54,467 102,695 352,543
Decrease in liabilities............................... (14) (2,059) (232,821)
------------ ------------ ------------
Net cash provided by operating activities........... 2,314,082 2,993,289 6,002,120
------------ ------------ ------------
Investing activities:
Principal collections on PIMs including Shared
Appreciation Interest and prepayment premium of
$1,162,777 in 1999...................................... 119,842 8,682,792 57,196,596
Principal collections on MBS.............................. 5,848,823 1,117,892 2,078,965
------------ ------------ ------------
Net cash provided by investing activities........... 5,968,665 9,800,684 59,275,561
------------ ------------ ------------
Financing activities:
Quarterly distributions................................... (5,931,570) (5,959,380) (11,355,834)
Special distributions..................................... (4,543,209) (14,802,066) (51,587,401)
------------ ------------ ------------
Net cash used for financing activities.............. (10,474,779) (20,761,446) (62,943,235)
------------ ------------ ------------
Net (decrease) increase in cash and equivalents............. (2,192,032) (7,967,473) 2,334,446
Cash and cash equivalents, beginning of year................ 3,125,710 11,093,183 8,758,737
------------ ------------ ------------
Cash and cash equivalents, end of year...................... $ 933,678 $ 3,125,710 $ 11,093,183
============ ============ ============
Supplemental disclosure of non-cash investing activities:
Reclassification of investment in a PIM to MBS............ $ 14,320,749 $ -- $ --
============ ============ ============
Non cash activities:
Increase (decrease) in fair value of MBS.................. $ 513,743 $ 87,582 $ (435,431)
============ ============ ============
The accompanying notes are an integral part of the financial statements.
F-91
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
A. ORGANIZATION
Krupp Insured Plus-II Limited Partnership (the "Partnership") was formed on
October 29, 1986 by filing a Certificate of Limited Partnership in The
Commonwealth of Massachusetts. The Partnership was organized for the purpose of
investing in multi-family loans and mortgage backed securities. The Partnership
issued all of the General Partner Interests to Krupp Plus Corporation and
Mortgage Services Partners Limited Partnership in exchange for capital
contributions aggregating $3,000. The Partnership terminates on December 31,
2026, unless terminated earlier upon the occurrence of certain events as set
forth in the Partnership Agreement.
The Partnership commenced the public offering of Limited Partner interests
on May 29, 1987 and completed its public offering having sold 14,655,412 Limited
Partner interests for $292,176,381 net of purchase volume discounts of $931,859
as of May 27, 1988. In addition, Krupp Depositary Corporation owns one hundred
Limited Partner interests.
B. SIGNIFICANT ACCOUNTING POLICIES
The Partnership uses the following accounting policies for financial
reporting purposes, which may differ in certain respects from those used for
federal income tax purposes (Note G).
BASIS OF PRESENTATION
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with accounting principles generally accepted
in the United States of America ("GAAP").
MBS
The Partnership, in accordance with Financial Accounting Standards Board's
Statement 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("FAS 115"), classifies its MBS portfolio as available-for-sale. As
such the Partnership carries its MBS at fair market value and reflects any
unrealized gains (losses) as a separate component of Partners' Equity. The
Partnership amortizes purchase premiums or discounts over the life of the
underlying mortgages using the effective interest method.
The Partnership also holds a Federal Housing Administration ("FHA") insured
mortgage which is classified as MBS and is carried at amortized cost. The
Partnership holds this loan at amortized cost. The Partnership does not
establish loan loss reserves as its investments are fully insured by the FHA.
PIMS
The Partnership accounts for the MBS portion of its PIM in accordance with
FAS 115 under the classification of held to maturity. The Partnership carries
the Government National Mortgage Association ("GNMA") MBS at amortized cost.
Basic interest on the PIM is recognized based on the stated coupon rate of
the GNMA MBS. The Partnership's recognizes interest related to the participation
feature when the amount becomes fixed and the transaction that gives rise to
such amount is consummated.
CASH AND CASH EQUIVALENTS
The Partnership includes all short-term investments with maturities of three
months or less at the date of acquisition in cash and cash equivalents. The
Partnership invests its cash primarily in commercial paper and money market
funds with a commercial bank and has not experienced any loss to date on its
invested cash.
PREPAID FEES AND EXPENSES
Prepaid fees and expenses consisted of acquisition fees and expenses paid
for the acquisition of PIMs. The Partnership amortized prepaid acquisition fees
and expenses using a method that approximated the effective interest method over
a period of ten to twelve years, which represented the estimated life of the
underlying mortgage.
Upon the repayment of a PIM, any unamortized acquisition fees and expenses
related to such loan were expensed.
INCOME TAXES
The Partnership is not liable for federal or state income taxes because
Partnership income is allocated to the partners for income tax purposes. If the
Partnership's tax returns are examined by the Internal Revenue Service or state
taxing authority and such an examination results in a change in Partnership
taxable income, such change will be reported to the partners.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, contingent assets and liabilities and revenues and
expenses during the period. Actual results could differ from those estimates.
C. PIMS
At December 31, 2001 and 2000, the Partnership had investments in one PIM
and two PIMs, respectively. The Partnership's remaining PIM consists of a GNMA
MBS representing the securitized first mortgage loan on the underlying property
and participation interests in the
F-92
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMS (CONTINUED)
revenue stream and appreciation of the underlying property above specified base
levels. The borrower conveys these participation features to the Partnership
generally through a subordinated promissory note and mortgage (the "Agreement").
The Partnership receives guaranteed monthly payments of principal and basic
interest on the GNMA MBS and HUD insures the first mortgage loan underlying the
GNMA MBS.
The Partnership may receive income related to its participation interests in
the underlying property, however, these amounts are neither insured nor
guaranteed.
The participation features consist of the following: (i) "Minimum Additional
Interest" equal to .5% per annum calculated on the unpaid principal balance of
the first mortgage on the underlying property, (ii) "Shared Income Interest" is
25% of the monthly gross rental income generated by the underlying property in
excess of a specified base, but only to the extent that it exceeds the amount of
Minimum Additional Interest received during such month and (iii) "Shared
Appreciation Interest" is 25% of any increase in the value of the underlying
property in excess of a specified base. Payment of Minimum Additional Interest
and Shared Income Interest from the operations of the property is limited to 50%
of net revenue or Surplus Cash as defined by HUD.
The total amount of Minimum Additional Interest, Shared Income Interest and
Shared Appreciation Interest payable on the maturity date by the underlying
borrower usually cannot exceed 50% of any increase in value of the property.
Shared Appreciation Interest is payable when one of the following occurs:
(1) the sale of the underlying property to an unrelated third party on a date
which is later than five years from the date of the Agreement, (2) the maturity
date or accelerated maturity date of the Agreement, or (3) prepayment of amounts
due under the Agreement and the insured mortgage.
Under the Agreement, the Partnership, upon giving twelve months written
notice, can accelerate the maturity date of the Agreement and insured mortgage
to a date not earlier than ten years from the date of the Agreement for (a) the
payment of all participation interest due under the Agreement as of the
accelerated maturity date, or (b) the payment of all participation interest due
under the Agreement plus all amounts due on the first mortgage note on the
property.
During May 2001, the Partnership received $30,769 from the borrowers of the
Richmond Park PIM as a settlement to release the loan's participation features.
The property was not generating sufficient cash flow to pay any participation
from property operations nor did it have sufficient value to meet the threshold
to pay any participation based on value if the property was sold or refinanced.
The borrowers asked for a release of the participation features while keeping
the insured first mortgage in place until the property turns around. The General
Partners agreed to this request in return for the settlement because there was
no expectation that the Partnership would be entitled to any participation
proceeds now or in the future in the property's current condition. Upon this
settlement, the insured first mortgage loan on Richmond Park was reclassified
from a PIM to a MBS as the only remaining portion of the investment is a GNMA
MBS. The Partnership also reclassified this investment to available for sale
concurrent with the release of the participation feature. The Partnership will
continue to receive the scheduled principal and interest payments on the first
mortgage until the property is refinanced or sold.
On March 30, 2000, the Partnership paid a special distribution of $.58 per
Limited Partner interest from the prepayment proceeds received during
February 2000 on the Greenhouse Apartments PIM in the amount of $8,428,984. The
underlying property was foreclosed on by the first mortgage lender during
January 1999. The Partnership continued to receive its full principal and basic
interest payments due on the PIM while the underlying mortgage was in default
because those payments were guaranteed by GNMA. The Partnership did not receive
any participation interest from this transaction.
On January 11, 2000, the Partnership paid a special distribution of $.43 per
Limited Partner interest from the Saratoga Apartments PIM prepayment proceeds
received in December 1999 in the amount of $6,204,960. The underlying property
value had not increased sufficiently enough to meet the criteria for the
Partnership to earn any participation interest.
In September 1999, the Partnership received Shared Appreciation Interest and
accrued Minimum Additional and Shared Income Interest of $1,102,701 and
$472,587, respectively in connection with the Le Coeur du Monde PIM. The
Partnership also received $279,447 relating to repayment of interest rate
rebates. The Partnership received the principal proceeds of $9,422,001 in
October. The principal proceeds and Shared Appreciation Interest were
distributed to the Limited Partners through a special distribution of $.72 per
Limited Partner interest on November 22, 1999.
On June 18, 1999, the Partnership made a special distribution of $.83 per
Limited Partner interest with the proceeds of the Country Meadows PIM. The
Partnership received principal of $12,015,224 and a prepayment premium of
$60,076 from this prepayment.
On February 26, 1999, the Partnership made a special distribution to the
Limited Partners of $1.97 per Limited Partner Interest. This special
distribution was the result of the prepayment of the Stanford Court, Hillside
Court, Carlyle Court and Waterford Court Apartments PIMs. The Partnership
received principal of $27,967,284 during January 1999, Shared Appreciation
Interest and prepayment premiums of $860,052 and accrued Minimum Additional and
Shared Income Interest of $432,877 during December 1998 from these prepayments.
At December 31, 2001 and 2000 there were no loans within the Partnership's
portfolio that were delinquent as to principal or interest.
F-93
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMS (CONTINUED)
The Partnership's PIMs consisted of the following at December 31, 2001 and
2000:
INVESTMENT BASIS AT
DECEMBER 31,
ORIGINAL INTEREST MATURITY MONTHLY ---------------------------
GNMA FACE AMOUNT RATES(A) DATES(E) PAYMENT(F) 2001 2000
---- ----------- -------- ----------- ---------- ---------- -----------
Denrich Apartments
Philadelphia, PA................................ $3,500,000 8% 12/15/23 $24,800 $3,101,005 $ 3,148,969
(b)(c)
(d)(g)
Richmond Park (h)
Richmond Heights, OH............................ 16,000,000 -- -- -- -- 14,392,627
----------- ---------- -----------
$19,500,000 $3,101,005(j) $17,541,596
=========== ========== ===========
------------------------------
(a) Represents the permanent interest rate of the GNMA MBS. In addition, the
Partnership receives participation interest consisting of (i) Minimum
Additional Interest, (ii) Shared Income Interest and (iii) Shared
Appreciation Interest.
(b) Minimum Additional Interest is at a rate of .5% per annum calculated on the
unpaid principal balance of the first mortgage note.
(c) Shared Income Interest is based on 25% of monthly gross rental income over a
specified base amount.
(d) Shared Appreciation Interest is based on 25% of any increase in the value of
the project over the specified base value.
(e) The Partnership's GNMA MBS has a call provision, which allows the
Partnership to accelerate the maturity date.
(f) The normal monthly payment consisting of principal and basic interest is
payable monthly at level amounts over the term of the GNMA MBS.
(g) On June 28, 1995, the Partnership entered into a temporary basic interest
rate reduction agreement on the Denrich Apartments PIM. Beginning July 1,
1995, the basic interest rate decreased from 8% per annum to 6.25% per annum
for thirty months, then increased to 6.75% per annum for the following
thirty-six month period and then increased to the original rate of 8% per
annum. The difference between basic interest at the original interest rate
and the reduced rates accumulated and will be payable from surplus cash or
from the net proceeds of a sale or refinancing. These accumulated amounts
will be due and payable prior to any distributions to the borrower or
payment of participation interest to the Partnership. Also under the
agreement, the Base Value for calculating Shared Appreciation Interest
decreased from $4,025,000 to $3,500,000.
(h) During May 2001, the Partnership received $30,769 as a settlement to release
the loan's participation features. The insured first mortgage loan was
reclassified from a PIM to a MBS.
(i) The aggregate cost of the PIM for federal income tax purposes is $3,101,005.
A reconciliation of the carrying value of PIMs for each of the three years
in the period ended December 31, 2001 is as follows:
2001 2000 1999
----------- ----------- -----------
Balance at beginning of period.............................. $17,541,596 $26,224,388 $82,258,207
Deductions during period:
Prepayments and principal collections..................... (119,842) (8,682,792) (56,033,819)
Reclass to MBS............................................ (14,320,749) -- --
----------- ----------- -----------
Balance at end of period.................................... $ 3,101,005 $17,541,596 $26,224,388
=========== =========== ===========
The underlying mortgage of the Denrich Apartments PIM is collateralized by a
multi-family apartment complex located in Philadelphia, Pennsylvania. The
apartment complex has 89 units.
F-94
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
D. MBS
During May 2001, the Partnership received a payoff of the Orchard Landing
MBS in the amount of $4,440,315. On July 18, 2001 the Partnership paid a special
distribution of $.31 per Limited Partner interest from the principal proceeds.
At December 31, 2001, the Partnership's MBS portfolio had an amortized cost
of $17,982,354 and unrealized gains of $706,406. At December 31, 2001, the
Partnership's insured mortgage had an amortized cost of $11,522,402 and an
unrealized gain of $363,763. At December 31, 2000, the Partnership's MBS
portfolio has an amortized cost of $9,407,384 and unrealized gains and losses of
$233,123 and $40,460, respectively. At December 31, 2000, the Partnership's
insured mortgage had an amortized cost of $11,647,599 and an unrealized gain of
$203,833. The portfolio has maturities ranging from 2007 to 2028.
UNREALIZED
MATURITY DATE FAIR VALUE GAIN
------------- ----------- ----------
2002-2006................................................... $ -- $ --
2007-2011................................................... 1,643,717 159,611
2012-2028................................................... 28,931,208 910,558
----------- ----------
Total..................................................... $30,574,925 $1,070,169
=========== ==========
E. PARTNERS' EQUITY
Profits and losses from Partnership operations and Distributable Cash Flow
are allocated 97% to the Unitholders and Corporate Limited Partner (the "Limited
Partners") and 3% to the General Partners.
Upon the occurrence of a capital transaction, as defined in the Partnership
Agreement, net cash proceeds will be distributed first, to the Limited Partners
until they have received a return of their total invested capital, second, to
the General Partners until they have received a return of their total invested
capital, third, 99% to the Limited Partners and 1% to the General Partners until
the Limited Partners receive an amount equal to any deficiency in the 11%
cumulative return on their invested capital that exists through fiscal years
prior to the date of the capital transaction, fourth, to the class of General
Partners until they have received an amount equal to 4% of all amounts of cash
distributed under all capital transactions and fifth, 96% to the Limited
Partners and 4% to the General Partners.
Upon the occurrence of a terminating capital transaction, as defined in the
Partnership Agreement, the net cash proceeds and winding up of the affairs of
the Partnership will be allocated among the Partners first, to each class of
Partners in the amount equal to, or if less than, in proportion to, the positive
balance in the Partner's capital accounts, second, to the Limited Partners until
they have received a return of their total invested capital, third, to the
General Partners until they have received a return of their total invested
capital, fourth, 99% to the Limited Partners and 1% to the General Partners
until the Limited Partners have received to any deficiency in the 11% cumulative
return on their invested capital that exists through fiscal years prior to the
date of the capital transaction, fifth, to the General Partners until they have
received an amount equal to 4% of all amounts of cash distributed under all
capital transactions and sixth, 96% to the Limited Partners and 4% to the
General Partners.
Profits arising from a capital transaction, will be allocated in the same
manner as related cash distributions. Losses from a capital transaction will be
allocated 97% to the Limited Partners and 3% to the General Partners.
During 2001, 2000 and 1999 the Partnership made quarterly distributions
totaling $.40, $.40 and $.76 per Limited Partner interest, respectively. The
Partnership made special distributions of $.31, $1.01 and $3.52 per Limited
Partner interest in 2001, 2000 and 1999, respectively.
As of December 31, 2001, the following cumulative partner contributions and
allocations have been made since the inception of the Partnership:
CORPORATE ACCUMULATED
LIMITED GENERAL COMPREHENSIVE
UNITHOLDERS PARTNER PARTNERS INCOME TOTAL
------------- --------- ----------- ------------- -------------
Capital contributions................................... $ 292,176,381 $ 2,000 $ 3,000 $ -- $ 292,181,381
Syndication costs....................................... (15,580,734) -- -- -- (15,580,734)
Quarterly distributions................................. (249,750,539) (1,740) (5,898,928) -- (255,651,207)
Special distributions................................... (172,347,642) (1,176) -- -- (172,348,818)
Net income.............................................. 179,586,552 1,253 5,554,261 -- 185,142,066
Unrealized gains on MBS................................. -- -- -- 706,406 706,406
------------- ------- ----------- -------- -------------
Total at December 31, 2001.............................. $ 34,084,018 $ 337 $ (341,667) $706,406 $ 34,449,094
============= ======= =========== ======== =============
F. RELATED PARTY TRANSACTIONS
Under the terms of the Partnership Agreement, the General Partners or their
affiliates are entitled to an asset management fee for the management of the
Partnership's business, equal to .75% per annum of the value of the
Partnership's actual and committed mortgage assets, payable quarterly. The
General Partners may also receive an incentive management fee in an amount equal
to .3% per annum on the Partnership's total invested assets provided the
Unitholders have received their specified non-cumulative annual return on their
Invested
F-95
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
F. RELATED PARTY TRANSACTIONS (CONTINUED)
Capital. Total fees payable to the General Partners for management services
shall not exceed 10% of Distributable Cash Flow over the life of the
Partnership.
Additionally, the Partnership reimburses affiliates of the General Partners
for certain costs incurred in connection with maintaining the books and records
of the Partnership the preparation and mailing of financial reports, tax
information and other communications to investors and legal fees and expenses.
G. FEDERAL INCOME TAXES
The reconciliation of the income reported in the accompanying financial
statements with the income reported in the Partnership's 2001 federal income tax
return is as follows:
Net income per statement of income.......................... $2,171,571
Less: Book to tax difference for amortization of prepaid
fees and expenses......................................... (232,139)
----------
Net income for federal income tax purposes.................. $1,939,432
----------
The allocation of the 2001 net income for federal income tax purposes is as
follows:
PORTFOLIO
INCOME
----------
Unitholders................................................. $1,881,236
Corporate Limited Partner................................... 13
General Partners............................................ 58,183
----------
$1,939,432
==========
For the years ended December 31, 2001, 2000 and 1999 the average per unit
net income to the Unitholders for federal income tax purposes was $.13, $.15 and
$.33 respectively.
The basis of the Partnership's assets for financial reporting purposes was
less than its tax basis by approximately $183,000 and $929,000 at December 31,
2001 and 2000, respectively. The basis of the Partnership's liabilities for
financial reporting purposes were the same as its tax basis at December 31, 2001
and 2000, respectively.
H. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The Partnership uses the following methods and assumptions to estimate the
fair value of each class of financial instruments:
CASH AND CASH EQUIVALENTS
The carrying amount approximates fair value because of the short maturity of
those instruments.
MBS
The Partnership estimates the fair value of MBS based on quoted market
prices while it estimates the fair value of insured mortgages based on quoted
prices of MBS with similar interest rates. Based on the estimated fair value
determined using these methods and assumptions, the Partnership's investments in
MBS had gross unrealized gains of approximately $1,070,000 at December 31, 2001
and gross unrealized gains and losses of $437,000 and $40,000, respectively, at
December 31, 2000.
PIMS
As there is no active trading market for these investments, Management
estimates the fair value of the PIMs using quoted market prices of MBS having a
similar interest rate. Management does not include any participation interest in
the Partnership's estimated fair value arising from the properties as Management
does not believe it can predict the time of realization of the feature with any
certainty. Based on the estimated fair value determined using these methods and
assumptions, the Partnership's investments in PIMs had gross unrealized gains of
approximately $146,000 at December 31, 2001 and gross unrealized gains of
approximately $46,000 at December 31, 2000.
At December 31, 2001 and 2000, the estimated fair values of the
Partnership's financial instruments are as follows (amounts rounded to nearest
thousand):
2001 2000
------------------- -------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
Cash and cash equivalents................................... $ 934 $ 934 $ 3,126 $ 3,126
MBS and insured mortgages................................... 30,575 30,211 21,451 21,248
PIMs........................................................ 3,247 3,101 17,588 17,542
------- ------- ------- -------
$34,756 $34,246 $42,165 $41,916
======= ======= ======= =======
F-96
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED)
ASSETS
Participating Insured Mortgages ("PIMs")(Note 2)............ $ -- $ 3,101,005
Mortgage-Backed Securities and insured mortgage ("MBS")
(Note 3).................................................. 14,313,515 30,211,162
----------- -----------
Total mortgage investments.............................. 14,313,515 33,312,167
Cash and cash equivalents................................... 15,858,095 933,678
Interest receivable and other assets........................ 112,512 221,124
----------- -----------
Total assets............................................ $30,284,122 $34,466,969
=========== ===========
LIABILITIES AND PARTNERS' EQUITY
Liabilities................................................. $ 84,855 $ 17,875
----------- -----------
Partners' equity (deficit) (Note 4):
Limited Partners (14,655,512 Limited Partner interests
outstanding)............................................ 30,354,914 34,084,355
General Partners.......................................... (343,653) (341,667)
Accumulated comprehensive income.......................... 188,006 706,406
----------- -----------
Total Partners' equity.................................. 30,199,267 34,449,094
----------- -----------
Total liabilities and Partners' equity.................. $30,284,122 $34,466,969
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-97
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- -----------------------
2002 2001 2002 2001
--------- -------- ---------- ----------
(UNAUDITED)
Revenues:
Interest income--PIMs:
Basic interest.......................................... $ 121,186 $152,093 $ 183,038 $ 488,700
Participation interest.................................. -- 30,769 -- 30,769
Interest income--MBS...................................... 454,391 466,875 1,037,960 876,742
Other interest income..................................... 23,925 48,349 29,600 92,806
--------- -------- ---------- ----------
Total revenues........................................ 599,502 698,086 1,250,598 1,489,017
--------- -------- ---------- ----------
Expenses:
Asset management fee to an affiliate...................... 46,328 65,651 105,917 136,740
Expense reimbursements to affiliates...................... 33,918 31,230 58,395 56,706
Amortization of prepaid fees and expenses................. -- 25,965 -- 47,933
General and administrative................................ 73,783 40,554 96,262 61,493
--------- -------- ---------- ----------
Total expenses........................................ 154,029 163,400 260,574 302,872
--------- -------- ---------- ----------
Net income.................................................. 445,473 534,686 990,024 1,186,145
Other comprehensive income:
Net change in unrealized gain on MBS........................ (497,260) 246,665 (518,400) 376,385
--------- -------- ---------- ----------
Total comprehensive income................................ $ (51,787) $781,351 $ 471,624 $1,562,530
========= ======== ========== ==========
Allocation of net income (Note 4):
Limited Partners.......................................... $ 432,109 $518,646 $ 960,323 $1,150,561
========= ======== ========== ==========
Average net income per Limited Partner interest (14,655,512
Limited Partner interests outstanding).................... $ .03 $ .04 $ .07 $ .08
========= ======== ========== ==========
General Partners.......................................... $ 13,364 $ 16,040 $ 29,701 $ 35,584
========= ======== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-98
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS
ENDED JUNE 30,
-------------------------
2002 2001
----------- -----------
(UNAUDITED)
Operating activities:
Net income................................................ $ 990,024 $ 1,186,145
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of prepaid fees and expenses............... -- 47,933
Premium amortization.................................... -- 38,286
Changes in assets and liabilities:
Decrease in interest receivable and other assets...... 108,612 32,752
Increase in liabilities............................... 66,980 18,848
----------- -----------
Net cash provided by operating activities........... 1,165,616 1,323,964
----------- -----------
Investing activities:
Principal collections on PIMs............................. 3,101,005 95,367
Principal collections on MBS.............................. 15,379,247 5,078,802
----------- -----------
Net cash provided by investing activities........... 18,480,252 5,174,169
----------- -----------
Financing activities:
Quarterly distributions................................... (1,497,239) (2,968,234)
Special distribution...................................... (3,224,212) --
----------- -----------
Net cash used for financing activities.............. (4,721,451) (2,968,234)
----------- -----------
Net increase in cash and cash equivalents................... 14,924,417 3,529,899
Cash and cash equivalents, beginning of period.............. 933,678 3,125,710
----------- -----------
Cash and cash equivalents, end of period.................... $15,858,095 $ 6,655,609
=========== ===========
Supplemental disclosure of non-cash investing activities:
Reclassification of investment in a PIM to a MBS.......... $ -- $14,320,749
=========== ===========
Non cash activities:
Increase (decrease) in Fair Value of MBS.................. $ (518,400) $ 376,385
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-99
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. ACCOUNTING POLICIES
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted in this report
pursuant to the Rules and Regulations of the Securities and Exchange Commission.
However, in the opinion of the general partners, Krupp Plus Corporation and
Mortgage Services Partners Limited Partnership (collectively the "General
Partners"), of Krupp Insured Plus-II Limited Partnership (the "Partnership"),
the disclosures contained in this report are adequate to make the information
presented not misleading. See Notes to Financial Statements included in the
Partnership's financial statements for the year ended December 31, 2001 for
additional information relevant to significant accounting policies followed by
the Partnership.
In the opinion of the General Partners of the Partnership, the accompanying
unaudited financial statements reflect all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the Partnership's
financial position as of June 30, 2002, the results of operations for the three
and six months ended June 30, 2002 and 2001 and its cash flows for the six
months ended June 30, 2002 and 2001.
The results of operations for the three and six months ended June 30, 2002
are not necessarily indicative of the results which may be expected for the full
year. See Management's Discussion and Analysis of Financial Condition and
Results of Operations included in this report.
2. PIMS
On May 15, 2002, the Partnership received $3,084,121 representing the
principal proceeds on the first mortgage loan from the Denrich Apartments PIM.
In addition, the Partnership received $100,625 from an affiliate to compensate
the fund for the inability to collect the accumulated but unpaid interest that
resulted from the interest rate reduction agreement entered into in June, 1995.
On June 19, 2002, the Partnership paid a special distribution of $.22 per
Limited Partner interest from the principal proceeds received.
3. MBS
The Partnership received a payoff of the Richmond Park Apartments MBS on
June 17, 2002 for $14,073,943. The Partnership intends to pay a special
distribution of $.97 per Limited Partner interest from the proceeds of the
Richmond Park prepayment in the third quarter of 2002.
At June 30, 2002, the Partnership's MBS portfolio had an amortized cost of
$2,669,366 and unrealized gains of $188,006. At June 30, 2002, the Partnership's
insured mortgage had an amortized cost of $11,456,143. The portfolio had
maturities ranging from 2008 to 2028.
4. CHANGES IN PARTNERS' EQUITY
A summary of changes in Partners' Equity for the six months ended June 30,
2002 is as follows:
ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
PARTNERS PARTNERS INCOME EQUITY
----------- --------- ------------- -----------
Balance at December 31, 2001................................ $34,084,355 $(341,667) $ 706,406 $34,449,094
Net income.................................................. 960,323 29,701 -- 990,024
Quarterly distributions..................................... (1,465,552) (31,687) -- (1,497,239)
Special Distribution........................................ (3,224,212) -- -- (3,224,212)
Change in unrealized gain on MBS............................ -- -- (518,400) (518,400)
----------- --------- --------- -----------
Balance at June 30, 2002.................................... $30,354,914 $(343,653) $ 188,006 $30,199,267
=========== ========= ========= ===========
F-100
REPORT OF INDEPENDENT ACCOUNTANTS
To the Partners of
Krupp Insured Plus-III Limited Partnership:
In our opinion, the financial statements listed in the accompanying index,
present fairly, in all material respects, the financial position of Krupp
Insured Plus-III Limited Partnership (the "Partnership") at December 31, 2001
and 2000 and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Partnership's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America which
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 financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 22, 2002
F-101
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
2001 2000
----------- -----------
ASSETS
Participating Insured Mortgages ("PIMs")
(Notes B, C, H and I)..................................... $27,762,795 $34,608,223
Mortgage-Backed Securities and insured mortgage
("MBS")(Notes B, D and H)................................. 11,407,452 12,453,025
----------- -----------
Total mortgage investments.............................. 39,170,247 47,061,248
Cash and cash equivalents (Notes B, C and H)................ 1,900,744 1,910,212
Interest receivable and other assets........................ 275,094 328,054
Prepaid acquisition fees and expenses, net of accumulated
amortization of $955,545 and $2,201,139, respectively
(Note B).................................................. 36,194 200,938
Prepaid participation servicing fees, net of accumulated
amortization of $293,743 and $803,998, respectively (Note
B)........................................................ 34,921 84,189
----------- -----------
Total assets............................................ $41,417,200 $49,584,641
=========== ===========
LIABILITIES AND PARTNERS' EQUITY
Liabilities................................................. $ 17,877 $ 17,650
Partners' equity (deficit) (Notes A, C, E and I):
Limited Partners (12,770,261 Limited Partner interests
outstanding).............................................. 41,486,071 49,660,074
General Partners............................................ (217,863) (205,525)
Accumulated Comprehensive Income (Note B)................... 131,115 112,442
----------- -----------
Total Partners' equity.................................. 41,399,323 49,566,991
----------- -----------
Total liabilities and Partners' equity.................. $41,417,200 $49,584,641
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-102
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
---------- ---------- ----------
Revenues:(Notes B, C and D)
Interest income -- PIMs:
Basic interest.......................................... $2,510,661 $2,755,352 $4,209,758
Participation interest.................................. 25,000 [cad228] 1,000,885
Interest income -- MBS.................................... 894,099 964,919 1,071,160
Other interest income....................................... 101,289 278,064 488,332
---------- ---------- ----------
Total revenues........................................ 3,531,049 3,998,335 6,770,135
---------- ---------- ----------
Expenses:
Asset management fee to an affiliate (Note F)............. 318,136 354,888 508,943
Expense reimbursements to affiliates (Note F)............. 96,318 97,729 74,461
Amortization of prepaid fees and expenses (Note B)........ 214,012 380,069 1,106,566
General and administrative................................ 139,043 171,995 149,589
---------- ---------- ----------
Total expenses........................................ 767,509 1,004,681 1,839,559
---------- ---------- ----------
Net income (Notes E and G).................................. 2,763,540 2,993,654 4,930,576
Other comprehensive income:
Net change in unrealized gain on MBS...................... 18,673 111,473 (326,520)
---------- ---------- ----------
Total comprehensive income.................................. $2,782,213 $3,105,127 $4,604,056
========== ========== ==========
Allocation of net income (Notes E and G):
Limited Partners.......................................... $2,680,634 $2,903,844 $4,782,659
========== ========== ==========
Average net income per Limited Partner interest
(12,770,261 Limited Partner interests outstanding)........ $ .21 $ .23 $ .37
========== ========== ==========
General Partners.......................................... $ 82,906 $ 89,810 $ 147,917
========== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-103
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
PARTNERS PARTNERS INCOME EQUITY
------------ --------- ------------- ------------
Balance at December 31, 1998....................... $ 94,969,742 $(157,989) $ 327,489 $ 95,139,242
Net income......................................... 4,782,659 147,917 -- 4,930,576
Quarterly distributions............................ (9,705,323) (177,147) -- (9,882,470)
Special distributions.............................. (21,453,869) -- -- (21,453,869)
Change in unrealized gain on MBS................... -- -- (326,520) (326,520)
------------ --------- --------- ------------
Balance at December 31, 1999....................... 68,593,209 (187,219) 969 68,406,959
Net income......................................... 2,903,844 89,810 -- 2,993,654
Quarterly distributions............................ (6,895,888) (108,116) -- (7,004,004)
Special distributions.............................. (14,941,091) -- -- (14,941,091)
Change in unrealized gain on MBS................... -- -- 111,473 111,473
------------ --------- --------- ------------
Balance at December 31, 2000....................... 49,660,074 (205,525) 112,442 49,566,991
Net income......................................... 2,680,634 82,906 -- 2,763,540
Quarterly distributions............................ (4,086,451) (95,244) -- (4,181,695)
Special distributions.............................. (6,768,186) -- -- (6,768,186)
Change in unrealized gain on MBS................... -- -- 18,673 18,673
------------ --------- --------- ------------
Balance at December 31, 2001....................... $ 41,486,071 $(217,863) $ 131,115 $ 41,399,323
============ ========= ========= ============
The accompanying notes are an integral part of the financial statements.
F-104
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
------------ ----------- ------------
Operating activities:
Net income.................................................. $ 2,763,540 $ 2,993,654 $ 4,930,576
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of prepaid fees and expenses................... 214,012 380,069 1,106,566
Shared Appreciation Interest and prepayment premium......... (15,000) -- (828,829)
Changes in assets and liabilities:
Decrease (increase) in interest receivable and other
assets.................................................... 52,960 317,642 (57,677)
Increase (decrease) in liabilities.......................... 227 (1,898) (141,891)
------------ ----------- ------------
Net cash provided by operating activities................... 3,015,739 3,689,467 5,008,745
------------ ----------- ------------
Investing activities:
Principal collections on PIMs including Shared Appreciation
Interest and prepayment premium of $15,000 in 2001 and
$828,829 in 1999, respectively............................ 6,860,428 321,166 36,396,881
Principal collections on MBS................................ 1,064,246 607,297 2,322,861
------------ ----------- ------------
Net cash provided by investing activities................... 7,924,674 928,463 38,719,742
------------ ----------- ------------
Financing activities:
Special distributions....................................... (6,768,186) (14,941,091) (21,453,869)
Quarterly distributions..................................... (4,181,695) (7,004,004) (9,882,470)
------------ ----------- ------------
Net cash used for financing activities...................... (10,949,881) (21,945,095) (31,336,339)
------------ ----------- ------------
Net (decrease) increase in cash and cash equivalents........ (9,468) (17,327,165) 12,392,148
Cash and cash equivalents, beginning of period.............. 1,910,212 19,237,377 6,845,229
------------ ----------- ------------
Cash and cash equivalents, end of period.................... $ 1,900,744 $ 1,910,212 $ 19,237,377
============ =========== ============
Non cash activities:
Increase (decrease) in Fair Value of MBS.................... $ 18,673 $ 111,473 $ (326,520)
============ =========== ============
The accompanying notes are an integral part of the financial statements.
F-105
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
A. ORGANIZATION
Krupp Insured Plus-III Limited Partnership (the "Partnership") was formed on
March 21, 1988 by filing a Certificate of Limited Partnership in The
Commonwealth of Massachusetts. The Partnership was organized for the purpose of
investing in multi-family loans and mortgage backed securities. The Partnership
issued all of the General Partner Interests to Krupp Plus Corporation and
Mortgage Services Partners Limited Partnership in exchange for capital
contributions aggregating $3,000. The Partnership terminates on December 31,
2028, unless terminated earlier upon the occurrence of certain events as set
forth in the Partnership Agreement.
The Partnership commenced the public offering of Limited Partner interests
on June 24, 1988 and completed its public offering having sold 12,770,161
Limited Partner interests for $254,686,736 net of purchase volume discounts of
$716,484 as of June 22, 1990. In addition, Krupp Depositary Corporation owns one
hundred Limited Partner interests.
B. SIGNIFICANT ACCOUNTING POLICIES
The Partnership uses the following accounting policies for financial
reporting purposes, which differ in certain respects from those used for federal
income tax purposes (Note G):
BASIS OF PRESENTATION
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with accounting principles generally accepted
in the United States of America ("GAAP").
MBS
The Partnership, in accordance with Financial Accounting Standards Board's
Statement 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("FAS 115"), classifies its MBS portfolio as available-for-sale. As
such the Partnership carries its MBS at fair market value and reflects any
unrealized gains (losses) as a separate component of Partners' Equity. The
Partnership amortizes purchase premiums or discounts over the life of the
underlying mortgages using the effective interest method.
The Partnership holds a Federal Housing Administration ("FHA") insured
mortgage which is classified as MBS and is carried at amortized cost. The
Partnership holds this loan at amortized cost. The Partnership does not
establish loan loss reserves as its investments are fully insured by the FHA.
PIMS
The Partnership accounts for its MBS portion of a PIM in accordance with
FAS 115 under the classification of held to maturity. The Partnership carries
the Government National Mortgage Association ("GNMA") or Fannie Mae MBS at
amortized cost.
Basic interest on PIMs is recognized based on the stated coupon rate of the
GNMA or Fannie Mae MBS. The Partnership recognizes interest related to the
participation features when the amount becomes fixed and the transaction that
gives rise to such amount is consummated.
CASH AND CASH EQUIVALENTS
The Partnership includes all short-term investments with maturities of three
months or less from the date of acquisition in cash and cash equivalents. The
Partnership invests its cash primarily in commercial paper and money market
funds with a commercial bank and has not experienced any loss to date on its
invested cash.
PREPAID FEES AND EXPENSES
Prepaid fees and expenses consist of prepaid acquisition fees and expenses
and prepaid participation servicing fees paid for the acquisition and servicing
of PIMs.
The Partnership amortizes the prepaid acquisition fees and expenses using a
method that approximates the effective interest method over a period of ten to
twelve years, which represents the estimated life of the underlying mortgage.
The Partnership amortizes prepaid participation servicing fees using a
method that approximates the effective interest method over a ten year period
beginning at final endorsement of the GNMA loan and at closing if a Fannie Mae
loan.
Upon the repayment of a PIM, any unamortized acquisition fees and expenses
and unamortized participation servicing fees related to such loan are expensed.
INCOME TAXES
The Partnership is not liable for federal or state income taxes as
Partnership income is allocated to the partners for income tax purposes. If the
Partnership's tax returns are examined by the Internal Revenue Service or state
taxing authority and such an examination results in a change in Partnership
taxable income, such change will be reported to the partners.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance GAAP requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, contingent assets and liabilities and revenues and
expenses during the period. Actual results could differ from those estimates.
F-106
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMS
At December 31, 2001 and 2000, the Partnership had investments in two
PIMs and three PIMs, respectively. The Partnership's PIMs consist of a GNMA or
Fannie Mae MBS representing the securitized first mortgage loan on the
underlying property and a participation interest in the revenue stream and
appreciation of the underlying property above specified base levels.
The borrower conveys this participation feature to the Partnership generally
through a subordinated multifamily mortgage (the "Agreement"). The Partnership
receives guaranteed monthly payments of principal and interest on the GNMA and
Fannie Mae MBS and HUD insures the first mortgage loan underlying the GNMA MBS.
The borrower usually can not prepay the first mortgage loan during the first
five years and may prepay the first mortgage loan thereafter subject to a 9%
prepayment premium in years six through nine, a 1% prepayment premium in year
ten and no prepayment premium thereafter. The Partnership may receive interest
related to its participation interest in the underlying property, however, this
amount is neither insured nor guaranteed.
Generally, the participation features consist of the following:
(i) "Minimum Additional Interest" rates ranging from .5% to .75% per annum
calculated on the unpaid principal balance of the first mortgage on the
underlying property, (ii) "Shared Income Interest" ranging from 25% to 30% of
the monthly gross rental income generated by the underlying property in excess
of a specified base, but only to the extent that it exceeds the amount of
Minimum Additional Interest received during such month and (iii) "Shared
Appreciation Interest" ranging from 30% to 35% of any increase in the value of
the underlying property in excess of a specified base. Payment of Minimum
Additional Interest and Shared Income Interest from the operations of the
property is limited to 50% of net revenue or Surplus Cash as defined by Fannie
Mae or HUD, respectively.
The total amount of Minimum Additional Interest, Shared Income Interest and
Shared Appreciation Interest payable on the maturity date by the underlying
borrower usually can not exceed 50% of any increase in value of the property.
However, generally any net proceeds from a sale or refinancing will be available
to satisfy any accrued but unpaid Shared Income or Minimum Additional Interest.
Shared Appreciation Interest is payable when one of the following occurs:
(1) the sale of the underlying property to an unrelated third party on a date
which is later than five years from the date of the Agreement, (2) the maturity
date or accelerated maturity date of the Agreement, or (3) prepayment of amounts
due under the Agreement and the insured mortgage.
Under the Agreement, the Partnership, upon giving twelve months written
notice, can accelerate the maturity date of the Agreement and insured mortgage
to a date not earlier than ten years from the date of the Agreement for (a) the
payment of all participation interest due under the Agreement as of the
accelerated maturity date, or (b) the payment of all participation interest due
under the Agreement plus all amounts due on the first mortgage note on the
property.
During June 2001, the Partnership received a payoff of the Casa Marina PIM
in the amount of $6,727,016. In addition, the Partnership received $15,000 of
Shared Appreciation Interest and $10,000 of Minimum Additional Interest upon the
payoff of the underlying mortgage. On July 18, 2001, the Partnership paid a
special distribution of $.53 per Limited Partner interest from the principal
proceeds and Shared Appreciation received from Casa Marina.
On January 11, 2000, the Partnership paid a special distribution of $1.17
per Limited Partner interest consisting of the principal proceeds and Shared
Appreciation Interest in the amounts of $14,491,746 and $426,321, respectively
from the Marina Shores Apartments PIM payoff in December of 1999.
In August 1999, the Partnership received a prepayment of the Mill Ponds
Apartments PIM in the amount of $9,751,550 representing the outstanding
principal balance. In addition to the prepayment, the Partnership received
$402,508 of Shared Appreciation Interest and $172,464 of Minimum Additional
Interest and Shared Income Interest in July, 1999. The Partnership distributed
the capital transaction proceeds from this prepayment to the Limited Partners
through a special distribution on September 9, 1999 in the amount of $.80 per
Limited Partner interest.
In January 1999, the Partnership received a prepayment of the Windsor Court
Apartments PIM in the amount of $10,876,051 representing the outstanding
principal balance. In addition to the prepayment, the Partnership received
$243,620 of Shared Appreciation Interest and prepayment premiums and $196,828 of
Minimum Additional Interest and Shared Income Interest during December 1998. The
Partnership distributed the capital transaction proceeds from this prepayment to
the Limited Partners through a special distribution on February 26, 1999 in the
amount of $.88 per Limited Partner interest.
At December 31, 2001 and 2000 there were no loans within the Partnership's
portfolio that were delinquent as to principal or interest.
F-107
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. PIMS (CONTINUED)
The Partnership's PIMs consist of the following at December 31, 2001 and
2000:
APPROXIMATE INVESTMENT BASIS AT
ORIGINAL MONTHLY DECEMBER 31,
FACE INTEREST MATURITY PAYMENT -------------------------
PIMS AMOUNT RATE (A) DATES (F) (G) 2001 2000
---- ----------- -------- --------- ----------- ----------- -----------
GNMA
Casa Marina Apts. Miami, FL................... $ 7,099,700 -- -- $ -- $ -- $ 6,748,832
Harbor Club Apts. Ann Arbor, MI............... 13,562,000 8.00%(c)(d)(e) 10/15/31 95,000 12,998,733 13,095,330
----------- ----------- -----------
20,661,700 12,998,733 19,844,162
----------- ----------- -----------
FANNIE MAE
Royal Palm Pl. Apts Kendall, FL............. 15,978,742 8.375%(b)(h) 4/1/06 103,000 14,764,062 14,764,061
----------- ----------- -----------
Total..................................... $36,640,442 $27,762,795(i) $34,608,223
=========== =========== ===========
------------------------------
(a) Represents the permanent interest rate of the GNMA or Fannie Mae MBS. The
Partnership may also receive additional interest, consisting of (i) Minimum
Additional Interest (ii) Shared Income Interest and (iii) Shared
Appreciation Interest
(b) Minimum Additional Interest is at a rate of .5% per annum calculated on the
unpaid principal balance of the first mortgage note.
(c) Minimum Additional Interest is at a rate of .75% per annum calculated on the
unpaid principal balance of the first mortgage note.
(d) Shared Income Interest is based on 25% of monthly gross rental income over a
specified base amount.
(e) Shared Appreciation Interest is based on 35% of any increase in the value of
the project over the specified base value.
(f) The Partnership's GNMA MBS have call provisions, which allow the Partnership
to accelerate their respective maturity date.
(g) The normal monthly payment consisting of principal and interest is payable
monthly at level amounts over the term of the GNMA MBS. The normal monthly
payment consists of interest only for the Fannie Mae MBS. The GNMA MBS and
Fannie Mae MBS may not be prepaid during the first five years and may
generally be prepaid subject to a 9% prepayment premium in years six through
nine, a 1% prepayment premium in year ten and no prepayment premium after
year ten.
(h) During December 1995, the Partnership agreed to a modification of the Royal
Palm PIM. The Partnership received a reissued Fannie Mae MBS and increased
its participation percentage in income and appreciation from 25% to 30%. The
Partnership will receive interest only payments on the Fannie Mae MBS at
interest rates ranging from 8.375% to 8.775% per annum through maturity. The
original face value of the PIM on the underlying property was $22,000,000 of
which 27% or $6,021,258 is held by Krupp Insured Plus Limited Partnership,
an affiliate of the Partnership.
(i) The aggregate cost of PIMs for federal income tax purposes is $27,762,795.
A reconciliation of the carrying value of PIMs for each of the three years
in the period ended December 31, 2001 is as follows:
2001 2000 1999
----------- ----------- ------------
Balance at beginning of period.............................. $34,608,223 $34,929,389 $ 70,497,441
Deductions during period:
Principal collections..................................... (6,845,428) (321,166) (35,568,052)
----------- ----------- ------------
Balance at end of period.................................... $27,762,795 $34,608,223 $ 34,929,389
=========== =========== ============
The underlying mortgages of the PIMs are collateralized by multi-family
apartment complexes located in two states. The apartment complexes range in size
from 208 to 377 units.
D. MBS
At December 31, 2001, the Partnership's MBS portfolio had an amortized cost
of $3,343,185 and unrealized gains of $131,115. At December 31, 2001, the
Partnership's insured mortgage loan had an amortized cost of $7,933,152 and an
unrealized gain of $221,970. At December 31, 2000, the Partnership's MBS
portfolio had an amortized cost of $4,356,235 and unrealized gains and losses of
$113,260 and $818, respectively. At December 31, 2000, the Partnership's insured
mortgage loan had an amortized cost of $7,984,348 and an unrealized gain of
$79,844. The portfolio has maturity dates ranging from 2016 to 2035.
UNREALIZED
MATURITY DATE FAIR VALUE GAIN
------------- ----------- ----------
2002--2006.................................................. $ -- $ --
2007--2011.................................................. -- --
2012--2035.................................................. 11,629,422 353,085
----------- --------
Total..................................................... $11,629,422 $353,085
=========== ========
F-108
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
E. PARTNERS' EQUITY
Under the terms of the Partnership Agreement, profits from Partnership
operations and Distributable Cash Flow are allocated 97% to the Unitholders and
Corporate Limited Partner (the "Limited Partners") and 3% to the General
Partners.
Upon the occurrence of a capital transaction, as defined in the Partnership
Agreement, net cash proceeds and profits from the capital transaction will be
distributed first, to the Limited Partners until they have received a return of
their total invested capital, second, to the General Partners until they have
received a return of their total invested capital, third, 99% to the Limited
Partners and 1% to the General Partners until the Limited Partners receive an
amount equal to any deficiency in the 11% cumulative return on their invested
capital that exists through fiscal years prior to the date of the capital
transaction, fourth, to the class of General Partners until they have received
an amount equal to 4% of all amounts of cash distributed under all capital
transactions and fifth, 96% to the Limited Partners and 4% to the General
Partners. Losses from a capital transaction will be allocated 97% to the Limited
Partners and 3% to the General Partners.
Upon the occurrence of a terminating capital transaction, as defined in the
Partnership Agreement, the net cash proceeds and winding up of the affairs of
the Partnership will be allocated among the Partners first, to each class of
Partners in the amount equal to, or if less than, in proportion to, the positive
balance in the Partner's capital accounts, second, to the Limited Partners until
they have received a return of their total invested capital, third, to the
General Partners until they have received a return of their total invested
capital, fourth, 99% to the Limited Partners and 1% to the General Partners
until the Limited Partners have received to any deficiency in the 11% cumulative
return on their invested capital that exists through fiscal years prior to the
date of the capital transaction, fifth, to the General Partners until they have
received an amount equal to 4% of all amounts of cash distributed under all
capital transactions and sixth, 96% to the Limited Partners and 4% to the
General Partners.
During 2001, 2000 and 1999, the Partnership made quarterly distributions
totaling $.32, $.54 and $.76 per Limited Partner interest respectively. The
Partnership made special distributions of $.53, $1.17 and $1.68 per Limited
Partner interest in 2001, 2000, and 1999, respectively.
As of December 31, 2001, the following cumulative partner contributions and
allocations have been made since inception of the Partnership:
CORPORATE ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
UNITHOLDERS PARTNER PARTNERS INCOME EQUITY
------------- --------- ----------- ------------- -------------
Capital contributions................................... $ 254,686,736 $ 2,000 $ 3,000 $ -- $ 254,691,736
Syndication costs....................................... (15,834,700) -- -- -- (15,834,700)
Quarterly distributions................................. (193,374,105) (1,625) (4,445,830) -- (197,821,560)
Special distributions................................... (140,598,377) (1,101) -- -- (140,599,478)
Net income.............................................. 136,606,104 1,139 4,224,967 -- 140,832,210
Unrealized gains on MBS................................. -- -- -- 131,115 131,115
------------- ------- ----------- -------- -------------
Total at December 31, 2001.............................. $ 41,485,658 $ 413 $ (217,863) $131,115 $ 41,399,323
============= ======= =========== ======== =============
F. RELATED PARTY TRANSACTIONS
Under the terms of the Partnership Agreement, the General Partners or their
affiliates are paid an Asset Management Fee equal to .75% per annum of the
remaining face value of the Partnership's mortgage assets, payable quarterly.
The General Partners may also receive an incentive management fee in the amount
equal to .3% per annum on the Partnership's total invested assets provided the
Unitholders have received their specified non-cumulative return on their
Invested Capital. Total Asset Management Fees and Incentive Management Fees
payable to the General Partners or their affiliates shall not exceed 10% of
Distributable Cash Flow over the life of the Partnership.
Additionally, the Partnership reimburses affiliates of the General Partners
for certain expenses incurred in connection with maintaining the books and
records of the Partnership, the preparation and mailing of financial reports,
tax information and other communications to the investors and legal fees and
expenses.
G. FEDERAL INCOME TAXES
The reconciliation of the net income reported in the accompanying statement
of income with the net income reported in the Partnership's 2001 federal income
tax return is as follows:
Net income per statement of income.......................... $2,763,540
Less:
Book to tax difference for amortization of prepaid fees
and expenses............................................ (375,904)
----------
Net income for federal income tax purposes................ $2,387,636
==========
F-109
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
G. FEDERAL INCOME TAXES (CONTINUED)
The allocation of the net income for federal income tax purposes for 2001 is
as follows:
PORTFOLIO
INCOME
----------
Unitholders................................................. $2,316,739
Corporate Limited Partner................................... 18
General Partners............................................ 70,879
----------
$2,387,636
==========
During the years ended December 31, 2001, 2000 and 1999 the average per unit
net income to the Unitholders for federal income tax purposes was $.18, $.24 and
$.34, respectively.
The basis of the Partnership's assets for financial reporting purposes was
less than its tax basis by approximately $815,000 and $1,191,000 at
December 31, 2001 and 2000, respectively. The basis of the Partnership's
liabilities for financial reporting purposes was less than its tax basis by
approximately $18,000 at December 31, 2001. At December 31, 2000 the basis of
the Partnerships liabilities for financial reporting purposes was the same as
its tax basis.
H. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The Partnership uses the following methods and assumptions to estimate the
fair value of each class of financial instrument:
CASH AND CASH EQUIVALENTS
The carrying amount approximates the fair value because of the short
maturity of those instruments.
MBS
The Partnership estimates the fair value of MBS based on quoted market
prices while it estimates the fair value of insured mortgages based on quoted
prices of MBS with similar interest rates. Based on the estimated fair value
determined using these methods and assumptions, the Partnership's investments in
MBS and insured mortgages had gross unrealized gains of approximately $353,000
at December 31, 2001 and unrealized gains and losses of approximately $193,000
and $1,000 at December 31, 2000.
PIMS
As there is no active trading market for these investments, Management
estimates the fair value of the PIMs using quoted market prices of MBS having a
similar interest rate. Management does not include any participation interest in
the Partnership's estimated fair value arising from the properties, as
Management does not believe it can predict the time of realization of the
feature with any certainty. Based on the estimated fair value determined using
these methods and assumptions, the Partnership's investments in PIMs had gross
unrealized gains of approximately $613,000 and $161,000 at December 31, 2001 and
December 31, 2000, respectively.
At December 31, 2001 and 2000, the Partnership estimates the fair values of
its financial instruments as follows (amounts rounded to nearest thousand):
2001 2000
------------------- -------------------
FAIR CARRYING FAIR CARRYING
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
Cash and cash equivalents................................... $ 1,901 $ 1,901 $ 1,910 $ 1,910
MBS and insured mortgage.................................... 11,629 11,407 12,533 12,453
PIMs........................................................ 28,376 27,763 34,769 34,608
------- ------- ------- -------
$41,906 $41,071 $49,212 $48,971
======= ======= ======= =======
I. SUBSEQUENT EVENTS
The Partnership received a prepayment of the Royal Palm Place Subordinate
Promissory note. On January 2, 2002, the Partnership received $1,004,379 of
Shared Appreciation Interest and $322,401 of Minimum Additional Interest. On
February 25, 2002, the Partnership received $14,764,062 representing the
principal proceeds on the first mortgage. The Partnership has declared a special
distribution of $1.24 per Limited Partner interest consisting of Shared
Appreciation Interest and prepayment proceeds which will be paid in the first
quarter of 2002.
UNAUDITED DISTRIBUTABLE CASH FLOW AND NET CASH PROCEEDS FROM CAPITAL
TRANSACTIONS
Shown below is the calculation of Distributable Cash Flow and Net Cash
Proceeds from Capital Transactions as defined in Section 17 of the Partnership
Agreement and the source of cash distributions for the year ended December 31,
2001 and the period from inception through December 31, 2001. The General
Partners provide certain of the information below to meet requirements of the
Partnership Agreement and because they believe that it is an appropriate
supplemental measure of operating performance. However, Distributable Cash Flow
and Net Cash Proceeds from Capital Transactions should not be considered by the
reader as a substitute to net income as an indicator of the Partnership's
operating performance or to cash flows as a measure of liquidity.
F-110
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED)
ASSETS
Participating Insured Mortgages ("PIMs")(Note 2)............ $12,947,374 $27,762,795
Mortgage-Backed Securities and insured mortgage ("MBS")(Note
3)........................................................ 10,865,520 11,407,452
----------- -----------
Total mortgage investments.............................. 23,812,894 39,170,247
Cash and cash equivalents................................... 1,703,750 1,900,744
Interest receivable and other assets........................ 163,702 275,094
Prepaid acquisition fees and expenses, net of accumulated
amortization of $991,739 and $955,545, respectively....... -- 36,194
Prepaid participation servicing fees, net of accumulated
amortization of $311,204 and $293,743, respectively....... 17,460 34,921
----------- -----------
Total assets............................................ $25,697,806 $41,417,200
=========== ===========
LIABILITIES AND PARTNERS' EQUITY
Liabilities................................................. $ 69,895 $ 17,877
----------- -----------
Partners' equity (deficit) (Note 4):
Limited Partners (12,770,261 Limited Partner interests
outstanding).............................................. 25,680,840 41,486,071
General Partners............................................ (199,481) (217,863)
Accumulated comprehensive income............................ 146,552 131,115
----------- -----------
Total Partners' equity.................................. 25,627,911 41,399,323
----------- -----------
Total liabilities and Partners' equity.................. $25,697,806 $41,417,200
=========== ===========
The accompanying notes are an integral part of the financial statements.
F-111
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- -----------------------
2002 2001 2002 2001
--------- --------- ---------- ----------
(UNAUDITED)
Revenues:
Interest income--PIMs:
Basic interest.......................................... $259,121 $659,966 $ 621,798 $1,371,638
Participation Interest.................................. -- 25,000 1,339,172 25,000
Interest income--MBS...................................... 203,107 225,173 411,342 457,859
Other interest income..................................... 9,665 30,340 41,972 58,898
-------- -------- ---------- ----------
Total revenues........................................ 471,893 940,479 2,414,284 1,913,395
-------- -------- ---------- ----------
Expenses:
Asset management fee to an affiliate...................... 44,406 82,829 98,284 169,471
Expense reimbursements to affiliates...................... 26,817 24,987 46,081 46,345
Amortization of prepaid fees and expenses................. 23,208 52,072 53,655 135,635
General and administrative................................ 59,592 33,935 79,157 51,734
-------- -------- ---------- ----------
Total expenses........................................ 154,023 193,823 277,177 403,185
-------- -------- ---------- ----------
Net income.................................................. 317,870 746,656 2,137,107 1,510,210
Other comprehensive income:
Net change in unrealized gain (loss) on MBS............... 17,550 (8,061) 15,437 (2,445)
-------- -------- ---------- ----------
Total comprehensive income.................................. $335,420 $738,595 $2,152,544 $1,507,765
======== ======== ========== ==========
Allocation of net income (Note 4):
Limited Partners.......................................... $308,334 $724,257 $2,072,994 $1,464,904
======== ======== ========== ==========
Average net income per Limited Partner interest
(12,770,261 Limited Partner interests outstanding)...... $ .02 $ .05 $ .16 $ .11
======== ======== ========== ==========
General Partners.......................................... $ 9,536 $ 22,399 $ 64,113 $ 45,306
======== ======== ========== ==========
The accompanying notes are an integral part of the financial statements.
F-112
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
2002 2001
------------ -----------
(UNAUDITED)
Operating activities:
Net income................................................ $ 2,137,107 $ 1,510,210
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of prepaid fees and expenses............... 53,655 135,635
Shared Appreciation Interest............................ (1,004,379) (15,000)
Changes in assets and liabilities:
Decrease in interest receivable and other assets...... 111,392 41,448
Increase in liabilities............................... 52,018 13,495
------------ -----------
Net cash provided by operating activities............. 1,349,793 1,685,788
------------ -----------
Investing activities:
Principal collections on PIMs including Shared
Appreciation Interest of $1,004,379 in 2002 and $15,000
in 2001................................................. 15,819,800 6,811,137
Principal collections on MBS.............................. 557,369 530,310
------------ -----------
Net cash provided by investing activities............. 16,377,169 7,341,447
------------ -----------
Financing activities:
Quarterly distributions................................... (2,088,956) (2,095,378)
Special distribution...................................... (15,835,000) --
------------ -----------
Net cash used for financing activities................ (17,923,956) (2,095,378)
------------ -----------
Net increase (decrease) in cash and cash equivalents........ (196,994) 6,931,857
Cash and cash equivalents, beginning of period.............. 1,900,744 1,910,212
------------ -----------
Cash and cash equivalents, end of period.................... $ 1,703,750 $ 8,842,069
============ ===========
Non cash activities:
Increase (decrease) in Fair Value of MBS.................. $ 15,437 $ (2,445)
============ ===========
The accompanying notes are an integral part of the financial statements.
F-113
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. ACCOUNTING POLICIES
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted in this report
pursuant to the Rules and Regulations of the Securities and Exchange Commission.
However, in the opinion of the general partners, Krupp Plus Corporation and
Mortgage Services Partners Limited Partnership, (collectively the "General
Partners") of Krupp Insured Plus-III Limited Partnership (the "Partnership"),
the disclosures contained in this report are adequate to make the information
presented not misleading. See Notes to Financial Statements included in the
Partnership's financial statements for the year ended December 31, 2001 for
additional information relevant to significant accounting policies followed by
the Partnership.
In the opinion of the General Partners of the Partnership, the accompanying
unaudited financial statements reflect all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the Partnership's
financial position as of June 30, 2002, its results of operations for the three
and six months ended June 30, 2002 and 2001 and its cash flows for the six
months ended June 30, 2002 and 2001.
The results of operations for the three and six months ended June 30, 2002
are not necessarily indicative of the results which may be expected for the full
year. See Management's Discussion and Analysis of Financial Condition and
Results of Operations included in this report.
2. PIMS
At June 30, 2002, the Partnership's remaining PIM had a fair market value of
approximately $13,744,414 and gross unrealized gains of approximately $797,040.
The PIM matures in 2031.
The Partnership received a prepayment of the Royal Palm Place PIM. On
January 2, 2002, the Partnership received $1,004,379 of Shared Appreciation
Interest and $334,793 of Minimum Additional Interest. On February 25, 2002, the
Partnership received $14,764,062 representing the principal proceeds on the
first mortgage. On March 19, 2002, the Partnership paid a special distribution
of $1.24 per Limited Partner interest from the principal proceeds and Shared
Appreciation Interest received.
3. MBS
At June 30, 2002, the Partnership's MBS portfolio had an amortized cost of
$2,812,886 and gross unrealized gains of $146,552. At June 30, 2002, the
Partnership's insured mortgage loan had an amortized cost of $7,906,082 and a
gross unrealized gain of $330,474. The portfolio has maturities ranging from
2016 to 2035.
4. CHANGES IN PARTNERS' EQUITY
A summary of changes in Partners' Equity for the six months ended June 30,
2002 is as follows:
ACCUMULATED TOTAL
LIMITED GENERAL COMPREHENSIVE PARTNERS'
PARTNERS PARTNERS INCOME EQUITY
------------ --------- ------------- ------------
Balance at December 31, 2001................................ $ 41,486,071 $(217,863) $131,115 $ 41,399,323
Net income.................................................. 2,072,994 64,113 -- 2,137,107
Special Distribution........................................ (15,835,000) -- -- (15,835,000)
Quarterly distributions..................................... (2,043,225) (45,731) -- (2,088,956)
Change in unrealized gain on MBS............................ -- -- 15,437 15,437
------------ --------- -------- ------------
Balance at June 30, 2002.................................... $ 25,680,840 $(199,481) $146,552 $ 25,627,911
============ ========= ======== ============
F-114
INDEX TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION
Unaudited Pro Forma Condensed Consolidated Financial
Information:
Unaudited Pro Forma Condensed Consolidated Balance Sheet
as of June 30, 2002 assuming 8.84% of the Interests in
the Mortgage Funds are tendered for Series A Preferred
Shares.................................................. P-2
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the six months ended June 30, 2002
assuming 8.84% of the Interests in the Mortgage Funds
are tendered for Series A Preferred Shares.............. P-3
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the year ended December 31, 2001 assuming
8.84% of the Interests in the Mortgage Funds are
tendered for Series A Preferred Shares.................. P-4
Unaudited Pro Forma Condensed Consolidated Balance Sheet
as of June 30, 2002 assuming 25% of the Interests in the
Mortgage Funds are tendered for Series A Preferred
Shares.................................................. P-5
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the six months ended June 30, 2002
assuming 25% of the Interests in the Mortgage Funds are
tendered for Series A Preferred Shares.................. P-6
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the year ended December 31, 2001 assuming
25% of the Interests in the Mortgage Funds are tendered
for Series A Preferred Shares........................... P-7
Notes and Management's Assumptions to Unaudited Pro Forma
Condensed Consolidated Financial Information............ P-8
P-1
BERKSHIRE INCOME REALTY, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
ASSUMING 8.84% INVESTMENT IN MORTGAGE FUNDS
AS OF JUNE 30, 2002
BERKSHIRE PRO FORMA ADJUSTMENTS (NOTE 2)
INCOME --------------------------------
REALTY, INC. PREDECESSOR FORMATION OTHER
(NOTE 1) (NOTE 1) TRANSACTIONS ADJUSTMENTS PRO FORMA
------------ ----------- ------------ ----------- ---------
(IN THOUSANDS)
ASSETS
Multi-family apartment communities, net of
accumulated depreciation................ $86,623 $ 86,623
Investment in GIT, GIT II, KIM, KIP, KIP
II and KIP III.......................... $25,000 (a) 25,000
Other assets.............................. 10,647 15,530 (d) 22,052
875 (b) --
(5,000)(c) --
------- ------- ------- ------- --------
Total assets.......................... $ -- $97,270 $20,875 $15,530 $133,675
======= ======= ======= ======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Mortgage notes payable.................. $90,167 $16,168 (d) $106,335
Accrued expenses and other
liabilities........................... 2,184 2,184
------- ------- ------- ------- --------
Total liabilities..................... -- 92,351 -- 16,168 108,519
Minority common interest in Operating
Partnership............................. -- -- -- (629)(d) 154
783 (e)
Stockholders' equity...................... -- 4,919 $25,000 (a) (9)(d) 25,002
875 (b) (783)(e)
(5,000)(c)
------- ------- ------- ------- --------
Total stockholders' equity............ -- 4,919 20,875 (792) 25,002
------- ------- ------- ------- --------
Total liabilities and stockholders'
equity.............................. $ -- $97,270 $20,875 $15,530 $133,675
======= ======= ======= ======= ========
P-2
BERKSHIRE INCOME REALTY, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
ASSUMING 8.84% INVESTMENT IN MORTGAGE FUNDS
FOR THE SIX MONTHS ENDED JUNE 30, 2002
BERKSHIRE
INCOME PRO FORMA
REALTY, INC. PREDECESSOR ADJUSTMENTS
(NOTE 1) (NOTE 1) (NOTE 2) PRO FORMA
------------ ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenue:
Rental................................................. $11,672 $11,672
Other.................................................. 731 731
Investment............................................. $ 1,531 (f) 1,753
222 (g)
------- ------- ------- -------
Total revenue........................................ $ -- 12,403 1,753 14,156
Expenses:
Operating.............................................. 2,680 2,680
Maintenance............................................ 900 900
Real estate taxes...................................... 878 878
General and administrative............................. 324 225 (h) 549
Management fees........................................ 877 101 (i) 978
Depreciation........................................... 2,215 2,215
Interest............................................... 1,586 1,529 (j) 3,115
------- ------- ------- -------
Total expenses....................................... -- 9,460 1,855 11,315
Income before minority interest.......................... -- 2,943 (102) 2,841
Minority interest in properties.......................... -- (1,436) (1,436)
------- ------- ------- -------
Income before minority common interest in Operating
Partnership............................................ -- 1,507 (102) 1,405
Minority common interest in Operating Partnership........ -- -- (276)(k) (276)
------- ------- ------- -------
Income before preferred dividend......................... -- 1,507 (378) 1,129
Preferred dividend....................................... -- -- (1,125)(l) (1,125)
------- ------- ------- -------
Income available for common shares....................... $ -- $ 1,507 $(1,503) $ 4
======= ======= ======= =======
Earnings per common share................................ $ 0.004
=======
Weighted average number of common shares outstanding..... 874,692
=======
P-3
BERKSHIRE INCOME REALTY, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
ASSUMING 8.84% INVESTMENT IN MORTGAGE FUNDS
FOR THE YEAR ENDED DECEMBER 31, 2001
BERKSHIRE
INCOME PRO FORMA
REALTY, INC. PREDECESSOR ADJUSTMENTS
(NOTE 1) (NOTE 1) (NOTE 2) PRO FORMA
------------ ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenue:
Rental................................................. $23,056 $23,056
Other.................................................. 1,515 1,515
Investment............................................. $ 4,252 (m) 4,695
443 (n)
------- ------- ------- -------
Total revenue........................................ $ -- 24,571 4,695 29,266
Expenses:
Operating.............................................. 5,158 5,158
Maintenance............................................ 1,944 1,944
Real estate taxes...................................... 1,679 1,679
General and administrative............................. 657 450 (o) 1,107
Management fees........................................ 1,288 424 (p) 1,712
Depreciation........................................... 4,751 852 (q) 5,603
Interest............................................... 5,682 665 (r) 6,347
Participating note interest............................ 6,591 (6,591)(s) --
------- ------- ------- -------
Total expenses....................................... -- 27,750 (4,200) 23,550
Income (loss) before minority interest................... -- (3,179) 8,895 5,716
Minority interest in properties.......................... -- 228 228
------- ------- ------- -------
Income (loss) before minority common interest in
Operating Partnership.................................. -- (2,951) 8,895 5,944
Minority common interest in Operating Partnership........ -- -- (3,643)(t) (3,643)
------- ------- ------- -------
Income (loss) before preferred dividend.................. -- (2,951) 5,252 2,301
Preferred dividend....................................... -- -- (2,250)(u) (2,250)
------- ------- ------- -------
Income (loss) available for common shares................ $ -- $(2,951) $ 3,002 $ 51
======= ======= ======= =======
Earnings per common share................................ $ 0.06
=======
Weighted average number of common shares outstanding..... 874,692
=======
P-4
BERKSHIRE INCOME REALTY, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
ASSUMING 25% INVESTMENT IN MORTGAGE FUNDS
AS OF JUNE 30, 2002
BERKSHIRE PRO FORMA ADJUSTMENTS (NOTE 2)
INCOME --------------------------------
REALTY, INC. PREDECESSOR FORMATION OTHER
(NOTE 1) (NOTE 1) TRANSACTIONS ADJUSTMENTS PRO FORMA
------------ ----------- ------------ ----------- ---------
(IN THOUSANDS)
ASSETS
Multi-family apartment communities, net of
accumulated depreciation................ -- $86,623 $ 86,623
Investment in GIT, GIT II, KIM, KIP, KIP
II and KIP III.......................... -- -- 70,706 (v) 70,706
Other assets.............................. -- 10,647 1,336 (w) $15,530 (y) 22,513
(5,000)(x)
------- ------- ------- ------- --------
Total assets.......................... $ -- $97,270 $67,042 $15,530 $179,842
======= ======= ======= ======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Mortgage notes payable.................. -- $90,167 $16,168 (y) $106,335
Accrued expenses and other
liabilities........................... -- 2,184 2,184
------- ------- ------- ------- --------
Total liabilities..................... -- 92,351 -- 16,168 108,519
Minority common interest in Operating
Partnership............................. -- -- (625)(y) 604
1,229 (z)
Stockholders' equity...................... -- 4,919 70,706 (v) (13)(y) 70,719
1,336 (w) (1,229)(z)
(5,000)(x)
------- ------- ------- ------- --------
Total stockholders' equity............ -- -- 67,042 (1,242) 70,719
------- ------- ------- ------- --------
Total liabilities and stockholders'
equity.............................. $ -- $97,270 $67,042 $15,530 $179,842
======= ======= ======= ======= ========
P-5
BERKSHIRE INCOME REALTY, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
ASSUMING 25% INVESTMENT IN MORTGAGE FUNDS
FOR THE SIX MONTHS ENDED JUNE 30, 2002
BERKSHIRE
INCOME PRO FORMA
REALTY, INC. PREDECESSOR ADJUSTMENTS
(NOTE 1) (NOTE 1) (NOTE 2) PRO FORMA
------------ ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenue:
Rental................................................ $11,672 $ 11,672
Other................................................. 731 731
Investment............................................ 4,329 (aa) 4,956
627 (bb)
------- ------- ------- ---------
Total revenue....................................... $ -- 12,403 4,956 17,359
Expenses:
Operating............................................. 2,680 2,680
Maintenance........................................... 900 900
Real estate taxes..................................... 878 878
General and administrative............................ 324 225 (cc) 549
Management fees....................................... 877 101 (dd) 978
Depreciation.......................................... 2,215 2,215
Interest.............................................. 1,586 1,529 (ee) 3,115
------- ------- ------- ---------
Total expenses...................................... -- 9,460 1,855 11,315
Income before minority interest......................... -- 2,943 3,101 6,044
Minority interest in properties......................... -- (1,436) (1,436)
------- ------- ------- ---------
Income before minority common interest in Operating
Partnership........................................... -- 1,507 3,101 4,608
Minority common interest in Operating Partnership....... -- -- (1,396)(ff) (1,396)
------- ------- ------- ---------
Income before preferred dividend........................ -- 1,507 1,705 3,212
Preferred dividend...................................... -- -- (3,182)(gg) (3,182)
------- ------- ------- ---------
Income available for common shares...................... $ -- $ 1,507 $(1,477) $ 30
======= ======= ======= =========
Earnings per common share............................... $ 0.02
=========
Weighted average number of common shares outstanding.... 1,336,362
=========
P-6
BERKSHIRE INCOME REALTY, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
ASSUMING 25% INVESTMENT IN MORTGAGE FUNDS
FOR THE YEAR ENDED DECEMBER 31, 2001
BERKSHIRE
INCOME PRO FORMA
REALTY, INC. PREDECESSOR ADJUSTMENT
(NOTE 1) (NOTE 1) (NOTE 2) PRO FORMA
------------ ----------- ---------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenue:
Rental................................................. $23,056 $ 23,056
Other.................................................. 1,515 1,515
Investment............................................. $12,025 (hh) 13,278
1,253 (ii)
------- ------- ------- ---------
Total revenue........................................ $ -- 24,571 13,278 37,849
Expenses:
Operating.............................................. 5,158 5,158
Maintenance............................................ 1,944 1,944
Real estate taxes...................................... 1,679 1,679
General and administrative............................. 657 450 (jj) 1,107
Management fees........................................ 1,288 424 (kk) 1,712
Depreciation........................................... 4,751 852 (ll) 5,603
Interest............................................... 5,682 665 (mm) 6,347
Participating mortgage interest........................ 6,591 (6,591)(nn) --
------- ------- ------- ---------
Total expenses....................................... -- 27,750 (4,200) 23,550
Income (loss) before minority interest................... -- (3,179) 17,478 14,299
Minority interest in properties.......................... -- 228 228
------- ------- ------- ---------
Income (loss) before minority common interest in
Operating Partnership.................................. -- (2,951) 17,478 14,527
Minority common interest in Operating Partnership........ -- -- (7,992)(oo) (7,992)
------- ------- ------- ---------
Income (loss) before preferred dividend.................. -- (2,951) 9,486 6,535
Preferred dividend....................................... -- -- (6,364)(pp) (6,364)
------- ------- ------- ---------
Income (loss) available for common shares................ $ -- $(2,951) $ 3,122 $ 171
======= ======= ======= =========
Earnings per common share................................ $ 0.13
=========
Weighted average number of common shares outstanding..... 1,336,362
=========
P-7
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
1. ORGANIZATION AND FORMATION
Berkshire Income Realty, Inc. (the "Company"), a Maryland corporation, was
organized on July 19, 2002. The Company intends to acquire, own and operate
multi-family residential properties. The Company has no operating history to
date.
THE OFFERING
The Company has filed a registration statement on Form S-11 with the
Securities and Exchange Commission with respect to the offering (the "Offering"
or "Exchange Offer") to exchange Series A preferred shares ("Preferred Shares")
of the Company for interests ("Interests") in the following six mortgage funds:
Krupp Government Income Trust, Krupp Government Income Trust II, Krupp Insured
Mortgage Limited Partnership, Krupp Insured Plus Limited Partnership, Krupp
Insured Plus II Limited Partnership, Krupp Insured Plus III Limited Partnership
(collectively, the "Mortgage Funds"). For each Interest in the Mortgage Funds
that is validly tendered and not properly withdrawn in the Offering, the Company
will exchange its Preferred Shares based on an exchange ratio applicable to each
Mortgage Fund.
The following table shows the ratio at which each fund was assumed to have
been exchanged for purposes of the pro forma. The actual exchange ratios may
differ, and that difference may be significant, to the final exchange ratios
offered as part of the Offering on this Form S-11.
PREFERRED SHARES
PER UNIT
TENDERED
----------------
GIT......................................................... 0.196
GIT II...................................................... 0.229
KIM......................................................... 0.086
KIP......................................................... 0.105
KIP II...................................................... 0.082
KIP III..................................................... 0.068
Simultaneous with the completion of the Offering, KRF Company, LLC ("KRF
Company"), an affiliate of the Company, will contribute its ownership interests
in five multi-family residential properties (the "Properties") to Berkshire
Income Realty-OP, L.P. (the "Operating Partnership") in exchange for common
limited partner interests in the Operating Partnership. Prior to the Offering,
KRF Company contributed $100 in exchange for 100 shares of common stock of the
Company. Concurrent with the completion of the Offering, KRF Company will
contribute cash to the Company in exchange for common stock of the Company in an
amount equal to 1% of the fair value of total net assets of the Operating
Partnership. This amount will be contributed to the Company's wholly owned
subsidiary, BIR GP, L.L.C., who will then contribute the cash to the Operating
Partnership in exchange for the sole general partner interest in the Operating
Partnership. The Company will contribute the Interests tendered in the Offering
to the Operating Partnership in exchange for preferred limited partner interests
in the Operating Partnership. The Operating Partnership is the successor to the
Berkshire Income Realty Predecessor Group (the "Predecessor"). The merger of the
separate businesses into the Company and the Operating Partnership is considered
a purchase business combination with the Predecessor being the accounting
acquirer. Accordingly, the acquisition or contribution of the various
Predecessor interests will be accounted for at their historical cost. The
acquisition of the Interests will be accounted for using purchase accounting
based upon the fair value of the Interests acquired.
THE PROPERTIES
Upon completion of the Offering, the Company will own the Properties
aggregating 2,539 units. Berkshire Real Estate Advisors, L.L.C. ("Berkshire
Advisors"), an affiliate of the Company, will be responsible for managing the
day-to-day activities, subject to the control and supervision of the Company's
Board of Directors. The Company will pay Berkshire Advisors an advisory fee
equal to 0.40% of the purchase price of real estate properties, as adjusted from
time to time to reflect the then current fair market value of the properties.
Another affiliate of the Company, Berkshire Realty Holdings, L.P. and its
affiliates, will provide on-site property management services and will receive
property management fees of 5% of gross rental receipts.
BASIS OF PRESENTATION
Upon completion of the Offering, the consolidated financial statements of
the Company will include all the accounts of the Company, its majority-owned
Operating Partnership, and subsidiaries. All significant intercompany balances
and transactions will be eliminated.
THE PRO FORMA FINANCIAL STATEMENTS
The unaudited pro forma balance sheet of the Company as of June 30, 2002 has
been prepared as if the Exchange Offer and contribution of Predecessor interests
had been consummated on June 30, 2002. The unaudited pro forma statements of
operations of the Company for the six months ended June 30, 2002 and for the
year ended December 31, 2001 have been prepared as if the Exchange Offer and
contribution of Predecessor interests had been consummated as of January 1, 2001
for all periods presented.
The unaudited pro forma balance sheet of the Company as of June 30, 2002 has
been prepared as if the July 31, 2002 refinancing of the Seasons of Laurel
mortgage note payable and an estimated $5 million distribution of working
capital which is anticipated to be made to KRF Company prior to the Exchange
Offer and contribution of Predecessor interests had been consummated on
June 30, 2002.
P-8
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
1. ORGANIZATION AND FORMATION (CONTINUED)
The unaudited pro forma statements of operations of the Company for the six
months ended June 30, 2002 and for the year ended December 31, 2001 have been
prepared as if the April 1, 2002 refinancings of the Century, Dorsey's Forge and
Hannibal Grove, mortgage notes payable, the July 31, 2002 refinancing of the
Seasons of Laurel mortgage note payable and the 2001 acquisition of limited
partner interests related to Seasons of Laurel and Walden Pond all had been
consummated as of January 1, 2001 for all periods presented.
The unaudited pro forma information is not necessarily indicative of what
the actual financial position would have been at June 30, 2002 or what the
actual results of operations would have been for the six months ended June 30,
2002, or for the year ended December 31, 2001, had the Exchange Offer and
contribution of Predecessor interests been consummated on June 30, 2002,
January 1, 2002 or January 1, 2001 and carried forward through the period
presented, nor does it purport to present the future financial position or
results of operations of the Company. The pro forma financial information should
be read in conjunction with the historical combined financial statements and
notes thereto of the Predecessor.
The pro forma balance sheet has been prepared on a historical cost basis and
does not reflect the fair value of the real estate contributed by KRF Company,
which, based upon independent appraisals, is $62,962 in excess of its net
historical cost, less minority interest.
Certain assumptions regarding the Offering have been made in connection with
the preparation of the pro forma financial information. These assumptions are as
follows:
(1) The pro forma financial information assumes that the Company has elected
to be, and qualified as, a REIT for federal income tax purposes and has
distributed all of its taxable income for the applicable periods, and,
therefore, incurred no federal income tax liabilities. As a REIT, the
Company is required to distribute at least 90% of its REIT taxable income
to its shareholders to maintain its REIT status.
(2) For purposes of the pro forma financial information, the Company will
record the fair value of the Interests tendered and will recognize the
discount from book value of the Interests acquired in the Mortgage Funds
as investment income on a basis which approximates the effective interest
method over 10 years, the expected weighted average life of the mortgages
owned by the Mortgage Funds. Upon completion of the Offering, the
accretion income will be allocated to the individual mortgages in each
Mortgage Fund over their respective lives.
(3) The Interests have been included in the pro forma financial information
under the equity method of accounting based on management's assumption
that investors owning between 8.84% to 25% of the Interests will tender
Interests and the Company will not obtain control over the Mortgage
Funds.
(4) The Company will contribute its Interests tendered in the Offering to
the Operating Partnership in exchange for preferred limited partner
interests in the Operating Partnership, having the same economic terms as
the Preferred Shares. Management estimates the Company and its wholly
owned affiliate, BIR GP, L.L.C., will own approximately 30% and 54% of
the aggregate fair value of the equity contributed into the Operating
Partnership upon completion of the Offering assuming an 8.84% and 25%
tender of Interests, respectively. The Company will consolidate the
results of the Operating Partnership as a result of its controlling
general partnership interest in the Operating Partnership. The preferred
limited partnership units to be transferred to the Company in exchange
for Interests will be equal to the number of Preferred Shares outstanding
for the Company.
(5) KRF Company will contribute its ownership interests in the Properties to
the Operating Partnership in exchange for common limited partner
interests in the Operating Partnership, having the same economic terms as
the Company's common stock. Management estimates KRF Company will own
approximately 70% and 46% of the aggregate fair value of the equity
contributed into the Operating Partnership upon completion of the
Offering assuming a 8.84% and 25% tender of Interests, respectively. KRF
Company will make a capital contribution to the Company, in exchange for
common stock, in an amount equal to 1% of the fair value of the Operating
Partnership, taking into account any cash contributed to the Company by
KRF Company prior to completion of the Offering. KRF Company's
contribution will be approximately $875 and $1,336 assuming an 8.84% and
25% tender of Interests, respectively. This amount will be contributed to
the Company's wholly owned subsidiary, BIR GP, L.L.C., which in turn will
contribute this amount to the Operating Partnership in exchange for a
general partnership interest in the Operating Partnership.
P-9
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
1. ORGANIZATION AND FORMATION (CONTINUED)
(6) The aggregate fair value of equity contributed into the Operating
Partnership is calculated as follows:
Calculation of aggregate fair value of equity contributed into the
Operating Partnership assuming an 8.84% tender of Interests:
TOTAL FAIR
VALUE OF
THE COMPANY OPERATING
& PARTNERSHIP
KRF COMPANY BIR GP, L.L.C. EQUITY
------------ -------------- -----------
Historical equity........................................ $ 4,919 $ -- $ 4,919
Adjustment of other assets to fair value................. (649) (649)
Cash contribution........................................ -- 875 875
Distribution of working capital to KRF Company........... (5,000) -- (5,000)
Effect of refinancing of Seasons of Laurel mortgage note
payable................................................ (630) (8) (638)
Contribution of Interests in Properties, fair value
adjustment............................................. 62,962 -- 62,962
Contribution of Interests, at fair value................. -- 25,000 25,000
------- ------- --------
$61,602 $25,867 $ 87,469
Ownership of aggregate fair value of total Operating
Partnership equity..................................... 70.43% 29.57% 100.00%
Calculation of aggregate fair value of equity contributed into the
Operating Partnership assuming a 25% tender of Interests:
TOTAL FAIR
VALUE OF
THE COMPANY OPERATING
& PARTNERSHIP
KRF COMPANY BIR GP, L.L.C. EQUITY
------------ -------------- -----------
Historical equity........................................ $ 4,919 $ -- $ 4,919
Adjustment of other assets to fair value................. (649) (649)
Cash contribution........................................ -- 1,336 1,336
Distribution of working capital to KRF Company........... (5,000) -- (5,000)
Effect of refinancing of Seasons of Laurel mortgage note
payable................................................ (625) (13) (638)
Contribution of Interests in Properties, fair value
adjustment............................................. 62,962 -- 62,962
Contribution of Interests, at fair value................. -- 70,706 70,706
------- ------- --------
$61,607 $72,029 $133,636
Ownership of aggregate fair value of total Operating
Partnership equity..................................... 46.10% 53.90% 100.00%
(7) General and administrative expenses historically incurred by the
Properties and the Predecessor have been adjusted to reflect the
structure of the Company and the estimated additional expenses of being a
public company. Management estimates the following additional expenses:
Directors fees and expenses................................. $150
Audit fees.................................................. 75
Legal fees.................................................. 90
Tax return fees............................................. 60
AMEX fees................................................... 35
Investor service............................................ 25
General costs............................................... 15
----
Total additional general and administrative expenses........ $450
====
(8) Management estimates the coupon on Preferred Shares will entitle each
holder to receive preferential quarterly cash distributions at an annual
rate of 9% of the liquidation preference of $25 per share.
2. PRO FORMA ADJUSTMENTS
BALANCE SHEET--ASSUMING 8.84% OF THE INTERESTS IN THE MORTGAGE FUNDS ARE
TENDERED FOR PREFERRED SHARES
The following pro forma adjustments summarize the adjustments made to the
June 30, 2002 Berkshire Income Realty Predecessor Balance Sheet. The letters
below correspond to the net adjustments presented in the Balance Sheet on P-2.
P-10
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
2. PRO FORMA ADJUSTMENTS (CONTINUED)
(a) Represents the minimum Interests to be acquired by the Company
valued at the exchange value of each Mortgage Fund, based on the
minimum closing condition of $25,000 Interests tendered. The
$25,000 minimum equates to a flat 8.84% acceptance rate across all
Mortgage Funds.
(b) Reflects the initial capitalization of the Company including the
issuance of common shares to KRF Company in connection with the
Offering in exchange for a cash contribution equal to 1% of the
fair value of the total net assets of the Operating Partnership.
Also represents the estimated $2,860 of Offering costs to be funded
by KRF Company, of which the net effect to equity is zero. The
aggregate fair value of total net assets of the Operating
Partnership after the contribution is as follows:
Assets:
Multi-family apartment communities........................ $152,470
Investment in GIT, GIT II, KIM, KIP, KIP II and
KIP III................................................. 25,000
Cash and cash equivalents................................. 18,948
Prepaid expenses, accounts receivable affiliates and other
assets.................................................. 2,455
--------
Total assets............................................ 198,873
Liabilities:
Mortgage notes payable.................................... 106,335
Accrued expenses and other liabilities.................... 2,184
--------
Total liabilities....................................... 108,519
Minority interest........................................... 2,885
Total net assets at fair value.............................. $ 87,469
========
(c) Reflects an estimated distribution of the Predecessor's excess
working capital, aggregating $5,000, to KRF Company.
(d) Reflects the refinancing of the Seasons of Laurel mortgage note
payable which occurred on July 31, 2002. The proceeds from the
refinancing were used to repay the existing mortgage note payable
and accrued interest of $36,412 and to provide additional working
capital of $15,530. An estimated $5,000 of this additional working
capital currently reserved for a distribution to the owners of KRF
Company.
(e) Represents KRF Company's equity attributable to common limited
partner interests of the Operating Partnership. The minority
interest is reported as the remaining equity of the Operating
Partnership, after allocation of the preferred Operating
Partnership units to the Company, multiplied by KRF Company's
ownership percentage of the aggregate fair value of the common
equity contributed into the Operating Partnership. Minority
interest is calculated as follows:
Predecessor equity.......................................... $ 4,919
Preferred Operating Partnership units....................... 25,000
Distribution of working capital to KRF Company.............. (5,000)
Common Operating Partnership units of BIR GP, L.L.C......... 875
--------
Total preferred and common equity of the Operating
Partnership............................................... 25,794
Less allocation of preferred Operating Partnership units.... (25,000)
--------
Total common equity......................................... 794
Common Operating Partnership units of KRF Company........... 98.61%
Minority interest in Operating Partnership.................. $ 783
========
P-11
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
2. PRO FORMA ADJUSTMENTS (CONTINUED)
KRF Company ownership percentage is calculated as follows:
TOTAL FAIR
VALUE OF
KRF COMPANY BIR GP, L.L.C. COMMON EQUITY
------------ -------------- ---------------
Historical equity................................... $ 4,919 -- $ 4,919
Adjustment of other assets to fair value............ (649) (649)
Cash contribution................................... -- $ 875 875
Distribution of working capital to KRF Company...... (5,000) -- (5,000)
Effect of refinancing of Seasons of Laurel mortgage
note payable...................................... (630) (8) (638)
Contribution of Interests in Properties, fair value
adjustment........................................ 62,962 -- 62,962
------- ----- -------
$61,602 $ 867 $62,469
Ownership percentage of fair value of common
equity............................................ 98.61% 1.39% 100%
STATEMENT OF OPERATIONS--ASSUMING 8.84% OF THE INTERESTS IN THE MORTGAGE FUNDS
ARE TENDERED FOR PREFERRED SHARES
The following pro forma adjustments summarize the adjustments made to the
Berkshire Income Realty Predecessor Statement of Operations for the six months
ended June 30, 2002. The letters below correspond to the net adjustments
presented in the Statement of Operations on P-3.
(f) Reflects the equity interest in the net income of the Mortgage
Funds earned for the period indicated prior to the acquisition of
the Interests by the Company assuming holders owning 8.84% of the
Interests of each Mortgage Fund tendered their Interests in the
Offering. The historical net income for each Mortgage Fund for the
six months ended June 30, 2002 is as follows:
NET
INCOME
-------
Government Income Trust..................................... $ 4,415
Government Income Trust II.................................. 7,475
Krupp Insured Mortgage Limited Partnership.................. 1,087
Krupp Insured Plus Limited Partnership...................... 1,211
Krupp Insured Plus Limited Partnership II................... 990
Krupp Insured Plus Limited Partnership III.................. 2,137
-------
17,315
8.84%
-------
$ 1,531
=======
(g) Reflects accretion income, for the period indicated, for the fair
value, which is a discount from book value, of the Interests
acquired in the Mortgage Funds, and is being recognized as
investment income on a basis which approximates the effective
interest method over 10 years, the expected weighted average life
of the mortgages owned by the Mortgage Funds.
(h) Reflects an increase of $225 in general and administrative expenses
as a result of being a public company.
(i) Reflects an increase for advisory fees based on the advisory
contract to be entered into with an affiliate, calculated as
follows:
Multi-family apartments at fair market value................ $152,470
0.4%
--------
Annual advisory fee......................................... 610
Advisory fee for the six months ended June 30, 2002......... 305
Amount reflected in Predecessor combined financial
statements................................................ (204)
--------
Total advisory fee adjustment............................... $ 101
========
P-12
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
2. PRO FORMA ADJUSTMENTS (CONTINUED)
(j) Represents the net change to interest expense including
amortization of deferred financing fees to reflect fixed rate
interest as if the refinancings on the Century, Dorsey's Forge,
Hannibal Grove and Seasons of Laurel mortgage notes payable
occurred at the beginning of the period, as follows:
FOR THE SIX MONTHS ENDED JUNE 30, 2002
------------------------------------------------
DATE OF HISTORICAL PRO FORMA PRO FORMA
PROPERTY REFINANCING INTEREST EXPENSE INTEREST EXPENSE ADJUSTMENT
-------- ----------------- ---------------- ---------------- ----------
(IN THOUSANDS)
Century............................ April 1, 2002 $ 527 $ 703 $ 176
Dorsey's Forge..................... April 1, 2002 154 323 169
Hannibal Grove..................... April 1, 2002 296 489 193
Seasons of Laurel.................. July 31, 2002 523 1,514 991
Walden Pond........................ November 14, 2001 86 86 --
------ ------ ------
$1,586 $3,115 $1,529
====== ====== ======
(k) Represents KRF Company's share of income attributable to common
limited partner interests of the Operating Partnership. The
minority interest is reported as the remaining income of the
Operating Partnership, after allocation of the distribution on the
preferred Operating Partnership units to the Company, multiplied by
KRF Company's ownership percentage of the aggregate fair value of
the equity contributed into the Operating Partnership. Minority
interest is calculated as follows:
Income before minority common interest in Operating
Partnership............................................... $ 1,405
Preferred dividend.......................................... (1,125)
-------
Income available for common equity.......................... 280
Common Operating Partnership units of KRF Company(1)........ 98.61%
Minority common interest in Operating Partnership........... $ 276
=======
---------------------------------------
(1) Refer to Note 2(e) for a calculation of the ownership
percentage of KRF Company.
(l) Reflects a preferred dividend on the Preferred Shares, calculated
as follows:
Preferred stock............................................. $25,000
Estimated 9% coupon......................................... 9%
-------
Annual preferred dividend................................... $ 2,250
-------
Preferred dividend for the six months ended June 30, 2002... $ 1,125
=======
The following pro forma adjustments summarize the adjustments made to the
Berkshire Income Realty Predecessor Statement of Operations for the year ended
December 31, 2001. The letters below correspond to the net adjustments presented
in the Statement of Operations on P-4.
(m) Reflects the equity interest in the net income of the Mortgage Funds
earned for the period indicated prior to the acquisition of the
Interests by the Company assuming holders owning 8.84% of the
Interests of each Mortgage Fund tendered their Interests in the
Offering. The historical net income of each Mortgage Fund for the
year ended December 31, 2001 is as follows:
NET
INCOME
-------
Government Income Trust..................................... $15,972
Government Income Trust II.................................. 22,141
Krupp Insured Mortgage Limited Partnership.................. 2,511
Krupp Insured Plus Limited Partnership...................... 2,541
Krupp Insured Plus Limited Partnership II................... 2,172
Krupp Insured Plus Limited Partnership III.................. 2,764
-------
48,101
8.84%
-------
$ 4,252
=======
P-13
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
2. PRO FORMA ADJUSTMENTS (CONTINUED)
(n) Reflects accretion income, for the period indicated, for the fair
value, which is a discount from book value, of the Interests
acquired in the Mortgage Funds, and is being recognized as
investment income on a basis which approximates the effective
interest method over 10 years, the expected weighted average life
of the mortgages owned by the Mortgage Funds.
(o) Reflects an increase of $450 in general and administrative expenses
as a result of being a public company.
(p) Reflects an increase for advisory fees based on the advisory
contract to be entered into with an affiliate, calculated as
follows:
Multi-family apartments at fair market value................ $152,470
0.4%
--------
Annual advisory fee......................................... 610
Amount reflected in Predecessor combined financial
statements................................................ (186)
--------
Total advisory fee adjustment............................... $ 424
========
(q) Represents additional depreciation on the incremental increase in
the basis of the Predecessor's real estate as a result of the
acquisition of limited partner interests as if the 2001
acquisitions of Seasons of Laurel and Walden Pond had occurred at
the beginning of the period.
(r) Represents the net change to interest expense including
amortization of deferred financing fees to reflect interest as if
the refinancings on the Century, Dorsey's Forge, Hannibal Grove,
Seasons of Laurel and Walden Pond mortgage notes payable occurred
at the beginning of the period, as follows:
FOR THE YEAR ENDED DECEMBER 31, 2001
---------------------------------------------------
DATE OF HISTORICAL PRO FORMA PRO FORMA
PROPERTY REFINANCING INTEREST EXPENSE INTEREST EXPENSE ADJUSTMENT
-------- ----------------- ---------------- ---------------- -------------
(IN THOUSANDS)
Century........................ April 1, 2002 $ 1,424 $1,439 $ 15
Dorsey's Forge................. April 1, 2002 438 657 219
Hannibal Grove................. April 1, 2002 752 995 243
Seasons of Laurel.............. July 31, 2002 9,185(1) 3,081 (6,104)
Walden Pond.................... November 14, 2001 474 175 (299)
------- ------ -------
$12,273 $6,347 $(5,926)(2)
======= ====== =======
---------------------------------------
(1) Includes participating note interest of $6,591.
(2) Represents the net adjustment related to the removal of the
Seasons of Laurel participating note interest of $(6,591) and
a net increase to interest on the refinanced mortgage notes
payable of $665.
(s) Reflects an adjustment to remove the participating note interest
related to the former Seasons of Laurel mortgage note payable which
was paid off in July 2001.
(t) Represents KRF Company's share of income attributable to common
limited partner interests of the Operating Partnership. The
minority interest is reported as the remaining income of the
Operating Partnership, after allocation of the distribution on the
preferred Operating Partnership units to the Company, multiplied by
KRF Company's ownership percentage of the aggregate fair value of
the equity contributed into the Operating Partnership. Minority
interest is calculated as follows:
Income before minority common interest in Operating
Partnership............................................... $ 5,944
Preferred dividend.......................................... (2,250)
-------
Income available for common equity.......................... 3,694
Common Operating Partnership units of KRF Company(1)........ 98.61%
Minority common interest in Operating Partnership........... $ 3,643
=======
---------------------------------------
(1) Refer to Note 2(e) for a calculation of the ownership
percentage of KRF Company.
(u) Reflects a preferred dividend on the Preferred Shares, calculated
as follows:
Preferred stock............................................. $25,000
Estimated 9% coupon......................................... 9%
-------
Preferred dividend for the year ended December 31, 2001..... $ 2,250
=======
P-14
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
2. PRO FORMA ADJUSTMENTS (CONTINUED)
BALANCE SHEET--ASSUMING 25% OF THE INTERESTS IN THE MORTGAGE FUNDS ARE TENDERED
FOR PREFERRED SHARES
The following pro forma adjustments summarize the adjustments made to the
June 30, 2002 Berkshire Income Realty Predecessor Balance Sheet. The letters
below correspond to the net adjustments presented in the Balance Sheet on P-5.
(v) Represents the maximum Interests to be acquired by the Company
valued at the exchange value of each Mortgage Fund, based on the
maximum closing condition of $70,706 Interests tendered. The
$70,706 maximum equates to a flat 25% acceptance rate across all
Mortgage Funds.
(w) Reflects the initial capitalization of the Company including the
issuance of common shares to KRF Company in connection with the
Offering in exchange for a cash contribution equal to 1% of the
fair value of the total net assets of the Operating Partnership.
Also represents the estimated $2,860 of Offering costs to be funded
by KRF Company, of which the net effect to equity is zero. The
aggregate fair value of total net assets of the Operating
Partnership after the contribution is as follows:
Assets:
Multi-family apartment communities........................ $152,470
Investment in GIT, GIT II, KIM, KIP, KIP II and
KIP III................................................. 70,706
Cash and cash equivalents................................. 19,409
Prepaid expenses, accounts receivable affiliates and other
assets.................................................. 2,455
--------
Total assets............................................ 245,040
Liabilities:
Mortgage notes payable.................................... 106,335
Accrued expenses and other liabilities.................... 2,184
--------
Total liabilities....................................... 108,519
Minority interest........................................... 2,885
Total net assets at fair value.............................. $133,636
========
(x) Reflects an estimated distribution of the Predecessor's excess
working capital, aggregating $5,000, to KRF Company.
(y) Reflects the refinancing of the Seasons of Laurel mortgage note
payable which occurred on July 31, 2002. The proceeds from the
refinancing were used to repay the existing mortgage note payable
and accrued interest of $36,412 and to provide additional working
capital of $15,530. An estimated $5,000 of this additional working
capital currently reserved for a distribution to the owners of KRF
Company.
(z) Represents KRF Company's equity attributable to common limited
partner interests of the Operating Partnership. The minority
interest is reported as the remaining equity of the Operating
Partnership, after allocation of the preferred Operating
Partnership units to the Company, multiplied by KRF Company's
ownership percentage of the aggregate fair value of the common
equity contributed into the Operating Partnership. Minority
interest is calculated as follows:
Predecessor equity.......................................... $ 4,919
Preferred Operating Partnership units....................... 70,706
Distribution of working capital to KRF Company.............. (5,000)
Common Operating Partnership units of BIR GP, L.L.C......... 1,336
--------
Total preferred and common equity of the Operating
Partnership............................................... 71,961
Less allocation of preferred Operating Partnership units.... (70,706)
--------
Total common equity......................................... 1,255
Common Operating Partnership units of KRF Company........... 97.90%
Minority interest in Operating Partnership.................. $ 1,229
========
P-15
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
2. PRO FORMA ADJUSTMENTS (CONTINUED)
KRF Company ownership percentage is calculated as follows:
TOTAL FAIR
VALUE OF
COMMON
KRF COMPANY BIR GP, L.L.C. EQUITY
------------ -------------- ----------
Historical equity.......................................... $ 4,919 -- $ 4,919
Adjustment of other assets to fair value................... (649) (649)
Cash contribution.......................................... -- $1,336 1,336
Distribution of working capital to KRF Company............. (5,000) -- (5,000)
Effect of refinancing of Seasons of Laurel mortgage note
payable.................................................. (625) (13) (638)
Contribution of Interests in Properties, fair value
adjustment............................................... 62,962 -- 62,962
------- ------ -------
$61,607 $1,323 $62,930
Ownership percentage of fair value of common equity........ 97.90% 2.10% 100%
STATEMENT OF OPERATIONS--ASSUMING 25% OF THE INTERESTS IN THE MORTGAGE FUNDS ARE
TENDERED FOR PREFERRED SHARES
The following pro forma adjustments summarize the adjustments made to the
Berkshire Income Realty Predecessor Statement of Operations for the six months
ended June 30, 2002. The letters below correspond to the net adjustments
presented in the Statement of Operations on P-6.
(aa) Reflects the equity interest in the net income of the Mortgage
Funds earned for the period indicated prior to the acquisition of
the Interests by the Company assuming holders owning 25% of the
Interests of each Mortgage Fund tendered their Interests in the
Offering. Refer to Note 2(f) for the historical net income of each
Mortgage Fund for the six months ended June 30, 2002.
(bb) Reflects accretion income, for the period indicated, for the fair
value, which is a discount from book value, of the Interests
acquired in the Mortgage Funds, and is being recognized as
investment income on a basis which approximates the effective
interest method over 10 years, the expected weighted average life
of the mortgages owned by the Mortgage Funds.
(cc) Reflects an increase of $225 in general and administrative expenses
as a result of being a public company.
(dd) Reflects an increase for advisory fees based on the advisory
contract to be entered into with an affiliate. Refer to Note 2(i)
for a calculation of the adjustment.
(ee) Represents the net change to interest expense including
amortization of deferred financing fees to reflect fixed rate
interest as if the refinancings on the Century, Dorsey's Forge,
Hannibal Grove and Seasons of Laurel mortgage notes payable
occurred at the beginning of the period, as follows:
FOR THE SIX MONTHS ENDED JUNE 30, 2002
------------------------------------------------
DATE OF HISTORICAL PRO FORMA PRO FORMA
PROPERTY REFINANCING INTEREST EXPENSE INTEREST EXPENSE ADJUSTMENT
-------- ----------------- ---------------- ---------------- ----------
(IN THOUSANDS)
Century............................ April 1, 2002 $ 527 $ 703 $ 176
Dorsey's Forge..................... April 1, 2002 154 323 169
Hannibal Grove..................... April 1, 2002 296 489 193
Seasons of Laurel.................. July 31, 2002 523 1,514 991
Walden Pond........................ November 14, 2001 86 86 --
------ ------ ------
$1,586 $3,115 $1,529
====== ====== ======
(ff) Represents KRF Company's share of income attributable to common
limited partner interests of the Operating Partnership. The
minority interest is reported as the remaining income of the
Operating Partnership, after allocation of the distribution on the
preferred Operating Partnership units to the Company, multiplied
by KRF Company's ownership percentage of the aggregate fair value
of the equity contributed into the Operating Partnership. Minority
interest is calculated as follows:
Income before minority common interests in Operating
Partnership............................................... $ 4,608
Preferred dividend.......................................... (3,182)
-------
Income available for common equity.......................... 1,426
Common Operating Partnership units of KRF Company(1)........ 97.90%
Minority common interest in Operating Partnership........... $ 1,396
=======
---------------------------------------
(1) Refer to Note 2(z) for a calculation of the ownership
percentage of KRF Company.
P-16
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
2. PRO FORMA ADJUSTMENTS (CONTINUED)
(gg) Reflects a preferred dividend on the Preferred Shares, calculated
as follows:
Preferred Stock............................................. $70,706
Estimated 9% coupon......................................... 9%
Annual preferred dividend................................... $ 6,364
-------
Preferred dividend for the six months ended June 30, 2002... $ 3,182
=======
The following pro forma adjustments summarize the adjustments made to the
Berkshire Income Realty Predecessor Statement of Operations for the year ended
December 31, 2001. The letters below correspond to the net adjustments presented
in the Statement of Operations on P-7.
(hh) Reflects the equity interest in the net income of the Mortgage
Funds earned for the period indicated prior to the acquisition of
the Interests by the Company assuming holders owning 25% of the
Interests of each Mortgage Fund tendered their Interests in the
Offering. Refer to Note 2(m) for the historical net income of each
Mortgage Fund for the year ended December 31, 2001.
(ii) Reflects accretion income, for the period indicated, for the fair
value, which is a discount from book value, of the Interests
acquired in the Mortgage Funds, and is being recognized as
investment income on a basis which approximates the effective
interest method over 10 years, the expected weighted average life
of the mortgages owned by the Mortgage Funds.
(jj) Reflects an increase of $450 in general and administrative
expenses as a result of being a public company.
(kk) Reflects an increase for advisory fees based on the advisory
contract to be entered into with an affiliate. Refer to Note 2(p)
for a calculation of the adjustment.
(ll) Represents additional depreciation on the incremental increase in
the basis of the Predecessor's real estate as a result of the
acquisition of limited partner interests as if the 2001
acquisitions of Seasons of Laurel and Walden Pond had occurred at
the beginning of the period.
(mm) Represents the net change to interest expense including amortization
of deferred financing fees to reflect interest as if the
refinancings on the Century, Dorsey's Forge, Hannibal Grove, Seasons
of Laurel and Walden Pond mortgage notes payable occurred at the
beginning of the period, as follows:
FOR THE YEAR ENDED DECEMBER 31, 2001
---------------------------------------------------
DATE OF HISTORICAL PRO FORMA PRO FORMA
PROPERTY REFINANCING INTEREST EXPENSE INTEREST EXPENSE ADJUSTMENT
-------- ----------------- ---------------- ---------------- -------------
(IN THOUSANDS)
Century........................ April 1, 2002 $ 1,424 $1,439 $ 15
Dorsey's Forge................. April 1, 2002 438 657 219
Hannibal Grove................. April 1, 2002 752 995 243
Seasons of Laurel.............. July 31, 2002 9,185(1) 3,081 (6,104)
Walden Pond.................... November 14, 2001 474 175 (299)
------- ------ -------
$12,273 $6,347 $(5,926)(2)
======= ====== =======
---------------------------------------
(1) Includes participating note interest of $6,591.
(2) Represents the net adjustment related to the removal of the
Seasons of Laurel participating note interest of $(6,591) and
a net increase to interest on the refinanced mortgage notes
payable of $665.
(nn) Reflects an adjustment to remove the participating note interest
related to the former Seasons of Laurel mortgage note payable which
was paid off in July 2001.
(oo) Represents KRF Company's share of income attributable to common
limited partner interests of the Operating Partnership. The
minority interest is reported as the remaining income of the
Operating Partnership, after allocation of the distribution on the
P-17
NOTES AND MANAGEMENT'S ASSUMPTIONS TO UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)
2. PRO FORMA ADJUSTMENTS (CONTINUED)
preferred Operating Partnership units to the Company, multiplied by KRF
Company's ownership percentage of the aggregate fair value of the
equity contributed into the Operating Partnership. Minority
interest is calculated as follows:
Income before minority common interest in Operating
Partnership............................................... $14,527
Preferred dividend.......................................... (6,364)
-------
Income available for common equity.......................... 8,163
Common Operating Partnership units of KRF Company(1)........ 97.90%
Minority common interest in Operating Partnership........... $ 7,992
=======
---------------------------------------
(1) Refer to Note 2(z) for a calculation of the ownership
percentage of KRF Company.
(pp) Reflects a preferred dividend on the Preferred Shares, calculated
as follows:
Preferred stock............................................. $70,706
Estimated 9% coupon......................................... 9%
-------
Preferred dividend for the year ended December 31, 2001..... $ 6,364
=======
P-18
APPENDIX A
FORM OF FAIRNESS OPINION
, 2002
Berkshire Income Realty, Inc.
One Beacon Street
Boston, MA 02108
Attention:David C. Quade
President
Dear Sirs:
We understand that Berkshire Income Realty, Inc. ("BIR") intends to offer to
exchange its % Series A Cumulative Redeemable Preferred Stock (the
"Preferred Stock") for equity interests ("Interests") of the following entities
(the "Mortgage Funds") that are affiliated with The Berkshire Group ("BG"):
Krupp Government Income Trust ("GIT")
Krupp Government Income Trust II ("GIT II")
Krupp Insured Mortgage Limited Partnership ("KIM")
Krupp Insured Plus Limited Partnership ("KIP")
Krupp Insured Plus II Limited Partnership ("KIP II")
Krupp Insured Plus III Limited Partnership ("KIP III")
The terms of the Preferred Stock provide that it will have a liquidation
preference of $25 per share, will be callable at $25 per share plus accrued
dividends after February 15, 2010, and will pay a quarterly dividend of $ .
The number of shares of Preferred Stock to be issued in exchange for an Interest
in each Mortgage Fund are as follows:
PREFERRED SHARES
MORTGAGE FUND PER INTEREST
------------- ----------------
GIT.........................................................
GIT II......................................................
KIM.........................................................
KIP.........................................................
KIP II......................................................
KIP III.....................................................
You have provided us with a copy of the registration statement containing
the prospectus relating to the exchange offer (the "Prospectus") in
substantially final form. The terms of the Preferred Stock and the terms and
conditions of the exchange offer are set forth in the Prospectus.
You have asked us to render our opinion as to whether the consideration to
be received by holders of Interests who elect to tender their Interests for
shares of Preferred Stock is fair, from a financial point of view, to such
holders.
In the course of our analyses for rendering this opinion, we have:
1. reviewed the Prospectus in substantially final form;
2. reviewed the Mortgage Funds' Annual Reports for the fiscal years ended
December 31, 2001, and their Quarterly Reports for the periods ended
March 31 and June 30, 2002;
A-1
3. met with members of BG's senior management to discuss the operations and
financial statements of the Mortgage Funds, and the intended operations,
financial data and future prospects of BIR, including the properties to
be acquired by BIR upon completion of the exchange offer (the
"Properties");
4. reviewed certain operating and financial information, including
projections, relating to the business and prospects of each of the
Mortgage Funds and of BIR and the Properties, all of which was provided
to us by BG's management;
5. reviewed publicly available financial information relating to each of
the Mortgage Funds and BG's management's estimates of the future
financial performance and prospects of each of the Mortgage Funds;
6. reviewed the methodology and assumptions used by BG's management in
valuing the Interests for purposes of establishing the exchange ratio;
7. reviewed appraisals, dated July 2, 2002, prepared by Robert D. Wright,
MAI, of three of the Properties located in Maryland;
8. reviewed an appraisal, dated June 28, 2002, prepared by Cushman &
Wakefield of Washington D.C. Inc., of one of the Properties located in
Maryland;
9. reviewed an appraisal, dated June 20, 2002, prepared by Cushman &
Wakefield of Texas, Inc., of the Property located in Texas;
10. visited the four Maryland Properties;
11. reviewed the historical trading activity of the Interests;
12. reviewed publicly available information with respect to the preferred
stock of other real estate investment trusts which we deemed generally
comparable to BIR;
13. reviewed publicly available income and balance sheet data of other such
real estate investment trusts; and
14. conducted such other studies, analyses, inquiries and investigations as
we deemed appropriate.
In the course of our review, we have relied upon and assumed the accuracy
and completeness of the financial and other information provided to us by BG.
With respect to the projected financial results of BIR and of the Mortgage
Funds, we have assumed that they have been reasonably prepared on bases
reflecting the best currently available estimates and judgment of the management
of BG. We have not assumed any responsibility for the information or projections
provided to us and we have further relied upon the assurances of the management
of BG that it is unaware of any facts that would make the information or
projections provided to us incomplete or misleading. In arriving at our opinion,
we have not performed any independent appraisal of the Properties or of the
assets of the Mortgage Funds. We have assumed that BIR will continue to qualify
as a REIT. Our opinion is necessarily based on economic, market and other
conditions, and the information made available to us, as of the date hereof.
Based on the foregoing, it is our opinion that the consideration being
offered to holders of Interests is fair, from a financial point of view, to
holders of Interests who elect to tender their Interests for Preferred Shares.
Our opinion does not constitute a recommendation as to whether or not
holders of Interests should tender their Interests in the exchange offer.
Very truly yours,
SUTTER SECURITIES INCORPORATED
By:
--------------------------------------
Senior Managing Director
A-2
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN OR
MADE, ANY INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY BERKSHIRE INCOME REALTY, INC. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE UNDER THIS PROSPECTUS SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF BERKSHIRE INCOME REALTY, INC. SINCE THE DATE OF THIS PROSPECTUS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER
TO BUY THESE SECURITIES IN ANY CIRCUMSTANCES IN WHICH THIS OFFER OR SOLICITATION
IS UNLAWFUL.
Until , 2002, all dealers that effect transactions in these
securities, whether or not participating on this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to deliver
a prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
TABLE OF CONTENTS
PAGE
--------
Additional Information...................................... i
Questions and Answers About the Proposed Transaction........ ii
Prospectus Summary.......................................... 1
Risk Factors................................................ 17
Cautionary Statement Regarding Forward-Looking Statements... 28
Use of Proceeds............................................. 29
Ratios of Earnings and "Adjusted" Earnings to Fixed Charges
and Combined Fixed Charges and Preferred Share
Dividends................................................. 30
Capitalization.............................................. 32
Selected Financial Data..................................... 33
Management's Discussion and Analysis of Financial Condition
and Results of Operations of Berkshire Income Realty
Predecessor Group......................................... 36
Management's Discussion and Analysis of Financial Condition
and Results of Operations of the Mortgage Funds........... 42
Business and Properties..................................... 68
Policies with respect to Certain Activities................. 76
The Offers.................................................. 78
Formation Transactions...................................... 90
Management.................................................. 91
Security Ownership of Beneficial Owners and Management...... 99
Information Relating to Our Common Stock.................... 100
Certain Relationships and Related Transactions.............. 100
Compensation Payable to Our Affiliates...................... 103
Conflicts of Interest....................................... 107
Comparison of the Rights of Holders of Preferred Shares and
the Rights of Holders of Interests........................ 109
Information with respect to the Mortgage Funds.............. 124
Description of the Preferred Shares......................... 145
Summary of Operating Partnership Agreement.................. 153
Description of the Preferred OP Units....................... 156
Important Provisions of Maryland Law........................ 158
Federal Income Tax Considerations........................... 160
Plan of Distribution........................................ 176
Experts..................................................... 177
Legal Matters............................................... 177
Where You Can Find More Information About Us and the
Mortgage Funds............................................ 177
Index to Financial Statements and Financial Statement
Schedules and Supplementary Data.......................... F-1
Index to Unaudited Pro Forma Condensed Consolidated
Financial Information..................................... P-1
Appendix A--Fairness Opinion
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
SEC Registration Fee........................................ $ 9,948
AMEX Listing Fee............................................ $ 35,000
Dealer Manager Fees......................................... $ 374,000
Printing Expenses........................................... $ 355,000
Legal Fees and Expenses..................................... $1,600,000
Accounting Fees and Expenses................................ $ 270,000
Miscellaneous............................................... $ 216,000
Total....................................................... $2,859,948
ITEM 32. SALES TO SPECIAL PARTIES.
Not applicable.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
On August 12, 2002, we issued an aggregate of 100 shares of Class B common
stock to KRF Company, L.L.C. at a price of $1.00 per share. This issuance was
exempt from registration under Section 4(2) of the Securities Act of 1933, as
amended, as a transaction by an issuer not involving a public offering.
ITEM 34. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Maryland law permits us to include in our charter a provision limiting the
liability of our directors and officers to us and our stockholders for money
damages, except for liability resulting from:
- actual receipt of an improper benefit or profit in money, property or
services, or
- active and deliberate dishonesty established by a final judgment, which is
material to the cause of action.
Our charter contains a provision which eliminates directors' and officers'
liability to the maximum extent permitted by Maryland law.
Maryland law requires us (unless our charter provides otherwise, which our
charter does not) to indemnify a director or officer who has been successful in
the defense of any proceeding to which he is made a party by reason of his
service in that capacity. Maryland law permits us to indemnify our present and
former directors and officers, among others, against judgments, penalties,
fines, settlements and reasonable expenses actually incurred by them in
connection with any proceeding unless it is established that:
- the act or omission was material to the matter giving rise to the
proceeding and was committed in bad faith or was the result of active and
deliberate dishonesty,
- the director or officer actually received an improper personal benefit in
money, property or services, or
- in the case of any criminal proceeding, the director or officer had
reasonable cause to believe that the act or omission was unlawful.
A court may order indemnification if it determines that the director or
officer is fairly and reasonably entitled to indemnification, even though the
prescribed standard of conduct is not met. However, indemnification for an
adverse judgment in a suit by us or in our right, or for a judgment of liability
on the basis that personal benefit was improperly received, is limited to
expenses.
In addition, Maryland law permits us to advance reasonable expenses to a
director or officer upon receipt of:
- a written affirmation by the director or officer of his good faith belief
that he has met the standard of conduct necessary for indemnification, and
- a written undertaking by him or on his behalf to repay the amount paid or
reimbursed if it is ultimately determined that the standard of conduct was
not met.
II-1
Our charter also authorizes us, to the maximum extent permitted by Maryland
law, to indemnify:
- any present or former director or officer, or
- any director or officer who, at our request, serves another corporation or
other enterprise as a director, officer, partner or trustee, against any
claim or liability arising from that status and to pay or reimburse their
reasonable expenses in advance of final disposition of a proceeding.
Our bylaws obligate us to provide such indemnification and advance of
expenses. Our charter and bylaws also permit us to indemnify and advance
expenses to any person who served our predecessor in any of the capacities
described above and any employee or agent of us or our predecessor.
Reference is made to Item 37 for our undertakings with respect to
indemnification for liabilities arising under the Securities Act of 1933, as
amended.
ITEM 35. TREATMENT OF PROCEEDS FROM STOCK BEING REGISTERED.
Not applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements (all included in prospectus):
BERKSHIRE INCOME REALTY, INC.
Report of Independent Accountants
Balance Sheet at August 12, 2002
Notes to Balance Sheet
BERKSHIRE INCOME REALTY PREDECESSOR GROUP
Report of Independent Accountants
Combined Financial Statements:
Combined Balance Sheets at December 31, 2001 and 2000 and
(unaudited) as of June 30, 2002
Combined Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999 and (Unaudited) for the
Six Months Ended June 30, 2002 and June 30, 2001
Combined Statements of Changes in Owners' Equity for the
Years Ended December 31, 2001, 2000 and 1999 and
(Unaudited) for the Six Months Ended June 30, 2002
Combined Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 and (Unaudited) for the
Six Months Ended June 30, 2002 and June 30, 2001
Notes to Combined Financial Statements
Schedule III--Real Estate and Accumulated Depreciation at
December 31, 2001
KRUPP GOVERNMENT INCOME TRUST
Report of Independent Accountants
Balance Sheets at December 31, 2001 and 2000
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999
Notes to Financial Statements
Schedule II--Valuation and Qualifying Accounts
Supplementary Data--Selected Quarterly Financial Data
(Unaudited)
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)
Notes to Financial Statements (Unaudited)
KRUPP GOVERNMENT INCOME TRUST II
Report of Independent Accountants
Balance Sheets at December 31, 2001 and 2000
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999
II-2
Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999
Notes to Financial Statements
Schedule II--Valuation and Qualifying Accounts
Supplementary Data--Selected Quarterly Financial Data
(Unaudited)
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)
Notes to Financial Statements (Unaudited)
KRUPP INSURED MORTGAGE LIMITED PARTNERSHIP
Report of Independent Accountants
Balance Sheets at December 31, 2001 and 2000
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Changes in Partners' Equity for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999
Notes to Financial Statements
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)
Notes to Financial Statements (Unaudited)
KRUPP INSURED PLUS LIMITED PARTNERSHIP
Report of Independent Accountants
Balance Sheets at December 31, 2001 and 2000
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Changes in Partners' Equity for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Cash Flows for the Years Ended December 31,
2001, and 1999
Notes to Financial Statements
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)
Notes to Financial Statements (Unaudited)
KRUPP INSURED PLUS-II LIMITED PARTNERSHIP
Report of Independent Accountants
Balance Sheets at December 31, 2001 and 2000
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Changes in Partners' Equity for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999
Notes to Financial Statements
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)
Statements of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)
Notes to Financial Statements (Unaudited)
KRUPP INSURED PLUS-III LIMITED PARTNERSHIP
Report of Independent Accountants
Balance Sheets at December 31, 2001 and 2000
Statements of Income and Comprehensive Income for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Changes in Partners' Equity for the Years
Ended December 31, 2001, 2000 and 1999
Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999
Notes to Financial Statements
Balance Sheets at June 30, 2002 and December 31, 2001
(Unaudited)
II-3
Statement of Income and Comprehensive Income for the Three
and Six Months Ended June 30, 2002 and 2001 (Unaudited)
Statements of Cash Flows for the Six Months Ended June 30,
2002 and 2001 (Unaudited)
Notes to Financial Statements (Unaudited)
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL
INFORMATION
Unaudited Pro Forma Condensed Consolidated Balance Sheet as
of June 30, 2002 assuming 10% of the Interests in the
Mortgage
Funds are tendered for Series A Preferred Shares
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the six months ended June 30, 2002 assuming
10% of the
Interests in the Mortgage Funds are tendered for Series A
Preferred Shares
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the year ended December 31, 2001 assuming
10% of the
Interests in the Mortgage Funds are tendered for Series A
Preferred Shares
Unaudited Pro Forma Condensed Consolidated Balance Sheet as
of June 30, 2002 assuming 25% of the Interests in the
Mortgage
Funds are tendered for Series A Preferred Shares
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the six months ended June 30, 2002 assuming
25% of the
Interests in the Mortgage Funds are tendered for Series A
Preferred Shares
Unaudited Pro Forma Condensed Consolidated Statement of
Operations for the year ended December 31, 2001 assuming
25% of the
Interests in the Mortgage Funds are tendered for Series A
Preferred Shares
Notes and Management's Assumptions to Unaudited Pro Forma
Condensed Consolidated Financial Information
(b) Exhibits:
EXHIBIT NUMBER DESCRIPTION
-------------- ------------------------------------------------------------
3.1* Form of Articles of Amendment and Restatement of Berkshire
Income Realty, Inc.
3.2* Bylaws of Berkshire Income Realty, Inc.
5.1*** Opinion of Ballard Spahr Andrews & Ingersoll, LLP regarding
the legality of the Preferred Shares.
8.1* Form of opinion of Paul, Weiss, Rifkind, Wharton & Garrison
regarding federal income tax considerations.
10.1*** Form of Amended and Restated Agreement of Limited
Partnership of Berkshire Income Realty-OP, L.P.
10.2* Form of Contribution and Sale Agreement among KRF Company,
L.L.C., KRF GP, Inc., Berkshire Income Realty-OP, L.P. and
BIR Sub, L.L.C.
10.3* Form of Advisory Services Agreement between Berkshire Income
Realty, Inc. and Berkshire Real Estate Advisors, L.L.C.
10.4* Property Management Agreement between KRF3 Acquisition
Company, L.L.C. and BRI OP Limited Partnership dated January
1, 2002.
10.5* Property Management Agreement between Walden Pond Limited
Partnership and BRI OP Limited Partnership dated January 1,
2002.
10.6* Property Management Agreement between KRF5 Acquisition
Company, L.L.C. and BRI OP Limited Partnership dated January
1, 2002.
10.7* Property Management Agreement between KRF3 Acquisition
Company, L.L.C. and BRI OP Limited Partnership dated January
1, 2002.
10.8** Property Management Agreement between Seasons of Laurel,
L.L.C. and BRI OP Limited Partnership dated January 1, 2002.
10.9* Form of Letter Agreement between Georgeson Shareholder
Communications Inc., Georgeson Shareholder Securities
Corporation and Berkshire Income Realty, Inc.
II-4
EXHIBIT NUMBER DESCRIPTION
-------------- ------------------------------------------------------------
10.10* Waiver and Standstill Agreement, dated as of August 22,
2002, by and among Krupp Government Income Trust, Krupp
Government Income Trust II, Berkshire Income Realty, Inc.
and Berkshire Income Realty-OP, L.P.
10.11* Letter Agreement, dated November 1, 2002, by and among Aptco
Gen-Par, L.L.C., WXI/BRH Gen-Par, L.L.C., BRE/Berkshire GP
L.L.C and BRH Limited Partner, L.P.
10.12* Voting Agreement, dated as of November 1, 2002, among Krupp
Government Income Trust, Krupp Government Income Trust II
and Berkshire Income Realty, Inc.
12.1* Statement regarding Computation of Ratio of Earnings and
"Adjusted" Earnings to Fixed Charges and Combined Fixed
Charges and Preferred Share Dividends.
21.1* Subsidiaries of Berkshire Income Realty, Inc.
23.1* Consent of PricewaterhouseCoopers.
23.2*** Consent of Ballard Spahr Andrews & Ingersoll, LLP (included
in Exhibit 5.1).
23.3*** Consent of Paul, Weiss, Rifkind, Wharton & Garrison
(included in Exhibit 8.1).
24.1* Power of Attorney (included on the signature page).
------------------------
* Filed herewith
** Previously filed
*** To be filed by amendment
ITEM 37. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers, trustees and controlling
persons of the registrant under the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. If a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, then the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
II-5
SIGNATURES
As contemplated by the requirements of the Securities Act of 1933, the
undersigned registrant certifies that it has reasonable grounds to believe that
it meets all of the requirements for filing on Form S-11 and has duly caused
this amendment to the Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Boston, Commonwealth of
Massachusetts, on the 5th day of November, 2002.
BERKSHIRE INCOME REALTY, INC.
By: /s/ DAVID C. QUADE
---------------------------------------------------
Name: David C. Quade
Title: President
II-6
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears
below hereby constitutes and appoints George D. Krupp and David C. Quade or
either of them his true and lawful agent, proxy and attorney-in-fact, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to (i) act on, sign and file with the
Securities and Exchange Commission any and all amendments (including
post-effective amendments) to this amendment to the registration statement
together with all schedules and exhibits and any subsequent registration
statement filed under Rule 462(b) under the Securities Act of 1933, together
with all schedules and exhibits thereto, (ii) act on, sign and file such
certificates, instruments, agreements and other documents as may be necessary or
appropriate, (iii) act on and file any supplement to any prospectus included in
this amendment to the registration statement or any such amendment or any
subsequent registration statement filed pursuant to Rule 462(b) under the
Securities Act of 1933 and (iv) take any and all actions which may be necessary
or appropriate, granting unto such agent, proxy and attorney-in-fact full power
and authority to do and perform each and every act and thing necessary or
appropriate to be done, as fully for all intents and purposes as he might or
could do in person, hereby approving, ratifying and confirming all that such
agents, proxies and attorneys-in-fact or any of their substitutes may lawfully
do or cause to be done.
As contemplated by the requirements of the Securities Act of 1933, this
amendment to the Registration Statement has been signed by the following persons
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ GEORGE D. KRUPP
------------------------------------------- Chairman of the Board of Directors November 5, 2002
George D. Krupp
/s/ DAVID C. QUADE President, Chief Financial Officer
------------------------------------------- and Director (Principal Executive November 5, 2002
David C. Quade Officer)
/s/ ROBERT M. KAUFMAN
------------------------------------------- Director November 5, 2002
Robert M. Kaufman
/s/ RANDOLPH G. HAWTHORNE
------------------------------------------- Director November 5, 2002
Randolph G. Hawthorne
/s/ RICHARD B. PEISER
------------------------------------------- Director November 5, 2002
Richard B. Peiser
/s/ WAYNE H. ZAROZNY
------------------------------------------- Vice President and Controller November 5, 2002
Wayne H. Zarozny (Principal Accounting Officer)
II-7
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION
-------------- ------------------------------------------------------------
3.1* Form of Articles of Amendment and Restatement of Berkshire
Income Realty, Inc.
3.2* Bylaws of Berkshire Income Realty, Inc.
5.1*** Opinion of Ballard Spahr Andrews & Ingersoll, LLP regarding
the legality of the Preferred Shares.
8.1* Form of opinion of Paul, Weiss, Rifkind, Wharton & Garrison
regarding federal income tax considerations.
10.1*** Form of Amended and Restated Agreement of Limited
Partnership of Berkshire Income Realty-OP, L.P.
10.2* Form of Contribution and Sale Agreement among KRF
Company, L.L.C., KRF GP, Inc., Berkshire Income
Realty-OP, L.P. and BIR Sub, L.L.C.
10.3* Form of Advisory Services Agreement between Berkshire Income
Realty, Inc. and Berkshire Real Estate Advisors, L.L.C.
10.4* Property Management Agreement between KRF3 Acquisition
Company, L.L.C. and BRI OP Limited Partnership dated
January 1, 2002.
10.5* Property Management Agreement between Walden Pond Limited
Partnership and BRI OP Limited Partnership dated January 1,
2002.
10.6* Property Management Agreement between KRF5 Acquisition
Company, L.L.C. and BRI OP Limited Partnership dated
January 1, 2002.
10.7* Property Management Agreement between KRF3 Acquisition
Company, L.L.C. and BRI OP Limited Partnership dated
January 1, 2002.
10.8** Property Management Agreement between Seasons of
Laurel, L.L.C. and BRI OP Limited Partnership dated
January 1, 2002.
10.9* Form of Letter Agreement between Georgeson Shareholder
Communications Inc., Georgeson Shareholder Securities
Corporation and Berkshire Income Realty, Inc.
10.10* Waiver and Standstill Agreement, dated as of August 22,
2002, by and among Krupp Government Income Trust, Krupp
Government Income Trust II, Berkshire Income Realty, Inc.
and Berkshire Income Realty-OP, L.P.
10.11* Letter Agreement, dated November 1, 2002, by and among Aptco
Gen-Par, L.L.C., WXI/BRH Gen-Par, L.L.C., BRE/Berkshire
GP L.L.C and BRH Limited Partner, L.P.
10.12* Voting Agreement, dated as of November 1, 2002, among Krupp
Government Income Trust, Krupp Government Income Trust II
and Berkshire Income Realty, Inc.
12.1* Statement regarding Computation of Ratio of Earnings and
"Adjusted" Earnings to Fixed Charges and Combined Fixed
Charges and Preferred Share Dividends.
21.1* Subsidiaries of Berkshire Income Realty, Inc.
23.1* Consent of PricewaterhouseCoopers.
23.2*** Consent of Ballard Spahr Andrews & Ingersoll, LLP (included
in Exhibit 5.1).
23.3*** Consent of Paul, Weiss, Rifkind, Wharton & Garrison
(included in Exhibit 8.1).
24.1* Power of Attorney (included on the signature page).
------------------------
* Filed herewith
** Previously filed
*** To be filed by amendment