All of the assets of the Real Property Account are invested in the Partnership.
Accordingly, the liquidity and capital resources and results of operations for
the Real Property Account are contingent upon those of the Partnership.
Therefore, this management's discussion and analysis addresses these items at
the Partnership level. The general partners in the Partnership are The
Prudential Insurance Company of America, Pruco Life Insurance Company, and Pruco
Life Insurance Company of New Jersey, or collectively, the "Partners".
The following discussion and analysis of the liquidity and capital resources and
results of operations of the Partnership should be read in conjunction with the
unaudited Consolidated Financial Statements of the Real Property Account and the
Partnership and the related Notes included in this filing.
(a) Liquidity and Capital Resources
As of June 30, 2012, the Partnership's liquid assets, consisting of cash and
cash equivalents, were approximately $23.9 million, a decrease of approximately
$3.5 million from $27.4 million as of December 31, 2011. The decrease was
primarily due to the following activities: (a) $22.3 million for an acquisition
of a 59-unit apartment property located in Seattle, Washington; (b) $5.0 million
distribution to general partners' controlling interest; (c) $0.4 million of
principal payments made on financed properties; and (d) $1.6 million paid for
capital improvements. Partially offsetting this decrease was the (a) net cash
flow generated from property operations of $3.8 million; (b) net proceeds of
$8.6 million from the final payment of the Capital Automotive Real Estate
Services (or "CARS") preferred equity investment; (c) $11.7 million of loan
proceeds associated with the apartment acquisition in Seattle, Washington; and
(d) contributions from noncontrolling interest of $1.7 million. The $1.6 million
payment for capital improvements included the following items: (a) $0.3 million
for tenant improvements and leasing costs at the office property in Beaverton,
Oregon; (b) $0.3 million for tenant improvement and leasing costs at the office
building in Lisle, Illinois; (c) $0.3 million for roof replacements at the
retail property in Dunn, North Carolina; (d) $0.2 million for exterior painting
at the apartment property in Raleigh, North Carolina; and (e) $0.5 million for
capital improvements and transaction costs associated with leasing expenses at
various properties.
Sources of liquidity included net cash flow from property operations, capital
redemptions, and interest from cash equivalents. The Partnership uses cash for
its real estate investment activities and for its distributions to its partners.
As of June 30, 2012, approximately 10.6% of the Partnership's total assets
consisted of cash and cash equivalents.
On July 19, 2012, the Partnership entered into a purchase and sale agreement to
acquire a $20.7 million grocery-anchored retail property in Roswell, Georgia.
The Partnership has placed a $0.3 million refundable deposit in escrow in
connection with this purchase. The Partnership will assume the existing loan of
$12.5 million and will contribute approximately $8.2 million of equity at
closing. The loan is an interest only loan at a fixed rate of 5.10% and matures
in November 2015. Closing is anticipated in September of 2012.
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(b) Results of Operations
The following is a comparison of the Partnership's results of operations for the
three and six month periods ended June 30, 2012 and 2011.
Net Investment Income Overview
The Partnership's net investment income attributable to the general partners'
controlling interest for the six months ended June 30, 2012 was approximately
$3.9 million, a decrease of approximately $0.3 million from the prior year
period. The decrease in net investment income attributable to the general
partners' controlling interest was primarily due to a decrease of $0.8 million
in the retail sector investments' net investment income from the prior year
period. Additionally, there was approximately $0.1 million of additional losses
in other income and the hotel property sector. Partially offsetting the decrease
were increases of approximately $0.4 million and $0.2 million from the prior
year period in net investment income attributable to the general partners'
controlling interest from the office sector and apartment sector, respectively.
The Partnership's net investment income attributable to the general partners'
controlling interest for the three months ended June 30, 2012 was approximately
$2.0 million, a decrease of approximately $0.1 million from the prior year
period. The components of this net investment income and/or loss attributable to
the general partners' controlling interest are discussed below by investment
type.
Valuation Overview
The Partnership recorded a net recognized gain attributable to the general
partner's controlling interest of $0.3 million for the six month period ended
June 30, 2012, compared with no recognized gains/losses for the prior year
period. The net recognized gain attributable to the partner's controlling
interest was due to the final payment of the CARS preferred equity investment.
The Partnership recorded net unrealized losses attributable to the general
partners' controlling interest of approximately $0.2 million for the six month
period ended June 30, 2012. This is compared with net unrealized gains
attributable to the general partners' controlling interest of approximately $7.5
million for the prior year period. The net unrealized losses attributable to the
general partners' controlling interest for the six month period ended June 30,
2012 were primarily due to valuation decreases in the office and retail sector
investments. Offsetting the net unrealized losses were net unrealized gains at
the apartment and hotel sector investments.
The Partnership recorded net unrealized losses attributable to the general
partner's controlling interest of $1.2 million for the three month period ended
June 30, 2012, compared with $2.0 million of unrealized gain for the prior year
period. The components of these valuation gains and/or losses attributable to
the general partners' controlling interest are discussed below by property type.
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The following table presents a comparison of the Partnership's sources of net
investment income attributable to the general partners' controlling interest,
and net recognized and unrealized gains or losses attributable to the general
partners' controlling interest for the six and three month periods ended
June 30, 2012 and 2011.
Six Months Ended June 30, Three Months Ended June 30,
2012 2011 2012 2011
Net Investment Income:
Office properties $ 1,612,518 $ 1,211,642 $ 824,275 $ 636,920
Apartment properties 1,560,913 1,402,236 808,802 713,189
Retail properties 1,845,849 2,690,228 894,879 1,194,107
Hotel property 246,965 248,362 165,965 211,416
Other (including interest
income, investment mgt fee,
etc.) (1,398,874 ) (1,380,171 )
(705,225 ) (703,217 )
Total Net Investment Income $ 3,867,371$ 4,172,297 $
1,988,696 $ 2,052,415
Net Recognized Gain (Loss) on
Real Estate Investments:
Retail properties 348,760 - - -
Net Recognized Gain (Loss) on
Real Estate Investments 348,760 - - -
Net Unrealized Gain (Loss) on
Real Estate Investments:
Office properties (235,521 ) 1,933,392 (122,935 ) 968,390
Apartment properties 278,171 1,790,032 (746,076 ) 439,398
Retail properties (418,035 ) 3,276,957 25,310 529,884
Hotel property 211,886 483,764 (363,421 ) 59,666
Net Unrealized Gain (Loss) on
Real Estate Investments (163,499 ) 7,484,145
(1,207,122 ) 1,997,338
Net Recognized and Unrealized
Gain (Loss) on Real Estate
Investments $ 185,261 $ 7,484,145 $
(1,207,122 ) $ 1,997,338
Increase/(Decrease) in Net
Assets $ 4,052,632 $ 11,656,442 $ 781,574 $ 4,049,753
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OFFICE PROPERTIES
Net Investment Net Investment Unrealized Unrealized Occupancy Occupancy
Six Months Ended June 30, Income/(Loss) 2012 Income/(Loss) 2011 Gain/(Loss) 2012 Gain/(Loss) 2011 2012 2011
Property
Lisle, IL $ 156,914 $ 139,660 $ (147,905 ) $ (46,760 ) 57 % 55 %
Brentwood, TN 574,782 225,663 629,533 1,693,683 100 % 97 %
Beaverton, OR 248,579 269,838 (488,199 ) 222,498 91 % 85 %
Brentwood, TN 632,243 576,481 (228,950 ) 63,971 100 % 100 %
$ 1,612,518 $ 1,211,642 $ (235,521 ) $ 1,933,392
Three Months Ended June 30,
Property
Lisle, IL $ 73,488 $ 78,273 $ (195,537 ) $ (24,112 )
Brentwood, TN 275,155 133,077 293,037 675,986
Beaverton, OR 165,111 134,599 (91,485 ) 220,016
Brentwood, TN 310,521 290,971 (128,950 ) 96,500
$ 824,275 $ 636,920 $ (122,935 ) $ 968,390
Net Investment Income
Net investment income attributable to the general partners' controlling interest
for the Partnership's office properties was approximately $1.6 million and $0.8
million for the six and three month periods ended June 30, 2012, respectively,
which represents an increase of approximately $0.4 million and $0.2 million,
respectively, from the prior year period. The increase in net investment income
attributable to the general partners' controlling interest for the six and three
month periods ended June 30, 2012 were primarily due to actual occupancy and
rental rate increases from new and existing tenants at one of the properties in
Brentwood, Tennessee.
Unrealized Gain/(Loss)
The office properties owned by the Partnership recorded net unrealized losses
attributable to the general partners' controlling interest of approximately $0.2
million and $0.1 million for the six and three month periods ended June 30,
2012, respectively, compared with a net unrealized gain attributable to the
general partners' controlling interest of approximately $2.0 million and $1.0
million, respectively, from the prior year period. The net unrealized losses
attributable to the general partners' controlling interest for the six and three
month periods ended June 30, 2012 were primarily due to (a) valuation losses at
the property in Beaverton, Oregon due to a reconciliation of costs spent on
tenant improvements and less favorable market leasing assumptions; (b) increased
operating expenses and the addition of planned capital expenditures at one of
the properties in Brentwood, Tennessee; and (c) increased capital expenditures
at the property in Lisle, Illinois related to leasing and tenant improvement
costs. Partially offsetting the decrease was an increase at one of the
Brentwood, Tennessee properties due to more favorable market leasing
assumptions.
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APARTMENT PROPERTIES
Net Investment Net Investment Unrealized Unrealized
Income/(Loss) Income/(Loss) Gain/(Loss) Gain/(Loss) Occupancy Occupancy
Six Months Ended June 30,
2012 2011 2012 2011 2012 2011
Property
Atlanta, GA (1) $ - $ (5,203 ) $ - $ - N/A N/A
Raleigh, NC 564,120 501,457 332,584 605,733 98 % 98 %
Austin, TX 694,134 617,799 (345,925 ) 493,073 97 % 99 %
Charlotte, NC 329,748 288,183 291,512 691,226 99 % 99 %
Seattle, WA (27,089 ) - - - 93 % N/A
$ 1,560,913 $ 1,402,236 $ 278,171 $ 1,790,032
Three Months Ended June 30,
Property
Atlanta, GA (1) $ - $ 1,461 $ - $ -
Raleigh, NC 315,222 266,606 (16,240 ) (32,709 )
Austin, TX 364,855 300,108 (1,036,177 ) 297,094
Charlotte, NC 155,814 145,014 306,341 175,013
Seattle, WA (27,089 ) - - -
$ 808,802 $ 713,189 $ (746,076 ) $ 439,398
(1) The Atlanta, Georgia property was sold on September 29, 2010. The loss for
the six months ended June 30, 2011 is a result of post-closing adjustments.
The income for the three months ended June 30, 2011 is due to a reclass from
a retail property.
Net Investment Income
Net investment income attributable to the general partners' controlling interest
for the Partnership's apartment properties was approximately $1.6 million and
$0.8 million for the six and three month periods ended June 30, 2012,
respectively, which represents increases of approximately $0.2 million and $0.1
million, respectively from the prior year period. The increase in net investment
income attributable to the general partners' controlling interest for the six
and three month periods ended June 30, 2012 were primarily due to increased
rental rates and reduced concessions at the properties in Raleigh, North
Carolina, Austin, Texas, and Charlotte, North Carolina.
Unrealized Gain/(Loss)
The apartment properties owned by the Partnership recorded net unrealized gains
attributable to the general partners' controlling interest of approximately $0.3
million for the six months ended June 30, 2012, compared with net unrealized
gains attributable to the general partners' controlling interest of
approximately $1.8 million for the prior year period. The net unrealized gains
attributable to the general partners' controlling interest for the six months
ended June 30, 2012 were generally due to more favorable market leasing
assumptions at the properties in Raleigh, North Carolina and Charlotte, North
Carolina. The apartment properties owned by the Partnership recorded net
unrealized losses attributable to the general partners' controlling interest of
approximately $0.7 million for the three months ended June 30, 2012, compared
with net unrealized gains attributable to the general partners' controlling
interest of approximately $0.4 million for the prior year period. The net
unrealized losses attributable to the general partners' controlling interest for
the three months ended June 30, 2012 were generally due to increased real estate
taxes at the property in Austin, Texas as a result of a reassessment by the
county tax assessor.
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RETAIL PROPERTIES
Recognized/
Net Investment Net Investment Unrealized Unrealized
Income/(Loss) Income/(Loss) Gain/(Loss) Gain/(Loss) Occupancy Occupancy
Six Months Ended June 30, 2012 2011 2012 2011 2012 2011
Property
Roswell, GA(1) $ - $ 72,833 $ - $ - N/A N/A
Hampton, VA 501,184 496,577 290,045 897,640 81 % 96 %
Ocean City, MD 389,731 513,885 (420,304 ) 780,938 96 % 98 %
Westminster, MD 664,115 640,526 (684 ) 597,673 98 % 100 %
Dunn, NC 169,397 226,069 (287,092 ) (153,575 ) 36 % 35 %
CARS Preferred Equity (2) 121,422 740,338 348,760 1,154,281 N/A N/A
$ 1,845,849 $ 2,690,228 $ (69,275 ) $ 3,276,957
Three Months Ended June 30,
Property
Roswell, GA(1) $ - $ (1,461 ) $ - $ -
Hampton, VA 266,519 252,241 - 197,640
Ocean City, MD 194,511 224,571 226,740 156,068
Westminster, MD 336,857 334,724 (200,377 ) 97,673
Dunn, NC 102,858 94,996 (1,053 ) (111,977 )
CARS Preferred Equity (2) (5,866 ) 289,036 - 190,480
$ 894,879 $ 1,194,107 $ 25,310 $ 529,884
(1) The Roswell, Georgia retail property was sold on May 1, 2009. The income in
2011 is a result of post-closing adjustments.
(2) A partial capital redemption of the CARS preferred equity position was paid
on March 11, 2011. On March 5, 2012, the Partnership received final payment
on the position which is reflected as a recognized gain.
Net Investment Income
Net investment income attributable to the general partners' controlling interest
for the Partnership's retail properties was approximately $1.8 million and $0.9
million for the six and three month periods ended June 30, 2012, respectively,
which represents a decrease of approximately $0.9 million and $0.3 million,
respectively from the prior year period. The decrease in net investment income
attributable to the general partners' controlling interest for the six and three
month periods ended June 30, 2012 was largely due to (a) reduced interest income
from the CARS preferred equity investment due to the final payment of the
investment which occurred in the first quarter of 2012; and (b) increased
interest expense as a result of refinancing the loan for the Ocean City,
Maryland property.
Recognized and Unrealized Gain/(Loss)
The retail properties owned by the Partnership recorded a net recognized gain
and unrealized losses attributable to the general partners' controlling interest
of approximately $0.1 million for the six months ended June 30, 2012, compared
with a net unrealized gain attributable to the general partners' controlling
interest of approximately $3.3 million for the prior year period. The net
unrealized losses attributable to the general partners' controlling interest for
the six months ended June 30, 2012 were primarily due to (a) increased leasing
and tenant improvement costs at the property in Ocean City, Maryland; and
(b) capital expenditures for roof replacements at the property in Dunn, North
Carolina. Partially offsetting the losses were gains primarily due to
(a) recognized gains on the CARS preferred equity investment as a result of the
sale of the investment; and (b) rental increases at the property in Hampton,
Virginia. The retail properties owned by the Partnership recorded nominal net
unrealized gains attributable to the general partners' for the three months
ended June 30, 2012, compared with net unrealized gains attributable to the
general partners' controlling interest of approximately $0.5 million for the
prior year period. The net unrealized gains attributable to the general
partners' controlling interest for the three months ended June 30, 2012 were due
to increased rents at the Ocean City, Maryland property. Partially offsetting
this increase was a decrease at the Westminster, Maryland property due to less
favorable market leasing assumptions.
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HOTEL PROPERTY
Net Investment Net Investment Unrealized Unrealized
Income/(Loss) Income/(Loss) Gain/(Loss) Gain/(Loss) Occupancy Occupancy
Six Months Ended June 30,
2012 2011 2012 2011 2012 2011
Property
Lake Oswego, OR $ 246,965 $ 248,362 $ 211,886 $ 483,764 61 % 60 %
Three Months Ended June 30,
Property
Lake Oswego, OR $ 165,965 $ 211,416 $ (363,421 ) $ 59,666
Net Investment Income
Net investment income attributable to the general partners' controlling interest
for the Partnership's hotel property was approximately $0.2 million for the six
months ended June 30, 2012, which remained relatively unchanged from the prior
year period. Net investment income attributable to the general partners'
controlling interest for the Partnership's hotel property was approximately $0.2
million for the three months ended June 30, 2012, which was slightly lower than
the prior year period due to lower food and beverage revenue.
Unrealized Gain/(Loss)
The Partnership's hotel property recorded a net unrealized gain attributable to
the general partners' controlling interest of approximately $0.2 million for the
six months ended June 30, 2012, compared with a net unrealized gain attributable
to the general partners' controlling interest of approximately $0.5 million for
the prior year period. The unrealized gain attributable to the general partners'
controlling interest for the six months ended June 30, 2012 was primarily due to
an increase in projected occupancy, revenue per available room, and average
daily rate at the property reflecting improvements in the overall hotel market.
The Partnership's hotel property recorded a net unrealized loss attributable to
the general partners' controlling interest of approximately $0.4 million for the
three months ended June 30, 2012, compared with a net unrealized gain
attributable to the general partners' controlling interest of approximately $0.1
million for the prior year period. The unrealized loss attributable to the
general partners' controlling interest for the three months ended June 30, 2012
was primarily due to a decrease in the growth rates applied to the average daily
rate projections.
Other
Other net investment loss mainly includes investment management fees, other
portfolio level expenses and interest income. Other net investment loss
attributable to the general partners' controlling interest was approximately
$1.4 million and $0.7 million for the six and three month periods ended June 30,
2012, which remained relatively unchanged from the prior year periods,
respectively.
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(c) Inflation
A majority of the Partnership's leases with its commercial tenants provide for
recoveries of expenses based upon the tenant's proportionate share of, and/or
increases in, real estate taxes and certain operating costs, which may partially
reduce the Partnership's exposure to increases in operating costs resulting from
inflation.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America, or "U.S. GAAP", requires the
application of accounting policies that often involve a significant degree of
judgment. Management reviews critical estimates and assumptions on an ongoing
basis. If management determines, as a result of its consideration of facts and
circumstances, that modifications in assumptions and estimates are appropriate,
results of operations and financial position as reported in the unaudited
Consolidated Financial Statements of the Real Property Account and the
Partnership may change significantly.
The following sections discuss those critical accounting policies applied in
preparing the unaudited Consolidated Financial Statements of the Real Property
Account and the Partnership that are most dependent on the application of
estimates and assumptions.
Accounting Pronouncements Adopted
See Note 1B to the Partnership's unaudited Consolidated Financial Statements for
a discussion of recently adopted accounting pronouncements.
Valuation of Investments
Real Estate Investments - Real estate investments are carried at fair value.
Properties owned are initially recorded at the purchase price plus closing
costs. Development costs and major renovations are capitalized as a component of
cost, and routine maintenance and repairs are charged to expense as incurred.
Real estate costs include the cost of acquired property, including all the
tangible and intangible assets. Tangible assets include the value of all land,
building and tenant improvements at the time of acquisition. Intangible assets
include the value of any above and below market leases, in-place leases, and
tenant relationships at the time of acquisition.
In general, fair value estimates are based upon property appraisal reports
prepared by independent real estate appraisers (members of the Appraisal
Institute or an equivalent organization) within a reasonable amount of time
following acquisition of the real estate and no less frequently than annually
thereafter. The Chief Real Estate Appraiser of Prudential Investment Management,
Inc. ("PIM"), which is an indirectly owned subsidiary of Prudential Financial,
Inc. ("PFI"), is responsible for assuring that the valuation process provides
independent and reasonable property fair value estimates. An unaffiliated third
party has been appointed by PIM to assist the Chief Real Estate Appraiser in
maintaining and monitoring the independence and the accuracy of the appraisal
process. The fair value of real estate investments does not reflect the
transaction sale costs, which may be incurred upon disposition of the real
estate investments.
The purpose of an appraisal is to estimate the fair value of real estate as of a
specific date. In accordance with FASB authoritative guidance on fair value
measurements and disclosures, fair value is the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. The estimate of fair value is based
on the conventional approaches to value, all of which require the exercise of
subjective judgment. The three approaches are: (1) current cost of reproducing
the real estate less deterioration and functional and economic obsolescence;
(2) discounting a series of income streams and reversion at a specific yield or
by directly capitalizing a single year income estimate by an appropriate factor;
and (3) value indicated by recent sales of comparable real estate in the market.
Key inputs and assumptions include rental income and expense amounts, related
rental income and expense growth rates, discount rates and capitalization rates.
In the reconciliation of these three approaches, the independent appraiser uses
one or a combination of them, to determine the approximated value for the type
of real estate in the market. The real estate investments consisting of real
estate, improvements, and preferred equity investments are therefore classified
as Level 3.
Cash equivalents include short term investments. Short term investments are
generally valued using unadjusted quoted prices in active markets that are
accessible for identical assets and primarily are classified as Level 1.
Other Estimates
The preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the unaudited Consolidated Financial
Statements of the Real Property Account and the Partnership and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
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