PRUCO LIFE VARIABLE CONTRACT REAL PROPERTY ACCOUNT – 10-Q – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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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 areThe Prudential Insurance Company of America ,Pruco Life Insurance Company , and Pruco Life Insurance Company ofNew 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 ofMarch 31, 2012 , the Partnership's liquid assets, consisting of cash and cash equivalents, were approximately$32.0 million , an increase of approximately$4.6 million from$27.4 million as ofDecember 31, 2011 . The increase was primarily due to the following activities: (a) net cash flow generated from property operations of$2.3 million ; and (b) net proceeds of$8.5 million from the final payment of the Capital Automotive Real Estate Services (or "CARS") preferred equity investment. Partially offsetting this increase is the$5.0 million distribution to all of the investors,$0.2 million of principal payments made on financed properties and$1.0 million paid for capital improvements. The$1.0 million payment for capital improvements included the following items: (a)$0.4 million for tenant improvements and leasing costs at the office property inBeaverton, Oregon ; (b)$0.3 million for roof replacements at the retail property inDunn, North Carolina ; and (c)$0.3 million for minor capital improvements and transaction costs associated with leasing expenses at various properties. Sources of liquidity included net cash flow from property operations, investment redemptions, and interest from cash equivalents. The Partnership uses cash for its real estate investment activities and for its distributions to its partners. As ofMarch 31, 2012 , approximately 15.2% of the Partnership's total assets consisted of cash and cash equivalents. 25
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(b) Results of Operations
The following is a comparison of the Partnership's results of operations for the three month periods ended
Net Investment Income Overview The Partnership's net investment income attributable to the general partners' controlling interest for the three months endedMarch 31, 2012 was approximately$1.9 million , a decrease of approximately$0.2 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$0.5 million in the retail sector investments' net investment income from the prior year period largely due to reduced interest income from the CARS preferred equity investment due to the final payment of the investment which was received early in the third month of the first quarter of 2012. Partially offsetting the decrease were increases of approximately$0.2 million and$0.1 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. Valuation Overview The Partnership recorded a net recognized gain attributable to the general partner's controlling interest of$0.3 million for the three month period endedMarch 31, 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 gains attributable to the general partners' controlling interest of approximately$1.0 million for the three month period endedMarch 31, 2012 . This is compared with net unrealized gains attributable to the general partners' controlling interest of approximately$5.5 million for the prior period. The net unrealized gains attributable to the general partners' controlling interest for the three month period endedMarch 31, 2012 were due to valuation increases in the apartment and hotel sector investments. Offsetting the net unrealized gains were net unrealized losses at the office and retail sector investments. 26
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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 three month periods endedMarch 31, 2012 and 2011. Three Months Ended March 31, 2012 2011 Net Investment Income: Office properties $ 788,244 $ 574,722 Apartment properties 752,111 689,046 Retail properties 950,970 1,496,120 Hotel property 81,000 36,947 Other (including interest income, investment mgt fee, etc.) (693,651 ) (676,954 ) Total Net Investment Income $ 1,878,674 $ 2,119,881 Net Recognized Gain (Loss) onReal Estate Investments : Retail properties 348,760 - Net Recognized Gain (Loss) on Real Estate Investments 348,760 - Net Unrealized Gain (Loss) onReal Estate Investments : Office properties (112,585 ) 965,004 Apartment properties 1,024,245 1,350,634 Retail properties (443,343 ) 2,747,073 Hotel property 575,306 424,097 Net Unrealized Gain (Loss) on Real Estate Investments 1,043,623
5,486,808
Net Recognized and Unrealized Gain (Loss) on Real Estate Investments 1,392,383 $ 5,486,808 27
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Table of Contents OFFICE PROPERTIES Net Investment Net Investment Unrealized Unrealized Three Months Ended Income/(Loss) Income/(Loss) Gain/(Loss) Gain/(Loss) Occupancy Occupancy March 31, 2012 2011 2012 2011 2012 2011 Property Lisle, IL $ 83,427 $ 61,386 $ 47,631 $ (22,647 ) 55 % 49 % Brentwood, TN 299,627 92,586 336,498 1,017,698 100 % 97 % Beaverton, OR 83,468 135,240 (396,714 ) 2,482 91 % 85 % Brentwood, TN 321,722 285,510 (100,000 ) (32,529 ) 100 % 100 % $ 788,244 $ 574,722 $ (112,585 ) $ 965,004 Net Investment Income Net investment income attributable to the general partners' controlling interest for the Partnership's office properties was approximately$0.8 million for the three months endedMarch 31, 2012 , which represents an increase of approximately$0.2 million from the prior year period. The increase in net investment income attributable to the general partners' controlling interest for the three month period endedMarch 31, 2012 was primarily due to actual occupancy and rental rate increases from new and existing tenants at one of the properties inBrentwood, Tennessee . Partially offsetting this increase was a decrease in rental income at the property inBeaverton, Oregon due to a rent concession given to the building's largest tenant. Unrealized Gain/(Loss) The office properties owned by the Partnership recorded net unrealized losses attributable to the general partners' controlling interest of approximately$0.1 million for the three months endedMarch 31, 2012 , compared with a net unrealized gain attributable to the general partners' controlling interest of approximately$1.0 million from the prior year period. The net unrealized losses attributable to the general partners' controlling interest for the three months endedMarch 31, 2012 were primarily due to (a) valuation losses at the property inBeaverton, Oregon due to a reconciliation of costs spent on tenant improvements; and (b) increased operating expenses and the addition of planned capital expenditures at one of the properties inBrentwood, Tennessee . Partially offsetting the decrease was an increase at one of theBrentwood, Tennessee properties due to lower investment rates and more favorable market leasing assumptions. Investment rates include direct and terminal capitalization rates, and discount rates, which reflect investors' yield requirements on investments. 28
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Table of Contents APARTMENT PROPERTIES Three Months Net Investment Net Investment Unrealized Unrealized Ended Income/(Loss) Income/(Loss) Gain/(Loss) Gain/(Loss) Occupancy Occupancy March 31, 2012 2011 2012 2011 2012 2011 Property Atlanta, GA(1) $ - $ (6,664 ) $ - $ - N/A N/A Raleigh, NC 248,898 234,851 348,823 638,442 97% 98% Austin, TX 329,279 317,691 690,251 195,979 94% 98% Charlotte, NC 173,934 143,168 (14,829 ) 516,213 99% 97% $ 752,111 $ 689,046 $ 1,024,245 $ 1,350,634
(1) The
2011 is a result of post-closing adjustments. Net Investment Income Net investment income attributable to the general partners' controlling interest for the Partnership's apartment properties was approximately$0.8 million for the three months endedMarch 31, 2012 , which remained relatively unchanged from the prior year period. Unrealized Gain/(Loss) The apartment properties owned by the Partnership recorded net unrealized gains attributable to the general partners' controlling interest of approximately$1.0 million for the three months endedMarch 31, 2012 , compared with net unrealized gains attributable to the general partners' controlling interest of approximately$1.4 million for the prior year period. The net unrealized gains attributable to the general partners' controlling interest for the three month period endedMarch 31, 2012 were generally due to (a) valuation increases at the property inAustin, Texas related to more favorable market leasing assumptions; and (b) decreased investment rates and more favorable market leasing assumptions at the property inRaleigh, North Carolina . 29
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Table of Contents RETAIL PROPERTIES Recognized Net Investment Net Investment & Unrealized Unrealized Income/(Loss) Income/(Loss)
Gain/(Loss) Gain/(Loss) Occupancy Occupancy Three Months Ended
2011 2012 2011 2012 2011 Property Roswell, GA(1) $ - $ 74,293 $ - $ - N/A N/A Hampton, VA 234,666 244,335 290,046 700,000 81% 94% Ocean City, MD 195,219 289,314 (647,042 ) 624,870 96% 98% Westminster, MD 327,258 305,802 199,693 500,000 100% 100% Dunn, NC 66,539 131,073 (286,040 ) (41,598 ) 36% 35% CARS Preferred Equity(2) 127,288 451,303 348,760 963,801 N/A N/A $ 950,970 $ 1,496,120 $ (94,583 ) $ 2,747,073
(1) The
2011 is a result of post-closing adjustments.
(2) A partial capital redemption of the CARS preferred equity position was paid
on
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$0.9 million for the three months endedMarch 31, 2012 , which represents a decrease of approximately$0.5 million from the prior year period. The decrease in net investment income attributable to the general partners' controlling interest for the three month period endedMarch 31, 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 early in the third month of the first quarter of 2012; (b) the reconciliation of the interest rate at the CARS preferred equity investment resulting in a$0.2 million true-up in 2011; and (c) increased interest expense as a result of refinancing at the property inOcean City, Maryland . Recognized & Unrealized Gain/(Loss) The retail properties owned by the Partnership recorded a net recognized and unrealized loss attributable to the general partners' controlling interest of approximately$0.1 million for the three months endedMarch 31, 2012 , compared with a net unrealized gain attributable to the general partners' controlling interest of approximately$2.7 million for the prior year period. The net unrealized losses attributable to the general partners' controlling interest for the three month period endedMarch 31, 2012 were primarily due to (a) increased leasing and tenant improvement costs at the property inOcean City, Maryland ; and (b) capital expenditures for roof replacements at the property inDunn, 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; (b) rental increases at the property inHampton, Virginia ; and (c) more favorable market leasing assumptions at the property inWestminster, Maryland . 30
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Table of Contents HOTEL PROPERTY Net Investment Net Investment Unrealized Unrealized Average Average Income/(Loss) Income/(Loss) Gain/(Loss) Gain/(Loss) Occupancy Occupancy Three Months Ended March 31, 2012 2011 2012 2011 2012 2011 Property Lake Oswego, OR $ 81,000 $ 36,947 $ 575,306 $ 424,097 55 % 52 % Net Investment Income
Net investment income attributable to the general partners' controlling interest for the Partnership's hotel property was approximately
Unrealized Gain/(Loss) The Partnership's hotel property recorded a net unrealized gain attributable to the general partners' controlling interest of approximately$0.6 million for the three months endedMarch 31, 2012 , compared with a net unrealized gain attributable to the general partners' controlling interest of approximately$0.4 million for the prior year period. The unrealized gain attributable to the general partners' controlling interest for the three month period endedMarch 31, 2012 was primarily due to a valuation increase caused by an increase in projected occupancy, revenue per available room, and average daily rate at the property reflecting improvements in the overall hotel market.
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$0.7 million for the three month period endedMarch 31, 2012 , which remained relatively unchanged from the prior period. 31
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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 inthe 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 theAppraisal 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 ofPrudential 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.
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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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