TRANSCONTINENTAL REALTY INVESTORS, INC. FORM 10-Q

Management’s Overview

Transcontinental Realty Investors, Inc. is a real estate investment company that owns a diverse portfolio of income-producing properties and land held for development in the Southern United States. The company’s portfolio includes residential apartment communities, office buildings, and retail properties. Transcontinental’s investment strategy involves acquiring existing income-producing properties as well as developing new properties on land it already owns or acquires.

The company’s operations are managed by Pillar Income Asset Management, Inc. under an advisory agreement. Pillar’s responsibilities include finding, evaluating, and recommending real estate investment opportunities, as well as arranging the company’s debt and equity financing. Transcontinental has no employees, as Pillar’s staff provides services to the company.

Financing Activities

Over the past year, Transcontinental has been actively managing its financing:

• Paid off $67.5 million in Series C bonds on January 31, 2023.
• Extended the maturity of a $67.5 million loan on the Windmill Farms property to February 28, 2024 at a 7.75% interest rate.
• Obtained a $33 million construction loan to finance the development of the Alera multifamily property, with an interest rate of SOFR plus 3% and a maturity date of March 15, 2026.
• Paid off the remaining $14 million in Series A bonds and $28.9 million in Series B bonds on May 4, 2023, resulting in a $1.7 million loss on early extinguishment of debt.
• Paid off a $1.2 million loan on the Athens property on August 28, 2023.
• Amended the terms of the UHF notes receivable, changing the interest rate from a fixed 12% to a floating rate indexed to SOFR, and forgiving $3.6 million in accrued interest.
• Obtained a $25.4 million construction loan to finance the Merano multifamily development, with an interest rate of prime plus 0.25% and a maturity date of November 6, 2028.
• Obtained a $23.5 million construction loan to finance the Bandera Ridge multifamily development, with an interest rate of SOFR plus 3% and a maturity date of December 15, 2028.
• Amended the cash management agreement with Pillar, changing the interest rate on the related party receivable from prime plus one to SOFR.
• Extended the maturity of the Windmill Farms loan to February 28, 2026 at a 7.50% interest rate.
• Replaced the existing loan on the Forest Grove property with a $6.6 million loan at SOFR plus 1.85%, maturing on August 1, 2031.
• Obtained a $27.5 million construction loan to finance the Mountain Creek multifamily development, with an interest rate of SOFR plus 3.45% and a maturity date of October 20, 2026.

Development Activities

Transcontinental has several ongoing development projects:

• Agreements to develop 125 acres of raw land in Windmill Farms into approximately 470 single-family home lots over a two-year period starting in Q4 2024, at a total cost of $24.3 million.
• A development agreement with Pillar to build a 240-unit multifamily property called Alera in Lake Wales, Florida, with a total cost of $55.3 million and expected completion in 2025.
• A development agreement with Pillar to build a 216-unit multifamily property called Merano in McKinney, Texas, with a total cost of $51.9 million and expected completion in 2025.
• A development agreement with Pillar to build a 216-unit multifamily property called Bandera Ridge in Temple, Texas, with a total cost of $49.6 million and expected completion in 2025.
• A development agreement with Pillar to build a 234-unit multifamily property called Mountain Creek in Dallas, Texas, with a total cost of $49.8 million and expected completion in 2026.

Critical Accounting Policies

Transcontinental’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP), which requires management to make estimates and assumptions that affect the reported amounts. The company’s critical accounting policies include:

Fair Value of Financial Instruments: Transcontinental applies fair value accounting guidance to the valuation of its real estate assets. This establishes a fair value hierarchy with three levels based on the transparency of inputs used in the valuation process.

Related Parties: The company evaluates its business relationships to identify related parties, which include entities in which it has invested, trusts for the benefit of principal owners and management, and other parties that may not be able to pursue their own separate interests.

Results of Operations

Comparison of Q3 2024 to Q3 2023:

• Net income decreased by $2.9 million, primarily due to:
  • A $0.2 million increase in profit from the multifamily segment, offset by a $0.5 million decrease in profit from the commercial segment.
  • A $0.4 million decrease in general, administrative, and advisory expenses.
  • A $3.9 million decrease in net interest income.
  • A $0.8 million increase in other income, primarily from a decrease in income tax provision.

Comparison of first 9 months of 2024 to first 9 months of 2023:

• Net income decreased by $3.0 million, primarily due to:
  • A $0.7 million increase in profit from the multifamily segment, offset by a $1.0 million decrease in profit from the commercial segment.
  • A $4.4 million decrease in general, administrative, and advisory expenses.
  • An $8.1 million decrease in net interest income.
  • A $1.7 million loss on early extinguishment of debt and a $1.0 million decrease in gain on foreign currency transactions in 2023.

Liquidity and Capital Resources

Transcontinental’s principal sources of cash are property operations, proceeds from asset sales, collection of notes receivable, refinancing of existing debt, and additional borrowings. The company’s main liquidity needs are to fund normal expenses, meet debt service and principal repayment obligations, fund capital expenditures, and finance development costs not covered by construction loans.

The company believes its current cash and cash equivalents, along with cash generated from notes, related party receivables, and investments, will be sufficient to meet all of its cash requirements. Transcontinental may also selectively sell land and income-producing assets, refinance or extend real estate debt, and seek additional secured borrowings to meet its liquidity needs.

The key changes in cash flows were:

• A $9.2 million increase in cash provided by operating activities, primarily due to decreased interest and insurance payments.
• A $17.5 million increase in cash used in investing activities, mainly from higher development and renovation spending, offset by increased net redemption of short-term investments and higher collections on notes receivable.
• A $137.4 million decrease in cash used in financing activities, primarily from the $131.2 million repayment of bonds in 2023.

Funds From Operations (FFO)

Transcontinental uses Funds From Operations (FFO) as a supplemental measure of its operating performance, in addition to net income. FFO excludes gains or losses from property sales and real estate depreciation and amortization, which the company believes provides a more meaningful comparison of its results to other real estate companies.

The company also presents FFO excluding the impact of foreign currency transactions. This adjusted FFO metric provides a more consistent comparison of operating performance.

For the three and nine months ended September 30, 2024, Transcontinental reported the following FFO and adjusted FFO:

• Q3 2024 FFO: $4.8 million
• Q3 2024 Adjusted FFO: $4.8 million
• First 9 months 2024 FFO: $15.2 million
• First 9 months 2024 Adjusted FFO: $15.2 million

Conclusion

Transcontinental Realty Investors has been actively managing its financing and development activities over the past year. The company has paid off various bonds and loans, obtained new construction financing, and continued to progress on several multifamily development projects.

While net income declined in the third quarter and first nine months of 2024 compared to the prior year, this was primarily due to decreases in interest income and the impact of debt extinguishment in 2023. The company’s core operating performance, as measured by Funds From Operations, remained relatively stable.

Transcontinental appears to have a solid liquidity position, with sufficient cash and access to financing to meet its ongoing obligations and fund future development. The company’s diversified portfolio of multifamily, office, and retail properties provides a stable income stream, and its development pipeline offers opportunities for growth. Overall, Transcontinental seems well-positioned to navigate the current real estate market environment.