Item 1. Business
Rancon Realty Fund V, a California Limited Partnership, (“the Partnership”) was organized in accordance with the provisions of the California Revised Limited Partnership Act for the purpose of acquiring, developing, operating and ultimately selling real property. The Partnership was organized in 1985 and completed its public offering of limited partnership units (“Units”) in February 1989. The general partners of the Partnership are Daniel L. Stephenson (“DLS”) and Rancon Financial Corporation (“RFC”), collectively, the “General Partner.” RFC is wholly owned by DLS. The Partnership has no employees.
The Partnership’s initial acquisition of property in September 1985 consisted of approximately 76.21 acres of partially developed and unimproved land located in San Bernardino, California. The property is part of a master-planned development of 153 acres known as Tri-City Corporate Centre (“Tri-City”) and is zoned for mixed commercial, office, hotel, transportation-related, and light industrial uses. The balance of Tri-City is owned by Rancon Realty Fund IV (“Fund IV”), a partnership sponsored by the General Partner of the Partnership. Since the acquisition of the land, the Partnership has constructed eleven projects at Tri-City consisting of five office projects, one industrial property, a 25,000 square foot health club, three restaurants, and a retail space. The Partnership’s properties are more fully described in Item 2.
Item 2. Properties
Tri-City Corporate Centre
In 1985, the Partnership acquired 76.21 acres of partially developed land in Tri-City for a total acquisition price of $14,118,000. In 1984 and 1985, a total of 76.56 acres within Tri-City were acquired by Fund IV.
Tri-City is located at the northeastern quadrant of the intersection of Interstate 10 (San Bernardino Freeway) and Waterman Avenue in the southernmost part of the City of San Bernardino, and is in the heart of the Inland Empire, the most densely populated area of San Bernardino and Riverside counties.
The Inland Empire is generally broken down into two major markets, Inland Empire East and Inland Empire West. Tri-City is located within the Inland Empire East market, which consists of approximately 12.4 million square feet of office space and an overall vacancy rate of approximately 11% as of December 31, 2004, according to research conducted by an independent broker.
Within the Tri-City as of December 31, 2004, the Partnership has 441,000 square feet of office space with a vacancy rate of 2%, 51,000 square feet of R & D space with a vacancy rate of 13% and 55,000 square feet of retail space with no vacancy.
Tri-City Properties
The Partnership’s improved properties in the Tri-City Corporate Centre are as follows:
Property
Type
Square Footage
One Carnegie Plaza
Two, two story office buildings
107,278
Two Carnegie Plaza
Two story office building
68,957
Carnegie Business Center II
Two R & D buildings
50,867
Lakeside Tower
Six story office building
112,791
One Parkside
Four story office building
70,068
Bally’s Health Club
Health club facility
25,000
Outback Steakhouse
Restaurant
6,500
Palm Court Retail #3
Retail
6,004
Chuck E. Cheese
Restaurant
12,200
Two Parkside
Three story office building
82,004
Pat & Oscars
Restaurant
5,100
These eleven properties total approximately 547,000 rentable square feet and offer a wide range of commercial, R & D, office and retail product to the market.
Occupancy rates for the Partnership’s Tri-City buildings for each of the five years ended December 31, 2004, expressed as a percentage of the total net rentable square feet, were as follows:
In 2004, management renewed 17 leases, totaling 116,869 square feet and executed 11 new leases totaling 32,613 square feet of space. In 2005, 16 leases, totaling 86,476 square feet, are due to expire. Of these, management has renewed 10 leases totaling 59,009 square feet, while 5 tenants occupying 10,744 square feet have indicated that they will vacate upon expiration of their leases. The remaining one tenant occupying 16,723 square feet of space has not yet indicated whether it plans to renew its lease or vacate the premises. Management is actively marketing the space.
The annual effective rents per square foot for each of the five years ended December 31, 2004 were as follows:
Annual effective rent is calculated by dividing the aggregate of annualized current monthly rental income for each tenant by the total square feet occupied at the property.
The Partnership’s Tri-City properties had the following tenants that occupied a significant portion of the net rentable square footage as of December 31, 2004:
continued
On February 1, 2005, New York Life Insurance relocated to Vanderbilt Plaza, a new building developed by Fund IV.
Paychex has extended their lease for one year.
Computer Associates has not yet exercised their lease renewal option. Management is aggressively working with the tenant to renew their lease prior to its expiration.
The Partnership’s Tri-City rental properties are owned by the Partnership, in fee, subject to the following note and lines of credit:
The interest rate for the line of credit related to One Carnegie Plaza and Carnegie Business Center II is a variable interest rate of “Prime Rate” plus 0.75%. This line of credit had a maturity date of March 5, 2005. On that date, the Partnership extended the maturity date of this line of credit to June 5, 2005. The Partnership intends to either extend the term of the existing line of credit or to refinance the properties with a lower interest rate loan to replace the line of credit after the 90-day extension.
The note payable may be prepaid with a penalty based on a yield maintenance formula. There is no prepayment penalty if the note is repaid within six months of the maturity date of the note. The Partnership’s plan is to either sell the properties or refinance with a lower interest rate loan to pay off this high interest rate note when the prepayment penalty period ends on December 1, 2005.
Tri-City Land
As of December 31, 2004, the Partnership owned approximately 10.5 acres of land. Construction has commenced on a one-acre land parcel (discussed below). Approximately 5-acres of land, known as Brier Corporate Center, is in a pre-design stage. The remaining 4.5 acres are currently undeveloped. The Partnership’s plan is to develop properties on the remaining acres of unimproved land to generate more operating income for the Partnership in this fast-growing market.
A two-story office building of 86,200 square feet, known as Three Carnegie, is currently under construction. The estimated construction cost is approximately $6,400,000, which is estimated to be completed in June 2005. In April 2004, the Partnership obtained a new line of credit with a total availability of $7,425,000, secured by Two Parkside, to provide the funding for the construction costs.
Item 3.
Item 3. Legal Proceedings
Certain claims and lawsuits have arisen against the Partnership in its normal course of business. The Partnership believes that such claims and lawsuits will not in the future have a material adverse effect on the Partnership’s financial position, cash flow or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Part II
Item 5.
Item 5. Market for Partnership’s Common Equity and Related Stockholder Matters
Market Information
There is no established trading market for the Units issued by the Partnership.
Holders
As of December 31, 2004, there were 9,357 holders of Partnership Units.
Distributions
Distributions are paid from either Cash From Operations or Cash From Sales or Refinancing (as such terms are defined in the Partnership Agreement).
Cash From Operations includes all cash receipts from operations in the ordinary course of business (except for the sale, exchange or other disposition of real property in the ordinary course of business) after deducting payments for operating expenses. All distributions of Cash From Operations are paid in the ratio of 90% to the Limited Partners and 10% to the General Partner.
Cash From Sales or Refinancing is the net cash realized by the Partnership from the sale, disposition or refinancing of any property after redemption of applicable mortgage debt and all expenses related to the transaction, together with interest on any notes taken back by the Partnership upon the sale of a property. All distributions of Cash From Sales or Refinancing are generally allocated as follows: (i) first, 1 percent to the General Partner and 99 percent to the Limited Partners until the Limited Partners have received an amount equal to their capital contributions; (ii) second, 1 percent to the General Partner and 99 percent to the Limited Partners until the Limited Partners have received a 12 percent return on their unreturned capital contributions including prior distributions of Cash From Operations; plus their Limited Incremental Preferred Return for the twelve month period following the purchase date of each Unit and following admission as a Limited Partner; (iii) third, 99 percent to the General Partner and 1 percent to the Limited Partners until the General Partner has received an amount equal to 20 percent of all distributions of Cash From Sales or Refinancing previously made under clauses (ii) and (iii) above, reduced by the amount of prior distributions made to the General Partner under clauses (ii) and (iii); and (iv) fourth, the balance 20 percent to the General Partner and 80 percent to the Limited Partners. A more detailed statement of the distribution policies is set forth in the Partnership Agreement.
In 2004, the Partnership distributed from operations $1,555,000 to the Limited Partners and accrued distributions of $172,000 for the General Partner.
In 2003, the Partnership distributed from operations $1,353,000 and $151,000 to the Limited Partners and General Partner, respectively.
Item 6.
Item 6. Selected Financial Data
The following is selected financial data for each of the five years ended December 31, 2004 (in thousands, except per Unit data):
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the financial statements and the notes thereto as listed in Item 15 of Part IV.
Results of Operations
Comparison of the year ended December 31, 2004 to the year ended December 31, 2003
Revenue
Rental income increased $1,803,000, or 21%, for the year ended December 31, 2004, compared to the year ended December 31, 2003, primarily due to the increases in occupancy at Two Parkside.
Occupancy rates at the Partnership’s Tri-City properties for each of the five years ended December 31, 2004 were as follows:
As of December 31, 2004, tenants at Tri-City occupying substantial portions of leased rental space included: (i) New York Life Insurance with a lease through January 31, 2005 (see below for detail); (ii) Paychex with a lease through July 2005; (iii) Computer Associates with a lease through November 2005; (iv) Chicago Title with leases through May 2007 and February 2009; (v) First Franklin Financial with a lease through February 2009; (vi) Gresham, Savage, Nolan & Tilden with a lease through March 2009; (vii) Arrowhead Central Credit Union with two leases through September 2005 and September 2010; (viii) Holiday Spa Health Club with a lease through December 2010; and (ix) Lewis, D’amato, Brisbois and Bisgaard, LLP with a lease through December 2012. These nine tenants, in the aggregate, occupy approximately 230, 000 square feet of the 547,000 total rentable square feet at Tri-City and account for approximately 45% of the rental income generated at Tri-City for the Partnership as of December 31, 2004.
On February 1, 2005, New York Life Insurance relocated to Vanderbilt Plaza, a new building developed by Fund IV.
The 5% increase in occupancy from December 31, 2003 to December 31, 2004 at Carnegie Business Center II was due to leasing 2,400 square feet to a new tenant.
Two Parkside began lease-up in September 2003. The 35% increase in occupancy from December 31, 2003 to December 31, 2004 at Two Parkside is due to leasing the remaining 29,000 square feet to two new tenants in March and April 2004.
Pat & Oscars began occupancy in March 2004 with a ground lease of 15 years.
Expenses
Property operating increased $603,000, or 16%, during the year ended December 31, 2004, compared to the year ended December 31, 2003, primarily due to the additional operating costs associated with the completion of three new properties developed by the Partnership.
Depreciation and amortization expense increased $292,000, or 13%, during the year ended December 31, 2004, compared to the year ended December 31, 2003, primarily due to depreciation of one new building, land improvements and tenant improvements placed into service.
Expenses associated with undeveloped land decreased $84,000, or 30%, for year ended December 31, 2004, compared to the year ended December 31, 2003, primarily due to decreased capitalization of property taxes and insurance at two East Lake pads and Three Carnegie during the construction period. The two East Lake pads were completed in March 2004.
Non-operating income /expenses
Interest and other income for the year ended December 31, 2004 decreased $30,000 from the year ended December 31, 2003, primarily due to a lower invested cash balance resulting from payment of the construction costs at Two Parkside.
Interest expense increased $688,000, or 135%, during the year ended December 31, 2004, compared to the year ended December 31, 2003, primarily due to interest paid on increased borrowings from the two lines of credit, offset by interest capitalized during construction at Three Carnegie and two East Lake pads. The two East Lake pads were completed in March 2004.
Comparison of the year ended December 31, 2003 to the year ended December 31, 2002
Revenue
Rental income increased $1,103,000, or 15%, for the year ended December 31, 2003, compared to the year ended December 31, 2002, primarily due to the increases in occupancy at One Carnegie Plaza, Two Carnegie Plaza, Lakeside Tower, Chuck E. Cheese and Two Parkside, as well as an increase in rental rates, offset by the decrease in occupancy at Carnegie Business Center II.
Occupancy rates at the Partnership’s Tri-City properties for each of the five years ended December 31, 2003 were as follows:
As of December 31, 2003, tenants at Tri-City occupying substantial portions of leased rental space included: (i) Chicago Title with a lease through February 2004; (ii) New York Life Insurance with a lease through May 2004; (iii) Paychex with a lease through July 2004; (iv) Computer Associates with a lease through November 2005; (v) Holiday Spa Health Club with a lease through December 2010; (vi) Lewis, D’Amato & Brisbois et al with a lease through December 2012; and (vii) Arrowhead Central Credit Union with two leases through September 2004 and 2010. These seven tenants, in the aggregate, occupied approximately 199,000 square feet of the 542,000 total rentable square feet at Tri-City and accounted for approximately 42% of the rental income generated at Tri-City for the Partnership as of December 31, 2003.
The 5% increase in occupancy from December 31, 2002 to December 31, 2003 at One Carnegie Plaza was due to leasing 1,100 square feet to a new tenant, and expansion of two existing tenants into approximately 4,100 square feet of space.
The 4% increase in occupancy from December 31, 2002 to December 31, 2003 at Two Carnegie Plaza was due to expansion of two existing tenants into approximately 2,600 square feet of space.
The 9% decrease in occupancy from December 31, 2002 to December 31, 2003 at Carnegie Business Center II was due to a tenant of 4,300 square feet moving out upon its lease expiration.
The 5% increase in occupancy from December 31, 2002 to December 31, 2003 at Lakeside Tower was due to leasing 5,800 square feet to a new tenant.
Land improvement at Harriman Plaza was completed, and costs were transferred from construction in progress to land and land improvements in June 2003. A new tenant, Chuck E. Cheese, occupies the whole site as a restaurant and started paying ground lease rent in June 2003.
Construction of the core and shell for Two Parkside, a Class A three-story building was completed in June 2003, and costs were transferred from construction in progress to land, land improvements and building. On September 26, 2003, an anchor tenant moved into two floors totaling 53,003 rentable square feet. Two other tenants executed leases which brought this building to 100% occupancy by April 2004. One of these two tenants leased 14,422 square feet for March 2004 occupancy, and the other leased 14,491 square feet for April 2004 occupancy.
Expenses
Property operating increased $350,000, or 11%, during the year ended December 31, 2003, compared to the year ended December 31, 2002, primarily due to increases in occupancy at One Carnegie Plaza, Two Carnegie Plaza, Chuck E. Cheese and Two Parkside, as well as an increase in utility and janitorial costs.
Depreciation and amortization expense increased $510,000, or 28%, during the year ended December 31, 2003, compared to the year ended December 31, 2002, primarily due to depreciation of the new building, land improvements and tenant improvements.
Expenses associated with undeveloped land decreased $104,000, or 27%, for year ended December 31, 2003, compared to the year ended December 31, 2002, primarily due to capitalization of property taxes and insurance at Two Parkside and Harriman Plaza during the construction period.
Non-operating income /expenses
Interest and other income for the year ended December 31, 2003 decreased $150,000 from the year ended December 31, 2002, primarily due to a lower invested cash balance resulting from payment of the construction costs at Two Parkside and Harriman Plaza.
Interest expense decreased $349,000, or 41%, during the year ended December 31, 2003, compared to the year ended December 31, 2002, primarily due to interest capitalized during construction at Two Parkside and Harriman Plaza, offset by interest on a new line of credit.
Liquidity and Capital Resources
As of December 31, 2004, the Partnership had cash and cash equivalents of $967,000.
The Partnership’s liabilities at December 31, 2004, included a note payable and two lines of credit totaling approximately $17,465,000, secured by properties with an aggregate net book value of approximately $30,374,000. The note payable requires monthly principal and interest payments of $83,000, bears a fixed interest rate of 9.39%, and has a maturity date of June 1, 2006. One line of credit with a total availability of $6,000,000 requires monthly interest-only payments, bears an interest rate of prime plus 0.75% with a floor set at 5.5% (6% and 5.5% as of December 31, 2004 and 2003, respectively), and had a maturity date of March 5, 2005. On that date, the Partnership extended the maturity date of this line of credit to June 5, 2005. The Partnership intends to either extend the term of the existing line of credit or to refinance the properties with a lower interest rate loan to replace this line of credit after the 90-day extension. Another line of credit with a total availability of $7,425,000 requires monthly interest-only payments, bears an interest rate of prime rate (5.25% and 4% as of December 31, 2004 and 2003, respectively), and has a maturity date of April 15, 2007.
The Partnership is contingently liable for subordinated real estate commissions payable to the General Partner in the amount of $102,000 at December 31, 2004 for sales that occurred in previous years. The subordinated real estate commissions are payable only after the
Limited Partners have received distributions equal to their original invested capital plus a cumulative non-compounded return of nine percent per annum on their adjusted invested capital. Since the circumstances under which these commissions would be payable are limited, the liability has not been recognized in the accompanying consolidated financial statements; however, the amount will be recorded when and if it becomes payable.
Operationally, the Partnership’s primary source of funds consists of cash provided by its rental activities. Other sources of funds may include permanent financing, draws on the lines of credit, proceeds from property sales, interest income on certificates of deposit and other deposits of funds invested temporarily. Cash generated from property sales is generally added to the Partnership’s cash reserves, pending use in development of other properties or distribution to the partners.
Management expects that the Partnership’s cash balance at December 31, 2004, together with cash from operations and financings will be sufficient to finance the Partnership’s and the properties’ continuing operations and development plans on a short-term basis and the reasonably foreseeable future. In April 2004, the Partnership obtained a new line of credit with a total availability of $7,425,000 to cover the construction costs at Three Carnegie, a two-story office building of 86,200 square feet (as discussed above). There can be no assurance that the Partnership’s results of operations will not fluctuate in the future and at times affect its ability to meet its operating requirements.
Contractual Obligations
At December 31, 2004, we had contractual obligations as follows (in thousands):
(1) For variable rate loans, this represents estimated interest expense based on outstanding balances and interest rates at December 31, 2004.
(2) In January 2004, the Partnership entered into a contract with a construction company for $5,900,000 to build a two-story office building with a total of 86,200 square feet, known as Three Carnegie. The project is estimated to be completed in June 2005.
The Partnership knows of no demands, commitments, events or uncertainties, which might affect its capital resources in any material respect. In addition, the Partnership is not subject to any covenants pursuant to its secured debt that would constrain its ability to obtain additional capital.
Operating Activities
During the year ended December 31, 2004, the Partnership’s cash provided by operating activities totaled $2,678,000.
The $600,000 increase in deferred costs during 2004 was primarily due to lease commissions paid for Lakeside Tower, Pat & Oscars and One & Two Parkside.
The $116,000 increase in prepaid expenses and other assets during 2004 was primarily due to an increase in tenant rents recognized on a straight line basis and prepaid insurance, offset by a decrease in impound accounts resulting from property tax payments.
The $214,000 increase in accounts payable and other liabilities during 2004 was primarily due to accruals for interest expense and supplementary property taxes for Two Parkside.
The $403,000 decrease in prepaid rent during 2004 was due to January 2004 rents received in December 2003, offset by January 2005 rents received in December 2004.
Investing Activities
During the year ended December 31, 2004, the Partnership’s cash used for investing activities totaled $4,193,000, which consisted of $579,000 for land improvements at two East Lake pads, $213,000 for building improvements at One & Two Parkside, One & Two Carnegie Plaza and Carnegie Business Center II, $1,039,000 for tenant improvements at Lakeside Tower, One & Two Parkside and One Carnegie Plaza, and $2,472,000 for construction costs at Three Carnegie, offset by the partial collection of $110,000 from a note receivable related to tenant improvements.
Financing Activities
During the year ended December 31, 2004, the Partnership’s cash provided by financing activities totaled $1,346,000, which consisted of $3,840,000 of draws on the two lines of credit (as discussed above), offset by $203,000 in principal payments on the note payable, $141,000 in loan fees paid for the refinance of the line of credit, $1,555,000 of distributions to the Limited Partners, and $595,000 paid to redeem limited partnership Units, of which $46,000 was accrued at December 31, 2004 for final settlement in the first quarter of 2005.
Critical Accounting Policies
Revenue recognized on a straight-line basis
The Partnership recognizes rental revenue on a straight-line basis at amounts that it believes it will collect on a tenant-by-tenant basis. The estimation process may result in higher or lower levels from period to period as the Partnership’s collection experience and the credit quality of the Partnership’s tenants changes. Actual amounts collected could be lower or higher than the amounts recognized on a straight-line basis if specific tenants are unable to pay rent that the Partnership has previously recognized as revenue.
Carrying value of rental properties and land held for development
The Partnership’s rental properties, including the related land, are stated at cost unless events or circumstances indicate that cost cannot be recovered, in which case, the carrying value of the property is reduced to its estimated fair value. Estimated fair value is based upon (i) the Partnership’s plans for the continued operations of each property, and (ii) is computed using estimated sales price, as determined by prevailing market values for comparable properties and/or the use of capitalization rates multiplied by annualized rental income based upon the age, construction and use of the building. The fulfillment of the Partnership’s plans related to each of its properties is dependent upon, among other things, the presence of economic conditions which will enable the Partnership to continue to hold and operate the properties prior to their eventual sale. Due to uncertainties inherent in the valuation process and in the economy, it is reasonably possible that the actual results of operating and disposing of the Partnership’s properties could be materially different than current expectations.
Land held for development is stated at cost unless events or circumstances indicate that cost cannot be recovered, in which case, the carrying value is reduced to estimated fair value. Estimated fair value: (i) is based on the Partnership’s plans for the development of each property; (ii) is computed using estimated sales price, based upon market values for comparable properties; and (iii) considers the cost to complete and the estimated fair value of the completed project. The fulfillment of the Partnership’s plans related to each of its properties is dependent upon, among other things, the presence of economic conditions which will enable the Partnership to either hold the properties for eventual sale or obtain financing to further develop the properties.
The actual value of the Partnership’s portfolio of properties and land held for development could be significantly higher or lower than their carrying amounts.
Accounting Pronouncements Issued But Not Yet Adopted
In December 2004, the FASB issued SFAS No. 123 revised 2004, “Share-Based Payment”. This Statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB No. 25, “Accounting for Stock Issued to Employees”. The Statement requires companies to recognize in the income statement the grant-date fair value of stock options and other equity based compensation issued to employees. This Statement is effective as of the beginning of the first interim or annual period that commences after June 15, 2005. The Partnership anticipates that the adoption of SFAS No. 123 revised 2004 will have no impact on its financial position, net earnings or cash flows.
In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-Monetary Assets an amendment of APB No. 29”. This Statement amends APB Opinion No. 29, “Accounting for Non-Monetary Transactions” to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. That exception required that some non-monetary exchanges be recorded on a carryover basis versus this Statement, which requires that an entity record a non-monetary exchange at fair value and recognize any gain or loss if the transaction has commercial substance. This Statement is effective for fiscal years beginning after June 15, 2005. The Partnership anticipates that the adoption of SFAS No. 153 will not have a material impact on its financial position, net earnings or cash flows.
In November 2004, the FASB issued EITF Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144, Accounting for Impairment or Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued Operations” (EITF No. 03-13). This issue assists in the development of a model for evaluating (a) which cash flows are to be considered in determining whether cash flows have been or will be eliminated and (b) what types of continuing involvement constitute significant continuing involvement. The guidance in this issue should be applied to a component of an enterprise that is either disposed of or classified as held for sale in fiscal periods beginning after December 15, 2004. Previously reported operating results related to disposal transactions initiated within an enterprise’s fiscal year that includes the date that this consensus was ratified (November 30, 2004) may be reclassified. The adoption of EITF No. 03-13 on January 1, 2005, had no impact on the Partnership’s financial position, net earnings or cash flows.
Forward Looking Statements; Factors That May Affect Operating Results
This Report on Form 10-K contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934, including statements regarding the Partnership’s expectations, hopes, intentions, beliefs and strategies regarding the future. These forward looking statements include statements relating to:
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The Partnership’s intention to develop one or more properties to generate more operating income;
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The Partnership’s belief that certain claims and lawsuits which have arisen against it in the normal course of business will not in the future have a material adverse effect on the Partnership’s cash flow or results of operations;
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The Partnership’s expectation that cash, cash equivalents and cash generated by its operations will be adequate to meet its operating requirements in both the short and the reasonably foreseeable long-term;
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The Partnership’s anticipation that the adoption of SFAS No. 123 revised 2004 will not have an impact on the Partnership’s financial position, net earnings or cash flow;
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The Partnership’s anticipation that the adoption of SFAS No. 153 will not have a material impact on the Partnership’s financial position, net earnings or cash flow; and
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The Partnership’s expectation that changes in market interest rates will not have a material impact on the performance or fair value of its portfolio.
All forward-looking statements included in this document are based on information available to the Partnership on the date hereof. Because these forward looking statements involve risk and uncertainty, there are important factors that could cause our actual results to differ materially from those stated or implied in the forward-looking statements. Those important factors include:
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risks and uncertainties affecting property development and construction (including construction delays, cost overruns, our inability to obtain necessary permits and public opposition to these activities);
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the unpredictability of both the frequency and final outcome of litigation;
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failure of market conditions and occupancy levels to continue to improve in certain geographic areas;
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reduced demand for rental space;
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availability and credit worthiness of prospective tenants and our ability to execute lease deals with them;
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failure to obtain anticipated outside financing;
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market fluctuations in rental rates, concessions and occupancy;
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defaults or non-renewal of leases by customers;
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increased interest rates and operating costs;
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the adoption of SFAS No. 123 revised 2004 has an unanticipated, negative impact on the Partnership’s financial position;
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an interpretation of fair value differing from the Partnership’s prevails in the application of SFAS No. 153; and
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the unpredictability of changes in accounting rules.
The forward-looking statements in this Annual Report on Form 10-K are subject to additional risks and uncertainties further discussed below under Risk Factors. The Partnership assumes no obligation to update or supplement any forward looking-statement.
Risk Factors
Market Fluctuations in Rental Rates and Occupancy Could Adversely Affect Our Operations
As leases turn over, our ability to re-lease the space to existing or new tenants at rates equal to or greater than those realized historically is impacted by, among other things, the economic conditions of the market in which a property is located, the availability of competing space (including sublease space offered by tenants who have vacated space in competing buildings prior to the expiration of their lease term), and the level of improvements which may be required at the property. We cannot assure you that the rental rates we obtain in the future will be equal to or greater than those obtained under existing contractual commitments. If we cannot lease all or substantially all of the expiring space at our properties promptly, or if the rental rates are significantly lower than expected, then our results of operations and financial condition could be negatively impacted.
Tenants’ Defaults Could Adversely Affect Our Operations
Our ability to manage our assets is subject to federal bankruptcy laws and state laws that limit creditors’ rights and remedies available to real property owners to collect delinquent rents. If a tenant becomes insolvent or bankrupt, we cannot be sure that we could recover the premises from the tenant promptly or from a trustee or debtor-in-possession in any bankruptcy proceeding relating to that tenant. We also cannot be sure that we would receive rent in the proceeding sufficient to cover our expenses with respect to the premises. If a tenant becomes bankrupt, the federal bankruptcy code will apply, which in some instances may restrict the amount and recoverability of our claims against the tenant. A tenant’s default on its obligations to us could adversely affect our results of operations and financial condition.
We May Suffer Adverse Consequences If Our Revenues Decline Since Our Operating Costs Do Not Necessarily Decline In Proportion To Our Revenue
We earn a significant portion of our income from renting our properties. Our operating costs, however, do not necessarily fluctuate in relation to changes in our rental revenue. This means that our costs will not necessarily decline even if our revenues do. Our operating costs could also increase while our revenues do not. If our operating costs increase but our rental revenues do not, we may be forced to borrow to cover our costs, we may incur losses and we may not have cash available for distributions to our partners.
Potential Liability Due to Environmental Matters
Under federal, state and local laws relating to protection of the environment, or Environmental Laws, a current or previous owner or operator of real estate may be liable for contamination resulting from the presence or discharge of petroleum products or other hazardous or toxic substances on the property. These owners may be required to investigate and clean-up the contamination on the property as well as the contamination which has migrated from the property. Environmental Laws typically impose liability and clean-up responsibility without regard to whether the owner or operator knew of, or was responsible for, the presence of the contamination. This liability may be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility. In addition, the owner or operator of a property may be subject to claims by third parties based on personal injury, property damage and/or other costs, including investigation and clean-up costs, resulting from environmental contamination. 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. These restrictions may require expenditures. Under the Environmental Laws, any person who arranges for the transportation, disposal or treatment of hazardous or toxic substances may also be liable for the costs of investigation or clean-up of those substances at the disposal or treatment facility, whether or not the facility is or ever was owned or operated by that person.
Our tenants generally are required by their leases to operate in compliance with all applicable Environmental Laws, and to indemnify us against any environmental liability arising from their activities on the properties. However, we could be subject to strict liability by virtue of our ownership interest in the properties. Also, tenants may not satisfy their indemnification obligations under the leases. We are also subject to the risk that:
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any environmental assessments of our properties may not have revealed all potential environmental liabilities,
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any prior owner or prior or current operator of these properties may have created an environmental condition not known to us, or
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an environmental condition may otherwise exist as to any one or more of these properties.
Any one of these conditions could have an adverse effect on our results of operations and financial condition. Moreover, future environmental laws, ordinances or regulations may have an adverse effect on our results of operations and financial condition. Also, the current environmental condition of those properties may be affected by tenants and occupants of the properties, by the condition of land or operations in the vicinity of the properties (such as the presence of underground storage tanks), or by third parties unrelated to us.
Environmental Liabilities May Adversely Affect Operating Costs and Ability to Borrow
The obligation to pay for the cost of complying with existing Environmental Laws as well as the cost of complying with future legislation may affect our operating costs. In addition, the presence of petroleum products or other hazardous or toxic substances at any of our properties, or the failure to remediate those properties properly, may adversely affect our ability to borrow by using those properties as collateral. The cost of defending against claims of liability and the cost of complying with Environmental Laws, including investigation or clean-up of contaminated property, could materially adversely affect our results of operations and financial condition.
General Risks of Ownership of Real Estate
We are subject to risks generally incidental to the ownership of real estate. These risks include:
•
changes in general economic or local conditions;
•
changes in supply of or demand for similar or competing properties in an area;
•
the impact of environmental protection laws;
•
changes in interest rates and availability of financing which may render the sale or financing of a property difficult or unattractive;
•
changes in tax, real estate and zoning laws; and
•
the creation of mechanics’ liens or similar encumbrances placed on the property by a lessee or other parties without our knowledge and consent.
Should any of these events occur, our results of operations and financial condition could be adversely affected.
Uninsured Losses May Adversely Affect Operations
We, or in certain instances, tenants of our properties, carry property and liability insurance with respect to the properties. This coverage has policy specification and insured limits customarily carried for similar properties. However, certain types of losses (such as from earthquakes and floods) may be either uninsurable or not economically insurable. Further, certain of the properties are located in areas that are subject to earthquake activity and floods. Should a property sustain damage as a result of an earthquake or flood, we may incur losses due to insurance deductibles, co-payments on insured losses or uninsured losses. Additionally, we have elected to obtain insurance coverage for “certified acts of terrorism” as defined in the Terrorism Risk Insurance Act of 2002; however, our policies of insurance may not provide coverage for other acts of terrorism. Any losses from such other acts of terrorism might be uninsured. Should an uninsured loss occur, we could lose some or all of our capital investment, cash flow and anticipated profits related to one or more properties. This could have an adverse effect on our results of operations and financial condition.
Illiquidity of Real Estate May Limit Our Ability to Vary Our Portfolio
Real estate investments are relatively illiquid and, therefore, will tend to limit our ability to vary our portfolio quickly in response to changes in economic or other conditions.
Potential Liability Under the Americans With Disabilities Act
All of our properties are required to be in compliance with the Americans With Disabilities Act. The Americans With Disabilities Act generally requires that places of public accommodation be made accessible to people with disabilities to the extent readily achievable. Compliance with the Americans With Disabilities Act requirements could require removal of access barriers. Non-compliance could result in imposition of fines by the federal government, an award of damages to private litigants and/or a court order to remove access barriers. Because of the limited history of the Americans With Disabilities Act, the impact of its application to our properties, including the extent and timing of required renovations, is uncertain. Pursuant to lease agreements with tenants in certain of the “single-tenant” properties, the tenants are obligated to comply with the Americans With Disabilities Act provisions. If our costs are greater than anticipated or tenants are unable to meet their obligations, our results of operations and financial condition could be adversely affected.
Risks of Litigation
Certain claims and lawsuits have arisen against us in our normal course of business. We believe that such claims and lawsuits will not have a material adverse effect on our financial position, cash flow or results of operations.
Item 7A.
Item 7A. Qualitative and Quantitative Disclosures about Market Risk
Interest Rates
The Partnership’s primary market risk exposure is to changes in interest rates obtainable on its secured borrowings. The Partnership expects that changes in market interest rates will not have a material impact on the performance or fair value of its portfolio. The Partnership does not own any derivative instruments.
For debt obligations, the table below presents principal cash flows and interest rates by expected maturity dates.
A change of 1/8% in the index rate to which the Partnership’s variable rate debt is tied would not have a material impact on the annual interest incurred by the Partnership, based upon the balances outstanding on variable rate instruments at December 31, 2004.
As of December 31, 2004, the Partnership had no investments in interest-bearing certificates of deposit.
Item 8.
Item 8. Financial Statements and Supplementary Data
For information with respect to this item, see Financial Statements and Schedule as listed in Item 15.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision of the General Partner’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, the General Partner’s Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in alerting him on a timely basis to material information required to be included in this report. There has been no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Partnership
Daniel L. Stephenson and Rancon Financial Corporation (“RFC”) are the general partners of the Partnership. The executive officer and director of RFC is Daniel L. Stephenson who is Director, President, Chief Executive Officer and Chief Financial Officer.
Mr. Stephenson founded RFC (formerly known as Rancon Corporation) in 1971 for the purpose of establishing a commercial, industrial and residential property syndication, development and brokerage concern. Mr. Stephenson has, from inception, held the position of Director. In addition, Mr. Stephenson was President and Chief Executive Officer of RFC from 1971 to 1986, from August 1991 to September 1992, and from March 1995 to present. Mr. Stephenson is Chairman of the Board of PacWest Group, Inc., a real estate firm that has acquired a portfolio of assets from the Resolution Trust Corporation.
Item 11.
Item 11. Executive Compensation
The Partnership has no executive officers. For information relating to fees, compensation, reimbursement and distributions paid to related parties, reference is made to Item 13 below.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Security Ownership of Certain Beneficial Owners
No person is known by the Partnership to be the beneficial owner of more than 5% of the Units outstanding.
Security Ownership of Management
Title of Class
Name of Beneficial Owner
Amount and Nature of
Beneficial Ownership
Percent of Class
Units
Daniel L. Stephenson (IRA)
3 Units (direct)
*
Units
Daniel L. Stephenson Family Trust
100 Units (direct)
*
* Less than 1 percent
Changes in Control
The Limited Partners have no right, power or authority to act for or bind the Partnership. However, the Limited Partners generally have the power to vote upon the following matters affecting the basic structure of the Partnership, passage of each of which requires the approval of Limited Partners holding a majority of the outstanding Units: (i) amendment of the Partnership Agreement; (ii) termination and dissolution of the Partnership; (iii) sale, exchange or pledge of all or substantially all of the assets of the Partnership; (iv) removal of the General Partner or any successor General Partner; (v) election of a new General Partner or General Partner upon the removal, redemption, death, insanity, insolvency, bankruptcy or dissolution of the General Partner or any successor General Partner; (vi) modification of the terms of any agreement between the Partnership and the General Partner or an affiliate of the General Partner; and (vii) extension of the term of the Partnership.
Item 13.
Item 13. Certain Relationships and Related Transactions
During the year ended December 31, 2004, the Partnership did not incur any expenses or costs reimbursable to RFC or any other affiliate of the Partnership.
Item 14.
Item 14. Principal Accountant Fees and Services
The Partnership was billed $71,000 and $67,500 in 2004 and 2003, respectively for professional services rendered by the principal accountant in connection with the audit of the annual financial statements included on Form 10-K and review of the quarterly financial statements included on Form 10-Q.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of the report:
(1) Financial Statements:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Partners’ Equity for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
(2) Financial Statement Schedule:
Schedule III - Real Estate and Accumulated Depreciation as of December 31, 2004 and Notes thereto
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
(3) Exhibits:
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
AND SCHEDULE
All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
Report of Independent Registered Public Accounting Firm
The General Partner
RANCON REALTY FUND V, A California Limited Partnership:
We have audited the accompanying consolidated balance sheets of RANCON REALTY FUND V, a California Limited Partnership, and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, partners’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule listed in the accompanying index to the financial statements and schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RANCON REALTY FUND V, a California Limited Partnership, and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in three-year period ended December 31, 2004 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related information in the financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
KPMG LLP
San Francisco, California
March 23, 2005
RANCON REALTY FUND V
A California Limited Partnership, and Subsidiaries
Consolidated Balance Sheets
December 31, 2004 and 2003
(in thousands, except unit amounts)
The accompanying notes are an integral part of these consolidated financial statements.
RANCON REALTY FUND V
A California Limited Partnership, and Subsidiaries
Consolidated Statements of Operations
For the years ended December 31, 2004, 2003 and 2002
(in thousands, except per unit amounts and units outstanding)
The accompanying notes are an integral part of these consolidated financial statements.
RANCON REALTY FUND V
A California Limited Partnership, and Subsidiaries
Consolidated Statements of Partners’ Equity
For the years ended December 31, 2004, 2003 and 2002
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
RANCON REALTY FUND V
A California Limited Partnership, and Subsidiaries
Consolidated Statements of Cash Flows
For the years ended December 31, 2004, 2003 and 2002
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004, and 2003 and 2002
Note 1. ORGANIZATION
Rancon Realty Fund V, a California Limited Partnership, (“the Partnership”), was organized in accordance with the provisions of the California Revised Limited Partnership Act for the purpose of acquiring, developing, operating and disposing of real property. The Partnership was organized in 1985 and reached final funding in February 1989. The general partners of the Partnership are Daniel L. Stephenson and Rancon Financial Corporation (“RFC”), hereinafter collectively referred to as the Sponsor or the General Partner. RFC is wholly owned by Daniel L. Stephenson. The Partnership has no employees.
In 2003, a total of 1,998 Units were redeemed at an average price of $375. In 2004, a total of 1,509 Units were redeemed at an average price of $394. As of December 31, 2004, there were 87,410 Units outstanding.
Allocation of Net Income and Net Loss
Allocations of net income and net losses are made pursuant to the terms of the Partnership Agreement. Generally, net income and net losses from operations are allocated 90% to the limited partners and 10% to the General Partner; however, if the limited partners and the General Partner have, as a result of an allocation of net loss, a deficit balance in their capital accounts, net loss shall not be allocated to the limited partners and General Partner in excess of the positive balance until the balances of the limited partners’ and General Partner’s capital accounts are reduced to zero. Capital accounts shall be determined after taking into account the other allocations and distributions for the fiscal year.
Net income other than net income from operations shall be allocated as follows: (i) first, to the partners who have a deficit balance in their capital account, provided that, in no event shall the General Partner be allocated more than 5% of the net income other than net income from operations until the earlier of sale or disposition of substantially all of the assets or the distribution of cash (other than cash from operations) equal to the Unit holder’s original invested capital; (ii) second, to the limited partners in proportion to and to the extent of the amounts required to increase their capital accounts to an amount equal to the sum of the adjusted invested capital of their units plus an additional cumulative non-compounded 12% return per annum (plus additional amounts depending on the date Units were purchased); (iii) third, to the partners in the minimum amount required to first equalize their capital accounts in proportion to the number of units owned, and then, to bring the sum of the balances of the capital accounts of the limited partners and the General Partner into the ratio of 4 to 1; and (iv) the balance, if any, 80% to the limited partners and 20% to the General Partner. In no event shall the General Partner be allocated less than 1% of the net income other than net income from operations for any period.
Net losses other than net losses from operations are allocated 99% to the limited partners and 1% to the General Partner. Such net losses will be allocated among limited partners as necessary to equalize their capital accounts in proportion to their Units, and thereafter will be allocated in proportion to their Units.
The terms of the Partnership Agreement call for the General Partner to restore any deficits that may exist in its capital account after allocation of gains and losses from the sale of the final property owned by the Partnership, but prior to any liquidating distributions being made to the partners.
Distribution of Cash
The Partnership shall make annual or more frequent distributions of substantially all cash available to be distributed to partners as determined by the General Partner, subject to the following: (i) distributions may be restricted or suspended for limited periods when the General Partner determine in their absolute discretion that it is in the best interests of the Partnership; and (ii) all distributions are subject to the payment of partnership expenses and maintenance of reasonable reserves for debt service, alterations improvements, maintenance, replacement of furniture and fixtures, working capital and contingent liabilities.
All excess cash from operations shall be distributed 90 percent to the limited partners and 10 percent to the General Partner.
All cash from sales or refinancing and any other cash determined by the General Partner to be available for distribution other than cash from operations shall be distributed in the following order of priority: (i) first, 1 percent to the General Partner and 99 percent to the limited partners in proportion to the outstanding positive amounts of Adjusted Invested Capital (as defined in the Partnership Agreement) for each of their Units until Adjusted Invested Capital (as defined in the Partnership Agreement) for each Unit is reduced to zero; (ii) second, 1 percent to the General Partner and 99 percent to the limited partners until each of the limited partners has received an amount which, including cash from operations previously distributed to the limited partners equals a 12 percent annual cumulative non-compounded return on the Adjusted Invested Capital (as defined in the Partnership Agreement) of their Units plus such limited partners’ Limited Incremental Preferential Return (as defined in the Partnership Agreement), if any, with respect to each
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004, and 2003 and 2002
such Unit, on the Adjusted Investment Capital (as defined in the Partnership Agreement) of such Units for the twelve month period following the date upon which such Unit was purchased from the Partnership and following the admission of such limited partner (iii) third, 99 percent to the General Partner and 1 percent to the limited partners, until the General Partner have received an amount equal to 20 percent of all distributions of cash from sales or refinancing: (iv) the balance, 80 percent to the limited partners, pro rata in proportion to the number of Units held by each, and 20 percent to the General Partner.
Management Agreement
Effective January 1, 1995, Glenborough Corporation (“GC”) entered into an agreement with the Partnership and other related Partnerships (collectively, the Rancon Partnerships) to perform or contract on the Partnership’s behalf for financial, accounting, data processing, marketing, legal, investor relations, asset and development management and consulting services for a period of ten years or until the liquidation of the Partnership, whichever comes first. Effective January 1, 1998, the agreement was amended to eliminate GC’s responsibilities for providing investor relation services. Preferred Partnership Services, Inc., a California corporation unaffiliated with the Partnership, contracted to assume the investor relation services. In October 2000, GC merged into Glenborough Realty Trust Incorporated (“Glenborough”).
The Partnership will pay Glenborough for its services as follows: (i) a specified asset administration fee ($661,000, $652,000 and $643,000 in 2004, 2003 and 2002, respectively); (ii) sales fees of 2% for improved properties and 4% for land; (iii) a refinancing fee of 1% ($73,000 and $59,000 in 2004 and 2003, respectively) and (iv) a management fee of 5% of gross rental receipts. As part of this agreement, Glenborough will perform certain duties for the General Partner of the Rancon Partnerships. The General Partner has assigned any distributions it receives to Glenborough. Such distributions were $172,000, $151,000 and $136,000 in 2004, 2003 and 2002, respectively. RFC agreed to cooperate with Glenborough, should Glenborough attempt to obtain a majority vote of the limited partners to substitute itself as the Sponsors for the Rancon Partnerships. Glenborough is not an affiliate of RFC or the Partnership.
In July 2004, the Partnership extended its management relationship with Glenborough through December 31, 2006. The following provides the general terms of the new agreement. Commencing on January 1, 2005 and ending December 31, 2006, the Partnership engages Glenborough to perform services for the following fees: (i) a management fee of 3 % of gross rental revenue; (ii) a construction services fee per certain schedules; (iii) a specified asset and Partnership services fee of $300,000 per year with reimbursements of certain expenses and consulting service fees; (vi) a sales fee of 2% for improved properties and 4% for unimproved properties; (v) a financing services fee of 1% of gross loan amount; and (vi) a development fee equal to 5% of the hard costs of the development project, excluding the cost of the land, and the development fee and the general contractor’s fee shall not exceed 11.5%, in the aggregate, of the hard costs of the development project.
The new management agreement represents a savings of $361,000 for the asset and Partnership services fee in 2005 and 2006, respectively, compared to the asset and Partnership services fee paid in 2004; as well as a reduction of 2% in the management fee from 5% in 2004 to 3% in 2005 and 2006, respectively.
Risks and Uncertainties
The Partnership’s ability to (i) achieve positive cash flow from operations, (ii) meet its debt obligations, (iii) provide distributions either from operations or the ultimate disposition of the Partnership’s properties or (iv) continue as a going concern may be impacted by changes in interest rates, property values, local and regional economic conditions, or the entry of other competitors into the market. The accompanying consolidated financial statements do not provide for adjustments with regard to these uncertainties.
Note 2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in accordance with U.S. Generally Accepted Accounting Principles. They include the accounts of certain wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Use of 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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported results of operations during the reporting period. Actual results could differ from those estimates.
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004, and 2003 and 2002
Consolidation
In May 1996, the Partnership formed Rancon Realty Fund V Tri-City Limited Partnership, a Delaware limited partnership (“RRF V Tri-City”). The limited partner of RRF V Tri-City is the Partnership and the General Partner is Rancon Realty Fund V, Inc. (“RRF V, Inc.”), a corporation wholly owned by the Partnership. Since the Partnership owns 100% of RRF V, Inc. and indirectly owns 100% of RRF V Tri-City, the financial statements of RRF V, Inc. and RRF V Tri-City have been consolidated with those of the Partnership. All intercompany balances and transactions have been eliminated in consolidation.
Rental Properties
Rental properties, including the related land, are stated at cost unless events or circumstances indicate that cost cannot be recovered, in which case, the carrying value of the property is reduced to its estimated fair value. Estimated fair value: (i) is based upon the Partnership’s plans for the continued operations of each property; and (ii) is computed using estimated sales price, as determined by prevailing market values for comparable properties and/or the use of capitalization rates multiplied by annualized rental income based upon the age, construction and use of the building. The fulfillment of the Partnership’s plans related to each of its properties is dependent upon, among other things, the presence of economic conditions which will enable the Partnership to continue to hold and operate the properties prior to their eventual sale. Due to uncertainties inherent in the valuation process and in the economy, it is reasonably possible that the actual results of operating and disposing of the Partnership’s properties could be materially different than current expectations.
Depreciation is provided using the straight-line method over useful lives ranging from five to forty years for the respective assets.
Construction In Progress and Land Held for Development
Construction in progress and land held for development are stated at cost, unless events or circumstances indicate that cost cannot be recovered, in which case the carrying value is reduced to estimated fair value. Estimated fair value: (i) is based on the Partnership’s plans for the development of each property; and (ii) considers the cost to complete and the estimated fair value of the completed project. The fulfillment of the Partnership’s plans related to each of its properties is dependent upon, among other things, the presence of economic conditions which will enable the Partnership to either hold the properties for eventual sale or obtain financing to further develop the properties.
Interest and property taxes related to property constructed by the Partnership are capitalized during the period of construction.
Cash and Cash Equivalents
The Partnership considers certificates of deposit and money market funds with original maturities of less than ninety days when purchased to be cash equivalents.
Fair Value of Financial Instruments
For certain financial instruments, including cash and cash equivalents, accounts receivable, notes payable, lines of credit payable ($9,110,000 and $5,270,000 as of December 31, 2004 and December 31, 2003), accounts payable and other liabilities, and construction costs payable, recorded amounts approximate fair value due to the relatively short maturity period. Based on interest rates available to the Partnership for debt with comparable maturities and other terms, the estimated fair value of the Partnership’s secured note payable as of December 31, 2004, and December 31, 2003 was approximately $9,259,000 and $10,218,000, respectively.
Deferred Costs
Deferred loan fees are amortized on a straight-line basis over the life of the related loan, which approximates the interest method, and deferred lease commissions are amortized on a straight-line basis over the initial fixed term of the related lease agreements.
Revenues
The Partnership recognizes rental revenue on a straight-line basis at amounts that it believes it will collect on a tenant by tenant basis. The estimation process may result in higher or lower levels from period to period as the Partnership’s collection experience and the credit quality of the Partnership’s tenants changes. Actual amounts collected could be lower or higher than the amounts recognized on a straight line basis if specific tenants are unable to pay rent that the Partnership has previously recognized as revenue.
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004, and 2003 and 2002
The Partnership’s portfolio of leases turns over continuously, with the number and value of expiring leases varying from year to year. The Partnership’s ability to re-lease the space to existing or new tenants at rates equal to or greater than those realized historically is impacted by, among other things, the economic conditions of the market in which a property is located, the availability of competing space, and the level of improvements which may be required at the property. No assurance can be given that the rental rates that the Partnership will obtain in the future will be equal to or greater than those obtained under existing contractual commitments.
Reimbursements from tenants for real estate taxes and other recoverable operating expenses are recognized as revenue in the period the applicable expenses are incurred. Differences between estimated and actual amounts are recognized in the subsequent year.
Net Income (Loss) Per Limited Partnership Unit
Net income (loss) per limited partnership unit is calculated using the weighted average number of limited partnership units outstanding during the period and the Limited Partners’ allocable share of the net income (loss).
Income Taxes
No provision for income taxes is included in the accompanying consolidated financial statements, as the Partnership’s results of operations are allocated to the partners for inclusion in their respective income tax returns. Net income (loss) and partners’ equity for financial reporting purposes will differ from the Partnership’s income tax return because of different accounting methods used for certain items, including depreciation expense, capitalization of development period interest and property taxes, income recognition and provisions for impairment of investments in real estate.
Concentration risk
One tenant represented 12% of total rentable square feet and 15% of rental income as of December 31, 2004. No one tenant represented more than 10% of rentable square feet and rental income for the years ended December 31, 2003 and 2002.
Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” which addresses consolidation by business enterprises of variable interest entities (“VIEs”) either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (FIN 46 Revised) resulting in multiple effective dates based on the nature as well as the creation date of the VIE. However, FIN 46 Revised must be applied no later than the first quarter of fiscal 2004. Special Purpose Entities (“SPEs”) created prior to February 1, 2003 may be accounted for under FIN 46 or FIN 46 Revised’s provisions no later than the fourth quarter of fiscal 2003. The Partnership has not entered into any arrangements which are considered SPEs. FIN 46 Revised may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The disclosure requirements of FIN 46 Revised are effective for all financial statements initially issued after December 31, 2003. The adoption of FIN 46 Revised did not have any impact on the consolidated financial statements of the Partnership since the Partnership has not entered into any arrangements that are VIEs.
Note 3. INVESTMENTS IN REAL ESTATE
Rental properties consisted of the following at December 31, 2004 and 2003 (in thousands):
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004, and 2003 and 2002
The Partnership’s rental properties include five office and six retail projects, aggregating approximately 547,000 rentable square feet, at the Tri-City Corporate Centre in San Bernardino, California.
Land and land improvements increased primarily due to the conversion of two East Lake pads from construction in progress. The two East Lake pads were completed in March 2004. In March 2004, a new tenant on one of the sites commenced a 15-year ground lease. Currently, management is aggressively marketing the remaining site which is on a build-to-suit basis as tenants become available.
In 2004, fully depreciated buildings and tenant improvements of $12,201 were removed from the balances of such accounts.
Construction in progress consisted of the following at December 31, 2004 and 2003 (in thousands):
Construction in progress increased primarily due to a new development project at Three Carnegie, and a pre-design 5-acre land parcel, known as Brier Corporate Center, transferred from land held for development, offset by the conversion of two East Lake pads to land and land improvements upon their completion in March 2004. In January 2004, the Partnership entered into a contract with a construction company for $5,900,000 to build a two-story office building at Three Carnegie with a total of 86,200 square feet. The project is estimated to be completed in June 2005. In 2004, construction and other costs of $3,808,000 had been incurred. In April 2004, the Partnership obtained a new line of credit with a total availability of $7,425,000, secured by Two Parkside, to fund the construction costs (as discussed in Note 4 below).
Land held for development consisted of the following at December 31, 2004 and 2003 (in thousands):
Land held for development decreased primarily due to the conversion of Three Carnegie and Brier Corporate Center to construction in progress.
Note 4. NOTE PAYABLE AND LINES OF CREDIT
Note payable and lines of credits as of December 31, 2004 and 2003, were as follows (in thousands):
The interest rate for the line of credit related to One Carnegie Plaza and Carnegie Business Center II is a variable interest rate of
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004, and 2003 and 2002
Prime Rate” plus 0.75%. The line of credit had a maturity date of March 5, 2005. On that date, the Partnership extended the maturity date of this line of credit to June 5, 2005. The Partnership intends to either extend the term of the existing line of credit or to refinance the properties with a lower interest rate loan to replace the line of credit after the 90-day extension.
On March 30, 2004, the Partnership obtained a new line of credit with a total availability of $7,425,000, secured by Two Parkside, with a maturity date of April 15, 2007, to provide the funding for the construction costs at Three Carnegie which are estimated to be approximately $6,400,000. As of December 31, 2004, construction costs of $3,808,000 had been incurred. The construction began in March 2004 and is estimated to be completed in June 2005.
The note payable may be prepaid with a penalty based on a yield maintenance formula. There is no prepayment penalty if the note is repaid within nine months of the maturity date of the note. The Partnership’s plan is to either sell the properties or refinance with a lower interest rate loan to pay off this high interest rate note when the prepayment penalty period ends on December 1, 2005.
The annual maturities on the Partnership’s note payable and lines of credit as of December 31, 2004, are as follows (in thousands):
Note 5. COMMITMENTS AND CONTINGENT LIABILITIES
Environmental Matters
The Partnership follows a policy of monitoring its properties for the presence of hazardous or toxic substances. The Partnership is not aware of any environmental liability with respect to the properties that would have a material adverse effect on the Partnership’s business, assets or results of operations. There can be no assurance that such a material environmental liability does not exist. The existence of any such material environmental liability could have an adverse effect on the Partnership’s consolidated results of operations and cash flows.
General Uninsured Losses
The Partnership carries property and liability insurance with respect to the properties. This coverage has policy specification and insured limits customarily carried for similar properties. However, certain types of losses (such as from earthquakes and floods) may be either uninsurable or not economically insurable. Should the properties sustain damage as a result of an earthquake or flood, the Partnership may incur losses due to insurance deductibles, co-payments on insured losses or uninsured losses. Additionally, the Partnership has elected to obtain insurance coverage for “certified acts of terrorism” as defined in the Terrorism Risk Insurance Act of 2003; however, our policies of insurance may not provide coverage for other acts of terrorism. Any losses from such other acts of terrorism might be uninsured. Should an uninsured loss occur, the Partnership could lose some or all of its capital investment, cash flow and anticipated profits related to the properties.
Other Matters
The Partnership is contingently liable for subordinated real estate commissions payable to the General Partner in the amount of $102,000 at December 31, 2004, for sales that occurred in previous years. The subordinated real estate commissions are payable only after the Limited Partners have received distributions equal to their original invested capital plus a cumulative non-compounded return of six percent per annum on their adjusted invested capital. Since the circumstances under which these commissions would be payable are limited, the liability has not been recognized in the accompanying consolidated financial statements; however, the amount will be recorded when and if it becomes payable.
Note 6. LEASES
The Partnership’s rental properties are leased under non-cancelable operating leases that expire at various dates through December 2010.
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004, and 2003 and 2002
In addition to monthly base rents, several of the leases provide for additional contingent rents based upon a percentage of sales levels attained by the tenants. Future minimum rents under non-cancelable operating leases as of December 31, 2004 are as follows (in thousands):
In addition to minimum rental payments, certain tenants pay reimbursements for their pro rata share of specified operating expenses, which amounted to $662,000, $723,000 and $354,000 for the years ended December 31, 2004, 2003, and 2002, respectively. These amounts are included as rental income in the accompanying consolidated statements of operations.
Note 7. TAXABLE INCOME
The Partnership’s tax returns, the qualification of the Partnership as a partnership for federal income tax purposes, and the amount of reported income or loss are subject to examination by federal and state taxing authorities. If such examinations result in changes to the Partnership’s taxable income or loss, the tax liability of the partners could change accordingly. The following is a reconciliation for the years ended December 31, 2004, 2003 and 2002, of the net income for financial reporting purposes to the estimated taxable income determined in accordance with accounting practices used in preparation of federal income tax returns (in thousands):
The following is a reconciliation of partners’ equity for financial reporting purposes to estimated partners’ capital for federal income tax purposes as of December 31, 2004 and 2003 (in thousands):
* Unaudited
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2004, and 2003 and 2002
Note 8. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following represents an unaudited summary of quarterly results of operations for the years ended December 31, 2004 and 2003 (in thousands, except for per unit amounts and units outstanding):
RANCON REALTY FUND V
A California Limited Partnership, and Subsidiaries
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2004
(In Thousands)
(A) The aggregate cost of land and buildings for federal income tax purposes is $83,384 (unaudited).
(B) Two Carnegie Plaza, Lakeside Tower and One Parkside are collateral for debt in the aggregate amount of $8,355.
(C) One Carnegie Plaza and Carnegie Business Center II are collateral for a line of credit in the aggregate amount of $5,920.
(D) Two Parkside is collateral for a line of credit in the aggregate amount of $3,190.
(continued)
RANCON REALTY FUND V,
A California Limited Partnership, and Subsidiaries
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
(in thousands)
Reconciliation of gross amount at which real estate was carried for the years ended December 31, 2004, 2003 and 2002:
See accompanying independent registered public accounting firm’s report.
EXHIBIT INDEX