Item 1.
Business
Pruco Life of New Jersey Variable Contract Real Property Account (the “Real Property Account” or the “Registrant”) was established on October 30, 1987. The Real Property Account was established as a separate investment account of Pruco Life Insurance Company of New Jersey (“Pruco Life of New Jersey”), pursuant to New Jersey law. The Real Property Account was established to provide a real estate investment option offered in connection with the funding of benefits under certain variable life insurance and variable annuity contracts (the “Contracts”) issued by Pruco Life of New Jersey.
The assets of the Real Property Account are invested in The Prudential Variable Contract Real Property Partnership (the “Partnership”). The Partnership, a general partnership organized under New Jersey law on April 29, 1988, was formed through an agreement among The Prudential Insurance Company of America (“Prudential”), Pruco Life Insurance Company (“Pruco Life”) and Pruco Life of New Jersey, to provide a means for assets allocated to the real estate investment option under certain variable life insurance and variable annuity contracts issued by the respective companies to be invested in a commingled pool.
The Partnership has an investment policy of investing at least 65% of its assets in direct ownership interests in income-producing real estate and participating mortgage loans. The largest portion of these real estate investments are direct ownership interests in income-producing real estate, such as office buildings, shopping centers, hotels, apartments, or industrial properties. Approximately 10% of the Partnership’s assets are generally held in cash or invested in liquid instruments and securities although the Partners reserve discretion to increase this amount to meet partnership liquidity requirements.
Office Properties - The Partnership owns office properties in Lisle, Illinois; Brentwood, Tennessee; and Beaverton, Oregon. Total square footage owned is approximately 370,550 of which 79%, or 291,652 square feet, are leased between 1 and 10 years.
Apartment Complexes - The Partnership owns apartment complexes in Atlanta, Georgia and Raleigh, North Carolina, comprising a total of 490 apartment units, of which 91%, or 445 units, are leased. Leases range from month to month to one year.
Retail Property - The Partnership owns retail centers in Roswell, Georgia; Kansas City, Kansas; Ocean City, Maryland; Hampton, Virginia; and Westminster, Maryland. Total square footage owned is approximately 814,878 of which 95%, or 770,473 square feet, are leased between 1 and 30 years.
Industrial Properties - The Partnership owns an industrial property in Aurora, Colorado. Total square footage owned is approximately 277,930 of which 85%, or 234,997 square feet, are leased between 1 and 10 years.
Hotel Property - The Partnership owns a hotel property in Lake Oswego, Oregon. This joint venture investment has 161 rooms. Occupancy for the year ended 2006 averaged 79.6%.
Investment in Real Estate Trust - The Partnership liquidated its entire investment in REIT shares in December 2001. The Partnership does, however, maintain a preferred equity investment in an existing private real estate investment trust, or “REIT” (See Item 7(a)).
The Partnership’s investments are maintained so as to meet the diversification requirements set forth in treasury regulations issued pursuant to Section 817(h) of the Internal Revenue Code relating to the investments of variable life insurance and variable annuity separate accounts. Section 817(h) requires, among other things, that the partnership will have no more than 55% of the assets invested in any one investment, no more than 70% of the assets will be invested in any two investments, no more than 80% of the assets will be invested in any three investments, and no more than 90% of the assets will be invested in any four investments. To comply with regulatory requirements of the State of Arizona, the Partnership will limit additional investments in any one parcel or related parcels to an amount not exceeding 10% of the Partnership’s gross assets as of the prior fiscal year.
For information regarding the Partnership’s investments, operations, and other significant events, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Financial Statements and Supplementary Data.
The following is a description of general conditions in the U.S. real estate markets. It does not relate to specific properties held by the Partnership. The Partnership does not have widely diversified holdings; therefore, the discussions of vacancy rates, property values and returns to this section are not necessarily relevant to the Partnership’s portfolio. These results are not indicative of future performance.
MARKET CONDITIONS
Commercial property market fundamentals continued to improve steadily last year despite the dramatic slowdown in the U.S. housing market and the modest deceleration in economic growth. Healthy tenant demand and limited new supply caused vacancy rates to decline across most property types for a third consecutive year, allowing more markets to move decisively from recovery into the rent growth phase of the cycle. Although trailing one-year total returns for private real estate, as measured by the National Council of Real Estate Investment Fiduciaries’ Property Index, peaked in the first quarter, commercial real estate delivered a healthy total return of 16.6% in 2006.
Debt Market
The commercial real estate debt markets weathered the brief spike in long-term interest rates in 2006 with little disruption. Debt remained readily available for borrowers across all property types and with little differentiation in spreads by sector. Year-end origination data is not yet available. However, at the end of the third quarter, year-to-date commercial mortgage originations were about 11% higher than at the same time in 2005, according to the Mortgage Bankers Association. The public debt markets for commercial real estate also remained active last year. New issuance of commercial mortgage-backed securities surged to nearly $300 billion in 2006, a 25% rise above the record volume in 2005.
Public Real Estate Securities
Equity REITs delivered average total returns of about 35% in 2006, according to the National Association of Real Estate Investment Trusts. A private-equity-fueled surge in Mergers and Acquisitions, or “M&A” activity helped drive REIT share prices higher in 2006 as more private capital converged on the REIT market as a source of large portfolios of quality assets. More than $110 billion in real estate M&A deals were announced in 2006, including about $70 billion in privatizations of public REITs. All major property types performed well. Office REITs led all major property types with average total returns of about 45%, followed by apartment REITs, which gained nearly 40%.
Property Markets
Office: The office sector continued to attract significant investor interest in 2006. According to Real Capital Analytics, or “RCA,” office transaction volume soared to nearly $134 billion last year, an increase of about 33% over the volume in 2005 and more than 80% over 2004. Office space market fundamentals in a growing number of markets are very attractive today. According to Torto Wheaton Research, or “TWR,” the average office vacancy rate in its 56 market coverage universe fell from 13.6% at year-end 2005 to 12.6% in 4Q06, its lowest level since 2Q01.
Industrial: Investor demand for warehouse properties also remained fairly strong in 2006, despite a modest slowdown in the manufacturing sector. According to RCA, industrial transaction volume totaled nearly $39 billion in 2006, an increase of about 9% over the total in 2005. Transaction volumes declined over the second half of last year, however. Industrial space market fundamentals continued to improve in 2006. According to TWR, the average industrial vacancy rate fell about 50 bps last year to 9.4%, its lowest level since 3Q01.
Residential: The slowdown in the U.S. housing market produced mostly positive effects in the apartment market in 2006. Apartment fundamentals continued to strengthen as vacancies fell and rent concessions became less common.
However, apartment transaction volumes fell about 1% in 2006 to a little more than $87 billion, while the average unit price declined 3%. Many apartment markets recorded healthy rent growth in 2006 as concessions were eliminated and landlords regained enough pricing power to push rents higher, especially on the coasts.
Retail: Retail transaction activity continued to decline last year. In 2006, total volume was down about 12% from the peak in October 2005. Retail prices, however, have remained firm. Average retail transaction cap rates fell about 30 bps in 2006 to 6.7%, according to RCA, while average unit prices rose by 13%. Retail space market fundamentals and retailer demand have remained healthy.
Hotel: The lodging sector enjoyed one of its best years ever in 2006. According to Smith Travel Research, room demand rose 1.1% from 2005 to 2006, while supply expanded just 0.6%. Continued strong room demand pushed average occupancy rates 0.5% higher and allowed operators to increase average daily rates 7%. As a result, revenue per available room, or “RevPAR,” rose 7.5% in 2006. Luxury hotels and urban locations continued to perform well, with RevPAR growth rates of 11.7% and 9.7%, respectively.
Item 1A.
Item 1A.
Risk Factors
These risks could materially affect our business, results of operations or financial condition or cause our actual results to differ materially from those expected or those expressed in any forward looking statements made by or on behalf of the Company. These risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under “Forward-Looking Statements” above and the risks of our businesses described elsewhere in this Annual Report on Form 10-K.
All real estate investments are subject to varying degrees of risk. The yields available from investments depend on the amounts of income generated and expenses incurred. If investment properties do not generate revenues sufficient to meet operating expenses, including debt service and capital expenditures, cash flow will be adversely affected.
The revenues and value of a particular real estate investment may be adversely affected by a number of factors, including, but not limited to: the cyclical nature of the real estate market, general national economic conditions, local economic conditions, local real estate conditions, and fluctuations in operating costs, including real estate taxes and utilities. Certain significant expenditures associated with each equity investment, such as mortgage payments, real estate taxes, insurance and maintenance costs, are generally not reduced when circumstances cause a reduction in income from the investment. If a property is mortgaged to secure payment of indebtedness, and if the mortgaged property is unable to produce enough revenue to cover its mortgage or other debt payments, a loss could be sustained as a result of foreclosure on the property or the exercise of other remedies by the lender. In addition, a property’s revenues and real estate value may also be affected by such factors as potential liability under applicable federal, state and local laws and regulations, which may vary widely depending upon location, including tax laws, environmental laws, Americans with Disabilities Act accessibility requirements, and rent stabilization laws.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
Not Applicable.
Item 3.
Item 3.
Legal Proceedings
None.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
Contract owners participating in the Real Property Account have no voting rights with respect to the Real Property Account.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Owners of the Contracts may participate by allocating all or part of the net premiums or purchase payments to the Real Property Account. Contract values vary with the performance of the Real Property Account’s investments through the Partnership. Participating interests in the Real Property Account are not traded in any public market; therefore a discussion of market information is not relevant.
As of December 31, 2006 approximately 2,429 contract owners of record held investments in the Real Property Account.
Item 6.
Item 6.
Selected Financial Data
RESULTS OF OPERATIONS:
FINANCIAL POSITION:
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
All of the assets of the Real Property Account, or the “Account” are invested in the Partnership. Accordingly, the liquidity and capital resources and results of operations for the Account are contingent upon those of the Partnership. Therefore, this management’s discussion and analysis addresses these items at the Partnership level. The partners in the Partnership are Prudential, Pruco Life Insurance Company, and Pruco Life Insurance Company of New Jersey, or collectively, the “Partners”.
The following discussion and analysis of the liquidity and capital resources and results of operations of the Partnership should be read in conjunction with the audited Consolidated Financial Statements of the Account and the Partnership and the related Notes included in this filing.
(a)
Liquidity and Capital Resources
As of December 31, 2006, the Partnership’s liquid assets, consisting of cash and cash equivalents, were approximately $33.4 million, a decrease of approximately $12.1 million from $45.5 million at December 31, 2005. The decrease was primarily due to an additional funding for a preferred equity investment in a private real estate investment trust, or “REIT”, the acquisition of a retail property and a distribution to the Partners, as discussed below. Partially offsetting the decrease were proceeds received in connection with a loan payoff, as described below, and the cash flows from the Partnership’s operating activities of $11.9 million. Sources of liquidity included net cash flow from property operations, sales, financings and interest from short-term
investments. The Partnership uses cash for its real estate investment activities and for its distributions to its partners. As of December 31, 2006, approximately 12.3% of the Partnership’s total assets consisted of cash and cash equivalents.
During 2006, the Partnership completed the second funding of its preferred equity investment in its existing Capital Automotive, or “CARS”, REIT for $7.3 million. CARS owns approximately 364 properties, which are leased to sixty automobile dealership operators throughout the United States. This investment is expected to pay to investors an annual preferred return of 7.5% for years one through five, 8.75% during years six and seven, and 12% for all subsequent years. In addition, the Partnership invested $14.8 million in June to acquire an 89,849 square-foot retail property located in Westminster, Maryland.
Dispositions for the year included the sale of a portfolio of three retail properties located in Kansas City, Kansas and Kansas City, Missouri resulting in net proceeds of $3.6 million after the repayment of debt.
The Partnership made distributions to its Partners totaling $6.0 million during 2006.
The Partnership issued a Leasehold Mortgage Loan to a borrower in January 2004 in connection with the redevelopment of a retail center in Westminster, Maryland. The loan was paid in full by the borrower in March 2006, resulting in proceeds of approximately $4.3 million.
The Partnership spent approximately $3.2 million on capital improvements to various existing properties during 2006. Approximately $1.3 million was associated with leasing expenses at the office property in Lisle, Illinois, approximately $0.4 million funded the renovation of an apartment complex in Atlanta, Georgia and approximately $0.5 million was spent on budgeted capital projects and leasing expenses at the industrial property in Aurora, Colorado. The remaining $1.0 million was associated with minor capital improvements and transaction costs associated with leasing expenses of various other properties.
(b)
Results of Operations
The following is a comparison of the Partnership’s results of operations for the periods ended December 31, 2006 and 2005.
Net Investment Income Overview
The Partnership’s net investment income for the year ended December 31, 2006 was approximately $11.2 million, an increase of $2.0 million from $9.2 million for the prior year. The office, retail, industrial and hotel sector investments posted increases of approximately $0.3 million, $1.7 million, $0.2 million and $0.2 million, respectively, from the prior year. Partially offsetting this increase was a decrease in net investment income in the apartment sector of approximately $0.9 million. In addition, the land sector posted a slight decrease in net investment income during the year ended December 31, 2006. Other net investment income (loss) decreased $0.4 million during the year ended December 31, 2006 from the prior year. The components of this net investment income are discussed below by property type sector.
Valuation Overview
The Partnership recorded an aggregate net realized gain of approximately $0.1 million for the year ended December 31, 2006, compared to an aggregate net realized gain of $6.2 million for the prior year. The Partnership recorded an aggregate net unrealized gain of approximately $18.3 million for the year ended December 31, 2006, compared to an aggregate net unrealized gain of $9.2 million for the prior year. The aggregate net realized and unrealized gain of $18.4 million for the year ended December 31, 2006 was attributable to valuation gains in all property type sectors. Partially offsetting these gains for the year ended December 31, 2006 was a slight realized loss recorded in the land sector. The components of these valuation gains and/or losses are discussed below by property type sector.
The following table presents a comparison of the Partnership’s sources of net investment income, and realized and unrealized gains or losses by investment type for the years ended December 31, 2006 and 2005.
OFFICE PROPERTIES
(1)
The Oakbrook Terrace, Illinois office property was sold on June 8, 2005 but certain post-closing adjustments were recognized in the year ended December 31, 2006.
(2)
Net Investment Income for the year ended December 31, 2005 reflects a partial period rent abatement that was provided to the tenant as part of the lease.
Net Investment Income
Net investment income for the Partnership’s office properties was approximately $3.4 million for the year ended December 31, 2006, an increase of approximately $0.3 million from the prior year. The increase was primarily due to (a) increased rents and lower expenses at the office property in Lisle, Illinois; (b) stabilized occupancy and increased rents at the office properties in Brentwood, Tennessee; and (c) increased rents and higher occupancy at the office property in Beaverton, Oregon. Partially offsetting this increase was the loss of income from the Oakbrook Terrace, Illinois office property that was sold on June 8, 2005.
Total Realized and Unrealized Gain/(Loss)
The office properties owned by the Partnership recorded an aggregate net unrealized gain of approximately $2.5 million during the year ended December 31, 2006, compared to an aggregate net realized and unrealized gain of $4.5 million for the prior year. The net unrealized gain of $2.5 million for the year ended December 31, 2006 was primarily due to strengthening market fundamentals and investor demand in the office sector in Beaverton, Oregon as well as improving market conditions at the office properties in Brentwood, Tennessee. Partially offsetting these unrealized gains was a net unrealized loss of approximately $0.6 million at the office property in Lisle, Illinois due to continued soft market conditions, which resulted in a decrease in market rental rates.
APARTMENT COMPLEXES
(1)
The Salem, Oregon, Gresham, Oregon and Jacksonville, Florida apartment properties were sold on March 10, 2005, August 10, 2005 and November 30, 2005, respectively, but certain post-closing adjustments were recognized in the year ended December 31, 2006.
Net Investment Income
Net investment income for the Partnership’s apartment properties was $1.1 million for the year ended December 31, 2006, a decrease of approximately $0.9 million from the prior year. The decrease was primarily due to the loss of income on the Salem, Oregon, Gresham, Oregon and Jacksonville, Florida apartment properties that were sold on March 10, 2005, August 10, 2005 and November 30, 2005, respectively, and increased operating expenses at the apartment property in Raleigh, North Carolina. Partially offsetting the decrease was an increase in net investment income for the apartment property in Atlanta, Georgia due to increased rents, reduced operating expenses and lowered rental concessions.
Total Realized and Unrealized Gain/(Loss)
The apartment properties owned by the Partnership recorded an aggregate net realized and unrealized gain of $3.7 million for the year ended December 31, 2006, compared to an aggregate net realized and unrealized gain of $5.0 million for the prior year. The aggregate net realized and unrealized gain for the year ended December 31, 2006 was primarily due to valuation gains resulting from investor demand and the strengthening of both market and property fundamentals, which included reduced rental concessions and increased rental rates, at the apartment properties in Atlanta, Georgia and Raleigh, North Carolina. In addition, the Jacksonville, Florida apartment property that was sold in November 2005 recognized realized gains of approximately $0.1 million due to the disbursement of reserved funds that were escrowed at closing for any post-closing operating adjustments.
RETAIL PROPERTIES
(1)
Net investment income (loss) for the year ended December 31, 2006 reflects partial period results for the three out of four Kansas City, Kansas and Kansas City, Missouri retail properties that were sold on May 15, 2006. Occupancy for the year ended December 31, 2006 reflects remaining retail property in Kansas City, Kansas.
(2)
Net investment income for the year ended December 31, 2006 reflects partial period results for the Westminster, Maryland retail property that was acquired on June 13, 2006.
(3)
Mortgage Loan Receivable (mortgage paid in full on March 3, 2006).
(4)
Classified as Other Real Estate Investment (mortgage paid in full September 13, 2004).
(5)
Net investment income for the year ended December 31, 2006 reflects partial period results for the second funding of the Partnership’s preferred equity investment, which occurred on February 14, 2006.
Net Investment Income
Net investment income for the Partnership’s retail properties was $6.1 million for the year ended December 31, 2006, an increase of approximately $1.7 million from the prior year. The increase was primarily due to (a) stabilized occupancy and increased rents at the retail center in Roswell, Georgia; (b) income received from the preferred equity investments made by the Partnership on December 16, 2005 and February 14, 2006, respectively; (c) the acquisition of a retail property in Westminster, Maryland in June 2006; and (d) increased rents at the retail property in Hampton, Virginia. Partially offsetting the increase were (a) increased operating expenses at the retail property in Ocean City, Maryland; (b) the loss of income as well as higher expenses at the retail properties in Kansas City, Kansas and Kansas City, Missouri due to the prepayment penalty of the existing mortgage on the three properties upon their respective sales in May 2006; and (c) the loss of interest income for the Mortgage Loan Receivable that was paid in full by the borrower on March 7, 2006.
Unrealized Gain/(Loss)
The retail properties owned by the Partnership recorded an aggregate net unrealized gain of $6.3 million for the year ended December 31, 2006, compared to an aggregate net unrealized gain of $3.0 million for the prior year. The unrealized gain for the year ended December 31, 2006 was primarily due to the acquisition of the retail property in Westminster, Maryland at cost, which resulted in $5.4 million in valuation gains. In addition, unrealized gains of approximately $1.1 million and $0.1 million were recorded at the retail properties in Roswell, Georgia due to continued investor demand and in Ocean City, Maryland due to strengthening market fundamentals, respectively. Partially offsetting these gains for the year ended December 31, 2006 were unrealized losses of approximately $0.2 million recorded at the retail properties in Kansas City, Kansas and Kansas City, Missouri due to the three properties having been sold slightly below their previously appraised values and $0.1 million recorded at the retail property in Hampton, Virginia reflecting updated market conditions.
INDUSTRIAL PROPERTY
Net Investment Income
Net investment income for the Partnership’s industrial property was $0.8 million for the year ended December 31, 2006, an increase of approximately $0.2 million from the prior year. The increase was primarily due to higher occupancy, increased rents and reduced operating expenses, compared to the prior year.
Unrealized Gain/(Loss)
The industrial property owned by the Partnership recorded a net unrealized gain of approximately $2.1 million for the year ended December 31, 2006, compared to a net unrealized gain of $1.4 million for the prior year. The net unrealized gain for the year ended December 31, 2006 was primarily due to continued improving market fundamentals and investor demand in the industrial sector at Aurora, Colorado.
HOTEL PROPERTY
Net Investment Income
Net investment income for the Partnership’s hotel property was $1.3 million for the year ended December 31, 2006, an increase of approximately $0.2 million from the prior year. The increase was primarily due to higher average daily rates generated at the hotel compared to the prior year.
Unrealized Gain/(Loss)
The hotel property owned by the Partnership recorded a net unrealized gain of $3.8 million for the year ended December 31, 2006, compared to a net unrealized gain of $1.0 million for the prior year. The net unrealized gain for the year ended December 31, 2006 reflects the continued strengthening of market and property fundamentals and investor demand.
LAND
The Blue Springs, Missouri land property was sold on November 28, 2005, but certain post-closing adjustments were recognized during the year ended December 31, 2006, which resulted in a slight decrease to net investment income. The same land property also recorded a slight realized loss during the year ended December 31, 2006, which reflects a post-closing adjustment to the $0.6 million gain recognized during the fourth quarter of 2005 when the land was sold.
OTHER
Other net investment income (loss) decreased $0.4 million for the year ended December 31, 2006 from the prior year period. Other net investment income (loss), which is included in Net Investment Income, includes interest income from short-term investments, investment management fees, and portfolio level expenses.
(c)
Inflation
The Partnership’s leases with a majority of its commercial tenants provide for recoveries of expenses based upon the tenant’s proportionate share of, and/or increases in, real estate taxes and certain operating costs, which may partially reduce the Partnership’s exposure to increases in operating costs resulting from inflation.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or “U.S. GAAP”, requires the application of accounting policies that often involve a significant degree of judgment. Management reviews critical estimates and assumptions on an ongoing basis. If management determines, as a result of its consideration of facts and circumstances, that modifications in assumptions and estimates are appropriate, results of operations and financial position as reported in the audited Consolidated Financial Statements of the Account and the Partnership may change significantly.
The following sections discuss those critical accounting policies applied in preparing the audited Consolidated Financial Statements of the Account and the Partnership that are most dependent on the application of estimates and assumptions.
Valuation of Investments
Real Estate Investments - Real estate investments are shown at estimated market value in accordance with the terms of the Partnership’s contracts. 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. Market value estimates are based upon property appraisal reports prepared by independent real estate appraisers (members of the Appraisal Institute or an equivalent organization) within a reasonable amount of time following acquisition of the real estate and no less frequently than annually thereafter. The Chief Real Estate Appraiser of Prudential Investment Management, Inc., or “PIM”, which is an indirectly owned subsidiary of Prudential Financial, Inc., is responsible for assuring that the valuation process provides independent and reasonable property market value estimates. American Appraisal Associates, or the “Appraisal Management Firm”, an entity not affiliated with PIM, 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. Unless a property is currently held for sale, the market value of real estate investments does not reflect the transaction sale costs, which may be incurred upon disposition of the real estate investments.
Unconsolidated real estate partnerships are valued at the Partnership’s equity in net assets as reflected in the partnership’s financial statements with properties valued as described above. Under the equity method, the investment is initially recorded at the original investment amount, plus or minus additional amounts invested or distributed, and is subsequently adjusted for the Partnership’s share of undistributed earnings or losses, including unrealized appreciation and depreciation, from the underlying entity.
The Partnership periodically enters into forward contracts to acquire, for a fixed price, real estate investments to be constructed in accordance with predetermined plans and specifications or that achieve a certain level of leasing. Where conditions precedent to funding have been met by its development partner, and the Partnership’s commitment to fund is firm, the amount of any unrealized gain or loss is recognized based upon the difference between the estimated investment’s market value as described above and the Partnership’s funding obligation. The funding obligation and related assets are recorded in the consolidated financial statements.
As described above, the estimated market value of real estate and real estate related assets is determined through an appraisal process. These estimated market values may vary significantly from the prices at which the real estate investments would sell, because market prices of real estate investments can only be determined by negotiation between a willing buyer and seller and could be material to the consolidated financial statements. Although the estimated market values represent subjective estimates, management believes that these estimated market values are reasonable approximations of market prices and that the aggregate estimated value of investments in real estate is fairly presented as of December 31, 2006, and 2005.
Land and development properties held for future development is carried at acquisition cost including soft costs incurred prior to development.
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 audited Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk - The Partnership’s exposure to market rate risk for changes in interest rates relates to approximately 28.55% of its investment portfolio as of December 31, 2006, which consists primarily of short-term fixed rate commercial paper and fixed and variable interest rate debt. The Partnership does not use derivative financial instruments. By policy, the Partnership places its investments with high quality debt security issuers, limits the amount of credit exposure to any one issuer, limits duration by restricting the term, and holds investments to maturity except under unusual circumstances.
The table below presents the amounts and related weighted interest rates of the Partnership’s cash equivalents and short-term investments at December 31, 2006:
The table below discloses the Partnership’s debt as of December 31, 2006. All of the Partnership’s long-term debt bears interest at fixed rates and therefore the fair value of these instruments is affected by changes in market interest rates. The following table presents principal cash flows based upon maturity dates of the debt obligations and the related weighted-average interest rates by expected maturity dates for the fixed rate debt.
The Partnership is exposed to market risk from tenants. While the Partnership has not experienced any significant credit losses, in the event of significant increases in interest rates and/or an economic downturn, delinquencies could increase and result in losses to the Partnership and the Account that could adversely affect its operating results and liquidity.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The financial statements and supplementary data are listed in the accompanying Index to the Financial Statements and Supplementary Data on.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
In order to ensure that the information we must disclose in our filings with the Securities and Exchange Commission, or “SEC”, is recorded, processed, summarized, and reported on a timely basis, the Company’s management, including our Chief Executive Officer and Chief Financial Officer, have reviewed and evaluated the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), under the Securities Exchange Act of 1934, as amended, as of December 31, 2006. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2006, our disclosure controls and procedures were effective in timely alerting them to material information relating to us required to be included in our periodic SEC filings. There has been no change in our internal control over financial reporting, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), during the year ended December 31, 2006, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
JAMES J. AVERY, JR., Vice Chairman and Director - President, Prudential Individual Life Insurance since 1998. Age 55.
HELEN M. GALT, Director (Chief Actuary effective March 20, 2007) - Senior Vice President and Company Actuary, Prudential since 2005; prior to 2005: Company Actuary, Prudential. Age 59.
BERNARD J. JACOB, Treasurer and Director - Senior Vice President and Treasurer, Prudential. Age 51.
RONALD P. JOELSON, Director - Senior Vice President, Prudential Asset, Liability and Risk Management since 1999. Age 48.
DAVID R. ODENATH, JR., Director - President, Prudential Annuities since 2003; prior to 2003: President, Prudential Investments. Age 50.
SCOTT D. KAPLAN, Chief Executive Officer, President and Director - Vice President, Finance, Prudential since 2006. Age 42.
TUCKER I. MARR, Chief Financial Officer and Chief Accounting Officer - Vice President, Financial Reporting, Prudential. Age 51.
THOMAS C. CASTANO, Chief Legal Officer and Secretary - Vice President and Corporate Counsel, Variable Products, Prudential Law Department. Age 59.
JAMES M. O’CONNOR, Senior Vice President and Actuary - Vice President, Guaranteed Products since 2001. Age 51.
SHIRLEY H. SHAO, Senior Vice President and Chief Actuary (until March 20, 2007) - Vice President and Actuary, Prudential since 1996. Age 52.
KENT D. SLUYTER, Senior Vice President - Vice President, Chief Actuary of Individual Life Insurance, Prudential since 2002. Age 47.
KENNETH S. SOLON, Senior Vice President - Vice President, Customer Service, Prudential since 1999. Age 46.
The business address of all directors and officers of Pruco Life of New Jersey is 213 Washington Street, Newark, New Jersey 07102-2992. Pruco Life of New Jersey directors and officers are elected annually.
Code of Ethics
We have adopted a code of business conduct and ethics, known as “Making the Right Choices,” which applies to our Chief Executive Officer, Chief Financial Officer, as well as to our directors and other employees. Making the Right Choices is posted on our website at www.investor.prudential.com. Our code of business conduct and ethics, any amendments and any waiver granted to any of our directors or executive officers are available free of charge on our website at www.investor.prudential.com.
The Board of Directors has not designated a separate audit committee, and therefore the full Board serves as the Company’s audit committee. None of the members of the Board of Directors is independent of management within the meaning of SEC rules. The Board of Directors has determined that at least one of its members, Mr. Joelson, has the requisite experience to be designated an audit committee financial expert as that term is defined by rules of the SEC. Specifically, Mr. Joelson has accounting and financial management expertise, which he gained through his experience as Senior Vice President and head of the Asset, Liability and Risk Management area of Prudential Financial, Inc., the New York Stock Exchange listed parent of the Company, as well as experience in senior financial management positions and other similar positions. Mr. Joelson also received an M.B.A. degree in Finance and Accounting from the Columbia University School of Business.
Item 11.
Item 11.
Executive Compensation
The Real Property Account does not pay any fees, compensation or reimbursement to any Director or Officer of the Registrant.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Not applicable.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
See Related Transactions in Note 10 of Notes to Financial Statements of the Partnership on page F - 23.
The Registrant is an indirect wholly-owned subsidiary of Prudential, which, in turn, is an indirect, wholly-owned subsidiary of Prudential Financial, Inc. All Directors and Executive Officers of the Registrant are employees and officers of Prudential.
Item 14.
Item 14.
Principal Accounting Fees and Services
The Audit Committee of the Board of Directors of Prudential Financial, Inc. has appointed PricewaterhouseCoopers LLP as the independent registered public accounting firm of Prudential Financial, Inc. and certain of its domestic and international subsidiaries, including the Registrant. The Audit Committee has established a policy requiring its pre-approval of all audit and permissible non-audit services provided by the independent auditor. The specific information called for by this item is hereby incorporated by reference to the section entitled “Item 2 - Ratification of the Appointment of Independent Auditors” in the definitive proxy statement of Prudential Financial, Inc. for the Annual Meeting of Shareholders to be held on May 8, 2007, to be filed with the SEC pursuant to Regulation 14A within 120 days after the year ended December 31, 2006.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
(a) The following documents are filed as part of this report:
1. Financial Statements
See the Index to Financial Statements and Supplementary Data on page.
2. Financial Statement Schedules
The following financial statement schedules of The Prudential Variable Contract Real Property Partnership should be read in conjunction with the financial statements in Item 8 of this Annual Report on Form 10-K:
Schedule III - Real Estate Owned: Properties
Schedule IV - Mortgage Loans on Real Estate
See the Index to Financial Statements and Supplementary Data on page.
3. Documents Incorporated by Reference
See the following list of exhibits.
4. Exhibits
See the following list of exhibits.
(b) None.
(c)
The following is a list of Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006. The Registrant will furnish a copy of any Exhibit listed below to any security holder of the Registrant who requests it upon payment of a fee of 15 cents per page. All Exhibits are either contained in this Annual Report on Form 10-K or are incorporated by reference as indicated below.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PRUCO LIFE INSURANCE COMPANY OF NEW JERSEY
in respect of
Pruco Life of New Jersey Variable
Contract Real Property Account
(Registrant)
Date: March 23, 2007
By:
/s/ Scott D. Kaplan
Scott D. Kaplan
President and Director
(Principal Executive Officer)
Date: March 23, 2007
By:
/s/ Tucker I. Marr
Tucker I. Marr
Chief Accounting Officer
(Principal Accounting and Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
*By:
/s/ Thomas C. Castano
Thomas C. Castano
(Attorney-in-Fact)
PRUCO LIFE OF NEW JERSEY VARIABLE CONTRACT REAL PROPERTY ACCOUNT
(Registrant)
INDEX
All other schedules are omitted because they are not applicable, or because the required information is included in the financial statements or notes thereto.
Report of Independent Registered Public Accounting Firm
To the Contract Owners of the
Pruco Life of New Jersey Variable Contract Real Property Account
and the Board of Directors of
Pruco Life Insurance Company of New Jersey
In our opinion, the accompanying statements of net assets and the related statements of operations and of changes in net assets present fairly, in all material respects, the financial position of Pruco Life of New Jersey Variable Contract Real Property Account at December 31, 2006 and 2005, and the results of its operations and the changes in its net assets for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the management of Pruco Life Insurance Company of New Jersey; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of shares at December 31, 2006 with The Prudential Variable Contract Real Property Partnership, provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
March 20, 2007
FINANCIAL STATEMENTS OF
PRUCO LIFE OF NEW JERSEY VARIABLE CONTRACT REAL PROPERTY ACCOUNT
STATEMENTS OF NET ASSETS
December 31, 2006 and 2005
STATEMENTS OF OPERATIONS
For the years ended December 31, 2006, 2005 and 2004
STATEMENTS OF CHANGES IN NET ASSETS
For the years ended December 31, 2006, 2005 and 2004
The accompanying notes are an integral part of these financial statements.
NOTES TO THE FINANCIAL STATEMENTS OF
PRUCO LIFE OF NEW JERSEY VARIABLE CONTRACT REAL PROPERTY ACCOUNT
December 31, 2006
Note 1:
General
Pruco Life of New Jersey Variable Contract Real Property Account (the “Account”) was established on October 30, 1987 by resolution of the Board of Directors of Pruco Life Insurance Company of New Jersey (“Pruco Life of New Jersey”), a wholly-owned subsidiary of The Prudential Insurance Company of America (“Prudential”), an indirect wholly-owned subsidiary of Prudential Financial, Inc. (“PFI”) as a separate investment account pursuant to New Jersey law and is registered under the Securities Act of 1933, as amended. The assets of the Account are segregated from Pruco Life of New Jersey’s other assets. The Account is used to fund benefits under certain variable life insurance and variable annuity contracts issued by Pruco Life of New Jersey. These products are Appreciable Life (“VAL”), Variable Life (“VLI”), Discovery Plus (“SPVA”), and Discovery Life Plus (“SPVL”).
The assets of the Account are invested in The Prudential Variable Contract Real Property Partnership (the “Partnership”). The Partnership is the investment vehicle for assets allocated to the real estate investment option under certain variable life insurance and annuity contracts. The Account, along with the Pruco Life Variable Contract Real Property Account and The Prudential Variable Contract Real Property Account, are the sole investors in the Partnership. These financial statements should be read in conjunction with the financial statements of the Partnership.
The Partnership has a policy of investing at least 65% of its assets in direct ownership interests in income-producing real estate and participating mortgage loans.
Note 2:
Summary of Significant Accounting Policies and Pronouncements
The accompanying financial statements are prepared in conformity with U.S. GAAP. The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates.
In September 2006, the staff of the U.S. Securities and Exchange Commission, or “SEC”, issued Staff Accounting Bulletin, or “SAB”, No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” The interpretations in this SAB express the staff’s views regarding the process of quantifying financial statement misstatements. Specifically, the SEC staff believes that registrants must quantify the impact on current period financial statements of correcting all misstatements, including both those occurring in the current period and the effect of reversing those that have accumulated from prior periods. This SAB should be applied beginning with the first fiscal year ending after November 15, 2006, with early adoption encouraged. Since the Account’s method for quantifying financial statement misstatements already considers those occurring in the current period and the effect of reversing those that have accumulated from prior periods, the adoption of SAB No. 108 should have no effect to the financial position and result of operations of the Account.
The investment in the Partnership is based on the Account’s proportionate interest of the Partnership’s market value. At December 31, 2006 and 2005 the Account’s interest in the Partnership was 4.3% or 294,526 shares and 4.3% or 301,619 shares respectively.
Net investment income and realized and unrealized gains and losses are recognized daily. Amounts are based upon the Account’s proportionate interest in the Partnership.
Pruco Life of New Jersey maintains a position in the Account for liquidity purposes, including unit purchases and redemptions, Partnership share transactions, and expense processing. The position does not affect contract owners’ accounts or the related unit values.
Note 3:
Taxes
Pruco Life of New Jersey is taxed as a “life insurance company”, as defined by the Internal Revenue Code. The results of operations of the Account form a part of PFI’s consolidated federal tax return. Under current federal law, no federal income taxes are payable by the Account. As such, no provision for the tax liability has been recorded in these financial statements.
Note 4:
Net Contributions (Withdrawals) by Contract Owners
Net contract owner contributions (withdrawals) for the real estate investment option in Pruco Life of New Jersey’s variable insurance and variable annuity products for the years ended December 31, 2006, 2005 and 2004 were as follows:
NOTES TO THE FINANCIAL STATEMENTS OF
PRUCO LIFE OF NEW JERSEY VARIABLE CONTRACT REAL PROPERTY ACCOUNT
December 31, 2006
NOTES TO THE FINANCIAL STATEMENTS OF
PRUCO LIFE OF NEW JERSEY VARIABLE CONTRACT REAL PROPERTY ACCOUNT
December 31, 2006
Note 5:
Unit Activity
Transactions in units for the years ended December 31, 2006, 2005 and 2004 were as follows:
Note 6:
Purchases and Sales of Investments
The aggregate costs of purchases and proceeds from sales of investments in the Partnership for the years ended December 31, 2006, 2005 and 2004 were as follows:
NOTES TO THE FINANCIAL STATEMENTS OF
PRUCO LIFE OF NEW JERSEY VARIABLE CONTRACT REAL PROPERTY ACCOUNT
December 31, 2006
Note 7:
Financial Highlights
Pruco Life Insurance Company of New Jersey (the “Company” or “Prudential”) sells a number of variable annuity and variable life insurance products. These products have unique combinations of features and fees that are charged against the contract owner’s account balance. Differences in the fee structures result in a variety of unit values, expense ratios and total returns.
The following table was developed by determining which products offered by Pruco Life of New Jersey have the lowest and highest total expense ratio. The summary may not reflect the minimum and maximum contract charges offered by the Company as contract owners may not have selected all available and applicable contract options as discussed in Note 1. The table reflects contract owner units only.
The table above reflects information for units held by contract owners. Pruco Life of New Jersey also maintains a position in the Real Property Account, to provide for property acquisitions and capital expenditure funding needs. Pruco Life of New Jersey held 825,050, 804,224, 875,413, 901,524 and 1,393,587 units representing $2,464,171, $2,112,648, $2,040,688, $1,993,278 and $3,036,542 of net assets as of December 31, 2006, 2005, 2004, 2003 and 2002, respectively. Charges for mortality risk, expense risk and administrative expenses are used by Pruco Life of New Jersey to purchase additional units in its account resulting in no impact of its net assets.
*
This amount represents the proportionate share of the net investment income from the underlying Partnership divided by the total average assets of the Account. This ratio excludes those expenses, such as mortality and expense charges, that result in direct reductions in the unit values.
**
These ratios represent the annualized contract expenses of the separate account, consisting primarily of mortality and expense charges, for each period indicated. The ratios include only those expenses that result in a direct reduction to unit values. Charges made directly to contract owner accounts through the redemption of units and expenses of the underlying Partnership are excluded.
***
These amounts represent the total return for the periods indicated, including changes in the value of the underlying Partnership, and reflect deductions for all items included in the expense ratio. The total return does not include any expense assessed through the redemption of units; inclusion of these expenses in the calculation would result in a reduction in the total return presented.
Charges and Expenses
Mortality risk and expense risk charges are determined daily using an effective annual rate of 0.6%, 0.35%, 0.9% and 0.9% for VAL, VLI, SPVA and SPVL, respectively. Mortality risk is the risk that life insurance contract owners may not live as long as estimated or annuitants may live longer than estimated and expense risk is the risk that the cost of issuing and administering the policies may exceed related charges by Pruco Life of New Jersey. The mortality risk and expense risk charges are assessed through reduction in unit values.
Administrative charges are determined daily using an effective annual rate of 0.35% applied daily against the net assets representing equity of contract owners held in each subaccount for SPVA and SPVL. Administrative charges include costs associated with issuing the contract, establishing and maintaining records, and providing reports to contract owners. The administrative charge is assessed through reduction in unit values.
NOTES TO THE FINANCIAL STATEMENTS OF
PRUCO LIFE OF NEW JERSEY VARIABLE CONTRACT REAL PROPERTY ACCOUNT
December 31, 2006
Contract owner contributions are subject to certain deductions prior to being invested in the Account. The deductions for VAL and VLI are (1) state premium taxes; (2) sales charges, not to exceed 5% for VAL and 9% for VLI, which are deducted in order to compensate Pruco Life of New Jersey for the cost of selling the contract and (3) transaction costs, applicable to VAL, which are deducted from each premium payment to cover premium collection and processing costs. Contracts are subject to charges on each basic premium for assuming a guaranteed minimum death benefit risk. This charge compensates Pruco Life of New Jersey for the risk that an insured may die at a time when the death benefit exceeds the benefit that would have been payable in the absence of a minimum guarantee. These charges are assessed through the redemption of units.
A deferred sales charge is imposed upon surrenders of certain variable life insurance contracts to compensate Pruco Life of New Jersey for sales and other marketing expenses. The amount of any sales charge will depend on the number of years that have elapsed since the contract was issued but will not exceed 45% of one scheduled annual premium for VAL and 9% of the initial premium payment for SPVL. No sales charge will be imposed after the sixth and tenth year of the contract for SPVL and VAL, respectively. No sales charge will be imposed on death benefits. This deferred sales charge is assessed through the redemption of units.
A charge is imposed by Pruco Life of New Jersey on partial withdrawals of the cash surrender value for VAL. A charge equal to the lesser of $15 or 2% will be made in connection with each partial withdrawal of the cash surrender value of a contract. This charge is assessed through the redemption of units.
Note 8:
Related Party
Prudential and its affiliates perform various services on behalf of the Partnership in which the Account invests and may receive fees for the services performed. These services include, among other things, shareholder communications, preparation, postage, fund transfer agency and various other record keeping and customer service functions.
Report of Independent Registered Public Accounting Firm
To the Partners of
The Prudential Variable Contract Real Property Partnership:
In our opinion, the accompanying consolidated statements of assets and liabilities, including the consolidated schedule of real estate investments, and the related consolidated statements of operations, of changes in net assets and of cash flows present fairly, in all material respects, the financial position of The Prudential Variable Contract Real Property Partnership (the “Partnership”) at December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the management of The Prudential Insurance Company of America. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
February 15,
Report of Independent Registered Public Accounting Firm on
Financial Statement Schedules
To the Partners of
The Prudential Variable Contract Real Property Partnership:
Our audits of the consolidated financial statements referred to in our report dated February 15, 2007 appearing in this Annual Report on Form 10-K also included an audit of the financial statement schedules listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
New York, New York
February 15,
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
The accompanying notes are an integral part of these consolidated financial statements.
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
The accompanying notes are an integral part of these consolidated financial statements.
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
CONSOLIDATED SCHEDULE OF INVESTMENTS
The accompanying notes are an integral part of these consolidated financial statements.
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
CONSOLIDATED SCHEDULE OF INVESTMENTS
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 1: Organization
On April 29, 1988, The Prudential Variable Contract Real Property Partnership (the “Partnership”), a general partnership organized under New Jersey law, was formed through an agreement among The Prudential Insurance Company of America (“Prudential”), Pruco Life Insurance Company (“Pruco Life”), and Pruco Life Insurance Company of New Jersey (“Pruco Life of New Jersey”). The Partnership was established as a means by which assets allocated to the real estate investment option under certain variable life insurance and variable annuity contracts issued by the respective companies could be invested in a commingled pool. The partners in the Partnership are Prudential, Pruco Life and Pruco Life of New Jersey.
The Partnership’s policy is to invest at least 65% of its assets in direct ownership interests in income-producing real estate and participating mortgage loans.
The estimated market value of the Partnership’s shares is determined daily, consistent with the Partnership Agreement. On each day during which the New York Stock Exchange is open for business, the net asset value of the Partnership is estimated using the estimated market value of its assets, principally as described in Notes 2A, 2B and 2C below, reduced by any liabilities of the Partnership. The periodic adjustments to property values described in Notes 2A, 2B and 2C below and other adjustments to previous estimates are made on a prospective basis. There can be no assurance that all such adjustments to estimates will be made timely.
Shares of the Partnership are held by The Prudential Variable Contract Real Property Account, Pruco Life Variable Contract Real Property Account and Pruco Life of New Jersey Variable Contract Real Property Account (the “Real Property Accounts”) and may be purchased and sold at the then current share value of the Partnership’s net assets. Share value is calculated by dividing the estimated market value of net assets of the Partnership as determined above by the number of shares outstanding. A contract owner participates in the Partnership through interests in the Real Property Accounts.
PREItm is the real estate advisory unit of Prudential Investment Management, Inc. (“PIM”), which is an indirectly owned subsidiary of Prudential Financial, Inc. (“PFI”). PREItm provides investment advisory services to the Partnership’s partners pursuant to the terms of the Advisory Agreement as described in Note 10.
Note 2: Summary of Significant Accounting Policies
A:
Basis of Presentation - The accompanying consolidated financial statements of the Partnership have been presented on the market value basis of accounting in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements of Partnership include wholly owned entities, and those real estate partnerships in which the Partnership has a controlling interest. All significant inter-company balances and transactions have been eliminated in consolidation.
B:
Management’s Use of Estimates in the Financial Statements - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 2:
Summary of Significant Accounting Policies (continued)
C:
Real Estate Investments - Real estate investments are shown at estimated market value in accordance with the terms of the Partnership’s contracts. 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. Market value estimates are based upon property appraisal reports prepared by independent real estate appraisers (members of the Appraisal Institute or an equivalent organization) within a reasonable amount of time following acquisition of the real estate and no less frequently than annually thereafter. The Chief Real Estate Appraiser of PIM is responsible to assure that the valuation process provides independent and reasonable property market value estimates. American Appraisal Associates (the “Appraisal Management Firm”), an entity not affiliated with PIM, 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. Unless a property is currently held for sale, the market value of real estate investments does not reflect the transaction sale costs, which may be incurred upon disposition of the real estate investments.
Unconsolidated real estate partnerships are valued at the Partnership’s equity in net assets as reflected in the partnerships’ financial statements with properties valued as described above. Under the equity method, the investment is initially recorded at the original investment amount, plus or minus additional amounts invested or distributed, and is subsequently adjusted for the Partnership’s share of undistributed earnings or losses, including unrealized appreciation and depreciation, from the underlying entity.
Land and development properties held for future development is carried at acquisition cost including soft costs incurred prior to development.
The Partnership periodically enters into forward contracts to acquire, for a fixed price, real estate investments to be constructed in accordance with predetermined plans and specifications or those achieve a certain level of leasing. Where conditions precedent to funding have been met by its development partners, and the Partnership’s commitment to fund is firm, the amount of any unrealized gain or loss is recognized based upon the difference between the estimated investment’s market value as described above and the Partnership’s funding obligation. The funding obligation and related assets are recorded in the consolidated financial statements. As of December 31, 2006 and 2005, no such funding obligation existed.
As described above, the estimated market value of real estate and real estate related assets is determined through an appraisal process. These estimated market values may vary significantly from the prices at which the real estate investments would sell, since market prices of real estate investments can only be determined by negotiation between a willing buyer and seller and could be material to the consolidated financial statements. Although the estimated market values represent subjective estimates, management believes these estimated market values are reasonable approximations of market prices
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 2:
Summary of Significant Accounting Policies (continued)
and the aggregate estimated value of investments in real estate is fairly presented as of December 31, 2006 and 2005.
D:
Other Real Estate Investments - Other real estate investments include short term notes receivable, which are valued at the amount due and approximate market value.
G:
Investment Level Debt - Investment level debt is stated at the principal amount of the obligations outstanding. At times the Partnership may assume debt in connection with the purchase of real estate. For debt assumed, the Partnership allocates a portion of the purchase price to the below/above market debt and amortizes the premium/discount over the remaining life of the debt.
I:
Revenue Recognition - Revenue from real estate is recognized when earned in accordance with the terms of the respective leases. Revenue from certain real estate investments is net of all or a portion of related real estate expenses, as lease arrangements vary as to responsibility for payment of these expenses between tenants and the Partnership. Since real estate is stated at estimated market value, net income is not reduced by depreciation or amortization expense.
J:
Equity in Income of Real Estate Partnership - Equity in income from real estate partnership operations represents the Partnership’s share of the current year’s partnership income as provided for under the terms of the partnership agreements. As is the case with wholly owned real estate, partnership net income is not reduced by depreciation or amortization expense. Frequency of distribution of income is determined by formal agreements or by the executive committee of the partnership.
K:
Federal Income Taxes - The Partnership is not a taxable entity under the provisions of the Internal Revenue Code. The income and capital gains and losses of the Partnership are attributed, for federal income tax purposes, to the Partners in the Partnership. The Partnership may be subject to state and local taxes in jurisdictions in which it operates.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 2: Summary of Significant Accounting Policies (continued)
FIN 46-R defers the effective date for applying the provisions of FIN-46 for those companies currently accounting for their investments in accordance with the AICPA Audit and Accounting Guide, “Audits of Investment Companies” (the “Audit Guide”). The effective date is delayed while the AICPA finalizes the proposed Statement of Position (“SOP”) on the clarification of the scope of the Audit Guide. Following the issuance of the final SOP, the FASB will consider modifying FIN 46-R to provide an exception for companies that apply the Audit Guide. The Partnership is awaiting the final determination from the FASB in order to evaluate the extent in which, if any, its equity investments may need to be consolidated as a result of this FIN 46-R.
In September 2006, the staff of the U.S. Securities and Exchange Commission, or “SEC”, issued Staff Accounting Bulletin, or “SAB”, No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” The interpretations in this SAB express the staff’s views regarding the process of quantifying financial statement misstatements. Specifically, the SEC staff believes that registrants must quantify the impact on current period financial statements of correcting all misstatements, including both those occurring in the current period and the effect of reversing those that have accumulated from prior periods. This SAB should be applied beginning with the first fiscal year ending after November 15, 2006, with early adoption encouraged. Since the Partnership’s method for quantifying financial statement misstatements already considers those occurring in the current period and the effect of reversing those that have accumulated from prior periods, the adoption of SAB No. 108 should have no effect to the financial position and result of operations of the Partnership.
Note 3:
Disclosure of Supplemental Cash Flow Information and Non-Cash Investing and Financing Activity
Cash paid for interest during the years ended December 31, 2006, 2005, and 2004, was $1,806,320, $2,324,397, and $2,595,651, respectively.
During the fourth quarter of 2005, a minority interest partner bought out the Account’s investment in a consolidated real estate partnership resulting in net proceeds of $15.9 million. This transaction resulted in the assumption of a mortgage loan by the partner of approximately $10.0 million and a reduction of the partner’s minority interest of $3.7 million.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 4:
Real Estate Partnership and Preferred Equity Investments
Real estate partnerships and preferred equity investments are valued at the Partnership’s equity in net assets as reflected by the partnership’s financial statements with properties valued as indicated in Note 2C above. The Partnership’s combined financial position and results of operations are summarized as follows (in 000’s):
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 5:
Investment Level Debt
Debt includes mortgage loans payable as summarized below (in 000’s):
(1)
Represents the Partnership’s interest in the loan based upon the estimated percentage of net assets which would be distributed to the Partnership if the partnership were liquidated at December 31, 2006. It does not represent the Partnership’s legal obligation.
(2)
The Partnership’s weighted average interest rate was 6.14% at December 31, 2006 and 2005. The weighted average interest rates were calculated using the Partnership’s annualized interest expense for each loan (derived using the same percentage as that in (1) above) divided by the Partnership’s share of total debt.
(3)
Loan Terms PP=Prepayment penalties applicable to loan, I=Interest only, P&I=Principal and Interest
As of December 31, 2006, mortgage loans payable on wholly owned properties and consolidated partnerships are payable as follows:
The mortgage loans payable of wholly owned properties and consolidated partnerships are secured by real estate investments with an estimated market value of $89.4 million.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 5:
Investment Level Debt (continued)
As of December 31, 2006, principal amounts of mortgage loans payable on the equity partnerships are payable as follows:
Based on borrowing rates available to the Partnership at December 31, 2006 for loans with similar terms and average maturities, the Partnership’s mortgages on wholly owned properties and consolidated partnerships have an estimated fair value of approximately $33 million, and a carrying value of $33 million. The Partnership’s mortgage loan payable on the equity partnership has an estimated fair value of approximately $3 million and a carrying value of $3 million. Different assumptions or changes in future market conditions could significantly affect estimated fair value.
Note 6:
Purchase Commitment Obligations
Purchase commitments includes forward commitments without conditions waived, commitments to purchase real estate and/or fund additional expenditures on previously acquired properties and loan take out agreements. Certain purchases of real estate are contingent on a developer building the real estate according to plans and specifications outlined in the pre-sale agreement or the property achieving a certain level of leasing. It is anticipated that funding will be provided by operating cash flow, real estate investment sales and deposits from the Partnership.
As of December 31, 2006, the Partnership had the following outstanding purchase commitments:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 7:
Concentration of Risk on Real Estate Investments
At December 31, 2006, the Partnership had real estate investments located throughout the United States. The diversification of the Partnership’s holdings based on the estimated market values and established NCREIF regions is as follows:
The allocations on the previous page are based on (1) 100% of the estimated market value of wholly-owned properties and consolidated joint ventures and mortgage and other loans receivable, and (2) the estimated market value of the Partnership’s net equity in non-consolidated ventures.
Note 8:
Leasing Activity
The Partnership leases space to tenants under various operating lease agreements. These agreements, without giving effect to renewal options, have expiration dates ranging from 2007 to 2025. At December 31, 2006, the aggregate future minimum base rental payments under non-cancelable operating leases for wholly owned and consolidated joint venture properties by year are as follows:
Note 9:
Commitments and Contingencies
In 1986, Prudential committed to fund up to $100 million to enable the Partnership to acquire real estate investments. Contributions to the Partnership under this commitment have been utilized for property acquisitions, and were to be returned to Prudential on an ongoing basis from contract owners’ net contributions and other available cash. The amount of the commitment has been reduced by $10 million for every $100 million in current value net assets of the Partnership. As of December 31, 2006, the cost basis of Prudential’s equity interest in the Partnership under this commitment (held through the Real Property Accounts) was $44.2 million. Prudential terminated this commitment on December 31, 2002.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 9:
Commitments and Contingencies (continued)
The Partnership is subject to various legal proceedings and claims arising in the ordinary course of business. These matters are generally covered by insurance. In the opinion of Prudential’s management, the outcome of such matters will not have a significant effect on the financial position of the Partnership.
Note 10:
Other Related Party Transactions
Pursuant to an investment management agreement, PIM charges the Partnership a daily investment management fee at an annual rate of 1.25% of the average daily gross asset valuation of the Partnership. For the years ended December 31, 2006, 2005 and 2004 management fees incurred by the Partnership were $3.1 million, $2.8 million, and $2.7 million, for each of the years, respectively.
The Partnership also reimburses PIM for certain administrative services rendered by PIM. The amounts incurred for the years ended December 31, 2006, 2005 and 2004 were $146,930; $123,630; and $141,130, respectively, and are classified as administrative expenses in the Consolidated Statements of Operations.
During the years ended December 31, 2006, 2005 and 2004, the Partnership made the following distributions to the Partners:
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
For Years Ended December 31, 2006, 2005, and 2004
Note 11: Financial Highlights
(a)
Total Return, before management fee is calculated by geometrically linking quarterly returns which are calculated using the formula below:
Net Investment Income + Net Realized and Unrealized Gains/(Losses)
Beg. Net Asset Value + Time Weighted Contributions - Time Weighted Distributions
(b) Average net assets are based on beginning of quarter net assets.
Note 12:
Subsequent Events
On February 7, 2007, the Partnership sold Smith Road, a wholly owned property, to an unrelated party for a cash selling price of $15,000,000 and realized net proceeds of $14,649,241 after selling costs. The sale resulted in a gain of $349,110.
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
SCHEDULE III - REAL ESTATE OWNED: PROPERTIES
DECEMBER 31, 2006
MORTGAGE LOAN RECEIVABLE
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE
DECEMBER 31, 2006
*
I is Interest Only