Item 1. Business.
General
United Development Funding IV was organized on May 28, 2008 (“Inception”) as a Maryland real estate investment trust. The Trust is the sole general partner of and owns a 99.999% partnership interest in United Development Funding IV Operating Partnership, L.P. (“UDF IV OP”), a Delaware limited partnership. UMTH LD, the affiliated asset manager of the Trust, is the sole limited partner and owner of 0.001% (minority interest) of the partnership interests in UDF IV OP. At December 31, 2013 and 2012, UDF IV OP had no assets, liabilities or equity.
As of December 31, 2013, the Trust owns a 100% limited partnership interest in UDF IV Home Finance, LP (“UDF IV HF”), UDF IV Finance I, LP (“UDF IV FI”), UDF IV Finance II, LP (“UDF IV FII”), UDF IV Acquisitions, LP (“UDF IV AC”), UDF IV Finance III, LP (“UDF IV FIII”), UDF IV Finance IV, L.P. (“UDF IV Fin IV”), UDF IV Finance V, L.P. (“UDF IV Fin V”), UDF IV Finance VI, L.P. (“UDF IV Fin VI”), UDF IV Finance VII, L.P. (“UDF IV Fin VII”) and UDF IV Finance VIII, L.P. (“UDF IV Fin VIII”), all Delaware limited partnerships.
As of December 31, 2013, the Trust is the sole member of (i) UDF IV HF Manager, LLC (“UDF IV HFM”), a Delaware limited liability company, the general partner of UDF IV HF; (ii) UDF IV Finance I Manager, LLC (“UDF IV FIM”), a Delaware limited liability company, the general partner of UDF IV FI; (iii) UDF IV Finance II Manager, LLC (“UDF IV FIIM”), a Delaware limited liability company, the general partner of UDF IV FII; (iv) UDF IV Acquisitions Manager, LLC (“UDF IV ACM”), a Delaware limited liability company, the general partner of UDF IV AC; (v) UDF IV Finance III Manager, LLC (“UDF IV FIIIM”), a Delaware limited liability company, the general partner of UDF IV FIII; (vi) UDF IV Finance IV Manager, LLC (“UDF IV FIVM”), a Delaware limited liability company, the general partner of UDF IV Fin IV; (vii) UDF IV Finance V Manager, LLC (“UDF IV FVM”), a Delaware limited liability company, the general partner of UDF IV Fin V; (viii) UDF IV Finance VI Manager, LLC (“UDF IV FVIM”), a Delaware limited liability company, the general partner of UDF IV Fin VI; (ix) UDF IV Finance VII Manager, LLC (“UDF IV FVIIM”), a Delaware limited liability company, the general partner of UDF IV Fin VII; and (x) UDF IV Finance VIII Manager, LLC (“UDF IV FVIIIM”), a Delaware limited liability company, the general partner of UDF IV Fin VIII.
As of December 31, 2013, the Trust owns 100% of the outstanding shares of (i) UDF IV LB I, Inc. (“UDF IV LBI”), a Delaware corporation; (ii) UDF IV LB II, Inc. (“UDF IV LBII”), a Delaware corporation; (iii) UDF IV Woodcreek, Inc. (“UDF IV Woodcreek”), a Delaware corporation; (iv) UDF IV LB III, Inc. (“UDF IV LBIII”), a Delaware corporation; and (v) UDF IV LB IV, Inc. (“UDF IV LBIV”), a Delaware corporation.
As of December 31, 2013 and December 31, 2012, UDF IV HFM, UDF IV FIM, UDF IV FIIM, UDF IV ACM, UDF IV FIIIM, UDF IV FIVM, UDF IV FVM, UDF IV FVIM, UDF IV FVIIM, UDF IV FVIIIM and UDF IV LBIV had no assets, liabilities, or equity.
The Trust originates, purchases, participates in and holds for investment secured loans made directly by the Trust or indirectly through its affiliates to persons and entities for the acquisition and development of parcels of real property as single-family residential lots or mixed-use master planned residential communities, for the construction of single-family homes and for completed model homes. The Trust also makes direct investments in land for development into single-family lots, home construction and portfolios of finished lots and model homes; provides credit enhancements to real estate developers, home builders, land bankers and other real estate investors; and purchases participations in, or finances for other real estate investors the purchase of, securitized real estate loan pools and discounted cash flows secured by state, county, municipal or other similar assessments levied on real property. The Trust also may enter into joint ventures with unaffiliated real estate developers, home builders, land bankers and other real estate investors, or with other United Development Funding-sponsored programs, to originate or acquire the same kind of secured loans or real estate investments the Trust may originate or acquire directly. As of December 31, 2013, 2012 and 2011, our total assets were approximately $570.9 million, $336.5 million and $162.4 million, respectively. For the years ended December 31, 2013, 2012 and 2011, our total interest and non-interest income was approximately $53.2 million, $27.6 million and $13.3 million, respectively, and our net income was approximately $29.3 million, $13.9 million and $5.8 million, respectively.
We made an election under Section 856(c) of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), to be taxed as a real estate investment trust (“REIT”), beginning with the taxable year ended December 31, 2010, as it was our first year with material operations. As a REIT, we generally are not subject to federal income tax on income that we distribute to our shareholders. If we later fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates and may not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied unless we are entitled to relief under certain statutory provisions. Such an event could materially and adversely affect our net income. However, we intend to continue to operate so as to remain qualified as a REIT for federal income tax purposes.
UMTH General Services, L.P., a Delaware limited partnership (“UMTH GS” or the “Advisor”), is our advisor and is responsible for managing our affairs on a day-to-day basis. UMTH GS has engaged UMTH LD as our asset manager to oversee the investing and financing activities of the affiliated programs managed and advised by the Advisor and UMTH LD. The asset manager provides recommendations to our board of trustees regarding investments and finance transactions, management, policies and guidelines. The asset manager reviews for each investment the transaction structure and terms, underwriting, collateral, performance and risk management and also manages our capital structure at both the entity and asset level. Please see “Item 1 - Business - Investment Objectives and Policies - Conflicts of Interest” for a diagram illustrating the relationships between our Advisor and its affiliates. Approximately 12.5% of our loan portfolio consists of current performing investments with our Advisor and its affiliates. For the years ended December 31, 2013, 2012 and 2011, we paid approximately $24.4 million, $15.2 million and $7.2 million, respectively, to our Advisor and other affiliated entities for fees, expenses and compensation. For the years ended December 31, 2013, 2012 and 2011, we incurred related party expenses (including advisory fee - related party and general and administrative - related parties) of approximately $18.1 million, $9.8 million and $4.7 million, respectively, with our Advisor and other affiliated entities for fees, expenses and compensation.
On November 12, 2009, the Trust’s Registration Statement on Form S-11, covering an initial public offering (the “Offering”) of up to 25,000,000 common shares of beneficial interest to be offered in the primary offering at a price of $20 per share (the “Primary Offering”), was declared effective under the Securities Act of 1933, as amended. The Offering also initially covered up to 10,000,000 common shares of beneficial interest to be issued pursuant to our distribution reinvestment plan (the “DRIP”) for $20 per share. We had the right to reallocate the common shares of beneficial interest registered in the Offering between the Primary Offering and the DRIP, and pursuant to Supplement No. 6 to our prospectus regarding the Offering, which was filed with the SEC on May 3, 2013, we reallocated the shares being offered to be 34,000,000 shares offered pursuant to the Primary Offering and 1,000,000 shares offered pursuant to the DRIP. The shares were offered to investors on a reasonable best efforts basis, which means the dealer manager used its reasonable best efforts to sell the shares offered, but was not required to sell any specific number or dollar amount of shares and did not have a firm commitment or obligation to purchase any of the offered shares. The Offering terminated on May 13, 2013.
On October 19, 2012, we filed a Registration Statement on Form S-11 (Registration No. 333-184508) with the SEC with respect to a proposed follow-on public offering (the “Follow-On Offering”) of up to 20,000,000 common shares of beneficial interest to be offered at a price of $20.00 per share and up to 10,000,000 common shares of beneficial interest to be issued pursuant to our DRIP for $20.00 per share. The Registration Statement on Form S-11 for the proposed Follow-on Offering was withdrawn pursuant to a filing with the SEC on July 3, 2013, and we did not issue any shares under this registration statement.
On April 19, 2013, we registered 7,500,000 additional common shares of beneficial interest to be offered pursuant to the DRIP in a Registration Statement on Form S-3 (File No. 333-188045) (the “Secondary DRIP”) for $20 per share. We ceased offering common shares of beneficial interest under the DRIP portion of the Offering upon the termination of the Offering on May 13, 2013, and concurrently began offering our common shares of beneficial interest to our shareholders pursuant to the Secondary DRIP.
As of December 31, 2013, we had issued 32,115,232 common shares of beneficial interest in exchange for gross proceeds, including DRIP and Secondary DRIP, of approximately $642.3 million.
Loan Portfolio
As of December 31, 2013, we had originated or purchased 139 loans (25 of which were repaid in full by the respective borrowers or matured and were not renewed) with maximum loan amounts of approximately $869.4 million. As of December 31, 2013, there were approximately $174.9 million of commitments to be funded under the terms of mortgage notes receivable and loan participation interests, which included approximately $31.5 million to related parties. During the years ended December 31, 2013, 2012 and 2011, we originated 47, 29 and 20 loans, respectively, purchased 4, 3 and 1 loan(s), respectively, and entered into 4, 2 and 2 participation interests, respectively.
As of December 31, 2013, 100% of the outstanding aggregate principal of our loans are secured by properties located throughout Texas. As of December 31, 2013, approximately 67% of the outstanding aggregate principal amount of our loans are secured by properties located in the Dallas, Texas area; approximately 14% are secured by properties located in the Austin, Texas area; approximately 9% are secured by properties located in the Houston, Texas area; approximately 9% are secured by properties located in the San Antonio, Texas area; and approximately 1% are secured by properties located in the Lubbock, Texas area.
70 of the 114 loans outstanding as of December 31, 2013, representing approximately 63% of the aggregate principal amount of the outstanding loans, are secured by a first lien on the respective property; 30 loans, representing approximately 35% of the aggregate principal amount of the outstanding loans, are secured by a second lien on the respective property; 21 loans, representing approximately 23% of the aggregate principal amount of the outstanding loans, are secured by a pledge of some or all of the equity interests in the developer entity or other parent entity that owns the borrower entity; 28 loans, representing approximately 39% of the aggregate principal amount of the outstanding loans, are secured by reimbursements of development costs due to the developer under contracts with districts and cities; and 96 loans, representing approximately 84% of the aggregate principal amount of the outstanding loans, are secured by a guarantee of the principals or parent companies of the borrower in addition to the other collateral for the loan.
We did not have any individual loans to borrowers that accounted for over 10% of the outstanding balance of our portfolio as of December 31, 2013. Our largest individual borrower and its affiliates comprised approximately 65% of the outstanding balance of our portfolio.
As of December 31, 2013, interest rates ranged from 12% to 15% on the outstanding participation agreements and from 11% to 15% on the outstanding notes receivable, including notes receivable from related parties. The participation agreements have terms ranging from 12 to 31 months, while the notes receivable have terms ranging from 3 to 48 months.
Investment Objectives and Policies
Principal Investment Objectives
Our principal investment objectives are:
·to make, originate or acquire a participation interest in secured loans (first lien priority, junior lien priority and mezzanine loans secured by real estate and/or a pledge of the equity interest in the entity owning the real estate and/or pledges of other collateral including personal guarantees) for the acquisition of land and development of single-family lots, and the construction of model and new single-family homes, including development of mixed-use master planned residential communities, typically with the loan allocation for any single asset in the range of $2.5 million to $15.0 million;
·to make direct investments in land for development into single-family lots, new and model homes and finished lots and homes and joint ventures with real estate developers, homebuilders, land bankers and other real estate investors;
·to provide secured senior and subordinate lines of credit to real estate developers, homebuilders, land bankers and other real estate investors, including affiliated programs, for the purchase of finished lots and for the construction of single-family homes;
·to provide credit enhancements to real estate developers, homebuilders, land bankers and other real estate investors who acquire real property, subdivide real property into single-family residential lots, acquire finished lots and/or build homes on such lots;
·to purchase participations in, or finance for other real estate investors the purchase of, securitized real estate loan pools;
·to purchase participations in, or finance for other real estate investors the purchase of, discounted cash flows secured by state, county, municipal or other similar assessments levied on real property;
·to produce net interest income from the interest paid to us on secured loans, securitized loan pools and discounted cash flows that we originate, purchase or finance or in which we acquire a participation interest;
·to produce investment income from equity investments that we make or in which we acquire a participation interest;
·to produce a profitable fee from credit enhancements and other transaction fees;
·to participate, through a direct or indirect interest in borrowers, in the profits earned by such borrowers through the underlying properties;
·to maximize distributable cash to investors; and
·to preserve, protect and return capital contributions.
Investment Policy
We derive a significant portion of our income by originating, purchasing, participating in and holding for investment secured loans made directly by us or indirectly through our affiliates to persons and entities for the acquisition and development of parcels of real property as single-family residential lots, and the construction of model and new single-family homes, including development of mixed-use master planned residential communities, typically with the loan allocation for any single asset in the range of $2.5 million to $15.0 million. In most cases, we obtain a first or subordinate lien on the underlying real property to secure our loans (mortgage loans), and we also may require a pledge of all of the equity ownership interests in the borrower entity itself as additional security for our loans. In instances where we do not have a lien on the underlying real property, we obtain a pledge of all of the equity ownership interests of the borrower entity itself to secure such loans and/or a pledge of the equity ownership interests of the borrower entity (so-called “mezzanine loans”) or other parent entity that owns the borrower entity. We also may require a pledge of additional assets of the borrower, liens against additional parcels of undeveloped and developed real property and/or the personal guarantees of principals or guarantees of operating entities in connection with our secured loans. We apply the same underwriting criteria and analysis of the underlying real property to each of our secured loans, regardless of how we decide to structure the secured loan. Our intention is to structure any such mezzanine loans so that they are treated as a real estate asset, giving rise to interest on an obligation secured by an interest in real property for REIT qualification purposes.
Our declaration of trust limits our ability to invest more than 10% of our total assets in unimproved real property, or secured loans on unimproved property, which is defined as property not acquired for the purpose of producing rental or other operating income, which has no development or construction in progress at the time of acquisition and on which no development or construction is planned in good faith to commence within one year of the acquisition.
In addition to our investments in secured loans, we may make direct investments in land for development into single-family lots, new and model homes and finished lots and homes; however, we will not independently develop land or construct homes. In cases where we invest in land for the purpose of development, we may engage an unaffiliated third-party developer, and we may bear the cost of development and/or fund construction costs. When we acquire properties, we most often do so through a special purpose entity formed for such purpose or a joint venture formed with a single-family residential developer, homebuilder, real estate developer or other real estate investor, with us providing equity and/or debt financing for the newly-formed entity. In limited circumstances, and in accordance with the federal tax rules for REITs and the exemptions from registration under the Investment Company Act of 1940, as amended (the “Investment Company Act”), we may make equity investments through special purpose entities in land for development into single-family lots, new and model homes and finished lots. We also may enter into joint ventures with unaffiliated real estate developers, homebuilders, land bankers and other real estate investors, or with other United Development Funding-sponsored programs, to originate or acquire, as the case may be, the same kind of secured loans or real estate investments we may originate or acquire directly.
We also seek an increased return by entering into participation agreements with real estate developers, homebuilders or real estate investors or joint venture entities, or by providing credit enhancements for the benefit of other entities that are associated with residential real estate financing transactions. The participation agreements and credit enhancements may come in a variety of forms; participation agreements may take the form of profit agreements, ownership interests and participating loans, while credit enhancements may take the form of guarantees, pledges of assets, letters of credit and inter-creditor agreements. We also provide secured senior and subordinate lines of credit to real estate developers, homebuilders, land bankers and other real estate investors, including other United Development Funding-sponsored programs, for the purchase of finished lots and for the construction of single-family homes.
In the typical transaction in which we provide a credit enhancement to a borrower with respect to a loan from a third party, we expect to charge such borrower a credit enhancement fee of 1% to 7% of the projected maximum amount of our outstanding credit enhancement obligation for each 12-month period such obligation is outstanding, in addition to any costs that we may incur in providing the credit enhancement to the borrower. We cannot assure investors that we will obtain a 1% to 7% credit enhancement fee. The actual amount of such credit enhancement fee will be based on the risk perceived by our Advisor to be associated with the transaction, the value of the collateral associated with the transaction, our security priority as to the collateral associated with the transaction, the form and term of the credit enhancement, and our overall costs associated with providing the credit enhancement; higher risks and increased costs associated with providing the credit enhancement will necessitate the charging of a higher credit enhancement fee. Federal tax laws applicable to REITs also may limit our ability to charge credit enhancement fees unless we make our credit enhancements through a taxable REIT subsidiary (“TRS”).
Furthermore, we may purchase participations in, or finance for other real estate investors, the purchase of securitized real estate loan pools, including pools originated by our affiliates. Typically, real estate lenders wishing to create liquidity will pool loans and sell participations in the pools priced in accordance with the seniority in payment of each level or “tranche” of participation. We will seek yields and priority in accordance with our risk profile and return expectations. If we invest in securitized real estate loan pools originated by our affiliates, such investments must be approved by a majority of our trustees (including a majority of our independent trustees) not otherwise interested in the transaction as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties. In addition, the price must be based on the fair market value of the assets, as determined by an independent expert selected by a majority of our independent trustees.
We also may purchase participations in discounted cash flows secured by state, county, municipal or similar assessments levied on real property. In certain geographic areas, developers use a form of state, county, municipal or similar assessment-based financing to pay for development infrastructure. The development entity is empowered to levy and collect an assessment on real property to repay the cost of the designated improvements. Developers wishing to create liquidity will discount and sell the future revenue stream associated with the levy. We will seek yields and priority in accordance with our risk profile and return expectations.
We concentrate our investments on single-family lot developers who sell their lots to national, regional and local homebuilders for the acquisition of property and the development of residential lots, as well as homebuilders for the construction of single-family homes. We target as a primary development market lots that are under contract to national or regional affordable housing builders, as well as targeting homebuilders themselves for the construction of single-family homes. We generally seek to finance projects where the completed subdivision will consist of homes priced at or below the “conforming loan” limits for the specific geographic region. Conforming loans are loans that are eligible for purchase in the secondary market by government sponsored agencies or insured by an agency of the United States (“U.S.”) government. Generally, conforming loan limits are approximately 150% of the median home price of the respective housing market, adjusted for the specific market. The conforming loan limits are subject to change by law or regulation. We expect most of these homes will be targeted for the first time home buyer or, for the higher priced homes, persons moving from their first, or “starter,” homes to slightly more upscale homes, the so-called “move-up” home buyers. The housing development projects may also include large-scale planned communities, commonly referred to as “master planned communities,” that provide a variety of housing choices, including choices suitable for first time home buyers and move-up home buyers, as well as homes with purchase prices exceeding the conforming loan limits.
We anticipate that the developments that secure our loans and investments will consist of both single-phase and, where larger parcels of land are involved, multi-phase projects and will be subject to third-party land acquisition and development loans representing approximately 60% to 75% of total project costs. These loans will have priority over the loans that we originate or buy, which we expect will represent approximately 15% to 30% of total project costs; however, we will not invest in any property in which the total amount of all secured loans outstanding on such property, including our loans with respect to the property, exceeds 85% of the appraised improved value of the property, unless substantial justification exists because of the presence of other underwriting criteria. In each instance, we will require the borrower to cover at least 10% of the total project costs with its own equity investment, which may be in the form of cash, additional collateral or value-add improvements. We will oftentimes subordinate our loans to the terms of indebtedness from other lenders relating to the subject real property to allow our borrowers to avail themselves of additional land and lot acquisition and development financing at a lower total cost to the borrower than the cost of our loan, although we will not subordinate our loans to any debt or equity interest of our Advisor, our sponsor or any of our trustees, or any of our affiliates. The use of third-party leverage, typically senior bank debt, at favorable rates allows borrowers to reduce their overall cost of funds for lot and land acquisition, community development or home construction by combining our funds with lower-cost debt. Projects that fail to meet timing projections will increase the borrowers’ overall cost of funds because the borrower will be carrying debt and incurring interest for a longer period than anticipated. Conversely, borrowers whose lots, land and homes are sold or otherwise disposed of ahead of schedule may benefit from a lower overall cost of funds.
In addition to the risk that a borrower’s activities to build homes or develop the subject parcels will not be successful or will exceed the borrower’s budget, we believe that we will be subject to market-timing risk, or the risk that market conditions will adversely impact the borrower’s ability to sell the home or developed lots at a profit. Economic issues affecting the new home sales market, such as interest rates, employment rates, population growth, migration and immigration, as well as home ownership rates and household formation trends, will affect the demand for homes and lots, and therefore also impact the likelihood that a developer or homebuilder will be successful. Some of the risks inherent with development and construction financing include: (1) the availability of home mortgage loans and the liquidity of the secondary home mortgage market; (2) the availability of commercial land acquisition and development loans and the corresponding interest and advance rates; (3) the stability of global capital and financial institution markets; (4) the need to contribute additional capital in the event the market softens and the developer or homebuilder requires additional funding; (5) the reduction of the developer’s or homebuilder’s incentive if the developer’s or homebuilder’s profits decrease, which could result in both capital advanced and marketing time increases; and (6) the possibility, in those situations, that our returns will be less than our projected returns.
Our real estate loan and investment model differs from traditional models primarily due to our “actively managed portfolio” approach. UMTH LD, as our asset manager, will identify and underwrite real estate professionals in each region or, in some cases, each sub-market in which we invest, and it will utilize these proprietary strategic partner relationships to actively manage each loan or investment. In some cases, this may involve developing relationships with strategic partners in correcting markets, who may be able to provide us with knowledge, a presence and access to investment opportunities. Given the current economic environment and capital constraints, this also may involve banks, insurance companies, institutional investors and other traditional lending institutions that approach us for assistance with troubled assets. Large institutional investors generally rely on investments meeting initial expectations and, when market conditions negatively impact the performance of their investments, find themselves in need of asset managers or, in some cases, must liquidate investments below their initial return expectations. The inability of some homebuilders and developers to obtain financing through traditional sources may cause homebuilders and developers to seek additional financing from entities with cash, which may include us. Therefore, we will look to purchase investments at a discount when such opportunities are presented. We believe that our strategic partner relationships will help us to identify such potentially beneficial investments.
Our loans and investments are underwritten, in part, on the basis of an assessment by our asset manager of its ability to execute on possible alternative development and exit strategies in light of changing market conditions. We believe there is significant value added through the use of an actively managed portfolio investment model. We manage our investment portfolio in the context of both the development lifecycle and changing market conditions in order to ensure that our assets continue to meet our investment objectives and underwriting criteria.
A significant portion of our income is in the form of interest payments to us in respect of secured loans. Through the fifth year following the termination of our Primary Offering, we intend to reinvest the principal repayments we receive on loans to create or invest in new loans. Following the fifth anniversary of the termination of our Primary Offering, we will not reinvest such proceeds in order to provide our shareholders with increased distributions and provide increased cash flow from which we may repurchase shares from shareholders wishing to sell their shares.
Security
As of December 31, 2013, 91% of our loans were secured by multiple security interests or a security interest and a repayment guaranty. Additional security interests for our loans where we are not the first lien holder include reimbursements of development costs due to the developer being under contract with districts or municipalities, pledges of equity interests (generally, partnership interests or limited liability company interests, as applicable) that are documented by pledge agreements, assignments of equity interests, assignments of distributions from equity interests, assignments of lot sale contracts, cross collateralization agreements and subordinate deeds of trust. We also utilize guarantees to secure our loans. We expect that our real estate loans will be secured by one or more of the following:
·the parcels of land to be developed (secures 64 of 114 outstanding loans as of December 31, 2013, or 60% of the outstanding principal balance of real estate loans as of December 31, 2013);
·finished lots (secures 35 of 114 outstanding loans as of December 31, 2013, or 19% of the outstanding principal balance of real estate loans as of December 31, 2013);
·model homes and new single-family homes (secures 8 of 114 outstanding loans as of December 31, 2013, or 10% of the outstanding principal balance of real estate loans as of December 31, 2013);
·a pledge of some or all of the equity interests in the borrower entity or other parent entity that owns the borrower entity (secures 22 of 114 outstanding loans as of December 31, 2013, or 26% of the outstanding principal balance of real estate loans as of December 31, 2013);
·additional assets of the borrower, including reimbursements of development costs due to the developer under contracts with districts and cities (secures 27 of 114 outstanding loans as of December 31, 2013, or 37% of the outstanding principal balance of real estate loans as of December 31, 2013); and
·in certain cases, guarantees of the principals or parent companies of the operating entity (secures 96 of 114 outstanding loans as of December 31, 2013, or 84% of the outstanding principal balance of real estate loans as of December 31, 2013).
If there is no third-party financing for a development project, our lien on the subject parcels will be a first priority lien. If there is third-party financing, we expect our lien on the subject parcels will be subordinate to such financing. We will enter each loan prepared to assume or retire any senior debt, if necessary to protect our capital. We will seek to enter into agreements with third-party lenders that will require the third-party lenders to notify us of a default by the borrower under the senior debt and allow us to assume or retire the senior debt upon any default under the senior debt.
Mortgage notes that are secured only by a pledge of ownership interests may not be as valuable as notes secured by a first lien if a loan defaults, as there may be liens on the property and the borrower’s only source of cash flow and only asset may be the property itself. Most of our real estate loans, including loans made to entities affiliated with our Advisor, have the benefit of guarantees of the borrower and/or its parent company and pledges of additional assets of the borrower. The parent company of the borrower may own no assets other than its equity interest in the borrower and equity interest of other subsidiaries of the parent company. The parent company guarantees are not secured by the assets of the parent company or the assets of other subsidiaries of the parent company or its affiliates. Thus, we do not attribute any financial value to the parent company’s guarantees in our underwriting process. The use of pledges of ownership interests allows us to more quickly obtain ownership of a property when the borrower has defaulted on a loan, thus allowing us to more quickly determine future actions regarding the property. Where the borrower owns more than one property, the use of pledges may provide us with additional sources of repayment. In addition, loans made to the same borrower or related borrowers may be cross-collateralized, unless cross-collateralization is prohibited by the borrower’s senior lender or the investors in the related borrowers are materially different.
We obtain an appraisal in conjunction with the initial underwriting and origination of each loan in our portfolio. In some cases, we may use an appraisal that has been prepared for another third-party lender, such as a commercial bank. We are not required to reappraise any individual asset; however, we generally will obtain an updated appraisal within 36 months from the date we originate our loan. We actively manage our portfolio, reviewing development timelines and budgets, market absorption rates and trends, lot and land prices, homebuilder performance and third-party market studies to evaluate the value of our collateral on a real time and continuous basis.
Underwriting Criteria
We have developed general and asset specific underwriting criteria for the loans and investments that we originate and purchase. In most cases, we obtain a first or subordinate lien on the underlying real property to secure our loans (mortgage loans), and we also may require a pledge of all of the equity ownership interests in the borrower entity itself as additional security for our loans. In instances where we do not have a lien on the underlying real property, we will obtain a pledge of some or all of the equity ownership interests of the borrower entity itself to secure such loans and/or a pledge of the equity ownership interests of the borrower entity or other parent entity that owns the borrower entity (so-called “mezzanine loans”). We also may require a pledge of additional assets of the borrower, liens against additional parcels of undeveloped and developed real property and/or the personal guarantees of principals or guarantees of operating entities in connection with our secured loans. We typically originate loans bearing interest at rates ranging from 10% to 18% per annum. Loans secured by a first or senior lien generally bear interest from 10% to 18%, further dependent on the amount of all secured loans on the property, creditworthiness of the borrower, the term of the loan and the presence of additional guarantees and/or pledges of additional collateral. Land acquisition loans, finished lot loans and construction loans are generally first-lien secured. Loans secured by subordinate or junior liens or pledges of equity ownership interests generally bear interest from 13% to 18%, further dependent on the amount of all secured loans on the property, creditworthiness of the borrower, the term of the loan and the presence of additional guarantees and/or pledges of additional collateral. Loans for development of real property as single-family residential lots are generally subordinate to conventional third-party financing. We currently do not have a policy that establishes a minimum or maximum term for the loans we may make, nor do we intend to establish one. Loans typically are structured as interest-only notes with balloon payments or reductions to principal tied to net cash from the sale of developed lots and finished homes with the release formula created by the senior lender, i.e., the conditions under which principal is repaid to the senior lender, if any. We will not make or invest in loans on any one property if the aggregate amount of all secured loans on such property, including loans from us, exceeds an amount equal to 85% of the appraised value of such property, unless our board of trustees, including a majority of our independent trustees, determines that substantial justification exists for exceeding such limit because of the presence of other underwriting criteria. We may buy or originate loans in any of the 48 contiguous United States.
Credit Underwriting
We are primarily an asset-based lender and as such our loans are underwritten based on collateral value. The creditworthiness of our borrower and the presence of personal guarantees both influence the amount of money we will agree to advance to the borrower and the interest rate we will charge the borrower.
Asset Specific Underwriting Criteria
The following is a general description of our underwriting criteria with respect to the various types of real estate investments we make and loans we originate or acquire. Origination fees and interest rates charged to borrowers are determined based on collateral, credit repayment guarantees and competition in the credit markets. The term of the loan represents the typical initial term of a loan, without regard to subsequent extensions. Combined loan-to-value ratio is the aggregate of all loan balances, senior and subordinated, divided by the appraised value of the property. Substantial justification to exceed an 85% loan-to-value ratio may exist because of the presence of other underwriting criteria such as the net worth of the borrower, the credit rating of the borrower based on historical financial performance, or collateral adequate to justify a waiver of the 85% limitation. In addition, the 85% limitation may be exceeded where mortgage loans are or will be insured or guaranteed by a government or government agency; where the loan is secured by the pledge or assignment of other real estate or another real estate mortgage; where rents are assigned under a lease where a tenant or tenants have demonstrated through historical net worth and cash flow the ability to satisfy the terms of the lease, or where similar criteria is presented satisfactory to the official or agency administering the securities laws of a jurisdiction. Leverage refers to the maximum aggregate asset-specific indebtedness provided by unaffiliated third parties with respect to a specific asset and is expressed as a percentage of either cost or appraised value. A tri-party agreement refers to agreements between the senior and subordinate lenders that set forth the rights and obligations amongst and between the parties, and pursuant to which the subordinate lender may assume or purchase the senior indebtedness in the event of a default by the borrower.
Loans
·Senior and Subordinated Secured Land Acquisition Loans
·Asset: land designated for development into residential lots (in certain instances, this may include ancillary commercial land)
·Liens: first liens, junior liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 12 to 24 months
·Combined Loan-to-Value Ratio: not to exceed 85% of appraised value unless substantial justification exists because of the presence of other underwriting criteria
·Leverage: third party indebtedness up to 65% of the cost of the land
·Title Insurance: mortgagee’s title policy required on all senior and junior liens and owner’s title policy required on pledges of equity interests
·Tri-Party Agreement: required if loan is subordinated to third-party lender
·Senior and Subordinated Secured Development Loans
·Asset: land under development into residential lots and all improvements thereon
·Liens: first liens, junior liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 18 to 48 months
·Combined Loan-to-Value Ratio: not to exceed 85% of appraised value unless substantial justification exists because of the presence of other underwriting criteria
·Leverage: third-party senior indebtedness up to 75% of the cost of land and improvements
·Title Insurance: mortgagee’s title policy required on all senior and junior liens and owner’s title policy required on pledges of equity interests
·Tri-Party Agreement: required if loan is subordinated to third-party lender
·Senior and Subordinated Secured Finished Lot Loans
·Asset: finished residential lots
·Liens: first liens, junior liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 12 to 36 months
·Combined Loan-to-Value Ratio: not to exceed 85% of appraised value unless substantial justification exists because of the presence of other underwriting criteria
·Leverage: third-party senior indebtedness up to 75% of the appraised value of the finished lots
·Title Insurance: mortgagee’s title policy required on all senior and junior liens and owner’s title policy required on pledges of equity interests
·Tri-Party Agreement: required if loan is subordinated to third-party lender
·Senior and Subordinated Secured Model Home Loans
·Asset: finished model homes
·Liens: first liens, junior liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 12 to 36 months
·Combined Loan-to-Value Ratio: not to exceed 85% of appraised value unless substantial justification exists because of the presence of other underwriting criteria
·Leverage: third-party senior indebtedness up to 80% of the appraised value of the model homes
·Title Insurance: mortgagee’s title policy required on all senior and junior liens and owner’s title policy required on pledges of equity interests
·Other: assignment of model home lease
·Tri-Party Agreement: required if loan is subordinated to third-party lender
·Senior and Subordinated Secured Construction Loans
·Asset: residential lots with homes under construction
·Liens: first liens, junior liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 12 months
·Combined Loan-to-Value Ratio: not to exceed 85% of appraised value
·Leverage: third-party senior indebtedness up to 90% of the cost of the lots and homes
·Title Insurance: mortgagee’s title policy required on all senior and junior liens and owner’s title policy required on pledges of equity interests
·Tri-Party Agreement: required if loan is subordinated to third-party lender
·Senior Lines of Credit for Finished Lots
·Asset: finished residential lots
·Liens: first liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 12 to 36 months
·Loan-to-Value Ratio: not to exceed 85% of appraised value unless substantial justification exists because of the presence of other underwriting criteria
·Leverage: third-party senior indebtedness up to 90% of the appraised value of the finished lot
·Title Insurance: mortgagee’s title policy required
·Other: earnest money deposit, option fees and/or letters of credit supporting lot purchase contracts
·Senior Lines of Credit for Home Construction
·Asset: residential lots with homes under construction
·Liens: first liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 12 months
·Loan-to-Value Ratio: not to exceed 85% of appraised value
·Leverage: third-party senior indebtedness up to 90% of the cost of the lots and homes
·Title Insurance: mortgagee’s title policy required
·Subordinate Lines of Credit for Finished Lots
·Asset: finished residential lots
·Liens: junior liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 12 to 36 months
·Combined Loan-to-Value Ratio: not to exceed 85% of appraised value unless substantial justification exists because of the presence of other underwriting criteria
·Leverage: third-party senior indebtedness up to 75% of the appraised value of the finished lots
·Title Insurance: mortgagee’s title policy required on all senior and junior liens and owner’s title policy required on pledges of equity interests
·Other: earnest money deposit, option fees or letters of credit supporting lot purchase contracts
·Tri-Party Agreement: required if loan is subordinated to third-party lender
·Subordinate Lines of Credit for Home Construction
·Asset: residential lots with homes under construction
·Liens: junior liens and/or pledges of all of the equity interests of the entity holding title to the subject property, including without limitation personal and entity guarantees and additional pledges of cash, revenue streams, municipal reimbursements or property
·Term: 12 months
·Combined Loan-to-Value Ratio: not to exceed 85% of appraised value unless substantial justification exists because of the presence of other underwriting criteria
·Leverage: third-party senior indebtedness up to 90% of the cost of the lots and homes
·Title Insurance: mortgagee’s title policy required on all senior and junior liens and owner’s title policy required on pledges of equity interests
·Tri-Party Agreement: required if loan is subordinated to third-party lender
Real Estate Investments
·Land Investments
·Asset: land designated for development and land under development into residential lots
·Ownership: fee simple to us, our wholly-owned subsidiary or co-venturer entity designated for ownership of property
·Term: 12 to 60 months
·Leverage: third-party senior indebtedness up to 75% of the cost of the land
·Title Insurance: owner’s title policy required
·Model Home and Finished Home Investments
·Asset: finished model homes
·Ownership: fee simple to us, our wholly-owned subsidiary or co-venturer entity designated for ownership of property
·Term: 24 to 36 months
·Leverage: third-party senior indebtedness up to 90% of the appraised value of the lots and homes
·Title Insurance: owner’s title policy required
·Finished Lot Investments
·Asset: finished residential lots
·Ownership: fee simple to us, our wholly-owned subsidiary or co-venturer entity designated for ownership of property
·Term: 24 to 36 months
·Leverage: third-party senior indebtedness up to 80% of the appraised value of the finished lots
·Title Insurance: owner’s title policy required
·Purchase of Discounted Cash Flow
·Asset: state, county, municipal or other similar assessments levied on real property
·Ownership: through assignment or purchase of debt instrument to us, our wholly-owned subsidiary or co-venturer entity designated for ownership
·Term: indeterminate
·Leverage: the appraised value of the finished lots up to 90% of the cost of the asset
Credit Facility
On February 5, 2010, during the credit crisis in which financial institutions severely reduced the number of loans made to entities involved in real estate, we obtained a revolving credit facility in the maximum principal amount of $8.0 million (the “Credit Facility”) from Raley Holdings, LLC, an unaffiliated company (“Raley Holdings”). The interest rate on the Credit Facility was equal to 8.5% per annum and accrued interest on the outstanding principal amount of the Credit Facility was payable monthly. The Credit Facility’s original maturity date was February 5, 2011. Effective August 10, 2010, the Credit Facility was amended to increase the maximum principal amount to $20.0 million, pursuant to a First Amendment to Secured Line of Credit Promissory Note between us and Raley Holdings. The Credit Facility was subsequently amended three additional times pursuant to three separate extension agreements which extended the maturity date of the Credit Facility to February 5, 2014. The Credit Facility was secured by a first priority collateral assignment and lien on certain of our assets. The Credit Facility was paid in full and terminated in June 2013.
In connection with this Credit Facility, we paid debt financing fees totaling approximately $207,000 to UMTH GS.
Credit Enhancements
Credit enhancements are underwritten in the same manner as our other real estate investments. The collateral, term, leverage, rates and guarantee criteria will follow the applicable land, development, finished lot or construction loan terms.
The principal amounts of our loans and the number of loans and investments we make will be affected by market availability and will depend upon the amount of net offering proceeds available to us from the sale of shares.
Borrowing Policies
There is no limitation on the amount we may borrow for the purchase or origination of a single secured loan, the purchase of an individual property or any other investment. Under our declaration of trust, the maximum amount of our indebtedness shall not exceed 300% of our net assets as of the date of any borrowing; however, we may exceed that limit if approved by a majority of our independent trustees and disclosed in our next quarterly report to shareholders, along with justification for such excess. In addition to our declaration of trust limitation, our board of trustees has adopted a policy to generally limit our fund level borrowings to 50% of the aggregate fair market value of our assets unless substantial justification exists that borrowing a greater amount is in our best interests. We have incurred and may continue to incur debt at the asset level. Asset level leverage is determined by the anticipated term of the investment and the cash flow expected by the investment. Asset level leverage is expected to range from 0% to 90% of the asset value. Our policy limitation does not apply to individual real estate assets and only will apply once we have ceased raising capital under the Offering or any subsequent offering and invested a majority of the net proceeds from such offerings. We have incurred fund level indebtedness in the form of revolving credit facilities permitting us to borrow up to an agreed-upon outstanding principal amount. Such debt is and will continue to be secured by a first priority lien upon all of our existing and future acquired assets. See Note L to the Consolidated Financial Statements included in the accompanying consolidated financial statements for further discussion of our notes payable and lines of credit.
Investment Limitations
Our declaration of trust includes numerous limitations with respect to the manner in which we may invest our funds or issue securities. Until our common shares of beneficial interest are listed for trading on a national securities exchange, we will not:
·borrow in excess of 300% of our net tangible assets, unless a majority of the independent trustees approves each borrowing in excess of our declaration of trust limitation and we disclose such borrowing to our shareholders in our next quarterly report with an explanation from the independent trustees of the justification for the excess borrowing;
·invest in commodities or commodity futures contracts, except for futures contracts when used solely for the purpose of hedging in connection with our ordinary business of investing in real estate assets and secured loans;
·invest in real estate contracts of sale, otherwise known as land sale contracts, unless the contract is in recordable form and is appropriately recorded in the chain of title;
·make or invest in secured loans unless an appraisal is obtained concerning the underlying property, except for those secured loans insured or guaranteed by a government or government agency. Prior to making such investment, we will obtain an appraisal of such investment from a person who is in the business of rendering opinions regarding the value of assets of the type held by us and who is qualified to perform such work. In cases where our independent trustees determine, and in all cases in which the transaction is with any of our trustees or our Advisor or its affiliates, such appraisal will be obtained from an independent appraiser. We will maintain such appraisal in our records for at least five years, and it will be available for inspection and duplication by our shareholders. In addition, we will obtain a mortgagee’s or owner’s title insurance policy or a commitment as to the priority of the secured loan;
·make or invest in secured loans that are subordinate to any mortgage or equity interest of any of our trustees, our Advisor or its affiliates;
·make or invest in secured loans, including development and construction loans, on any one property if the aggregate amount of all secured loans on such property, including loans from us, would exceed an amount equal to 85% of the appraised value of such property unless substantial justification exists because of the presence of other underwriting criteria;
·invest more than 10% of our total assets in unimproved real property (which we define as property not acquired for the purpose of producing rental or other operating income, which has no development or construction in process at the time of acquisition and on which no development or construction is planned in good faith to commence within one year of the acquisition) or secured loans, bridge or mezzanine loans on unimproved real property;
·invest in equity securities, unless a majority of the board of trustees (including a majority of the independent trustees) not otherwise interested in the transaction approves such investment as being fair, competitive and commercially reasonable;
·issue equity securities on a deferred-payment basis or other similar arrangement;
·issue debt securities in the absence of adequate cash flow to cover debt service;
·issue options or warrants to purchase shares to our Advisor, trustees, sponsor or any affiliate thereof (1) on terms more favorable than we offer such options or warrants to the general public or (2) in excess of an amount equal to 10% of our outstanding shares of beneficial interest on the date of grant;
·issue securities that are redeemable solely at the option of the holder, which restriction has no effect on our share redemption program or the ability of our operating partnership to issue redeemable partnership interests; or
·make any investment that we believe would be inconsistent with our objectives of qualifying and remaining qualified as a REIT unless the board of trustees determines, in its sole discretion, that REIT qualification is not in our best interest.
Our declaration of trust requires that our independent trustees review our investment policies at least annually to determine that the policies we follow are in the best interest of our shareholders. We intend to conduct our operations so that we are not required to register as an investment company under the Investment Company Act.
Disposition Policies
If we acquire real properties, as each of those properties reach what we believe to be its optimum value during the expected life of the fund, we may consider disposing of the investment for the purpose of either distributing the net sale proceeds to our shareholders or investing the proceeds in other assets that we believe may produce a higher overall future return to our shareholders. The determination of when a particular investment should be sold or otherwise disposed of will be made after consideration of relevant factors, including prevailing and projected economic conditions, whether the value of the property or other investment is anticipated to decline substantially, whether we could apply the proceeds from the sale of the asset to make other investments consistent with our investment objectives, whether disposition of the asset would allow us to increase cash flow, and whether the sale of the asset would constitute a prohibited transaction under the Internal Revenue Code or otherwise impact our status as a REIT. Our ability to dispose of property during the first few years following its acquisition will be restricted to a substantial extent as a result of our REIT status. Under applicable provisions of the Internal Revenue Code regarding prohibited transactions by REITs, a REIT that sells property other than foreclosure property that is deemed to be inventory or property held primarily for sale in the ordinary course of business is deemed a “dealer” and subject to a 100% penalty tax on the net income from any such transaction. As a result, our board of trustees will attempt to structure any disposition of our properties to avoid this penalty tax through reliance on safe harbors available under the Internal Revenue Code for properties held at least two years or through the use of a TRS.
Conflicts of Interest
We depend on our Advisor and its affiliates for the day-to-day management of our operations. As a result, we are subject to various conflicts of interest arising out of our relationship with our Advisor and its affiliates, including conflicts related to the arrangements pursuant to which our Advisor and its affiliates will be compensated by us. All of our agreements and arrangements with our Advisor and its affiliates, including those relating to compensation, are not the result of arm’s length negotiations. However, we believe that all of our agreements and arrangements with our Advisor and its affiliates, including those relating to compensation, are consistent with the NASAA REIT Guidelines regarding conflicts of interest. In addition, our legal counsel, Morris, Manning & Martin, LLP, and our independent registered public accounting firm, Whitley Penn LLP, are independent entities who were selected by our board of trustees and each provides services to our Advisor and other entities affiliated with our Advisor. If the interests of the various parties become adverse, they may face conflicts of interest and may be precluded from representing any one or all of such parties.
Our independent trustees have an obligation to function on our behalf in all situations in which a conflict of interest may arise, and all of our trustees have a fiduciary obligation to act on behalf of our shareholders.
Our Advisor and its affiliates act as advisors, asset managers or general partners of other United Development Funding-sponsored programs that have investment objectives similar to ours, and we expect that they will organize other such programs in the future. These persons have legal and financial obligations with respect to these programs that are similar to their obligations to us. As general partners, they may have contingent liability for the obligations of programs structured as partnerships. If such obligations were enforced against them, it could result in a substantial reduction of their net worth. The chart below indicates the relationships between our Advisor and its affiliates.
(1)Todd F. Etter and Hollis M. Greenlaw each own one-half of the equity interests in UMT Services, Inc. (“UMT Services”). Messrs. Etter and Greenlaw and Michael K. Wilson serve as directors of UMT Services. UMT Services serves as general partner of UMTH GS, our Advisor.
(2)UMT Services serves as the general partner and owns 0.1% of the limited partnership interests in UMT Holdings, L.P. (“UMT Holdings”). The remaining 99.9% of the limited partnership interests in UMT Holdings are held as follows as of December 31, 2013: Mr. Etter (30.00%), Mr. Greenlaw (30.00%), Craig A. Pettit (5.00%), Timothy J. Kopacka (4.84%), Michael K. Wilson (7.41%), Christine A. Griffin (1.95%), Cara D. Obert (4.82%), William E. Lowe (1.06%), Ben L. Wissink (10.09%) and Melissa H. Youngblood (4.83%).
(3)UMT Services serves as the general partner and owns 0.1% of the limited partnership interests in each of UMTH GS and UMTH LD. UMT Holdings owns the remaining 99.9% of the limited partnership interests in each of UMTH GS and UMTH LD, our asset manager. UMTH LD also serves as the asset manager for United Development Funding, L.P. (“UDF I”) and United Development Funding II, L.P. (“UDF II”), each a Delaware limited partnership. In addition, UMTH LD serves as the general partner of United Development Funding III, L.P. (“UDF III”), a publicly registered Delaware limited partnership, and as the general partner and sole limited partner of UDF Land GenPar, LP, a Delaware limited partnership (“UDF LGP”). UDF LGP serves as the general partner of United Development Funding Land Opportunity Fund, L.P., a Delaware limited partnership (“UDF LOF”). UMTH LD also serves as the asset manager of UDF LOF.
(4)United Development Funding, Inc. is owned 33.75% by each of Messrs. Greenlaw and Etter, 22.5% by Mr. Kopacka, and 10% by Ms. Griffin.
(5)United Development Funding II, Inc. is owned 50% by each of Messrs. Etter and Greenlaw.
(6)UMTH LD owns 100% of the general partnership and limited partnership interests in UDF LGP.
(7)UMTH GS serves as the advisor for United Mortgage Trust (“UMT”), a Maryland real estate investment trust.
(8)United Development Funding, Inc. serves as general partner for UDF I and owns a 0.02% general partnership interest, UMTH LD owns a 49.99% subordinated profits interest, and unaffiliated limited partners own the remaining 49.99% of the interests in UDF I. UDF I is a real estate finance company that engages in the business in which we engage and intend to continue to engage.
(9)United Development Funding II, Inc. serves as general partner for UDF II and owns a 0.1% general partnership interest, UMTH LD owns a 49.95% subordinated profits interest, and unaffiliated limited partners own the remaining 49.95% of the interests in UDF II. UDF II is a real estate finance company that engages in the business in which we engage and intend to continue to engage.
(10)UMTH LD holds a 0.01% general partner interest in UDF III. Approximately 8,900 limited partners as of December 31, 2013 own 99.99% of the limited partnership units of UDF III. UDF III is a real estate finance company that engages in the business in which we engage and intend to continue to engage.
(11)UDF LGP holds a 0.01% general partnership interest in UDF LOF. UDF LGP also holds a subordinated profit participation interest in UDF LOF. The investors who purchased units in the private offering of UDF LOF own 99.9% of the limited partnership interests. As of December 31, 2013, approximately 610 limited partners held interests in UDF LOF. UDF LOF is a real estate finance company that engages in the business in which we engage and intend to continue to engage.
(12)UMT Holdings owns 10,000 of our shares of beneficial interest as of December 31, 2013.
(13)We own a 99.999% general partner interest in UDF IV OP. UMTH LD owns a 0.001% limited partner interest in UDF IV OP.
Housing Industry
After five years of declines, particularly in geographic areas that had previously experienced rapid growth, steep increases in property values and speculation, the U.S. housing market has seen positive trends in 2012 and 2013. In 2009, the homebuilding industry was focused on further reducing supply and inventory overhang of new single-family homes. In 2010, national and regional homebuilders increased the number of homes constructed from the number constructed in 2009. In 2011, the number of new homes constructed fell slightly from 2010 as homebuilders adjusted to the expiration of the federal homebuyer tax credit, which we believe pulled demand forward at the expense of the following sales season. We believe that while demand for new homes was affected across the country by the general decline of the housing industry, the housing markets in the geographic areas in which we have invested and intend to invest have not been impacted as greatly. Further, we believe that, as a result of the inventory reductions and corresponding lack of development over the past few years, the supply of new homes and finished lots has generally aligned with market demand in most real estate markets. Home starts increased in 2013 to 923,000, the highest level since 2007, and we expect that more homes will be started in 2014 than in 2013 as homebuilders meet increasing demand. We also believe that we will see continued demand for our products in 2014.
Competition
Real estate investment and finance is a very competitive industry. We compete with many other entities engaged in real estate investment activities, including individuals, corporations, bank and insurance company investment accounts, real estate limited partnerships, other real estate investment trusts, institutional investors, homebuilders, developers and other entities engaged in real estate investment activities. Many of these may have greater resources than we do and may enjoy significant competitive advantages, such as a lower cost of capital and enhanced operating efficiencies. In addition, the proliferation of the Internet as a tool for real estate acquisitions and loan origination has made it very inexpensive for new competitors to participate in the real estate investment and finance industry. Our ability to make or purchase a sufficient number of loans and investments to meet our objectives will depend on the extent to which we can compete successfully against these other entities, including entities that may have greater financial or marketing resources, greater name recognition or larger customer bases than we have. Our competitors may be able to undertake more effective marketing campaigns or adopt more aggressive pricing policies than we can, which may make it more difficult for us to attract customers. Increased competition could result in lower revenues and higher expenses, which would reduce our profitability.
Regulations
All real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. These laws and regulations generally govern wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials, and the remediation of contamination associated with disposals. Under limited circumstances, a secured lender, in addition to the owner of real estate, may be liable for clean-up costs or have the obligation to take remedial actions under environmental laws, including, but not limited to, the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or CERCLA. Some of these laws and regulations may impose joint and several liability for the costs of investigation or remediation of contaminated properties, regardless of fault or the legality of the original disposal. In addition, the presence of these substances, or the failure to properly remediate these substances, may adversely affect our ability to sell such property or to use the property as collateral for future borrowing.
If we foreclose on a defaulted loan to recover our investment, we may become subject to environmental liabilities associated with that property if we participate in the management of that property or do not divest ourselves of the property at the earliest practicable time on commercially reasonable terms. Environmental laws may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures. It is possible that property on which we foreclose may contain hazardous substances, wastes, contaminants or pollutants that we may be required to remove or remediate in order to clean up the property. If we foreclose on a contaminated property, we may also incur liability to tenants or other users of neighboring properties. We cannot assure our shareholders that we will not incur full recourse liability for the entire cost of removal and cleanup, that the cost of such removal and cleanup will not exceed the value of the property, or that we will recover any of these costs from any other party. It may be difficult or impossible to sell a property following discovery of hazardous substances or wastes on the property. The cost of defending against claims of liability, of compliance with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could materially adversely affect our business, assets or results of operations and, consequently, amounts available for distribution to our shareholders.
In addition, as a non-bank lender of commercial loans, we are subject to various state and federal regulations regarding usury laws. State and federal usury laws limit the interest that lenders are entitled to receive on a mortgage loan. In determining whether a given transaction is usurious, courts may include charges in the form of “points” and “fees” as “interest,” but may exclude payments in the form of “reimbursement of foreclosure expenses” or other charges found to be distinct from “interest.” While we contract for interest at a rate that is less than or equal to the applicable maximum amount of non-usurious interest and our loan documents and Texas law provide us with an opportunity to cure usurious charges, if the amount charged for the use of the money loaned is found to exceed a statutorily established maximum rate (under Texas law, the current maximum amount of non-usurious interest is 18% per annum) and we fail to cure, the form employed and the degree of overcharge are both immaterial to the determination that the loan is usurious. Statutes differ in their provision as to the consequences of a usurious loan. One group of statutes requires the lender to forfeit the interest above the applicable limit or imposes a specified penalty. Under this statutory scheme, the borrower may have the recorded mortgage or deed of trust cancelled upon paying its debt with lawful interest, or the lender may foreclose, but only for the debt plus lawful interest. Under a second, more severe type of statute, a violation of the usury law results in the invalidation of the transaction, thereby permitting the borrower to have the recorded mortgage or deed of trust cancelled without any payment (thus prohibiting the lender from foreclosing).
Employees
As of December 31, 2013, we had no employees; however, our Advisor and affiliates of our Advisor have a staff of employees who perform a range of services for us, including originations, acquisitions, asset management, accounting, legal and investor relations.
On February 3, 2014, our board of trustees appointed Stacey H. Dwyer as our Chief Operating Officer, effective February 17, 2014. See “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Subsequent Events” below for further discussion.
Financial Information about Industry Segments
Our current business consists only of originating, acquiring, servicing and managing loans on real property and reimbursements, acquiring participation interests in third-party loans on real property, issuing or acquiring an interest in credit enhancements to borrowers and making direct investments in finished lots. We internally evaluate our activities as one industry segment, and, accordingly, we do not report segment information.
Available Information
We electronically file an annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports with the SEC. We also have filed with the SEC our registration statement in connection with the Offering. Copies of our filings with the SEC may be obtained from the website maintained by our sponsor at http://www.udfonline.com or at the SEC’s website, at http://www.sec.gov. Access to these filings is free of charge. We are not incorporating our website or any information from the website into this Annual Report on Form 10-K.
Item 1A.
Item 1A. Risk Factors.
The factors described below represent our principal risks. Other factors may exist that we do not consider to be significant based on information that is currently available or that we are not currently able to anticipate.
Risks Related to the Restatement
We cannot be certain that any remedial measures we have taken or intend to take in the future will ensure that we design, implement and maintain adequate controls over our financial processes and reporting with respect to future filings with the SEC; accordingly, additional material weaknesses may occur in the future.
As a result of our review of issues identified in connection with the Restatement, we have determined that a material weakness in our internal control over financial reporting existed as of December 31, 2013 and for all periods since inception. Specifically, UMTH LD did not maintain (and we did not require them to maintain) contemporaneous, sufficiently detailed time records on a loan by loan basis to enable us to reasonably determine the amount of time allocable to direct loan origination activities and thus the amount of Acquisition and Origination Fees allowable for deferral under ASC 310-20. A detailed description of this material weakness is provided in “Part II - Item 9A - Controls and Procedures.” Due to this material weakness, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2013 (which also resulted in our disclosure controls and procedures to being ineffective as of December 31, 2013). This material weakness caused an accounting error requiring the Restatement.
It is possible that additional control deficiencies may be identified in the future that may represent one or more material weaknesses that, among other things, could cause us to fail to file timely our periodic reports with the SEC; prevent us from providing reliable and accurate financial information and forecasts or from avoiding or detecting fraud; or require us to incur additional costs or divert management resources to comply with Section 404 of the Sarbanes-Oxley Act of 2002.
Risks Related to an Investment in UDF IV
There is no public trading market for our shares; therefore, it will be difficult for shareholders to sell their shares. If a shareholder is able to sell their shares, the shareholder may have to sell them at a substantial discount from the public offering price. In addition, we do not have a fixed liquidation date, and the shareholder may have to hold their shares indefinitely.
There is no public market for our shares, and we cannot guarantee that one will ever develop. It will, therefore, be difficult for shareholders to sell their shares promptly, or at all. In addition, the price received for the sale of any of our common shares of beneficial interest is likely to be less than the proportionate value of our investments. We will seek to list our shares for trading on a national securities exchange only if our independent trustees believe listing would be in the best interest of our shareholders. If our shares are listed, we cannot assure shareholders a public trading market will develop. We cannot assure shareholders that the price they would receive in a sale on a national securities exchange would be representative of the value of the assets we own or that it would equal or exceed the amount they paid for the shares. Furthermore, our declaration of trust does not provide a specific date on which we must liquidate. Therefore, shareholders should purchase the shares only as a long-term investment and they may have to hold their shares indefinitely.
The minimum purchase requirements and suitability standards imposed on prospective investors in the Offering also apply to subsequent purchasers of our shares. If shareholders are able to find a buyer for their shares, they may not sell their shares to such buyer unless the buyer meets the suitability standards applicable to him, which may inhibit a shareholder’s ability to sell their shares. Furthermore, we are limited in our ability to buy back shares pursuant to our redemption program, including limits on the price we may pay for shareholders’ shares. Our board of trustees may reject any request for redemption of shares or amend, suspend or terminate our share redemption program at any time. Shareholders may not be able to sell their shares in the event of an emergency, and, if shareholders are able to sell their shares, they may have to sell them at a substantial discount from the public offering price. It is also likely that their shares would not be accepted as the primary collateral for a loan.
The prior performance of real estate investment programs sponsored by our Advisor and its affiliates may not be an indication of our future results.
We were formed in May 2008, and UMTH GS, our Advisor, was formed in March 2003. Shareholders should not assume that our performance will be similar to the past performance of other real estate investment programs sponsored by our Advisor and its affiliates. To be successful in this market, we must, among other things:
·increase awareness of the United Development Funding name within the investment products market;
·attract, integrate, motivate and retain qualified personnel to manage our day-to-day operations;
·respond to competition both for investment opportunities and potential investors in us; and
·build and expand our operations structure to support our business.
We cannot guarantee that we will succeed in achieving these goals, and our failure to do so could cause shareholders to lose all or a portion of their investment.
If we, through our Advisor, are unable to find suitable investments, then we may not be able to achieve our investment objectives or pay distributions.
Our ability to achieve our investment objectives and to pay distributions is dependent upon the performance of our Advisor in the identification of real estate loans and other investments and the determination of any financing arrangements. We have not identified all of the properties to acquire or secured loans to originate or acquire with proceeds from the Offering. Shareholders will have no opportunity to evaluate the terms of transactions or other economic or financial data concerning our investments. Shareholders must rely entirely on the oversight of our board of trustees and the management ability of our Advisor. We cannot be sure that our Advisor will be successful in obtaining suitable investments on financially attractive terms or that our objectives will be achieved.
Shareholders will not have the opportunity to evaluate our investments before they are made.
We will seek to invest substantially all of the offering proceeds available for investments, after the payment of fees and expenses, in secured loans made directly by us or indirectly through our affiliates to persons and entities for the acquisition and development of parcels of real property as single-family residential lots, and the construction of model and new single-family homes, including development of mixed-use master planned residential communities. We may also make direct investments in land for development into single-family lots, new and model homes and portfolios of finished lots and homes. We rely entirely on our Advisor with respect to the acquisition of our investments, and shareholders will not be able to evaluate our future investments. We cannot be sure that we will be successful in obtaining additional suitable investments. If we are unable to identify additional properties or loans that satisfy our investment objectives in a timely fashion, our business strategy and operations may be adversely affected.
We may suffer from delays in locating suitable investments, particularly as a result of the current economic environment and capital constraints, which could adversely affect the return on shareholders’ investments.
We could suffer from delays in locating suitable investments, particularly as a result of the current economic environment, capital constraints and our reliance on our Advisor and referrals by borrowers, developers, commercial lenders, homebuilders and other referral sources. Losses during the housing downturn combined with continuing capital constraints at the heart of the credit crisis have reduced the number of real estate lenders able or willing to finance development, construction and the purchase of homes, thus reducing the number of homebuilders and developers that are able to receive such financing. In the event that homebuilders and developers fail or reduce the number of their development and homebuilding projects, resulting in a reduction of new loan applicants, or the supply of referrals by borrowers, developers, commercial lenders and homebuilders decreases, the availability of investments for us would also decrease. Such decreases in the demand for secured loans could leave us with excess cash. In such instances, we plan to make short-term, interim investments with proceeds available from sales of shares and hold these interim investments, pending investment in suitable loans and real estate properties. Interest returns on these interim investments are usually lower than on secured loans and real estate properties, which may reduce the yield to holders of shares and our ability to pay distributions to our shareholders, depending on how long these interim investments are held.
When we invest in short-term, interim investments using proceeds from the sale of shares, those shareholders will nevertheless participate equally in our distributions of income with holders of shares whose sale proceeds have been invested in secured loans and real estate properties. This will favor, for a time, holders of shares whose purchase monies were invested in interim investments, to the detriment of holders of shares whose purchase monies are invested in normally higher-yielding secured loans and real estate properties.
The payment of distributions from sources other than our cash flow from operations reduces the funds available for real estate investments, and a shareholder’s overall return may be reduced.
Our organizational documents permit us to make distributions from any source. Because we have funded distributions from financings or the net proceeds from the Offering, we will have less funds available for real estate investments, and a shareholder’s overall return may be reduced. Further, to the extent distributions exceed cash flow from operations, a shareholder’s basis in our common shares of beneficial interest will be reduced and, to the extent distributions exceed a shareholder’s basis, the shareholder may recognize capital gain. We have not established any limit on the amount of proceeds from the Offering that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would (1) cause us to be unable to pay our debts as they become due in the usual course of business; or (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences, if any.
For the year ended December 31, 2013, we paid distributions of approximately $44.6 million ($27.7 million in cash and $16.9 million in our common shares of beneficial interest pursuant to our DRIP), as compared to cash flows provided by operations of approximately $24.5 million and funds from operations (“FFO”) of $29.3 million. From May 28, 2008 (Date of Inception) through December 31, 2013, we paid cumulative distributions of approximately $74.0 million, as compared to cumulative FFO of approximately $49.3 million (see “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Funds from Operations and Modified Funds from Operations” below for a discussion of FFO). As of December 31, 2013, we had approximately $2.7 million of cash distributions declared that were paid subsequent to period end.
The distributions paid during the years ended December 31, 2013 and 2012, along with the amount of distributions reinvested pursuant to our DRIP and the sources of our distributions are reflected in the table below. In connection with the Restatement, cash payments to UMTH LD associated with Acquisition and Origination Fees were reclassified from investing activities to operating activities, thus reducing operating cash available for distributions. The impact of the Restatement on the tables below is more specifically described in Note C of the accompanying Notes to the Consolidated Financial Statements. The sources of distributions in the table below have been adjusted to reflect the impact of the Restatement.
The following table reflects the impact of the Restatement on the sources of distributions paid during the years ended December 31, 2011 and 2010. We did not pay any distributions for the year ended December 31, 2009.
Competition with third parties in financing properties may reduce our profitability and the return on a shareholder’s investment.
Real estate investment and finance is a very competitive industry. We compete with many other entities engaged in real estate investment activities, including individuals, corporations, bank and insurance company investment accounts, real estate limited partnerships, other real estate investment trusts, institutional investors, homebuilders, developers and other entities engaged in real estate investment activities, many of which have greater resources than we do and may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. In addition, the proliferation of the Internet as a tool for real estate acquisitions and loan origination has made it very inexpensive for new competitors to participate in the real estate investment and finance industry. Our ability to make or purchase a sufficient number of loans and investments to meet our objectives will depend on the extent to which we can compete successfully against these other entities, including entities that may have greater financial or marketing resources, greater name recognition or larger customer bases than we have. Our competitors may be able to undertake more effective marketing campaigns or adopt more aggressive pricing policies than we can, which may make it more difficult for us to attract customers. Increased competition could result in lower revenues and higher expenses, which would reduce our profitability.
Deterioration in the homebuilding industry or economic conditions could decrease demand and pricing for new homes and residential home lots and have additional adverse effects on our operations and financial results.
Developers to whom we will make loans and with whom we will enter into subordinate debt positions will use the proceeds of our loans and investments to develop raw real estate into residential home lots. The developers obtain the money to repay our development loans by selling the residential home lots to homebuilders or individuals who will build single-family residences on the lots, or by obtaining replacement financing from other lenders. The developer’s ability to repay our loans is based primarily on the amount of money generated by the developer’s sale of its inventory of single-family residential lots.
The homebuilding industry is cyclical and is significantly affected by changes in industry conditions, as well as in general and local economic conditions, such as:
•employment levels and job growth;
•demographic trends, including population increases and decreases and household formation;
•availability of financing for homebuyers;
•interest rates;
•affordability of homes;
•consumer confidence;
•levels of new and existing homes for sale, including foreclosed homes; and
•housing demand.
These conditions may exist on a national scale or may affect some of the regions or markets in which we operate more than others. An oversupply of alternatives to new homes, such as existing homes, including homes held for sale by investors and speculators, foreclosed homes, and rental properties, can also reduce the homebuilder’s ability to sell new homes, depress new home prices, and reduce homebuilder margins on the sales of new homes, which likely would reduce the amount and price of the residential homes sold by the homebuilders purchasing lots from developers to which we have loaned money and/or increase the absorption period in which such lots are purchased.
Historically, the homebuilding industry uses expectations for future volume growth as the basis for determining the optimum amount of land and lots to own. The U.S. housing market suffered declines in 2006 and further deterioration in 2007, 2008 and 2009, particularly in geographic areas that had experienced rapid growth, steep increases in property values and speculation. We believe that the homebuilding industry significantly slowed its purchases of land and lots over that time as part of its strategy to reduce inventory to better match the reduced rate of production.
The majority of our investment activities are in the Southeast and Southwest section of the United States, particularly in Texas. Deterioration of homebuilding conditions or in the broader economic conditions of the markets where we operate could cause the number of homebuyers to decrease, which would increase the likelihood of defaults on our loans and, consequently, reduce our ability to pay distributions to our shareholders. We believe that the housing market conditions will continue to be challenging and we cannot predict the duration or ultimate severity of these challenges. Our operations could be negatively affected to the extent that any housing industry downturn is prolonged or becomes more severe. The reduction in availability of mortgage financing and the volatility and reduction in liquidity in the financial markets may adversely affect our business, and the duration and ultimate severity of the effects are uncertain.
We believe that since 2007, the mortgage lending industry has experienced significant instability due to defaults on subprime loans and a resulting decline in the market value of such loans, among other things. In light of these developments, lenders, investors, regulators and other third parties questioned the adequacy of lending standards and other credit requirements for several loan programs made available to borrowers in recent years. This has led to reduced investor demand for mortgage loans and mortgage-backed securities, tightened credit requirements, reduced liquidity and increased credit risk premiums. Deterioration in credit quality among subprime and other nonconforming loans has caused almost all lenders to eliminate subprime mortgages and most other loan products that are not conforming loans, FHA/VA-eligible loans or jumbo loans (which meet conforming underwriting guidelines other than loan size). Fewer loan products and tighter loan qualifications and any other limitations or restrictions on the availability of those types of financings in turn make it more difficult for some borrowers to finance the purchase of new homes and for some buyers of existing homes from move-up new home buyers to finance the purchase of the move-up new home buyer’s existing home. These factors have served to reduce the affordability of homes and the pool of qualified homebuyers and made it more difficult to sell to first time and first time move-up buyers which have long made up a substantial part of the affordable housing market. These reductions in demand would increase the likelihood of defaults on our loans and, consequently, reduce our ability to pay distributions to our shareholders, and the duration and severity of the effects remain uncertain.
We also believe that the liquidity provided by Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) (“Government Sponsored Enterprises” or “GSEs”) to the mortgage industry is very important to the housing market. The director of the Federal Housing Finance Agency (“FHFA”), James B. Lockhart III, on September 7, 2008 announced his decision to place Fannie Mae and Freddie Mac into a conservatorship run by the FHFA. That plan contained three measures: an increase in the line of credit available to the GSEs from the U.S. Treasury, so as to provide liquidity; the right of the U.S. Treasury to purchase equity in the GSEs, so as to provide capital; and a consultative role for the Federal Reserve in a reformed GSE regulatory system. The U.S. Treasury further announced an additional increase in the line of credit for the GSEs, guaranteeing the backing of all losses suffered by these enterprises. The U.S. Treasury’s support of the two GSEs while under conservatorship of the FHFA was intended to promote stability in the secondary mortgage market and lower the cost of funding. The GSEs modestly increased their mortgage-backed securities portfolios through the end of 2009. To address systemic risk, in 2010 their portfolios began to be gradually reduced, largely through natural run off, and will eventually stabilize at a lower, less risky size. Any limitations or restrictions on the availability of such financing or on the liquidity provided by such enterprises could adversely affect interest rates and mortgage availability and could cause the number of homebuyers to decrease, which would increase the likelihood of defaults on our loans and, consequently, reduce our ability to pay distributions to our shareholders.
We believe that the homebuilding industry’s strategies in response to the adverse conditions in the industry have had limited success, and the continued implementation of these and other strategies may not be successful.
We believe that since the downturn began, most homebuilders have been focused on generating positive operating cash flow, resizing and reshaping their product for a more price-conscious consumer and adjusting finished new home inventories to meet demand, and did so in many cases by significantly reducing the new home prices and increasing the level of sales incentives. After reaching a peak of approximately 1,283,000 new home sales in 2005, new home sales declined each year, year-over-year, to a low of approximately 306,000 new home sales in 2011 before rising to 368,000 in 2012 and 428,000 in 2013. We believe that the decline in new home sales was largely due to a decrease in consumer confidence, due principally to home price declines, elevated unemployment, and slow wage growth as well as the negative national housing, financial industry, and economic news. A more restrictive mortgage lending environment, unemployment and the inability of some buyers to sell their existing homes have also impacted new home sales. Many of the factors that affect new home sales are beyond the control of the homebuilding industry. A decrease in the number of new homes sold may increase the likelihood of defaults on our loans and, consequently, may reduce our ability to pay distributions to you.
Increases in interest rates, reductions in mortgage availability or increases in other costs of owning a home could prevent potential customers from buying new homes and adversely affect our business or our financial results.
Demand for new homes is sensitive to changes in housing affordability. Most new home purchasers finance their home purchases through lenders providing mortgage financing. Since 2007, the mortgage lending industry has experienced significant instability. As a result of increased default rates and governmental initiatives to improve capital ratios, many mortgage lenders tightened credit requirements and reduced residential mortgage lending. Fewer loan products, stricter loan qualification standards, and higher down payment requirements have made it more difficult for many potential homebuyers to finance the purchase of homes. Increases in interest rates may make houses more difficult to afford. Lack of availability of mortgage financing at acceptable rates reduces demand for homes.
Even if potential customers do not need financing, changes in interest rates and the availability of mortgage financing products may make it harder for them to sell their current homes to potential buyers who need financing.
A reduction in the demand for new homes may reduce the amount and price of the residential home lots sold by the homebuilders and developers to which we loan money and/or increase the absorption period in which such home lots are purchased and, consequently, increase the likelihood of defaults on our loans.
Increases in interest rates could increase the risk of default under our development loans.
Developers and homebuilders to whom we make loans and with whom we enter into subordinate debt positions will use the proceeds of our loans and investments to develop raw real estate into residential home lots and construct homes. The developers and homebuilders obtain the money to repay our loans by selling the residential home lots to homebuilders or individuals, by building and selling single-family residences or by obtaining replacement financing from other lenders. The developers’ or homebuilders’ ability to repay our loans will be based primarily on the amount of money generated by the developers’ or homebuilders’ sale of their inventory of single-family homes or residential lots. If interest rates increase and/or consumer mortgage credit standards tighten, the demand for single-family residences is likely to decrease. In such an interest rate and/or mortgage climate, developers and homebuilders to whom we have loaned money may be unable to generate sufficient income from the resale of single-family homes or residential lots to repay our loans, which could reduce our ability to pay distributions to our shareholders.
The loans we make as part of our investments will generally be secured by collateral that is already encumbered, so our loans may have a higher risk than conventional real estate loans on residential properties.
We plan to originate and purchase loans to affiliated and unaffiliated third parties on land to be developed into residential lots, new and model homes and finished home inventories. Our goal is to obtain a first or subordinate lien on the underlying real property to secure our loans, and we generally will require a pledge of the equity ownership interests in the borrower itself to secure our loans, either as the sole collateral or in addition to our lien on the underlying real property. In some instances where the subject parcel is encumbered by a lien in favor of a third party other than us, we may, at our option, become the senior lender in order to protect the priority of our lien on the parcels. Our loans may also be secured by other assets of the borrower. While we will seek to obtain a guarantee of the borrower and/or its parent companies to further secure the borrower’s obligations to us, we cannot assure our shareholders that we will obtain such a guarantee in all cases. If a default occurs under one or more of our loans, payments to us could be reduced or postponed. Further, in the event of a default, we may be left with a security or ownership interest in finished homes or lots or unfinished homes or an undeveloped or partially developed parcel of real estate, which may have less value than a completed home or developed parcel. The guarantee of the borrower and/or its parent companies and other pledged assets, if any, may be insufficient to compensate us for any difference in the amounts due to us under a loan and the value of our interest in the subject parcel.
Decreases in the value of the property underlying our loans may decrease the value of our assets.
In most cases, we obtain a first or subordinate lien on the underlying real property to secure our loans (mortgage loans), and we also may require a pledge of all of the equity ownership interests in the borrower entity itself as additional security for our loans. In instances where we do not have a lien on the underlying real property, we obtain a pledge of all of the equity ownership interests of the borrower entity itself to secure such loans and/or a pledge of the equity ownership interests of the borrower entity or other parent entity that owns the borrower entity (so-called “mezzanine loans”). We also may require a pledge of additional assets of the borrower, liens against additional parcels of undeveloped and developed real property and/or the personal guarantees of principals or guarantees of operating entities in connection with our secured loans. To the extent that the value of the property that serves as security for these loans or investments is lower than we expect, the value of our assets, and consequently our ability to pay distributions to our shareholders, will be adversely affected.
Our investments and participation agreements with borrowers will expose us to various risks and will not guarantee that we will receive any amount under such agreements.
The investments and participation agreements that we enter with borrowers will be separate from the loans that we will make to the borrowers. Participation agreements will be structured either as contracts entitling us to participate in the borrower’s profits or as joint venture investments organized as partnerships or limited liability companies in which we will have an equity interest. The participation agreements may represent an equity joint venture interest that will, and our investment will, expose us to all of the risks inherent in real estate investments generally and with real estate investments made with a co-venturer. These risks include, among others, the fact that there is no guaranteed return on the equity participations. In the event our loan is paid off prior to sale of the parcel, we would hold an equity participation that would be junior to any liens or claims against the parcel. Our joint venture participations could subject us to liabilities arising out of environmental claims or claims for injuries, tax levies or other charges against the owner of the parcel as well as from the risk of bankruptcy of our co-venturer.
We will be subject to the general market risks associated with real estate construction and development.
Our financial performance will depend on the successful construction and/or development and sale of the homes and real estate parcels that we own, that serve as security for the loans we make to homebuilders and developers or that will be the subject of our participation agreements with borrowers. As a result, we will be subject to the general market risks of real estate construction and development, including weather conditions, the price and availability of materials used in the construction of the homes and development of the lots, environmental liabilities and zoning laws and numerous other factors that may materially and adversely affect the success of the projects. In the event the market softens, the homebuilder or developer may require additional funding and such funding may not be available. In addition, if the market softens, the amount of capital required to be advanced and the required marketing time for such home or development may both increase, and the homebuilder’s or developer’s incentive to complete a particular home or real estate development may decrease. Such circumstances may reduce our profitability and the returns on our shareholders’ investments.
If we lose or are unable to obtain key personnel or one or more of our key personnel decides to compete with us, our ability to implement our investment strategies could be delayed or hindered which could adversely affect our ability to make distributions and the value of our shareholders’ investments.
Our success depends to a significant degree on the diligence, experience and skill of certain executive officers and other key personnel of us, our Advisor and its affiliates, including Todd F. Etter, Hollis M. Greenlaw, Michael K. Wilson, Ben L. Wissink, Melissa H. Youngblood, Cara D. Obert, David A. Hanson and Stacey H. Dwyer, for the selection, acquisition, structuring and monitoring of our lending and investment activities. With the exception of Ms. Dwyer, these individuals are not bound by employment agreements with us; however, certain other key personnel are bound by employment agreements with UMT Holdings, the parent company of our Advisor and our asset manager. If any of our key personnel were to cease their affiliation with us, our Advisor or its affiliates, our operating results could suffer. Affiliates of our Advisor maintain key person life insurance with respect to Hollis M. Greenlaw. We have not obtained life insurance policies on any other key personnel involved in our operations and, therefore, have no insulation against extraneous events that may adversely affect their ability to implement our investment strategies. We also believe that our future success depends, in large part, upon our Advisor’s and its affiliates’ ability to hire and retain highly skilled personnel. We cannot assure our shareholders that we will be successful in attracting and retaining such personnel. The loss of any key person could harm our business, financial condition, cash flow and results of operations. If we lose or are unable to obtain the services of key personnel, our ability to implement our investment strategy could be delayed or hindered.
In addition, many of the officers and key personnel of the Trust, our Advisor and its affiliates are bound by non-competition agreements, and there are remedies under certain state laws if such officers or key personnel conduct activities that compete with us either during or after their employment. However, our ability to prohibit former employees from competing with us, our Advisor or its affiliates may be limited in many respects, and we cannot assure our shareholders that one or more of those persons may not choose to compete with us, or that we could limit their ability to do so or recover anything in such an event. Competition by these officers or key employees may harm our business, financial condition and results of operations.
Our rights and the rights of our shareholders to recover claims against our independent trustees are limited, which could reduce our and our shareholders’ recovery against them if they negligently cause us to incur losses.
Maryland law provides that a trustee has no liability in that capacity if he performs his duties in good faith, in a manner he reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Subject to certain exceptions, our declaration of trust provides that no independent trustee will be liable to us or our shareholders for monetary damages and that we will generally indemnify them for losses unless they are grossly negligent or engage in willful misconduct. As a result, we and our shareholders may have more limited rights against our independent trustees than might otherwise exist under common law, which could reduce our and our shareholders’ recovery from these persons if they act in a negligent manner. In addition, we may be obligated to fund the defense costs incurred by our independent trustees (as well as by our other trustees, officers, employees of our Advisor and agents) in some cases, which would decrease the cash otherwise available for distributions to our shareholders.
Other real estate investment programs sponsored by our advisor and its affiliates have experienced adverse business developments, and our business may be affected by similar conditions.
The prior programs sponsored by our advisor and its affiliates have occasionally been adversely affected by the limited supply of suitable loans available for purchase. When sufficient numbers of suitable loans historically were not available for purchase, UMT experienced excess uninvested cash, resulting in lower earnings per share in 1998 and 1999. Increased loan default rates resulted in decreased net income for UMT for the years 2008, 2009, 2010, 2011 and 2012. As a result, UMT made distributions in excess of earnings for the period from September 30, 1997 through December 31, 2005 and in 2008, 2009, 2010, 2011 and 2012. Furthermore, decreases in the available amount and use of leverage, along with increases in the amount of equity in relation to debt, result in lower returns on equity, as was experienced by UDF I and UDF II for the years 2007, 2008, 2009, 2010 and 2011. The continuing operations of prior programs sponsored by our advisor and its affiliates can be expected in the future to experience decreases in net income when economic conditions decline, specifically the availability of suitable loans, loan default increases and decreases in the amount and availability of leverage. Some of these programs may be unable to optimize their returns to investors because of requirements to liquidate when adverse economic conditions cause real estate prices to be relatively depressed. In addition, prior programs may be required to assume or pay off senior debt in order to protect their investments. Our business will be affected by similar conditions, and no assurance can be made that our program or other programs sponsored by our advisor and its affiliates will ultimately be successful in meeting their investment objectives.
Risks Related to Conflicts of Interest
We will be subject to conflicts of interest arising out of our relationships with our Advisor and its affiliates, including the material conflicts discussed below. When conflicts arise between us and our Advisor and its affiliates, they may not be resolved in our favor, which could cause our operating results to suffer.
Our Advisor and its affiliates will have equity interests and/or profit participations in developments we finance and may have a greater incentive to make loans with respect to such developments and/or provide credit enhancements to preserve and/or enhance their economic interest in such development.
We expect to make loans and/or provide credit enhancement transactions to affiliates of our Advisor or asset manager. In connection with making such loans or providing such credit enhancements, we will obtain an appraisal concerning the underlying property from an independent expert who is in the business of rendering opinions regarding the value of assets of the type held by us and who is qualified to perform such work. In addition, a majority of the trustees (including a majority of the independent trustees) who are not otherwise interested in the transaction must approve all transactions with our Advisor or its affiliates as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties. We also will obtain a mortgagee’s or owner’s title insurance policy or a commitment as to the priority of the secured loan as part of our underwriting process. If an affiliate of our Advisor has an equity interest or participation interest in a development that requires a loan or credit enhancement, our Advisor may have a greater incentive to make a loan with respect to such development to preserve and/or enhance its economic interest in such development. As of December 31, 2013, our 18 loans to related parties have an outstanding balance of approximately $63.9 million.
Our Advisor is an affiliate of the general partners of UDF I, UDF II, UDF III and UDF LOF and may not always be able to allocate investment opportunities on a pro rata basis among us, UDF I, UDF II, UDF III and UDF LOF.
Our Advisor is an affiliate of the general partners of UDF I, UDF II, UDF III and UDF LOF, all of which engage in the same businesses in which we engage. Our Advisor, asset manager and the investment committee will seek to equitably apportion among us, UDF I, UDF II, UDF III and UDF LOF all investment opportunities of which it becomes aware. We have entered into a participation agreement with UDF I, UDF II, UDF III, UDF LOF and UMTH LD pursuant to which we will invest in the same loans and transactions as UDF I, UDF II, UDF III and UDF LOF on a pro rata basis based on the amount of capital held by each entity that is available for investment in accordance with each fund’s risk profile and capital available for investment. However, circumstances may arise, due to availability of capital or other reasons, when it is not possible for us to make an investment on such pro rata basis. Our Advisor may determine not to invest in otherwise suitable investments in which UDF I, UDF II, UDF III or UDF LOF will participate in order for us to avoid unrelated business taxable income, or “UBTI,” which is generally defined as income derived from any unrelated trade or business carried on by a tax-exempt entity or by a partnership of which it is a member, and which is generally subject to taxation. We cannot assure our shareholders that we will be able to invest in all investment opportunities of which our Advisor becomes aware that may be suitable for us on a pro rata basis or otherwise.
Our founders may form other companies that will engage in the same businesses as we will, and we may not always be able to participate in investment opportunities on a pro rata basis between us and such other companies.
Our Advisor and its affiliates may engage in additional real estate-related activities in the future, including the activities in which we engage, and may form new entities to engage in these activities. If new companies are formed for the purpose of engaging in the businesses in which we engage, including United Development Funding Income Fund V (“UDF V”), a Maryland real estate investment trust that is seeking to register its initial public offering of shares pursuant to a Registration Statement on Form S-11 that is currently in registration with the SEC, our founders intend to allocate investment opportunities among us, UDF I, UDF II, UDF III, UDF LOF and the new entities equitably. However, we cannot assure our shareholders that we will be able to participate in all or any investment opportunities in which such other companies participate, on an equitable basis or otherwise.
Certain of the principals of our Advisor will face conflicts of interest relating to the extension and purchase of loans, and such conflicts may not be resolved in our favor.
Certain of the principals of our Advisor, including Mr. Etter, Mr. Greenlaw, Michael K. Wilson, Ben L. Wissink, Melissa H. Youngblood and Cara D. Obert, are also principals, directors, officers and equity holders of other entities, including UDF I, UDF II, UDF III, UDF LOF, UMT Holdings and UMT Services, and they may also in the future hold positions with, and interests in, other entities engaged in real estate activities, including UDF V. These multiple responsibilities may create conflicts of interest for these individuals if they are presented with opportunities that may benefit us and their other affiliates. These individuals may be incentivized to allocate opportunities to other entities rather than to us if they are more highly compensated based on investments made by other entities. In determining which opportunities to allocate to us and to their other affiliates, these individuals will consider the investment strategy and guidelines of each entity. Because we cannot predict the precise circumstances under which future potential conflicts may arise, we intend to address potential conflicts on a case- by-case basis. There is a risk that our Advisor will choose an investment for us that provides lower returns to us than a loan made by one of our affiliates. Investors will not have the opportunity to evaluate the manner in which any conflicts of interest involving our Advisor and its affiliates are resolved before making their investment.
Our Advisor and its affiliates, including some of our trustees and all of our executive officers, with the exception of Ms. Dwyer, will face conflicts of interest caused by their compensation arrangements with us, which could result in actions that are not in the long-term best interests of our shareholders.
Our Advisor and its affiliates are entitled to substantial fees from us in connection with the Offering and our business operations. These fees could influence our Advisor’s advice to us as well as the judgment of affiliates of our Advisor performing services for us. Among other matters, these compensation arrangements could affect their judgment with respect to:
·the continuation, renewal or enforcement of our agreements with our Advisor and its affiliates, including the advisory agreement;
·borrowings, which would increase the fees payable to our Advisor;
·whether and when we seek to list our common shares of beneficial interest on a national securities exchange, which listing could entitle our Advisor to the payment of fees; and
·whether and when we seek to sell the company or its assets, which sale could entitle our Advisor or one of its affiliates to the payment of fees.
We will face risks relating to joint ventures with our affiliates and third parties that are not present with other methods of investing in properties and secured loans.
We may enter into joint ventures with certain of our affiliates, as well as with third parties, for the funding of loans or the acquisition of properties. We may also purchase loan participation interests or loans through joint ventures, partnerships or other co-ownership arrangements with our affiliates, the sellers of the loans, affiliates of the sellers, developers or other persons. Such investments may involve risks not otherwise present with other methods of investment in secured loans, including, for example:
·that such affiliate, co-venturer or partner may at any time have economic or business interests or goals that are or that become inconsistent with our business interests or goals, which may cause us to disagree with our affiliate, co-venturer or partner as to the best course of action with respect to the investment and which disagreement may not be resolved to our satisfaction;
·that such affiliate, co-venturer or partner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives, which may cause us not to realize the return anticipated from our investment; or
·that it may be difficult for us to sell our interest in any such participation, co-venture or partnership.
Moreover, in the event we determine to foreclose on the collateral underlying a non-performing investment, we may be required to obtain the cooperation of our affiliate, co-venturer or partner to do so. We anticipate that we will participate with our affiliates in certain development projects where we and our affiliates make loans to the borrower, in which case we expect to enter into an inter-creditor agreement that will define our rights and priority with respect to the underlying collateral. Our inability to foreclose on a property acting alone may cause significant delay in the foreclosure process, in which time the value of the property may decline.
As of December 31, 2013, we have not entered into any joint ventures. As of December 31, 2013, we are participating in 10 loans originated by affiliates, with an outstanding balance of approximately $32.9 million.
Our Advisor will face additional conflicts of interest relating to loan participations with affiliated entities and may make decisions that disproportionately benefit one or more of our affiliated entities instead of us.
Our Advisor also serves as the advisor for UMT and is an affiliate of the general partners of UDF I, UDF II, UDF III and UDF LOF, all of which engage in the same businesses in which we engage. Because our Advisor or its affiliates will have advisory and management arrangements with these other United Development Funding programs, it is likely that they will encounter opportunities to invest in or acquire interests in secured loans, participations and/or properties to the benefit of one of the United Development Funding programs, but not others. Our Advisor or its affiliates may make decisions to finance certain properties, which decisions might disproportionately benefit a United Development Funding program other than us. In such event, our results of operations and ability to pay distributions to our shareholders could be adversely affected.
Because our Advisor and its affiliates are affiliated with UMT, UDF I, UDF II, UDF III and UDF LOF, agreements and transactions among the parties with respect to any loan participation among two or more of such parties will not have the benefit of arm’s length negotiation of the type normally conducted between unrelated co-venturers. Under these loan participation arrangements, we may not have a first priority position with respect to the underlying collateral. In the event that a co-venturer has a right of first refusal to buy out the other co-venturer, it may be unable to finance such buy-out at that time. In addition, to the extent that our co-venturer is an affiliate of our Advisor, certain conflicts of interest will exist. As of December 31, 2013, we are participating in 10 loans originated by affiliates, with an outstanding balance of approximately $32.9 million.
Our Advisor’s officers and key personnel will face conflicts of interest relating to the allocation of their time and other resources among the various entities that they serve or have interests in, and such conflicts may not be resolved in our favor.
Certain of the officers and key personnel of our Advisor will face competing demands relating to their time and resources because they are also affiliated with entities with investment programs similar to ours, and they may have other business interests as well, including business interests that currently exist and business interests they develop in the future. Because these persons have competing interests for their time and resources, they may have conflicts of interest in allocating their time between our business and these other activities. As a result, they may devote less time and resources to our business than is necessary. If this occurs, our business, financial condition and results of operations may suffer.
There is no separate counsel for certain of our affiliates and us, which could result in conflicts of interest.
Morris, Manning & Martin, LLP acts as legal counsel to us, our Advisor and certain of its affiliates. If the interests of the various parties become adverse, under the Code of Professional Responsibility of the legal profession, Morris, Manning & Martin, LLP may be precluded from representing any one or all of such parties. If any situation arises in which our interests appear to be in conflict with those of our Advisor or its affiliates, additional counsel may be retained by one or more of the parties to assure that their interests are adequately protected.
Risks Related to Our Business in General
A limit on the number of shares a person may own may discourage a takeover.
Our declaration of trust, with certain exceptions, authorizes our trustees to take such actions as are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of trustees, no person may own more than 9.8% of the value of our outstanding shares or more than 9.8% of the number or value, whichever is more restrictive, of our outstanding common shares. This restriction may have the effect of delaying, deferring or preventing a change in control, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might otherwise provide shareholders with the opportunity to receive a premium price for their shares.
Our declaration of trust permits our board of trustees to issue securities with terms that may subordinate the rights of the holders of our current common shares of beneficial interest or discourage a third party from acquiring us.
Our declaration of trust permits our board of trustees to issue up to 350,000,000 common shares of beneficial interest and up to 50,000,000 preferred shares of beneficial interest. Our board of trustees, without any action by our shareholders, may (1) amend our declaration of trust from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series we have authority to issue or (2) classify or reclassify any unissued shares of beneficial interest from time to time in one or more classes or series of shares and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications, or terms or conditions of redemption of any such shares. Thus, our board of trustees could authorize the issuance of such shares with terms and conditions that could subordinate the rights of the holders of our current common shares of beneficial interest or have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our common shares of beneficial interest.
Maryland law prohibits certain business combinations, which may make it more difficult for us to be acquired.
Under Maryland law, “business combinations” between a Maryland corporation and an interested shareholder or an affiliate of an interested shareholder are prohibited for five years after the most recent date on which the interested shareholder becomes an interested shareholder. These business combinations include a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities. An interested shareholder is defined as:
·any person who beneficially owns 10% or more of the voting power of the then outstanding voting shares of the company; or
·an affiliate or associate of the company who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then outstanding shares of the company.
A person is not an interested shareholder under the statute if the board of trustees approved in advance the transaction by which the shareholder otherwise would have become an interested shareholder. However, in approving a transaction, the board of trustees may provide that its approval is subject to compliance, at or after the time of approval, with any terms and conditions determined by the board of trustees. After the expiration of the five-year period described above, any business combination between the Maryland corporation and an interested shareholder must generally be recommended by the board of trustees of the company and approved by the affirmative vote of at least:
·80% of the votes entitled to be cast by holders of the then outstanding voting shares of the company; and
·two-thirds of the votes entitled to be cast by holders of voting shares of the company other than voting shares held by the interested shareholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interest shareholder.
These super-majority vote requirements do not apply if the holder of the company’s common shares of beneficial interest receives a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested shareholder for its shares. Maryland law also permits various exemptions from these provisions, including business combinations that are exempted by the board of trustees before the time that the interested shareholder becomes an interested shareholder. Our board of trustees has exempted any business combination with UMTH GS or any affiliate of UMTH GS and, provided that such business combination is first approved by the board of trustees, any business combination with any other person. Consequently, the five-year prohibition and the super-majority vote requirements will not apply to business combinations between us and UMTH GS or any affiliate of UMTH GS or any board-approved business combination with any other person. As a result, UMTH GS or any affiliate of UMTH GS may be able to enter into business combinations with us that may not be in the best interest of our shareholders, without compliance with the super-majority vote requirements and the other provisions of the business combination statute.
Should the board of trustees opt back in to the business combination statute or fail to first approve a business combination with any person other than UMTH GS or any affiliate of UMTH GS, the business combination statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer.
Maryland law also limits the ability of a third party to buy a large stake in us and exercise voting power in electing trustees.
Under the Maryland Control Share Acquisition Act, “control shares” of a Maryland company acquired in a “control share acquisition” have no voting rights except to the extent approved by the company’s disinterested shareholders by a vote of two-thirds of the votes entitled to be cast on the matter. Common shares of beneficial interest owned by interested shareholders, that is, by the acquirer, by officers or by employees who are trustees of the company, are excluded from the vote on whether to accord voting rights to the control shares. “Control shares” are voting shares that would entitle the acquirer to exercise voting power in electing trustees within specified ranges of voting power. Control shares do not include shares the acquiring person is then entitled to vote as a result of having previously obtained shareholder approval. A “control share acquisition” means, subject to certain exceptions, the acquisition of issued and outstanding control shares. The control share acquisition statute does not apply (1) to shares acquired in a merger, consolidation or share exchange if the company is a party to the transaction or (2) to acquisitions approved or exempted by a company’s declaration of trust or bylaws. Our bylaws contain a provision exempting from the Control Share Acquisition Act any and all acquisitions by any person of our shares of beneficial interest. We can offer no assurance that this provision will not be amended or eliminated at any time in the future. This statute could have the effect of discouraging offers from third parties to acquire us and increasing the difficulty of successfully completing this type of offer by anyone other than our affiliates or any of their affiliates.
Our declaration of trust includes a provision that may discourage a person from launching a tender offer for our shares.
Our declaration of trust provides that any tender offer made by any person, including any “mini-tender” offer, must comply with most provisions of Regulation 14D of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The offeror must provide our company notice of such tender offer at least ten business days before initiating the tender offer. If the offeror does not comply with these requirements, our company will have the right to redeem that offeror’s shares and any shares acquired in such tender offer. In addition, the non-complying offeror will be responsible for all of our company’s expenses in connection with that offeror’s noncompliance. This provision of our declaration of trust may discourage a person from initiating a tender offer for our shares and prevent our shareholders from receiving a premium price for their shares in such a transaction.
Shareholders’ investment returns will be reduced if we are required to register as an investment company under the Investment Company Act of 1940.
If we were obligated to register as an investment company, we would have to comply with a variety of substantive requirements under the Investment Company Act imposing, among other things:
·limitations on capital structure;
·restrictions on specified investments;
·prohibitions on transactions with affiliates; and
·compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly change our operations.
We conduct our operations so as not to become regulated as an investment company under the Investment Company Act. We intend to qualify for an exclusion from registration under Section 3(c)(5)(C) of the Investment Company Act, which generally means that at least 55% of our portfolio must comprise qualifying real estate assets and at least another 25% of our portfolio must comprise additional qualifying real estate assets and real estate-related assets. Although we monitor our portfolio periodically and prior to each acquisition, we may not be able to maintain this exclusion from registration. How we determine to classify our assets for purposes of the Investment Company Act will be based in large measure upon no-action positions taken by the SEC in the past. We believe that we have conducted our operations to comply with these no-action positions. However, these no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations we may face, and a number of these no-action positions were issued more than ten years ago. No assurance can be given that the SEC will concur with our classification of our assets. Future revisions to the Investment Company Act or further guidance from the SEC may cause us to lose our exclusion from registration or force us to re-evaluate our portfolio and our investment strategy. Such changes may prevent us from operating our business successfully.
To maintain compliance with the Investment Company Act exclusion, we may be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional assets that we might not otherwise have acquired or may have to forego opportunities to acquire assets that we would otherwise want to acquire and would be important to our investment strategy. Further, we may not be able to invest in a sufficient number of qualifying real estate assets and/or real estate-related assets to comply with the exclusion from registration.
We may determine to operate through our operating partnership or other wholly-owned or majority-owned subsidiaries that may be formed in the future. If so, we intend to operate in such a manner that we would not come within the definition of an investment company under Section 3(a)(1) of the Investment Company Act, and we intend to operate our operating partnership and any other subsidiary or subsidiaries in a manner that would exclude such entities from registration under the Investment Company Act pursuant to the exclusions provided by Sections 3(c)(1), 3(c)(5)(C) or 3(c)(7) of the Investment Company Act.
As part of our Advisor’s obligations under the advisory agreement, our Advisor will agree to refrain from taking any action which, in its sole judgment made in good faith, would subject us to regulation under the Investment Company Act. Failure to maintain an exclusion from registration under the Investment Company Act would require us to significantly restructure our business plan. For example, because affiliate transactions are severely limited under the Investment Company Act, we would not be able to enter into transactions with any of our affiliates if we are required to register as an investment company, and we may be required to terminate our advisory agreement and any other agreements with affiliates, which could have a material adverse effect on our ability to operate our business and pay distributions.
Shareholders have limited control over changes in our policies and operations.
Our board of trustees determines our major policies, including our policies regarding financing, growth, debt capitalization, REIT qualification and distributions. Our board of trustees may amend or revise these and other policies without a vote of the shareholders. Our declaration of trust sets forth the shareholder voting rights required to be set forth therein under the Statement of Policy Regarding Real Estate Investment Trusts published by the North American Securities Administrators Association. Under our declaration of trust and the Maryland REIT Law, our shareholders currently have a right to vote only on the following matters:
·the election or removal of trustees;
·the amendment of our declaration of trust, except that our board of trustees may amend our declaration of trust without shareholder approval to:
§change our name;
§increase or decrease the aggregate number of shares;
§increase or decrease the number of the shares of any class or series that we have the authority to issue;
§effect certain reverse stock splits; or
§qualify as a real estate investment trust under the Internal Revenue Code or the Maryland REIT Law;
·our termination; and
·certain mergers, consolidations and sales or other dispositions of all or substantially all of our assets.
All other matters are subject to the discretion of our board of trustees.
Our board of trustees may change the methods of implementing our investment policies and objectives without shareholder approval, which could alter the nature of a shareholder’s investment.
Our declaration of trust requires that our independent trustees review our investment policies at least annually to determine that the policies we are following are in the best interest of the shareholders. These policies may change over time. The methods of implementing our investment policies may also vary, as new investment techniques are developed. The methods of implementing our investment policies, objectives and procedures may be altered by our board of trustees without the approval of our shareholders. As a result, the nature of our shareholders’ investment could change without their consent.
Shareholders are limited in their ability to sell their shares pursuant to our redemption program.
Any investor requesting repurchase of their shares pursuant to our share redemption program will be required to certify to us that such investor acquired the shares by either (1) a purchase directly from us or (2) a transfer from the original subscriber by way of a bona fide gift not for value to, or for the benefit of, a member of the subscriber’s immediate or extended family or through a transfer to a custodian, trustee or other fiduciary for the account of the subscriber or his/her immediate or extended family in connection with an estate planning transaction, including by bequest or inheritance upon death or by operation of law. Shareholders should also be fully aware that our share redemption program contains certain restrictions and limitations. Shares will be redeemed on a monthly basis, as follows: first, pro rata as to redemptions upon the death of a shareholder; next, pro rata among shareholders willing to have their shares redeemed at the then-current net asset value, as determined by our board of trustees in its sole discretion; next, pro rata as to shareholders who demonstrate to our satisfaction another involuntary exigent circumstance, such as bankruptcy; and finally, pro rata as to other redemption requests, with a priority given to the earliest redemption requests received. We will not redeem in excess of 5% of the weighted average number of shares outstanding during the trailing twelve-month period prior to the redemption date. In addition, the cash available for redemption generally will be limited to 1% of our operating cash flow from the previous fiscal year plus any proceeds from our DRIP. Further, our board of trustees reserves the right to reject any request for redemption or to terminate, suspend, or amend the share redemption program at any time. Therefore, in making a decision to purchase shares, investors should not assume that they will be able to sell any of their shares back to us pursuant to our redemption program.
If shareholders are able to resell their shares to us pursuant to our redemption program, they will likely receive substantially less than the fair market value for their shares.
The purchase price for shares we repurchase under our redemption program, for the period beginning after a shareholder has held their shares for a period of one year, will be (1) 92% of the purchase price for any shares held less than two years, (2) 94% of the purchase price of any shares held for at least two years but less than three years, (3) 96% of the purchase price of any shares held at least three years but less than four years, (4) 98% of the purchase price of any shares held at least four years but less than five years and (5) for any shares held at least five years, the lesser of the purchase price actually paid or the fair market value of the shares as determined by our annual valuations. However, at any time we are engaged in an offering of our shares, the per share price for shares purchased under our redemption program will always be equal to or less than the applicable per share offering price. The price we will pay for redeemed shares will be offset by any net proceeds from capital transactions previously distributed to the redeeming shareholder as a return of capital. Accordingly, shareholders would likely receive less by selling their shares back to us than they would receive if our investments were sold for their estimated values and such proceeds were distributed in our liquidation.
A shareholder’s interest in us may be diluted if the price we pay in respect of shares redeemed under our share redemption program exceeds the net asset value of our shares.
The prices we may pay for shares redeemed under our share redemption program may exceed the net asset value of such shares at the time of redemption. If this were to be the case, investors who do not elect or are unable to have some or all of their shares redeemed under our share redemption program would suffer dilution in the value of their shares as a result of redemptions. We will create a reserve from our net interest income and net proceeds from capital transactions to recover some of the organization and offering expenses, including selling commissions and dealer manager fees we will incur in connection with the offering of our shares in order to cause the net asset value of the company to be on parity with or greater than the amount we may pay for shares under our share redemption program. However, it is likely that non-redeeming shareholders will experience dilution as a result of redemptions which occur at a time when the net asset value has decreased, regardless of the reserve.
We will have broad discretion in how we use the net proceeds of the Offering.
We will have broad discretion in how to use the net proceeds of the Offering, and shareholders will be relying on our judgment regarding the application of the proceeds of the Offering. Shareholders will not have the opportunity to evaluate the manner in which the net proceeds of the Offering are invested or the economic merits of particular assets to be acquired or loans to be made.
Our Advisor’s subordinated incentive fee may create an incentive for our Advisor to make speculative investments.
Because the incentive fee is subordinate to the payment of cumulative distributions to our shareholders, our Advisor’s interest is not wholly aligned with those of our shareholders. The subordinated nature of the incentive fee means that our Advisor will not receive such fee if our investments result only in minimal returns. Our Advisor’s subordinated incentive fee may create an incentive for our Advisor to advise us to make investments that have a higher potential return but are riskier or more speculative than would be the case in the absence of this incentive fee.
Payment of fees to our Advisor and its affiliates will reduce cash available for investment and distribution.
Our Advisor and its affiliates will perform services for us in connection with the selection and acquisition of our investments and the administration of our investments. They will be paid substantial fees for these services, which will reduce the amount of cash available for investment in properties or distribution to shareholders.
We are under no obligation to continue to pay cash distributions. Distributions have been, and may continue to be, paid from capital and there can be no assurance that we will be able to pay or maintain cash distributions, or that distributions will increase over time.
There are many factors, including factors beyond our control that can affect the availability and timing of cash distributions to shareholders. Distributions are based principally on cash available from our loans, real estate securities, property acquisitions and other investments. The amount of cash available for distributions will be affected by our ability to invest in real estate properties, secured loans, mezzanine loans or participations in loans as offering proceeds become available, the yields on the secured loans in which we invest, amounts set aside to create a retained earnings reserve and our operating expense levels, as well as many other variables. Actual cash available for distributions may vary substantially from estimates. We are under no obligation to pay cash distributions and we can provide no assurance that we will be able to continue to pay or maintain distributions or that distributions will increase over time. Nor can we give any assurance that income from the properties we purchase or the loans we make or acquire, or in which we participate, will increase or that future investments will increase our cash available for distributions to shareholders. Our actual results may differ significantly from the assumptions used by our board of trustees in establishing the distribution rate to shareholders. In addition, our board of trustees, in its discretion, may reinvest or retain for working capital any portion of our cash on hand. We cannot assure our shareholders that sufficient cash will be available to continue to pay distributions to them.
Adverse market and economic conditions will negatively affect our returns and profitability.
Our results are sensitive to changes in market and economic conditions such as the level of employment, consumer confidence, consumer income, the availability of consumer and commercial financing, interest rate levels, supply of new and existing homes, supply of finished lots and the costs associated with constructing new homes and developing land. We may be affected by market and economic challenges, including the following, any of which may result from a continued or exacerbated general economic slowdown experienced by the nation as a whole or by the local economies where properties subject to our secured loans may be located:
·poor economic conditions may result in a slowing of new home sales and corresponding lot purchases by builders resulting in defaults by borrowers under our secured loans;
·job transfers and layoffs may cause new home sales to decrease;
·lack of liquidity in the secondary mortgage market;
·tighter credit standards for home buyers;
·general unavailability of commercial credit; and
·illiquidity of financial institutions.
The length and severity of any economic downturn cannot be predicted. Our operations could be negatively affected to the extent that an economic downturn is prolonged or becomes more severe.
The failure of any bank in which we deposit our funds could reduce the amount of cash we have available to pay distributions and make additional investments.
We diversify our cash and cash equivalents among several banking institutions in an attempt to minimize exposure to any one of these entities. Periodically, we may have cash and cash equivalents and restricted cash deposited in certain financial institutions in excess of federally insured levels. If any of the banking institutions in which we have deposited funds ultimately fails, we may lose our deposits over any federally insured amount. The loss of our deposits could reduce the amount of cash we have available to distribute or invest and could result in a decline in the value of our shareholders’ investments.
Risks Related to the Secured Loan Lending Business
Defaults on our secured loans will reduce our income and shareholders’ distributions.
Because a significant number of our assets will be secured loans, failure of a borrower to pay interest or repay a loan will have adverse consequences on our income. For example,
·failure by a borrower to repay loans or interest on loans will reduce our income and, consequently, distributions to our shareholders;
·we may not be able to resolve the default prior to foreclosure of the property securing the loan;
·we may be required to expend substantial funds for an extended period to complete or develop foreclosed properties;
·the subsequent income and sale proceeds we receive from the foreclosed properties may be less than competing investments; and
·the proceeds from sales of foreclosed properties may be less than our investment in the properties.
Investments in land development loans present additional risks compared to loans secured by operating properties.
We may invest up to 10% of the gross offering proceeds in loans to purchase unimproved real property, and as of December 31, 2013, we have invested 0% of the gross offering proceeds in such loans. For purposes of this limitation, “unimproved real property” is defined as real property which has the following three characteristics: (a) an equity interest in real property which was not acquired for the purpose of producing rental or other income; (b) has no development or construction in process on such land; and (c) no development or construction on such land is planned in good faith to commence within one year. Land development mortgage loans may be riskier than loans secured by improved properties, because:
·until disposition, the property does not generate separate income for the borrower to make loan payments;
·the completion of planned development may require additional development financing by the borrower, which may not be available;
·depending on the velocity or amount of lot sales to homebuilders, demand for lots may decrease, causing the price of the lots to decrease;
·depending on the velocity or amount of lot sales to developers or homebuilders, demand for land may decrease, causing the price of the land to decrease;
·there is no assurance that we will be able to sell unimproved land promptly if we are forced to foreclose upon it; and
·lot sale contracts are generally not “specific performance” contracts, and the borrower may have no recourse if a homebuilder elects not to purchase lots.
Investments in second, mezzanine and wraparound mortgage loans present additional risks compared to loans secured by first deeds of trust.
We expect that we will be the junior lender with respect to some of our loans. We may invest in (a) second mortgage loans (some of which are also secured by pledges), which investments represent approximately 28% of the gross offering proceeds as of December 31, 2013; (b) co-investment loans (which are secured by pledges and collateral-sharing arrangements permitting us to share in the proceeds of second liens held by affiliates), which investments represent 0% of the gross offering proceeds as of December 31, 2013; (c) mezzanine loans (which are secured by pledges), which investments represent approximately 2% of the gross offering proceeds as of December 31, 2013; and (d) wraparound mortgage loans, which investments represent 0% of the gross offering proceeds as of December 31, 2013. A wraparound, or all-inclusive, mortgage loan is a loan in which the lender combines the remainder of an old loan with a new loan at an interest rate that blends the rate charged on the old loan with the current market rate. In a second mortgage loan and in a mezzanine loan, our rights as a lender, including our rights to receive payment on foreclosure, will be subject to the rights of the prior mortgage lender. In a wraparound mortgage loan, our rights will be similarly subject to the rights of any prior mortgage lender, but the aggregate indebtedness evidenced by our loan documentation will be the prior mortgage loans in addition to the new funds we invest. Under a wraparound mortgage loan, we would receive all payments from the borrower and forward to any senior lender its portion of the payments we receive. Because all of these types of loans are subject to the prior mortgage lender’s right to payment on foreclosure, we incur a greater risk when we invest in each of these types of loans.
Credit enhancements provided by us are subject to specific risks relating to the particular borrower and are subject to the general risks of investing in residential real estate.
We may provide credit enhancements to real estate developers, homebuilders, land bankers and other real estate investors (such credit enhancements may take the form of a loan guarantee, the pledge of assets, a letter of credit or an inter-creditor agreement provided by us to a third-party lender for the benefit of a borrower and are intended to enhance the creditworthiness of the borrower, thereby affording the borrower credit at terms it would otherwise be unable to obtain). Our provision of credit enhancements will involve special risks relating to the particular borrower under the third-party loan, including the financial condition and business outlook of the borrower. In addition, the borrowers who receive our credit enhancements are subject to the inherent risks associated with residential real estate.
Many of our loans will require balloon payments, which are riskier than loans with fully amortized payments.
We anticipate that substantially all of our loans will have balloon payments or reductions to principal tied to net cash from the sale of developed lots and the release formula created by the senior lender (the conditions under which principal is repaid to the senior lender, if any). As of December 31, 2013, 100% of our loans have balloon payments or reductions to principal tied to net cash. A balloon payment is a large principal balance that is payable after a period of time during which the borrower has repaid none or only a small portion of the principal balance. Loans with balloon payments are riskier than loans with even payments of principal over an extended time period, such as 15 or 30 years, because the borrower’s repayment often depends on its ability to refinance the loan or sell the developed lots profitably when the loan comes due. There are no specific criteria used in evaluating the credit quality of borrowers for mortgage loans requiring balloon payments. Furthermore, a substantial period of time may elapse between the review of the financial statements of the borrower and the date when the balloon payment is due. As a result, there is no assurance that a borrower will have sufficient resources to make a balloon payment when due.
The interest-only loans we make or acquire may be subject to greater risk of default and there may not be sufficient funds or assets remaining to satisfy our loans, which may result in losses to us.
We will make and acquire interest-only loans or loans requiring reductions to accrued interest tied to net cash, and as of December 31, 2013, 100% of the loans we have made and acquired are interest-only loans or loans requiring reductions to accrued interest tied to net cash. Interest-only loans typically cost the borrower less in monthly loan payments than fully-amortizing loans which require a payment on principal as well as interest. This lower cost may enable a borrower to acquire a more expensive property than if the borrower was entering into a fully-amortizing mortgage loan. Borrowers utilizing interest-only loans are dependent on the appreciation of the value of the underlying property, and the sale or refinancing of such property, to pay down the interest-only loan since none of the principal balance is being paid down with the borrowers’ monthly payments. If the value of the underlying property declines due to market or other factors, it is likely that the borrower would hold a property that is worth less than the mortgage balance on the property. Thus, there may be greater risk of default by borrowers who enter into interest-only loans. In addition, interest-only loans include an interest reserve in the loan amount. If such reserve is required to be funded due to a borrower’s non-payment, the loan-to-value ratio for that loan will increase, possibly above generally acceptable levels. In the event of a defaulted interest-only loan, we would acquire the underlying collateral which may have declined in value. In addition, there are significant costs and delays associated with the foreclosure process. Any of these factors may result in losses to us.
Larger loans result in less portfolio diversity and may increase risk, and the concentration of loans with a common borrower may increase our risk.
We intend to invest in loans that individually constitute an average amount equal to the lesser of (a) 1% to 3% of the total amount raised in the Offering, or (b) $2.5 million to $15 million. However, we may invest in larger loans depending on such factors as our performance and the value of the collateral. These larger loans are riskier because they may reduce our ability to diversify our loan portfolio. Our largest loan to a single borrower will not exceed an amount equal to 20% of the total capital contributions raised in the Offering, and as of December 31, 2013, our largest loan to a single borrower is equal to approximately 5% of the total capital contributions raised in the Offering.
The concentration of loans with a common borrower may increase our risks.
We may invest in multiple mortgage loans that share a common borrower or loans to related borrowers. As of December 31, 2013, we have invested approximately 52% of our offering proceeds in 66 loans to our largest group of related borrowers. The bankruptcy, insolvency or other inability of any borrower that is the subject of multiple loans to pay interest or repay principal on its loans would have adverse consequences on our income and reduce the amount of funds available for distribution to investors. In addition, we expect to be dependent on a limited number of borrowers for a large portion of our business. The more concentrated our portfolio is with one or a few borrowers, the greater credit risk we face. The loss of any one of these borrowers would have a material adverse effect on our financial condition and results of operations.
Incorrect or changed property values could result in losses and decreased distributions to our shareholders.
We depend primarily upon our real estate security to protect us on the loans that we make. We depend partly upon the skill of independent appraisers to value the security underlying our loans and partly upon our Advisor’s internal underwriting and appraisal process. Notwithstanding the experience of the appraisers selected by our Advisor, they or our Advisor may make mistakes, and regardless of decisions made at the time of funding, market conditions may deteriorate for various reasons, causing a decrease to the value of the security for our loans. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the full amount of our loan, thus reducing the amount of funds available to distribute to our shareholders.
Changes in market interest rates may reduce our income and distributions to our shareholders.
A substantial portion of all of our loans are fixed-interest rate loans. Market interest rates on investments comparable to the shares could materially increase above the general level of our fixed-rate loans. Our distributions could then be less than the yield our shareholders may obtain from these other investments. We will also make loans with variable interest rates, which will cause variations in the yield to us from these loans. We may make loans with interest rate guarantee provisions in them, requiring a minimum period of months or years of earned interest even if the loan is paid off during the guarantee period. The duration of the guarantee is subject to negotiation and will likely vary from loan to loan. Other than these provisions, the majority of our loans will not include prepayment penalties for a borrower paying off a loan prior to maturity. The absence of a prepayment penalty in our loans may lead borrowers to refinance higher interest rate loans in a market of falling interest rates. This would then require us to reinvest the prepayment proceeds in loans or alternative short-term investments with lower interest rates and a corresponding lower yield to our shareholders. All of these risks increase as the length of maturity of a loan increases and the amount of cash available for new higher interest loans decreases. A material increase in market interest rates could result in a decrease in the supply of suitable secured loans to us, as there will likely be fewer attractive transactions for borrowers and less activity in the marketplace.
Some losses that borrowers might incur may not be insured and may result in defaults that would increase our shareholders’ risk.
Our loans require that borrowers of interim construction loans carry adequate hazard insurance for our benefit. Some events are, however, either uninsurable or insurance coverage is economically not practicable. Losses from earthquakes, floods or mudslides, for example, may be uninsured and cause losses to us on entire loans. If a borrower allows insurance to lapse, an event of loss could occur before we become aware of the lapse and have time to obtain insurance ourselves. Insurance coverage may be inadequate to cover property losses, even though our Advisor imposes on borrowers insurance requirements that it believes are adequate.
Foreclosures create additional ownership risks to us of unexpected increased costs or decreased income.
When we acquire property by foreclosure, we have economic and liability risks as the owner, including:
·less income and reduced cash flows on foreclosed properties than could be earned and received on secured loans;
·selling the homes or lots to homebuyers or homebuilders;
·selling the land to developers, homebuilders or other real estate investors;
·controlling construction or development and holding expenses;
·coping with general and local market conditions;
·complying with changes in laws and regulations pertaining to taxes, use, zoning and environmental protection; and
·possible liability for injury to persons and property.
If any of these risks were to materialize, then the return on the particular investment could be reduced, and our business, financial condition and results of operations could be adversely affected.
If we were found to have violated applicable usury laws, we would be subject to penalties and other possible risks.
Usury laws generally regulate the amount of interest that may lawfully be charged on indebtedness. Each state has its own distinct usury laws. We believe that our loans will not violate applicable usury laws (as of December 31, 2013, the highest interest rate we have charged on an annualized basis is 15%). There is a risk, however, that a court could determine that our loans do violate applicable usury laws. If we were found to have violated applicable usury laws, we could be subject to penalties, including fines equal to three times the amount of usurious interest collected and restitution to the borrower. Additionally, usury laws often provide that a loan that violates usury laws is unenforceable. If we are subject to penalties or restitution or if our loan agreements are adjudged unenforceable by a court, it would have a material, adverse effect on our business, financial condition and results of operations and we would have difficulty making distributions to our shareholders.
General Risks Related to Investments in Real Estate
Our operating results may be affected by economic and regulatory changes that have an adverse impact on the real estate market in general.
Our operating results are subject to risks generally incident to the ownership of assets related to the real estate industry, including:
·changes in interest rates and availability of permanent mortgage funds;
·changes in general economic or local conditions;
·changes in tax, real estate, environmental and zoning laws; and
·periods of high interest rates and tight money supply.
For these and other reasons, we cannot assure our shareholders that we will be profitable or that we will realize growth in the amount of income we receive from our investments.
We borrow money to make loans or purchase some of our real estate assets. If we fail to obtain or renew sufficient funding on favorable terms, we will be limited in our ability to make loans or purchase assets, which will harm our results of operations. Furthermore, our shareholders’ risks will increase if defaults occur.
We have incurred and may continue to incur substantial debt. We incur, when appropriate, debt at the asset level. Asset level leverage will be determined by the anticipated term of the investment and the cash flow expected by the investment. Asset level leverage is expected to range from 0% to 90% of the asset value. In addition, we incur debt at the fund level. Our board of trustees has adopted a policy to generally limit our fund level borrowings to 50% of the aggregate fair market value of our real estate properties or secured loans once we have invested a majority of the net proceeds of our initial public offering, this offering and subsequent offerings, if any. However, we are permitted by our declaration of trust to borrow up to 300% of our net assets, and may borrow in excess of such amount if such excess borrowing is approved by a majority of our independent trustees and disclosed in our next quarterly report to shareholders, along with justification for such excess. Generally, loans we obtain are secured with recourse to all of our assets, which will put those assets at risk of forfeiture if we are unable to pay our debts.
Our ability to achieve our investment objectives depends, in part, on our ability to borrow money in sufficient amounts and on favorable terms. We expect to depend on a few lenders to provide the primary credit facilities for our investments. In addition, our existing indebtedness may limit our ability to make additional borrowings. If our lenders do not allow us to renew our borrowings or we cannot replace maturing borrowings on favorable terms or at all, we might have to sell our investment assets under adverse market conditions, which would harm our results of operations and may result in permanent losses. In addition, loans we obtain may be secured by all of our assets, which will put those assets at risk of forfeiture if we are unable to pay our debts.
Dislocations in the credit markets and real estate markets could have a material adverse effect on our results of operations, financial condition and ability to pay distributions to our shareholders.
Domestic and international financial markets recently experienced significant dislocations which were brought about in large part by failures in the U.S. banking system. These dislocations have severely impacted the availability of credit and have contributed to rising costs associated with obtaining credit. If debt financing is not available on terms and conditions we find acceptable, we may not be able to obtain financing for investments. If this dislocation in the credit markets persists, our ability to borrow monies to finance investments in real estate assets will be negatively impacted. If we are unable to borrow monies on terms and conditions that we find acceptable, we likely will have to reduce the number of real estate investments we can make, and the return on the investments we do make likely will be lower. All of these events could have an adverse effect on our results of operations, financial condition and ability to pay distributions.
Our operating results may be negatively affected by potential development and construction delays and resultant increased costs and risks.
We may provide financing for borrowers that will develop and construct improvements to land at a fixed contract price. We will be subject to risks relating to uncertainties associated with re-zoning for development and environmental concerns of governmental entities and/or community groups, as well as our borrower’s ability to control land development costs or to build infrastructure in conformity with plans, specifications and timetables deemed necessary by builders. The borrower’s failure to perform may necessitate legal action by us to compel performance. Performance may also be affected or delayed by conditions beyond the borrower’s control. Delays in completion of construction could also give builders the right to terminate preconstruction lot purchase contracts. These and other such factors can result in increased costs to the borrower that may make it difficult for the borrower to make payments to us. Furthermore, we must rely upon projections of lot take downs, expenses and estimates of the fair market value of property when evaluating whether to make loans. If our projections are inaccurate, and we are forced to foreclose on a property, our return on our investment could suffer.
The costs of compliance with environmental laws and other governmental laws and regulations may adversely affect our income and the cash available for any distributions.
All real property and the operations conducted on real property are subject to federal, state and local laws, ordinances and regulations relating to environmental protection and human health and safety. These laws and regulations generally govern wastewater discharges; air emissions; the operation and removal of underground and above-ground storage tanks; the use, storage, treatment, transportation and disposal of solid and hazardous materials and the remediation of contamination associated with disposals. Under limited circumstances, a secured lender, in addition to the owner of real estate, may be liable for clean-up costs or have the obligation to take remedial actions under environmental laws, including, but not limited to, the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or CERCLA. Some of these laws and regulations may impose joint and several liability for the costs of investigation or remediation of contaminated properties, regardless of fault or the legality of the original disposal. In addition, the presence of these substances, or the failure to properly remediate these substances, may adversely affect our ability to sell such property or to use the property as collateral for future borrowing.
If we foreclose on a defaulted loan to recover our investment, we may become subject to environmental liabilities associated with that property if we participate in the management of that property or do not divest ourselves of the property at the earliest practicable time on commercially reasonable terms. Environmental laws may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures. It is possible that property on which we foreclose may contain hazardous substances, wastes, contaminants or pollutants that we may be required to remove or remediate in order to clean up the property. If we foreclose on a contaminated property, we may also incur liability to tenants or other users of neighboring properties. We cannot assure our shareholders that we will not incur full recourse liability for the entire cost of removal and cleanup, that the cost of such removal and cleanup will not exceed the value of the property, or that we will recover any of these costs from any other party. It may be difficult or impossible to sell a property following discovery of hazardous substances or wastes on the property. The cost of defending against claims of liability, compliance with environmental regulatory requirements, remediating any contaminated property, or paying personal injury claims could materially adversely affect our business, assets or results of operations and, consequently, amounts available for distribution to our shareholders.
Terrorist attacks or other acts of violence or war may affect the industry in which we operate, our operations and our profitability.
Terrorist attacks may harm our results of operations and our shareholders’ investments. We cannot assure our shareholders that there will not be further terrorist attacks against the United States or U.S. businesses. These attacks or armed conflicts may directly or indirectly impact the value of the property we own or the property underlying our loans. Losses resulting from these types of events are generally uninsurable. Moreover, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the United States and worldwide financial markets. They could also result in economic uncertainty in the United States or abroad. Adverse economic conditions resulting from terrorist activities could negatively impact borrowers’ ability to repay loans we make to them or harm the value of the property underlying our investments, both of which would impair the value of our investments and decrease our ability to make distributions to our shareholders.
We are subject to risks related to the geographic concentration of the properties securing the loans and equity investments we make.
Although we may purchase loans and make investments throughout the contiguous United States, the majority of investments are in the Southeastern and Southwestern United States, with a near term concentration of all of our investing and lending in the major Texas submarkets (100%, as of December 31, 2013). However, if the residential real estate market or general economic conditions in these geographic areas decline to an extent greater than we forecast, or recover to a lesser extent than we forecast, our and our borrowers’ ability to sell homes, lots and land located in these areas may be impaired, we may experience a greater rate of default on the loans or other investments we make with respect to real estate in these areas, and the value of the homes and parcels in which we invest and which are underlying our investments in these areas could decline. Any of these events could materially adversely affect our business, financial condition or results of operations.
We are subject to a number of legal and regulatory requirements, including regulations regarding interest rates, mortgage laws, securities laws and the taxation of REITs or business trusts, which may adversely affect our operations.
Federal and state lending laws and regulations generally regulate interest rates and many other aspects of real estate loans and contracts. Violations of those laws and regulations could materially adversely affect our business, financial condition and results of operations. We cannot predict the extent to which any law or regulation that may be enacted or enforced in the future may affect our operations. In addition, the costs to comply with these laws and regulations may adversely affect our profitability. Future changes to the laws and regulations affecting us, including changes to mortgage laws, securities laws and the Internal Revenue Code applicable to the taxation of REITs or business trusts, could make it more difficult or expensive for us to comply with such laws or otherwise harm our business.
Federal Income Tax Risks
Failure to maintain our REIT status would adversely affect our operations and our ability to make distributions.
We made an election under Section 856(c) of the Internal Revenue Code to be taxed as a REIT, beginning with the taxable year ended December 31, 2010. In order for us to continue to qualify as a REIT, we must satisfy certain requirements set forth in the Internal Revenue Code and treasury regulations promulgated thereunder and various factual matters and circumstances that are not entirely within our control. We structure our activities in a manner designed to satisfy all of these requirements. However, if certain of our operations were to be recharacterized by the Internal Revenue Service, such recharacterization could jeopardize our ability to satisfy all of the requirements for qualification as a REIT.
If we fail to qualify as a REIT for any taxable year, we will be subject to federal income tax on our taxable income at corporate rates. In addition, we may be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT status. Losing our REIT status would reduce our net earnings available for investment or distribution to shareholders because of the additional tax liability. In addition, distributions to shareholders would no longer qualify for the distributions paid deduction, and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.
Qualification as a REIT is subject to the satisfaction of tax requirements and various factual matters and circumstances that are not entirely within our control. New legislation, regulations, administrative interpretations or court decisions could change the tax laws with respect to qualification as a REIT or the federal income tax consequences of being a REIT. Our failure to continue to qualify as a REIT would adversely affect our shareholders’ returns on their investments.
Our investment strategy may cause us to incur penalty taxes, lose our REIT status, or own and sell properties through taxable REIT subsidiaries, each of which would diminish the return to our shareholders.
In light of our investment strategy, it is possible that one or more sales of our properties may be “prohibited transactions” under provisions of the Internal Revenue Code. If we are deemed to have engaged in a “prohibited transaction” (i.e., we sell a property held by us primarily for sale in the ordinary course of our trade or business), all income that we derive from such sale would be subject to a 100% tax. The Internal Revenue Code sets forth a safe harbor for REITs that wish to sell property without risking the imposition of the 100% tax. A principal requirement of the safe harbor is that the REIT must hold the applicable property for not less than two years prior to its sale. Given our investment strategy, it is entirely possible, if not likely, that the sale of one or more of our properties will not fall within the prohibited transaction safe harbor.
If we desire to sell a property pursuant to a transaction that does not fall within the safe harbor, we may be able to avoid the 100% penalty tax if we acquired the property through a TRS or acquired the property and transferred it to a TRS for a non-tax business purpose prior to the sale (for a reason other than the avoidance of taxes). However, there may be circumstances that prevent us from using a TRS in a transaction that does not qualify for the safe harbor. Additionally, even if it is possible to effect a property disposition through a TRS, we may decide to forego the use of a TRS in a transaction that does not meet the safe harbor based on our own internal analysis, the opinion of counsel or the opinion of other tax advisors that the disposition will not be subject to the 100% penalty tax. In cases where a property disposition is not effected through a TRS, the Internal Revenue Service could successfully assert that the disposition constitutes a prohibited transaction, in which event all of the net income from the sale of such property will be payable as a tax and none of the proceeds from such sale will be distributable by us to our shareholders or available for investment by us.
If we acquire a property that we anticipate will not fall within the safe harbor from the 100% penalty tax upon disposition, then we may acquire such property through a TRS in order to avoid the possibility that the sale of such property will be a prohibited transaction and subject to the 100% penalty tax. If we already own such a property directly or indirectly through an entity other than a TRS, we may contribute the property to a TRS if there is another, non-tax related business purpose for the contribution of such property to the TRS. Following the transfer of the property to a TRS, the TRS will operate the property and may sell such property and distribute the net proceeds from such sale to us, and we may distribute the net proceeds distributed to us by the TRS to our shareholders. Though a sale of the property by a TRS may eliminate the danger of the application of the 100% penalty tax, the TRS itself would be subject to a tax at the federal level, and potentially at the state and local levels, on the gain realized by it from the sale of the property, as well as on the income earned while the property is operated by the TRS. This tax obligation would diminish the amount of the proceeds from the sale of such property that would be distributable to our shareholders. As a result, the amount available for distribution to our shareholders would be substantially less than if the REIT had not operated and sold such property through the TRS and such transaction was not characterized as a prohibited transaction. The maximum federal corporate income tax rate currently is 35%. Federal, state and local corporate income tax rates may be increased in the future, and any such increase would reduce the amount of the net proceeds available for distribution by us to our shareholders from the sale of property through a TRS after the effective date of any increase in such tax rates.
If we own too many properties through one or more TRSs, then we may lose our status as a REIT. If we fail to qualify as a REIT for any taxable year, we will be subject to federal income tax on our taxable income at corporate rates. In addition, we may be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT status. Losing our REIT status would reduce our net earnings available for investment or distribution to shareholders because of the additional tax liability. In addition, distributions to shareholders would no longer qualify for the distributions paid deduction, and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax. As a REIT, the value of the securities we hold in all of our TRSs may not exceed 25% of the value of all of our assets at the end of any calendar quarter. If the Internal Revenue Service were to determine that the value of our interests in all of our TRSs exceeded 25% of the value of total assets at the end of any calendar quarter, then we would fail to qualify as a REIT. If we determine it to be in our best interests to own a substantial number of our properties through one or more TRSs, then it is possible that the Internal Revenue Service may conclude that the value of our interests in our TRSs exceeds 25% of the value of our total assets at the end of any calendar quarter and therefore cause us to fail to qualify as a REIT. Additionally, as a REIT, no more than 25% of our gross income with respect to any year may be from sources other than real estate. Distributions paid to us from a TRS are considered to be non-real estate income. Therefore, we may fail to qualify as a REIT if distributions from all of our TRSs, when aggregated with all other non-real estate income with respect to any one year, are more than 25% of our gross income with respect to such year. We will use all reasonable efforts to structure our activities in a manner that satisfies the requirements for qualification as a REIT. Our failure to qualify as a REIT would adversely affect our shareholders’ returns on their investments.
Certain fees paid to us may affect our REIT status.
Certain fees and income we receive could be characterized by the Internal Revenue Service as non-qualifying income for purposes of satisfying the “income tests” required for REIT qualification. If this fee income were, in fact, treated as non-qualifying, and if the aggregate of such fee income and any other non-qualifying income in any taxable year ever exceeded 5% of our gross revenues for such year, we could lose our REIT status for that taxable year and the four ensuing taxable years. We will use all reasonable efforts to structure our activities in a manner that satisfies the requirements for our qualification as a REIT. Our failure to qualify as a REIT would adversely affect our shareholders’ returns on their investments.
Shareholders may have tax liability on distributions they elect to reinvest in our common shares of beneficial interest, and they may have to use funds from other sources to pay such tax liability.
If shareholders elect to have their distributions reinvested in our common shares of beneficial interest pursuant to our distribution reinvestment plan, they will be deemed to have received, and for income tax purposes will be taxed on, the amount reinvested that does not represent a return of capital. As a result, unless a shareholder is a tax-exempt entity, a shareholder may have to use funds from other sources to pay their tax liability on the value of the shares received.
If our operating partnership fails to maintain its status as a partnership, its income may be subject to taxation, which would reduce our cash available for distribution to our shareholders.
We intend to maintain the status of our operating partnership, UDF IV OP, as a partnership for federal income tax purposes. However, if the Internal Revenue Service were to successfully challenge the status of the operating partnership as a partnership, it would be taxable as a corporation. In such event, this would reduce the amount of distributions that the operating partnership could make to us. This would also result in our losing REIT status, and becoming subject to a corporate level tax on our own income. This would substantially reduce our cash available to make distributions and the return on our shareholders’ investments. In addition, if any of the partnerships or limited liability companies through which the operating partnership owns its properties, in whole or in part, loses its characterization as a partnership for federal income tax purposes, it would be subject to taxation as a corporation, thereby reducing distributions to the operating partnership. Such a recharacterization of an underlying property owner could also threaten our ability to maintain REIT status.
In certain circumstances, we may be subject to federal and state taxes on income as a REIT, which would reduce our cash available for distribution to our shareholders.
Even if we maintain our status as a REIT, we may become subject to federal income taxes and related state taxes. For example, if we have net income from a “prohibited transaction,” such income will be subject to a 100% tax. We may not be able to make sufficient distributions to avoid excise taxes applicable to REITs. We may also decide to retain income we earn from the interest on our secured loans or the sale or other disposition of our property and pay income tax directly on such income. In that event, our shareholders would be treated as if they earned that income and paid the tax on it directly. However, shareholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability. We may also be subject to state and local taxes on our income or property, either directly or at the level of the operating partnership or at the level of the other companies through which we indirectly make secured loans or own our assets. Any federal or state taxes paid by us will reduce our cash available for distribution to our shareholders.
Legislative or regulatory action could adversely affect the returns to our investors.
In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of the federal income tax laws applicable to investments similar to an investment in our common shares of beneficial interest. On March 30, 2010, the President signed into law the Health Care and Education Reconciliation Act of 2010 (the “Reconciliation Act”). The Reconciliation Act will require certain U.S. shareholders who are individuals, estates or trusts to pay a 3.8% Medicare tax on, among other things, dividends on and capital gains from the sale or other disposition of shares, subject to certain exceptions. This additional tax will apply broadly to essentially all dividends and all gains from dispositions of shares, including dividends from REITs and gains from dispositions of REIT shares, such as our common shares of beneficial interest.
Additional changes to the tax laws are likely to continue to occur, and we cannot assure investors that any such changes will not adversely affect the taxation of a shareholder. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our assets. Investors are urged to consult with their own tax advisor with respect to the impact of recent legislation on their investment in our shares and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our shares.
Congress passed major federal tax legislation in 2003, with modifications to that legislation in 2005 and an extension of that legislation by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. One of the changes effected by that legislation generally reduced the maximum tax rate on qualified dividends paid by corporations to individuals to 15% through 2012. On January 3, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012, extending such 15% qualified dividend rate for 2013 and subsequent taxable years for those unmarried individuals with income under $400,000 and for married couples with income under $450,000. For those with income above such thresholds, the qualified dividend rate is 20%. REIT distributions, however, generally do not constitute qualified dividends and consequently are not eligible for this reduced maximum tax rate. Therefore, our shareholders will pay federal income tax on our distributions (other than capital gains dividends or distributions which represent a return of capital for tax purposes) at the applicable “ordinary income” rate, the maximum of which is currently 39.6%. However, as a REIT, we generally would not be subject to federal or state corporate income taxes on that portion of our ordinary income or capital gain that we distribute currently to our shareholders, and we thus expect to avoid the “double taxation” to which other companies are typically subject.
Although REITs continue to receive substantially better tax treatment than entities taxed as corporations, it is possible that future legislation would result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be taxed for federal income tax purposes as a corporation. As a result, our declaration of trust provides our board of trustees with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a corporation, without the vote of our shareholders. Our board of trustees has fiduciary duties to us and our shareholders and could only cause such changes in our tax treatment if it determines in good faith that such changes are in the best interest of our shareholders.
Equity participation in secured loans may result in taxable income and gains from these properties, which could adversely impact our REIT status.
If we participate under a secured loan in any appreciation of the properties securing the secured loan or its cash flow and the Internal Revenue Service characterizes this participation as “equity,” we might have to recognize income, gains and other items from the property. This could affect our ability to qualify as a REIT.
Distributions to tax-exempt investors may be classified as UBTI and tax-exempt investors would be required to pay tax on such income and to file income tax returns.
Neither ordinary nor capital gain distributions with respect to our common shares of beneficial interest nor gain from the sale of shares should generally constitute UBTI to a tax-exempt investor. However, there are certain exceptions to this rule, including:
·under certain circumstances, part of the income and gain recognized by certain qualified employee pension trusts with respect to our shares may be treated as UBTI if our shares are predominately held by qualified employee pension trusts, such that we are a “pension-held” REIT (which we do not expect to be the case);
·part of the income and gain recognized by a tax-exempt investor with respect to our shares would constitute UBTI if such investor incurs debt in order to acquire the common shares of beneficial interest; and
·part or all of the income or gain recognized with respect to our common shares of beneficial interest held by social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans which are exempt from U.S. federal income taxation under Sections 501(c)(7), (9), (17) or (20) of the Internal Revenue Code may be treated as UBTI.
Distributions to foreign investors may be treated as ordinary income distributions to the extent that they are made out of current or accumulated earnings and profits.
In general, foreign investors will be subject to regular U.S. federal income tax with respect to their investment in our shares if the income derived therefrom is “effectively connected” with the foreign investor’s conduct of a trade or business in the United States. A distribution to a foreign investor that is not attributable to gain realized by us from the sale or exchange of a “U.S. real property interest” within the meaning of the Foreign Investment in Real Property Tax Act of 1980, as amended, or FIRPTA, and that we do not designate as a capital gain dividend, will be treated as an ordinary income distribution to the extent that it is made out of current or accumulated earnings and profits (as determined for U.S. federal income tax purposes). Generally, any ordinary income distribution will be subject to a U.S. federal income tax equal to 30% of the gross amount of the distribution, unless this tax is reduced by the provisions of an applicable treaty.
Foreign investors may be subject to FIRPTA tax upon the sale of their shares.
A foreign investor disposing of a U.S. real property interest, including shares of a U.S. entity whose assets consist principally of U.S. real property interests, is generally subject to FIRPTA tax on the gain recognized on the disposition. Such FIRPTA tax does not apply, however, to the disposition of shares in a REIT if the REIT is “domestically controlled.” A REIT is “domestically controlled” if less than 50% of the REIT’s shares, by value, have been owned directly or indirectly by persons who are not qualifying U.S. persons during a continuous five-year period ending on the date of disposition or, if shorter, during the entire period of the REIT’s existence. While we intend to qualify as “domestically controlled,” we cannot assure shareholders that we will. If we were to fail to so qualify, gain realized by foreign investors on a sale of our shares would be subject to FIRPTA tax, unless the shares were traded on an established securities market and the foreign investor did not at any time during a specified testing period directly or indirectly own more than 5% of the value of our outstanding common shares of beneficial interest.
Foreign investors may be subject to FIRPTA tax upon the payment of a capital gain distribution.
A foreign investor also may be subject to income tax under FIRPTA tax upon the payment of any capital gain distribution by us that is attributable to gain from sales or exchanges of U.S. real property interests. Under FIRPTA, such distributions are taxed as though the foreign investor were engaged in a trade or business and the distributions constituted income that was effectively connected with such trade or business. A REIT is generally required to withhold 35% of all capital gain distributions paid to foreign investors to the extent attributable to gain from sales or exchanges of U.S. real property interests.
We encourage investors to consult their own tax advisor to determine the tax consequences applicable to them if they are a foreign investor.
Risks Related to Investments by Tax-Exempt Entities and Benefit Plans Subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”)
If our shareholders fail to meet the fiduciary and other standards under ERISA or the Internal Revenue Code as a result of an investment in our common shares of beneficial interest, they could be subject to criminal and civil penalties.
There are special considerations that apply to tax-qualified pension, stock bonus or profit-sharing plans, employee benefit plans described in Section 3(3) of ERISA and other retirement plans or accounts subject to Section 4975 of the Internal Revenue Code (such as individual retirement accounts (“IRAs”) or annuities described in Sections 408 or 408A of the Internal Revenue Code, annuities described in Sections 403(a) or (b) of the Internal Revenue Code, Archer MSAs described in Section 220(d) of the Internal Revenue Code, health savings accounts described in Section 223(d) of the Internal Revenue Code, and Coverdell education savings accounts described in Section 530 of the Internal Revenue Code) that are investing in our shares. If investors are investing the assets of a plan or IRA in our common shares of beneficial interest, they should satisfy themselves that, among other things:
·their investment is consistent with their fiduciary obligations under ERISA and the Internal Revenue Code applicable to their plan or IRA, and other applicable provisions of ERISA and the Internal Revenue Code applicable to their plan or IRA;
·their investment is made in accordance with the documents and instruments governing their plan or IRA (including their plan’s investment policy, if applicable);
·their investment satisfies the prudence and diversification requirements of Sections 404(a)(1)(B) and 404(a)(1)(C) of ERISA and all other applicable provisions of ERISA and the Internal Revenue Code that may apply to their plan or IRA;
·their investment will not impair the liquidity needs of the plan or IRA, including liquidity needs to satisfy minimum and other distribution requirements and tax withholding requirements that may be applicable;
·their investment will not produce UBTI for the plan or IRA;
·they will be able to value the assets of the plan or IRA annually or more frequently in accordance with ERISA and Internal Revenue Code requirements and any applicable provisions of the plan or IRA;
·their investment will not constitute a prohibited transaction under Section 406 of ERISA or Section 4975 of the Internal Revenue Code; and
·our assets will not be treated as “plan assets” of their plan or IRA.
Failure to satisfy the fiduciary standards of conduct and other applicable requirements of ERISA and the Internal Revenue Code may result in the imposition of civil (and, if willful, criminal) penalties and could subject the responsible fiduciaries to liability and equitable remedies. In addition, if an investment in our shares constitutes a prohibited transaction under ERISA or the Internal Revenue Code, the “party-in-interest” or “disqualified person” who engaged in the prohibited transaction may be subject to the imposition of excise taxes with respect to the amount involved, and for IRAs, the tax-exempt status of the IRA may be lost.
This summary does not include a discussion of any laws, regulations, or statutes that may apply to investors not covered by ERISA, including, for example, plans or arrangements that constitute governmental plans or church plans which are exempt from ERISA and many Internal Revenue Code requirements. For such plans and arrangements, applicable laws (such as state laws) may impose fiduciary responsibility requirements in connection with the investment of assets, and may have prohibitions that operate similarly to the prohibited transaction rules of ERISA and the Internal Revenue Code, but which may also vary significantly from such prohibitions. For any governmental or church plan, or other plans or arrangements not subject to ERISA, those persons responsible for the investment of the assets of such plans or arrangements should carefully consider the impact of such laws on an investment in our shares.
Item 1B.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2.
Item 2. Properties.
We do not maintain any physical properties. Our operations are conducted at the corporate offices of our Advisor at 1301 Municipal Way, Grapevine, Texas 76051.
Item 3.
Item 3. Legal Proceedings.
None.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.
Market Information
Unless and until our shares are listed on a national securities exchange, we do not expect that a public market for our shares will develop. This illiquidity creates a risk that a shareholder may not be able to sell shares at a time or price acceptable to the shareholder. Unless otherwise required pursuant to applicable regulations, until eighteen months after the termination of the Offering, we will use the offering price of shares in our most recent offering as the per share value (unless we have made a special distribution to shareholders of net proceeds from our investments prior to the date of determination of the per share value, in which case we will use the offering price less the per share amount of the special distribution). We are offering our common shares of beneficial interest at a price of $20.00 per share pursuant to the current Offering. Beginning eighteen months after the last offering of our shares or such earlier time as required by applicable regulations, our board of trustees will determine the value of our properties and other assets based on such information as our board of trustees determines appropriate, which may include independent valuations of our investments or of our enterprise as a whole, unless another valuation methodology is required pursuant to applicable regulations.
There can be no assurance, however, with respect to any estimate of value that we prepare, that:
·the estimated value per share would actually be realized by our shareholders upon liquidation, because these estimates do not necessarily indicate that all loans will be paid in full or the price at which properties can be sold;
·our shareholders would be able to realize estimated net asset values if they were to attempt to sell their shares, because no public market for our shares exists or is likely to develop;
·the estimated value per share would be related to any individual or aggregated value estimates or appraisals of our assets; or
·that the value, or method used to establish value, would comply with ERISA or Internal Revenue Code requirements.
Share Redemption Program
We have adopted a share redemption program that enables our shareholders to sell their shares back to us in limited circumstances. Generally, this program permits shareholders to sell their shares back to us after they have held them for at least one year. Except for redemptions upon the death of a shareholder (in which case we may waive the minimum holding periods), the purchase price for the redeemed shares, for the period beginning after a shareholder has held the shares for a period of one year, will be (1) 92% of the purchase price actually paid for any shares held less than two years, (2) 94% of the purchase price actually paid for any shares held for at least two years but less than three years, (3) 96% of the purchase price actually paid for any shares held at least three years but less than four years, (4) 98% of the purchase price actually paid for any shares held at least four years but less than five years and (5) for any shares held at least five years, the lesser of the purchase price actually paid or the then-current fair market value of the shares as determined by the most recent annual valuation of our shares. The purchase price for shares redeemed upon the death of a shareholder will be the lesser of (1) the purchase price the shareholder actually paid for the shares or (2) $20.00 per share.
We reserve the right in our sole discretion at any time and from time to time to (1) waive the one-year holding period in the event of the death or bankruptcy of a shareholder or other exigent circumstances, (2) reject any request for redemption, (3) change the purchase price for redemptions, or (4) terminate, suspend and/or reestablish our share redemption program. In respect of shares redeemed upon the death of a shareholder, we will not redeem in excess of 1% of the weighted average number of shares outstanding during the twelve-month period immediately prior to the date of redemption, and the total number of shares we may redeem at any time will not exceed 5% of the weighted average number of shares outstanding during the trailing twelve-month period prior to the redemption date. Our board of trustees will determine from time to time whether we have sufficient excess cash from operations to repurchase shares. Generally, the cash available for redemption will be limited to 1% of the operating cash flow from the previous fiscal year, plus any net proceeds from our DRIP.
The following table sets forth information relating to our common shares of beneficial interest that have been repurchased during the quarter ended December 31, 2013:
(1)A description of the maximum number of common shares of beneficial interest that may be purchased under our share redemption program is included in the narrative preceding this table.
For the year ended December 31, 2013, we had received valid redemption requests relating to 88,376 shares of beneficial interest, all of which were redeemed for an aggregate purchase price of approximately $1.7 million (an average redemption price of approximately $19.33 per share). For the year ended December 31, 2012, we had received valid redemption requests relating to 96,016 shares of beneficial interest, all of which were redeemed for an aggregate purchase price of approximately $1.8 million (an average redemption price of $19.05 per share). Such shares are included in treasury stock in the accompanying consolidated financial statements included in this Form 10-K. A valid redemption request is one that complies with the applicable requirements and guidelines of our current share redemption program set forth in the prospectus relating to the Offering. We have funded all share redemptions using funds from operations.
Holders
As of March 20, 2014, we had approximately 31,976,999 common shares of beneficial interest outstanding that were held by a total of approximately 16,508 shareholders.
Distribution Reinvestment Plan
Our DRIP allows our shareholders, and, subject to certain conditions set forth in the plan, any shareholder or partner of any other publicly offered limited partnership, real estate investment trust or other United Development Funding-sponsored real estate program, to elect to purchase our common shares with our distributions or distributions from such other programs. We are offering 7,500,000 shares for sale pursuant to our Secondary DRIP at $20 per share until the earliest to occur of: (1) the issuance of all shares authorized and reserved for issuance pursuant to the Secondary DRIP; (2) the termination of the offering of shares pursuant to the Secondary DRIP and any subsequent offering of DRIP shares pursuant to an effective registration statement; or (3) the determination by our board of trustees that the number of our shares traded in a secondary market is more than a de minimis amount. If shares authorized and reserved for issuance pursuant to the DRIP remain available for issuance, shares are being offered to the public pursuant to an effective offering, and our shares are being traded in a secondary market and the amount of such shares traded is more than a de minimis amount, we will invest distributions in shares at a price equal to the most recent per share price at which our shares were traded in the secondary market prior to the close of business on the last business day prior to the date of the distribution.
Distributions
Distributions are authorized at the discretion of our board of trustees, which is directed, in substantial part, by its obligation to cause us to comply with the REIT requirements of the Internal Revenue Code. The funds we receive from operations that are available for distribution may be affected by a number of factors, including the following:
·the amount of time required for us to invest the funds received in the Offering;
·our operating and interest expenses;
·the ability of borrowers to meet their obligations under the loans;
·the amount of distributions or dividends received by us from our indirect real estate investments;
·the ability of our clients to sell finished lots to homebuilders and the ability of homebuilders to sell new homes to home buyers;
·capital expenditures and reserves for such expenditures;
·the issuance of additional shares; and
·financings and refinancings.
We must distribute to our shareholders at least 90% of our taxable income each year in order to meet the requirements for being treated as a REIT under the Internal Revenue Code. In accordance with this requirement, we pay daily distributions to our shareholders monthly in arrears. Our distribution rate is determined quarterly by our board of trustees and is dependent on a number of factors, including funds available for payment of distributions, our financial condition, loan funding commitments and annual distribution requirements needed to maintain our status as a REIT under the Internal Revenue Code. In addition to these distributions, in an effort to ensure we distribute at least 90% of our taxable income, our board of trustees will periodically authorize additional, special distributions. All distributions are paid in cash and DRIP shares.
Our board of trustees has authorized distributions for our shareholders of record beginning as of the close of business on each day for the period commencing on December 18, 2009 and ending on June 30, 2014. For distributions declared for each record date in the December 2009 through June 2011 periods, our distribution rate was $0.0043836 per common share of beneficial interest, which is equal to an annualized distribution rate of 8.0%, assuming a purchase price of $20.00 per share. For distributions declared for each record date in the July 2011 through June 2014 periods, our distribution rate is $0.0044932 per common share of beneficial interest, which is equal to an annualized distribution rate of 8.2%, assuming a purchase price of $20.00 per share. These distributions are aggregated and paid monthly in arrears. Distributions are paid on or about the 25th day of the respective month. Distributions for shareholders participating in our DRIP are reinvested into our shares on the payment date of each distribution.
In addition to the distributions discussed above, the following table represents all special distributions authorized by our board of trustees through December 31, 2013:
(1)Represents the date the distribution was authorized by our board of trustees.
(2)All outstanding common shares of beneficial interest as of the record date receive the distribution.
(3)Represents the distribution rate per common share of beneficial interest on the record date.
(4)Represents the date the special distribution was paid in cash and DRIP shares.
We made the following distributions to our shareholders for the year ended December 31, 2013:
For the year ended December 31, 2013, we paid distributions of approximately $44.6 million ($27.7 million in cash and $16.9 million in our common shares of beneficial interest pursuant to our DRIP), as compared to cash flows provided by operations of approximately $24.5 million. From May 28, 2008 (Date of Inception) through December 31, 2013, we paid cumulative distributions of approximately $74.0 million, as compared to cumulative FFO of approximately $49.3 million (see “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Funds from Operations and Modified Funds from Operations” below for a discussion of FFO). As of December 31, 2013, we had approximately $2.7 million of cash distributions declared that were paid subsequent to period end.
The distributions paid during the years ended December 31, 2013 and 2012, along with the amount of distributions reinvested pursuant to our DRIP and the sources of our distributions are reflected in the table below. In connection with the Restatement, cash payments to UMTH LD associated with Acquisition and Origination Fees were reclassified from investing activities to operating activities, thus reducing operating cash available for distributions. The impact of the Restatement on the tables below is more specifically described in Note C of the accompanying Notes to the Consolidated Financial Statements. The sources of distributions in the table below have been adjusted to reflect the impact of the Restatement.
The following table reflects the impact of the Restatement on the sources of distributions paid during the years ended December 31, 2011 and 2010. We did not pay any distributions for the year ended December 31, 2009.
In our initial quarters of operations, and from time to time thereafter, we did not generate enough cash from operations to fully fund distributions declared. Therefore, some or all of our distributions are paid from sources other than operating cash flow, such as proceeds from our Offering and borrowings (including borrowings secured by our assets) in anticipation of future operating cash flow. Distributions in excess of our operating cash flows have been funded via financing activities, specifically proceeds from issuance of common shares of beneficial interest and borrowings under our credit facilities, consistent with our intent to use our credit facilities to meet our investment and distribution cash requirements throughout our initial period of operations.
We utilize cash to fund operating expenses, make investments, service debt obligations and pay distributions. We receive cash from operations (which includes interest payments) as well as cash from investing activities (which includes repayment of principal on loans we have made) and financing activities (which includes borrowing proceeds and additional capital from the sale of our shares). We have secured a note payable and lines of credit to manage the timing of our cash receipts and funding requirements. Over the long term, we expect that substantially all of our distributions will be funded from operating cash flow.
Recent Sales of Unregistered Securities
During the year ended December 31, 2013, we did not sell any equity securities that were not registered or otherwise exempt under the Securities Act of 1933, as amended.
Use of Proceeds from Registered Securities
On November 12, 2009, our Registration Statement (Registration No. 333-152760), covering the Offering of up to 25,000,000 common shares of beneficial interest to be offered in the Primary Offering at a price of $20 per share, was declared effective under the Securities Act of 1933, as amended. The Registration Statement also initially covered up to 10,000,000 common shares of beneficial interest to be issued pursuant to our DRIP for $20 per share. Therefore, the aggregate offering price of the shares registered pursuant to the Offering is $700 million. We had the right to reallocate the common shares of beneficial interest registered in the Offering between the Primary Offering and the DRIP, and pursuant to Supplement No. 6 to our prospectus regarding the Offering, which was filed with the SEC on May 3, 2013, we reallocated the shares being offered to be 34,000,000 shares offered pursuant to the Primary Offering and 1,000,000 shares offered pursuant to the DRIP. The Offering terminated on May 13, 2013.
On April 19, 2013, we registered 7,500,000 additional common shares of beneficial interest to be offered pursuant to Secondary DRIP for $20 per share. We ceased offering common shares of beneficial interest under the DRIP portion of the Offering upon the termination of the Offering on May 13, 2013 and concurrently began offering our common shares of beneficial interest to our shareholders pursuant to the Secondary DRIP.
As of December 31, 2013, we had issued an aggregate of 32,115,232 common shares of beneficial interest in the Primary Offering, DRIP and Secondary DRIP, consisting of 30,735,813 common shares of beneficial interest in accordance with the Primary Offering in exchange for gross proceeds of approximately $614.7 million, 723,617 common shares of beneficial interest in accordance with our DRIP in exchange for gross proceeds of approximately $14.5 million and 655,802 common shares of beneficial interest in accordance with our Secondary DRIP in exchange for gross proceeds of approximately $13.1 million. Including DRIP and Secondary DRIP proceeds, the net offering proceeds to us, after deducting approximately $79.7 million of offering costs, were approximately $535.0 million. Of the offering costs, approximately $18.3 million was paid to our Advisor for organization and offering expenses and approximately $61.4 million was paid to non-affiliates for selling commissions, dealer manager fees and other offering fees.
As of December 31, 2013, we had purchased or entered into 139 loans with aggregate, maximum, loan amounts totaling approximately $869.4 million. We had approximately $174.9 million of commitments to be funded under terms of the notes receivable and loan participation interest (including related parties), of which approximately $4.9 million relates to notes receivable - related parties, $143.4 million relates to notes receivable, and approximately $26.6 million relates to commitments to be funded under terms of the loan participation interest - related parties. In addition, we had purchased 132 finished single-family residential lots for approximately $9.0 million.
We pay UMTH LD, our asset manager, Acquisition and Origination Fees associated with the acquisition and origination of secured loans and other real estate assets. As of December 31, 2013, we have paid UMTH LD approximately $16.9 million for Acquisition and Origination Fees, as discussed in Note B to our accompanying consolidated financial statements.
Item 6.
Item 6. Selected Financial Data.
We present below selected financial information for the last five years. The selected consolidated financial data as of and for the years ended December 31, 2013, 2012, 2011, 2010 and 2009 are derived from the restated audited consolidated financial statements of the Trust set forth in Item 15 of this Annual Report. The financial information presented below for the years prior to the fiscal year ended December 31, 2013 has been restated as set forth in this Annual Report on Form 10-K as more fully described in Note C, “Restatement,” to the accompanying consolidated financial statements. We do not plan to amend our previously filed Annual Reports on Form 10-K for the periods affected by the Restatement but we do intend to file amendments to our previously filed Quarterly Reports on Form 10-Q for the quarters ended March 31, 2013 through September 30, 2013 as soon as practicable in connection with the Restatement.
We encourage you to read the consolidated financial statements and the notes accompanying the consolidated financial statements included in this Annual Report. This information is not intended to be a replacement for the consolidated financial statements.
(1)Net income (loss) per share and distributions per share are based upon the weighted average number of common shares of beneficial interest outstanding. Distributions of our current and accumulated earnings and profits for federal income tax purposes are taxable to shareholders as ordinary income. Distributions in excess of these earnings and profits generally are treated as a non-taxable reduction of the shareholders’ basis in the common shares of beneficial interest to the extent thereof (a return of capital for tax purposes) and, thereafter, as taxable gain. These distributions in excess of earnings and profits will have the effect of deferring taxation of the distributions until the sale of our shareholders’ common shares.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Restatement Overview
As described above under the caption “Explanatory Note,” in this Annual Report on Form 10-K, we are restating our previously issued (i) consolidated balance sheets included in our Annual Reports on Form 10-K as of December 31, 2012, 2011, 2010 and 2009 and (ii) consolidated statements of operations, consolidated statements of changes in shareholders’ equity, and consolidated statements of cash flows for the years ended December 31, 2012, 2011, 2010 and 2009. We do not plan to file amendments to any of our previously filed Annual Reports on Form 10-K in connection with the Restatement and, instead, will present all of the restated annual financial statements referred to above in this Annual Report on Form 10-K.
In addition, the error that requires us to restate the annual financial statements referred to above materially impacted each of our quarters beginning with the quarter ended March 31, 2010 through the quarter ended September 30, 2013. As a result, we intend to restate our previously issued (i) consolidated balance sheets, (ii) consolidated statements of operations and (iii) consolidated statements of cash flows included in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2013, June 30, 2013 and September 30, 2013. We intend to present these restated quarterly financial statements in amendments to our previously filed Quarterly Reports on Form 10-Q for the quarters ended March 31, 2013, June 30, 2013 and September 30, 2013 as soon as practicable following the filing of this Annual Report on Form 10-K. We do not intend to amend our previously filed Quarterly Reports on Form 10-Q for the quarters ended March 31, 2010 through September 30, 2012; however, as we reported in our Current Report on Form 8-K filed on April 4, 2014, the financial statements included in our Quarterly Reports on Form 10-Q for each of the periods beginning with the quarter ended March 31, 2010 through September 30, 2013 should not be relied upon.
The impact of the Restatement is included in Notes C and Q of the accompanying Notes to the Consolidated Financial Statements and in “Item 6 - Selected Financial Data” and in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. All references to prior periods included below in this Management’s Discussion and Analysis of Financial Condition and Results of Operations have been revised to reflect the effects of the Restatement.
Background to the Restatement
We incur Acquisition and Origination Fees, payable to UMTH LD equal to 3% of the net amount available for investment in secured loans and other real estate assets. From the year ended December 31, 2009 through the quarter ended September 30, 2013, we capitalized Acquisition and Origination Fees incurred and amortized them into expense on a straight-line basis over our expected economic life. GAAP guidance in ASC 310-20 requires direct loan origination costs, including the portion of total compensation paid to employees engaged in direct loan origination activities, to be capitalized and amortized into expense over the life of the related loan, provided that records are available in sufficient detail to reliably determine the amount of qualifying direct loan origination costs incurred. In our case, employees of UMTH LD were performing loan origination activities in consideration for our payment of Acquisition and Origination Fees. However, UMTH LD did not maintain (and we did not require them to maintain) contemporaneous, sufficiently detailed time records on a loan by loan basis for all years that would provide evidence of the amount of time allocable to direct loan origination activities and thus the amount of Acquisition and Origination Fees allowable for deferral under ASC 310-20. Thus, we have concluded that we were unable to reasonably determine the amount of Acquisition and Origination Fees allowable for deferral under ASC 310-20. As a result, we have restated our previously issued financial results to expense the Acquisition and Origination Fees as incurred, rather than capitalizing and amortizing them into expense over the life of the loan.
The following discussion and analysis should be read in conjunction with our accompanying consolidated financial statements and the notes thereto:
Overview
On November 12, 2009, the Trust’s Registration Statement on Form S-11, covering the Offering of up to 25,000,000 common shares of beneficial interest to be offered in the Primary Offering at a price of $20 per share, was declared effective under the Securities Act of 1933, as amended. The Offering also initially covered up to 10,000,000 common shares of beneficial interest to be issued pursuant to our DRIP at a price of $20 per share. We had the right to reallocate the common shares of beneficial interest registered in the Offering between the Primary Offering and the DRIP, and pursuant to Supplement No. 6 to our prospectus regarding the Offering, which was filed with the SEC on May 3, 2013, we reallocated the shares being offered to be 34,000,000 shares offered pursuant to the Primary Offering and 1,000,000 shares offered pursuant to the DRIP. The Offering terminated on May 13, 2013.
On April 19, 2013, we registered 7,500,000 additional common shares of beneficial interest to be offered pursuant to our Secondary DRIP for $20 per share. We ceased offering common shares of beneficial interest under the DRIP portion of the Offering upon the termination of the Offering on May 13, 2013 and concurrently began offering our common shares of beneficial interest to our shareholders pursuant to the Secondary DRIP.
We use substantially all of the net proceeds from the Primary Offering, the DRIP and the Secondary DRIP to originate, purchase, participate in and hold for investment secured loans made directly by us or indirectly through our affiliates to persons and entities for the acquisition and development of parcels of real property as single-family residential lots or mixed-use master planned residential communities, for the construction of single-family homes and for completed model homes. We also make direct investments in land for development into single-family lots, home construction and portfolios of finished lots and model homes; provide credit enhancements to real estate developers, home builders, land bankers and other real estate investors; and purchase participations in, or finance for other real estate investors the purchase of, securitized real estate loan pools and discounted cash flows secured by state, county, municipal or other similar assessments levied on real property. We also may enter into joint ventures with unaffiliated real estate developers, home builders, land bankers and other real estate investors, or with other United Development Funding-sponsored programs, to originate or acquire, as the case may be, the same kind of secured loans or real estate investments we may originate or acquire directly.
Until required in connection with the funding of loans or other investments, substantially all of the net proceeds of the Offering and, thereafter, our working capital reserves, may be invested in short-term, highly-liquid investments including, but not limited to, government obligations, bank certificates of deposit, short-term debt obligations and interest-bearing accounts.
We made an election under Section 856(c) of the Internal Revenue Code to be taxed as a REIT, beginning with the taxable year ended December 31, 2010, which was the first year in which we had material operations. As a REIT, we generally are not subject to federal income tax on income that we distribute to our shareholders. If we later fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates and may not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied, unless we are entitled to relief under certain statutory provisions. Such an event could materially and adversely affect our net income. However, we believe that we are organized and operated in a manner that will enable us to remain qualified as a REIT for federal income tax purposes.
After giving effect to the Restatement, our loan portfolio, consisting of notes receivable, notes receivable - related parties and loan participation interest - related parties, increased from approximately $1.3 million as of December 31, 2009, to approximately $63.6 million, $142.4 million, $297.2 million and $508.5 million as of December 31, 2010, 2011, 2012 and 2013, respectively. The impact of the Restatement on each period above is more specifically described in Note C of the accompanying Notes to the Consolidated Financial Statements. As our loan portfolio increased, our revenues also increased, since the majority of our revenue is from recognizing interest income associated with our loan portfolio. Our expenses related to the portfolio increased as well, including the provision for loan losses, which was approximately $2.1 million, $1.1 million and $512,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
Our cash balances were approximately $33.6 million, $23.2 million and $6.0 million as of December 31, 2013, 2012 and 2011, respectively. These balances have fluctuated since the Offering began with the raise of gross proceeds and the deployment of funds available.
We may use debt as a means of providing additional funds for the acquisition or origination of secured loans, acquisition of properties and the diversification of our portfolio. We may also use leverage at the asset level. As of December 31, 2013, 2012 and 2011, we did not have any asset-level indebtedness. Interest expense associated with both fund-level and asset-level indebtedness was approximately $1.0 million, $1.6 million and $1.7 million for the years ended December 31, 2013, 2012 and 2011, respectively. The changes in interest expense are a result of the timing of the leverage added to the fund from 2011 through 2013.
After giving effect to the Restatement, net income (loss) was approximately $29.3 million, $13.9 million, $5.8 million, $241,000 and $(62,000) for the years ended December 31, 2013, 2012, 2011, 2010 and 2009, respectively, and net income (loss) per share of beneficial interest was approximately $1.08, $1.17, $1.23, $0.18 and $(4.66), respectively, for the same periods. The impact of the Restatement on each period above is more specifically described in Note C of the accompanying Notes to the Consolidated Financial Statements. Our net income (loss) per share of beneficial interest is calculated based on net income divided by the weighted average shares of beneficial interest outstanding. Such net income per share of beneficial interest has fluctuated since the Offering began with the raise of gross proceeds and the deployment of funds available.
As of December 31, 2013, we had originated or purchased 139 loans, including 25 loans that have either been repaid in full by the respective borrower or have matured and have not been renewed, with maximum loan amounts totaling approximately $869.4 million. Of the 114 loans outstanding as of December 31, 2013, 8 loans totaling approximately $31.0 million and 10 loans totaling approximately $32.9 million are included in notes receivable - related parties, net and loan participation interest - related parties, net, respectively, on our balance sheet. In addition, through December 31, 2013, we had purchased a total of 132 finished single-family residential lots for approximately $9.0 million. As of December 31, 2013, we have 120 finished single-family residential lots included in our real estate owned balance of approximately $8.2 million. We have option agreements in place to sell these lots with terms ranging from 18 to 24 months.
Critical Accounting Policies and Estimates
Our accounting policies have been established to conform with GAAP in the United States. The preparation of consolidated financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. If management’s judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus resulting in a different presentation of the consolidated financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses.
Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. GAAP consists of a set of standards issued by the FASB and other authoritative bodies in the form of FASB Statements, Interpretations, FASB Staff Positions, EITF consensuses and AICPA Statements of Position, among others. The FASB recognized the complexity of its standard-setting process and embarked on a revised process in 2004 that culminated in the release on July 1, 2009 of the ASC. The ASC does not change how the Trust accounts for its transactions or the nature of related disclosures made. Rather, the ASC results in changes to how the Trust references accounting standards within its reports. This change was made effective by the FASB for periods ending on or after September 15, 2009. The Trust has updated references to GAAP in this Annual Report on Form 10-K to reflect the guidance in the ASC. The preparation of these consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including investment impairment. These estimates are based on management’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Trust and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates and assumptions.
Cash and Cash Equivalents
We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. At December 31, 2013 and 2012, there were no such amounts included in cash and cash equivalents.
Restricted Cash
Restricted cash includes monies held in escrow with respect to subscriptions for shares of beneficial interest, deposits associated with certain guarantees, and liquid investments with maturities of greater than three months.
Loan Participation Interest - Related Parties
Loan participation interest - related parties represents the purchase of a financial interest in certain interim construction, paper lot (residential lots shown on a plat that has been accepted by the city or county, but which is currently undeveloped or under development) and finished lot loan facilities originated by our affiliates. We participate in these loans by funding the lending obligations of our affiliates under these credit facilities up to a maximum amount for each participation. Such participations entitle us to receive payments of principal and interest from the borrower up to the amounts funded by us. The participation interests in interim construction loan facilities are collateralized by first lien deeds of trust on the homes financed under the construction loans. The participation interests in paper lot loan and finished lot loan facilities are collateralized by one or more of the following: first or second lien deeds of trust, a pledge of ownership interests in the borrower, assignments of lot sale contracts, or reimbursements of development costs due to the borrower under contracts with districts and cities. As of December 31, 2013, the participations have terms ranging from 12 to 31 months and bear interest at rates ranging from 12% to 15%. The participation interests may be paid off prior to maturity; however, we intend to hold all participation interests for the life of the loans.
Notes Receivable and Notes Receivable - Related Parties
Notes receivable and notes receivable - related parties are recorded at the lower of cost or net realizable value. The notes are collateralized by one or more of the following: first or second lien deeds of trust, a pledge of ownership interests in the borrower, assignments of lot sale contracts or reimbursements of development costs due to the borrower under contracts with districts and cities. None of such notes are insured or guaranteed by a federally owned or guaranteed mortgage agency. As of December 31, 2013, the notes have terms ranging from 3 to 48 months and bear interest at rates ranging from 11% to 15%. The notes may be paid off prior to maturity; however, the Trust intends to hold all notes for the life of the notes.
Determination of the Allowance for Loan Losses
The allowance for loan losses is our estimate of incurred losses in our portfolio of notes receivable, notes receivable - related parties and loan participation interest - related parties. We periodically perform a detailed review of our portfolio of notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses. Our review consists of evaluating economic conditions, the estimated value of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. This review is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
In reviewing our portfolio, we use cash flow estimates from the disposition of finished lots, paper lots and undeveloped land as well as cash flow received from the issuance of bonds from municipal reimbursement districts. These estimates are based on current market metrics, including, without limitation, the supply of finished lots, paper lots and undeveloped land; the supply of homes and the rate and price at which land and homes are sold; historic levels and trends; executed contracts; appraisals and discussions with third party market analysts and participants, including homebuilders. We have based our valuations on current and historic market trends on our analysis of market events and conditions, including activity within our portfolio, and on the analysis of third-party services such as Metrostudy and Residential Strategies, Inc. Cash flow forecasts also have been based on executed purchase contracts which provide base prices, escalation rates, and absorption rates on an individual project basis. For projects deemed to have an extended time horizon for disposition, we have considered third-party appraisals to provide a valuation in accordance with guidelines set forth in the Uniform Standards of Professional Appraisal Practice. In addition to cash flows from the disposition of property, cost analysis has been performed based on estimates of development and senior financing expenditures provided by developers and independent professionals on a project-by-project basis. These amounts have been reconciled with our best estimates to establish the net realizable value of the portfolio.
We charge additions to the allowance for loan losses to current period earnings through a provision for loan losses. Amounts determined to be uncollectible are charged directly against, or “charged off,” and decrease the allowance for loan losses, while amounts recovered on previously charged off accounts increase the allowance. As of December 31, 2013 and 2012, the allowance for loan losses had a balance of $3.8 million and $1.8 million, respectively, offset against notes receivable (see Note B to accompanying consolidated financial statements).
Organization and Offering Expenses
Organization costs will be expensed as incurred in accordance with Statement of Position 98-5, Reporting on the Costs of Start-up Activities, currently within the scope of FASB ASC 720-15. Offering costs related to raising capital from debt will be capitalized and amortized over the term of such debt. Offering costs related to raising capital from equity reduce equity and are reflected as shares issuance costs in shareholders’ equity. Certain offering costs were paid by our Advisor. As discussed in Note G to the accompanying consolidated financial statements, these costs have been reimbursed to our Advisor by the Trust (the “O&O Reimbursement”). For the years ended December 31, 2013 and 2012, the Trust reimbursed its Advisor approximately $8.2 million and $5.9 million, respectively, in connection with the O&O Reimbursement.
Acquisition and Origination Fees
We reimburse UMTH LD, our asset manager, for Acquisition and Origination Fees; provided, however, that no Acquisition and Origination Fees will be paid with respect to any asset level indebtedness we incur. The Acquisition and Origination Fees that we pay will be reduced by the amount of any acquisition and origination fees and expenses paid by borrowers or investment entities to our Advisor or affiliates of our Advisor with respect to our investment. We will not pay any Acquisition and Origination Fees with respect to any participation agreement we enter into with our affiliates or any affiliates of our Advisor for which our Advisor or affiliates of our Advisor previously has received acquisition and origination fees and expenses from such affiliate with respect to the same secured loan or other real estate asset. Such fees are expensed as incurred. See Note C to the accompanying consolidated financial statements for further discussion of the Restatement associated with Acquisition and Origination Fees. For the years ended December 31, 2013 and 2012, the Trust reimbursed UMTH LD approximately $8.0 million and $5.2 million, respectively, for Acquisition and Origination Fees.
Revenue Recognition
Interest income on loan participation interest - related parties, notes receivable and notes receivable - related parties is recognized over the life of the participation agreement or note agreement and recorded on the accrual basis. A loan is placed on non-accrual status and income recognition is suspended at the date at which, in the opinion of management, a full recovery of income and principal becomes more likely than not, but is no longer probable, based upon our review of economic conditions, the estimated value of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Any payments received on loans classified as non-accrual status are typically applied first to outstanding loan amounts and then to the recovery of lost interest. As of December 31, 2013 and 2012, we were accruing interest on all loan participation interest - related parties, notes receivable and notes receivable - related parties.
Commitment fee income and commitment fee income - related parties represents non-refundable fees charged to borrowers for entering into an obligation that commits us to make or acquire a loan or to satisfy a financial obligation of the borrower when certain conditions are met within a specified time period. When a commitment is considered an integral part of the resulting loan and we believe there is a reasonable expectation that the commitment will be called upon, the commitment fee is recognized as revenue over the life of the resulting loan. As of December 31, 2013 and 2012, approximately $2.5 million and $970,000, respectively, of unamortized commitment fees are included as an offset of notes receivable. Approximately $164,000 and $263,000 of unamortized commitment fees are included as an offset of notes receivable - related parties as of December 31, 2013 and 2012, respectively. When we believe it is unlikely that the commitment will be called upon or that the fee is not an integral part of the return of a specific future lending arrangement, the commitment fee is recognized as income when it is earned, based on the specific terms of the commitment. We make a determination of revenue recognition on a case-by-case basis, due to the unique and varying terms of each commitment.
In addition, commitment fee income includes option fees earned by us in connection with option agreements we have entered into to sell lots that are included in real estate owned. Option fees are recorded over the life of the lot option agreement as earned, pursuant to the terms of the lot option agreement.
Real estate owned - property sales income and real estate owned - property sales cost are recorded as lots are sold to builders.
Real Estate Owned and Loan Portfolio
Real Estate Owned
Our real estate owned consists of finished single-family residential lots purchased from third party builders. In some cases, we may use our lines of credit to finance these lots. For lots we intend to finance under a line of credit, a UDF IV subsidiary has originated a first lien on the lots which is assigned to the holder of the line of credit.
As of December 31, 2013, we have 120 finished single-family residential lots included in our real estate owned balance of approximately $8.2 million. We have option agreements in place to sell these lots with terms ranging from 18 to 24 months.
Loan Portfolio
For loans in which we are a subordinate lender, we are generally second in lien priority behind the senior lender. In some cases, we permit builders to file performance deeds of trust in second priority behind the senior lender. In such cases, we are generally third in lien priority behind the senior lender and the builder performance deeds of trust. For loans in which we are a subordinate lender, the aggregate of all loan balances on an individual project, both senior and subordinated, divided by the value of the collateral is 85% or less, unless substantial justification to exceed an 85% loan-to-value ratio exists because of the presence of other underwriting criteria.
We may secure our loans with pledges of equity interests in lieu of, or in addition to, real property liens. Pledges of equity interests are documented by pledge agreements, assignments of equity interests, and uniform commercial code (“UCC”) financing statements. In some cases, we also secure assignments of distributions to secure our pledges of equity interests. Should a loan secured by a pledge of equity interests default, we may foreclose on the pledge of equity interests through a personal property foreclosure under the terms of the pledge agreement and the UCC.
We may secure our loans with assignments of reimbursement rights in lieu of, or in addition to, real property liens. Assignments of reimbursement rights are documented by deeds of trust or by assignments and UCC financing statements. Should a loan secured by an assignment of reimbursement rights default, we may foreclose on the reimbursement rights either in conjunction with a real property foreclosure or through a personal property foreclosure under the terms of the UCC.
As of December 31, 2013, we had purchased or entered into 15 participation agreements with related parties (five of which were repaid in full) with aggregate, maximum loan amounts of approximately $77.5 million (with an unfunded balance of approximately $26.6 million) and 11 related party note agreements (two of which were repaid in full and one of which matured and was not renewed) with aggregate, maximum loan amounts totaling approximately $62.1 million (with an unfunded balance of approximately $4.9 million). Additionally, we had purchased or entered into 113 note agreements with third parties (17 of which were repaid in full) with aggregate, maximum loan amounts of approximately $729.8 million, of which approximately $143.4 million has yet to be funded.
The participation agreements outstanding as of December 31, 2013 are made to borrower entities which may hold ownership interests in projects in addition to the project funded by us and/or may be secured by multiple single-family residential communities. Certain participation agreements are secured by a personal guarantee of the borrower in addition to a lien on the real property or the equity interests in the entity that holds the real property. The outstanding aggregate principal amount of mortgage notes originated by us as of December 31, 2013 are secured by properties located in the Dallas, Fort Worth, Austin, Houston, San Antonio and Lubbock metropolitan markets in Texas. Security for such loans takes the form of either a direct security interest represented by a first or second lien on the respective property and/or an indirect security interest represented by a pledge of the ownership interests of the entity which holds title to the property.
As of December 31, 2013, we did not have any individual loans to borrowers that accounted for over 10% of the outstanding balance of our portfolio. As of December 31, 2013, our largest individual borrower and its affiliates comprised approximately 65% of the outstanding balance of our portfolio.
As of December 31, 2013, interest rates range from 12% to 15% on the outstanding participation agreements and from 11% to 15% on the outstanding notes receivable, including notes receivable from related parties. The participation agreements have terms ranging from 12 to 31 months, while the notes receivable have terms ranging from 3 to 48 months.
The following table summarizes our real property loans and investments as of December 31, 2013:
(1) Represents lender as of December 31, 2013. In some cases, loans may be assigned between UDF IV and its wholly-owned subsidiaries.
(2) Reflects remaining collateral as of December 31, 2013.
(3) Reflects most current amendment to loan as of December 31, 2013, if applicable.
(4) Loan acquired from a senior lender. Original Note Date represents date of acquisition.
Location of Real Property Loans and Investments
As of December 31, 2013, 100% of our real property loans and investments are secured by properties located in Texas. The following table summarizes the location of our real property loans and investments as of December 31, 2013:
Results of Operations
All prior results of operations presented below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations” have been revised to reflect the effects of the Restatement.
The year ended December 31, 2013 compared to the year ended December 31, 2012
Revenues
Interest income (including related party interest income) for the years ended December 31, 2013 and 2012 was approximately $50.8 million and $27.0 million, respectively. The increase in interest income for the year ended December 31, 2013 is primarily the result of our increased notes receivable portfolio (including related party transactions) and loan participation interest - related party portfolio of approximately $508.5 million as of December 31, 2013, compared to approximately $297.2 million as of December 31, 2012 as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments.
Commitment fee income (including related party commitment fee income) for the years ended December 31, 2013 and 2012 was approximately $1.6 million and $590,000, respectively. The increase in commitment fee income for the year ended December 31, 2013 is primarily the result of an increase in overall loan commitments as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments. In addition, for the year ended December 31, 2013, commitment fee income includes option fees earned with respect to finished lots that were acquired for resale to third party builders.
We expect revenues to increase commensurate with our continued deployment of available funds to borrowers and markets in which we have experience and as markets dictate in accordance with economic factors conducive for a stable residential market, and commensurate with our reinvestment of proceeds from loans that are repaid.
Expenses
Interest expense related to our notes payable, and lines of credit totaled approximately $1.0 million and $1.6 million for the years ended December 31, 2013 and 2012, respectively. Interest expense will fluctuate based on the timing of leverage introduced to the fund as well as the timing of draws and payments on our notes payable and lines of credit.
Advisory fee - related party expense was approximately $8.2 million and $4.2 million for the years ended December 31, 2013 and 2012, respectively. We pay Advisor fees of 2% per annum of our average invested assets (“Advisory Fees”), including secured loan assets; provided, however, that no Advisory Fees will be paid with respect to any asset level indebtedness we incur. The fee is calculated monthly in an amount equal to one-twelfth of 2% of the Trust’s average invested assets, including secured loan assets, as of the last day of the immediately preceding month. Advisory fee - related party expense represents the expense associated with these Advisory Fees. The increase in advisory fee - related party expense is associated with the increase in our average invested assets as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments.
General and administrative expense for the years ended December 31, 2013 and 2012 was approximately $1.8 million and $1.2 million, respectively. General and administrative expense consists primarily of legal and accounting fees, transfer agent fees, insurance expense and amortization of deferred financing costs. The increase in general and administrative expense is primarily associated with an increase in transfer agent fees commensurate with the increase in shareholders.
General and administrative - related parties expense for the years ended December 31, 2013 and 2012 was approximately $10.0 million and $5.6 million, respectively. We will occasionally enter into financing arrangements that require guarantees from entities affiliated with us. These guarantees require us to pay fees (“Credit Enhancement Fees”) to our affiliated entities as consideration for their guarantees. These Credit Enhancement Fees are either expensed as incurred or prepaid and amortized, based on the terms of the guarantee agreements. We also pay our Advisor 1% of the amount made available to us pursuant to the origination of any line of credit or other debt financing, provided that the Advisor has provided a substantial amount of services as determined by our independent trustees and, on each anniversary date of the origination of any such line of credit or other debt financing, we pay an additional fee to our Advisor of 0.25% of the primary loan amount (collectively, “Debt Financing Fees”) if such line of credit or other debt financing continues to be outstanding on such date. General and administrative - related parties expense consists of Acquisition and Origination Fees, amortization of Debt Financing Fees and expense associated with Credit Enhancement Fees. The increase in general and administrative - related parties expense is primarily a result of an increase in Acquisition and Origination Fees commensurate with the increase in our investment portfolio over the same period. See Note C to the consolidated financial statements for further discussion of the Restatement associated with Acquisition and Origination Fees.
We expect interest expense, general and administrative expense, and advisory fee - related party expense to increase commensurate with the growth of our portfolio as we continue to deploy funds available to the borrowers and markets in which we have experience and as markets dictate in accordance with economic factors conducive for a stable residential market.
The year ended December 31, 2012 compared to the year ended December 31, 2011
Revenues
Interest income (including related party interest income) for the years ended December 31, 2012 and 2011 was approximately $27.0 million and $12.9 million, respectively. The increase in interest income for the year ended December 31, 2012 is primarily the result of our increased notes receivable portfolio (including related party transactions) and loan participation interest - related party portfolio of approximately $297.2 million as of December 31, 2012, compared to approximately $142.4 million as of December 31, 2011 as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments.
Commitment fee income (including related party commitment fee income) for the years ended December 31, 2012 and 2011 was approximately $590,000 and $438,000, respectively. The increase in commitment fee income for the year ended December 31, 2012 is primarily the result of an increase in overall loan commitments as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments.
Expenses
Interest expense related to our senior credit facility, notes payable, and lines of credit totaled approximately $1.6 million and $1.7 million for the years ended December 31, 2012 and 2011, respectively. The decrease is primarily due to a reduction in the outstanding balance of the credit facility discussed further in note K to the accompanying consolidated financial statements.
Advisory fee - related party expense was approximately $4.2 million and $1.9 million for the years ended December 31, 2012 and 2011, respectively. We pay our Advisor fees of 2% per annum of our average invested assets (“Advisory Fees”), including secured loan assets; provided, however, that no Advisory Fees will be paid with respect to any asset level indebtedness we incur. The fee is calculated monthly in an amount equal to one-twelfth of 2% of the Trust’s average invested assets, including secured loan assets, as of the last day of the immediately preceding month. Advisory fee - related party expense represents the expense associated with these Advisory Fees. The increase in advisory fee - related party expense is associated with the increase in our average invested assets as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments.
General and administrative expense for the years ended December 31, 2012 and 2011 was approximately $1.2 million and $501,000, respectively. General and administrative expense consists primarily of legal and accounting fees, transfer agent fees, insurance expense and amortization of deferred financing costs. The increase in general and administrative expense is primarily associated with an increase in transfer agent fees and an increase in amortization of deferred financing costs commensurate with the increase in shareholders and the timing of leverage introduced to the fund over the same period.
General and administrative - related parties expense for the years ended December 31, 2012 and 2011 was approximately $5.6 million and $2.8 million, respectively. We will occasionally enter into financing arrangements that require guarantees from entities affiliated with us. These guarantees require us to pay fees (“Credit Enhancement Fees”) to our affiliated entities as consideration for their guarantees. These Credit Enhancement Fees are either expensed as incurred or prepaid and amortized, based on the terms of the guarantee agreements. We also pay our Advisor 1% of the amount made available to us pursuant to the origination of any line of credit or other debt financing, provided that the Advisor has provided a substantial amount of services as determined by our independent trustees and, on each anniversary date of the origination of any such line of credit or other debt financing, we pay an additional fee to our Advisor of 0.25% of the primary loan amount (collectively, “Debt Financing Fees”) if such line of credit or other debt financing continues to be outstanding on such date. General and administrative - related parties expense consists of Acquisition and Origination Fees, amortization of Debt Financing Fees and expense associated with Credit Enhancement Fees. The increase in general and administrative - related parties expense is primarily a result of an increase in Acquisition and Origination Fees commensurate with the increase in our investment portfolio over the same period. See Note C to the consolidated financial statements for further discussion of the Restatement associated with Acquisition and Origination Fees.
The year ended December 31, 2011 compared to the year ended December 31, 2010
Revenues
Interest income (including related party interest income) for the years ended December 31, 2011 and 2010 was approximately $12.9 million and $4.1 million, respectively. The increase in interest income for the year ended December 31, 2011 is primarily the result of our increased notes receivable portfolio (including related party transactions) and loan participation interest - related party portfolio of approximately $142.4 million as of December 31, 2011, compared to approximately $63.6 million as of December 31, 2010 as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments.
Commitment fee income (including related party commitment fee income) for the years ended December 31, 2011 and 2010 was approximately $438,000 and $425,000, respectively. The increase in commitment fee income for the year ended December 31, 2011 is primarily the result of an increase in overall loan commitments as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments.
Expenses
Interest expense related to our senior credit facility, notes payable, and lines of credit totaled approximately $1.7 million and $976,000 for the years ended December 31, 2011 and 2010, respectively. The increase was due to the timing of leverage introduced to the fund during 2011 and 2010.
Advisory fee - related party expense was approximately $1.9 million and $629,000 for the years ended December 31, 2011 and 2010, respectively. We pay our Advisor fees of 2% per annum of our average invested assets, including secured loan assets; provided, however, that no Advisory Fees will be paid with respect to any asset level indebtedness we incur. The fee is calculated monthly in an amount equal to one-twelfth of 2% of the Trust’s average invested assets, including secured loan assets, as of the last day of the immediately preceding month. Advisory fee - related party expense represents the expense associated with these Advisory Fees. The increase in advisory fee - related party expense is associated with the increase in our average invested assets as proceeds raised from our Offering continued to be invested in revenue-generating real estate investments.
General and administrative expense for the years ended December 31, 2011 and 2010 was approximately $501,000 and $140,000, respectively. General and administrative expense consists primarily of legal and accounting fees, transfer agent fees, insurance expense and amortization of deferred financing costs. The increase in general and administrative expense is primarily associated with an increase in transfer agent fees and an increase in amortization of deferred financing costs commensurate with the increase in shareholders and the timing of leverage introduced to the fund over the same period.
General and administrative - related parties expense for the years ended December 31, 2011 and 2010 was approximately $2,774,000 and $2,330,000, respectively. We will occasionally enter into financing arrangements that require guarantees from entities affiliated with us. These guarantees require us to pay Credit Enhancement Fees to our affiliated entities as consideration for their guarantees. These Credit Enhancement Fees are either expensed as incurred or prepaid and amortized, based on the terms of the guarantee agreements. We also pay our Advisor 1% of the amount made available to us pursuant to the origination of any line of credit or other debt financing, provided that the Advisor has provided a substantial amount of services as determined by our independent trustees and, on each anniversary date of the origination of any such line of credit or other debt financing, we pay an additional Debt Financing Fee to our Advisor of 0.25% of the primary loan amount if such line of credit or other debt financing continues to be outstanding on such date. General and administrative - related parties expense consists of Acquisition and Origination Fees, amortization of Debt Financing Fees and expense associated with Credit Enhancement Fees. The increase in general and administrative - related parties expense is primarily a result of an increase in expense associated with Credit Enhancement Fees and an increase in Acquisition and Origination Fees commensurate with the increase in our investment portfolio over the same period. See Note C to the consolidated financial statements for further discussion of the Restatement associated with Acquisition and Origination Fees.
The year ended December 31, 2010 compared to the year ended December 31, 2009
We commenced active operations after we satisfied the minimum offering of 50,000 common shares of beneficial interest for gross offering proceeds of $1.0 million in connection with the Offering on December 18, 2009. As a result, our operations for the year ended December 31, 2010 are not comparable to the results of operations for the year ended December 31, 2009.
Comparison Charts
The chart below summarizes the approximate payments to related parties for the years ended December 31, 2013 and 2012:
The chart below summarizes the approximate expenses associated with related parties for the years ended December 31, 2013, 2012 and 2011:
The chart below summarizes general and administrative - related parties expense for the years ended December 31, 2010 and 2009:
Cash Flow Analysis
The year ended December 31, 2013 compared to the year ended December 31, 2012
Cash flows provided by operating activities for the year ended December 31, 2013 were approximately $24.5 million and primarily comprised net income offset partially by accrued interest receivable. Cash flows provided by operating activities for the year ended December 31, 2012 were approximately $9.8 million and primarily comprised net income offset partially by accrued interest receivable.
Cash flows used in investing activities for the years ended December 31, 2013 and 2012 were approximately $220.0 million and $155.8 million, respectively, resulting primarily from originations of notes receivable (including related party transactions) and loan participation interest - related parties, offset by receipts from mortgage notes receivable (including related party transactions) and loan participation interest - related parties.
Cash flows provided by financing activities for the year ended December 31, 2013 were approximately $205.8 million and primarily comprised funds received from the issuance of common shares of beneficial interest pursuant to the Offering, net borrowings on lines of credit and advances on notes payable and the senior credit facility, offset partially by payments on notes payable, cash distributions to shareholders and payments of offering costs. Cash flows provided by financing activities for the year ended December 31, 2012 were approximately $163.3 million and primarily comprised funds received from the issuance of common shares of beneficial interest pursuant to the Offering, net borrowings on lines of credit and advances on notes payable and the senior credit facility, offset partially by payments on notes payable, cash distributions to shareholders and payments of offering costs.
Our cash and cash equivalents were approximately $33.6 million as of December 31, 2013, compared to approximately $23.2 million at December 31, 2012.
The year ended December 31, 2012 compared to the year ended December 31, 2011
Cash flows provided by operating activities for the year ended December 31, 2012 were approximately $9.8 million and primarily comprised net income offset partially by accrued interest receivable. Cash flows provided by operating activities for the year ended December 31, 2011 were approximately $4.5 million and primarily comprised net income offset partially by accrued interest receivable and accrued receivable - related parties.
Cash flows used in investing activities for the years ended December 31, 2012 and 2011 were approximately $155.8 million and $79.3 million, respectively, resulting primarily from originations of notes receivable (including related party transactions) and loan participation interest - related parties, offset by receipts from mortgage notes receivable (including related party transactions) and loan participation interest - related parties.
Cash flows provided by financing activities for the year ended December 31, 2012 were approximately $163.3 million and primarily comprised funds received from the issuance of common shares of beneficial interest pursuant to the Offering, net borrowings on lines of credit and advances on notes payable and the senior credit facility, offset partially by payments on notes payable, cash distributions to shareholders and payments of offering costs. Cash flows provided by financing activities for the year ended December 31, 2011 were approximately $78.2 million and primarily comprised funds received from the issuance of common shares of beneficial interest pursuant to the Offering, net borrowings on lines of credit and advances on notes payable and the senior credit facility, offset partially by payments on notes payable, cash distributions to shareholders and payments of offering costs.
Our cash and cash equivalents were approximately $23.2 million as of December 31, 2012, compared to approximately $6.0 million at December 31, 2011.
The year ended December 31, 2011 compared to the year ended December 31, 2010
Cash flows provided by operating activities for the year ended December 31, 2011 were approximately $4.5 million and primarily comprised net income offset partially by accrued interest receivable and accrued receivable - related parties. Cash flows used in operating activities for the year ended December 31, 2010 were approximately $2.8 million and primarily comprised net income offset with accrued interest receivable, accrued receivable - related parties and other assets.
Cash flows used in investing activities for the years ended December 31, 2011 and 2010 were approximately $79.3 million and $62.4 million, respectively, resulting primarily from originations of notes receivable (including related party transactions) and loan participation interest - related parties, offset by receipts from mortgage notes receivable (including related party transactions) and loan participation interest - related parties.
Cash flows provided by financing activities for the year ended December 31, 2011 were approximately $78.2 million and primarily comprised funds received from the issuance of common shares of beneficial interest pursuant to the Offering, net borrowings on lines of credit and advances on notes payable and the senior credit facility, offset partially by payments on notes payable, cash distributions to shareholders and payments of offering costs. Cash flows provided by financing activities for the year ended December 31, 2010 were approximately $67.2 million and primarily comprised funds received from the issuance of common shares of beneficial interest pursuant to the Offering, net borrowings on lines of credit and advances on notes payable and the senior credit facility, offset partially by cash distributions to shareholders and payments of offering costs.
Our cash and cash equivalents were approximately $6.0 million as of December 31, 2011, compared to approximately $2.5 million at December 31, 2010.
The year ended December 31, 2010 compared to the year ended December 31, 2009
We commenced active operations after we satisfied the minimum offering of 50,000 common shares of beneficial interest for gross offering proceeds of $1.0 million in connection with the Offering on December 18, 2009. As a result, our cash flows for the year ended December 31, 2010 are not comparable to the cash flows for the year ended December 31, 2009.
Funds from Operations and Modified Funds from Operations
Due to certain unique operating characteristics of real estate companies, the National Association of Real Estate Investment Trusts (“NAREIT”), an industry trade group, has promulgated a measure known as funds from operations (“FFO”), which we believe to be an appropriate supplemental measure to reflect the operating performance of a REIT. The use of FFO is recommended by the REIT industry as a supplemental performance measure. FFO is not equivalent to our net income or loss as determined under GAAP.
We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004 (the “White Paper”). The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property and asset impairment write-downs, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO. Our FFO calculation complies with NAREIT’s policy described above.
Loans are considered impaired and disregarded from FFO calculations when, based on current information and events, it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is generally evaluated on an individual loan basis for each loan in the portfolio. If an individual loan is considered impaired, this would lead us to evaluate whether the carrying value exceeds the fair market value requiring an impairment for excess carrying value. A specific valuation allowance may be allocated, if necessary, so that the individual loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from collateral. Loans that are not individually considered impaired are collectively and qualitatively measured as a portfolio for general valuation allowance. Investors should note that in reviewing our portfolio for this valuation analysis, we use cash flow estimates from the disposition of finished lots, paper lots (residential lots shown on a plat that has been accepted by the city or county, but which is currently undeveloped or under development) and undeveloped land, as well as cash flow received from the issuance of bonds from municipal reimbursement districts. These estimates are based on current market metrics, including, without limitation, the supply of finished lots, paper lots and undeveloped land; the supply of homes and the rate and price at which land and homes are sold; historic levels and trends; executed purchase contracts; appraisals and discussions with third-party market analysts and participants, including homebuilders. We base our valuations on current and historic market trends, on our analysis of market events and conditions, including activity within our portfolio, and on the analysis of third-party services such as Metrostudy and Residential Strategies, Inc. Cash flow forecasts are also based on executed purchase contracts which provide base prices, escalation rates, and absorption rates on an individual project basis. For projects deemed to have an extended time horizon for disposition, we consider third-party appraisals to provide a valuation in accordance with guidelines set forth in the Uniform Standards of Professional Appraisal Practice. In addition to cash flows from the disposition of property, cost analysis is performed based on estimates of development and senior financing expenditures provided by developers and independent professionals on a project-by-project basis. These amounts are reconciled with our best estimates to establish the net realizable value of the portfolio. While impairment charges are excluded from the calculation of FFO as described above, investors are cautioned that due to the fact that impairments are based on factors described above and that we intend to have a relatively limited term of our operations, it could be difficult to recover any impairment charges through the eventual disposition of the collateral. We have not had any impairment charges and, therefore, no such adjustments to FFO.
However, changes in the accounting and reporting promulgations under GAAP (including changes that were put into effect in 2009 subsequent to the establishment of NAREIT’s definition of FFO for acquisition fees and expenses from a capitalization/depreciation model to an expensed-as-incurred model) have impacted the reporting of operating income for all industries. Additionally, publicly registered, non-listed REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation as compared to later years and therefore require additional adjustments to FFO in evaluating performance. Due to these and other unique features of publicly registered, non-listed REITs, the Investment Program Association (the “IPA”), an industry trade group, has standardized a measure known as modified funds from operations (“MFFO”), which we believe to be another appropriate supplemental measure to reflect the operating performance of a REIT. The use of MFFO is recommended by the IPA as a supplemental performance measure for publicly registered, non-listed REITs. MFFO is a metric used by management to evaluate sustainable performance and dividend policy. MFFO is not equivalent to our net income or loss as determined under GAAP and MFFO may not be a useful measure of the impact of long-term operating performance or may not be useful as a comparative measure to other publicly registered, non-traded REITs, unless we continue to operate with a limited life and targeted exit strategy, as currently intended.
We define MFFO, a non-GAAP measure, consistent with the IPA’s Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations (Practice Guideline), issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for the following items included in the determination of GAAP net income or loss: acquisition and origination fees and expenses; amounts relating to deferred rent receivables and amortization of above and below market leases and liabilities; accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income or loss; gains or losses included in net income or loss from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan; unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting; and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. Mark-to-market and fair value adjustments to calculate MFFO may be reflective of on-going operations or reflect unrealized operational impacts, since such adjustments may be based upon current operational issues relating to our portfolio, industry or general market conditions. Mark-to-market and fair value adjustments represent a continuous process, analyzed on a quarterly and/or annual basis in accordance with GAAP. Our MFFO calculation complies with the IPA’s Practice Guideline described above. In calculating MFFO, we adjust for acquisition related expenses. Acquisition and origination fees paid to our Advisor or its affiliates in connection with the origination of notes receivables are expensed as incurred. Such acquisition related expenses are paid in cash to our Advisor or its affiliates that would otherwise be available to distribute to our shareholders. The origination and acquisition of secured loans, and the corresponding expenses associated with that process, is a key operational feature of our business plan in order to generate operating revenues and cash flows to make distributions to our shareholders. We may be required to pay acquisition and origination fees and expenses due to our Advisor or its affiliates, or a portion thereof, with net proceeds from borrowed funds, operational earnings or cash flows, principal repayments, or ancillary cash flows. As a result, the amount of proceeds available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds. Such fees will not be reimbursed by our Advisor or its affiliates. Acquisition related expenses under GAAP are considered operating expenses and as expenses included in the determination of net income (loss) and income (loss) from continuing operations, both of which are performance measures under GAAP. Management believes that acquisition related expenses are non-operating and do not affect our long-term operating performance; therefore, excluding acquisition and origination costs from MFFO provides investors with supplemental performance information that is consistent with the performance models used by management, and provides investors with a view of our portfolio over time, independent of direct costs associated with the timing of acquisition activity. MFFO would only be comparable to other publicly registered, non-listed REITs that have completed their acquisition activity and have similar operating characteristics to us.
With respect to loan loss provisions, management does not include these expenses in our evaluation of the operating performance of our real estate loan portfolio, as we believe these costs will be reflected in our reported results from operations if and when we actually realize a loss on a real estate investment. As many other publicly registered, non-listed REITs exclude such charges in reporting their MFFO, we believe that our calculation and reporting of MFFO will assist investors and analysts in comparing our performance versus other publicly registered, non-listed REITs. The other adjustments included in the IPA’s Practice Guideline are not applicable to us for the years ended December 31, 2013, 2012 and 2011.
Presentation of this information is intended to assist the reader in comparing the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way, so comparisons with other REITs may not be meaningful. Furthermore, FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income or loss as an indication of our performance, as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our shareholders. FFO and MFFO should be reviewed in conjunction with other measurements as an indication of our performance. FFO and MFFO should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or loss or in its applicability in evaluating our operating performance. MFFO has limitations as a performance measure in an offering such as ours where the price of a common share of beneficial interest is a stated value and there is no net asset value determination during the offering and for a period thereafter. MFFO may be useful in assisting management and investors in assessing the sustainability of operating performance and our current distribution policy in future operating periods, and in particular, after the offering of our shares is complete or the time when we cease to make investments on a frequent and regular basis and net asset value is disclosed. FFO and MFFO are not useful measures in evaluating net asset value because impairment write-downs are taken into account in determining net asset value but not in determining FFO and MFFO. In addition, because MFFO excludes the effect of acquisition and origination costs, which are an important component in an analysis of the historical performance of an asset, MFFO should not be construed as a historic performance measure. Our FFO and MFFO reporting complies with NAREIT’s policy described above.
Neither the SEC, NAREIT, nor any other regulatory body has passed judgment on the acceptability of the adjustments that we use to calculate FFO or MFFO. In the future, the SEC, NAREIT or another regulatory body may decide to standardize the allowable adjustments across the publicly registered, non-listed REIT industry and we would have to adjust our calculation and characterization of FFO or MFFO.
The following is a reconciliation of net income to FFO and MFFO for the years ended December 31, 2013, 2012, 2011, 2010 and 2009:
(a) With respect to loan loss provisions, management does not include these expenses in our evaluation of the operating performance of our real estate loan portfolio, as we believe these costs will be reflected in our reported results from operations if and when we actually realize a loss on a real estate investment. As many other publicly registered, non-listed REITs exclude such charges in reporting their MFFO, we believe that our calculation and reporting of MFFO will assist investors and analysts in comparing our performance versus other publicly registered, non-listed REITs.
(b) Acquisition and origination fees paid to our Advisor or its affiliates in connection with the origination of notes receivables are expensed as incurred. Such acquisition related expenses are paid in cash to our Advisor or its affiliates that would otherwise be available to distribute to our shareholders. The origination and acquisition of secured loans, and the corresponding expenses associated with that process, is a key operational feature of our business plan in order to generate operating revenues and cash flows to make distributions to our shareholders. In the future, if we are not able to raise additional proceeds from our offerings, this could result in us paying acquisition and origination fees and expenses due to our Advisor or its affiliates, or a portion thereof, with net proceeds from borrowed funds, operational earnings or cash flows, principal repayments, or ancillary cash flows. As a result, the amount of proceeds available for investment and operations would be reduced, or we may incur additional interest expense as a result of borrowed funds. Such fees will not be reimbursed by our Advisor or its affiliates. Changes in the accounting and reporting promulgations under GAAP (including changes that were put into effect in 2009 subsequent to the establishment of NAREIT’s definition of FFO for acquisition fees and expenses from a capitalization/depreciation model to an expensed-as-incurred model) have impacted the reporting of operating income for all industries. Acquisition related expenses under GAAP are considered operating expenses and as expenses included in the determination of net income (loss) and income (loss) from continuing operations, both of which are performance measures under GAAP. Management believes that acquisition related expenses are non-operating and do not affect our long-term operating performance; therefore, excluding acquisition and origination costs from MFFO provides investors with supplemental performance information that is consistent with the performance models used by management, and provides investors with a view of our portfolio over time, independent of direct costs associated with the timing of acquisition activity.
(c) MFFO would only be comparable to other publicly registered, non-listed REITs that have completed their acquisition activity and have similar operating characteristics to us.
Net Operating Income
We are disclosing net operating income and intend to disclose net operating income in future filings, because we believe that net operating income provides an accurate measure of the operating performance of our operating assets because net operating income excludes certain items that are not directly associated with our investments. Net operating income is a non-GAAP financial measure that is defined as net income, computed in accordance with GAAP, generated from properties before interest expense, general and administrative expense, depreciation, amortization and interest and dividend income. Additionally, we believe that net operating income is a widely accepted measure of comparative operating performance in the real estate community. However, our use of the term net operating income may not be comparable to that of other real estate companies as they may have different methodologies for computing this amount.
To facilitate understanding of this financial measure, the following is a reconciliation of net income to net operating income for the years ended December 31, 2013, 2012, 2011, 2010 and 2009:
(1)Excludes interest expense of approximately $136,000 and $97,000 associated with asset-level indebtedness for the years ended December 31, 2011 and 2010, respectively. We did not incur any interest expense associated with asset-level indebtedness for the years ended December 31, 2013, 2012 and 2009.
(2)Includes advisory fee - related party expense, provision for loan losses expense, REO property sales cost, general and administrative expense, net of amortization expense and general and administrative - related party expense, net of amortization expense.
(3)Represents amortization expense associated with capitalized debt financing costs. Does not include amortization expense associated with asset-level indebtedness of approximately $42,000 and $30,000 for the years ended December 31, 2011 and 2010, respectively. We did not incur any amortization expense associated with asset-level indebtedness for the years ended December 31, 2013, 2012 and 2009.
Net operating income does not reflect approximately $1.0 million, $1.6 million, $1.6 million and $880,000 of interest expense incurred for the years ended December 31, 2013, 2012, 2011 and 2010, respectively, associated with fund-level indebtedness. We did not incur any interest expense for the year ended December 31, 2009. Interest expense related to fund-level indebtedness is not considered directly associated with the operation of the fund as such indebtedness is not used to acquire and originate secured loans. Net operating income also does not reflect $22.8 million, $12.1 million, $5.7 million, $3.3 million and $66,000 of general and administrative expenses (including advisory fee - related party, provision for loan losses, REO property sales cost, general and administrative, and general and administrative - related parties) incurred for the years ended December 31, 2013, 2012, 2011, 2010 and 2009, respectively. Acquisition and Origination Fees are included in general and administrative - related parties expense, which is excluded from net operating income. Management believes that acquisition related expenses are non-operating and do not affect our long-term operating performance; therefore, excluding Acquisition and Origination Fees from net operating income provides investors with supplemental performance information that is consistent with the performance models used by management, and provides investors with a view of our portfolio over time, independent of direct costs associated with the timing of acquisition activity. The funds used to pay interest expense and general and administrative expenses will not be available to generate future net operating income, net income as defined by GAAP or cash flows from operations, nor be available to fund future distributions to shareholders.
Liquidity and Capital Resources
Our liquidity requirements will be affected by (1) outstanding loan funding obligations, (2) purchases of finished single-family residential lots, (3) our administrative expenses, (4) debt service on fund level and asset level indebtedness required to preserve our collateral position and (5) distributions and redemptions to shareholders. We expect that our liquidity will be provided by (1) loan interest, transaction fees and credit enhancement fee payments, (2) loan principal payments, (3) sales of finished single-family residential lots and (4) credit lines available to us.
There may be a delay between the sale of our shares and the making of real estate-related investments, which could result in a delay in our ability to make distributions to our shareholders. However, we have not established any limit on the amount of proceeds from the Offering that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would (1) cause us to be unable to pay our debts as they become due in the usual course of business; or (2) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences, if any. In addition, to the extent our investments are in development projects or in other properties that have significant capital requirements and/or delays in their ability to generate income, our ability to make distributions may be negatively impacted, especially during our early periods of operation.
We may use debt as a means of providing additional funds for the acquisition or origination of secured loans, acquisition of properties and the diversification of our portfolio. There is no limitation on the amount we may borrow for the purchase or origination of a single secured loan, the purchase of any individual property or other investment. Under our declaration of trust, the maximum amount of our indebtedness shall not exceed 300% of our net assets as of the date of any borrowing; however, we may exceed that limit if approved by a majority of our independent trustees and disclosed in our next quarterly report to shareholders, along with justification for such excess. In addition to our declaration of trust limitation, our board of trustees has adopted a policy to generally limit our fund level borrowings to 50% of the aggregate fair market value of our assets unless substantial justification exists that borrowing a greater amount is in our best interests. We may also use, when appropriate, leverage at the asset level. Asset level leverage is determined by the anticipated term of the investment and the cash flow expected by the investment. Asset level leverage is expected to range from 0% to 90% of the asset value.
Indebtedness will be either interest only or be amortized over the expected life of the asset. Our current typical indebtedness is a term loan or revolving credit facility permitting us to borrow up to an agreed-upon outstanding principal amount from senior commercial lenders who lend against a percentage of the fair market value of the assets which collateralize the loan. Indebtedness may be secured by a first priority lien upon specified assets or all of our existing and future acquired assets.
Our Advisor may, but is not required to, establish capital reserves from gross offering proceeds, out of cash flow generated from interest income from loans and income from other investments or out of non-liquidating net sale proceeds from the sale of our loans, properties and other investments. Alternatively, a lender may require its own formula for escrow of capital reserves.
Potential future sources of capital include proceeds from secured or unsecured financings from banks or other lenders, proceeds from the repayment of loans, sale of assets and undistributed funds from operations. If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures. Although we believe that the resources stated above will be sufficient to satisfy our operating requirements for the near future, depending on market conditions and other factors, we may choose to raise additional funds through debt or equity offerings or other means.
Material Trends Affecting Our Business
We are organized as a Maryland real estate investment trust and we use substantially all of the net proceeds from our Offering of common shares of beneficial interest to originate, purchase, participate in and hold for investment secured loans made directly by us or indirectly through our affiliates to persons and entities for the acquisition and development of parcels of real property as single-family residential lots, and the construction of model and new single-family homes, including development of mixed-use master planned residential communities. We also make direct investments in land for development into single-family lots, new and model homes and portfolios of finished lots and homes; provide credit enhancements to real estate developers, home builders, land bankers and other real estate investors; and purchase participations in, or finance for other real estate investors the purchase of, securitized real estate loan pools and discounted cash flows secured by state, county, municipal or other similar assessments levied on real property.
Currently, 100% of our portfolio relates to property located in the state of Texas, and we intend to invest in markets that demonstrate similarly sound economic and demand fundamentals - fundamentals that we believe will be the drivers of recovery in housing markets - and balanced supplies of homes and finished lots.
In managing and understanding the markets and submarkets in which we make loans, we monitor the fundamentals of supply and demand. We monitor the economic fundamentals in each of the respective markets in which we make loans by analyzing demographics, jobs and housing affordability. We also monitor movements in home prices and the presence of market disruption activity, such as investor or speculator activity. Further, we study new home starts, new home closings, finished home inventories, finished lot inventories, existing home sales, existing home prices, foreclosures, absorption, prices with respect to new and existing home sales, finished lots and land and the presence of sales incentives, discounts, or both, in a market.
We believe that the housing market continues to recover and strengthen. We also believe that this recovery will continue to be regional and is in its early stages, led by those housing markets with stronger demand fundamentals and more balanced supplies of land and housing inventory. Nationally, the housing recovery has strengthened as excess inventories of new and existing homes have been absorbed, home affordability has been restored, home prices have begun to recover and consumer demand continues to improve. We believe that continued strengthening of the recovery depends on adequate supplies of homes available for purchase and finished lots on which homebuilders can start new homes as well as the continued recovery of the consumer. Nationally, we believe consumers continue to remain cautious due to uncertainty present in many economic sectors, particularly with regards to elevated unemployment and under-employment, low wage growth, slow economic growth and events associated with tightened federal fiscal policy, including tax rates, spending and federal policies. Additionally, continued economic weakness and fiscal tightening on the state and local levels associated with particular states most severely affected by the collapse of the housing bubble will likely continue to drag on consumer health and confidence in those markets.
Easing policies of the Federal Reserve, coupled with extensive price correction over the past several years, have restored housing affordability across the country. Our measurement of housing affordability is determined as the ratio of median family income to the income required to qualify for a 90 percent, 30-year fixed-rate mortgage to purchase the median-priced new home, based on the average interest rate in 2013 and assuming an annual mortgage insurance premium of 80 basis points for private mortgage insurance, plus a cost that includes estimated property taxes and insurance for the home. Over the recent quarter, interest rates for a conventional, fixed-rate 30-year mortgage declined slightly following their rise over the previous quarter but above the record-lows experienced in the second half of 2012. As a result of the rise in interest rates and general home price appreciation, affordability has been reduced. However, even with such an increase in mortgage rates and home prices, we believe that home affordability remains high relative to historical standards, and the median income-earning family can still comfortably afford the median-priced home. In the short term, we believe that the recent stabilization in the 30 year fixed mortgage rate may quicken the return of consumer demand for new homes in anticipation of further increases in mortgage rates. Over the longer-term, significant increases in mortgage rates may cause homebuyers to reduce the size of the home that they purchase, but will likely not reduce the overall demand for new homes.
The Federal Reserve has indicated that it will no longer use a threshold of 6.5% national unemployment rate before it would raise short-term interest rates. Instead they will weigh a combination of economic indicators such as employment and inflation indicators. The Federal Reserve has stated that it intends to wind down its economic stimulus aimed at holding down long-term interest rates and spurring economic and job growth.
From a national perspective, ongoing credit constriction, a less robust economic recovery, continued elevated unemployment, and many consumers’ recent experience of housing price instability have made potential new home purchasers and real estate lenders cautious. As a result of these factors, the national housing market experienced a protracted decline, and the time necessary to correct the market likely means a corresponding slower recovery for the housing industry relative to historical trends. However, improving fundamentals such as the return of price inflation, continued high home affordability relative to historical levels, and continued inventory absorption indicate to us that the recovery will continue to gain strength in the coming quarters.
Nationally, the pace of new home sales increased during the fourth quarter of 2013 from the third quarter of 2013, but still remained below the pace of sales in the first and second quarters of 2013. We believe the drop in sales pace from the first and second quarters of 2013 is due to a combination of seasonal factors as well as the rise of interest rates, which likely causes some consumers to pause or adjust their home purchases in light of decreased affordability. However, national fundamentals that drive home sales continue to improve in most markets and home affordability remains high relative to historical levels, so we expect demand will continue to return and improve. The U.S. Census Bureau reports that the sales of new single-family residential homes in December 2013 were at a seasonally adjusted annual rate of 414,000 units. This number is up approximately 4.5% year-over-year from the December 2012 estimate of 396,000.
Since bottoming in early 2009, single-family permits and starts have improved significantly. According to the U.S. Census Bureau, single-family homes authorized by building permits in December 2013 were at a seasonally adjusted annual rate of 610,000 units. This was an increase year-over-year of approximately 4.5% from the rate of 584,000 in December 2012. Single-family home starts for December 2013 stood at a seasonally adjusted annual rate of 667,000 units. This pace is up approximately 7.6% from the December 2012 estimate of 620,000 units. Such increases suggest to us that the homebuilding industry now anticipates greater demand for new homes in coming months relative to the demand evident at the bottom of the new homebuilding cycle.
The new home market is beginning to experience broad shortages of new home inventory. The seasonally adjusted estimate of new homes for sale at the end of December 2013 was 171,000. The number of new homes for sale increased by 10,000 units during the fourth quarter of 2013; however, the current level still represents a short supply of 5.0 months at the December 2013 sales rate. Shortages of available new home inventory or finished lot inventory may become a headwind to demand in the near term by constraining the ability of potential home purchasers to find acceptable options or by prompting greater home price increases due to the imbalance between supply and demand, but we believe demand will continue to increase.
The primary factors affecting new home sales are home price stability, home affordability, and housing demand. Housing supply may affect both new home prices and the demand for new homes. When the supply of new homes exceeds new home demand, new home prices may generally be expected to decline. Also, home foreclosures cause the inventory of existing homes to increase, which may add additional downward price pressure on home prices. Declining new home prices may result in diminished new home demand as people postpone a new home purchase until such time as they are comfortable that stable price levels have been reached. The converse point is also true and equally important. When new home demand exceeds new home supply, new home prices may generally be expected to increase; and rising new home prices, particularly at or near the bottom of the housing cycle, may result in increased new home demand as people become confident in home prices and accelerate their timing of a new home purchase. We believe this point has been reached and expect the housing recovery to continue to accelerate over the coming quarters, led by those markets that did not participate in the housing bubble and which demonstrate stronger demand fundamentals.
The markets in which we invest continue to demonstrate healthy fundamentals. Annual new home starts in Austin outpaced sales 9,993 versus 9,697, with annual new home sales rising year-over-year by approximately 23.9% from the fourth quarter of 2012 to the fourth quarter of 2013. Annual new home starts in Houston outpaced sales 28,233 versus 25,627, with annual new home sales increasing year-over-year by approximately 17.9%. Annual new home starts in San Antonio outpaced sales 8,363 versus 8,154, with annual new home sales increasing year-over-year by approximately 9.7%. Annual new home starts in Dallas-Fort Worth outpaced sales 21,236 versus 20,019, with annual new home sales increasing year-over-year by approximately 23.2%. All numbers are as released by Metrostudy, a leading provider of primary and secondary market information.
According to the Real Estate Center at Texas A&M University, existing housing inventory levels are constrained, and we believe that such inventory constraint is likely contributing to home appreciation. As of December 2013, the number of months of home inventory for sale in Austin, Houston, Dallas, Fort Worth, Lubbock and San Antonio was 2.0 months, 2.7 months, 2.1 months, 3.0 months, 3.7 months and 4.0 months, respectively.
A 6-month supply of inventory is considered a balanced market with more than 6 months of inventory generally being considered a buyer’s market and less than 6 months of inventory generally being considered a seller’s market. Through December 2013, the number of existing homes sold to date in (a) Austin was 30,460, up 19% year-over-year; (b) San Antonio was 23,997, up 17% year-over-year; (c) Houston was 80,826, up 18% year-over-year; (d) Dallas was 59,365, up 18% year-over-year; (e) Fort Worth was 10,839, up 19% year-over-year; and (f) Lubbock was 4,049, up 22% year-over-year.
We face a risk of loss resulting from adverse changes in interest rates. Changes in interest rates may impact both demand for our real estate finance products and the rate of interest on the loans we make. In some instances, the loans we make will be junior in the right of repayment to senior lenders, who will provide loans representing 60% to 75% of total project costs. As senior lender interest rates available to our borrowers increase, demand for our mortgage loans may decrease, and vice versa.
Developers and homebuilders to whom we make loans and with whom we enter into subordinate debt positions use the proceeds of our loans and investments to develop raw real estate into residential home lots and to construct homes. The developers obtain the money to repay our development loans by reselling the residential home lots to homebuilders or individuals who build single-family residences on the lots, by obtaining reimbursement from bond sales or by obtaining replacement financing from other lenders. Homebuilders obtain the money to repay our loans by selling the homes they construct or by obtaining replacement financing from other lenders. If interest rates increase, the demand for single-family residences may decrease. Also, if mortgage financing underwriting criteria becomes stricter, demand for single-family residences may decrease. In such an interest rate and/or mortgage financing climate, developers and builders may be unable to generate sufficient income from the resale of single-family residential lots and homes to repay loans from us, and developers’ and builders’ costs of funds obtained from lenders in addition to us may increase, as well. Accordingly, increases in single-family mortgage interest rates or decreases in the availability of mortgage financing could increase the number of defaults on loans made by us.
We are not aware of any material trends or uncertainties, favorable or unfavorable, other than national economic conditions affecting real estate and interest rates generally, that we reasonably anticipate to have a material impact on either the income to be derived from our investments in mortgage loans or entities that make mortgage loans, other than those referred to in this Annual Report on Form 10-K.
Off-Balance Sheet Arrangements
From time to time, we enter into guarantees of debtor’s or affiliates’ borrowings and provide credit enhancements for the benefit of senior lenders in connection with our debtors and investments in partnerships (collectively referred to as “guarantees”), and account for such guarantees in accordance with FASB ASC 460-10 Guarantees. Guarantees generally have fixed expiration dates or other termination clauses and may require payment of a fee by the debtor. A guarantee involves, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. Our exposure to credit loss in the event of non-performance by the other party to the instrument is represented by the contractual notional amount of the guarantee.
In connection with the funding of some of our organization costs, on June 26, 2009, UMTH LD entered into a $6.3 million line of credit (the “UMTH LD CTB LOC”) with Community Trust Bank of Texas (“CTB”). Effective February 26, 2012, UMTH LD entered into a second loan modification agreement with CTB, which resulted in an extension of the maturity date on the UMTH LD CTB LOC to December 26, 2014. UMTH LD has a receivable from our Advisor for such costs. UMTH LD has assigned this receivable to the bank as security for the UMTH LD CTB LOC. In addition, the UMTH LD CTB LOC is secured by a collateral assignment of a first priority note and deed of trust held by a subsidiary of UMTH LD against a residential real estate project. As a condition to the modification entered into effective as of February 26, 2012, the Trust agreed to guaranty all obligations under the UMTH LD CTB LOC. As of December 31, 2013 and December 31, 2012, the outstanding balance on the line of credit was $5.1 million and $6.2 million, respectively.
Effective December 30, 2011, we entered into a Guaranty of Payment and Guaranty of Completion (collectively, the “Stoneleigh Guaranty”) for the benefit of Babson Mezzanine Realty Investors II, L.P. (“Babson”) as agent for a group of lenders pursuant to which we guaranteed all amounts due associated with the $25.0 million construction loan agreement (the “Stoneleigh Construction Loan”) entered into between Maple Wolf Stoneleigh, LLC, an affiliated Delaware limited liability company (“Stoneleigh”), and Babson. The Stoneleigh Construction Loan matures on January 1, 2015. Pursuant to the Stoneleigh Construction Loan, Babson will provide Stoneleigh with up to approximately $25.0 million to finance the construction associated with a condominium project located in Dallas, Texas. UDF LOF owns a 75% interest in Stoneleigh. Our asset manager, UMTH LD, also serves as the asset manager of UDF LOF. The general partner of our Advisor also serves as the general partner of UMTH LD. UMTH LD controls 100% of the partnership interests of the general partner of UDF LOF. In consideration of us entering into the Stoneleigh Guaranty, we entered into a letter agreement with Stoneleigh which provides for Stoneleigh to pay us a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance on the Stoneleigh Construction Loan at the end of each month as long as the Stoneleigh Guaranty remains outstanding. As of December 31, 2013 and December 31, 2012, approximately $7.6 million and $9.7 million, respectively, was outstanding under the Stoneleigh Construction Loan. For the years ended December 31, 2013 and 2012, approximately $90,000 and $21,000, respectively, is included in commitment fee income - related parties in connection with the credit enhancement fee associated with the Stoneleigh Construction Loan. As of December 31, 2013 and December 31, 2012, approximately $15,000 and $14,000, respectively, is included in accrued receivable - related parties in connection with the credit enhancement fee associated with the Stoneleigh Construction Loan.
Effective July 22, 2013, we entered into a guaranty agreement (the “URHF Guaranty”) pursuant to which we guaranteed all amounts due associated with a revolving credit facility (the “URHF Southwest Loan”) entered into between United Residential Home Finance, L.P. (“URHF”), an affiliated Delaware limited partnership and Southwest Bank (“Southwest”). Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in URHF. Pursuant to the URHF Southwest Loan, Southwest will provide URHF with up to $15.0 million to finance the origination or acquisition of finished lot loans. In consideration of us entering into the URHF Guaranty, we entered into a letter agreement with URHF which provides for URHF to pay us a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance on the URHF Southwest Loan at the end of each month. As of December 31, 2013, URHF had not made any draws on this loan and we had not recognized any income in connection with our guaranty.
As of December 31, 2013, including the guarantees described above, we had 9 outstanding repayment guarantees with total credit risk to us of approximately $65.7 million, of which approximately $18.7 million had been borrowed against by the debtor. As of December 31, 2012, including the guarantees described above, we had 7 outstanding repayment guarantees with total credit risk to us of approximately $51.9 million, of which approximately $27.5 million had been borrowed against by the debtor.
Contractual Obligations
As of December 31, 2013, we had purchased or entered into 15 participation agreements with related parties (5 of which were repaid in full) with aggregate, maximum loan amounts of approximately $77.5 million (with an unfunded balance of approximately $26.6 million) and 11 related party note agreements (2 of which were repaid in full and 1 of which matured and was not renewed) with aggregate, maximum loan amounts totaling approximately $62.1 million (with an unfunded balance of approximately $4.9 million). Additionally, we had purchased or entered into 113 note agreements with third parties (17 of which were repaid in full) with aggregate, maximum loan amounts of approximately $729.8 million, of which approximately $143.4 million has yet to be funded. For the year ended December 31, 2013, we originated 47 loans, purchased 4 loans, and entered into 4 participation interests.
In addition, we have entered into various credit facilities, as discussed in Note L to the accompanying consolidated financial statements. The following table reflects approximate amounts due associated with these credit facilities based on their maturity dates as of December 31, 2013:
We have no other outstanding debt or contingent payment obligations, other than the certain loan guarantees discussed above in “Off-Balance Sheet Arrangements” or letters of credit that we may make to or for the benefit of third-party lenders.
Subsequent Events
On February 3, 2014, our board of trustees appointed Stacey H. Dwyer as our Chief Operating Officer, effective February 17, 2014. We entered into an Employment Agreement with Ms. Dwyer effective as of February 17, 2014. In connection with Ms. Dwyer’s appointment, David A. Hanson stepped down from his role as our Chief Operating Officer. However, Mr. Hanson remains our Chief Accounting Officer.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market risk is the exposure to loss resulting from adverse changes in market prices, interest rates, foreign currency exchange rates, commodity prices and equity prices. A significant market risk to which we are exposed is interest rate risk, which is sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. Changes in interest rates may impact both demand for our real estate finance products and the rate of interest on the loans we make. Another significant market risk is the market price of finished homes and lots. The market price of finished homes or lots is driven by the demand for new single-family homes and the supply of unsold homes and finished lots in a market. The change in one or both of these factors can have a material impact on the cash realized by our borrowers and resulting collectability of our loans and interest.
Demand for our secured loans and the amount of interest we collect with respect to such loans depends on the ability of borrowers of real estate construction and development loans to sell single-family lots to homebuilders and the ability of homebuilders to sell homes to homebuyers.
The single-family lot and residential homebuilding market is highly sensitive to changes in interest rate levels. As interest rates available to borrowers increase, demand for secured loans decreases, and vice versa. Housing demand is also adversely affected by increases in housing prices and unemployment and by decreases in the availability of mortgage financing. In addition, from time to time, there are various proposals for changes in the federal income tax laws, some of which would remove or limit the deduction for home mortgage interest. If effective mortgage interest rates increase and/or the ability or willingness of prospective buyers to purchase new homes is adversely affected, the demand for new homes may also be negatively affected. As a consequence, demand for and the performance of our real estate finance products may also be adversely impacted.
We seek to mitigate our single-family lot and residential homebuilding market risk by closely monitoring economic, project market, and homebuilding fundamentals. We review a variety of data and forecast sources, including public reports of homebuilders, mortgage originators and real estate finance companies; financial statements of developers; project appraisals; proprietary reports on primary and secondary housing market data, including land, finished lot, and new home inventory and prices and concessions, if any; and information provided by government agencies, the Federal Reserve Bank, the National Association of Home Builders, the National Association of Realtors, public and private universities, corporate debt rating agencies, and institutional investment banks regarding the homebuilding industry and the prices of and supply and demand for single-family residential homes.
In addition, we further seek to mitigate our single-family lot and residential homebuilding market risk by having our asset manager assign an individual asset manager to each secured note or equity investment. This individual asset manager is responsible for monitoring the progress and performance of the builder or developer and the project as well as assessing the status of the marketplace and value of our collateral securing repayment of our secured loan or equity investment.
Item 8.
Item 8. Financial Statements and Supplementary Data.
The information required by this Item 8 is hereby incorporated by reference to our consolidated financial statements beginning on page of this Annual Report on Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
(a) Restatement
As previously disclosed, we commenced an inquiry into our historical accounting practice for the capitalization and amortization of Acquisition and Origination Fees that we incurred since our inception. As a result of this inquiry, we identified instances where our historical accounting practice was not in compliance with GAAP.
As described above under the caption “Explanatory Note,” and elsewhere in this Annual Report on Form 10-K, we are restating our previously issued (i) consolidated balance sheets included in our Annual Reports on Form 10-K as of December 31, 2012, 2011, 2010 and 2009 and (ii) consolidated statements of operations, consolidated statements of changes in shareholders’ equity, and consolidated statements of cash flows for the years ended December 31, 2012, 2011, 2010 and 2009. We do not plan to file an amended version of any previously filed Annual Reports on Form 10-K in connection with the Restatement.
In addition, the error that requires us to restate the annual financial statements referred to above materially impacted each of our quarters beginning with the quarter ended March 31, 2010 through the quarter ended September 30, 2013. As a result, we intend to restate our previously issued (i) consolidated balance sheets, (ii) consolidated statements of operations and (iii) consolidated statements of cash flows included in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2013, June 30, 2013 and September 30, 2013. We intend to present these restated quarterly financial statements in amendments to our previously filed Quarterly Reports on Form 10-Q for the quarters ended March 31, 2013, June 30, 2013 and September 30, 2013 as soon as practicable following the filing of this Annual Report on Form 10-K. We do not intend to amend our previously filed Quarterly Reports on Form 10-Q for the quarters ended March 31, 2010 through September 30, 2012; however, as we reported in our Current Report on Form 8-K filed on April 4, 2014, the financial statements included in our Quarterly Reports on Form 10-Q for each of the periods beginning with the quarter ended March 31, 2010 through September 30, 2013 should not be relied upon.
The impact of the Restatement is included in this Annual Report on Form 10-K, and is more specifically described in the Explanatory Note above, in Note C of the accompanying Notes to the Consolidated Financial Statements, in “Item 6 - Selected Financial Data” and in “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
(b) Evaluation of Disclosure Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial Officer, reviewed and evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of December 31, 2013. In addition, as a result of the Restatement our management re-evaluated the effectiveness of the design and operation of our disclosure controls and procedures for the annual and interim periods ended December 31, 2009 through September 30, 2013. As described below, management has identified a material weakness in certain components of our internal control over financial reporting, which is an integral component of our disclosure controls and procedures. Solely as a result of this material weakness, our Chief Executive Officer and Chief Financial Officer have concluded that the design and operating effectiveness of the controls over the selection, application and review of the implementation of accounting policies to ensure recorded amounts and disclosures are in accordance with GAAP were not effective for the annual and interim periods ended December 31, 2009 through December 31, 2013; therefore, our disclosure controls and procedures were not effective during these periods.
(c) Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting for the annual period ended December 31, 2013 based on the framework in the 1992 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In addition, as a result of the Restatement, our management re-evaluated the effectiveness of our internal control over financial reporting for the annual periods ended December 31, 2009 through December 31, 2012. Based on that evaluation, our management concluded that internal control over financial reporting was not effective for the annual and interim periods ended December 31, 2009 through December 31, 2013 due to the material weakness in internal control over financial reporting described below.
Material Weakness in Internal Control Over Financial Reporting
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.
Management has identified the following material weakness in our internal control over financial reporting for the annual and interim periods ended December 31, 2009 through December 31, 2013: from the year ended December 31, 2009 through the quarter ended September 30, 2013, we capitalized Acquisition and Origination Fees incurred and amortized them into expense on a straight-line basis over our expected economic life. GAAP guidance in ASC 310-20 requires direct loan origination costs, including the portion of total compensation paid to employees engaged in direct loan origination activities, to be capitalized and amortized into expense over the life of the related loan, provided that records are available in sufficient detail to reliably determine the amount of qualifying direct loan origination costs incurred. In our case, employees of UMTH LD were performing loan origination activities in consideration for our payment of Acquisition and Origination Fees. However, UMTH LD did not maintain (and we did not require them to maintain) contemporaneous, sufficiently detailed time records on a loan by loan basis for all years that would provide evidence of the amount of time allocable to direct loan origination activities and thus the amount of Acquisition and Origination Fees allowable for deferral under ASC 310-20. Thus, we have determined that we were unable to reasonably determine the amount of Acquisition and Origination Fees allowable for deferral under ASC 310-20. As a result, we have restated our previously issued financial results to expense the Acquisition and Origination Fees as incurred, rather than capitalizing and amortizing them into expense over the life of the loan.
The material weakness resulted in the Restatement. Due to the material weakness, management has concluded that we did not maintain an effective internal control over financial reporting as of December 31, 2013, based on criteria established in the COSO Framework. In addition, we have concluded, for the same reasons, that our internal control over financial reporting was not effective for each of the annual periods during the Restatement Period.
(d) Changes in Internal Control over Financial Reporting
In response to the material weakness described above we engaged a leading consulting firm to advise management with respect to accounting standards application and reporting matters to aid management with key facets of the Restatement. On a going forward basis, the Trust will account for Acquisition and Origination Fees by expensing all such fees as incurred.
Despite the existence of this material weakness, based on the remedial efforts discussed above and the fact that we are now expensing Acquisition and Origination Fees as incurred, our management, including our CEO and CFO, has concluded that the consolidated financial statements included in this Annual Report fairly present, in all material respects, our financial position, results of operations and cash flows.
Item 9B.
Item 9B. Other Information.
None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Board of Trustees
The names and ages (as of December 31, 2013) of our trustees are set forth below:
Name
Age
Offices Held
Hollis M. Greenlaw
Chief Executive Officer and Chairman of the Board of Trustees
Scot W. O’Brien
Trustee
Phillip K. Marshall
Independent Trustee
J. Heath Malone
Independent Trustee
Steven J. Finkle
Independent Trustee
John R. (“Bobby”) Ray
Independent Trustee
Hollis M. Greenlaw. Mr. Greenlaw has served as our Chief Executive Officer and Chairman of our board of trustees since our formation in May 2008. Mr. Greenlaw also has served as Chief Executive Officer of UMTH LD, our asset manager, since March 2003 and served as its President from March 2003 until July 2011. He also has served as partner, Vice Chairman and Chief Executive Officer of UMT Holdings and as President, Chief Executive Officer and a director of UMT Services since March 2003. Mr. Greenlaw is also the co-founder of UDF I, UDF II, UDF III and UDF LOF. UDF I, UDF II, UDF III and UDF LOF are affiliated real estate finance companies that provide custom financing, including transactions involving real estate development and construction loans and credit enhancements, and make opportunistic purchases of land for residential lot development and home construction. Mr. Greenlaw has directed the funding of more than $1.5 billion in loans and land banking transactions and over $168 million in equity investments through us and through these other United Development Funding products, receiving more than $686 million in repayments and over $92 million in equity investment distributions to date. From March 1997 until June 2003, Mr. Greenlaw served as Chairman, President and Chief Executive Officer of a multi-family real estate development and management company owned primarily by The Hartnett Group, Ltd., a closely-held private investment company managing more than $40 million in assets. There he developed seven multi-family communities in Arizona, Texas, and Louisiana with a portfolio value exceeding $80 million. Prior to joining The Hartnett Group, Mr. Greenlaw was an attorney with the Washington, D.C. law firm, Williams & Connolly, where he practiced business and tax law. Mr. Greenlaw was a member of Phi Beta Kappa at Bowdoin College and received his Juris Doctorate from the Columbia University School of Law in 1990. Mr. Greenlaw is a member of the Maine, District of Columbia, and Texas bars. Mr. Greenlaw is qualified to serve as a trustee because he is our Chief Executive Officer and has served in various executive roles with our sponsor or its affiliates since 2003. He has expansive knowledge of the public homebuilding and real estate industries, and has relationships with chief executives and other senior management at a multitude of real estate companies. His demonstrated leadership skills, business expertise and extensive REIT executive experience provide him with the skills and qualifications to serve as a trustee.
Scot W. O’Brien. Mr. O’Brien has served as a member of our board of trustees since August 2008. He is a shareholder in the law firm of Hallett & Perrin, P.C., has over 28 years of experience in real estate transactions, bank and other institutional financings, mergers and acquisitions, private placements, tax planning (including providing tax advice in conjunction with the formation and operation of real estate investment trusts), and general corporate matters and has a peer review rating of AV by Martindale-Hubbell. In his capacity with Hallett & Perrin, Mr. O’Brien provides legal services to our Advisor, our asset manager and affiliates of our Advisor and our asset manager. He has advised UMT, a real estate investment trust that is affiliated with our Advisor that invests exclusively in: (i) first lien secured mortgage loans for the acquisition and renovation of single-family homes, (ii) lines of credit and secured loans for the acquisition and development of single-family home lots, (iii) lines of credit and loans secured by developed single-family lots, and (iv) lines of credit and loans secured by completed model homes; formerly, UMT invested in: (i) first lien secured construction loans for the acquisition of lots and construction of single-family homes and (ii) first lien, fixed rate mortgages secured by single-family residential property). He has also advised UMTH and UDF I since 2003 and has advised UDF III since its initial public offering, which commenced in May 2006 and terminated in April 2009. Mr. O’Brien oversaw the structure and formation of UDF LOF, and UDF Paramount Multi-Family Opportunity Fund, L.P., an affiliated Delaware limited partnership. He is responsible for the direction and structure of the United Development Funding lending transactions. Mr. O’Brien also represents numerous real estate-related funds. As a regular part of his practice, Mr. O’Brien analyzes, structures, negotiates and closes numerous acquisitions and dispositions of real estate and real estate-related investments, including improved and unimproved real estate and loans secured by real estate. Mr. O’Brien has also structured and negotiated the financing, development and construction terms for numerous real estate development projects, including lot developments, hotels, medical office buildings, apartment complexes and shopping centers. He joined Hallett & Perrin in April 1996. Prior to joining Hallett & Perrin, Mr. O’Brien was an associate (1985-1992) and a shareholder (1993-1996) in the law firm of Winstead, P.C. (f/k/a Winstead, Sechrest & Minick). Mr. O’Brien received a Bachelor of Business Administration from the University of Notre Dame in 1982. He received a Juris Doctorate with honors from St. Mary’s University in 1985, and an L.L.M. (Taxation) from Southern Methodist University in 1988. Mr. O’Brien is a member of the State Bar of Texas. Mr. O’Brien is qualified to serve as a trustee due to his legal expertise, particularly in the real estate industry. He has provided counsel to our sponsor and its affiliates for the past five years.
Phillip K. Marshall. Mr. Marshall has served as one of our independent trustees since August 2008. Since September 2006, Mr. Marshall has served as an independent trustee of UMT, a REIT that invests exclusively in: (i) lines of credit and secured loans for the acquisition and development of single-family home lots; (ii) lines of credit and loans secured by developed single-family lots; (iii) lines of credit and loans secured by completed model homes; (iv) loans provided to entities that have recently filed for bankruptcy protection under Chapter 11 of the U.S. bankruptcy code, secured by a priority lien over pre-bankruptcy secured creditors; (v) lines of credit and loans, with terms of 18 months or less, secured by single-family lots and homes constructed thereon; (vi) discounted cash flows secured by assessments levied on real property; and (vii) credit enhancements to real estate developers, homebuilders, land bankers and other real estate investors who acquire real property, subdivide real property into single-family residential lots, acquire finished lots and/or build homes on such lots. As a trustee of UMT, Mr. Marshall participates in the monthly review and approval of real estate investments made and managed by such entities, and also participates annually in the review and restatement of such entities’ investment policies. Mr. Marshall also currently chairs the UMT audit committee and serves on the UMT financial reporting and liquidity committees. From May 2007 to the present, Mr. Marshall has served as Chief Financial Officer of Rick’s Cabaret International, Inc., a publicly traded restaurant and entertainment company. From February 2007 to May 2007, he served as Controller of Dorado Exploration, Inc., a privately held oil and gas company. From July 2003 to January 2007, he served as Chief Financial Officer of CDT Systems, Inc., a publicly held company that was located in Addison, Texas and was engaged in water technology. From 2001 to 2003, he was a principal of Whitley Penn LLP, independent certified public accountants. From 1992 to 2001, Mr. Marshall served as Director of Audit Services at Jackson & Rhodes PC, where he consulted in the structure and formation of UMT in 1996, including developing the criteria necessary to determine the type of assets suitable for acquisition by UMT pursuant to its desire to qualify as a real estate investment trust. While at Jackson & Rhodes PC and subsequently with Whitley Penn LLP, Mr. Marshall served as the audit partner for UMT. From 1991 to 1992, Mr. Marshall served as an audit partner at Toombs, Hall and Foster; from 1987 to 1991, he served as an audit partner for KPMG Peat Marwick (“KPMG”); and from 1980 to 1987, he served as audit partner for KMG Main Hurdman (“KMG”). As an audit partner for KPMG and KMG, Mr. Marshall had extensive experience working with a number of mortgage banking clients and savings and loan institutions involved in residential real estate finance. In his capacity as auditor and audit partner for his mortgage banking clients, Mr. Marshall performed reviews and tests of income recognition and reporting, quality of asset testing (including analysis of real estate appraisals), historical loss reserves and comparison to industry loss reserves. Additionally, Mr. Marshall performed single audit procedures to assess the adequacy of loan servicing services including collections, cash management and reporting procedure testing, and escrow analysis. Mr. Marshall is a Certified Public Accountant in the State of Texas. He received a BBA in Accounting, Texas State University in 1972. Mr. Marshall is qualified to serve as a trustee in part due to his financial and accounting expertise, as well as his knowledge of the financial markets in which we operate. His experience as a partner at a public accounting firm, as well as his previous service on the board of trustees of a real estate investment trust, brings value to us, particularly in his role as the audit committee chairman and audit committee financial expert.
J. Heath Malone. Mr. Malone has served as one of our independent trustees since August 2008. Mr. Malone is a co-founder and partner of Max Industries, LTD., an Inc. 5,000 company, which does business as Max Furniture. Max Furniture is a designer, importer and on-line retailer of furniture with $15 million in annual revenue. Since 2002, Mr. Malone has served as Chief Financial Officer of Max Furniture, managing all aspects of its operations including financing, accounting, administration, transportation management and warehouse management, and serving as one of the two principal buyers for the company. Previously, Mr. Malone was the Chief Financial Officer of Mericom Corporation from 1998 to 2002. Mericom was engaged in the service and installation of wireless networks throughout the United States. During Mr. Malone’s tenure, Mericom grew from a small regional $5 million firm to a $60 million national company. From 1995 to 1998, Mr. Malone served as the Chief Operating Officer of OmniAmerica Development, a Hicks, Muse, Tate & Furst company in the business of designing and building cell tower networks throughout the United States. Working with a sister company, Specialty Teleconstructors, OmniAmerica Development became the third-largest owner of cellular phone towers in the United States prior to an acquisition by American Tower in 1998. Mr. Malone was the Chief Financial Officer of US Alarm Systems from 1992 to 1995, building that company from a startup to a mid-sized regional alarm firm. From 1989 to 1992, he was employed by Arthur Andersen LLP, an international accounting and consulting firm. At Arthur Andersen, Mr. Malone specialized in manufacturing and retail companies and served on a fraud audit team. Mr. Malone is a Certified Public Accountant and received a Bachelor of Arts degree in accounting from Southern Methodist University in Dallas in 1989. Mr. Malone is qualified to serve as a trustee in part due to his financial and accounting expertise, as well as his experience in raising capital through public and private markets. He brings value to us in his role as an audit committee member, as well as providing an entrepreneurial perspective to our board of trustees.
Steven J. Finkle. Mr. Finkle has served as one of our independent trustees since August 2008. In 1995, Mr. Finkle founded National Brokerage Associates (“NBA”) and currently serves as its President. NBA is a full service insurance brokerage house serving agents in the Washington, D.C. metropolitan area and on a national basis. NBA has a niche in the variable life marketplace and has been involved with designing several variable life insurance products. A full service brokerage firm specializing in life, annuities, long term care, and disability, NBA works with several nationwide broker-dealers, a number of banks and the insurance brokerage community. From 1989 to 1995, Mr. Finkle served as a partner and President of CFG Insurance Services. In 1975, Mr. Finkle became part of the first franchised insurance brokerage operation in the United States when he co-founded MTA Brokerage. From 1972 to 1974, Mr. Finkle served as an assistant manager for the insurance brokerage firm of Johnson & Higgins at the Atlanta, Georgia regional office and later with National Life of Vermont. Mr. Finkle holds Series 7, 24, and 63 securities licenses and serves on the advisory committee for multiple insurance carriers. Mr. Finkle currently serves as Chairman of the Brokerage Task Force of the Association for Advanced Life Underwriting, a membership organization of over 2,200 of the top producing life insurance agents in the country, and is a partner of Brokerage Resources of America, an affiliation of national insurance brokerage firms. Mr. Finkle also previously served on the boards of directors of the District of Columbia Association of Insurance and Financial Advisors and the National Association of Life Brokerage Agencies, the premier association representing the insurance brokerage community. Mr. Finkle received his B.B.A. degree in Insurance from Georgia State University in 1972 where he was a Kemper Scholar. Mr. Finkle is qualified to serve as a trustee due to his strong relationships and his understanding of the financial markets through which we offer our shares for sale. This experience brings valuable operational expertise and insight to the board of trustees.
John R. (“Bobby”) Ray. Mr. Ray has served as one of our independent trustees since September 2013. From January 2012 through January 2013, Mr. Ray served as the Vice Chairman and Partner at Darling Homes, until the company was acquired by Taylor Morrison Homes, a public homebuilder. From 2003 through 2011, Mr. Ray served as Group President of K. Hovnanian Homes (Texas and Florida), focused on building and designing homes in select locations in Texas and Florida, and was responsible for managing due diligence efforts on homebuilder acquisitions, evaluating and approving land acquisitions and dispositions, evaluating personnel and overseeing all operations. At the peak in 2006, while at K. Hovnanian, Mr. Ray managed approximately 6,000 closings and almost $2 billion in revenues. From 1999 to 2003, Mr. Ray was President of K. Hovnanian Homes (Dallas/Fort Worth). From 1994 to 1999, Mr. Ray was President and Partner of Goodman Family of Builders, L.P., a private homebuilder in the Dallas/Fort Worth area which K. Hovnanian Homes acquired in October 1999. Mr. Ray formerly served as Chairman of the Board of Plano Presbyterian Hospital and currently serves on the Texas Health Resources North Zone board. From 2004 to 2012, Mr. Ray served on the board of Northern Trust Banks of Texas. From 1995 to 2007, Mr. Ray served on the Board of Regents at the University of North Texas and, from 1999 through 2007, he served as its Chairman, a position appointed by the Governor of Texas. Mr. Ray previously served on the board of the Home Builders Association of Greater Dallas and the Texas Association of Builders and as the President and Director of the Collin County Homebuilders Association. Mr. Ray holds a Bachelors of Business Administration from the University of North Texas. Mr. Ray’s experience as an executive officer in both private and public homebuilding companies, including land development, construction, finance and management, brings value to us as an independent trustee.
Audit Committee
Our audit committee is composed of Messrs. Marshall, Finkle, and Malone, all independent trustees. Each of our audit committee members would qualify as independent under the New York Stock Exchange’s rules applicable to audit committee members. Our board of trustees has determined that Mr. Marshall, the chairman of the audit committee, qualifies as an “audit committee financial expert,” as defined by SEC regulations, based on the experience described in “- Board of Trustees,” above. The audit committee of the board reports regularly to the full board. The audit committee meets periodically throughout the year, usually in conjunction with regular meetings of the board.
The audit committee, by approval of at least a majority of the members, selects the independent registered public accounting firm to audit our annual financial statements, reviews with the independent registered public accounting firm the plans and results for the audit engagement, approves the audit and non-audit services provided by the independent registered public accounting firm, reviews the independence of the independent registered public accounting firm, considers the range of audit and non-audit fees and reviews the adequacy of our internal controls.
Code of Business Conduct and Ethics
Our board of trustees has adopted a Code of Business Conduct and Ethics, which contains general guidelines for conducting our business and is designed to help our trustees, officers and employees resolve ethical issues in an increasingly complex business environment. Our Code of Business Conduct and Ethics is applicable to all trustees, officers and employees of the Trust. Our Code of Business Conduct and Ethics can be found in the “Legal” section of our website, www.udfonline.com. If, in the future, we amend, modify or waive a provision in our Code of Ethics, we may, rather than filing a Current Report on Form 8-K, satisfy the disclosure requirement by posting such information on our website.
Executive Officers
We have provided below certain information about our executive officers as of December 31, 2013. Each of our executive officers has stated that there is no arrangement or understanding of any kind between him or her and any other person relating to their appointment as an executive officer.
Name
Age*
Positions(s)
Hollis M. Greenlaw
Chief Executive Officer and Chairman of the Board of Trustees
David A. Hanson
Chief Operating Officer and Chief Accounting Officer
Cara D. Obert
Chief Financial Officer and Treasurer
* As of December 31, 2013.
For more information regarding the background and experience of Mr. Greenlaw, see “- Board of Trustees,” above.
David A. Hanson. Mr. Hanson has served as our Chief Accounting Officer since May 2008 and served as our Chief Operating Officer from May 2008 until February 2014. He has also served as President of UMTH GS, Chief Financial Officer of UMTH, and Chief Financial Officer of UMT Services since June 2007. Mr. Hanson has over 23 years of experience as a financial executive in the residential housing industry and as an accountant with an international public accounting firm. From 2006 to 2007, he was a Director of Land Finance for the Central/Eastern Region at Meritage Homes Corporation (“Meritage”), the twelfth largest publicly traded homebuilder. While at Meritage, Mr. Hanson handled all aspects of establishing, financing, administering and monitoring off-balance sheet FIN 46-compliant entities for the Central/Eastern Region. From 2001 to 2006, he was employed with Lennar Corporation, a national homebuilding company, as the Regional Finance Manager and served as acting homebuilding Division President, Regional Controller, and Controller for both homebuilding and land divisions. From 1999 to 2001, Mr. Hanson was the Director, Finance and Administration for One, Inc., a technology consulting firm. From 1996 to 1999, Mr. Hanson was the Vice President, Finance and Accounting for MedicalControl, Inc., a publicly traded managed healthcare company. Prior to 1996, he was employed with Arthur Andersen LLP, an international accounting and consulting firm, for approximately nine years. He graduated from the University of Northern Iowa in 1984 with a Bachelor of Arts degree in Financial Management/Economics and in 1985 with a Bachelor of Arts degree in Accounting. He is a Certified Public Accountant and Certified Management Accountant.
Cara D. Obert. Ms. Obert has served as our Chief Financial Officer and Treasurer since May 2008 and is a partner of UMTH. Ms. Obert served as the Chief Financial Officer for UMTH from March 2004 until August 2006 and served as Controller for UMTH from October 2003 through March 2004. She has served as the Chief Financial Officer of UMTH LD since August 2006. From 1996 to 2003, she was a self-employed consultant, assisting clients, including Fortune 500 companies, in creating and maintaining financial accounting systems. From May 1995 until June 1996, she served as Controller for Value-Added Communications, Inc., a Nasdaq-listed telecommunications company that provided communications systems for the hotel and prison industries. From 1990 to 1993, she was employed with Arthur Andersen LLP, an international accounting and consulting firm. She graduated from Texas Tech University in 1990 with a Bachelor of Arts degree in accounting. She is a Certified Public Accountant.
On February 3, 2014, our board of trustees appointed Stacey H. Dwyer as our Chief Operating Officer, effective February 17, 2014. We entered into an Employment Agreement with Ms. Dwyer effective as of February 17, 2014.
Ms. Dwyer, age 47, joined us from D.R. Horton, Inc., the nation’s largest homebuilding company (“D.R. Horton”), where she served as an Executive Vice President since 2000 and as Treasurer since 2003. In those roles, Ms. Dwyer was primarily responsible for financial community relations, including banks, investors, rating agencies and analysts. Prior to 2000, Ms. Dwyer held various positions at D.R. Horton in accounting, treasury and mergers and acquisitions. From 1989 to 1991, Ms. Dwyer was an auditor with Ernst and Young, LLP. Ms. Dwyer is a Certified Public Accountant and received a B.S. in Accounting from Southeastern Oklahoma State University and an M.S. in Accounting from the University of Texas at Arlington.
Duties of Our Executive Officers
The Chairman of the board of trustees presides at all meetings of the shareholders, the board of trustees and any committee on which he serves. The Chief Executive Officer is our highest ranking executive officer and, subject to the supervision of the board of trustees, has all authority and power with respect to, and is responsible for, the general management of our business, financial affairs, and day-to-day operations. The Chief Executive Officer oversees the advisory services performed by our Advisor.
The Chief Operating Officer, Chief Accounting Officer and the Chief Financial Officer report to the Chief Executive Officer, and have the authority and power with respect to, and the responsibility for, our accounting, auditing, reporting and financial record-keeping methods and procedures; controls and procedures with respect to the receipt, tracking and disposition of our revenues and expenses; the establishment and maintenance of our depository, checking, savings, investment and other accounts; relations with accountants, financial institutions, lenders, underwriters and analysts; the development and implementation of funds management and short-term investment strategies; the preparation of our financial statements and all of our tax returns and filings; and the supervision and management of all subordinate officers and personnel associated with the foregoing.
The Treasurer has responsibility for the general care and custody of our funds and securities and the keeping of full and accurate accounts of receipts and disbursements in our books. The Treasurer also shall deposit all moneys and other valuable effects in our name and to our credit in such depositories as may be designated by the board of trustees. The Treasurer shall disburse our funds as may be ordered by the board of trustees, taking proper vouchers for such disbursements, and shall render to the Chief Executive Officer and board of trustees, at the regular meetings of the board of trustees or whenever it may so require, an account of all his or her transactions as Treasurer and of our financial condition.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires each trustee, officer and individual beneficially owning more than 10% of a registered security of the Trust to file with the SEC, within specified time frames, initial statements of beneficial ownership (Form 3) and statements of changes in beneficial ownership (Forms 4 and 5) of common shares of beneficial interest of the Trust. Trustees, officers and greater than 10% beneficial owners are required by SEC rules to furnish the Trust with copies of all such forms they file. To the best of our knowledge, Mr. Hanson and Mr. Malone did not timely file a Form 4 related to their purchase of shares of beneficial interest during the year ended December 31, 2013. We are not aware of any other required Section 16(a) filings that were not timely and correctly made during the year ended December 31, 2013.
Item 11.
Item 11. Executive Compensation.
As of December 31, 2013, we had no employees. As of December 31, 2013, our executive officers were all employees of our Advisor and/or its affiliates, and were compensated by these entities for their services to us. Our day-to-day management is performed by our Advisor and its affiliates. We pay these entities fees and reimburse expenses pursuant to the advisory agreement.
On February 3, 2014, our board of trustees appointed Stacey H. Dwyer as our Chief Operating Officer, effective February 17, 2014 and in connection with this appointment, we entered into an employment agreement with Ms. Dwyer effective as of February 17, 2014. Ms. Dwyer thereby became our only employee and is directly compensated by us.
Compensation Discussion and Analysis
With the exception of Ms. Dwyer, we have no employees. Except for Ms. Dwyer, our executive officers are all employees of our advisor and/or its affiliates, and are compensated by these entities for their services to us. Our day-to-day management is performed by our advisor and its affiliates. We pay our advisor fees and reimburse expenses pursuant to our advisory agreement. We have not paid in the past, and, with the exception of Ms. Dwyer, we currently do not intend to pay in the future, any compensation directly to our executive officers. Therefore, this Compensation Discussion and Analysis relates only to the compensation of Ms. Dwyer.
Effective as of February 17, 2014, we entered into an employment agreement (the “Employment Agreement”) with Ms. Dwyer, which Employment Agreement was approved by our board of trustees. The Employment Agreement has a term ending on February 17, 2015 and shall automatically renew unless terminated pursuant to the provisions of the agreement. The Employment Agreement provides for compensation of Ms. Dwyer as follows: (a) an annual salary of $400,000; (b) an annual minimum guaranteed bonus of $350,000 and the eligibility to receive an additional bonus based on a combination of the performance of the Trust and her performance in the discretion of our board of trustees; (c) an initial equity award of 82,410 common shares which will vest annually over four years, subject to Ms. Dwyer’s continued employment with us through such date; (d) an annual equity grant of 12,500 common shares on each anniversary date of the effective date of the Employment Agreement, with each annual equity grant vesting five years after the applicable grant date, subject to Ms. Dwyer’s continued employment with us through such date; and (e) participation in a nonqualified supplemental employment retirement program whereby on each anniversary of the effective date of the Employment Agreement, we will fund her account in an amount equal to 10% of her base salary and such account will accrue interest at a compounded rate of 10% per annum. Ms. Dwyer’s compensation does not include any provisions for payment upon her termination or a change of control of the Trust, pension benefits, or any non-qualified deferred compensation.
Our compensation policies focus mainly on retaining and attracting employees necessary to operate and grow our business, and to compensate such employees in a manner that will align their interests with the interests of our shareholders. As a result, Ms. Dwyer’s compensation reflects a combination of a cash base salary and restricted shares, as well as an opportunity for bonus compensation that is based on both the performance of the Trust and Ms. Dwyer’s performance. We believe that the use of restricted shares as part of the compensation package aligns Ms. Dwyer’s interests with the interests of our shareholders, and we believe that a bonus that is partly based on the performance of the Trust helps align Ms. Dwyer’s interests with the success of the Trust. During our compensation negotiations with Ms. Dwyer, we engaged a third party compensation consultant to perform an executive compensation market analysis to determine whether Ms. Dwyer’s compensation package was in line with industry benchmarks. This analysis included a study of the pay data of executives in various positions within a peer group of 17 companies of a similar industry and asset size as well as the use of other published survey data. Our chief executive officer also engaged in one-on-one negotiations with Ms. Dwyer at the time of her hire. However, our board of trustees has not established a standing compensation committee based upon the fact that, with the exception of Ms. Dwyer, our executive officers do not receive compensation directly from us for services rendered to us, and we do not intend to pay compensation directly to our executive officers other than Ms. Dwyer. Our board of trustees currently believes that Ms. Dwyer’s compensation is commensurate with her duties and level of experience and complies with the Trust’s goals of retaining quality personnel to operate and grow our business. Ms. Dwyer and her performance and compensation are reviewed on an annual basis by our chief executive officer. Our board of trustees believes that Ms. Dwyer’s compensation is aligned with our business and risk management objectives and does not believe that any aspect of her compensation is likely to have a material adverse effect on us.
Board of Trustees Report
The board of trustees of the Trust has reviewed, and discussed with management, the Compensation Discussion and Analysis included above in this Annual Report on Form 10-K. Based on such review and discussions, the board of trustees of the Trust determined that the Compensation Discussion and Analysis should be included in this Annual Report on Form 10-K for the year ended December 31, 2013.
Submitted by the board of trustees:
Hollis M. Greenlaw, Chairman
Scot W. O’Brien
Phillip K. Marshall
J. Heath Malone
Steven J. Finkle
John R. Ray
Compensation of Trustees
We pay each of our independent trustees, as well as any trustees who are not also our executive officers or executive officers of our Advisor or its affiliates, an annual retainer of $25,000 per year. In addition, we pay each of our independent trustees, as well as any trustees who are not also our executive officers or executive officers of our Advisor or its affiliates, (i) $2,000 for each board or committee meeting attended in person (the chairman of the audit committee shall receive $3,000 for each audit committee meeting attended in person) and (ii) $250 for each board or committee meeting attended by telephone. In the event that there are multiple meetings in one day, the fees will be limited to $2,000 per day ($3,000 per day payable to the chairman of the audit committee if one of the meetings is of the audit committee).
The following table sets forth a summary of the compensation received by our trustees during the fiscal year ended December 31, 2013:
(1)The Trust does not have a share option plan.
(2)The Trust does not have an incentive plan.
(3)The Trust does not have a pension plan.
(4)Denotes a trustee who is not considered an independent trustee or who is also our executive officer or an executive officer of our Advisor or its affiliates.
Compensation Committee Interlocks and Insider Participation
Other than Mr. Greenlaw, no member of our board of trustees during the year ended December 31, 2013 has served as an officer, and no member of our board of trustees served as an employee, of the Trust or any of our subsidiaries. We have no standing compensation committee. During the year ended December 31, 2013, none of our executive officers served on the board or on the compensation committee (or other committee performing equivalent functions) of any other entity which had one or more executive officers who served on our board of trustees.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
As of March 25, 2014 we had 32,138,757 shares issued and outstanding. The following table sets forth certain information as of March 25, 2014 regarding the beneficial ownership of our common shares of beneficial interest by (i) each person known by us to be the beneficial owner of more than 5% of our outstanding shares, (ii) each trustee, (iii) each named executive officer, and (iv) all of our trustees and executive officers as a group. Except as indicated in the footnotes to this table, the persons named in the table, based on information provided by such persons, have sole voting and sole investment power with respect to all shares shown as beneficially owned by them, subject to community property laws where applicable. None of the shares described below has been pledged as security.
*Represents less than 1% of our outstanding common shares of beneficial interest.
(1)For purposes of this table, shares indicated as being owned beneficially include shares that the beneficial owner has the right to acquire within 60 days of March 25, 2014. For the purpose of computing the percentage of the outstanding shares owned by a shareholder, shares that may be acquired during the 60 days following March 25, 2014 are deemed to be outstanding securities of the class owned by that shareholder but are not deemed to be outstanding for the purpose of computing the percentage by any other person.
(2)A trustee and/or executive officer of the Trust. The address of all trustees and executive officers is c/o United Development Funding IV, 1301 Municipal Way, Suite 100, Grapevine, Texas 76051.
(3)Number of shares includes 10,000 shares owned directly by UMTH, a limited partnership of which the reporting person serves as chief executive officer, vice chairman and partner; the reporting person disclaims beneficial ownership of the securities owned by UMTH except to the extent of his pecuniary interest therein. Number of shares also includes 16,944 shares owned directly by WAB Ltd, a limited partnership of which the reporting person is a limited partner and the general partner is WAB Genpar, LLC, a limited liability company of which the reporting person is the managing member and president.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Our Advisor and certain of its affiliates receive fees in connection with the acquisition and management of the assets and reimbursement of costs of the Trust.
O&O Reimbursement
We pay our Advisor an O&O Reimbursement (as discussed in Note H of the accompanying Notes to the Consolidated Financial Statements) for reimbursement of organization and offering expenses funded by our Advisor or its affiliates. For the years ended December 31, 2013 and 2012, we reimbursed our Advisor approximately $8.2 million and $5.9 million, respectively in accordance with the O&O Reimbursement. As of December 31, 2013, no unpaid organization and offering costs are included in accrued liabilities - related parties. As of December 31, 2012, approximately $4.7 million is included in accrued liabilities - related parties in connection with organization and offering costs payable to our Advisor or its affiliates related to the Offering.
Advisory Fees
We incur monthly Advisory Fees, payable to our Advisor, equal to 2% per annum of our average invested assets (as discussed in Note I of the accompanying Notes to the Consolidated Financial Statements). For the years ended December 31, 2013, 2012 and 2011, approximately $8.2 million, $4.2 million and $1.9 million, respectively, is included in advisory fee - related party expense for Advisory Fees payable to our Advisor. As of December 31, 2013 and 2012, approximately $842,000 and $499,000, respectively, is included in accrued liabilities - related parties associated with Advisory Fees payable to our Advisor.
Acquisition and Origination Fees
We incur Acquisition and Origination Fees equal to 3% of the net amount available for investment in secured loans and other real estate assets (as discussed in Notes B and I of the accompanying Notes to the Consolidated Financial Statements); provided, however, that no such fees will be paid with respect to any asset level indebtedness we incur. The fees are further reduced by the amount of any acquisition and origination expenses paid by borrowers or investment entities to our Advisor or affiliates of our Advisor with respect to our investment. Such costs are expensed as incurred and are payable to UMTH LD, our asset manager. See Note C of the accompanying Notes to the Consolidated Financial Statements for further discussion of the Restatement associated with Acquisition and Origination Fees. The general partner of our Advisor is also the general partner of UMTH LD. After giving effect to the Restatement, for the years ended December 31, 2013, 2012, 2011, 2010 and 2009, approximately $9.5 million, $5.2 million, $2.4 million, $2.1 million and $40,000, respectively, is included in general and administrative - related parties expense associated with Acquisition and Origination Fees payable to UMTH LD. As of December 31, 2013 and 2012, approximately $2.4 million and $868,000, respectively, is included in accrued liabilities - related parties associated with Acquisition and Origination Fees payable to UMTH LD.
Debt Financing Fees
Pursuant to the origination of any line of credit or other debt financing, we pay our Advisor Debt Financing Fees, as discussed in Note I. These Debt Financing Fees are expensed on a straight line basis over the life of the financing arrangement.
The following table represents the approximate amount included in general and administrative - related parties expense for the period indicated associated with Debt Financing Fees paid to our Advisor in connection with our credit facility and lines of credit:
As of December 31, 2013 and 2012, approximately $0 and $44,000, respectively, is included in accrued liabilities - related parties associated with unpaid Debt Financing Fees.
Credit Enhancement Fees
We and our wholly-owned subsidiaries will occasionally enter into financing arrangements that require guarantees from entities affiliated with us. These guarantees require us to pay Credit Enhancement Fees to our affiliated entities as consideration for their guarantees. These Credit Enhancement Fees are either expensed as incurred or recorded as a prepaid asset and amortized, based on the terms of the guarantee agreements.
The following table represents the approximate amount included in general and administrative - related parties expense for the periods indicated associated with Credit Enhancement Fees paid to UDF III for its guarantees of our lines of credit, as discussed in Note K of the accompanying Notes to the Consolidated Financial Statements. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III. UDF III has received an opinion from Jackson Claborn, Inc., an independent advisor, that these credit enhancements are fair and at least as reasonable as credit enhancements with unaffiliated entities in similar circumstances.
As of December 31, 2013 and 2012, approximately $17,000 and $11,000, respectively, is included in accrued liabilities - related parties associated with Credit Enhancement Fees payable to our Advisor or its affiliates.
The chart below summarizes the approximate payments to related parties for the years ended December 31, 2013 and 2012:
The chart below summarizes general and administrative - related parties expens for the years ended December 31, 2013, 2012 and 2011:
The chart below summarizes general and administrative - related parties expense for the years ended December 31, 2010 and 2009:
Loan Participation Interest - Related Parties
A majority of our trustees, including a majority of our independent trustees who are not otherwise interested in these transactions, have approved the following loan participation interest - related parties agreements as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
Buffington Participation Agreements
On December 18, 2009, we entered into two participation agreements (collectively, the “Buffington Participation Agreements”) with UMT Home Finance, LP (“UMTHF”), an affiliated Delaware limited partnership, pursuant to which we purchased a participation interest in UMTHF’s construction loans (the “Construction Loans”) to Buffington Texas Classic Homes, LLC (“Buffington Classic”), an affiliated Texas limited liability company, and Buffington Signature Homes, LLC (“Buffington Signature”), an affiliated Texas limited liability company (collectively, “Buff Homes”). Our Advisor also serves as the advisor for United Mortgage Trust (“UMT”), a Maryland real estate investment trust, which owns 100% of the interests in UMTHF. UMTH LD has a minority limited partnership interest in Buffington Homebuilding Group, Ltd., which is the parent of Buff Homes.
The Construction Loans originally provided Buff Homes, which is a homebuilding group, with residential interim construction financing for the construction of new homes in the greater Austin, Texas area through October 28, 2012. In connection with the maturity of the Construction Loans, the Buffington Participation Agreements originally terminated on October 28, 2012, as well. Pursuant to a letter agreement entered into on October 28, 2012, UMTHF extended the termination date of the Construction Loans to October 28, 2013 and, in connection with this extension, we have extended the Buffington Participation Agreements to October 28, 2013. Effective October 28, 2013, pursuant to a Sixth Modification to Construction Loan Agreement, UMTHF extended the termination date of the Construction Loans to October 28, 2014. The Buffington Classic participation agreement was also extended to October 28, 2014 in connection with this modification. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
The Construction Loans are evidenced by promissory notes, are secured by first lien deeds of trust on the homes financed under the Construction Loans, and are guaranteed by the parent company and the principals of Buff Homes. Each loan financed under the Construction Loans matures and becomes due and payable in full upon the earlier of (i) the sale of the home financed under the loan, or (ii) nine months after the loan was originated; provided, that the maturity of each loan may be automatically extended for additional 90-day terms following the original maturity date. For each loan originated to it, Buff Homes is required to pay interest monthly and to repay the principal advanced to it upon the sale of the home or in any event no later than 12 months following the origination of the loan, unless the loan is further extended. The interest rate under the Construction Loans is the lower of 13% or the highest rate allowed by law.
On April 9, 2010, we entered into an Agent - Participant Agreement with UMTHF (the “UMTHF Agent Agreement”). In accordance with the UMTHF Agent Agreement, UMTHF will continue to manage and control the Construction Loans and each participant party has appointed UMTHF as its agent to act on its behalf with respect to all aspects of the Construction Loans, provided that, pursuant to the UMTHF Agent Agreement, we retain approval rights in connection with any material decisions pertaining to the administration and services of the loans and, with respect to any material modification to the loans and in the event that the loans become non-performing, we shall have effective control over the remedies relating to the enforcement of the loans, including ultimate control of the foreclosure process.
Pursuant to the Buffington Participation Agreements, we will participate in the Construction Loans by funding the lending obligations of UMTHF under the Construction Loans up to a maximum amount determined by us at our discretion. The Buffington Participation Agreements give us the right to receive payment from UMTHF of principal and accrued interest relating to amounts funded by us under the Buffington Participation Agreements. The interest rate under the Construction Loans is the lower of 13% or the highest rate allowed by law. Our participation interest is repaid as Buff Homes repays the Construction Loans or as the individual construction loans mature.
Buffington Lot Participation Agreements
On March 24, 2010, we entered into two Participation Agreements (collectively, the “Buffington Lot Participation Agreements”) with UDF III pursuant to which we purchased a 100% participation interest in UDF III’s lot inventory line of credit loan facilities with Buffington Signature (the “Buffington Signature Line”) and Buffington Classic (the “Buffington Classic Line”) (collectively, the “Lot Inventory Loans”). The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III, and UMTH LD has a minority limited partnership interest in Buffington Homebuilding Group, Ltd., which is the parent of Buff Homes. The Lot Inventory Loans are evidenced by promissory notes, are secured by first lien deeds of trust on the lots financed under the Lot Inventory Loans, and are guaranteed by Buff Homes’ parent company and an affiliate company of Buff Homes. The Lot Inventory Loans provide Buff Homes with financing for the acquisition of residential lots which are held as inventory to facilitate Buff Homes’ new home construction business in the greater Austin, Texas area. When a lot is slated for residential construction, Buff Homes obtains an interim construction loan and the principal advanced for the acquisition of the lot is repaid under the Lot Inventory Loans.
On April 9, 2010, we entered into an Agent Agreement with UDF III (the “UDF III Agent Agreement”). In accordance with the UDF III Agent Agreement, UDF III will continue to manage and control the Lot Inventory Loans and each participant party has appointed UDF III as its agent to act on its behalf with respect to all aspects of the Lot Inventory Loans, provided that, pursuant to the UDF III Agent Agreement, we retain approval rights in connection with any material decisions pertaining to the administration and services of the loans and, with respect to any material modification to the loans and in the event that the loans become non-performing, we shall have effective control over the remedies relating to the enforcement of the loans, including ultimate control of the foreclosure process.
Pursuant to the Buffington Lot Participation Agreements, we will participate in the Lot Inventory Loans by funding UDF III’s lending obligations under the Lot Inventory Loans up to a maximum amount of $2.5 million under the Buffington Signature Line and $2.0 million under the Buffington Classic Line. The Buffington Lot Participation Agreements give us the right to receive repayment of all principal and accrued interest relating to amounts funded by us under the Buffington Lot Participation Agreements. The interest rate for the Lot Inventory Loans is the lower of 14% or the highest rate allowed by law. Our participation interest is repaid as Buff Homes repays the Lot Inventory Loans. For each loan originated, Buff Homes is required to pay interest monthly and to repay the principal advanced no later than 12 months following the origination of the loan. The Buffington Signature Line matured and terminated in August 2011, at which time there was no outstanding balance, and our participation interest terminated simultaneously. The Buffington Classic Line was due and payable in full on August 21, 2012. Effective August 21, 2012, pursuant to an extension agreement, UDF III extended the maturity date of the Buffington Classic Line to August 21, 2013 and, in connection with this extension agreement, we entered into a letter agreement with UDF III extending the lot participation agreement associated with the Buffington Classic Line to August 21, 2013. Effective August 21, 2013, UDF III entered into an extension agreement with Buffington Classic pursuant to which the termination date of the Buffington Classic Line was extended to August 21, 2014. The lot participation agreement associated with the Buffington Classic Line was also extended to August 21, 2014 in connection with this extension. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
UDF III is required to purchase back from us the participation interest in the Lot Inventory Loans (i) upon a foreclosure of UDF III’s assets by its lenders, (ii) upon the maturity of the Lot Inventory Loans, or (iii) at any time upon 30 days prior written notice from us. In such event, the purchase price paid to us will be equal to the outstanding principal amount of the Lot Inventory Loans on the date of termination, together with all accrued interest due thereon, plus any other amounts due to us under the Buffington Lot Participation Agreements.
TR Finished Lot Participation
On June 30, 2010, we purchased a participation interest (the “TR Finished Lot Participation”) in a finished lot loan (the “Travis Ranch II Finished Lot Loan”) made by UDF III to CTMGT Travis Ranch II, LLC, an unaffiliated Texas limited liability company. UMTH LD is the general partner of UDF III. The Travis Ranch II Finished Lot Loan is secured by a subordinate, second lien deed of trust recorded against finished residential lots in the Travis Ranch residential subdivision located in Kaufman County, Texas. The Travis Ranch II Finished Lot Loan is guaranteed by the limited liability company owners of the borrower and by the principal of the borrower.
In accordance with the TR Finished Lot Participation, we are entitled to receive repayment of our participation in the outstanding principal amount of the Travis Ranch II Finished Lot Loan, plus accrued interest thereon, over time as the borrower repays the loan. We have no obligation to increase our participation interest in the Travis Ranch II Finished Lot Loan. The interest rate under the Travis Ranch II Finished Lot Loan is the lower of 15% or the highest rate allowed by law. The borrower has obtained a senior loan secured by a first lien deed of trust on the finished lots. For so long as the senior loan is outstanding, proceeds from the sale of the residential lots securing the Travis Ranch II Finished Lot Loan will be paid to the senior lender and will be applied to reduce the outstanding balance of the senior loan. After the senior loan is paid in full, the proceeds from the sale of the residential lots securing the Travis Ranch II Finished Lot Loan are required to be used to repay the Travis Ranch II Finished Lot Loan. The Travis Ranch II Finished Lot Loan and our participation in this loan was originally due and payable in full on August 28, 2012. The Travis Ranch II Finished Lot Loan has subsequently been amended three times pursuant to three separate extension agreements resulting in a current maturity date of January 28, 2015. The TR Finished Lot Participation has also been extended to January 28, 2015 in connection with these modifications. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
TR Paper Lot Participation
On June 30, 2010, we purchased a participation interest (the “TR Paper Lot Participation”) in a “paper” lot loan (the “Travis Ranch Paper Lot Loan”) from UDF III to CTMGT Travis Ranch, LLC, an unaffiliated Texas limited liability company. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III. A “paper” lot is a residential lot shown on a plat that has been accepted by the city or county, but which is currently undeveloped or under development. The borrower owns paper lots in the Travis Ranch residential subdivision of Kaufman County, Texas. The Travis Ranch Paper Lot Loan was initially secured by a pledge of the equity interests in the borrower instead of a real property lien, effectively subordinating the Travis Ranch Paper Lot Loan to all real property liens. The Travis Ranch Paper Lot Loan is guaranteed by the limited liability company owners of the borrower and by the principal of the borrower.
We are entitled to receive repayment of our participation in the outstanding principal amount of the Travis Ranch Paper Lot Loan, plus its proportionate share of accrued interest thereon, over time as the borrower repays the Travis Ranch Paper Lot Loan. We have no obligation to increase our participation interest in the Travis Ranch Paper Lot Loan. The interest rate under the Travis Ranch Paper Lot Loan is the lower of 15% or the highest rate allowed by law. The borrower has obtained a senior loan secured by a first lien deed of trust on the paper lots. For so long as the senior loan is outstanding, proceeds from the sale of the paper lots will be paid to the senior lender and will be applied to reduce the outstanding balance of the senior loan. After the senior loan is paid in full, the proceeds from the sale of the paper lots are required to be used to repay the Travis Ranch Paper Lot Loan. The Travis Ranch Paper Lot Loan and our participation in this loan was originally due and payable in full on September 24, 2012. The Travis Ranch Paper Lot Loan has subsequently been amended three times pursuant to three separate extension agreements resulting in a current maturity date of January 28, 2015. The TR Paper Lot Participation has also been extended to January 28, 2015 in connection with these modifications. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
Carrollton Participation Agreement
On June 10, 2011, we entered into a participation agreement (the “Carrollton Participation Agreement”) with UMT Home Finance III, LP (“UMTHFIII”), an affiliated Delaware limited partnership, pursuant to which we purchased a participation interest in UMTHFIII’s finished lot loan (the “Carrollton Lot Loan”) to Carrollton TH, LP (“Carrollton TH”), an unaffiliated Texas limited partnership. Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFIII. The Carrollton Lot Loan provides Carrollton TH with a finished lot loan totaling $3.4 million for townhome lots located in Carrollton, Texas. The Carrollton Lot Loan is evidenced by a promissory note, is secured by first lien deeds of trust on the finished lots financed under the Carrollton Lot Loan, and is guaranteed by the borrower’s general partner and its principal.
The Carrollton Participation Agreement gave us the right to receive payment from UMTHFIII of principal and accrued interest relating to amounts funded by us under the Carrollton Participation Agreement. The interest rate under the Carrollton Lot Loan was the lower of 13% or the highest rate allowed by law. The original maturity date of the Carrollton Lot Loan is June 10, 2014. Pursuant to a letter agreement entered into in March 2012, the Carrollton Participation Agreement maturity date was extended from March 10, 2012 to December 10, 2012. Pursuant to a letter agreement entered into in December 2012, the Carrollton Participation Agreement maturity date was extended from December 10, 2012 to June 10, 2014. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. We received payment in full for the Carrollton Participation Agreement on May 31, 2013.
165 Howe Participation Agreement
On October 4, 2011, we entered into a participation agreement (the “165 Howe Participation Agreement”) with UMT Home Finance III, LP (“UMTHFIII”), an affiliated Delaware limited partnership, pursuant to which we purchased a participation interest in UMTHFIII’s finished lot loan (the “165 Howe Lot Loan”) to 165 Howe, L.P., an unaffiliated Texas limited partnership, and Allen Partners, L.P., an unaffiliated Texas limited partnership (collectively, “165 Howe”). Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFIII. The 165 Howe Lot Loan provides 165 Howe with a finished lot loan totaling $2.9 million for finished single-family residential lots located in Fort Worth, Texas. The 165 Howe Lot Loan is evidenced by a promissory note, is secured by first lien deeds of trust on the finished lots financed under the 165 Howe Lot Loan, and is guaranteed by the borrower’s general partner and its principal.
The 165 Howe Participation Agreement gave the Trust the right to receive payment from UMTHFIII of principal and accrued interest relating to amounts funded by the Trust under the 165 Howe Participation Agreement. The interest rate under the 165 Howe Lot Loan is the lower of 11.5% or the highest rate allowed by law. The original maturity date of the 165 Howe Participation Agreement was July 4, 2012. Pursuant to a letter agreement entered into in July 2012, the 165 Howe Participation Agreement maturity date was extended from July 4, 2012 to December 10, 2012. Pursuant to a letter agreement entered into in December 2012, the 165 Howe Participation Agreement maturity date was extended from December 10, 2012 to October 4, 2013. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. We received payment in full for the 165 Howe Participation Agreement on November 6, 2013.
Pine Trace Participation Agreement
On May 31, 2012, we entered into a participation agreement (the “Pine Trace Participation Agreement”) with UMTHFIII pursuant to which we purchased a participation interest in UMTHFIII’s loan (the “Pine Trace Loan”) to Pine Trace Village, LLC an unaffiliated Texas limited liability company (“Pine Trace”). Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFIII. The Pine Trace Loan was initially secured by approximately 118 finished lots and 151 acres of undeveloped land located in Houston, Texas. The Pine Trace Loan is evidenced by a promissory note and is secured by first lien deeds of trust on the finished lots financed under the Pine Trace Loan.
The Pine Trace Participation Agreement gives us the right to receive payment from UMTHFIII of principal and accrued interest relating to amounts funded by us under the Pine Trace Participation Agreement. The interest rate under the Pine Trace Loan is the lower of 13% or the highest rate allowed by law. Our interest will be repaid as Pine Trace repays the Pine Trace Loan. Pine Trace is required to pay interest monthly and to repay a portion of principal upon the sale of lots covered by the deed of trust. The original maturity date of the Pine Trace Participation Agreement was March 29, 2013. The Pine Trace Loan has subsequently been amended twice pursuant to two separate extension agreements resulting in a current maturity date of March 29, 2015. The Pine Trace Participation Agreement has also been extended to March 29, 2015 in connection with these modifications. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
Northpointe Participation Agreement
On June 11, 2012, we entered into a participation agreement (the “Northpointe Participation Agreement”) with UDF III pursuant to which we purchased a participation interest in UDF III’s loan (the “Northpointe Loan”) to UDF Northpointe, LLC, an unaffiliated Texas limited liability company (“Northpointe”). The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III. The Northpointe Loan was initially secured by approximately 301 lots located in Collin County, Tarrant County and Kaufman County, Texas. The Northpointe Loan is evidenced by a promissory note and is secured by first lien deeds of trust on the lots financed under the Northpointe Loan.
The Northpointe Participation Agreement gives us the right to receive payment from UDF III of principal and accrued interest relating to amounts funded by us under the Northpointe Participation Agreement. The interest rate under the Northpointe Loan is the lower of 12% or the highest rate allowed by law. Our interest will be repaid as Northpointe repays the Northpointe Loan. Northpointe is required to pay interest monthly and to repay a portion of principal upon the sale of lots covered by the deed of trust. The original maturity date of the Northpointe Participation Agreement was December 4, 2012. Pursuant to a letter agreement entered into in December 2012, the Northpointe Participation Agreement maturity date was extended from December 4, 2012 to June 4, 2013. Effective June 4, 2013, pursuant to a loan modification agreement, UDF III extended the maturity date of the Northpointe Loan to June 4, 2014. The Northpointe Participation Agreement was also extended to June 4, 2014 in connection with this modification. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
Northpointe II Participation Agreement
On May 2, 2013, we entered into a participation agreement (the “Northpointe II Participation Agreement”) with UDF III pursuant to which we purchased a participation interest in UDF III’s loan (the “Northpointe II Loan”) to UDF Northpointe II, LLC (“Northpointe II”). The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III. The Northpointe II Loan is evidenced by two secured promissory notes and was initially secured by second lien deeds of trust on approximately 251 finished lots and 110 acres of land in Texas.
The Northpointe II Participation Agreement gives us the right to receive payment from UDF III of principal and accrued interest relating to amounts funded by us under the Northpointe II Participation Agreement. The interest rate under the Northpointe II Loan is the lower of 12% or the highest rate allowed by law. Our interest will be repaid as Northpointe II repays the Northpointe II Loan. Northpointe II is required to pay interest monthly and to repay a portion of principal upon the sale of lots covered by the deed of trust. The Northpointe II Loan and our participation in this loan were originally due and payable in full on December 28, 2013. Effective December 28, 2013, pursuant to a loan modification agreement, UDF III extended the maturity date of the Northpointe II Loan to December 28, 2014. The Northpointe Participation Agreement was also extended to December 28, 2014 in connection with this modification. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
UMTHF Megatel Participation
On October 3, 2013, we entered into a participation agreement (the “UMTHF Megatel Participation”) with UMTHF pursuant to which we purchased a participation interest in UMTHF’s construction loan (the “UMTHF Megatel Loan”) to Megatel Homes II, LLC (“Megatel”). Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHF.
The UMTHF Megatel Loan provides Megatel, which is a homebuilding group, with up to $10.0 million in residential interim construction financing for the construction of new homes in the Dallas, Texas area through October 3, 2014. The UMTHF Megatel Loan is evidenced by promissory notes and is secured by first lien deeds of trust on the homes financed under the UMTHF Megatel Loan, and is guaranteed by the parent company and the principals of Megatel. Each loan financed under the UMTHF Megatel Loan matures and becomes due and payable in full upon the earlier of (i) the sale of the home financed under the loan, or (ii) 12 months after the loan was originated; provided, that the maturity of each loan may be automatically extended for additional 12 month terms following the original maturity date. For each loan originated to it, Megatel is required to pay interest monthly and to repay the principal advanced to it upon the sale of the home or in any event no later than 12 months following the origination of the loan, unless the loan is further extended. The interest rate under the UMTHF Megatel Loan is the lower of 13% or the highest rate allowed by law.
Pursuant to the UMTH Megatel Participation, we will participate in the UMTHF Megatel Loan by funding the lending obligations of UMTHF under the UMTHF Megatel Loan up to a maximum amount determined by us at our discretion. The UMTH Megatel Participation gives us the right to receive payment from UMTHF of principal and accrued interest relating to amounts funded by us under the UMTH Megatel Participation. The interest rate under the UMTHF Megatel Loan is the lower of 13% or the highest rate allowed by law. Our participation interest is repaid as Megatel repays the UMTHF Megatel Loan or as the individual construction loans mature.
URHF Buckingham Participation
On December 16, 2013, we entered into a participation agreement (the “URHF Buckingham Participation”) with URHF pursuant to which we purchased a participation interest in URHF’s $4.9 million loan (the “URHF Buckingham Loan”) to CTMGT Buckingham, LLC (“Buckingham”), a Texas limited liability company. Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in URHF. The URHF Buckingham Loan provides financing to Buckingham to acquire and develop 81 paper lots located in Texas. The URHF Buckingham Loan is evidenced by a secured promissory note and secured by a first lien deed of trust on the lots and is guaranteed by principals of the borrower.
The URHF Buckingham Participation gives us the right to receive payment from URHF of principal and accrued interest relating to amounts funded by us under the URHF Buckingham Participation. The interest rate under the URHF Buckingham Loan is the lower of 13% or the highest rate allowed by law. Our interest will be repaid as Buckingham repays the URHF Buckingham Loan. Buckingham is required to make loan payments upon the sale of lots covered by the deed of trust. The URHF Buckingham Loan and our participation in this loan are due and payable in full on June 28, 2016.
URHF Bratton Hill Participation
On December 16, 2013, we entered into a participation agreement (the “URHF Bratton Hill Participation”) with URHF pursuant to which we purchased a participation interest in URHF’s $3.0 million loan (the “URHF Bratton Hill Loan”) to BLD Bratton Hill, LLC (“Bratton Hill”), a Texas limited liability company. Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in URHF. The URHF Bratton Hill Loan provides financing to Bratton Hill to acquire and develop 52 paper lots located in Texas. The URHF Bratton Hill Loan is evidenced by a secured promissory note and secured by a first lien deed of trust on the lots and is guaranteed by principals of the borrower.
The URHF Buckingham Participation gives us the right to receive payment from URHF of principal and accrued interest relating to amounts funded by us under the URHF Bratton Hill Participation. The interest rate under the URHF Bratton Hill Loan is the lower of 13% or the highest rate allowed by law. Our interest will be repaid as Bratton Hill repays the URHF Bratton Hill Loan. Bratton Hill is required to pay make loan payments upon the sale of lots covered by the deed of trust. The URHF Bratton Hill Loan and our participation in this loan are due and payable in full on July 31, 2016.
Summary Information
The chart below summarizes the approximate outstanding balance of each of our loans included in loan participation interest - related parties as of the date indicated:
The chart below summarizes the approximate accrued interest included in accrued receivable - related parties associated with each of our loans included in loan participation interest - related parties as of the date indicated:
The following table summarizes the approximate income included in interest income - related parties associated with each of our loans included in loan participation interest - related parties for the periods indicated:
Notes Receivable - Related Parties
A majority of our trustees, including a majority of our independent trustees who are not otherwise interested in these transactions, have approved the following notes receivable - related parties agreements as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
HLL Indian Springs Loan
On January 18, 2010, we made a finished lot loan (the “HLL Indian Springs Loan”) of approximately $1.8 million to HLL Land Acquisitions of Texas, L.P., an affiliated Texas limited partnership (“HLL”). HLL is a wholly owned subsidiary of United Development Funding, L.P. (“UDF I”), an affiliated Delaware limited partnership. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The HLL Indian Springs Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 71 finished residential lots in The Preserve at Indian Springs, a residential subdivision in the City of San Antonio, Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts and earnest money, and other loan documents. The interest rate under the HLL Indian Springs Loan was the lower of 13% or the highest rate allowed by law. The HLL Indian Springs Loan was scheduled to mature on July 18, 2013, pursuant to the First Modification Agreement dated July 18, 2011. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. The HLL Indian Springs Loan was paid in full in May 2013.
In connection with the HLL Indian Springs Loan, HLL agreed to pay an origination fee of approximately $18,000 to UMTH LD, which was funded by us at the closing of the HLL Indian Springs Loan.
Buffington Loan Agreements
On April 30, 2010, we entered into two construction loan agreements with Buffington Signature (the “Buffington Signature CL”) and Buffington Classic (the “Buffington Classic CL”) (collectively, the “Buffington Loan Agreements”) through which we agreed to provide interim construction loan facilities (collectively, the “Buffington Loan Facilities”) to Buffington Signature and Buffington Classic. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD owns an investment in Buffington Homebuilding Group, Ltd., which is the parent of Buff Homes. Effective July 2010, we assigned our rights and obligations under the Buffington Loan Facilities to UDF IV HF.
The Buffington Signature CL provides Buffington Signature with up to $1.0 million in residential interim construction financing for the construction of new homes in the greater Austin, Texas area and other Texas counties approved by UDF IV HF. The Buffington Signature CL matured and was not renewed in October 2011, at which time there were no amounts outstanding and payable to UDF IV HF.
The Buffington Classic CL originally provided Buffington Classic with up to $6.5 million in residential interim construction financing for the construction of new homes in the greater Austin, Texas area and other Texas counties approved by UDF IV HF. Pursuant to the Third Modification to Construction Loan Agreement entered into between UDF IV HF and Buffington Classic in October 2011, the Buffington Classic CL provided Buffington Classic with up to $7.5 million in residential interim construction financing through October 28, 2012. Pursuant to a letter agreement entered into on October 28, 2012, we extended the maturity date of the Buffington Classic CL to October 28, 2013. Pursuant to a Fourth Modification to Construction Loan Agreement, we extended the maturity date of the Buffington Classic CL to October 28, 2014. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
The Buffington Loan Facilities are evidenced and secured by the Buffington Loan Agreements, promissory notes, first lien deeds of trust on the homes financed under the Buffington Loan Facilities and various other loan documents. They are guaranteed by the parent company and certain principals of Buff Homes. The interest rate under the Buffington Loan Facilities is the lower of 13% per annum, or the highest rate allowed by law. Interest is payable monthly. Each loan financed under the Buffington Loan Facilities matures and becomes due and payable in full upon the earlier of (i) the sale of the home financed under the loan, or (ii) nine months after the loan was originated; provided, that the maturity of the loan may be extended up to 90 days following the original maturity date. At the closing of each loan, Buff Homes will pay a 0.5% origination fee to our asset manager.
HLL II Highland Farms Loan
Effective December 22, 2010, we made a finished lot loan (the “HLL II Highland Farms Loan”) of approximately $1.9 million to HLL II Land Acquisitions of Texas, L.P., an affiliated Texas limited partnership (“HLL II”). HLL II is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The HLL II Highland Farms Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 68 finished residential lots and 148 undeveloped lots in Highland Farms, a residential subdivision in the City of San Antonio, Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts and earnest money, and other loan documents. The interest rate under the HLL II Highland Farms Loan is the lower of 13% or the highest rate allowed by law. The original maturity date of the HLL II Highland Farms Loan was March 22, 2013. The HLL II Highland Farms Loan has subsequently been amended twice pursuant to two separate extension agreements resulting in a current maturity date of March 22, 2015. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. The HLL II Highland Farms Loan provides HLL II with an interest reserve of approximately $354,000 pursuant to which we will fund HLL II’s monthly interest payments and add the payments to the outstanding principal balance of the HLL II Highland Farms Loan.
In connection with the HLL II Highland Farms Loan, HLL II agreed to pay us an origination fee of approximately $19,000, which was funded at the closing of the loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
HLL Hidden Meadows Loan
Effective February 17, 2011, we entered into a Loan Agreement providing for a maximum $9.9 million loan (the “HLL Hidden Meadows Loan”) to be made to HLL. HLL is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The HLL Hidden Meadows Loan was initially secured by (i) a first priority lien deed of trust to be recorded against 91 finished residential lots, 190 partially developed residential lots and residual undeveloped land located in the residential subdivision of Hidden Meadows, Harris County, Texas, (ii) the assignment of lot sale contracts providing for sales of finished residential lots to a builder, and (iii) the assignment of development reimbursements owing from a Municipal Utility District to HLL. The interest rate under the HLL Hidden Meadows Loan is the lower of 13% or the highest rate allowed by law. The HLL Hidden Meadows Loan matures and becomes due and payable in full on January 21, 2015. The HLL Hidden Meadows Loan provides HLL with an interest reserve, pursuant to which we will fund HLL’s monthly interest payments and add the payments to the outstanding principal balance of the HLL Hidden Meadows Loan.
In connection with the HLL Hidden Meadows Loan, HLL agreed to pay a $99,000 origination fee to us, which was funded at the closing of the HLL Hidden Meadows Loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
Ash Creek Loan
Effective April 20, 2011, we entered into a $3.0 million loan agreement (the “Ash Creek Loan”) with UDF Ash Creek, LP (“UDF Ash Creek”), an affiliated Delaware limited partnership. UDF Ash Creek is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The Ash Creek Loan provides UDF Ash Creek with interim construction financing for the construction of 19 new townhomes in an existing townhome community in Dallas, Texas. The Ash Creek Loan is evidenced and secured by a promissory note, first lien deeds of trust on the townhomes financed under the Ash Creek Loan and various other loan documents. The interest rate under the Ash Creek Loan is the lower of 13% per annum, or the highest rate allowed by law. UDF Ash Creek is required to pay interest monthly and to repay a portion of the principal upon the sale of the townhomes covered by the deed of trust. The Ash Creek Loan matured and became due and payable in full on October 20, 2012. Effective October 20, 2012, we entered into a loan modification agreement with UDF Ash Creek, which extended the maturity date of the Ash Creek Loan to October 20, 2013. Pursuant to a Second Loan Modification Agreement, we extended the maturity date of the Ash Creek Loan to October 20, 2014. In determining whether to extend this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
In connection with the Ash Creek Loan, UDF Ash Creek agreed to pay a $15,000 origination fee to us, which was funded at the closing of the Ash Creek Loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
UMTHFII Loan
On October 26, 2011, we entered into a secured line of credit promissory note (the “UMTHFII Loan”) with UMT Home Finance II, LP (“UMTHFII”), an affiliated Delaware limited partnership. Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFII. The UMTHFII Loan provided UMTHFII with a $5.0 million line of credit to acquire or originate and fund construction loans and for business purposes approved by the Trust that are related to the acquisition or origination of construction loans. The UMTHFII Loan was subordinate to a senior loan entered into by UMTHFII and was secured by a pledge of the partnership interests in UMTHFII, a security interest against the assets of UMTHFII and a guaranty from UMT.
The interest rate under the UMTHFII Loan was the lower of 13% per annum, or the highest rate allowed by law. UMTHFII was required to repay the UMTHFII Loan as it receives net proceeds from the disposition of assets underlying the construction loans and as it receives net proceeds of interest associated with the construction loans. In addition, UMTHFII was required to repay the UMTHFII Loan as it received net proceeds from its private placement offering of up to $5.0 million in promissory notes. The UMTHFII Loan matured and became due and payable in full on October 26, 2012, at which point it terminated. We did not fund any advances or recognize any income associated with the UMTHFII Loan prior to its maturity.
UDF TX Two Loan
On September 20, 2012, we entered into a loan purchase agreement with a third party to acquire a loan obligation (the “UDF TX Two Loan”) owing from UDF TX Two, L.P., an affiliated Texas limited partnership (“UDF TX Two”) for approximately $2.9 million. UDF I has a 50% partnership interest in UDF TX Two. Our asset manager, UMTH LD, also serves as the asset manager of UDF I. The general partner of our Advisor is also the general partner of UMTH LD. The UDF TX Two Loan provided UDF TX Two with financing to acquire 70 finished home lots in Lakeway, Texas. The UDF TX Two Loan is evidenced and secured by a promissory note, first lien deeds of trust on the finished lots financed under the UDF TX Two Loan and various other loan documents. The interest rate under the UDF TX Two Loan is the lower of 13% per annum, or the highest rate allowed by law. Upon acquisition of the UDF TX Two Loan, we entered into an extension agreement with UDF TX Two pursuant to which we extended the maturity date of the UDF TX Two Loan to September 20, 2014. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
UDF PM Loan
Effective October 17, 2012, we entered into a $5.1 million loan agreement (the “UDF PM Loan”) with UDF PM, LLC (“UDF PM”), an affiliated Texas limited liability company. UDF PM is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The UDF PM Loan provides UDF PM with up to $4.8 million in financing for the development of an amenity center and related project amenities located in Lubbock County, Texas. The UDF PM Loan is evidenced and secured by a promissory note and the assignment of development reimbursements owing to UDF PM pursuant to (i) an economic development agreement and (ii) a public improvement district reimbursement contract, both of which were entered into between UDF PM and the city of Wolfforth, Texas. The interest rate under the UDF PM Loan is the lower of 13% per annum, or the highest rate allowed by law. The UDF PM Loan matures and becomes due and payable in full on October 17, 2015. The UDF PM Loan provides UDF PM with an interest reserve of approximately $300,000, pursuant to which we will fund UDF PM’s monthly interest payments and add the payments to the outstanding principal balance of the UDF PM Loan.
HLL IS Loan
Effective November 29, 2012, we entered into a $6.4 million loan agreement (the “HLL IS Loan”) with HLL. HLL is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The HLL IS Loan provides HLL with up to $5.8 million in financing for the development of residential lots located in Bexar County, Texas. The HLL IS Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 24 acres in The Preserve at Indian Springs, a residential subdivision in the City of San Antonio, Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts, and other loan documents. The interest rate under the HLL IS Loan is the lower of 13% per annum, or the highest rate allowed by law. The HLL IS Loan matures and becomes due and payable in full on November 29, 2015. The HLL IS Loan provides HLL with an interest reserve of approximately $600,000, pursuant to which we will fund HLL’s monthly interest payments and add the payments to the outstanding principal balance of the HLL IS Loan.
In connection with the HLL IS Loan, HLL agreed to pay a $64,000 origination fee to us, which was funded at the closing of the HLL IS Loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
One KR Loan
Effective December 14, 2012, we entered into a $15.3 million loan agreement (the “One KR Loan”) with One KR Venture, L.P., an affiliated Texas limited partnership (“One KR”). One KR is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The One KR Loan provides One KR with up to $12.1 million to refinance existing third party debt and develop real property located in Bexar County, Texas. The One KR Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 31 acres of real property located in Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts, a pledge of partnership interests in the borrower and other loan documents. The interest rate under the One KR Loan is the lower of 13% per annum, or the highest rate allowed by law. The One KR Loan matures and becomes due and payable in full on June 14, 2016. The One KR Loan provides One KR with an interest reserve of approximately $3.2 million, pursuant to which we will fund One KR’s monthly interest payments and add the payments to the outstanding principal balance of the One KR Loan.
In connection with the One KR Loan, One KR agreed to pay a $153,000 origination fee to us, which was funded at the closing of the One KR Loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
Summary Information
The chart below summarizes the approximate outstanding balance of each of our loans included in notes receivable - related parties as of the date indicated:
The chart below summarizes the approximate accrued interest included in accrued receivable - related parties associated with each of our loans included in notes receivable - related parties as of the date indicated:
The following table summarizes the approximate income included in interest income - related parties associated with each of our loans included in notes receivable - related parties for the period indicated:
Commitment Fee Income
We and our wholly-owned subsidiaries will occasionally enter into loan agreements with affiliated entities that require origination fees to be funded to us at the closing of the loan. These origination fees are recognized as revenue over the life of the resulting loan and this revenue is included in commitment fee income - related parties.
The following table represents the approximate origination fees included in commitment fee income - related parties associated with each loan for the periods indicated:
Guaranties
In connection with the funding of some of our organization costs, on June 26, 2009, UMTH LD entered into a $6.3 million line of credit (as amended, the “UMTH LD CTB LOC”) with CTB. Effective February 26, 2012, UMTH LD entered into a second loan modification agreement with CTB, which resulted in an extension of the maturity date on the UMTH LD CTB LOC to December 26, 2014. UMTH LD has a receivable from our Advisor for organization costs funded by UMTH LD on behalf of the Trust. UMTH LD has assigned this receivable to the bank as security for the UMTH LD CTB LOC. In addition, the UMTH LD CTB LOC is secured by a collateral assignment of a first priority note and deed of trust held by a subsidiary of UMTH LD against a residential real estate project. As a condition to the modification entered into effective as of February 26, 2012, the Trust agreed to guaranty all obligations under the UMTH LD CTB LOC. As of December 31, 2013 and December 31, 2012, the outstanding balance on the line of credit was $5.1 million and $6.2 million, respectively.
Effective December 30, 2011, we entered into a Guaranty of Payment and Guaranty of Completion (collectively, the “Stoneleigh Guaranty”) for the benefit of Babson Mezzanine Realty Investors II, L.P. (“Babson”) as agent for a group of lenders pursuant to which we guaranteed all amounts due associated with a $25.0 million construction loan agreement (the “Stoneleigh Construction Loan”) entered into between Maple Wolf Stoneleigh, LLC, an affiliated Delaware limited liability company (“Stoneleigh”), and Babson. Pursuant to the Stoneleigh Construction Loan, Babson will provide Stoneleigh with up to approximately $25.0 million to finance the construction associated with a condominium project located in Dallas, Texas. United Development Funding Land Opportunity Fund, L.P., an affiliated Delaware limited partnership (“UDF LOF”), owns a 75% interest in Stoneleigh. Our asset manager, UMTH LD, also serves as the asset manager of UDF LOF. The general partner of our Advisor also serves as the general partner of UMTH LD. UMTH LD controls 100% of the partnership interests of the general partner of UDF LOF. In consideration of us entering into the Stoneleigh Guaranty, we entered into a letter agreement with Stoneleigh which provides for Stoneleigh to pay us a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance on the Stoneleigh Construction Loan at the end of each month. As of December 31, 2013 and December 31, 2012, approximately $7.6 million and $9.7 million, respectively, was outstanding under the Stoneleigh Construction Loan. For the years ended December 31, 2013 and 2012, approximately $90,000 and $21,000, respectively, is included in commitment fee income - related parties in connection with the credit enhancement fee associated with the Stoneleigh Construction Loan. As of December 31, 2013 and December 31, 2012, approximately $15,000 and $14,000, respectively, is included in accrued receivable - related parties in connection with the credit enhancement fee associated with the Stoneleigh Construction Loan.
Effective July 22, 2013, we entered into a guaranty agreement (the “URHF Guaranty”) pursuant to which we guaranteed all amounts due associated with a $15.0 million revolving credit facility (the “URHF Southwest Loan”) entered into between United Residential Home Finance, L.P. (“URHF”), an affiliated Delaware limited partnership, and Southwest Bank (“Southwest”). Our Advisor also serves as the advisor for United Mortgage Trust (“UMT”), a Maryland real estate investment trust, which owns 100% of the interests in URHF. The URHF Southwest Loan is secured by a first priority collateral assignment and lien on certain mortgage notes and loans held by URHF. In consideration of us entering into the URHF Guaranty, we entered into a letter agreement with URHF which provides for URHF to pay us a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance on the URHF Southwest Loan at the end of each month. As of December 31, 2013, URHF had not made any draws on this loan and we had not recognized any income in connection with our guaranty.
Certain Conflict Resolution Procedures
In order to reduce or eliminate certain potential conflicts of interest, our declaration of trust contains a number of restrictions relating to transactions we enter into with our Advisor and its affiliates and allocation of investment opportunities among affiliated entities. These restrictions include, among others, the following:
·We will not purchase or lease properties in which our Advisor, any of our trustees or any of their respective affiliates, has an interest unless a majority of the trustees, including a majority of the independent trustees, not otherwise interested in such transaction determines that such transaction is fair and reasonable to us and at a price to us no greater than the cost of the property to the seller or lessor, unless there is substantial justification for any amount that exceeds such cost and such excess amount is determined to be reasonable. In no event will we acquire any property at an amount in excess of its appraised value. We will not sell or lease properties to our Advisor, any of our trustees or any of their respective affiliates unless a majority of the trustees, including a majority of the independent trustees, not otherwise interested in the transaction determines that the transaction is fair and reasonable to us.
·We will not make any loans to our Advisor, any of our trustees or any of their respective affiliates, except that we may make or invest in mortgage loans involving our Advisor, our trustees or their respective affiliates, provided that an appraisal is obtained from an independent expert concerning the underlying property from an independent expert who is in the business of rendering opinions regarding the value of assets of the type held by us and who is qualified to perform such work. In addition, a majority of the trustees, including a majority of the independent trustees, who are not otherwise interested in the transaction must approve all transactions with our Advisor or its affiliates as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties. We also will obtain a mortgagee’s or owner’s title insurance policy or a commitment as to the priority of the secured loan as part of our underwriting process. Furthermore, our Advisor, any of our trustees and any of their respective affiliates will not make loans to us or to joint ventures in which we are a joint venture partner unless approved by a majority of the trustees, including a majority of the independent trustees, not otherwise interested in the transaction as fair, competitive and commercially reasonable, and no less favorable to us than comparable loans between unaffiliated parties.
·Our Advisor and its affiliates will be entitled to reimbursement, at cost, for actual expenses incurred by them on behalf of us or joint ventures in which we are a joint venture partner; provided, however, our Advisor must reimburse us for the amount, if any, by which our total operating expenses, including the Advisor asset management fee, paid during the previous fiscal year exceeded the greater of: (i) 2% of our average invested assets for that fiscal year, or (ii) 25% of our net income, before any additions to reserves for depreciation, bad debts or other similar non-cash reserves and before any gain from the sale of our assets, for that fiscal year.
·We will not enter into any other transaction with our Advisor or its affiliates, including the acceptance of goods or services from our Advisor or its affiliates, unless a majority of our trustees, including a majority of the independent trustees, not otherwise interested in the transaction approves such transaction as fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
We may invest in the same loans in which UDF I, UDF II, UDF III and UDF LOF invest. We believe that we will be able to invest in a more diversified portfolio of loans and benefit from integrated exit strategies if we are able to hold loans jointly with our affiliates. The lifecycle of single-family lot development and home construction generally begins with the acquisition of land for development of single-family lots, followed by the entitlement and engineering of the subject property, followed by the development of raw land into a finished lot, followed by the construction and sale of a single-family home. There are differing levels of capital appreciation, cash flow, loan-to-value ratios, development risk, market risk and investment yields over the course of the development lifecycle. UDF I, UDF II, UDF III, UDF LOF and we invest, or will invest, in substantially similar land development opportunities, although such investments may be made at different points in the development lifecycle in accordance with the investment criteria, yield requirements, cash flow expectations, investment horizon and risk tolerances of the respective fund at the time the investment is made. In addition, UDF I, UDF II, UDF III, UDF LOF and we will determine to exit investments in land development and home construction projects at different points in the development lifecycle in accordance with the investment criteria, yield requirements, cash flow expectations, investment horizon and risk tolerances of the respective fund at the time the exit is made. Subject to the respective limitations set forth in the organizational and operational documents of each of UDF I, UDF II, UDF III, UDF LOF and us, investments may be entered into as loan participations or joint ventures between two or more of these funds, and may be sold to or refinanced by one or more other of such funds in accordance with the investment criteria, yield requirements, cash flow expectations, investment horizon and risk tolerances of the respective fund.
UMTH LD is the asset manager of UDF I, UDF II, UDF LOF and us and the general partner of UDF III. In exercising its duties to each of these funds, UMTH LD will manage each investment in accordance with the investment criteria, yield requirements, cash flow expectations, investment horizon and risk tolerances of the respective fund as each investment progresses. UDF I, UDF II, UDF III, UDF LOF and we each recognize that, in exercising its duties to each fund, UMTH LD will encounter conflicts of interest. Thus, each of these funds and UMTH LD seeks to equitably apportion investment opportunities among and between such entities in accordance with each fund’s investment criteria, yield requirements, cash flow expectations, investment horizon and risk tolerances at the time each transaction opportunity is presented by UMTH LD. We have entered into a participation agreement with UDF I, UDF II, UDF III, UDF LOF and UMTH LD that provides that, in the event that a transaction opportunity becomes available that is suitable, under all of the factors considered by our Advisor, including cash flow, capital appreciation, investment horizon and risk tolerance, for both us and one or more of these programs, and for which more than one of such entities has sufficient uninvested funds, then:
·each respective entity will be allocated a percentage of the transaction opportunity determined as the ratio of the total amount of “equity invested” in such entity over the “total combined equity invested,” such percentage being the “investment percentage.” For purposes of the participation agreement, “equity invested” shall include both direct investment and retained earnings as determined by the most recently available audited or unaudited financial statements prepared by the respective entities as completed with respect to the most recent calendar quarter. For purposes of this paragraph, “total combined equity invested” shall mean the sum of the equity invested in each of UDF I, UDF II, UDF III, UDF LOF and us. Each of the respective entities will invest in such transaction opportunity an amount equal to the investment percentage multiplied by the amount of “required cash.” For purposes of the participation agreement, “required cash” means the aggregate amount of cash required to be invested by the respective United Development Funding-sponsored program in the transaction opportunity;
·if, after allocating available cash pursuant to the paragraphs above, the full amount of the required cash has not been invested, the remaining transaction opportunity shall be allocated amongst and between the entities with remaining available cash by repeating the process set forth in the paragraph immediately above until the full amount of required cash has been invested;
·For purposes of the participation agreement, “available cash” shall mean all cash of the respective entity available for investment, not including lines of credit or other borrowing facilities, as determined by UMTH LD, taking into consideration the projected sources and uses of cash for that respective entity.
In determining whether or not a transaction opportunity is suitable for more than one program, our Advisor, subject to approval by our board of trustees, shall examine, among others, the following factors:
·the anticipated cash flow of the property to be acquired or underlying the secured loan and the cash requirements of each program;
·the effect of the investment both on diversification of each program’s investments by type of property and geographic area;
·the policy of each program relating to leverage;
·the income tax effects of the investment to each program;
·the size of the investment; and
·the amount of funds available to each program and the length of time such funds have been available for investment.
If a subsequent development, such as a delay in the closing of an investment, causes any such investment, in the opinion of our Advisor, to be more appropriate for a program other than the program that committed to make the investment, our Advisor may determine that another program affiliated with our Advisor or its affiliates will make the investment. Our board of trustees, including our independent trustees, has a duty to ensure that the method used by our Advisor for the allocation of investments by two or more affiliated programs seeking to make similar types of investments is applied fairly to us.
Circumstances may arise, due to availability of capital or other reasons, when it is not possible for UDF I, UDF II, UDF III, UDF LOF and us to each make an investment on such a pro rata basis. We cannot assure you that we will be able to invest in all investment opportunities of which our Advisor becomes aware that are suitable for us on a pro rata basis with UDF I, UDF II, UDF III and UDF LOF or otherwise. Furthermore, UDF I, UDF II, UDF III and UDF LOF may make investments in which we will not participate, and we may make investments in which UDF I, UDF II, UDF III and/or UDF LOF will not participate. If we do make an investment with UDF I, UDF II, UDF III and/or UDF LOF, the structure of our participation in such investments may vary and will be determined on a case-by-case basis.
Our participation agreement with UDF I, UDF II, UDF III, UDF LOF and UMTH LD provides that, unless the organizational and operational documents of a fund are more restrictive, (i) no loan shall be sold between UDF I, UDF II, UDF III, UDF LOF and/or us for an amount in excess of the outstanding loan balance, including accrued interest, at the time of the sale; provided, however, that this does not prohibit the acquiring entity from subsequently restructuring the loan in any way, including an increase in the loan amount; and (ii) no asset shall be sold between UDF I, UDF II, UDF III, UDF LOF and/or us for an amount in excess of its fair market value as determined by an independent expert; provided, however, that this does not prohibit the financing of the investment by one of the other such funds.
Trustee Independence
We have a six-member board of trustees. Our declaration of trust provides that a majority of the trustees must be “independent trustees.” Two of our directors, Hollis M. Greenlaw and Scot W. O’Brien, are affiliated with us and we do not consider them to be independent trustees. Our four remaining trustees qualify as “independent trustees” as defined in our declaration of trust in compliance with the requirements of the North American Securities Administrators Association’s Statement of Policy Regarding Real Estate Investment Trusts. As defined in our declaration of trust, the term “independent trustee” means a trustee who is not on the date of determination, and within the last two years from the date of determination has not been, directly or indirectly associated with our sponsor or our Advisor by virtue of: (i) ownership of an interest in our sponsor, our Advisor or any of their affiliates, other than in us; (ii) employment by our sponsor, our Advisor or any of their affiliates; (iii) service as an officer or director of our sponsor, our Advisor or any of their affiliates, other than as our trustee or a director or trustee of any other real estate investment trust organized by our sponsor or advised by our Advisor; (iv) performance of services, other than as a trustee for us; (v) service as a director or trustee of more than three real estate investment trusts organized by our sponsor or advised by our Advisor; or (vi) maintenance of a material business or professional relationship with our sponsor, our Advisor or any of their affiliates. A business or professional relationship is considered “material” if the aggregate gross income derived by a trustee from our sponsor, our Advisor and their affiliates (excluding fees for serving as our trustee or another real estate investment trust or real estate program that is organized, advised or managed by our Advisor or its affiliates) exceeds 5% of either the trustee’s annual gross income during either of the last two years or the trustee’s net worth on a fair market value basis. An indirect association with our sponsor or our Advisor shall include circumstances in which a trustee’s spouse, parent, child, sibling, mother- or father-in-law, son- or daughter-in-law or brother- or sister-in-law is or has been associated with our sponsor, our Advisor, any of their affiliates or with us.
While our shares are not listed on the New York Stock Exchange, each of our independent trustees would also qualify as independent under the rules of the New York Stock Exchange.
Item 14.
Item 14. Principal Accounting Fees and Services.
Whitley Penn LLP has served as our independent registered public accounting firm since our inception in May 2008 and audited our financial statements for the period from May 28, 2008 (Date of Inception) through December 31, 2013. To our knowledge, neither Whitley Penn LLP nor any of its partners has any direct financial interest or any material indirect financial interest in us, or has had any connection since our inception in the capacity of promoter, underwriter, trustee, officer or employee.
The following table reflects fees billed by Whitley Penn LLP for services rendered to the Trust in 2013 and 2012:
All of the services and fees described above were pre-approved by the audit committee.
The Trust has a policy of requiring that the audit committee pre-approve all audit and non-audit services (including the fees and terms thereof) provided to the Trust by the independent registered public accounting firm, subject to the de minimis exceptions for non-audit services described in Section 10A(i)(1)(b) of the Exchange Act and the rules and regulations of the SEC. The audit committee approved all of the services rendered by Whitley Penn LLP for the years ended December 31, 2013 and 2012.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a)List of Documents Filed.
1.Financial Statements.
The list of the consolidated financial statements filed as part of this Annual Report on Form 10-K is set forth on page herein.
2.Financial Statement Schedules.
None.
3.Exhibits.
The list of exhibits filed as part of this Annual Report on Form 10-K is submitted in the Exhibit Index following the consolidated financial statements in response to Item 601 of Regulation S-K.
(b)Exhibits.
The exhibits filed in response to Item 601 of Regulation S-K are listed in the Exhibit Index attached hereto.
(c)Financial Statement Schedules.
None.
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.
United Development Funding IV
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:
Signature
Title
Date
Principal Executive Officer:
/s/ Hollis M. Greenlaw
Hollis M. Greenlaw
Chief Executive Officer and
April 15, 2014
Chairman of the Board of Trustees
Principal Financial Officer:
/s/ Cara D. Obert
Cara D. Obert
Chief Financial Officer
April 15, 2014
Principal Accounting Officer:
/s/ David A. Hanson
David A. Hanson
Chief Operating Officer and Chief Accounting Officer
April 15, 2014
/s/ Scot W. O’Brien
Scot W. O’Brien
Trustee
April 15, 2014
/s/ Phillip K. Marshall
Phillip K. Marshall
Trustee
April 15, 2014
/s/ J. Heath Malone
J. Heath Malone
Trustee
April 15, 2014
/s/ Steven J. Finkle
Steven J. Finkle
Trustee
April 15, 2014
/s/ Bobby Ray
Bobby Ray
Trustee
April 15, 2014
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees of
United Development Funding IV
We have audited the accompanying consolidated balance sheets of United Development Funding IV (the “Trust”) as of December 31, 2013 and 2012 and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for the years ended December 31, 2013, 2012 and 2011. The Trust’s management is responsible for these financial statements. Our responsibility is to express an opinion on these consolidated financial statements 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. The Trust is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Trust’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, 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 consolidated financial position of United Development Funding IV as of December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for the years ended December 31, 2013, 2012 and 2011 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note C, the Trust restated its consolidated financial statements as of and for the years ended December 31, 2012, 2011, 2010 and 2009.
/s/ Whitley Penn LLP
Dallas, Texas
April 15, 2014
UNITED DEVELOPMENT FUNDING IV
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
UNITED DEVELOPMENT FUNDING IV
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
UNITED DEVELOPMENT FUNDING IV
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended December 31, 2013, 2012 and 2011
See accompanying notes to consolidated financial statements.
UNITED DEVELOPMENT FUNDING IV
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
UNITED DEVELOPMENT FUNDING IV
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
A. Nature of Business
United Development Funding IV (which may be referred to as the “Trust,” “we,” “our,” or “UDF IV”) was organized on May 28, 2008 (“Inception”) as a Maryland real estate investment trust. The Trust is the sole general partner of and owns a 99.999% partnership interest in United Development Funding IV Operating Partnership, L.P. (“UDF IV OP”), a Delaware limited partnership. UMTH Land Development, L.P. (“UMTH LD”), a Delaware limited partnership and the affiliated asset manager of the Trust, is the sole limited partner and owner of 0.001% (minority interest) of the partnership interests in UDF IV OP. At December 31, 2013 and December 31, 2012, UDF IV OP had no assets, liabilities or equity.
As of December 31, 2013, the Trust owns a 100% limited partnership interest in UDF IV Home Finance, LP (“UDF IV HF”), UDF IV Finance I, LP (“UDF IV FI”), UDF IV Finance II, LP (“UDF IV FII”), UDF IV Acquisitions, LP (“UDF IV AC”), UDF IV Finance III, LP (“UDF IV FIII”), UDF IV Finance IV, L.P. (“UDF IV Fin IV”), UDF IV Finance V, L.P. (“UDF IV Fin V”), UDF IV Finance VI, L.P. (“UDF IV Fin VI”), UDF IV Finance VII, L.P. (“UDF IV Fin VII”) and UDF IV Finance VIII, L.P. (“UDF IV Fin VIII”), all Delaware limited partnerships.
As of December 31, 2013, the Trust is the sole member of (i) UDF IV HF Manager, LLC (“UDF IV HFM”), a Delaware limited liability company, the general partner of UDF IV HF; (ii) UDF IV Finance I Manager, LLC (“UDF IV FIM”), a Delaware limited liability company, the general partner of UDF IV FI; (iii) UDF IV Finance II Manager, LLC (“UDF IV FIIM”), a Delaware limited liability company, the general partner of UDF IV FII; (iv) UDF IV Acquisitions Manager, LLC (“UDF IV ACM”), a Delaware limited liability company, the general partner of UDF IV AC; (v) UDF IV Finance III Manager, LLC (“UDF IV FIIIM”), a Delaware limited liability company, the general partner of UDF IV FIII; (vi) UDF IV Finance IV Manager, LLC (“UDF IV FIVM”), a Delaware limited liability company, the general partner of UDF IV Fin IV; (vii) UDF IV Finance V Manager, LLC (“UDF IV FVM”), a Delaware limited liability company, the general partner of UDF IV Fin V; (viii) UDF IV Finance VI Manager, LLC (“UDF IV FVIM”), a Delaware limited liability company, the general partner of UDF IV Fin VI; (ix) UDF IV Finance VII Manager, LLC (“UDF IV FVIIM”), a Delaware limited liability company, the general partner of UDF IV Fin VII; and (x) UDF IV Finance VIII Manager, LLC (“UDF IV FVIIIM”), a Delaware limited liability company, the general partner of UDF IV Fin VIII.
As of December 31, 2013, the Trust owns 100% of the outstanding shares of (i) UDF IV LB I, Inc. (“UDF IV LBI”), a Delaware corporation; (ii) UDF IV LB II, Inc. (“UDF IV LBII”), a Delaware corporation; (iii) UDF IV Woodcreek, Inc. (“UDF IV Woodcreek”), a Delaware corporation; (iv) UDF IV LB III, Inc. (“UDF IV LBIII”), a Delaware corporation; and (v) UDF IV LB IV, Inc. (“UDF IV LBIV”), a Delaware corporation.
As of December 31, 2013 and December 31, 2012, UDF IV HFM, UDF IV FIM, UDF IV FIIM, UDF IV ACM, UDF IV FIIIM, UDF IV FIVM, UDF IV FVM, UDF IV FVIM, UDF IV FVIIM, UDF IV FVIIIM and UDF IV LBIV had no assets, liabilities, or equity.
The Trust originates, purchases, participates in and holds for investment secured loans made directly by the Trust or indirectly through its affiliates to persons and entities for the acquisition and development of parcels of real property as single-family residential lots or mixed-use master planned residential communities, for the construction of single-family homes and for completed model homes. The Trust also makes direct investments in land for development into single-family lots, home construction and portfolios of finished lots and model homes; provides credit enhancements to real estate developers, home builders, land bankers and other real estate investors; and purchases participations in, or finances for other real estate investors the purchase of, securitized real estate loan pools and discounted cash flows secured by state, county, municipal or other similar assessments levied on real property. The Trust also may enter into joint ventures with unaffiliated real estate developers, home builders, land bankers and other real estate investors, or with other United Development Funding-sponsored programs, to originate or acquire, as the case may be, the same kind of secured loans or real estate investments the Trust may originate or acquire directly.
UMTH General Services, L.P. (“UMTH GS” or “Advisor”), a Delaware limited partnership, is the Trust’s advisor and is responsible for managing the Trust’s affairs on a day-to-day basis. UMTH GS has engaged UMTH LD as the Trust’s asset manager. The asset manager oversees the investing and financing activities of the affiliated programs managed and advised by the Advisor and UMTH LD as well as provides recommendations to the Trust’s board of trustees regarding investments and finance transactions, management, policies and guidelines. The asset manager reviews for each investment the transaction structure and terms, underwriting, collateral, performance and risk management and also manages the Trust’s capital structure at both the entity and asset level.
As of December 31, 2013, the Trust had no employees and did not maintain any physical properties. The Trust’s operations are conducted at the corporate offices of the Trust’s Advisor at 1301 Municipal Way, Grapevine, Texas 76051. On February 3, 2014, our board of trustees appointed Stacey H. Dwyer as our Chief Operating Officer, effective February 17, 2014. See Note R - Subsequent Events for further discussion.
B. Summary of Significant Accounting Policies
Restatement
We are restating our previously issued (i) consolidated balance sheets included in our Annual Reports on Form 10-K as of December 31, 2012, 2011, 2010 and 2009 and (ii) consolidated statements of operations, consolidated statements of changes in shareholders’ equity, and consolidated statements of cash flows for the years ended December 31, 2012, 2011, 2010 and 2009 (the “Restatement”). We do not plan to file amendments to any of our previously filed Annual Reports on Form 10-K in connection with the Restatement and, instead, will present all of the restated annual financial statements referred to above in this Annual Report on Form 10-K.
In addition, the error that requires us to restate the annual financial statements referred to above materially impacted each of our quarters beginning with the quarter ended March 31, 2010 through the quarter ended September 30, 2013. As a result, we intend to restate our previously issued (i) consolidated balance sheets, (ii) consolidated statements of operations and (iii) consolidated statements of cash flows included in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2013, June 30, 2013 and September 30, 2013. We intend to present these restated quarterly financial statements in amendments to our previously filed Quarterly Reports on Form 10-Q for the quarters ended March 31, 2013, June 30, 2013 and September 30, 2013 as soon as practicable following the filing of this Annual Report on Form 10-K. We do not intend to amend our previously filed Quarterly Reports on Form 10-Q for the quarters ended March 31, 2010 through September 30, 2012; however, as we reported in our Current Report on Form 8-K filed on April 4, 2014, the financial statements included in our Quarterly Reports on Form 10-Q for each of the periods beginning with the quarter ended March 31, 2010 through September 30, 2013 should not be relied upon. In this Annual Report on Form 10-K, the annual and interim periods from the year ended December 31, 2009 through the quarter ended September 30, 2013 are collectively referred to as the “Restatement Period.”
The impact of the Restatement is included in this Annual Report on Form 10-K, and is more specifically described in Notes C and Q below, and in “Item 6 - Selected Financial Data” and “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.
A summary of our significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows:
Basis of Presentation
These consolidated audited financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
Principles of Consolidation
The consolidated financial statements include the accounts of the Trust and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates and assumptions.
Cash and Cash Equivalents
We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. At December 31, 2013 and 2012, there were no such amounts included in cash and cash equivalents.
Restricted Cash
Restricted cash includes monies held in escrow with respect to subscriptions for shares of beneficial interest, deposits associated with certain guarantees, and investments with maturities greater than three months.
Loan Participation Interest - Related Parties
Loan participation interest - related parties are recorded at the lower of cost or net realizable value. Loan participation interest - related parties represents the purchase of a financial interest in certain interim construction loan, paper lot (residential lots shown on a plat that has been accepted by the city or county, but which is currently undeveloped or under development) loan and finished lot loan facilities originated by our affiliates. We participate in these loans by funding the lending obligations of our affiliates under these credit facilities up to a maximum amount for each participation. Such participations entitle us to receive payments of principal and interest from the borrower up to the amounts funded by us and interest on the funded amounts from the borrower. The participation interests in interim construction loan facilities are collateralized by first lien deeds of trust on the homes financed under the construction loans. The participation interests in paper lot loan and finished lot loan facilities are collateralized by one or more of the following: first or second lien deeds of trust, a pledge of ownership interests in the borrower, assignments of lot sale contracts, or reimbursements of development costs due to the borrower under contracts with districts and cities. None of such loans are insured or guaranteed by a federally owned or guaranteed mortgage agency. The participations have terms ranging from 12 to 31 months and bear interest at rates ranging from 12% to 15%. The participation interests may be paid off prior to maturity; however, we intend to hold all participation interests for the life of the loans.
Notes Receivable and Notes Receivable - Related Parties
Notes receivable and notes receivable - related parties are recorded at the lower of cost or net realizable value. The notes are collateralized by one or more of the following: first or second lien deeds of trust, a pledge of ownership interests in the borrower, assignments of lot sale contracts, or reimbursements of development costs due to the borrower under contracts with districts and cities. None of such notes are insured or guaranteed by a federally owned or guaranteed mortgage agency. The notes have terms ranging from 3 to 48 months and bear interest at rates ranging from 11% to 15%. The notes may be paid off prior to maturity; however, we intend to hold all notes for the life of the notes.
Real Estate Owned
Real estate owned is stated at cost, which includes costs associated with the acquisition of the real estate, unless it is determined that the value has been impaired, in which case the real estate owned would be reduced to fair value.
Real estate owned consists of finished single-family residential lots purchased by UDF IV LBI, UDF IV LBII and UDF IV LBIII (collectively, the “UDF IV LB Entities”) from third party builders. Each UDF IV LB Entity has entered into a lot option agreement with each builder whereby the builder will reacquire the lots in accordance with a takedown schedule for a pre-determined lot price (the “base lot price”) identified in the lot option agreement. In consideration for the right to repurchase the lots from the UDF IV LB Entity, each builder provided the UDF IV LB entity a non-refundable earnest money deposit, a portion of which will be applied to the purchase price of each lot, as it is repurchased. In addition, each builder has agreed to pay the appropriate UDF IV LB Entity a monthly option fee equal to one twelfth of 13% of the base lot price of the lots the builder has not yet reacquired from the UDF IV LB Entity. If the builder does not perform in accordance with the terms of the lot option agreement, the builder will forfeit the remaining earnest money deposit and the lots can be sold to another builder. As of December 31, 2013, the lot option agreements have terms ranging from 18 to 24 months.
Allowance for Loan Losses
The allowance for loan losses is our estimate of incurred losses in our portfolio of notes receivable, notes receivable - related parties and loan participation interest - related parties. We periodically perform a detailed review of our portfolio of notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses. Our review consists of evaluating economic conditions, the estimated value of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral, and other relevant factors. This review is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
In reviewing our portfolio, we use cash flow estimates from the disposition of finished lots, paper lots and undeveloped land as well as cash flow received from the issuance of bonds from municipal reimbursement districts. These estimates are based on current market metrics, including, without limitation, the supply of finished lots, paper lots and undeveloped land; the supply of homes and the rate and price at which land and homes are sold; historic levels and trends; executed contracts; appraisals and discussions with third party market analysts and participants, including homebuilders. We have based our valuations on current and historic market trends on our analysis of market events and conditions, including activity within our portfolio, and on the analysis of third-party services such as Metrostudy and Residential Strategies, Inc. Cash flow forecasts also have been based on executed purchase contracts which provide base prices, escalation rates, and absorption rates on an individual project basis. For projects deemed to have an extended time horizon for disposition, we have considered third-party appraisals to provide a valuation in accordance with guidelines set forth in the Uniform Standards of Professional Appraisal Practice. In addition to cash flows from the disposition of property, cost analysis has been performed based on estimates of development and senior financing expenditures provided by developers and independent professionals on a project-by-project basis. These amounts have been reconciled with our best estimates to establish the net realizable value of the portfolio.
We charge additions to the allowance for loan losses to current period earnings through a provision for loan losses. Amounts determined to be uncollectible are charged directly against, or “charged off,” and decrease the allowance for loan losses, while amounts recovered on previously charged off accounts increase the allowance.
Organization and Offering Expenses
Organization costs will be expensed as incurred in accordance with Statement of Position 98-5, Reporting on the Costs of Start-up Activities, currently within the scope of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 720-15. Offering costs related to raising capital from debt will be capitalized and amortized over the term of such debt. Offering costs related to raising capital from equity reduce equity and are reflected as shares issuance costs in shareholders’ equity. Certain offering costs were paid by our Advisor. As discussed in Note O to the consolidated financial statements, these costs have been reimbursed to our Advisor by the Trust.
Investor Subscriptions Receivable
Investor subscriptions receivable represents amounts receivable from our transfer agent related to investments they have admitted in connection with our initial public offering. See Note D - Registration Statement for further discussion of our offering. Our transfer agent processed investor admissions on a daily basis, then sent the proceeds of each admission to us the subsequent day. The investor subscriptions receivable represents our receivable related to the previous day’s investor admissions.
Interest Income and Non-Interest Income Recognition
Interest income on loan participation interest - related parties, notes receivable and notes receivable - related parties is recognized over the life of the participation agreement or note agreement and recorded on the accrual basis. A loan is placed on non-accrual status and income recognition is suspended at the date at which, in the opinion of management, a full recovery of income and principal becomes more likely than not, but is no longer probable, based upon our review of economic conditions, the estimated value of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Any payments received on loans classified as non-accrual status are typically applied first to outstanding loan amounts and then to the recovery of lost interest. As of December 31, 2013 and 2012, we were accruing interest on all loan participation interest - related parties, notes receivable and notes receivable - related parties.
Commitment fee income and commitment fee income - related parties represents non-refundable fees charged to borrowers for entering into an obligation that commits us to make or acquire a loan or to satisfy a financial obligation of the borrower when certain conditions are met within a specified time period. When a commitment is considered an integral part of the resulting loan and we believe there is a reasonable expectation that the commitment will be called upon, the commitment fee is recognized as revenue over the life of the resulting loan. As of December 31, 2013 and 2012, approximately $2.5 million and $970,000, respectively, of unamortized commitment fees are included as an offset of notes receivable. Approximately $164,000 and $263,000 of unamortized commitment fees are included as an offset of notes receivable - related parties as of December 31, 2013 and 2012, respectively. When we believe it is unlikely that the commitment will be called upon or that the fee is not an integral part of the return of a specific future lending arrangement, the commitment fee is recognized as income when it is earned, based on the specific terms of the commitment. We make a determination of revenue recognition on a case by case basis, due to the unique and varying terms of each commitment.
In addition, commitment fee income includes option fees earned by us in connection with option agreements we have entered into to sell lots that are included in real estate owned. Option fees are recorded over the life of the lot option agreement as earned, pursuant to the terms of the lot option agreement.
Real estate owned - property sales income and real estate owned - property sales cost are recorded as lots are sold to builders.
Acquisition and Origination Fees
We incur acquisition and origination fees, payable to UMTH LD, our asset manager, equal to 3% of the net amount available for investment in secured loans and other real estate assets (“Acquisition and Origination Fees”); provided, however, that we will not incur Acquisition and Origination Fees with respect to any asset level indebtedness we incur. The Acquisition and Origination Fees that we incur will be reduced by the amount of any acquisition and origination fees and expenses paid by borrowers or investment entities to our Advisor or affiliates of our Advisor with respect to our investment. We will not incur any Acquisition and Origination Fees with respect to any participation agreement we enter into with our affiliates or any affiliates of our Advisor for which our Advisor or affiliates of our Advisor have previously received acquisition and origination fees and expenses from such affiliate with respect to the same secured loan or other real estate asset. Acquisition and Origination Fees are expensed as incurred. See Note C for further discussion of the Restatement associated with Acquisition and Origination Fees.
Income Taxes
We made an election under Section 856(c) of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), to be taxed as a real estate investment trust (“REIT”), beginning with the taxable year ended December 31, 2010. As a REIT, we generally are not subject to federal income tax on income that we distribute to our shareholders. If we later fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate rates and may not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied unless we are entitled to relief under certain statutory provisions. Such an event could materially and adversely affect our net income. However, we intend to continue to operate so as to remain qualified as a REIT for federal income tax purposes.
FASB ASC 740 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. In accordance with FASB ASC 740, we must determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. We believe we have no such uncertain positions.
We file income tax returns in the United States federal jurisdiction. At December 31, 2013, tax returns related to fiscal years ended December 31, 2010 through December 31, 2013 remain open to possible examination by the tax authorities. No tax returns are currently under examination by any tax authorities. We did not incur any penalties or interest during the years ended December 31, 2013 and 2012.
Fair Value of Financial Instruments
In accordance with the reporting requirements of FASB ASC 825-10, Financial Instruments-Fair Value, we calculate the fair value of our assets and liabilities which qualify as financial instruments under this statement and include this additional information in the notes to the financial statements when the fair value is different than the carrying value of those financial instruments. The estimated fair value of restricted cash, accrued interest receivable, accrued receivable - related parties, accounts payable, accrued liabilities and accrued liabilities - related parties approximates the carrying amounts due to the relatively short maturity of these instruments. The estimated fair value of notes receivable, notes receivable - related parties, loan participation interest - related parties, senior credit facility, lines of credit and notes payable approximate the carrying amount since they bear interest at the market rate.
Guarantees
From time to time we enter into guarantees of debtor’s or affiliates’ borrowings and provide credit enhancements for the benefit of senior lenders in connection with our debtors and investments (collectively referred to as “guarantees”), and we account for such guarantees in accordance with FASB ASC 460-10, Guarantees.
Reclassifications
Certain reclassifications have been made to prior period amounts in order to conform with the current year presentation.
C. Restatement
In December 2013, we commenced an inquiry into our historical accounting practice for the capitalization and amortization of Acquisition and Origination Fees that we incurred since our inception. As a result of this inquiry, we identified instances where our historical accounting practice was not in compliance with GAAP.
From the year ended December 31, 2009 through the quarter ended September 30, 2013, we capitalized Acquisition and Origination Fees incurred and amortized them into expense on a straight-line basis over our expected economic life. GAAP guidance in ASC Subtopic 310-20, Nonrefundable Fees and Other Costs (“ASC 310-20”) requires direct loan origination costs, including the portion of total compensation paid to employees engaged in direct loan origination activities, to be capitalized and amortized into expense over the life of the related loan, provided that records are available in sufficient detail to reliably determine the amount of qualifying direct loan origination costs incurred. In our case, employees of UMTH LD were performing loan origination activities in consideration for our payment of Acquisition and Origination Fees. However, UMTH LD did not maintain (and we did not require them to maintain) contemporaneous, sufficiently detailed time records on a loan by loan basis for all years that would provide evidence of the amount of time allocable to direct loan origination activities and thus the amount of Acquisition and Origination Fees allowable for deferral under ASC 310-20. Thus, we have determined that we were unable to reasonably determine the amount of Acquisition and Origination Fees allowable for deferral under ASC 310-20. As a result, we have restated our previously issued financial results to expense the Acquisition and Origination Fees as incurred, rather than capitalizing and amortizing them into expense over the life of the loan.
The following tables present the effects of the Restatement described above on the affected line items within the Trust’s previously reported consolidated balance sheets as of December 31, 2012, 2011, 2010 and 2009.
The following tables present the effects of the Restatement described above on the affected line items within the Trust’s previously reported consolidated statements of operations for the years ended December 31, 2012, 2011, 2010 and 2009.
The following table presents the effects of the Restatement described above on the affected line items within the Trust’s previously reported consolidated statements of changes in shareholders’ equity for the years ended December 31, 2012, 2011, 2010 and 2009.
The following tables present the effects of the Restatement described above on the affected line items within the Trust’s previously reported consolidated statements of cash flows for the years ended December 31, 2012, 2011, 2010 and 2009.
D. Registration Statement
On November 12, 2009, the Trust’s Registration Statement on Form S-11, covering an initial public offering (the “Offering”) of up to 25,000,000 common shares of beneficial interest to be offered in the primary offering at a price of $20 per share (the “Primary Offering”), was declared effective under the Securities Act of 1933, as amended. The Offering also initially covered up to 10,000,000 common shares of beneficial interest to be issued pursuant to our distribution reinvestment plan (the “DRIP”) for $20 per share. We had the right to reallocate the common shares of beneficial interest registered in the Offering between the Primary Offering and the DRIP, and pursuant to Supplement No. 6 to our prospectus regarding the Offering, which was filed with the Securities and Exchange Commission (“SEC”) on May 3, 2013, we reallocated the shares being offered to be 34,000,000 shares offered pursuant to the Primary Offering and 1,000,000 shares offered pursuant to the DRIP. The shares were offered to investors on a reasonable best efforts basis, which means the dealer manager used its reasonable best efforts to sell the shares offered, but was not required to sell any specific number or dollar amount of shares and did not have a firm commitment or obligation to purchase any of the offered shares. The Offering terminated on May 13, 2013.
On October 19, 2012, we filed a Registration Statement on Form S-11 (Registration No. 333-184508) with the SEC with respect to a proposed follow-on public offering (the “Follow-On Offering”) of up to 20,000,000 common shares of beneficial interest to be offered at a price of $20.00 per share and up to 10,000,000 common shares of beneficial interest to be issued pursuant to our DRIP for $20.00 per share. The Registration Statement on Form S-11 for the proposed Follow-on Offering was withdrawn pursuant to a filing with the SEC on July 3, 2013, and we did not issue any shares under this registration statement.
On April 19, 2013, we registered 7,500,000 additional common shares of beneficial interest to be offered pursuant to the DRIP in a Registration Statement on Form S-3 (File No. 333-188045) (the “Secondary DRIP”) for $20 per share. We ceased offering common shares of beneficial interest under the DRIP portion of the Offering upon the termination of the Offering on May 13, 2013, and concurrently began offering our common shares of beneficial interest to our shareholders pursuant to the Secondary DRIP.
E. Loans and Allowance for Loan Losses
All prior year information presented in this footnote has been revised to reflect the effects of the Restatement described in Note C above.
The table below reflects our aggregate loan portfolio as of December 31, 2013 and 2012, which comprises loan participation interest - related parties, notes receivable, net and notes receivable - related parties and is recorded at the lower of cost or estimated net realizable value. See Note C above for the impact of the Restatement on our aggregate loan portfolio as of December 31, 2011, 2010 and 2009.
Our loans are classified as follows:
As of December 31, 2013, we had originated or purchased 139 loans, including 25 loans that have either been repaid in full by the respective borrower or have matured and have not been renewed. As of December 31, 2012, we had originated or purchased 84 loans, including 16 loans that had either been repaid in full by the respective borrower or had matured and had not been renewed.
The following table represents the scheduled maturity dates of the 114 loans outstanding as of December 31, 2013:
The following table represents the scheduled maturity dates of the 68 loans outstanding as of December 31, 2012:
* Less than 1%
As of December 31, 2013, we have no matured loans.
As of December 31, 2012, we had 1 matured loan with an aggregate unpaid principal balance of approximately $160,000. This loan matured in December 2012 and full collectability was considered probable, based on our ongoing review of the credit quality of our loan portfolio, discussed in further detail below. In March 2013, we amended this loan, resulting in a new maturity date of June 30, 2013, and in June 2013, this loan was paid in full. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
The following table describes the loans that were matured as of December 31, 2012, the activity with respect to such loans during the year ended December 31, 2013 and the loans that matured during the twelve months ended December 31, 2013 and remained matured as of December 31, 2013:
(1)Amounts represent aggregate unpaid principal balance as of December 31, 2012 of matured loans as of December 31, 2012 that were extended but not paid in full during the twelve months ended December 31, 2013.
(2)For loans matured as of December 31, 2012, net loan activity represents all activity on the loans during the twelve months ended December 31, 2013, including accrued interest, payment of fees and expenses, charge-offs and/or repayments.
(3)Amounts represent aggregate unpaid principal balance as of December 31, 2012 of loans that matured during the twelve months ended December 31, 2013 and remained matured as of December 31, 2013.
(4)The table does not reflect activity for loans that matured or were due to mature during the twelve months ended December 31, 2013, but were extended on or prior to December 31, 2013.
A loan is placed on non-accrual status and income recognition is suspended at the date at which, in the opinion of management, a full recovery of income and principal becomes more likely than not, but is no longer probable, based upon our review of economic conditions, the estimated value of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed. Any payments received on loans classified as non-accrual status are typically applied first to outstanding loan amounts and then to the recovery of lost interest. As of December 31, 2013 and December 31, 2012, we have not placed any loans on non-accrual status.
Loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is generally evaluated on an individual loan basis for each loan in the portfolio. If an individual loan is considered impaired, a specific valuation allowance may be allocated, if necessary, so that the individual loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from collateral. Loans that are not individually considered impaired are collectively and qualitatively measured as a portfolio for general valuation allowance. In reviewing our portfolio for this valuation analysis, we use cash flow estimates from the disposition of finished lots, paper lots (residential lots shown on a plat that has been accepted by the city or county, but which is currently undeveloped or under development) and undeveloped land as well as cash flow received from the issuance of bonds from municipal reimbursement districts. These estimates are based on current market metrics, including, without limitation, the supply of finished lots, paper lots and undeveloped land; the supply of homes and the rate and price at which land and homes are sold; historic levels and trends; executed contracts, appraisals and discussions with third party market analysts and participants, including homebuilders. We base our valuations on current and historic market trends and on our analysis of market events and conditions, including activity within our portfolio, and on the analysis of third-party services such as Metrostudy and Residential Strategies, Inc. Cash flow forecasts also are based on executed purchase contracts which provide base prices, escalation rates, and absorption rates on an individual project basis. For projects deemed to have an extended time horizon for disposition, we consider third-party appraisals to provide a valuation in accordance with guidelines set forth in the Uniform Standards of Professional Appraisal Practice. In addition to cash flows from the disposition of property, cost analysis is performed based on estimates of development and senior financing expenditures provided by developers and independent professionals on a project-by-project basis. These amounts are reconciled with our best estimates to establish the net realizable value of the portfolio.
Interest is recognized on an accrual basis for impaired loans in which the collectability of the unpaid principal amount is deemed probable. Any payments received on such loans are first applied to outstanding accrued interest receivable and then to outstanding unpaid principal balance. Unpaid principal balance is materially the same as recorded investments. Any payments received on impaired loans in which the collectability of the unpaid principal amount is less than probable are typically applied to outstanding unpaid principal and then to the recovery of lost interest on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
For the year ended December 31, 2013, we did not have any impaired loans and we did not recognize any interest income associated with impaired loans. For the years ended December 31, 2013 and 2012, we did not recognize any cash basis interest income related to impaired loans.
As part of the ongoing monitoring of the credit quality of the loan portfolio, we periodically, no less than quarterly, perform a detailed review of our portfolio of mortgage notes and other loans. The following is a general description of the credit levels used:
Level 1 - Full collectability of loans in this category is considered probable.
Level 2 - Full collectability of loans in this category is deemed more likely than not, but not probable, based upon our review of economic conditions, the estimated value of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. Interest income is suspended on Level 2 loans.
Level 3 - For loans in this category, it is probable that we will be unable to collect all amounts due.
As of the dates indicated, our loans were classified as follows:
The allowance for loan losses is our estimate of incurred losses in our portfolio of notes receivable, notes receivable - related parties and loan participation interest - related parties. We periodically perform a detailed review of our portfolio of notes and other loans to determine if impairment has occurred and to assess the adequacy of the allowance for loan losses. We charge additions to the allowance for loan losses to current period earnings through a provision for loan losses. Amounts determined to be uncollectible are charged directly against (and decrease) the allowance for loan losses (“charged off”), while amounts recovered on previously charged off amounts increase the allowance for loan losses. The following table summarizes the change in the reserve for loan losses during the years ended December 31, 2013 and 2012, which is offset against notes receivable:
We have adopted the provisions of ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. In accordance with ASU 2011-02, the restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. As of December 31, 2013 and December 31, 2012, we have no loan modifications that are classified as troubled debt restructurings.
F. Shareholders’ Equity
All prior year information presented in this footnote has been revised to reflect the effects of the Restatement described in Note C above.
On December 18, 2009, the Trust’s initial public subscribers were accepted as shareholders pursuant to the Offering and the subscription proceeds from such initial public subscribers were released to the Trust from escrow.
As of December 31, 2013, the Trust had issued an aggregate of 32,115,232 common shares of beneficial interest pursuant to the Primary Offering, DRIP and Secondary DRIP, consisting of 30,735,813 common shares of beneficial interest pursuant to the Primary Offering in exchange for gross proceeds of approximately $614.7 million (approximately $535.0 million, net of costs associated with the Primary Offering), 723,617 common shares of beneficial interest in accordance with our DRIP in exchange for gross proceeds of approximately $14.5 million and 655,802 common shares of beneficial interest in accordance with our Secondary DRIP in exchange for gross proceeds of approximately $13.1 million. As of December 31, 2013, the Trust had redeemed an aggregate of 212,907 common shares of beneficial interest at a cost of approximately $4.1 million.
As of December 31, 2012, the Trust had issued an aggregate of 17,624,839 common shares of beneficial interest pursuant to the Primary Offering and DRIP, consisting of 17,089,857 common shares of beneficial interest pursuant to the Primary Offering in exchange for gross proceeds of approximately $341.8 million (approximately $297.4 million, net of costs associated with the Primary Offering) and 534,982 common shares of beneficial interest in accordance with our DRIP in exchange for gross proceeds of approximately $10.7 million. As of December 31, 2012, the Trust had redeemed an aggregate of 124,531 common shares of beneficial interest at a cost of approximately $2.4 million.
We must distribute to our shareholders at least 90% of our taxable income each year in order to meet the requirements for being treated as a REIT under the Internal Revenue Code. In accordance with this requirement, we pay daily distributions monthly in arrears to our shareholders. Our distribution rate is determined quarterly by our board of trustees and is dependent on a number of factors, including funds available for payment of distributions, our financial condition, loan funding commitments and annual distribution requirements needed to maintain our status as a REIT under the Internal Revenue Code. In addition to these distributions, in an effort to ensure we distribute at least 90% of our taxable income, our board of trustees will periodically authorize additional, special distributions. All distributions are paid in cash and DRIP shares.
Our board of trustees has authorized distributions for our shareholders of record as of the close of business on each day for the period commencing on December 18, 2009 and ending on June 30, 2014. For distributions declared for each record date in the December 2009 through June 2011 periods, our distribution rate was $0.0043836 per common share of beneficial interest, which is equal to an annualized distribution rate of 8%, assuming a purchase price of $20.00 per share. For distributions declared for each record date in the July 2011 through June 2014 periods, our distribution rate is $0.0044932 per common share of beneficial interest, which is equal to an annualized distribution rate of 8.2%, assuming a purchase price of $20.00 per share. These distributions are aggregated and paid monthly in arrears. Distributions are paid on or about the 25th day of the respective month. Distributions for shareholders participating in our DRIP and Secondary DRIP are reinvested into our shares on the payment date of each distribution.
In addition to the distributions discussed above, the following table represents all special distributions authorized by our board of trustees through December 31, 2013:
(1)Represents the date the distribution was authorized by our board of trustees.
(2)All outstanding common shares of beneficial interest as of the record date receive the distribution.
(3)Represents the distribution rate per common share of beneficial interest on the record date.
(4)Represents the date the special distribution was paid or will be paid in cash and DRIP or Secondary DRIP shares.
As of December 31, 2013, we have made the following distributions to our shareholders in 2013:
For the year ended December 31, 2013, we paid distributions of approximately $44.6 million ($27.7 million in cash and $16.9 million in our common shares of beneficial interest pursuant to our DRIP and Secondary DRIP), as compared to cash flows provided by operations of approximately $24.5 million. From May 28, 2008 (Date of Inception) through December 31, 2013, we paid cumulative distributions of approximately $74.0 million. As of December 31, 2013, we had approximately $2.7 million of cash distributions declared that were paid subsequent to period end.
The distributions paid during the years ended December 31, 2013 and 2012, along with the amount of distributions reinvested pursuant to our DRIP and the sources of our distributions are reflected in the table below. In connection with the Restatement, cash payments to UMTH LD associated with Acquisition and Origination Fees were reclassified from investing activities to operating activities, thus reducing operating cash available for distributions. The impact of the Restatement on the tables below is more specifically described in Note C above. The sources of distributions in the table below have been adjusted to reflect the impact of the Restatement.
The following table reflects the impact of the Restatement on the sources of distributions paid during the years ended December 31, 2011 and 2010. We did not pay any distributions for the year ended December 31, 2009.
In our initial quarters of operations, and from time to time thereafter, we did not generate enough cash flow from operations to fully fund distributions declared. Therefore, some or all of our distributions are paid from sources other than operating cash flow, such as proceeds from our Offering and borrowings (including borrowings secured by our assets) in anticipation of future operating cash flow. Distributions in excess of our operating cash flows have been funded via financing activities, specifically proceeds from issuance of common shares of beneficial interest and borrowings under our credit facilities, consistent with our intent to use our credit facilities to meet our investment and distribution cash requirements throughout our initial period of operations.
We utilize cash to fund operating expenses, make investments, service debt obligations and pay distributions. We receive cash from operations (which includes interest payments) as well as cash from investing activities (which includes repayment of principal on loans we have made) and financing activities (which includes borrowing proceeds and additional capital from the sale of our shares). We have secured a note payable and lines of credit to manage the timing of our cash receipts and funding requirements. Over the long term, we expect that substantially all of our distributions will be funded from operating cash flow.
G. Share Redemption Program
We have adopted a share redemption program that enables our shareholders to sell their shares back to us in limited circumstances. Generally, this program permits shareholders to sell their shares back to us after they have held them for at least one year. Except for redemptions upon the death of a shareholder (in which case we may waive the minimum holding periods), the purchase price for the redeemed shares, for the period beginning after a shareholder has held the shares for a period of one year, will be (1) 92% of the purchase price actually paid for any shares held less than two years, (2) 94% of the purchase price actually paid for any shares held for at least two years but less than three years, (3) 96% of the purchase price actually paid for any shares held at least three years but less than four years, (4) 98% of the purchase price actually paid for any shares held at least four years but less than five years and (5) for any shares held at least five years, the lesser of the purchase price actually paid or the then-current fair market value of the shares as determined by the most recent annual valuation of our shares. The purchase price for shares redeemed upon the death of a shareholder will be the lesser of (1) the purchase price the shareholder actually paid for the shares or (2) $20.00 per share.
We reserve the right in our sole discretion at any time and from time to time to (1) waive the one-year holding period in the event of the death or bankruptcy of a shareholder or other exigent circumstances, (2) reject any request for redemption, (3) change the purchase price for redemptions, or (4) terminate, suspend and/or reestablish our share redemption program. In respect of shares redeemed upon the death of a shareholder, we will not redeem in excess of 1% of the weighted average number of shares outstanding during the twelve-month period immediately prior to the date of redemption, and the total number of shares we may redeem at any time will not exceed 5% of the weighted average number of shares outstanding during the trailing twelve-month period prior to the redemption date. Our board of trustees will determine from time to time whether we have sufficient excess cash from operations to repurchase shares. Generally, the cash available for redemption will be limited to 1% of the operating cash flow from the previous fiscal year, plus any net proceeds from our DRIP and Secondary DRIP.
The Trust complies with FASB ASC 480-10, Distinguishing Liabilities from Equity, which requires, among other things, that financial instruments that represent a mandatory obligation of the Trust to repurchase shares be classified as liabilities and reported at settlement value. We believe that shares tendered for redemption by the shareholder under the Trust’s share redemption program do not represent a mandatory obligation until such redemptions are approved at our discretion. At such time, we will reclassify such obligations from equity to an accrued liability based upon their respective settlement values. As of December 31, 2013, we did not have any approved redemption requests included in our liabilities.
The following table summarizes the redemption activity for the years ended December 31, 2013 and 2012. The amounts presented are in total shares:
Shares redeemed are included in treasury stock in the consolidated balance sheet.
H. Organizational and Offering Compensation
Various parties received compensation as a result of the Offering, including the Advisor, affiliates of the Advisor, the dealer manager and soliciting dealers. The Advisor or an affiliate of the Advisor funded organization and offering costs on the Trust’s behalf and our Advisor has been paid by the Trust for such costs in an amount equal to 3% of the gross offering proceeds raised by the Trust in the Offering (the “O&O Reimbursement”) less any offering costs paid by the Trust directly (except that no organization and offering expenses will be reimbursed with respect to sales under the DRIP and Secondary DRIP). Payments to the dealer manager include selling commissions (6.5% of gross offering proceeds, except that no commissions are paid with respect to sales under the DRIP and Secondary DRIP) and dealer manager fees (up to 3.5% of gross offering proceeds, except that no dealer manager fees are paid with respect to sales under the DRIP and Secondary DRIP).
I. Operational Compensation
The Advisor or its affiliates will receive Acquisition and Origination Fees as described in Note B. Acquisition and Origination Fees will not be paid with respect to any asset level indebtedness the Trust incurs. Acquisition and Origination Fees incurred by the Trust will be reduced by the amount of any acquisition and origination fees and expenses paid by borrowers or investment entities to the Advisor or affiliates of the Advisor with respect to the investment. The Trust will not incur any Acquisition and Origination Fees with respect to any participation agreement the Trust enters into with its affiliates or any affiliates of the Advisor for which the Advisor or affiliates of the Advisor previously has received acquisition and origination fees and expenses from such affiliate with respect to the same secured loan or other real estate asset.
The Advisor will receive advisory fees of 2% per annum of the average of invested assets (“Advisory Fees”), including secured loan assets; provided, however, that no Advisory Fees will be paid with respect to any asset level indebtedness the Trust incurs. The fee will be payable monthly in an amount equal to one-twelfth of 2% of the Trust’s average invested assets, including secured loan assets, as of the last day of the immediately preceding month.
The Advisor will receive 1% of the amount made available to the Trust pursuant to the origination of any line of credit or other debt financing, provided that the Advisor has provided a substantial amount of services as determined by the Trust’s independent trustees and, on each anniversary date of the origination of any such line of credit or other debt financing, an additional fee of 0.25% of the primary loan amount (collectively, “Debt Financing Fees”) will be paid if such line of credit or other debt financing continues to be outstanding on such date, or a prorated portion of such additional fee will be paid for the portion of such year that the financing was outstanding.
The Trust will reimburse the expenses incurred by the Advisor in connection with its provision of services to the Trust (the “Advisor Expense Reimbursement”), including the Trust’s allocable share of the Advisor’s overhead, such as rent, personnel costs, utilities and IT costs. The Trust will not reimburse the Advisor for personnel costs in connection with services for which the Advisor or its affiliates receive other fees.
The Advisor will receive 15% of the amount by which the Trust’s net income for the immediately preceding year exceeds a 10% per annum return on aggregate capital contributions, as adjusted to reflect prior cash distributions to shareholders which constitute a return of capital. This fee will be paid annually and upon termination of the advisory agreement.
J. Disposition/Liquidation Compensation
Upon successful sales by the Trust of securitized loan pool interests, the Advisor will be paid a securitized loan pool placement fee equal to 2% of the net proceeds realized by the Trust, provided the Advisor or an affiliate of the Advisor has provided a substantial amount of services as determined by the Trust’s independent trustees.
For substantial assistance in connection with the sale of properties, the Trust will pay the Advisor or its affiliates disposition fees of the lesser of one-half of the reasonable and customary real estate or brokerage commission or 2% of the contract sales price of each property sold; provided, however, in no event may the disposition fees paid to the Advisor, its affiliates and unaffiliated third parties exceed 6% of the contract sales price. The Trust’s independent trustees will determine whether the Advisor or its affiliate has provided substantial assistance to the Trust in connection with the sale of a property. Substantial assistance in connection with the sale of a property includes the Advisor’s preparation of an investment package for the property (including a new investment analysis, rent rolls, tenant information regarding credit, a property title report, an environmental report, a structural report and exhibits) or such other substantial services performed by the Advisor in connection with a sale.
Upon listing the Trust’s common shares of beneficial interest on a national securities exchange, the Advisor will be entitled to a fee equal to 15% of the amount, if any, by which (1) the market value of the Trust’s outstanding shares plus distributions paid by the Trust prior to listing, exceeds (2) the sum of the total amount of capital raised from investors and the amount of cash flow necessary to generate a 10% annual cumulative, non-compounded return to investors.
K. Real Estate Owned
Real estate owned consists of finished single-family residential lots purchased by the UDF IV LB Entities from third party builders. The following table summarizes the purchase and sale activity associated with these lots for the years ended December 31, 2013 and 2012.
L. Notes Payable and Lines of Credit
Credit Facility
On February 5, 2010, during the credit crisis in which financial institutions severely reduced the number of loans made to entities involved in real estate, we obtained a revolving credit facility in the maximum principal amount of $8.0 million (the “Credit Facility”) from Raley Holdings, LLC, an unaffiliated company (“Raley Holdings”). The interest rate on the Credit Facility was equal to 8.5% per annum and accrued interest on the outstanding principal amount of the Credit Facility was payable monthly. Effective August 10, 2010, the Credit Facility was amended to increase the maximum principal amount to $20.0 million, pursuant to the First Amendment to Secured Line of Credit Promissory Note between us and Raley Holdings. The Credit Facility was subsequently amended three additional times pursuant to three separate extension agreements that extended the maturity date of the credit facility to February 5, 2014. The Credit Facility was secured by a first priority collateral assignment and lien on certain of our assets. The Credit Facility was paid in full and terminated in June 2013.
In connection with this Credit Facility, we agreed to pay Debt Financing Fees to UMTH GS. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
UDF IV HF CTB LOC
On May 19, 2010, UDF IV HF entered into a $6.0 million revolving line of credit (the “UDF IV HF CTB LOC”) with Community Trust Bank of Texas (“CTB”). Pursuant to an amendment entered into on July 31, 2013, the maturity date of the UDF IV HF CTB LOC was extended from February 19, 2014 to July 30, 2015, the interest rate was modified to prime plus 1%, subject to a floor of 4.25% (4.25% at December 31, 2013) and the revolving line was increased to $10.0 million. Proceeds from the line of credit will be used to fund our obligations under our interim home construction loan agreements. Advances are subject to a borrowing base and are secured by a first priority collateral assignment and lien on certain mortgage notes and construction loans held by UDF IV HF. Principal and all unpaid interest will be due at maturity. The UDF IV HF CTB LOC is guaranteed by us and by United Development Funding III, L.P. (“UDF III”), an affiliated and publicly registered Delaware limited partnership. UMTH LD, our asset manager, is the general partner for UDF III.
In connection with this line of credit, UDF IV HF has agreed to pay origination fees totaling $90,000 to CTB. In addition, UDF IV HF has agreed to pay Debt Financing Fees to UMTH GS associated with the UDF IV HF CTB LOC and, in consideration for its guarantee of the UDF IV HF CTB LOC, UDF IV HF agreed to pay an annual credit enhancement fee equal to 1% of the line of credit amount to UDF III. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
CTB Revolver
Effective August 19, 2010, UDF IV AC obtained a three-year revolving credit facility in the maximum principal amount of $8.0 million (the “CTB Revolver”) from CTB pursuant to a Revolving Loan Agreement (the “Revolver Loan Agreement”). Accrued interest on the outstanding principal amount of the CTB Revolver is payable monthly. The CTB Revolver is secured by a first priority collateral assignment and lien on the loans purchased or held by UDF IV AC, and by a first lien security interest in all of UDF IV AC’s assets. Pursuant to an amendment entered into on April 11, 2013, CTB increased its commitment under the CTB Revolver from $8.0 million to $15.0 million. Effective August 19, 2013, UDF IV AC entered into the Loan Modification Agreement with CTB, pursuant to which the maturity date of the CTB Revolver was extended to July 30, 2015 and the interest rate was modified to prime plus 1%, subject to a floor of 4.25% (4.25% at December 31, 2013). The CTB Revolver is guaranteed by us and by UDF III.
In connection with the CTB Revolver, as amended, UDF IV AC has agreed to pay origination fees totaling $150,000 to CTB. In addition, UDF IV AC agreed to pay Debt Financing Fees to UMTH GS in connection with the CTB Revolver and, in consideration for UDF III guaranteeing the CTB Revolver, UDF IV AC agreed to pay UDF III a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance of the CTB Revolver at the end of each month. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
UTB Revolver
Effective September 29, 2010, UDF IV FI entered into a $3.4 million revolving line of credit (as amended, the “UTB Revolver”) with United Texas Bank (“UTB”). Pursuant to the First Loan Modification and Extension Agreement, effective August 18, 2011 (the “First UTB Extension Agreement”), UTB increased its commitment under the UTB Revolver to $4.0 million and the maturity date, which was originally September 29, 2011, was extended to September 29, 2012. Pursuant to the Second Loan Modification and Extension Agreement, effective September 29, 2012 (the “Second UTB Extension Agreement”), the maturity date was extended to September 29, 2013. The UTB Revolver bore interest at prime plus 1%, subject to a floor of 5.5% (5.5% at December 31, 2013), and required monthly interest payments. Advances under the line were made from time to time through September 1, 2012. Proceeds from the UTB Revolver were used to fund our obligations under our land acquisition loans, development loans and finished lot loan agreements. Advances were subject to a borrowing base and are secured by a first priority collateral assignment and lien on certain mortgage notes and construction loans held by UDF IV FI. The balance of this loan and all accrued interest were paid in full on November 7, 2013 and this loan was terminated.
In connection with the UTB Revolver, as amended, UDF IV FI agreed to pay total origination fees of approximately $78,000 to UTB. In addition, UDF IV FI agreed to pay Debt Financing Fees to UMTH GS in connection with the UTB Revolver. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
F&M Loan
On December 14, 2010, UDF IV FII obtained a revolving credit facility from F&M Bank and Trust Company (“F&M”) in the maximum principal amount of $5.0 million pursuant to a loan agreement (as amended, the “F&M Loan”). Pursuant to the First Amendment to the F&M Loan, F&M increased its commitment to $7.5 million, effective September 1, 2011. The interest rate on the F&M Loan is equal to the greater of prime plus 1.5% or 5.0% per annum (5.0% at December 31, 2013). Accrued interest on the outstanding principal amount of the F&M Loan is payable monthly. The F&M Loan was scheduled to mature and become due and payable in full on December 14, 2012. Pursuant to the Amended and Restated Loan Agreement entered into on December 4, 2012, F&M increased its commitment associated with the F&M Loan to $10.0 million and the maturity date of the F&M Loan was extended to December 14, 2014. Pursuant to an amendment entered into on October 31, 2013, F&M increased its commitment associated with the F&M Loan to $15.0 million. The F&M Loan is secured by a first priority collateral assignment and lien on certain mortgage notes and construction loans originated by UDF IV FII. The F&M Loan is guaranteed by us and by UDF III. The full outstanding principal balance of the F&M Loan was paid in July 2013, although UDF IV FII retains the right to draw under the F&M Loan until it matures on December 14, 2014.
In connection with the F&M Loan, as amended, UDF IV FII has agreed to pay origination and renewal fees totaling approximately $188,000 to F&M. In addition, UDF IV FII agreed to pay Debt Financing Fees to UMTH GS in connection with the F&M Loan and, in consideration for UDF III guaranteeing the F&M Loan, UDF IV FII agreed to pay UDF III a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance of the F&M Loan at the end of each month. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
Legacy Revolver
Effective November 1, 2011, UDF IV FIII obtained a credit facility in the maximum principal amount of $5.0 million (the “Legacy Revolver”) from LegacyTexas Bank (“Legacy”) pursuant to a loan agreement. As amended, the interest rate on the Legacy Revolver is equal to the greater of prime plus 1% or 5.5% per annum (5.5% at December 31, 2013), provided that the interest rate associated with advances related to development loans is 5.875% until substantial completion of the development project. Accrued interest on the outstanding principal amount of the Legacy Revolver is payable monthly. Pursuant to the Loan Renewal, Extension and Modification Agreement entered into in October 2012, the maturity date of the Legacy Revolver, which was originally October 12, 2012, was extended to January 12, 2013. Pursuant to the Loan Renewal, Extension and Modification Agreement entered into in January 2013, the maturity date of the Legacy Revolver was extended to January 12, 2015. Proceeds from the Legacy Revolver will be used to fund our obligations under certain eligible finished lot, construction and development loans that are approved in advance by Legacy. The Legacy Revolver is secured by a first priority collateral assignment and lien on certain mortgage notes and construction loans held by UDF IV FIII. The Legacy Revolver is guaranteed by us. The full outstanding principal balance of the Legacy Revolver was paid in September 2013, although UDF IV FIII retains the right to draw under the Legacy Revolver until it matures.
In connection with the Legacy Revolver, as amended, UDF IV FIII has agreed to pay origination fees totaling $100,000 to Legacy. In addition, UDF IV FIII agreed to pay Debt Financing Fees to UMTH GS in connection with the Legacy Revolver. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
Veritex Revolver
On July 31, 2012, UDF IV Fin IV obtained a revolving credit facility from Veritex Community Bank, National Association (“Veritex”) in the maximum principal amount of $5.3 million pursuant to a loan agreement (the “Veritex Revolver”). Effective August 21, 2013, UDF IV Fin IV entered into a loan modification agreement with Veritex, pursuant to which the interest rate associated with the Veritex Revolver was modified to prime plus 1%, subject to a floor of 4.5% (4.5% at December 31, 2013). Accrued interest on the outstanding principal amount of the Veritex Revolver is payable monthly. The Veritex Revolver matures and becomes due and payable in full on July 31, 2015. The Veritex Revolver is secured by a first priority collateral assignment and lien on certain finished lot loans funded by UDF IV Fin IV and is guaranteed by us. The full outstanding principal balance of the Veritex Revolver was paid in September 2013, although UDF IV Fin IV retains the right to draw under the Veritex Revolver until it matures on July 31, 2015.
In connection with the Veritex Revolver, UDF IV Fin IV agreed to pay an origination fee of $53,000 to Veritex. In addition, UDF IV Fin IV agreed to pay Debt Financing Fees to UMTH GS in connection with the Veritex Revolver. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
Affiliated Bank Loan
On July 23, 2013, UDF IV Fin V obtained a revolving credit facility from Affiliated Bank (“Affiliated Bank”) in the maximum principal amount of $5.5 million pursuant to a loan agreement (the “Affiliated Bank Loan”). The interest rate under the Affiliated Bank Loan is equal to the greater of prime plus 1% or 5% per annum (5% at December 31, 2013). Accrued interest on the outstanding principal amount of the Affiliated Bank Loan is payable monthly. The Affiliated Bank Loan matures and becomes due and payable in full on July 23, 2015. The Affiliated Bank Loan is secured by a first priority collateral assignment and lien on certain mortgage notes and loans held by UDF IV Fin V and is guaranteed by us.
In connection with the Affiliated Bank Loan, UDF IV Fin V agreed to pay an origination fee of $55,000 to Affiliated Bank. In addition, UDF IV Fin V has agreed to pay Debt Financing Fees to UMTH GS in connection with the Affiliated Bank Loan. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
UDF IV Fin VII Legacy LOC
On August 5, 2013, UDF IV Fin VII obtained a revolving credit facility from Legacy in the maximum principal amount of $10.0 million pursuant to a loan agreement (the “UDF IV Fin VII Legacy LOC”). The interest rate under the UDF IV Fin VII Legacy LOC is equal to the greater of prime plus 1% or 5% per annum (5% at December 31, 2013). Accrued interest on the outstanding principal amount of the UDF IV Fin VII Legacy LOC is payable monthly. The UDF IV Fin VII Legacy LOC matures and becomes due and payable in full on August 5, 2015. The UDF IV Fin VII Legacy LOC is guaranteed by us and secured by a first priority collateral assignment and lien on certain mortgage notes and loans held by UDF IV Fin VII as well as certain cash deposits.
In connection with the UDF IV Fin VII Legacy LOC, UDF IV Fin VII agreed to pay an origination fee of $100,000 to Legacy. In addition, UDF IV Fin VII has agreed to pay Debt Financing Fees to UMTH GS in connection with the UDF IV Fin VII Legacy LOC. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
UDF IV Fin VI CTB LOC
On August 19, 2013, UDF IV Fin VI obtained a revolving credit facility from CTB in the maximum principal amount of $25.0 million pursuant to a loan agreement (the “UDF IV Fin VI CTB LOC”). The interest rate under the UDF IV Fin VI CTB LOC is equal to the greater of prime plus 1% or 4.25% per annum (4.25% at December 31, 2013). Accrued interest on the outstanding principal amount of the UDF IV Fin VI CTB LOC is payable monthly. In addition, on a quarterly basis, UDF IV Fin VI is required to pay an unused line fee to CTB of 0.25% per annum on the average daily unused portion of the $25.0 million loan commitment. The UDF IV Fin VI CTB LOC matures and becomes due and payable in full on August 19, 2015. The UDF IV Fin VI CTB LOC is secured by a first priority collateral assignment and lien on certain mortgage notes and loans held by UDF IV Fin VI as well as certain cash deposits. The UDF IV Fin VI CTB LOC is guaranteed by us and by UDF III.
In connection with the UDF IV Fin VI CTB LOC, UDF IV Fin VI agreed to pay an origination fee of $187,500 to CTB. In addition, UDF IV Fin VI has agreed to pay Debt Financing Fees to UMTH GS in connection with the UDF IV Fin VI CTB LOC and, in consideration for UDF III guaranteeing the UDF IV Fin VI CTB LOC, UDF IV Fin VI agreed to pay UDF III a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance of the UDF IV Fin VI CTB LOC at the end of each month. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
Independent Bank Loan
On December 6, 2013, UDF IV Fin VIII obtained a revolving credit facility from Independent Bank (“Independent Bank”) in the maximum principal amount of $15.0 million pursuant to a loan agreement (the “Independent Bank Loan”). The interest rate under the Independent Bank Loan is equal to the greater of prime plus 0.875% or 4.125% per annum (4.125% at December 31, 2013). Accrued interest on the outstanding principal amount of the Independent Bank Loan is payable monthly. In addition, on a quarterly basis, UDF IV Fin VIII is required to pay an unused line fee to Independent Bank of 0.5% per annum on the average daily unused portion of the $15.0 million loan commitment. The Independent Bank Loan matures and becomes due and payable in full on December 6, 2015. The Independent Bank Loan is secured by a first priority collateral assignment and lien on certain mortgage notes and loans held by UDF IV Fin VIII and is guaranteed by us.
In connection with the Independent Bank Loan, UDF IV Fin VIII agreed to pay an origination fee of $75,000 to Independent Bank. In addition, UDF IV Fin VIII has agreed to pay Debt Financing Fees to UMTH GS in connection with the Independent Bank Loan. See Note O - Related Party Transactions, for further discussion of fees paid to related parties.
Summary Information
The chart below summarizes the approximate outstanding balance of our notes payable and each of our lines of credit as of the date indicated:
The following table represents the approximate interest expense incurred associated with our notes payable and lines of credit for the period indicated:
M. Commitments and Contingencies
Litigation
In the ordinary course of business, the Trust may become subject to litigation or claims. There are no material pending or threatened legal proceedings known to be contemplated against the Trust.
Off-Balance Sheet Arrangements
From time to time, we enter into guarantees of debtor’s borrowings and provide credit enhancements for the benefit of senior lenders in connection with our debtors and investments in partnerships (collectively referred to as “guarantees”), and account for such guarantees in accordance with FASB ASC 460-10 Guarantees. Guarantees generally have fixed expiration dates or other termination clauses and may require payment of a fee by the debtor. A guarantee involves, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. Our exposure to credit loss in the event of non-performance by the other party to the instrument is represented by the contractual notional amount of the guarantee.
In connection with the funding of some of our organization costs, on June 26, 2009, UMTH LD entered into a $6.3 million line of credit (as amended, the “UMTH LD CTB LOC”) with CTB. Effective February 26, 2012, UMTH LD entered into a second loan modification agreement with CTB, which resulted in an extension of the maturity date on the UMTH LD CTB LOC to December 26, 2014. UMTH LD has a receivable from our Advisor for organization costs funded by UMTH LD on behalf of the Trust. UMTH LD has assigned this receivable to the bank as security for the UMTH LD CTB LOC. In addition, the UMTH LD CTB LOC is secured by a collateral assignment of a first priority note and deed of trust held by a subsidiary of UMTH LD against a residential real estate project. As a condition to the modification entered into effective as of February 26, 2012, the Trust agreed to guaranty all obligations under the UMTH LD CTB LOC. As of December 31, 2013 and December 31, 2012, the outstanding balance on the line of credit was $5.1 million and $6.2 million, respectively.
Effective December 30, 2011, we entered into a Guaranty of Payment and Guaranty of Completion (collectively, the “Stoneleigh Guaranty”) for the benefit of Babson Mezzanine Realty Investors II, L.P. (“Babson”) as agent for a group of lenders pursuant to which we guaranteed all amounts due associated with a $25.0 million construction loan agreement (the “Stoneleigh Construction Loan”) entered into between Maple Wolf Stoneleigh, LLC, an affiliated Delaware limited liability company (“Stoneleigh”), and Babson. Pursuant to the Stoneleigh Construction Loan, Babson will provide Stoneleigh with up to approximately $25.0 million to finance the construction associated with a condominium project located in Dallas, Texas. United Development Funding Land Opportunity Fund, L.P., an affiliated Delaware limited partnership (“UDF LOF”), owns a 75% interest in Stoneleigh. Our asset manager, UMTH LD, also serves as the asset manager of UDF LOF. The general partner of our Advisor also serves as the general partner of UMTH LD. UMTH LD controls 100% of the partnership interests of the general partner of UDF LOF. In consideration of us entering into the Stoneleigh Guaranty, we entered into a letter agreement with Stoneleigh which provides for Stoneleigh to pay us a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance on the Stoneleigh Construction Loan at the end of each month. As of December 31, 2013 and December 31, 2012, approximately $7.6 million and $9.7 million, respectively, was outstanding under the Stoneleigh Construction Loan. For the years ended December 31, 2013 and 2012, approximately $90,000 and $21,000, respectively, is included in commitment fee income - related parties in connection with the credit enhancement fee associated with the Stoneleigh Construction Loan. As of December 31, 2013 and December 31, 2012, approximately $15,000 and $14,000, respectively, is included in accrued receivable - related parties in connection with the credit enhancement fee associated with the Stoneleigh Construction Loan.
Effective July 22, 2013, we entered into a guaranty agreement (the “URHF Guaranty”) pursuant to which we guaranteed all amounts due associated with a $15.0 million revolving credit facility (the “URHF Southwest Loan”) entered into between United Residential Home Finance, L.P. (“URHF”), an affiliated Delaware limited partnership, and Southwest Bank (“Southwest”). Our Advisor also serves as the advisor for United Mortgage Trust (“UMT”), a Maryland real estate investment trust, which owns 100% of the interests in URHF. The URHF Southwest Loan is secured by a first priority collateral assignment and lien on certain mortgage notes and loans held by URHF. In consideration of us entering into the URHF Guaranty, we entered into a letter agreement with URHF which provides for URHF to pay us a monthly credit enhancement fee equal to 1/12th of 1% of the outstanding principal balance on the URHF Southwest Loan at the end of each month. As of December 31, 2013, URHF had not made any draws on this loan and we had not recognized any income in connection with our guaranty.
As of December 31, 2013, including the guarantees described above, we had 9 outstanding repayment guarantees with total credit risk to us of approximately $65.7 million, of which approximately $18.7 million had been borrowed against by the debtor. As of December 31, 2012, we had 7 outstanding repayment guarantees with total credit risk to us of approximately $51.9 million, of which approximately $27.5 million had been borrowed against by the debtor.
N. Economic Dependency
Under various agreements, the Trust has engaged or will engage the Advisor and its affiliates to provide certain services that are essential to the Trust, including asset management services, asset acquisition and disposition decisions, the sale of the Trust’s common shares of beneficial interest available for issue, as well as other administrative responsibilities for the Trust. As a result of these relationships, the Trust is dependent upon the Advisor and its affiliates. In the event that these entities were unable to provide the Trust with the respective services, the Trust would be required to find alternative providers of these services.
O. Related Party Transactions
All prior year information presented in this footnote has been revised to reflect the effects of the Restatement described in Note C above.
O&O Reimbursement
We pay our Advisor an O&O Reimbursement (as discussed in Note H) for reimbursement of organization and offering expenses funded by our Advisor or its affiliates. For the years ended December 31, 2013 and 2012, we reimbursed our Advisor approximately $8.2 million and $5.9 million, respectively in accordance with the O&O Reimbursement. As of December 31, 2013, no unpaid organization and offering costs are included in accrued liabilities - related parties. As of December 31, 2012, approximately $4.7 million is included in accrued liabilities - related parties in connection with organization and offering costs payable to our Advisor or its affiliates related to the Offering.
Advisory Fees
We incur monthly Advisory Fees, payable to our Advisor, equal to 2% per annum of our average invested assets (as discussed in Note I). For the years ended December 31, 2013, 2012 and 2011, approximately $8.2 million, $4.2 million and $1.9 million, respectively, is included in advisory fee - related party expense for Advisory Fees payable to our Advisor. As of December 31, 2013 and 2012, approximately $842,000 and $499,000, respectively, is included in accrued liabilities - related parties associated with Advisory Fees payable to our Advisor.
Acquisition and Origination Fees
We incur Acquisition and Origination Fees equal to 3% of the net amount available for investment in secured loans and other real estate assets (as discussed in Note B and Note I); provided, however, that no such fees will be paid with respect to any asset level indebtedness we incur. The fees are further reduced by the amount of any acquisition and origination expenses paid by borrowers or investment entities to our Advisor or affiliates of our Advisor with respect to our investment. Such costs are expensed as incurred and are payable to UMTH LD, our asset manager. See Note C for further discussion of the Restatement associated with Acquisition and Origination Fees. The general partner of our Advisor is also the general partner of UMTH LD. After giving effect to the Restatement, for the years ended December 31, 2013, 2012, 2011, 2010 and 2009, approximately $9.5 million, $5.2 million, $2.4 million, $2.1 million and $40,000, respectively, is included in general and administrative - related parties expense associated with Acquisition and Origination Fees payable to UMTH LD. As of December 31, 2013 and 2012, approximately $2.4 million and $868,000, respectively, is included in accrued liabilities - related parties associated with Acquisition and Origination Fees payable to UMTH LD.
Debt Financing Fees
Pursuant to the origination of any line of credit or other debt financing, we pay our Advisor Debt Financing Fees, as discussed in Note I. These Debt Financing Fees are expensed on a straight line basis over the life of the financing arrangement.
The following table represents the approximate amount included in general and administrative - related parties expense for the period indicated associated with Debt Financing Fees paid to our Advisor in connection with our credit facility and lines of credit:
As of December 31, 2013 and 2012, approximately $0 and $44,000, respectively, is included in accrued liabilities - related parties associated with unpaid Debt Financing Fees.
Credit Enhancement Fees
We and our wholly-owned subsidiaries will occasionally enter into financing arrangements that require guarantees from entities affiliated with us. These guarantees require us to pay fees (“Credit Enhancement Fees”) to our affiliated entities as consideration for their guarantees. These Credit Enhancement Fees are either expensed as incurred or recorded as a prepaid asset and amortized, based on the terms of the guarantee agreements.
The following table represents the approximate amount included in general and administrative - related parties expense for the periods indicated associated with Credit Enhancement Fees paid to UDF III for its guarantees of our lines of credit, as discussed in Note K. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III. UDF III has received an opinion from Jackson Claborn, Inc., an independent advisor, that these credit enhancements are fair and at least as reasonable as credit enhancements with unaffiliated entities in similar circumstances.
As of December 31, 2013 and 2012, approximately $17,000 and $11,000, respectively, is included in accrued liabilities - related parties associated with Credit Enhancement Fees payable to our Advisor or its affiliates.
The chart below summarizes the approximate payments to related parties for the years ended December 31, 2013 and 2012:
The chart below summarizes the approximate expenses associated with related parties for the years ended December 31, 2013, 2012 and 2011:
The chart below summarizes the approximate general and administrative - related parties expense for the years ended December 31, 2010 and 2009:
Loan Participation Interest - Related Parties
A majority of our trustees (including a majority of our independent trustees) who are not otherwise interested in these transactions have approved the following loan participation interest - related parties agreements as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
Buffington Participation Agreements
On December 18, 2009, we entered into two participation agreements (collectively, the “Buffington Participation Agreements”) with UMT Home Finance, LP (“UMTHF”), an affiliated Delaware limited partnership, pursuant to which we purchased a participation interest in UMTHF’s construction loans (the “Construction Loans”) to Buffington Texas Classic Homes, LLC (“Buffington Classic”), an affiliated Texas limited liability company, and Buffington Signature Homes, LLC (“Buffington Signature”), an affiliated Texas limited liability company (collectively, “Buff Homes”). Our Advisor also serves as the advisor for United Mortgage Trust (“UMT”), a Maryland real estate investment trust, which owns 100% of the interests in UMTHF. UMTH LD has a minority limited partnership interest in Buffington Homebuilding Group, Ltd., which is the parent of Buff Homes.
The Construction Loans originally provided Buff Homes, which is a homebuilding group, with residential interim construction financing for the construction of new homes in the greater Austin, Texas area through October 28, 2012. In connection with the maturity of the Construction Loans, the Buffington Participation Agreements originally terminated on October 28, 2012, as well. Pursuant to a letter agreement entered into on October 28, 2012, UMTHF extended the termination date of the Construction Loans to October 28, 2013 and, in connection with this extension, we have extended the Buffington Participation Agreements to October 28, 2013. Effective October 28, 2013, pursuant to a Sixth Modification to Construction Loan Agreement, UMTHF extended the termination date of the Construction Loans to October 28, 2014. The Buffington Classic participation agreement was also extended to October 28, 2014 in connection with this modification. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
The Construction Loans are evidenced by promissory notes, are secured by first lien deeds of trust on the homes financed under the Construction Loans, and are guaranteed by the parent company and the principals of Buff Homes. Each loan financed under the Construction Loans matures and becomes due and payable in full upon the earlier of (i) the sale of the home financed under the loan, or (ii) nine months after the loan was originated; provided, that the maturity of each loan may be automatically extended for additional 90-day terms following the original maturity date. For each loan originated to it, Buff Homes is required to pay interest monthly and to repay the principal advanced to it upon the sale of the home or in any event no later than 12 months following the origination of the loan, unless the loan is further extended. The interest rate under the Construction Loans is the lower of 13% or the highest rate allowed by law.
On April 9, 2010, we entered into an Agent - Participant Agreement with UMTHF (the “UMTHF Agent Agreement”). In accordance with the UMTHF Agent Agreement, UMTHF will continue to manage and control the Construction Loans and each participant party has appointed UMTHF as its agent to act on its behalf with respect to all aspects of the Construction Loans, provided that, pursuant to the UMTHF Agent Agreement, we retain approval rights in connection with any material decisions pertaining to the administration and services of the loans and, with respect to any material modification to the loans and in the event that the loans become non-performing, we shall have effective control over the remedies relating to the enforcement of the loans, including ultimate control of the foreclosure process.
Pursuant to the Buffington Participation Agreements, we will participate in the Construction Loans by funding the lending obligations of UMTHF under the Construction Loans up to a maximum amount determined by us at our discretion. The Buffington Participation Agreements give us the right to receive payment from UMTHF of principal and accrued interest relating to amounts funded by us under the Buffington Participation Agreements. The interest rate under the Construction Loans is the lower of 13% or the highest rate allowed by law. Our participation interest is repaid as Buff Homes repays the Construction Loans or as the individual construction loans mature.
Buffington Lot Participation Agreements
On March 24, 2010, we entered into two Participation Agreements (collectively, the “Buffington Lot Participation Agreements”) with UDF III pursuant to which we purchased a 100% participation interest in UDF III’s lot inventory line of credit loan facilities with Buffington Signature (the “Buffington Signature Line”) and Buffington Classic (the “Buffington Classic Line”) (collectively, the “Lot Inventory Loans”). The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III, and UMTH LD has a minority limited partnership interest in Buffington Homebuilding Group, Ltd., which is the parent of Buff Homes. The Lot Inventory Loans are evidenced by promissory notes, are secured by first lien deeds of trust on the lots financed under the Lot Inventory Loans, and are guaranteed by Buff Homes’ parent company and an affiliate company of Buff Homes. The Lot Inventory Loans provide Buff Homes with financing for the acquisition of residential lots which are held as inventory to facilitate Buff Homes’ new home construction business in the greater Austin, Texas area. When a lot is slated for residential construction, Buff Homes obtains an interim construction loan and the principal advanced for the acquisition of the lot is repaid under the Lot Inventory Loans.
On April 9, 2010, we entered into an Agent Agreement with UDF III (the “UDF III Agent Agreement”). In accordance with the UDF III Agent Agreement, UDF III will continue to manage and control the Lot Inventory Loans and each participant party has appointed UDF III as its agent to act on its behalf with respect to all aspects of the Lot Inventory Loans, provided that, pursuant to the UDF III Agent Agreement, we retain approval rights in connection with any material decisions pertaining to the administration and services of the loans and, with respect to any material modification to the loans and in the event that the loans become non-performing, we shall have effective control over the remedies relating to the enforcement of the loans, including ultimate control of the foreclosure process.
Pursuant to the Buffington Lot Participation Agreements, we will participate in the Lot Inventory Loans by funding UDF III’s lending obligations under the Lot Inventory Loans up to a maximum amount of $2.5 million under the Buffington Signature Line and $2.0 million under the Buffington Classic Line. The Buffington Lot Participation Agreements give us the right to receive repayment of all principal and accrued interest relating to amounts funded by us under the Buffington Lot Participation Agreements. The interest rate for the Lot Inventory Loans is the lower of 14% or the highest rate allowed by law. Our participation interest is repaid as Buff Homes repays the Lot Inventory Loans. For each loan originated, Buff Homes is required to pay interest monthly and to repay the principal advanced no later than 12 months following the origination of the loan. The Buffington Signature Line matured and terminated in August 2011, at which time there was no outstanding balance, and our participation interest terminated simultaneously. The Buffington Classic Line was due and payable in full on August 21, 2012. Effective August 21, 2012, pursuant to an extension agreement, UDF III extended the maturity date of the Buffington Classic Line to August 21, 2013 and, in connection with this extension agreement, we entered into a letter agreement with UDF III extending the lot participation agreement associated with the Buffington Classic Line to August 21, 2013. Effective August 21, 2013, UDF III entered into an extension agreement with Buffington Classic pursuant to which, the termination date of the Buffington Classic Line was extended to August 21, 2014. The lot participation agreement associated with the Buffington Classic Line was also extended to August 21, 2014, in connection with this extension. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
UDF III is required to purchase back from us the participation interest in the Lot Inventory Loans (i) upon a foreclosure of UDF III’s assets by its lenders, (ii) upon the maturity of the Lot Inventory Loans, or (iii) at any time upon 30 days prior written notice from us. In such event, the purchase price paid to us will be equal to the outstanding principal amount of the Lot Inventory Loans on the date of termination, together with all accrued interest due thereon, plus any other amounts due to us under the Buffington Lot Participation Agreements.
TR Finished Lot Participation
On June 30, 2010, we purchased a participation interest (the “TR Finished Lot Participation”) in a finished lot loan (the “Travis Ranch II Finished Lot Loan”) made by UDF III to CTMGT Travis Ranch II, LLC, an unaffiliated Texas limited liability company. UMTH LD is the general partner of UDF III. The Travis Ranch II Finished Lot Loan is secured by a subordinate, second lien deed of trust recorded against finished residential lots in the Travis Ranch residential subdivision located in Kaufman County, Texas. The Travis Ranch II Finished Lot Loan is guaranteed by the limited liability company owners of the borrower and by the principal of the borrower.
In accordance with the TR Finished Lot Participation, we are entitled to receive repayment of our participation in the outstanding principal amount of the Travis Ranch II Finished Lot Loan, plus accrued interest thereon, over time as the borrower repays the loan. We have no obligation to increase our participation interest in the Travis Ranch II Finished Lot Loan. The interest rate under the Travis Ranch II Finished Lot Loan is the lower of 15% or the highest rate allowed by law. The borrower has obtained a senior loan secured by a first lien deed of trust on the finished lots. For so long as the senior loan is outstanding, proceeds from the sale of the residential lots securing the Travis Ranch II Finished Lot Loan will be paid to the senior lender and will be applied to reduce the outstanding balance of the senior loan. After the senior loan is paid in full, the proceeds from the sale of the residential lots securing the Travis Ranch II Finished Lot Loan are required to be used to repay the Travis Ranch II Finished Lot Loan. The Travis Ranch II Finished Lot Loan and our participation in this loan was originally due and payable in full on August 28, 2012. The Travis Ranch II Finished Lot Loan has subsequently been amended three times pursuant to three separate extension agreements resulting in a current maturity date of January 28, 2015. The TR Finished Lot Participation has also been extended to January 28, 2015 in connection with these modifications. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
TR Paper Lot Participation
On June 30, 2010, we purchased a participation interest (the “TR Paper Lot Participation”) in a “paper” lot loan (the “Travis Ranch Paper Lot Loan”) from UDF III to CTMGT Travis Ranch, LLC, an unaffiliated Texas limited liability company. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III. A “paper” lot is a residential lot shown on a plat that has been accepted by the city or county, but which is currently undeveloped or under development. The borrower owns paper lots in the Travis Ranch residential subdivision of Kaufman County, Texas. The Travis Ranch Paper Lot Loan was initially secured by a pledge of the equity interests in the borrower instead of a real property lien, effectively subordinating the Travis Ranch Paper Lot Loan to all real property liens. The Travis Ranch Paper Lot Loan is guaranteed by the limited liability company owners of the borrower and by the principal of the borrower.
We are entitled to receive repayment of our participation in the outstanding principal amount of the Travis Ranch Paper Lot Loan, plus its proportionate share of accrued interest thereon, over time as the borrower repays the Travis Ranch Paper Lot Loan. We have no obligation to increase our participation interest in the Travis Ranch Paper Lot Loan. The interest rate under the Travis Ranch Paper Lot Loan is the lower of 15% or the highest rate allowed by law. The borrower has obtained a senior loan secured by a first lien deed of trust on the paper lots. For so long as the senior loan is outstanding, proceeds from the sale of the paper lots will be paid to the senior lender and will be applied to reduce the outstanding balance of the senior loan. After the senior loan is paid in full, the proceeds from the sale of the paper lots are required to be used to repay the Travis Ranch Paper Lot Loan. The Travis Ranch Paper Lot Loan and our participation in this loan was originally due and payable in full on September 24, 2012. The Travis Ranch Paper Lot Loan has subsequently been amended three times pursuant to three separate extension agreements resulting in a current maturity date of January 28, 2015. The TR Paper Lot Participation has also been extended to January 28, 2015 in connection with these modifications. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
Carrollton Participation Agreement
On June 10, 2011, we entered into a participation agreement (the “Carrollton Participation Agreement”) with UMT Home Finance III, LP (“UMTHFIII”), an affiliated Delaware limited partnership, pursuant to which we purchased a participation interest in UMTHFIII’s finished lot loan (the “Carrollton Lot Loan”) to Carrollton TH, LP (“Carrollton TH”), an unaffiliated Texas limited partnership. Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFIII. The Carrollton Lot Loan provides Carrollton TH with a finished lot loan totaling $3.4 million for townhome lots located in Carrollton, Texas. The Carrollton Lot Loan is evidenced by a promissory note, is secured by first lien deeds of trust on the finished lots financed under the Carrollton Lot Loan, and is guaranteed by the borrower’s general partner and its principal.
The Carrollton Participation Agreement gave us the right to receive payment from UMTHFIII of principal and accrued interest relating to amounts funded by us under the Carrollton Participation Agreement. The interest rate under the Carrollton Lot Loan was the lower of 13% or the highest rate allowed by law. The original maturity date of the Carrollton Lot Loan is June 10, 2014. Pursuant to a letter agreement entered into in March 2012, the Carrollton Participation Agreement maturity date was extended from March 10, 2012 to December 10, 2012. Pursuant to a letter agreement entered into in December 2012, the Carrollton Participation Agreement maturity date was extended from December 10, 2012 to June 10, 2014. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. We received payment in full for the Carrollton Participation Agreement on May 31, 2013.
165 Howe Participation Agreement
On October 4, 2011, we entered into a participation agreement (the “165 Howe Participation Agreement”) with UMT Home Finance III, LP (“UMTHFIII”), an affiliated Delaware limited partnership, pursuant to which we purchased a participation interest in UMTHFIII’s finished lot loan (the “165 Howe Lot Loan”) to 165 Howe, L.P., an unaffiliated Texas limited partnership, and Allen Partners, L.P., an unaffiliated Texas limited partnership (collectively, “165 Howe”). Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFIII. The 165 Howe Lot Loan provides 165 Howe with a finished lot loan totaling $2.9 million for finished single-family residential lots located in Fort Worth, Texas. The 165 Howe Lot Loan is evidenced by a promissory note, is secured by first lien deeds of trust on the finished lots financed under the 165 Howe Lot Loan, and is guaranteed by the borrower’s general partner and its principal.
The 165 Howe Participation Agreement gave the Trust the right to receive payment from UMTHFIII of principal and accrued interest relating to amounts funded by the Trust under the 165 Howe Participation Agreement. The interest rate under the 165 Howe Lot Loan is the lower of 11.5% or the highest rate allowed by law. The original maturity date of the 165 Howe Participation Agreement was July 4, 2012. Pursuant to a letter agreement entered into in July 2012, the 165 Howe Participation Agreement maturity date was extended from July 4, 2012 to December 10, 2012. Pursuant to a letter agreement entered into in December 2012, the 165 Howe Participation Agreement maturity date was extended from December 10, 2012 to October 4, 2013. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. We received payment in full for the 165 Howe Participation Agreement on November 6, 2013.
Pine Trace Participation Agreement
On May 31, 2012, we entered into a participation agreement (the “Pine Trace Participation Agreement”) with UMTHFIII pursuant to which we purchased a participation interest in UMTHFIII’s loan (the “Pine Trace Loan”) to Pine Trace Village, LLC an unaffiliated Texas limited liability company (“Pine Trace”). Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFIII. The Pine Trace Loan was initially secured by approximately 118 finished lots and 151 acres of undeveloped land located in Houston, Texas. The Pine Trace Loan is evidenced by a promissory note and is secured by first lien deeds of trust on the finished lots financed under the Pine Trace Loan.
The Pine Trace Participation Agreement gives us the right to receive payment from UMTHFIII of principal and accrued interest relating to amounts funded by us under the Pine Trace Participation Agreement. The interest rate under the Pine Trace Loan is the lower of 13% or the highest rate allowed by law. Our interest will be repaid as Pine Trace repays the Pine Trace Loan. Pine Trace is required to pay interest monthly and to repay a portion of principal upon the sale of lots covered by the deed of trust. The original maturity date of the Pine Trace Participation Agreement was March 29, 2013. The Pine Trace Loan has subsequently been amended twice pursuant to two separate extension agreements resulting in a current maturity date of March 29, 2015. The Pine Trace Participation Agreement has also been extended to March 29, 2015 in connection with these modifications. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
Northpointe Participation Agreement
On June 11, 2012, we entered into a participation agreement (the “Northpointe Participation Agreement”) with UDF III pursuant to which we purchased a participation interest in UDF III’s loan (the “Northpointe Loan”) to UDF Northpointe, LLC, an unaffiliated Texas limited liability company (“Northpointe”). The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III. The Northpointe Loan was initially secured by approximately 301 lots located in Collin County, Tarrant County and Kaufman County, Texas. The Northpointe Loan is evidenced by a promissory note and is secured by first lien deeds of trust on the lots financed under the Northpointe Loan.
The Northpointe Participation Agreement gives us the right to receive payment from UDF III of principal and accrued interest relating to amounts funded by us under the Northpointe Participation Agreement. The interest rate under the Northpointe Loan is the lower of 12% or the highest rate allowed by law. Our interest will be repaid as Northpointe repays the Northpointe Loan. Northpointe is required to pay interest monthly and to repay a portion of principal upon the sale of lots covered by the deed of trust. The original maturity date of the Northpointe Participation Agreement was December 4, 2012. Pursuant to a letter agreement entered into in December 2012, the Northpointe Participation Agreement maturity date was extended from December 4, 2012 to June 4, 2013. Effective June 4, 2013, pursuant to a loan modification agreement, UDF III extended the maturity date of the Northpointe Loan to June 4, 2014. The Northpointe Participation Agreement was also extended to June 4, 2014 in connection with this modification. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
Northpointe II Participation Agreement
On May 2, 2013, we entered into a participation agreement (the “Northpointe II Participation Agreement”) with UDF III pursuant to which we purchased a participation interest in UDF III’s loan (the “Northpointe II Loan”) to UDF Northpointe II, LLC (“Northpointe II”). The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD is the general partner of UDF III. The Northpointe II Loan is evidenced by two secured promissory notes and was initially secured by second lien deeds of trust on approximately 251 finished lots and 110 acres of land in Texas.
The Northpointe II Participation Agreement gives us the right to receive payment from UDF III of principal and accrued interest relating to amounts funded by us under the Northpointe II Participation Agreement. The interest rate under the Northpointe II Loan is the lower of 12% or the highest rate allowed by law. Our interest will be repaid as Northpointe II repays the Northpointe II Loan. Northpointe II is required to pay interest monthly and to repay a portion of principal upon the sale of lots covered by the deed of trust. The Northpointe II Loan and our participation in this loan were originally due and payable in full on December 28, 2013. Effective December 28, 2013, pursuant to a loan modification agreement, UDF III extended the maturity date of the Northpointe II Loan to December 28, 2014. The Northpointe Participation Agreement was also extended to December 28, 2014 in connection with this modification. In determining whether to extend this participation, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
UMTHF Megatel Participation
On October 3, 2013, we entered into a participation agreement (the “UMTHF Megatel Participation”) with UMTHF pursuant to which we purchased a participation interest in UMTHF’s construction loan (the “UMTHF Megatel Loan”) to Megatel Homes II, LLC (“Megatel”). Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHF.
The UMTHF Megatel Loan provides Megatel, which is a homebuilding group, with up to $10.0 million in residential interim construction financing for the construction of new homes in the Dallas, Texas area through October 3, 2014. The UMTHF Megatel Loan is evidenced by promissory notes and is secured by first lien deeds of trust on the homes financed under the UMTHF Megatel Loan, and is guaranteed by the parent company and the principals of Megatel. Each loan financed under the UMTHF Megatel Loan matures and becomes due and payable in full upon the earlier of (i) the sale of the home financed under the loan, or (ii) 12 months after the loan was originated; provided, that the maturity of each loan may be automatically extended for additional 12 month terms following the original maturity date. For each loan originated to it, Megatel is required to pay interest monthly and to repay the principal advanced to it upon the sale of the home or in any event no later than 12 months following the origination of the loan, unless the loan is further extended. The interest rate under the UMTHF Megatel Loan is the lower of 13% or the highest rate allowed by law.
Pursuant to the UMTH Megatel Participation, we will participate in the UMTHF Megatel Loan by funding the lending obligations of UMTHF under the UMTHF Megatel Loan up to a maximum amount determined by us at our discretion. The UMTH Megatel Participation gives us the right to receive payment from UMTHF of principal and accrued interest relating to amounts funded by us under the UMTH Megatel Participation. The interest rate under the UMTHF Megatel Loan is the lower of 13% or the highest rate allowed by law. Our participation interest is repaid as Megatel repays the UMTHF Megatel Loan or as the individual construction loans mature.
URHF Buckingham Participation
On December 16, 2013, we entered into a participation agreement (the “URHF Buckingham Participation”) with URHF pursuant to which we purchased a participation interest in URHF’s $4.9 million loan (the “URHF Buckingham Loan”) to CTMGT Buckingham, LLC (“Buckingham”), a Texas limited liability company. Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in URHF. The URHF Buckingham Loan provides financing to Buckingham to acquire and develop 81 paper lots located in Texas. The URHF Buckingham Loan is evidenced by a secured promissory note and secured by a first lien deed of trust on the lots and is guaranteed by principals of the borrower.
The URHF Buckingham Participation gives us the right to receive payment from URHF of principal and accrued interest relating to amounts funded by us under the URHF Buckingham Participation. The interest rate under the URHF Buckingham Loan is the lower of 13% or the highest rate allowed by law. Our interest will be repaid as Buckingham repays the URHF Buckingham Loan. Buckingham is required to make loan payments upon the sale of lots covered by the deed of trust. The URHF Buckingham Loan and our participation in this loan are due and payable in full on June 28, 2016.
URHF Bratton Hill Participation
On December 16, 2013, we entered into a participation agreement (the “URHF Bratton Hill Participation”) with URHF pursuant to which we purchased a participation interest in URHF’s $3.0 million loan (the “URHF Bratton Hill Loan”) to BLD Bratton Hill, LLC (“Bratton Hill”), a Texas limited liability company. Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in URHF. The URHF Bratton Hill Loan provides financing to Bratton Hill to acquire and develop 52 paper lots located in Texas. The URHF Bratton Hill Loan is evidenced by a secured promissory note and secured by a first lien deed of trust on the lots and is guaranteed by principals of the borrower.
The URHF Buckingham Participation gives us the right to receive payment from URHF of principal and accrued interest relating to amounts funded by us under the URHF Bratton Hill Participation. The interest rate under the URHF Bratton Hill Loan is the lower of 13% or the highest rate allowed by law. Our interest will be repaid as Bratton Hill repays the URHF Bratton Hill Loan. Bratton Hill is required to pay make loan payments upon the sale of lots covered by the deed of trust. The URHF Bratton Hill Loan and our participation in this loan are due and payable in full on July 31, 2016.
Summary Information
The chart below summarizes the approximate outstanding balance of each of our loans included in loan participation interest - related parties as of the date indicated:
The chart below summarizes the approximate accrued interest included in accrued receivable - related parties associated with each of our loans included in loan participation interest - related parties as of the date indicated:
The following table summarizes the approximate income included in interest income - related parties associated with each of our loans included in loan participation interest - related parties for the periods indicated:
Notes Receivable - Related Parties
A majority of our trustees (including a majority of our independent trustees) who are not otherwise interested in these transactions have approved the following notes receivable - related parties agreements as being fair and reasonable to us and on terms and conditions not less favorable to us than those available from unaffiliated third parties.
HLL Indian Springs Loan
On January 18, 2010, we made a finished lot loan (the “HLL Indian Springs Loan”) of approximately $1.8 million to HLL Land Acquisitions of Texas, L.P., an affiliated Texas limited partnership (“HLL”). HLL is a wholly owned subsidiary of United Development Funding, L.P. (“UDF I”), an affiliated Delaware limited partnership. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The HLL Indian Springs Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 71 finished residential lots in The Preserve at Indian Springs, a residential subdivision in the City of San Antonio, Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts and earnest money, and other loan documents. The interest rate under the HLL Indian Springs Loan was the lower of 13% or the highest rate allowed by law. The HLL Indian Springs Loan was scheduled to mature on July 18, 2013, pursuant to the First Modification Agreement dated July 18, 2011. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. The HLL Indian Springs Loan was paid in full in May 2013.
In connection with the HLL Indian Springs Loan, HLL agreed to pay an origination fee of approximately $18,000 to UMTH LD, which was funded by us at the closing of the HLL Indian Springs Loan.
Buffington Loan Agreements
On April 30, 2010, we entered into two construction loan agreements with Buffington Signature (the “Buffington Signature CL”) and Buffington Classic (the “Buffington Classic CL”) (collectively, the “Buffington Loan Agreements”) through which we agreed to provide interim construction loan facilities (collectively, the “Buffington Loan Facilities”) to Buffington Signature and Buffington Classic. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD owns an investment in Buffington Homebuilding Group, Ltd., which is the parent of Buff Homes. Effective July 2010, we assigned our rights and obligations under the Buffington Loan Facilities to UDF IV HF.
The Buffington Signature CL provides Buffington Signature with up to $1.0 million in residential interim construction financing for the construction of new homes in the greater Austin, Texas area and other Texas counties approved by UDF IV HF. The Buffington Signature CL matured and was not renewed in October 2011, at which time there were no amounts outstanding and payable to UDF IV HF.
The Buffington Classic CL originally provided Buffington Classic with up to $6.5 million in residential interim construction financing for the construction of new homes in the greater Austin, Texas area and other Texas counties approved by UDF IV HF. Pursuant to the Third Modification to Construction Loan Agreement entered into between UDF IV HF and Buffington Classic in October 2011, the Buffington Classic CL provided Buffington Classic with up to $7.5 million in residential interim construction financing through October 28, 2012. Pursuant to a letter agreement entered into on October 28, 2012, we extended the maturity date of the Buffington Classic CL to October 28, 2013. Pursuant to a Fourth Modification to Construction Loan Agreement, we extended the maturity date of the Buffington Classic CL to October 28, 2014. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
The Buffington Loan Facilities are evidenced and secured by the Buffington Loan Agreements, promissory notes, first lien deeds of trust on the homes financed under the Buffington Loan Facilities and various other loan documents. They are guaranteed by the parent company and certain principals of Buff Homes. The interest rate under the Buffington Loan Facilities is the lower of 13% per annum, or the highest rate allowed by law. Interest is payable monthly. Each loan financed under the Buffington Loan Facilities matures and becomes due and payable in full upon the earlier of (i) the sale of the home financed under the loan, or (ii) nine months after the loan was originated; provided, that the maturity of the loan may be extended up to 90 days following the original maturity date. At the closing of each loan, Buff Homes will pay a 0.5% origination fee to our asset manager.
HLL II Highland Farms Loan
Effective December 22, 2010, we made a finished lot loan (the “HLL II Highland Farms Loan”) of approximately $1.9 million to HLL II Land Acquisitions of Texas, L.P., an affiliated Texas limited partnership (“HLL II”). HLL II is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The HLL II Highland Farms Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 68 finished residential lots and 148 undeveloped lots in Highland Farms, a residential subdivision in the City of San Antonio, Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts and earnest money, and other loan documents. The interest rate under the HLL II Highland Farms Loan is the lower of 13% or the highest rate allowed by law. The original maturity date of the HLL II Highland Farms Loan was March 22, 2013. The HLL II Highland Farms Loan has subsequently been amended twice pursuant to two separate extension agreements resulting in a current maturity date of March 22, 2015. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors. The HLL II Highland Farms Loan provides HLL II with an interest reserve of approximately $354,000 pursuant to which we will fund HLL II’s monthly interest payments and add the payments to the outstanding principal balance of the HLL II Highland Farms Loan.
In connection with the HLL II Highland Farms Loan, HLL II agreed to pay us an origination fee of approximately $19,000, which was funded at the closing of the loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
HLL Hidden Meadows Loan
Effective February 17, 2011, we entered into a Loan Agreement providing for a maximum $9.9 million loan (the “HLL Hidden Meadows Loan”) to be made to HLL. HLL is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The HLL Hidden Meadows Loan was initially secured by (i) a first priority lien deed of trust to be recorded against 91 finished residential lots, 190 partially developed residential lots and residual undeveloped land located in the residential subdivision of Hidden Meadows, Harris County, Texas, (ii) the assignment of lot sale contracts providing for sales of finished residential lots to a builder, and (iii) the assignment of development reimbursements owing from a Municipal Utility District to HLL. The interest rate under the HLL Hidden Meadows Loan is the lower of 13% or the highest rate allowed by law. The HLL Hidden Meadows Loan matures and becomes due and payable in full on January 21, 2015. The HLL Hidden Meadows Loan provides HLL with an interest reserve, pursuant to which we will fund HLL’s monthly interest payments and add the payments to the outstanding principal balance of the HLL Hidden Meadows Loan.
In connection with the HLL Hidden Meadows Loan, HLL agreed to pay a $99,000 origination fee to us, which was funded at the closing of the HLL Hidden Meadows Loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
Ash Creek Loan
Effective April 20, 2011, we entered into a $3.0 million loan agreement (the “Ash Creek Loan”) with UDF Ash Creek, LP (“UDF Ash Creek”), an affiliated Delaware limited partnership. UDF Ash Creek is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The Ash Creek Loan provides UDF Ash Creek with interim construction financing for the construction of 19 new townhomes in an existing townhome community in Dallas, Texas. The Ash Creek Loan is evidenced and secured by a promissory note, first lien deeds of trust on the townhomes financed under the Ash Creek Loan and various other loan documents. The interest rate under the Ash Creek Loan is the lower of 13% per annum, or the highest rate allowed by law. UDF Ash Creek is required to pay interest monthly and to repay a portion of the principal upon the sale of the townhomes covered by the deed of trust. The Ash Creek Loan matured and became due and payable in full on October 20, 2012. Effective October 20, 2012, we entered into a loan modification agreement with UDF Ash Creek, which extended the maturity date of the Ash Creek Loan to October 20, 2013. Pursuant to a Second Loan Modification Agreement, we extended the maturity date of the Ash Creek Loan to October 20, 2014. In determining whether to extend this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
In connection with the Ash Creek Loan, UDF Ash Creek agreed to pay a $15,000 origination fee to us, which was funded at the closing of the Ash Creek Loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
UMTHFII Loan
On October 26, 2011, we entered into a secured line of credit promissory note (the “UMTHFII Loan”) with UMT Home Finance II, LP (“UMTHFII”), an affiliated Delaware limited partnership. Our Advisor also serves as the advisor for UMT, which owns 100% of the interests in UMTHFII. The UMTHFII Loan provided UMTHFII with a $5.0 million line of credit to acquire or originate and fund construction loans and for business purposes approved by the Trust that are related to the acquisition or origination of construction loans. The UMTHFII Loan was subordinate to a senior loan entered into by UMTHFII and was secured by a pledge of the partnership interests in UMTHFII, a security interest against the assets of UMTHFII and a guaranty from UMT.
The interest rate under the UMTHFII Loan was the lower of 13% per annum, or the highest rate allowed by law. UMTHFII was required to repay the UMTHFII Loan as it receives net proceeds from the disposition of assets underlying the construction loans and as it receives net proceeds of interest associated with the construction loans. In addition, UMTHFII was required to repay the UMTHFII Loan as it received net proceeds from its private placement offering of up to $5.0 million in promissory notes. The UMTHFII Loan matured and became due and payable in full on October 26, 2012, at which point it terminated. We did not fund any advances or recognize any income associated with the UMTHFII Loan prior to its maturity.
UDF TX Two Loan
On September 20, 2012, we entered into a loan purchase agreement with a third party to acquire a loan obligation (the “UDF TX Two Loan”) owing from UDF TX Two, L.P., an affiliated Texas limited partnership (“UDF TX Two”) for approximately $2.9 million. UDF I has a 50% partnership interest in UDF TX Two. Our asset manager, UMTH LD, also serves as the asset manager of UDF I. The general partner of our Advisor is also the general partner of UMTH LD. The UDF TX Two Loan provided UDF TX Two with financing to acquire 70 finished home lots in Lakeway, Texas. The UDF TX Two Loan is evidenced and secured by a promissory note, first lien deeds of trust on the finished lots financed under the UDF TX Two Loan and various other loan documents. The interest rate under the UDF TX Two Loan is the lower of 13% per annum, or the highest rate allowed by law. Upon acquisition of the UDF TX Two Loan, we entered into an extension agreement with UDF TX Two pursuant to which we extended the maturity date of the UDF TX Two Loan to September 20, 2014. In determining whether to modify this loan, we evaluated the economic conditions, the estimated value and performance of the underlying collateral, the guarantor, adverse situations that may affect the borrower’s ability to pay or the value of the collateral and other relevant factors.
UDF PM Loan
Effective October 17, 2012, we entered into a $5.1 million loan agreement (the “UDF PM Loan”) with UDF PM, LLC (“UDF PM”), an affiliated Texas limited liability company. UDF PM is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The UDF PM Loan provides UDF PM with up to $4.8 million in financing for the development of an amenity center and related project amenities located in Lubbock County, Texas. The UDF PM Loan is evidenced and secured by a promissory note and the assignment of development reimbursements owing to UDF PM pursuant to (i) an economic development agreement and (ii) a public improvement district reimbursement contract, both of which were entered into between UDF PM and the city of Wolfforth, Texas. The interest rate under the UDF PM Loan is the lower of 13% per annum, or the highest rate allowed by law. The UDF PM Loan matures and becomes due and payable in full on October 17, 2015. The UDF PM Loan provides UDF PM with an interest reserve of approximately $300,000, pursuant to which we will fund UDF PM’s monthly interest payments and add the payments to the outstanding principal balance of the UDF PM Loan.
HLL IS Loan
Effective November 29, 2012, we entered into a $6.4 million loan agreement (the “HLL IS Loan”) with HLL. HLL is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The HLL IS Loan provides HLL with up to $5.8 million in financing for the development of residential lots located in Bexar County, Texas. The HLL IS Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 24 acres in The Preserve at Indian Springs, a residential subdivision in the City of San Antonio, Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts, and other loan documents. The interest rate under the HLL IS Loan is the lower of 13% per annum, or the highest rate allowed by law. The HLL IS Loan matures and becomes due and payable in full on November 29, 2015. The HLL IS Loan provides HLL with an interest reserve of approximately $600,000, pursuant to which we will fund HLL’s monthly interest payments and add the payments to the outstanding principal balance of the HLL IS Loan.
In connection with the HLL IS Loan, HLL agreed to pay a $64,000 origination fee to us, which was funded at the closing of the HLL IS Loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
One KR Loan
Effective December 14, 2012, we entered into a $15.3 million loan agreement (the “One KR Loan”) with One KR Venture, L.P., an affiliated Texas limited partnership (“One KR”). One KR is a wholly owned subsidiary of UDF I. The general partner of our Advisor is also the general partner of UMTH LD, our asset manager. UMTH LD also serves as the asset manager of UDF I. The One KR Loan provides One KR with up to $12.1 million to refinance existing third party debt and develop real property located in Bexar County, Texas. The One KR Loan was initially evidenced and secured by a first lien deed of trust recorded against approximately 31 acres of real property located in Bexar County, Texas, as well as a promissory note, assignments of certain lot sale contracts, a pledge of partnership interests in the borrower and other loan documents. The interest rate under the One KR Loan is the lower of 13% per annum, or the highest rate allowed by law. The One KR Loan matures and becomes due and payable in full on June 14, 2016. The One KR Loan provides One KR with an interest reserve of approximately $3.2 million, pursuant to which we will fund One KR’s monthly interest payments and add the payments to the outstanding principal balance of the One KR Loan.
In connection with the One KR Loan, One KR agreed to pay a $153,000 origination fee to us, which was funded at the closing of the One KR Loan. Revenue associated with this origination fee is included in commitment fee income - related parties and is recognized over the life of the loan.
Summary Information
The chart below summarizes the approximate outstanding balance of each of our loans included in notes receivable - related parties as of the date indicated:
The chart below summarizes the approximate accrued interest included in accrued receivable - related parties associated with each of our loans included in notes receivable - related parties as of the date indicated:
The following table summarizes the approximate income included in interest income - related parties associated with each of our loans included in notes receivable - related parties for the period indicated:
Commitment Fee Income
We and our wholly-owned subsidiaries will occasionally enter into loan agreements with affiliated entities that require origination fees to be funded to us at the closing of the loan. These origination fees are recognized as revenue over the life of the resulting loan and this revenue is included in commitment fee income - related parties.
The following table represents the approximate origination fees included in commitment fee income - related parties associated with each loan for the periods indicated:
P. Concentration of Credit Risk
Financial instruments that potentially expose us to concentrations of credit risk are primarily temporary cash equivalent and loan participation interest - related parties. We maintain deposits in financial institutions that may at times exceed amounts covered by insurance provided by the United States Federal Deposit Insurance Corporation (“FDIC”). We have not experienced any losses related to amounts in excess of FDIC limits.
At December 31, 2013, our real estate investments were secured by property located in Texas.
We may invest in multiple secured loans that share a common borrower. The bankruptcy, insolvency or other inability of any borrower that is the subject of multiple loans to pay interest or repay principal on its loans would have adverse consequences on our income and reduce the amount of funds available for distribution to investors. The more concentrated our portfolio is with one or a few borrowers, the greater credit risk we face. The loss of any one of these borrowers would have a material adverse effect on our financial condition and results of operations.
We did not have any individual loans to borrowers that accounted for over 10% of the outstanding balance of our portfolio as of December 31, 2013. Our largest individual borrower and its affiliates comprised approximately 65% of the outstanding balance of our portfolio.
Q. Quarterly Financial Data (Unaudited)
The tables below illustrate the impact of the Restatement on our historical consolidated balance sheets, consolidated statements of operations and consolidated statements of cash flows for the interim quarters impacted, each as compared with the amounts presented in the original Quarterly Report on Form 10-Q previously filed with the SEC.
The following table sets forth the effects of the Restatement on the affected line items within the Trust’s previously reported consolidated balance sheets as of March 31, 2013, June 30, 2013 and September 30, 2013.
The following table sets forth the effects of the Restatement on the affected line items within the Trust’s previously reported consolidated balance sheets as of March 31, 2012, June 30, 2012 and September 30, 2012.
The following table sets forth the effects of the Restatement on the affected line items within the Trust’s previously reported consolidated statements of operations for the quarters ended March 31, 2013, June 30, 2013 and September 30, 2013.
The following table sets forth the effects of the Restatement on the affected line items within the Trust’s previously reported consolidated statements of operations for the quarters ended March 31, 2012, June 30, 2012 and September 30, 2012.
The following table sets forth the effects of the Restatement on the affected line items within the Trust’s previously reported consolidated statements of cash flows for the three months ended March 31, 2013, the six months ended June 30, 2013 and the nine months ended September 30, 2013.
The following table sets forth the effects of the Restatement on the affected line items within the Trust’s previously reported consolidated statements of cash flows for the three months ended March 31, 2012, the six months ended June 30, 2012 and the nine months ended September 30, 2012.
Selected quarterly financial data (unaudited) for the years ended December 31, 2013 and 2012 is set forth below:
R. Subsequent Events
On February 3, 2014, our board of trustees appointed Stacey H. Dwyer as our Chief Operating Officer, effective February 17, 2014. We entered into an Employment Agreement with Ms. Dwyer effective as of February 17, 2104. In connection with Ms. Dwyer’s appointment, David A. Hanson stepped down from his role as our Chief Operating Officer. However, Mr. Hanson remains our Chief Accounting Officer.
Index to Exhibits
Exhibit Number
Description
3.1
Second Articles of Amendment and Restatement of United Development Funding IV (previously filed in and incorporated by reference to Exhibit 3.1 to Registrant’s Pre-Effective Amendment No. 2 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on December 16, 2008)
3.2
Bylaws of United Development IV (previously filed in and incorporated by reference to Exhibit 3.2 to Registrant’s Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 5, 2008)
4.1
Form of Subscription Agreement (previously filed in and incorporated by reference to Exhibit B to the prospectus dated April 27, 2012 filed pursuant to Rule 424(b)(3), Commission File No. 333-152760, filed on April 30, 2012 and incorporated herein by reference)
4.2
Distribution Reinvestment Plan (previously filed in and incorporated by reference to Exhibit C to the prospectus dated April 27, 2012 filed pursuant to Rule 424(b)(3), Commission File No. 333-152760, filed on April 30, 2012 and incorporated herein by reference)
4.3
Share Redemption Program (previously filed in and incorporated by reference to the description under “Description of Shares - Share Redemption Program” in the prospectus dated April 27, 2012 filed pursuant to Rule 424(b)(3), Commission File No. 333-152760, filed on April 30, 2012 and incorporated herein by reference)
10.1
Advisory Agreement by and between United Development Funding IV and UMTH General Services, L.P. (previously filed in and incorporated by reference to Exhibit 10.1 to Form 10-Q filed on December 22, 2009)
10.2
Agreement of Limited Partnership of United Development Funding IV Operating Partnership, L.P. (previously filed in and incorporated by reference to Exhibit 10.2 to Form 10-Q filed on December 22, 2009)
10.3
Third Amended and Restated Escrow Agreement by and among United Development Funding IV, Realty Capital Securities, LLC and LegacyTexas Bank (previously filed in and incorporated by reference to Exhibit 10.3 to Registrant’s Pre-Effective Amendment No. 7 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on November 12, 2009)
10.4
Participation Agreement by and among United Development Funding IV, United Development Funding, L.P., United Development Funding II, L.P., United Development Funding III, L.P. and UMTH Land Development, L.P. (previously filed in and incorporated by reference to Exhibit 10.4 to Form 10-Q filed on December 22, 2009)
10.5
Guaranty Agreement (Limited) by United Development Funding IV for the benefit of Community Trust Bank of Texas (previously filed in and incorporated by reference to Exhibit 10.5 to Registrant’s Pre-Effective Amendment No. 5 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 24, 2009)
10.6
Loan Participation Agreement - Buffington Texas Classic Homes, LLC between UMT Home Finance L.P. and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.6 to Form 10-K filed on March 31, 2010)
10.7
Loan Participation Agreement - Buffington Signature Homes, LLC between UMT Home Finance, L.P. and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.7 to Form 10-K filed on March 31, 2010)
10.8
Loan Participation Agreement between United Development Funding III, L.P. and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.1 to Form 10-Q filed on May 17, 2010)
10.9
Finished Lot Loan Agreement between HLL Land Acquisitions of Texas, LP and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.2 to Form 10-Q filed on May 17, 2010)
10.10
Revolving Credit Facility between Raley Holdings, LLC and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.3 to Form 10-Q filed on May 17, 2010)
10.11
Loan Participation Agreement between United Development Funding III, L.P. and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.4 to Form 10-Q filed on May 17, 2010)
10.12
Loan Agreement between PineTraceVillage, LLC and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.5 to Form 10-Q filed on May 17, 2010)
10.13
First Amendment to Advisory Agreement by and between United Development Funding IV and UMTH General Services, L.P. dated June 2, 2010 (previously filed in and incorporated by reference to Exhibit 10.1 to Form 8-K filed on June 4, 2010)
10.14
Secured Promissory Note by 165 Howe, LP for the benefit of United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.14 to Registrant’s Post-Effective Amendment No. 1 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 9, 2010)
10.15
Construction Loan Agreement between Cheldan MM, LLC and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.15 to Registrant’s Post-Effective Amendment No. 1 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 9, 2010)
10.16
Construction Loan Agreement between Buffington Signature Homes, LLC and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.16 to Registrant’s Post-Effective Amendment No. 1 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 9, 2010)
10.17
Construction Loan Agreement between Buffington Texas Classic Homes, LLC and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.17 to Registrant’s Post-Effective Amendment No. 1 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 9, 2010)
10.18
Secured Promissory Note by One Prairie Meadows, Ltd. for the benefit of United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.18 to Registrant’s Post-Effective Amendment No. 1 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 9, 2010)
10.19
Construction Loan Agreement between Crescent Estates Custom Homes, LP and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.19 to Registrant’s Post-Effective Amendment No. 1 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 9, 2010)
10.20
Secured Promissory Note by CTMGT Land Holdings, LP for the benefit of United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.20 to Registrant’s Post-Effective Amendment No. 1 to Registration Statement on Form S-11, Commission File No. 333-152760, filed on August 9, 2010)
10.21
Revolving Loan Agreement between Community Trust Bank and UDF IV Acquisitions, L.P. (previously filed in and incorporated by reference to Exhibit 10.2 to Form 10-Q filed on November 15, 2010)
10.22
Loan Purchase Agreement between FH 295, LLC and UDF IV Acquisitions, L.P. (previously filed in and incorporated by reference to Exhibit 10.3 to Form 10-Q filed on November 15, 2010)
10.23
Revolving Loan Agreement between United Texas Bank and UDF IV Finance I, L.P. (previously filed in and incorporated by reference to Exhibit 10.4 to Form 10-Q filed on November 15, 2010)
10.24
Extension Agreement between Raley Holdings, LLC and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.24 to Form 10-K filed on March 31, 2011)
10.25
Secured Promissory Note between HLL Land Acquisitions of Texas, LP and United Development Funding IV (previously filed in and incorporated by reference to Exhibit 10.25 to Form 10-K filed on March 31, 2011)
10.26
Loan Agreement among CTMGT Williamsburg, LLC, CTMGT, LLC, Centamtar Terras, L.L.C., and United Development Funding IV effective as of September 27, 2011 (previously filed in and incorporated by reference to Exhibit 10.1 to Form 10-Q filed on November 14, 2011)
10.27
Loan Agreement among CTMGT Williamsburg, LLC, CTMGT, LLC, Centamtar Terras, L.L.C., Mehrdad Moayedi, and United Development Funding IV Finance II, L.P., effective as of November 30, 2011 (previously filed in and incorporated by reference to Exhibit 10.27 to Form 10-K filed on March 30, 2012)
10.28
Guaranty of Payment by United Development Funding IV for the benefit of Babson Mezzanine Realty Investors II, L.P., effective as of December 30, 2011 (previously filed in and incorporated by reference to Exhibit 10.28 to Form 10-K filed on March 30, 2012)
10.29
Guaranty of Completion by United Development Funding IV for the benefit of Babson Mezzanine Realty Investors II, L.P., effective as of December 30, 2011 (previously filed in and incorporated by reference to Exhibit 10.29 to Form 10-K filed on March 30, 2012)
10.30
Second Extension Agreement between Raley Holdings, LLC and United Development Funding IV, effective as of February 5, 2012 (previously filed in and incorporated by reference to Exhibit 10.30 to Form 10-K filed on March 30, 2012)
10.31
Third Extension Agreement between Raley Holdings, LLC and United Development Funding IV, effective as of February 5, 2013 (previously filed in and incorporated by reference to Exhibit 10.31 to Form 10-K filed on April 1, 2013)
10.32
Employment Agreement between United Development Funding IV and Stacey H. Dwyer, dated February 21, 2014 (previously filed in and incorporated by reference to Exhibit 10.1 to Form 8-K/A filed on February 24, 2014)
10.33*
Restricted Stock Award Agreement between United Development Funding IV and Stacey H. Dwyer, dated February 21, 2014
21.1*
List of Subsidiaries
23.1*
Consent of Whitley Penn LLP, Independent Registered Public Accounting Firm
31.1*
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer
31.2*
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer
32.1**
Section 1350 Certifications
101.INS*
XBRL Instance Document
101.SCH*
XBRL Taxonomy Extension Schema Document
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*
XBRL Taxonomy Extension Label Linkbase Document
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*
XBRL Taxonomy Extension Definition Linkbase Document
* Filed herewith.
** Furnished herewith. In accordance with Item 601(b)(32) of Regulation S-K, this Exhibit is not deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Such certifications will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.