ITEM 1. BUSINESS (Continued)
Business Plan and Investment Policy (Continued)
operating expenses, the Company's management believes that such expenditures are necessary to maintain or enhance the value of the Company's properties.
The Company has determined that it will no longer seek to fund or acquire new mortgage loans. It may, however, originate mortgage loans in conjunction with providing purchase money financing of a property sale. The Company does intend, however, to service and hold for investment the mortgage notes currently in its portfolio. The Company also intends to pursue its rights vigorously with respect to mortgage notes that are in default. The Company's Articles of Incorporation impose no limitations on the Company's investment policy with respect to mortgage loans and do not prohibit the Company from investing more than a specified percentage of its assets in any one mortgage loan.
The Company's Board of Directors currently intends to continue its policy of prohibiting the Company from incurring aggregate secured and unsecured indebtedness in excess of 300% of the Company's net asset value (defined as the book value of all assets of the Company minus all of its liabilities); however, the Board of Directors may alter such policy at any time.
Management of the Company
Although the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by Basic Capital Management, Inc. ("BCM" or the "Advisor"), a contractual advisor under the supervision of the Company's Board of Directors. The duties of the Advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities, as well as financing and refinancing sources for the Company. The Advisor also serves as a consultant in connection with the Company's business plan and investment decisions made by the Company's Board of Directors.
BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Director of the Company until December 31, 1992. Mr. Phillips also served as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company. BCM is more fully described in ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor."
BCM has been providing advisory services to the Company since March 28, 1989. Renewal of BCM's advisory agreement with the Company was approved by the Company's stockholders at the Company's annual meeting of stockholders held on May 31, 1996. BCM also serves as advisor to
ITEM 1. BUSINESS (Continued)
Management of the Company (Continued)
Continental Mortgage and Equity Trust ("CMET") and Income Opportunity Realty Investors, Inc. ("IORI"). The Directors of the Company are also trustees or directors of CMET and IORI and the officers of the Company are also officers of CMET and IORI. Mr. Phillips is a general partner of Syntek Asset Management, L.P. ("SAMLP"), the general partner of National Realty, L.P. ("NRLP") and National Operating, L.P. ("NOLP"), the operating partnership of NRLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to American Realty Trust, Inc. ("ART"). Mr. Phillips served as Chairman of the Board and as a director of ART until November 16, 1992. Randall M. Paulson, President of the Company, also serves as President of BCM, CMET and IORI, Executive Vice President of ART, and as the President and sole director of Syntek Asset Management, Inc. ("SAMI"), which is the managing general partner of SAMLP. The officers of the Company are also officers of ART. As of March 7, 1997, the Company owned approximately 22.5% of IORI's outstanding shares of common stock and ART owned approximately 30.5% of the outstanding shares of the Company's Common Stock and approximately 29.6% of IORI's outstanding shares of common stock.
Since February 1, 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel Realty Services, Ltd. ("Carmel, Ltd.") provides such property management services. Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Company. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. ("SWI"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of 28 of the Company's commercial properties and its hotel and the commercial properties owned by a real estate partnership in which the Company and IORI are partners to Carmel Realty, Inc. ("Carmel Realty"), which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.
Carmel Realty is also entitled to receive real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement as discussed in ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor."
The Company has no employees. Employees of the Advisor render services to the Company.
Competition
The real estate business is highly competitive and the Company competes with numerous entities engaged in real estate activities (including certain entities described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions"), some of which may
ITEM 1. BUSINESS (Continued)
Competition (Continued)
have greater financial resources than those of the Company. The Company's management believes that success against such competition is dependent upon the geographic location of the property, the performance of property managers in areas such as marketing, collections and the ability to control operating expenses, the amount of new construction in the area and the maintenance and appearance of the property. Additional competitive factors with respect to commercial properties are the ease of access to the property, the adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rent levels. With respect to apartments, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the tenants. The Company's management believes that general economic circumstances and trends and new or renovated properties in the vicinity of each of the Company's properties are also competitive factors.
To the extent that the Company seeks to sell any of its properties, the sales prices for such properties may be affected by competition from other real estate entities and financial institutions also attempting to sell their properties located in areas in which the Company's properties are located.
As described above and in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions", the officers and Directors of the Company also serve as officers or trustees or directors of certain other entities, each of which is also advised by BCM, and each of which has business objectives similar to those of the Company. The Company's Directors, officers and Advisor owe fiduciary duties to such other entities as well as to the Company under applicable law. In determining to which entity a particular investment opportunity will be allocated, the officers, directors or trustees and the Advisor consider the respective investment objectives of each such entity and the appropriateness of a particular investment in light of each such entity's existing real estate portfolio. To the extent that any particular investment opportunity is appropriate to more than one of such entities, such investment opportunity will be allocated to the entity which has had funds available for investment for the longest period of time or, if appropriate, the investment may be shared among all or some of such entities.
In addition, as also described in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships," the Company also competes with other entities which are affiliates of the Advisor and which may have investment objectives similar to the Company's and that may compete with the Company in purchasing, selling, leasing and financing real estate and real estate related investments. In resolving any potential conflicts of interest which may arise, the Advisor has informed the Company that it intends to continue to exercise its best judgment as to what is fair and reasonable under the circumstances in accordance with applicable law.
ITEM 1. BUSINESS (Continued)
Certain Factors Associated with Real Estate and Related Investments
The Company is subject to all the risks incident to ownership and financing of real estate and interests therein, many of which relate to the general illiquidity of real estate investments. These risks include, but are not limited to, changes in general or local economic conditions, changes in interest rates and the availability of permanent mortgage financing which may render the acquisition, sale or refinancing of a property difficult or unattractive and which may make debt service burdensome, changes in real estate and zoning laws, increases in real estate taxes, federal or local economic or rent controls, floods, earthquakes, hurricanes and other acts of God and other factors beyond the control of the Company's management or Advisor. The illiquidity of real estate investments may also impair the ability of the Company to respond promptly to changing circumstances. The Company's management believes that such risks are partially mitigated by the diversification by geographic region and property type of the Company's real estate and mortgage notes receivable portfolios. However, to the extent new property investments are concentrated in any particular region, the advantages of geographic diversification may be mitigated.
ITEM 2.

ITEM 2. PROPERTIES
The Company's principal offices are located at 10670 North Central Expressway, Suite 300, Dallas, Texas 75231. In the opinion of the Company's management, the Company's offices are suitable and adequate for its present operations.
Details of the Company's real estate and mortgage notes receivable portfolios at December 31, 1996, are set forth in Schedules III and IV, respectively, to the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA." The discussions set forth below under the headings "Real Estate" and "Mortgage Loans" provide certain summary information concerning the Company's real estate and mortgage notes receivable portfolios.
The Company's real estate portfolio consists of properties held for investment, investments in real estate entities and properties held for sale, primarily obtained through foreclosure of the collateral securing mortgage notes receivable. The discussion set forth below under the heading "Real Estate" provides certain summary information concerning the Company's real estate and further summary information with respect to the Company's properties held for investment, properties held for sale and investments in real estate entities.
At December 31, 1996, none of the Company's properties, mortgage notes receivable or investments in real estate entities exceeded 10% or more of the Company's total assets. At December 31, 1996, 89% of the Company's assets consisted of properties held for investment, 1% consisted of properties held for sale, 3% consisted of mortgage notes and interest receivable and 2% consisted of investments in real estate entities. The remaining 5% of the Company's assets at December 31, 1996 were invested in cash, cash equivalents and other assets. The percentage of the Company's assets invested in any one category is
ITEM 2. PROPERTIES (Continued)
subject to change and no assurance can be given that the composition of the Company's assets in the future will approximate the percentages listed above.
The Company's real estate is geographically diverse. At December 31, 1996, the Company held investments in apartments and commercial properties in each of the geographic regions of the continental United States, although its apartments and commercial properties are concentrated in the Southeast and Southwest regions, as shown more specifically in the table under "Real Estate" below. At December 31, 1996, the Company held mortgage notes receivable secured by real estate located in each of the geographic regions, other than the Midwest, Mountain and Pacific regions, of the continental United States, with a concentration in the Southeast region, as shown more specifically in the table under "Mortgage Loans" below.
To continue to qualify for federal taxation as a REIT under the Code, the Company is required, among other things, to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year.
[THIS SPACE INTENTIONALLY LEFT BLANK.]
ITEM 2. PROPERTIES (Continued)
Geographic Regions
The Company has divided the continental United States into the following six geographic regions.
Northeast region comprised of the states of Connecticut, Delaware, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont, and the District of Columbia. The Company owns 3 apartments and 1 commercial property in this region.
Southeast region comprised of the states of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee and Virginia. This Company owns 3 apartments and 10 commercial properties in this region.
Southwest region comprised of the states of Arizona, Arkansas, Louisiana, New Mexico, Oklahoma and Texas. The Company owns 10 apartments and 9 commercial properties in this region.
Midwest region comprised of the states of Illinois, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, West Virginia and Wisconsin. The Company owns 3 commercial properties in this region.
Mountain region comprised of the states of Colorado, Idaho, Montana, Nevada, Utah and Wyoming. The Company owns 1 commercial property in this region.
Pacific region comprised of the states of California, Oregon and Washington. The Company owns 2 apartments, 1 hotel and 2 commercial properties in this region.
Excluded from the above are five parcels of unimproved land and a single family residence, as described below.
Real Estate
At December 31, 1996, over 90% of the Company's assets were invested in real estate. The Company invests in real estate located throughout the continental United States, either on a leveraged or nonleveraged basis. The Company's real estate portfolio consists of properties held for investment, investments in real estate entities and properties held for sale (which were primarily obtained through foreclosure of the collateral securing mortgage notes receivable).
Types of Real Estate Investments. The Company's real estate consists of commercial properties (a hotel, office buildings, industrial warehouses and shopping centers) and apartments or similar properties having established income-producing capabilities. In selecting new real estate investments, the location, age and type of property, gross rentals,
ITEM 2. PROPERTIES (Continued)
Real Estate (Continued)
lease terms, financial and business standing of tenants, operating expenses, fixed charges, land values and physical condition are among the factors considered. The Company may acquire properties subject to or assume existing debt and may mortgage, pledge or otherwise obtain financing for its properties. The Company's Board of Directors may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of stockholders.
Although the Company has typically invested in developed real estate, and has no current intentions to do otherwise, the Company may also invest in new construction or development either directly or in partnership with nonaffiliated parties or affiliates (subject to approval by the Company's Board of Directors). To the extent that the Company invests in construction and development projects, the Company would be subject to business risks, such as cost overruns and construction delays, associated with such higher risk projects.
At December 31, 1996 the Company had no properties on which significant capital improvements were in process.
In the opinion of the Company's management, the properties owned by the Company are adequately covered by insurance.
The following table sets forth the percentages, by property type and geographic region, of the Company's real estate (other than a hotel in the Pacific region and five parcels of unimproved land, as described below) at December 31, 1996.
The foregoing table is based solely on the number of apartment units and amount of commercial square footage owned by the Company and does not reflect the value of the Company's investment in each region. The Company also owns five parcels of unimproved land, parcels of 4.7 acres and 80 acres in the Southeast region and parcels containing 4.66 acres, 4.7 acres and .9976 acres in the Southwest region, all of which, except for the 4.7 acre parcel in the Southwest region, are held for sale or were under contract for sale at December 31, 1996. See Schedule III to the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" for a more detailed description of the Company's real estate portfolio.
ITEM 2. PROPERTIES (Continued)
Real Estate (Continued)
A summary of activity in the Company's owned real estate portfolio during 1996 is as follows:
Properties Held for Investment. Set forth below are the Company's properties held for investment and the monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1996, 1995 and 1994:
ITEM 2. PROPERTIES (Continued)
Real Estate (Continued)
- --------------- * Property was acquired in either 1996 or 1995.
Occupancy presented here and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.
In March 1994, the Company borrowed $1.4 million from a Northtown Mall tenant, secured by a second lien on the shopping center. The loan proceeds were used primarily for renovations and repairs to the shopping center. In October 1994, the tenant loaned the Company an additional $1.9 million, the proceeds of which were used in part to repay the first mortgage secured by the property. At funding of the second loan, the two loans were combined into a new first mortgage. The new first mortgage, in the amount of $3.3 million, matured December 31, 1995. In August 1996, the Company modified and extended the mortgage. In conjunction with the modification, the Company made $450,000 in principal paydowns to extend the loan's maturity date to March 31, 1997. The mortgage had a principal balance of $2.8 million at December 31, 1996 which the Company intends to pay off at maturity unless new financing is obtained.
ITEM 2. PROPERTIES (Continued)
Real Estate (Continued)
In January 1996, the Company purchased the Las Colinas land, a 4.7 acre parcel of partially developed land in Las Colinas, Texas, for $941,000 in cash. The parcel, within the Las Colinas Urban Center, is adjacent to developed office buildings. The Company paid a real estate brokerage commission of $38,000 to Carmel Realty and a real estate acquisition fee of $9,000 to BCM based on the $941,000 purchase price.
In May 1996, the Company refinanced the mortgage debt secured by Parkway Centre Shopping Center in Dallas, Texas in the amount of $1.8 million. The Company received net cash of $771,000 after the payoff of $735,000 in existing mortgage debt and the payment of various closing costs associated with the refinancing. The new mortgage bears interest at 9.5625% per annum, requires monthly payments of principal and interest of $16,024 and matures in June 2006. The Company paid a mortgage brokerage and equity refinancing fee of $18,000 to BCM based on the $1.8 million refinancing.
In July 1996, the Company refinanced the matured mortgage debt secured by the Westgate of Laurel Apartments in Laurel, Maryland in the amount of $7.7 million. The Company received net cash of $126,000 after the payoff of $7.2 million in existing mortgage debt and the payment of various closing costs and escrows associated with the refinancing. The new mortgage bears interest at 9.1875% per annum, requires monthly payments of principal and interest of $63,202 and matures in August 2006. The Company paid a mortgage brokerage and equity refinancing fee of $77,000 to BCM based upon the $7.7 million refinancing.
In August 1996, in a single transaction, the Company purchased the Arbor Point Apartments, a 195 unit apartment complex in Odessa, Texas, the Coventry Apartments, a 120 unit apartment complex in Midland, Texas, the Southgate Apartments, a 180 unit apartment complex in Odessa, Texas, and the Westwood Apartments, a 79 unit apartment complex in Odessa, Texas, for a total of $4.1 million in cash. The Company paid a real estate brokerage commission of $144,000 to Carmel Realty and a real estate acquisition fee of $41,000 to BCM based on the $4.1 million purchase price of the properties. In November 1996, the Company obtained mortgage financing in the amount of $2.0 million, on the unencumbered apartments. The Company received net cash of $1.7 million after paying various closing costs associated with the financing. The mortgage bears interest at a variable rate, currently at 8.5% per annum, requires monthly payments of principal and interest of $16,105 and matures December 1, 2001. The Company paid a mortgage brokerage and equity financing fee of $20,000 to BCM based on the $2.0 million financing.
In September 1996, as provided in the mortgage, the Company increased the mortgage principal balance on the Plaza Towers Office Building in
ITEM 2. PROPERTIES (Continued)
Real Estate (Continued)
St. Petersburg, Florida by $2.0 million. The Company received net cash of $1.9 million after paying various costs associated with the additional borrowing. The additional $2.0 million borrowing bears interest at a variable rate, currently 9.22% per annum, requires monthly payments of principal and interest of $18,741 and matures in May 2000. The Company paid a mortgage brokerage and equity refinancing fee of $20,000 to BCM based upon the $2.0 million mortgage increase.
In November 1996, the Company purchased the Carseka Apartments, a 54 unit apartment complex in Los Angeles, California, for $2.2 million in cash. The Company paid a real estate brokerage commission of $85,250 to Carmel Realty and a real estate acquisition fee of $21,750 to BCM based on the $2.2 million purchase price.
In January 1997, the Company refinanced the mortgage debt secured by 74 New Montgomery, an office building in San Francisco, California in the amount of $6.3 million. The Company received net cash of $1.0 million after the payoff of $5.2 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund a tax escrow and to pay various closing costs associated with the refinancing. The new mortgage bears interest at variable rate, currently 9.25% per annum, requires monthly principal and interest payments of $53,996 and matures in January 2004. The Company paid a mortgage brokerage and equity refinancing fee of $63,000 to BCM based on the $6.3 million refinancing.
Also in January 1997, the Company refinanced the mortgage debt secured by the Woods Edge Apartments in Rockville, Maryland in the amount of $6.2 million. The Company received no net cash. The refinancing proceeds being used to pay off $5.9 million in existing mortgage debt, to fund a tax escrow and to pay various closing costs associated with the refinancing. The new mortgage bears interest at 8.125% per annum, requires monthly payments of principal and interest of $46,035 and matures in February 2007. The Company paid a mortgage brokerage and equity refinancing fee of $62,000 to BCM based on the $6.2 million refinancing.
In February 1997, the Company refinanced the mortgage debt secured by the Spa Cove Apartments in Annapolis, Maryland in the amount of $12.2 million. The Company received net cash of $249,000 after the payoff of $11.6 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund a tax escrow and to pay various closing costs associated with the refinancing. The new mortgage bears interest at 8.015% per annum, requires monthly payments of principal and interest of $89,529 and matures in March 2007. The Company paid a mortgage brokerage and equity refinancing fee of $122,000 to BCM based on the $12.2 million refinancing.
In March 1997, the Company purchased the Terrace Hills Apartments, a 310 unit apartment complex in El Paso, Texas, for $6.2 million. The Company paid $1.4 million in cash and obtained new mortgage financing of $4.8 million. The mortgage bears interest at 8.07% per annum, requires monthly principal and interest payments of $35,086, and matures in April 2007. The Company paid a real estate brokerage commission of $193,000 to
ITEM 2. PROPERTIES (Continued)
Real Estate (Continued)
Carmel Realty and a real estate acquisition fee of $62,000 to BCM based upon the $6.2 million purchase price of the property.
Partnership Properties. Set forth below are the properties owned by partnerships which the Company accounts for using the equity method and the monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1996, 1995 and 1994:
The Company owns a combined 55% limited and general partnership interest in Jor-Trans Investors Limited Partnership ("Jor-Trans") which owns the Lincoln Court Apartments.
The Company owns a combined 63.7% limited and general partner interest and IORI owns a 36.3% general partner interest in Tri-City Limited Partnership ("Tri-City") which owns the five other properties in the table above. In 1996, the Company made $115,000 in advances to the partnership and received $532,000 in operating distributions from the partnership. See ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions."
Properties Held for Sale. Set forth below are the Company's properties held for sale, primarily obtained through foreclosure, and the average rental rate for a commercial property and occupancy thereof at December 31, 1996, 1995 and 1994.
ITEM 2. PROPERTIES (Continued)
Real Estate (Continued)
In January 1996, the Company sold the Cheyenne Mountain land, a 7 acre parcel of foreclosed unimproved land in Colorado Springs, Colorado, for $330,000 in cash. The Company recognized a gain of $218,000 on the sale.
In March 1996, the Company sold the Park Forest Apartments, a 44 unit foreclosed held for sale apartment complex in Dearborn Heights, Michigan, for $4.7 million. The Company received net cash of $1.6 million after paying off the existing mortgage debt of $2.9 million and the payment of various closing costs associated with the sale. The Company recognized a gain of $1.4 million on the sale. The Company paid a real estate sales commission of $160,000 to Carmel Realty based on the $4.7 million sales price.
In June 1996, the Company entered into a contract to sell Latham Square, a 106,067 square foot office building in Oakland, California, for $2.2 million in cash. The agreed sales price was $1.4 million less than the property's carrying value. Accordingly, at June 30, 1996, the Company recognized a provision for loss of $1.6 million to reduce the property's carrying value to its sales price less estimated costs of sale. In July 1996, the Company completed the sale receiving net cash of $2.0 million after the payment of various closing costs associated with the sale. The Company paid a real estate sales commission of $85,000 to Carmel Realty based upon the $2.2 million sales price. The Company incurred a loss on the sale of $64,000 in excess of the amount which had been previously provided.
In August 1996, the Company sold a 177 acre tract of the Moss Creek land, a 257 acre parcel of foreclosed land held for sale in Greensboro, North Carolina, for $750,000 in cash. The Company received net cash of $690,000 after paying various closing costs associated with the sale. The Company recognized a gain of $56,000 on the sale. In December 1996, the Company repurchased three lots in Moss Creek, in Greensboro, North Carolina that secured three of the Company's mortgage notes receivable, as more fully discussed under "Mortgage Loans," below.
As discussed more fully under "Mortgage Loans," below, in September 1996, the Company obtained through, trustee sale, a single family residence that secured one of the Company's mortgage notes receivable.
Also in September 1996, the Company sold the Byron land, a 522 acre parcel of foreclosed land held for sale in Greensboro, North Carolina, for $1.6 million in cash. The Company paid a real estate sales commission of $33,000 to Carmel Realty based on the $1.6 million sales price. The Company recognized a loss of $63,000 on the sale.
ITEM 2. PROPERTIES (Continued)
Real Estate (Continued)
At December 31, 1996, the Fiesta Mart, a 29,000 square foot shopping center in San Angelo, Texas, was under contract for sale. In February 1997, the Company completed the sale for $544,000 in cash. The Company received net cash of $403,000 after the payoff of $90,000 in existing mortgage debt and various closing costs associated with the sale. The Company paid a real estate sales commission of $22,000 to Carmel based upon the $544,000 sales price. The Company incurred no gain or loss on the sale.
Also at December 31, 1996, a .9976 acre parcel of land in Dallas, Texas, was under contract for sale. In February 1997, the Company completed the sale for $2.7 million in cash. The Company received net cash of $2.6 million after paying various closing costs associated with the sale. The Company will recognize a gain of approximately $1.3 million on the sale. The Company paid a real estate sales commission of $102,000 to Carmel Realty based on the $2.7 million sales price.
Mortgage Loans
In addition to investments in real estate, a substantial portion of the Company's assets are invested in mortgage notes receivable, principally secured by income-producing real estate. The Company expects that the percentage of its assets invested in mortgage loans will decrease, as it has determined that it will no longer seek to fund or acquire mortgage loans, other than those which it may originate in conjunction with providing purchase money financing of a property sale. The Company does intend, however, to service and hold for investment the mortgage notes currently in its portfolio. The Company's mortgage notes receivable consist of first, wraparound and junior mortgage loans.
Types of Mortgage Activity. In the past the Company has originated its own mortgage loans, as well as acquired existing mortgage notes either directly from builders, developers or property owners, or through mortgage banking firms, commercial banks or other qualified brokers. The Company is not considering new mortgage lending, except in connection with purchase money financing offered to facilitate the sale of Company owned properties. BCM, in its capacity as a mortgage servicer, services the Company's mortgage notes. The Company's investment policy is described in ITEM 1. "BUSINESS - Business Plan and Investment Policy."
Types of Properties Securing Mortgage Notes. The properties securing the Company's mortgage notes receivable portfolio at December 31, 1996, consisted of an office building, a shopping center, 3 apartment complexes, a hotel, 36.3 acres of commercial land, 9 developed residential lots and a 34,847 square foot parcel of unimproved land. The Company's Board of Directors may alter the types of properties securing or collateralizing mortgage loans in which the Company invests
ITEM 2. PROPERTIES (Continued)
Mortgage Loans (Continued)
without a vote of stockholders. The Company's Articles of Incorporation impose certain restrictions on transactions with related parties, as discussed in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS."
At December 31, 1996, the Company's mortgage notes receivable portfolio included 7 mortgage loans with an aggregate outstanding balance of $9.3 million secured by income-producing real estate located throughout the United States, 17 loans with an aggregate outstanding balance of $775,000 which are secured by collateral other than income-producing real estate and one unsecured note. At December 31, 1996,3% of the Company's assets were invested in notes and interest receivable (1% in first mortgage notes, 2% in wraparound mortgage notes and less than 1% in junior and other mortgage notes).
The following table sets forth the percentages (based on the outstanding mortgage note balance) by property type and geographic region, of the properties (other than a hotel and unimproved land) that serve as collateral for the Company's outstanding mortgage notes receivable at December 31, 1996. See Schedule IV to the Consolidated Financial Statements included at ITEM 8. "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" for further details of the Company's mortgage notes receivable portfolio.
A summary of the activity in the Company's mortgage notes receivable portfolio during 1996 is as follows:
During 1996, a mortgage note receivable of $825,000 was collected and $82,000 in mortgage principal payments were received.
At December 31, 1996, less than 1% of the Company's assets were invested in mortgage notes secured by non-income-producing real estate, comprised of a first mortgage note secured by 36.3 acres of commercial land in Maumelle, Arkansas, a first mortgage note secured by 34,847 square feet of unimproved land in Milwaukee, Wisconsin and nine first mortgage notes secured by developed residential lots in Greensboro, North Carolina.
First Mortgage Loans. The Company has invested in first mortgage notes, with short, medium or long-term maturities. First mortgage loans generally provide for level periodic payments of principal and interest
ITEM 2. PROPERTIES (Continued)
Mortgage Loans (Continued)
sufficient to substantially repay the loan prior to maturity, but may involve interest-only payments or moderate amortization of principal and a "balloon" principal payment at maturity. With respect to first mortgage loans, the Company's general policy was to require that the borrower provide a mortgagee's title policy or an acceptable legal title opinion as to the validity and the priority of the mortgage lien over all other obligations, except liens arising from unpaid property taxes and other exceptions normally allowed by first mortgage lenders in the relevant area. The Company may grant to other lenders, participations in first mortgage loans originated by the Company.
The following discussion briefly describes the events that affected previously funded first mortgage loans during 1996.
In February 1994, the Company provided $6.7 million of purchase money financing in conjunction with the sale of 1,406 acres of land in sixteen developed residential and commercial subdivisions located in Maumelle, Arkansas. The borrower did not make the scheduled February 1995 principal and interest payments. In September 1995, the Company reached a settlement with the borrower that provided the following: (i) the payment by the borrower of $2.5 million in cash; (ii) the Company's release of all land securing the note; (iii) the Company's acceptance of a new $1.4 million note secured by 36.3 acres of commercial land, such note bore interest at 9.0% and matured in January 1996 and (iv) the Company's receipt of 700,000 shares of the borrower's capital stock, which the borrower has the option to repurchase at $5.00 per share for two years from closing. The original sale had been recorded under the cost recovery method with gain being deferred until the note was collected. With the Company's receipt of $2.5 million in cash on September 12, 1995, it recognized $1.6 million of the gain previously deferred. The $1.4 million note was not paid at maturity. The Company is negotiating with the borrower in an effort to correct the default and has also instituted foreclosure proceedings. The Company does not expect to incur a loss on the note as the fair value of the property exceeds the nominal carrying value of the note.
In March 1996, the Company accepted a discounted payoff of $825,000 in settlement of a first mortgage note receivable with a principal balance of $875,000. The Company recorded no loss on the note settlement in excess of the reserve previously established.
In 1993, in conjunction with the sale of a foreclosed residence in Scottsdale, Arizona, the Company provided purchase money financing of $725,000 with a maturity date of August 1996. In January 1996, the borrower ceased making payments and in June 1996, filed for bankruptcy protection. In September 1996, the Company reacquired the property through trustee sale. The fair market value of the residence less, estimated costs of sale, exceeded the note's principal balance and accrued interest of $691,000 at the date the property was reacquired. See "Real Estate," above.
ITEM 2. PROPERTIES (Continued)
Mortgage Loans (Continued)
In December 1996, the Company repurchased three residential lots in Moss Creek, in Greensboro, North Carolina for $44,000 in cash and cancellation of mortgage each property secured. The buyer was unable to obtain the necessary building permits for the lots in the time required by his purchase contract. See "Real Estate," above.
Wraparound Mortgage Loans. A wraparound mortgage loan, sometimes called an all-inclusive loan, is a mortgage loan having an original principal balance equal to the outstanding balance under the prior existing mortgage loan(s) plus the amount actually advanced under the wraparound mortgage loan. Wraparound mortgage loans may provide for full, partial or no amortization of principal. The Company's policy was to make wraparound mortgage loans in amounts and on properties as to which it would otherwise make first mortgage loans.
The Company did not originate or acquire any wraparound mortgage loans in 1996.
Junior Mortgage Loans. The Company has invested in junior mortgage loans. Such loans are secured by mortgages that are subordinate to one or more prior liens either on the fee or a leasehold interest in real estate. Recourse on such loans ordinarily includes the real estate on which the loan is made, other collateral and personal guarantees by the borrower. The Company's Board of Directors restricts investment in junior mortgage loans, excluding wraparound mortgage loans, to not more than 10% of the Company's assets. At December 31, 1996, less than 1% of the Company's assets were invested in junior mortgage loans.
The Company did not originate or acquire any junior mortgage loans in 1996.
Loans Secured by Collateral Other than Real Estate. In June 1992, the Company received ten notes receivable secured by collateral other than real estate in satisfaction of a $622,000 obligation to the Company. At December 31, 1996, five of the notes with a combined principal balance of $374,000 remained outstanding. The Company's investment policy precludes the origination of loans secured by collateral other than real estate. In June 1996, the Company wrote off a mortgage note receivable with a balance of $47,000. The Company recorded no loss in excess of the reserve previously established. In July 1996, the Company received $4,000 in settlement of a note receivable with a principal balance of $20,000. The Company recorded no loss on the settlement in excess of the reserve previously established.
Partnership mortgage loans. The Company owns a 60% general partner interest and IORI owns a 40% general partner interest in Nakash Income Associates ("NIA"). NIA in turn owns a wraparound mortgage note receivable. In 1996, the partnership extended the maturity date to April 1, 1997, of the underlying note payable secured by a building occupied by a Wal-Mart in Maulden, Missouri.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
Olive Litigation
In February 1990, the Company, together with CMET, IORI and National Income Realty Trust ("NIRT"), three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Company, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., in the United States District Court for the Northern District of California relating to the operation and management of each of such entities. On April 23, 1990, the Court granted final approval of the terms of the settlement.
On May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the "Modification") which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the Court on July 1, 1994 and final Court approval of the Modification was entered on December 12, 1994. The effective date of the Modification was January 11, 1995.
The Modification, among other things, provided for the addition of new unaffiliated members to the Company's Board of Directors and set forth new requirements for the approval of any transactions with affiliates until April 28, 1999. In addition, BCM, the Company's advisor, Gene E. Phillips and William S. Friedman, who served as President and Director of the Company until February 24, 1994, President of BCM until May 1, 1993 and director of BCM until December 22, 1989, agreed to pay a total of $1.2 million to CMET, IORI, NIRT and the Company, of which the Company's share was $150,000.
Under the Modification, the Company, CMET, IORI and NIRT and their stockholders released the defendants from any claims relating to the plaintiffs' allegations. The Company, CMET, IORI and NIRT also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Company held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all then current members of the Company's Board of Directors that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new members of the Company's Board of Directors appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.
Pursuant to the terms of the Modification, certain related party transactions which the Company may enter into prior to April 28, 1999, require the unanimous approval of the Company's Board of Directors. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Company's Board of Directors that the transaction is in the best interests of the Company and that no other opportunity exists that is as good as the opportunity presented by such transaction.
ITEM 3. LEGAL PROCEEDINGS (Continued)
Olive Litigation (Continued)
For purposes of the Modification requirements, the term "related party transaction" means and includes: (i) any transaction between or among the Company or CMET, IORI or NIRT or any of their affiliates or subsidiaries; (ii) any transaction between or among the Company, its affiliates or subsidiaries and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and (iii) any transaction between or among the Company or any of its affiliates or subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates has an ongoing or contemplated business or financial transaction or relationship of any kind, whether direct or indirect, or has had such a transaction or relationship in the preceding one year.
The Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Company and the Advisor or one of its affiliates (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements require the prior approval by two-thirds of the Directors of the Company, and if required, approval by a majority of the Company's stockholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Company and CMET, IORI or NIRT or any of their affiliates or subsidiaries and a third party having no prior or intended future business or financial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Directors of the Company.
The Modification also terminated a number of the provisions of the settlement, including the requirement that the Company, CMET, IORI and NIRT maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The Court retained jurisdiction to enforce the Modification, and during August and September 1996, the Court held evidentiary hearings to assess compliance with the terms of the Modification by various parties. The Court issued no ruling or order with respect to the matters addressed at the hearings.
Separately, in 1996, legal counsel for the plaintiffs notified the Company's Board of Directors that he intends to assert that certain actions taken by the Board of Directors breached the terms of the Modification. On January 27, 1997, the parties entered into an Amendment to the Modification effective January 9, 1997 (the "Amendment"), which was submitted to the Court for approval on January 29, 1997. The Amendment provides for the settlement of all matters raised at the evidentiary hearings and by plaintiffs' counsel in his notices to the Company's Board of Directors. As of March 20, 1997, the Court had taken no action on the Amendment.
The Amendment provides for the addition of three new unaffiliated members to the Company's Board of Directors and sets forth new requirements for the approval of any transactions with certain affiliates until April 28, 1999. In addition, the Company, CMET, IORI and their stockholders released the defendants from any claims relating
ITEM 3. LEGAL PROCEEDINGS (Continued)
Olive Litigation (Continued)
to the plaintiffs' allegations and matters which were the subject of the evidentiary hearings. The plaintiffs' allegations of any breaches of the Modification shall be settled by mutual agreement of the parties or, lacking such agreement, by an arbitration proceeding.
Under the Amendment, all shares of the Company owned by Mr. Phillips or any of his affiliates shall be voted at all stockholders' meetings held until April 28, 1999 in favor of all new members of the Company's Board of Directors added under the Amendment. The Amendment also requires that, until April 28, 1999, all shares of the Company owned by Mr. Phillips or his affiliates in excess of forty percent (40%) of the Company's outstanding shares shall be voted in proportion to the votes cast by all non-affiliated stockholders of the Company.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
______________________________
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange ("NYSE") using the symbol "TCI". The following table sets forth the high and low sales prices as reported in the consolidated reporting system of the NYSE.
* Restated for the three for two forward stock split effected February 15, 1996.
As of March 7, 1997, the closing price of the Company's Common Stock as report in the consolidated reporting system of the NYSE was $11.00 per share.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (Continued)
As of March 7, 1997, the Company's Common Stock was held by 6,148 holders of record.
In November 1995 the Company's Board of Directors approved the Company's resumption of the payment of regular quarterly dividends. The Company paid dividends in 1996 and 1995 as follows:
* Restated for the three for two forward stock split effected February 15, 1996.
The Company reported to the Internal Revenue Service that 100% of the dividends paid in 1996 and 1995 represented a return of capital.
On December 5, 1989, the Company's Board of Directors approved a share repurchase program. The Company's Board of Directors has authorized the Company to repurchase a total of 687,000 shares of its Common Stock pursuant to such program. Through March 7, 1997, the Company has repurchased 350,588 shares pursuant to such program at a cost to the Company of $1.7 million. None of such shares were repurchased in 1996 or 1997.
In August 1996, the Company announced an offer to buy back shares of its Common Stock from stockholders owning 99 or fewer shares. The Company paid a premium of $.50 per share over the average closing price of its shares as reported in the consolidated reporting system of the NYSE from August 8, 1996 through September 30, 1996, the expiration date of the offer. On October 17, 1996, the Company repurchased 85,830 of its shares pursuant to such offer, at a total cost of $903,790.
On March 24, 1989, the Company distributed one share purchase right for each outstanding share of the Company's Common Stock. The rights were terminated effective March 24, 1992 upon the Company's Board of Directors having determined that the rights were no longer necessary to protect the Company from coercive tender offers. In connection with this determination, Messrs. Phillips and Friedman and their affiliates agreed not to acquire more than 49% of the outstanding shares of the Company's Common Stock without prior action by the Company's Independent Directors to the effect that they do not object to such increased ownership.
In August 1994, the Company's Board of Directors reviewed the limitation and determined that, due to the fact that Mr. Friedman is no longer affiliated with the stockholder group, and had disposed of any shares of the Company's Common Stock which he or his affiliates may have owned,
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (Continued)
the limitation should no longer apply to Mr. Friedman or his affiliates. On August 23, 1994, the Company's Board of Directors adopted a resolution to the effect that in determining total ownership, shares of the Company's Common Stock owned by Mr. Friedman and his affiliates are no longer to be included. As of March 7, 1997, Mr. Phillips and his affiliates, primarily ART, owned approximately 43.4% of the Company's outstanding shares of Common Stock.
On March 21, 1996, the Company's Board of Directors reconsidered the share ownership limitation and determined that there was no reason to object to the purchase by Mr. Phillips and his affiliates of additional shares in excess of 49% of the Company's outstanding shares of Common Stock. Accordingly, there is no longer any limitation on the percentage of shares of Common Stock of the Company which may be acquired by Mr. Phillips and his affiliates.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
ITEM 6. SELECTED FINANCIAL DATA
Shares and per share data have been restated for the three for two forward stock split effected February 15, 1996.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
Transcontinental Realty Investors, Inc. (the "Company") invests in real estate through acquisitions, leases and partnerships and in mortgage loans on real estate, including first, wraparound and junior mortgage loans. The Company is the successor to a California business trust organized on September 6, 1983 which commenced operations on January 31, 1984.
Liquidity and Capital Resources
Cash and cash equivalents at December 31, 1996 aggregated $1.0 million compared with $9.6 million at December 31, 1995. The principal reasons for this decrease in cash are discussed in the paragraphs below.
The Company's principal sources of cash have been and will continue to be from property operations, proceeds from property sales, the collection of mortgage notes receivable, borrowings and to a lesser extent, distributions from partnerships. The Company expects that its cash balance at December 31, 1996, and cash that will be generated in 1997 from the collection of mortgage notes receivable, sales of properties, an insurance settlement received in January 1997, borrowings against certain of the Company's unencumbered properties and refinancing or extension of certain of its mortgage debt will be sufficient to meet all of the Company's cash requirements, including debt service obligations coming due in 1997, dividend payments and property maintenance and improvements, as more fully discussed in the paragraphs below.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
The Company's cash flow from property operations (rents collected less payments for property operating expenses) has increased over the last three years from $8.6 million and $15.3 million in 1994 and 1995 to $12.6 million in 1996. Of this $4.0 million net increase from 1994 to 1996, $3.3 million is the result of the Company having acquired additional income producing properties, both through purchase and foreclosure, and the remaining $700,000 of the increase is due to increased occupancy and rents, at its apartments and commercial properties, and the Company's control of operating expenses. The Company's management believes that this trend will continue as a result of increased rental rates at both the Company's apartments and commercial properties and increased occupancy at its commercial properties.
The Company owns a combined 63.7% limited and general partner interest in Tri-City Limited Partnership which owns five properties in Texas. In 1996, the Company received net distributions of $417,000 from the partnership. See NOTE 5. "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."
In October 1996, the Company received a $1.5 million settlement from one of the defendants in a lawsuit brought by the Company against the former owners of an office building in New Jersey and their agents. The Company had made a loan secured by the building in 1987 and filed a foreclosure action which was subsequently amended in 1990, to include claims of negligent misrepresentation against the borrowers, their legal counsel, architect and engineers.
In 1996, the Company received cash of $907,000 from the payoff or collection of mortgage notes receivable. The Company also received a total of $13.6 million from new mortgage financings and refinancings and $6.0 million net of debt payoff from property sales during 1996. In 1996, the Company expended $7.0 million in cash on property acquisitions and made a total of $11.6 million in principal payoffs or paydowns on its mortgage debt.
Scheduled principal payments on notes payable of $19.6 million are due in 1997. It is the Company's intention to either pay the mortgages that mature in 1997 when due, or seek to extend the due dates one or more years, or refinance the debt on a long-term basis. The Company's management believes it will continue to be successful in obtaining loan extensions or refinancings.
As discussed in NOTE 3. "REAL ESTATE AND DEPRECIATION," also during 1996 the Company funded $3.1 million for operating cash flow deficits of the Republic Towers Office Building in Dallas, Texas due to minimal occupancy and operating expenses far exceeding rents. The Company expects to fund a greater amount for this property in 1997 for tenant and capital improvements. In January 1997, the Company received a final insurance settlement totaling $10.0 million from 1995 hail storm and flood damage to the Republic Towers Office Building in Dallas, Texas.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
In January and February 1997, the Company refinanced the mortgage debt secured by three of its properties, totaling $22.5 million of which $11.0 million was scheduled to mature in 1996, receiving net refinancing proceeds of $1.2 million and sold two other of its properties receiving net cash of $3.1 million. In March 1997, the Company purchased an apartment complex, expending net cash of $1.4 million. See NOTE 17. "SUBSEQUENT EVENTS."
In August 1996, the Company announced an offer to buy back shares of its Common Stock from stockholders owning 99 or fewer shares. The Company paid a premium of $.50 per share over the average closing price of its shares as reported in the consolidated reporting system of the New York Stock Exchange from August 8, 1996 through September 30, 1996, the expiration date of the offer. On October 17, 1996, the Company repurchased 85,830 of its shares pursuant to such offer, at a total cost of $903,790.
Pursuant to a repurchase program originally announced by the Company on December 5, 1989, the Company's Board of Directors has authorized the repurchase of a total of 687,000 shares of the Company's Common Stock. As of March 7, 1997, the Company had purchased 350,588 shares of its Common Stock at a total cost to the Company of $1.7 million. None of such shares were repurchased in 1996 or 1997.
During 1996, the Company declared and paid dividends of $1.1 million or $.28 per share.
The Company's management reviews the carrying values of the Company's properties and mortgage note receivable at least annually and whenever events or a change in circumstances indicate that impairment may exist. Impairment is considered to exist if, in the case of a property, the future cash flow from the property (undiscounted and without interest) is less than the carrying amount of the property. For notes receivable impairment is considered to exist if it is probable that all amounts due under the terms of the note will not be collected. In those instances where impairment is found to exist, a provision for loss is recorded by a charge against earnings. The Company's mortgage note receivable review includes an evaluation of the collateral property securing such note. The property review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of maintenance requirements, a review of the property's cash flow, discussions with the manager of the property and a review of properties in the surrounding area.
Results of Operations
1996 compared to 1995. The Company's net loss for 1996 was $7.8 million compared to a net loss of $3.7 million in 1995. The Company's 1996 net loss includes gains on sale of real estate of $1.6 million and extraordinary gains of $256,000. The Company's 1995 net loss includes gains on sale of real estate of $5.8 million and extraordinary gains of $1.4 million. Fluctuations in the components of the Company's revenues and expenses between the 1996 and 1995 are described below.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Rents decreased $1.4 million in 1996 to $45.4 million compared to $46.8 million in 1995. A decrease of $5.3 million in rents is due to properties sold in 1995 and 1996. Offsetting this decrease in rents is an increase of $538,000 due to the acquisition of the remaining partnership interest in three partnerships in 1995; $926,000 is due to property acquisitions in late 1995 and 1996; and $2.4 million is due to increases in occupancy at several of the Company's commercial properties primarily: Corporate Center at Beaumeade Industrial Warehouse, a 29% increase; Park Long Industrial Warehouse, a 9% increase; Plaza Towers Office Building, a 6% increase; and 74 New Montgomery Office Building, a 3% increase.
Property operating expenses decreased $1.7 million in 1996 to $28.5 million as compared to $30.2 million in 1995. Of this decrease, $3.1 million is due to properties sold. This decrease is partially offset by increases of $935,000 due to property acquisitions and $544,000 due to the acquisition of the remaining partnership interest in three partnerships in 1995.
Rents and property operations expenses both are expected to increase in 1997 due to anticipated increases in rents at the Company's apartments and increased occupancy of its commercial properties as a result of a full year of operations of the properties acquired during 1996 and in the first quarter of 1997.
Interest income for 1996 of $1.5 million approximated the $1.5 million in 1995, and is expected to remain constant in 1997.
Interest expense decreased to $15.0 million in 1996 as compared to $16.1 million in 1995. Of this decrease, $1.7 million due to properties sold and mortgages paid off. This decrease is partially offset by increases of $180,000 attributable to the acquisition of the remaining partnership interests in three partnerships during 1995, $107,000 attributable to properties acquired in 1996, $488,000 attributable to property financings and refinancings during 1996, and $107,000 attributable to increases in the interest rates on variable rate mortgage debt. Interest expense is expected to increase in 1997 due to anticipated property refinancings and the property acquired in the first quarter of 1997.
Depreciation expense decreased to $8.5 million in 1996 as compared to $8.6 million in 1995. An increase of $36,000 is attributable to the acquisition of the remaining partnership interests in three partnerships during 1995, an increase of $57,000 is attributable to property acquisitions and an increase of $570,000 is due to increased depreciation from property additions and tenant improvements. These increases were more than offset by a decreases of $645,000 due to properties sold and $179,000 due to assets becoming fully depreciated. Depreciation expense is expected to increase in 1997 due to a full year of depreciation of properties acquired in 1996 and the property acquired in the first quarter of 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
The advisory fee of $1.8 million in 1996 was comparable to the $1.8 million in 1995. Such fee is expected to increase as the Company's average asset base increases. See NOTE 9. "ADVISORY AGREEMENT."
General and administrative expenses increased to $2.7 million in 1996 from $2.0 million in 1995. The increase is due to an increase in legal fees related to the Olive litigation (see NOTE 15. "COMMITMENTS AND CONTINGENCIES") and increased advisory cost reimbursements.
As described in "Liquidity and Capital Resources" above, in 1996 and 1995 the Company received litigation settlements of $1.5 million and $500,000, respectively.
In the second quarter of 1996, the Company recognized a provision for loss of $1.6 million to reduce the carrying value of an office building to its agreed sales price less estimated costs of sale. Sale of the property was completed in July 1996. No provision for loss was recognized in 1995.
Equity in losses of investees was $20,000 in 1996 compared to $1.1 million in 1995. The decreased equity loss is primarily due to the 1995 modification of a wraparound mortgage note receivable and underlying note payable by Nakash Income Associates ("NIA"), a partnership in which the Company has a 60% general partner interest, and the writedown of a wraparound mortgage note receivable to the balance of an underlying first lien mortgage also by NIA. The Company's equity share of the loss on the note modification was $127,000 and its equity share of the note writedown was $901,000. See NOTE 5. "INVESTMENTS IN EQUITY METHOD REAL ESTATE ENTITIES." The Company expects its share of equity investees' income or losses to be insignificant in 1997.
The Company recognized extraordinary gains totaling $256,000 in 1996 on the modification of the mortgage debt secured by the Dunes Plaza Shopping Center. See NOTE 14. "EXTRAORDINARY GAIN." In 1995, the Company recognized extraordinary gains totaling $1.4 million on the payoff of the mortgage debt secured by the Fountain Village Apartments and a principal pay down and modification of the mortgage debt secured by the Dunes Plaza Shopping Center.
In 1996, the Company recognized gains of $218,000, $1.4 million and $56,000 from the sales of Cheyenne Mountain land, Park Forest Apartments and Moss Creek land. In September 1996, the Company recognized a loss of $63,000 from the sale of Byron land. In 1995, the Company recognized a gain of $1.6 million on the collection of the note receivable secured by the Maumelle land and a gain of $4.1 million on the sale of the Summerchase Apartments. See NOTE 3. "REAL ESTATE AND DEPRECIATION."
1995 compared to 1994. The Company's net loss for 1995 was $3.7 million compared to a net loss of $3.4 million in 1994. The Company's 1995 net loss includes extraordinary gains of $1.4 million and a gain on sale of real estate of $5.8 million and its 1994 net income includes a gain on
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
sale of partnership interests of $2.5 million, a gain on sale of real estate of $2.2 million and an extraordinary gain of $1.2 million. Fluctuations in the components of the Company's revenues and expenses between the 1994 and 1995 are described below.
Rents increased $10.3 million in 1995 compared to 1994. Of this increase in rents, $4.5 million is due to the acquisition of the remaining partnership interest in three partnerships in 1995; $5.1 million is due to property acquisitions in late 1994; and $1.6 million is due to increases in occupancy at several of the Company's commercial properties: Chesapeake Ridge Office Building, a 24% increase; Forum Office Building, a 10% increase; President's Square Shopping Center, a 19% increase; and 74 New Montgomery Office Building, a 41% increase. These increases are partially offset by a decrease of $1.1 million in rents due to properties sold.
Property operating expenses increased $3.3 million in 1995 as compared to 1994. Of this increase, $2.1 million is due to the acquisition of the remaining partnership interest in three partnerships in 1995 and $3.8 million is due to property acquisitions in late 1994. These increases are partially offset by a decrease of $1.6 million due to decreases in replacements, utilities and administrative expenses, primarily at Republic Towers Office Building as well as a decrease of $800,000 due to the buyout of a tenant lease in 1994, and a decrease of $524,000 due to property sales.
Interest income for 1995 of $1.5 million was comparable to the $1.5 million in 1994.
Interest expense increased to $16.1 million in 1995 as compared to $10.6 million in 1994. Of this increase, $1.8 million is attributable to the acquisition of the remaining partnership interests in three partnerships during 1995, $1.9 million is attributable to properties acquired in late 1994, $1.8 million is attributable to property financings and refinancings during 1995, and $459,000 is attributable to increases in the interest rates on variable rate mortgage debt. These increases are partially offset by a decrease of $431,000 due to properties sold.
Depreciation expense increased to $8.6 million in 1995 as compared to $6.1 million in 1994. An increase of $638,000 is attributable to the acquisition of the remaining partnership interests in three partnerships during 1995, an increase of $787,000 is attributable to properties acquired in late 1994 and an increase of $1.3 million is due to increased depreciation from property additions and tenant improvements. These increases are partially offset by a decrease of $230,000 due to properties sold and $84,000 due to assets becoming fully depreciated.
The advisory fee increased to $1.8 million in 1995 as compared to $1.7 million in 1994. The increase is due to the increase in the Company's gross assets, the basis for such fee.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
General and administrative expenses increased to $2.0 million in 1995 from $1.8 million in 1994. The increase is due to an increase in advisory cost reimbursements.
Equity in losses of investees was $1.1 million in 1995 compared to $90,000 in 1994. The increased equity loss is primarily due to the modification of a wraparound mortgage note receivable and underlying note payable by Nakash Income Associates ("NIA"), a partnership in which the Company has a 60% general partner interest, and the writedown of a wraparound mortgage note receivable to the balance of an underlying first lien mortgage also by NIA. The Company's equity share of the loss on the note modification was $127,000 and its equity share of the note writedown was $901,000. See NOTE 5. "INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES."
In 1995 the Company received a litigation settlement of $500,000. Also in 1995, the Company recognized a gain of $1.6 million on the collection of the note receivable secured by the Maumelle land and a gain of $4.1 million on the sale of the Summerchase Apartments. See NOTE 2. "NOTES AND INTEREST RECEIVABLE" and NOTE 3. "REAL ESTATE AND DEPRECIATION."
The Company recognized extraordinary gains totaling $1.4 million in 1995, on the payoff of the mortgage debt secured by the Fountain Village Apartments and a principal pay down and modification of the mortgage debt secured by the Dunes Plaza Shopping Center. See NOTE 6. "NOTES PAYABLE." In 1994, the Company recognized a gain of $2.5 million on the sale of its interests in two partnerships and a gain of $2.2 million on the sale of Cedar Creek Apartments, and an extraordinary gain of $1.2 million on the disposition of a limited partnership interest.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and regulations, the Company may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos-containing materials into the air, and third parties may seek recovery from the Company for personal injury associated with such materials.
The Company's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Company's business, assets or results of operations.
Inflation
The effects of inflation on the Company's operations are not quantifiable. Revenues from property operations fluctuate proportion-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Inflation (Continued)
ately with inflationary increases and decreases in housing costs. Fluctuations in the rate of inflation also affect sale values of properties, and correspondingly, the ultimate realizable value of the Company's real estate and notes receivable portfolios. Inflation also has an effect on the Company's earnings from short-term investments.
Tax Matters
For the years 1996, 1995 and 1994, the Company elected and in the opinion of the Company's management, qualified to be taxed as a Real Estate Investment Trust ("REIT") as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"). To continue to qualify for federal taxation as a REIT under the Code, the Company is required to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year. The Code also requires a REIT to distribute at least 95% of its REIT taxable income, plus 95% of its net income from foreclosure property, all as defined in Section 857 of the Code, on an annual basis to stockholders.
Recent Accounting Pronouncement
In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 121 - "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of". The statement requires that long-lived assets be considered impaired "...if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset." If impairment exists, an impairment loss shall be recognized, by a charge against earnings, equal to "...the amount by which the carrying amount of the asset exceeds the fair value of the asset." If impairment of a long-lived asset is recognized, the carrying amount of the asset shall be reduced by the amount of the impairment, shall be accounted for as the asset's "new cost" and such new cost shall be depreciated over the asset's remaining useful life.
SFAS No. 121 further requires that long-lived assets held for sale "...be reported at the lower of carrying amount or fair value less cost to sell." If a reduction in a held for sale asset's carrying amount to fair value less cost to sell is required, a provision for loss shall be recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale asset's fair value less cost to sell shall be recorded as an adjustment to the asset's carrying amount, but not in excess of the asset's carrying amount when originally classified as held for sale. A corresponding charge or credit to earnings is to be recognized. Long-lived assets held for sale are not to be depreciated. The Company adopted 121 effective January 1, 1996.
The effect of adopting SFAS No. 121 was the discontinuance of depreciation of the Company's properties held for sale of $91,000 and a corresponding reduction in the Company's reported net loss.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
All other schedules are omitted because they are not required, are not applicable or the information required is included in the Consolidated Financial Statements or the notes thereto.
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors of Transcontinental Realty Investors, Inc.
We have audited the accompanying consolidated balance sheets of Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 1996 and 1995 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. We have also audited the schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedules. We believe 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 Transcontinental Realty Investors, Inc. and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Also, in our opinion, the schedules referred to above present fairly, in all material respects, the information set forth therein.
BDO Seidman, LLP
Dallas, Texas March 20, 1997
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying Consolidated Financial Statements of Transcontinental Realty Investors, Inc. and consolidated entities (the "Company") have been prepared in conformity with generally accepted accounting principles, the most significant of which are described in NOTE 1. "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES." These, along with the remainder of the Notes to Consolidated Financial Statements, are an integral part of the Consolidated Financial Statements. The data presented in the Notes to Consolidated Financial Statements are as of December 31 of each year and for the year then ended, unless otherwise indicated. Dollar amounts in tables are in thousands, except per share amounts.
Certain balances for 1995 and 1994 have been reclassified to conform to the 1996 presentation. Shares and per share data have been restated for the three for two forward stock split effected February 15, 1996.
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Company business. Transcontinental Realty Investors, Inc. ("TCI"), a Nevada corporation, is successor to a California business trust which was organized on September 6, 1983 and commenced operations on January 31, 1984. The Company invests in real estate through direct equity ownership and investments in real estate entities. It also has invested in mortgage loans on real estate, including first, wraparound and junior mortgage loans.
Basis of consolidation. The Consolidated Financial Statements include the accounts of TCI and subsidiaries and partnerships which it controls. All intercompany transactions and balances have been eliminated.
Accounting estimates. In the preparation of the Company's Consolidated Financial Statements in conformity with generally accepted accounting principles it was necessary for the Company's management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expense for the year then ended. Actual results could differ from these estimates.
Interest recognition on notes receivable. It is the Company's policy to cease recognizing interest income on notes receivable that have been delinquent for 60 days or more. In addition, accrued but unpaid interest income is only recognized to the extent that the net realizable value of the underlying collateral exceeds the carrying value of the receivable.
Allowance for estimated losses. Valuation allowances are provided for estimated losses on notes receivable considered to be impaired. Impairment is considered to exist when it is probable that all amounts due under the terms of the note will not be collected. Valuation allowances are provided for estimated losses on notes receivable to the
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
extent that the Company's investment in the note exceeds the Company's estimate of net realizable value of the collateral securing such note, or fair value of the collateral if foreclosure is probable.
Real Estate Held for Investment and Depreciation. Real estate held for investment is carried at cost. Statement of Financial Accounting Standards No. 121 ("SFAS No. 121") requires that a property be considered impaired, if the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property. If impairment exists, an impairment loss is recognized, by a charge against earnings, equal to the amount by which the carrying amount of the property exceeds the fair value of the property. If impairment of a property is recognized, the carrying amount of the property is reduced by the amount of the impairment, and a new cost for the property is established. Such new cost is depreciated over the property's remaining useful life. Depreciation is provided by the straight-line method over estimated useful lives, which range from 3 to 40 years.
Real Estate Held for Sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair value minus estimated costs of sale. SFAS No. 121 also requires that properties held for sale be reported at the lower of carrying amount or fair value less costs of sale. If a reduction in a held for sale property's carrying amount to fair value less costs of sale is required, a provision for loss shall be recognized by a charge against earnings. Subsequent revisions, either upward or downward, to a held for sale property's estimated fair value less costs of sale is recorded as an adjustment to the property's carrying amount, but not in excess of the property's carrying amount when originally classified as held for sale. A corresponding charge against or credit to earnings is recognized. Properties held for sale are not to be depreciated.
Present value discounts. The Company provides for present value discounts on notes receivable or payable that have interest rates that differ substantially from prevailing market rates and amortizes such discounts by the interest method over the lives of the related notes. The factors considered in determining a market rate for notes receivable include the borrower's credit standing, nature of the collateral and payment terms of the note.
Revenue recognition on the sale of real estate. Sales of real estate are recognized when and to the extent permitted by Statement of Financial Accounting Standards No. 66, "Accounting for Sales of Real Estate" ("SFAS No. 66"). Until the requirements of SFAS No. 66 for full profit recognition have been met, transactions are accounted for using either the deposit, the installment, the cost recovery or the financing method, whichever is appropriate.
Investment in noncontrolled partnerships and equity investees. The Company uses the equity method to account for investments in partner-
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
ships which it does not control and for its investment in the shares of common stock of Income Opportunity Realty Investors, Inc., formerly Income Opportunity Realty Trust (collectively "IORI"). Under the equity method, the Company's initial investment, recorded at cost, is increased by the Company's proportionate share of the investee's operating income and additional advances and decreased by the Company's proportionate share of the investee's operating losses and distributions received.
Fair value of financial instruments. The Company used the following assumptions in estimating the fair value of its notes receivable, marketable equity securities and notes payable. For performing notes receivable, the fair value was estimated by discounting future cash flows using current interest rates for similar loans. For nonperforming notes receivable, the estimated fair value of the Company's interest in the collateral property was used. For marketable equity securities, fair value was based on the year end closing market price of the security. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities.
Cash equivalents. For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Earnings per share. Loss per share is computed based upon the weighted average number of shares of Common Stock outstanding during each year adjusted for the three for two forward stock split effected February 15, 1996.
NOTE 2. NOTES AND INTEREST RECEIVABLE
Notes and interest receivable consisted of the following:
The Company recognizes interest income on nonperforming notes receivable on a cash basis only. For the years 1996, 1995 and 1994, unrecognized interest income on nonperforming notes receivable aggregated $424,000, $231,000 and $256,000, respectively.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)
Notes receivable at December 31, 1996, mature from 1997 through 2016 with interest rates ranging from 3.9% to 12.5%, with a weighted average rate of 12.23%. Discounts are based on imputed interest rates of 10.0%. Notes receivable are generally nonrecourse and are generally collateralized by real estate. Scheduled principal maturities of $479,000 are due in 1997.
In March 1996, the Company accepted a discounted payoff of $825,000 in settlement of a mortgage note receivable with a principal balance of $875,000. The Company recorded no loss on the note settlement in excess of the reserve previously established.
In 1993 in conjunction with the sale of a foreclosed single family residence in Scottsdale, Arizona, the Company provided purchase money financing of $725,000 with a maturity date of August 1996. In January 1996, the borrower ceased making payments and in June 1996, filed for bankruptcy protection. In September 1996, the Company reacquired the property through trustee sale. The fair market value of the residence less estimated costs of sale, exceeded the note's principal balance and accrued interest of $691,000 at the date the property was reacquired. See NOTE 3. "REAL ESTATE AND DEPRECIATION."
In December 1996, the Company repurchased three residential lots in Moss Creek, in Greensboro, North Carolina for $44,000 in cash and cancellation of the mortgage each property secured. The buyer was unable to obtain the necessary building permits for the lots in the time required by his purchase contract. See NOTE 3. "REAL ESTATE AND DEPRECIATION."
In February 1994, the Company provided $6.7 million of purchase money financing in conjunction with the sale of 1,406 acres of the land in sixteen developed residential and commercial subdivisions secured by a first lien on the properties sold. The borrower did not make the scheduled February 1995 principal and interest payments. In September 1995, the Company reached a settlement with the borrower that provided the following: (i) the payment by the borrower of $2.5 million in cash; (ii) the Company's release of all land securing the note; (iii) the Company's acceptance of a new $1.4 million note secured by 36.3 acres of commercial land, such note bore interest at 9.0% and matured in January 1996 and (iv) the Company's receipt of 700,000 shares of the borrower's capital stock, which the borrower has the option to repurchase at $5.00 per share for two years from closing. The original sale had been recorded under the cost recovery method with gain being deferred until the note was collected. With the Company's receipt of $2.5 million on September 12, 1995, it recognized $1.6 million of the gain previously deferred. The $1.4 million note was not paid at maturity. The Company is negotiating with the borrower in an effort to correct the default and has also instituted foreclosure proceedings. The Company does not expect to incur a loss on the note as the fair value of the property exceeds the nominal carrying value of the note.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)
In January 1995, the Company received $11,000 in settlement of a note receivable with a principal balance of $20,000. In April, May and October 1995, four mortgage notes receivable, secured by developed residential lots in Moss Creek, in Greensboro, North Carolina, in the total amount of $43,000 were paid in full. Also in April 1995, a mortgage note receivable secured by an office building with a principal balance of $100,000 was paid in full.
In June 1995, the Company obtained the Gladstell Forest Apartments, a 136 unit apartment complex in Conroe, Texas, through foreclosure of a note receivable which the Company had received in December 1991 in satisfaction of a debtor's guarantee of another obligation to the Company. The Company had assigned no value to the note receivable. In conjunction with the foreclosure, the Company refinanced the property's $2.7 million mortgage for a like amount with the Company receiving no net refinancing proceeds.
NOTE 3. REAL ESTATE AND DEPRECIATION
In January 1996, the Company purchased a 4.7 acre parcel of partially developed land in Las Colinas, Texas, for $941,000 in cash. The parcel, within the Las Colinas Urban Center, is adjacent to developed office buildings.
Also in January 1996, the Company sold the Cheyenne Mountain land, a 7 acre parcel of foreclosed undeveloped land held for sale in Colorado Springs, Colorado for $330,000 in cash. The Company recognized a gain of $218,000 on the sale.
In March 1996, the Company sold the Park Forest Apartments, a 44 unit foreclosed held for sale apartment complex in Dearborn Heights, Michigan, for $4.7 million. The Company received net cash of $1.6 million after paying off the existing mortgage debt of $2.9 million and the payment of various closing costs associated with the sale. The Company recognized a gain of $1.4 million on the sale.
In July 1996, the Company entered into a contract to sell the Latham Square, a 106,067 square foot office building in Oakland, California for $2.2 million in cash. The agreed sales price was $1.4 million less than the property's carrying value. Accordingly, at June 30, 1996, the Company recognized a provision for loss of $1.6 million to reduce the property's carrying value to its sales price less estimated costs of sale. In July 1996, the Company completed the sale, receiving net cash of $2.0 million after the payment of various closing costs associated with the sale. The Company incurred a loss on the sale of $64,000 in excess of the amount which had been previously provided.
In August 1996, the Company sold a 177 acre tract of the Moss Creek land, a 257 acre parcel of foreclosed land held for sale in Greensboro,
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 3. REAL ESTATE AND DEPRECIATION (Continued)
North Carolina, for $750,000 in cash. The Company received net cash of $690,000 after paying various closing costs associated with the sale. The Company recognized a gain of $56,000 on the sale.
Also in August 1996, in a single transaction, the Company purchased the Arbor Point Apartments, a 195 unit apartment complex in Odessa, Texas, the Coventry Apartments, a 120 unit apartment complex in Midland, Texas, the Southgate Apartments, a 180 unit apartment complex in Odessa, Texas, and the Westwood Apartments, a 79 unit apartment complex in Odessa, Texas, for a total of $4.1 million in cash.
In September 1996, the Company obtained through trustee sale a single family residence that secured one of the Company's mortgage notes receivable, as more fully discussed in NOTE 2. "NOTES AND INTEREST RECEIVABLE."
In September 1996, the Company sold the Byron land, a 522 acre parcel of foreclosed land held for sale in Greensboro, North Carolina, for $1.6 million in cash. The Company recognized a loss of $63,000 on the sale.
In November 1996, the Company purchased the Carseka Apartments, a 54 unit apartment complex in Los Angeles, California, for $2.2 million in cash.
In December 1996, the Company repurchased three residential lots in Moss Creek, in Greensboro, North Carolina, for $44,000 in cash, as more fully discussed in NOTE 2. "NOTES AND INTEREST RECEIVABLE."
During 1995, the Company purchased (i) the remaining general partner interest in the partnership which owns the Shadow Run Apartments for $50,000 in cash, (ii) a 48.18% interest in 8,153 square feet of land in proximity to the Company's Republic Towers Office Building ("Republic Towers") in Dallas, Texas for $166,000 in cash, and (iii) a .9976 acre parking lot also in proximity to Republic Towers for $1.1 million in cash. Also in 1995, the Company sold an apartment complex in Norcross, Georgia, for $12.1 million, an office building in Dallas, Texas for $4.8 million, and a shopping center in Tulsa, Oklahoma for $418,000. The Company received net cash of $8.3 million from the sales after the payoff of $9.0 million in mortgage debt. The Company recognized a gain of $4.2 million on such sales.
NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES
Activity in the allowance for estimated losses was as follows:
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4. ALLOWANCE FOR ESTIMATED LOSSES (Continued)
The 1996 provision for losses in the accompanying Consolidated Statements of Operations is the June 1996 write down of the Latham Square Office Building to its agreed sales price less estimated cost of sale. The sale of the property was completed in July 1996. See NOTE 3. "REAL ESTATE AND DEPRECIATION."
NOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES
The Company's investments in equity method real estate entities consist of the following:
The Company owns an approximate 22.5% interest in IORI, a publicly held Real Estate Investment Trust ("REIT"), with a market value of $3.9 million at December 31, 1996. IORI owns five apartments (three in Texas and one each in California and Wisconsin) and four office buildings (three in California and one in Florida).
The Company owns a combined 63.7% general and limited partner interest in Tri-City which owns five properties in Texas. The Tri-City partnership agreement requires the consent of both the Company and IORI (a 36.3% general partner) for any material changes in the operations of Tri-City's properties, including sales, refinancings and changes in property management. The Company, as a noncontrolling partner, accounts for its investment in Tri-City using the equity method.
The Company owns 60% general partner interest and IORI owns a 40% general partner interest in NIA. The NIA partnership agreement requires the consent of both the Company and IORI for any material changes in the operations of NIA. The Company, as a noncontrolling partner, accounts for its investment in NIA on the equity method. NIA owned two wraparound mortgage notes receivable, one of which was secured by a shopping center in Onandaga, New York. In July 1995, the owner of the shopping center informed NIA that it had determined that further investment in the shopping center was not justified, and further that it had offered to deed the property back to the first lienholder in lieu of foreclosure making the wraparound note receivable held by NIA uncollectible. NIA recorded a provision for loss of $1.5 million to write down its wraparound note receivable to the balance of the mortgage. The Company's equity share of the loss was $901,000. The property was returned to the lender in 1996. In September 1995, the Company received notice from NIA that the other of its wraparound notes receivable had been modified in conjunction with the modification of the
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 5. INVESTMENT IN EQUITY METHOD REAL ESTATE ENTITIES (Continued)
underlying note payable. NIA recorded a provision for loss of $212,000 on such modification of which the Company's share is $127,000. This note remained outstanding at December 31, 1996.
Set forth below are summary financial data for the real estate entities accounted for using the equity method:
The Company's equity share of the above net losses for 1996, 1995 and 1994 was $2,000, $1.1 million and $46,000, respectively, before amortization of property acquisition costs discussed below. The Company's share of the above equity investee capital was $10.0 million in 1996 and $10.5 million in 1995.
The excess of the Company's investment over its respective share of the equity in the underlying net assets of equity investees relates primarily to unamortized property acquisition costs of $116,000 in 1996, $119,000 in 1995 and $715,000 in 1994. These amounts are being amortized over the estimated useful lives of the properties.
NOTE 6. NOTES AND INTEREST PAYABLE
Notes and interest payable consisted of the following:
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6. NOTES AND INTEREST PAYABLE (Continued)
Scheduled principal payments are due as follows:
Mortgage notes payable at December 31, 1996 bear interest at rates ranging from 7.88% to 12.0% per annum, and mature between 1997 and 2024. The mortgages are collateralized by deeds of trust on real estate with a net carrying value of $203.7 million.
In May 1996, the Company refinanced the mortgage debt secured by Parkway Centre Shopping Center in Dallas, Texas in the amount of $1.8 million. The Company received net cash of $771,000 after the payoff of $735,000 in existing mortgage debt and the payment of various closing costs associated with the refinancing. The new mortgage bears interest at 9.5625% per annum, requires monthly payments of principal and interest of $16,024 and matures in June 2006.
In July 1996, the Company refinanced the matured mortgage debt secured by the Westgate of Laurel Apartments in Laurel, Maryland in the amount of $7.7 million. The Company received net cash of $126,000 after the payoff of $7.2 million in existing mortgage debt and the payment of various closing costs and escrows associated with the refinancing. The new mortgage bears interest at 9.1875% per annum, requires monthly payments of principal and interest of $63,202 and matures in August 2006.
In August 1996, the Company modified and extended the matured mortgage debt secured by the Northtown Mall Shopping Center in Dallas, Texas. In conjunction with the modification, the Company paid $450,000 in principal paydowns to extend the loan's maturity date to March 31, 1997.
In September 1996, as provided in the original mortgage, the Company increased the mortgage principal balance on the Plaza Towers Office Building in St. Petersburg, Florida by $2.0 million. The Company received net cash of $1.9 million after paying various costs associated with the additional borrowing. The additional $2.0 million borrowing bears interest at a variable rate, currently 9.22% per annum, requires monthly payments of principal and interest of $18,741 and matures in May 2000.
In November 1996, the Company obtained mortgage financing in the amount of $2.0 million, on four previously unencumbered apartment complexes in Midland and Odessa, Texas. These apartments were purchased in a single
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 6. NOTES AND INTEREST PAYABLE (Continued)
transaction in August 1996. See NOTE 3. "REAL ESTATE AND DEPRECIATION." The Company received net cash of $1.7 million after paying various closing costs associated with the financing. The mortgage bears interest at a variable rate, currently at 8.5% per annum, requires monthly payments of principal and interest of $16,105 and matures in December 2001. The note agreement allows for an additional advances of up to $2.6 million.
In 1995, the Company obtained mortgage financing totaling $10.5 million secured by four previously unencumbered commercial properties. The Company received net cash of $8.7 million after the funding of various tax and insurance escrows and the payment of various closing costs associated with the financings. The mortgages bear interest at rates ranging from 9% to 9.8% per annum and mature from May 2000 to May 2005. Also in 1995, the Company refinanced the mortgage debt secured by two apartment complexes, in the total amount of $9.4 million. The Company received net refinancing proceeds of $3.9 million after the payoff of $6.6 million in existing mortgage debt and the funding of various tax and insurance escrows and the payment of various closing costs associated with the refinancings. The mortgages bear interest at rates of 7.9% and 8.0% per annum and mature in December 2005. The Company also modified and extended three mortgage loans, combining them into one loan with a principal balance of $4.6 million, bearing interest at 9.5% with the lender forgiving $144,000 of the mortgage principal balance.
NOTE 7. DIVIDENDS
In November 1995, the Company's Board of Directors approved the Company's resumption of the payment of regular quarterly dividends.
In 1996, the Company declared and paid dividends of $.28 per share, or a total of $1.1 million. In 1995, the Company declared and paid dividends of $.07 per share or a total of $267,000.
The Company reported to the Internal Revenue Service that 100% of the dividends paid in 1996 and 1995 represented a return of capital.
NOTE 8. RENTS UNDER OPERATING LEASES
The Company's operations include the leasing of office buildings, industrial warehouses and shopping centers. The leases thereon expire at various dates through 2008. The following is a schedule of minimum future rents on non- cancelable operating leases at December 31, 1996:
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. ADVISORY AGREEMENT
Basic Capital Management, Inc. ("BCM" or the "Advisor") has served as advisor to the Company since March 28, 1989. BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Director of the Company until December 31, 1992, as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company.
At the Company's annual meeting of stockholders held on May 31, 1996, the Company's stockholders approved the renewal of the Company's Advisory Agreement with BCM through the next annual meeting of the Company's stockholders. Subsequent renewals of the Advisory Agreement with BCM do not require the approval of the Company's stockholders but do require the approval of the Company's Board of Directors.
Under the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Company's Board of Directors a budget and business plan for the Company containing a twelve-month forecast of operations and cash flow, a general plan for asset sales and acquisitions, lending, foreclosure and borrowing activity and other investments. The Advisor is required to report quarterly to the Company's Board of Directors on the Company's performance against the business plan. In addition, all transactions or investments by the Company shall require prior approval by the Company's Board of Directors unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Company's Board of Directors. The Advisory Agreement also requires prior approval of the Company's Board of Directors for the retention of all consultants and third party professionals, other than legal counsel.
The Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Company and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Company (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Company's net income.
The Advisory Agreement also provides for BCM to receive an annual incentive sales fee. BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Company. BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Company. BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Company or refinancing on Company properties and BCM is to receive reimbursement of certain expenses incurred by it in the performance of advisory services to the Company.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 9. ADVISORY AGREEMENT (Continued)
The Advisory Agreement requires BCM or any affiliate of BCM to pay to the Company one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Company.
Under the Advisory Agreement, all or a portion of the annual advisory fee must be refunded by the Advisor to the Company if the Operating Expenses of the Company (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement. The effect of this limitation was to require that BCM refund $87,000 and $246,000 of the annual advisory fee for 1996 and 1995, respectively. The operating expenses of the Company did not exceed such limitation in 1994.
Additionally, if the Company were to request that BCM render services to the Company other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed in NOTE 10. "PROPERTY MANAGEMENT," the Company has hired Carmel Realty Services, Ltd. ("Carmel, Ltd."), an affiliate of BCM, to perform property management for the Company's properties and as discussed in NOTE 11. "REAL ESTATE BROKERAGE," has engaged, on a non-exclusive basis, Carmel Realty, Inc. ("Carmel Realty"), also an affiliate of BCM, to provide brokerage services for the Company.
NOTE 10. PROPERTY MANAGEMENT
Carmel, Ltd. provides property management services to the Company for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Company at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) Syntek West, Inc. ("SWI"), of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of 28 of the Company's commercial properties, its hotel and the commercial properties owned by Tri-City in which the Company and IORI are partners to Carmel Realty, which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.
NOTE 11. REAL ESTATE BROKERAGE
Carmel Realty provides brokerage services to the Company on a non-exclusive basis. Carmel Realty is entitled to receive a commission for property acquisitions and sales in accordance with a sliding scale of total fees to be paid by the Company.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 12. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.
Fees and cost reimbursements to BCM and its affiliates:
____________________________
* Net of property management fees paid to subcontractors, other than Carmel Realty.
NOTE 13. INCOME TAXES
For the years 1996, 1995 and 1994, the Company has elected and qualified to be treated as a REIT, as defined in Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"), and as such, will not be taxed for federal income tax purposes on that portion of its taxable income which is distributed to stockholders, provided that at least 95% of its REIT taxable income, plus 95% of its taxable income from foreclosure property as defined in Section 857 of the Code, is distributed. See NOTE 7. "DIVIDENDS."
The Company had a loss for federal income tax purposes in 1996, 1995 and 1994; therefore, the Company recorded no provision for income taxes.
The Company's tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties and investments in joint venture partnerships. At December 31, 1996, the Company's tax basis in its net assets exceeded its basis for financial statement purposes by $10.5 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes, and the Company would be able to maintain its REIT status without distributing 95% of its financial statement income. Additionally, at December 31, 1996, the Company had tax net operating loss carryforwards of $51.6 million expiring through the year 2011.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 13. INCOME TAXES
As a result of the Company's election to be treated as a REIT for income tax purposes and of its intention to distribute its taxable income, if any, in future years, no deferred tax asset, liability or valuation allowance was recorded.
NOTE 14. EXTRAORDINARY GAIN
In 1996, the Company recognized an extraordinary gain of $256,000 on the principal reductions of the mortgage debt, granted for capital improvements made to the Dunes Plaza Shopping Center.
In 1995, the Company recognized extraordinary gains totaling $1.4 million on the payoff of the mortgage debt secured by the Fountain Village Apartments and a principal pay down and modification of the mortgage debt secured by the Dunes Plaza Shopping Center.
In 1994, the Company recognized an extraordinary gain of $1.2 million on the conveyance of it's limited partner interest in a partnership owning an office building in Philadelphia, Pennsylvania to the lender on a mortgage secured by the property owned by the partnership, in settlement of all litigation between the Company and the lender.
NOTE 15. COMMITMENTS AND CONTINGENCIES
Olive Litigation. In February 1990, the Company, together with CMET, IORI and National Income Realty Trust ("NIRT"), three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Company, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., relating to the operation and management of each of such entities. On April 23, 1990, the Court granted final approval of the terms of the settlement.
On May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the "Modification") which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the Court on July 1, 1994 and final Court approval of the Modification was entered on December 12, 1994. The effective date of the Modification was January 11, 1995.
The Modification, among other things, provided for the addition of new unaffiliated members to the Company's Board of Directors and set forth new requirements for the approval of any transactions with affiliates until April 28, 1999. In addition, BCM, the Company's advisor, Gene E. Phillips and William S. Friedman, who served as President and Director of the Company until February 24, 1994, President of BCM until May 1,
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)
1993 and director of BCM until December 22, 1989, agreed to pay a total of $1.2 million to CMET, IORI, NIRT and the Company, of which the Company's share was $150,000.
Under the Modification, the Company, CMET, IORI and NIRT and their stockholders released the defendants from any claims relating to the plaintiffs' allegations. The Company, CMET, IORI and NIRT also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Company held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all then current members of the Company's Board of Directors that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new members of the Company's Board of Directors appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.
Pursuant to the terms of the Modification, certain related party transactions which the Company may enter into prior to April 28, 1999, require the unanimous approval of the Company's Board of Directors. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Company's Board of Directors that the transaction is in the best interests of the Company and that no other opportunity exists that is as good as the opportunity presented by such transaction.
For purposes of the Modification requirements, the term "related party transaction" means and includes: (i) any transaction between or among the Company or CMET, IORI or NIRT or any of their affiliates or subsidiaries; (ii) any transaction between or among the Company, its affiliates or subsidiaries and the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates; and (iii) any transaction between or among the Company or any of its affiliates or subsidiaries and a third party with whom the Advisor, Mr. Phillips, Mr. Friedman or any of their affiliates has an ongoing or contemplated business or financial transaction or relationship of any kind, whether direct or indirect, or has had such a transaction or relationship in the preceding one year.
The Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Company and the Advisor or one of its affiliates, (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements require the prior approval by two-thirds of the Directors of the Company, and if required, approval by a majority of the Company's stockholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Company and CMET, IORI or NIRT or any of their affiliates
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)
or subsidiaries and a third party having no prior or intended future business or financial relationship with Mr. Phillips, Mr. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Directors of the Company.
The Modification also terminated a number of the provisions under the settlement, including the requirement that the Company, CMET, IORI and NIRT maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The Court retained jurisdiction to enforce the Modification, and during August and September 1996, the Court held evidentiary hearings to assess compliance with the terms of the Modification by various parties. The Court issued no ruling or order with respect to the matters addressed at the hearings.
Separately, in 1996, legal counsel for the plaintiffs notified the Company's Board of Directors that he intends to assert that certain actions taken by the Board of Directors breached the terms of the Modification. On January 27, 1997, the parties entered into an Amendment to the Modification effective January 9, 1997 (the "Amendment"), which was submitted to the Court for approval on January 29, 1997. The Amendment provides for the settlement of all matters raised at the evidentiary hearings and by plaintiffs' counsel in his notices to the Company's Board of Directors. As of March 20, 1997, the Court had taken no action on the Amendment.
The Amendment provides for the addition of three new unaffiliated members to the Company's Board of Directors and sets forth new requirements for the approval of any transactions with certain affiliates until April 28, 1999. In addition, the Company, CMET, IORI and their stockholders released the defendants from any claims relating to the plaintiffs' allegations and matters which were the subject of the evidentiary hearings. The plaintiffs' allegations of any breaches of the Modification shall be settled by mutual agreement of the parties or, lacking such agreement, by an arbitration proceeding.
Under the Amendment, all shares of the Company owned by Mr. Phillips or any of his affiliates shall be voted at all stockholders' meetings held until April 28, 1999 in favor of all new members of the Company's Board of Directors added under the Amendment. The Amendment also requires that, until April 28, 1999, all shares of the Company owned by Mr. Phillips or his affiliates in excess of forty percent (40%) of the Company's outstanding shares shall be voted in proportion to the votes cast by all non-affiliated stockholders of the Company.
Other Litigation. The Company is also involved in various other lawsuits arising in the ordinary course of business. Management of the Company is of the opinion that the outcome of these lawsuits will have no material impact on the Company's financial condition, results of operations or liquidity.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)
Litigation settlement. In October 1996 and June 1995, the Company received $1.5 million and $500,000, respectively, from the defendants in a lawsuit brought by the Company against the former owners of an office building in New Jersey and their agents. The Company made a loan secured by the building in 1987 and filed a foreclosure action which was subsequently amended in 1990, to include claims of negligent misrepresentation against the borrowers, their legal counsel, architect and engineers.
NOTE 16. QUARTERLY RESULTS OF OPERATIONS
The following is a tabulation of the Company's quarterly results of operations for the years 1996 and 1995:
In the first and third quarters of 1996, extraordinary gains totaling $256,000 were recognized due to mortgage principal reductions granted for specified capital improvements at the Dunes Plaza Shopping Center. In the fourth quarter of 1996, the Company received a $1.5 million litigation settlement.
In the first quarter of 1996, gains on sale of real estate of $218,000 and $1.4 million were recognized on the sale of Cheyenne Mountain Land and the Park Forest Apartments, respectively. In the third quarter of 1996, a gain of $56,000 was recognized on the sale of a 177 acre parcel of the Moss Creek land, a loss of $63,000 was recognized on the sale of the Byron Land and a loss of $64,000 was recognized on the sale of the Latham Square Office Building, a provision for loss of $1.6 million relating to such sale having been recognized in the second quarter of 1996.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 16. QUARTERLY RESULTS OF OPERATIONS (Continued)
In the first quarter of 1995, an extraordinary gain of $1.3 million was recognized on the payoff of the mortgage debt secured by the Fountain Village Apartments. In the second and fourth quarters of 1995, extraordinary gains totaling $144,000 were recognized on the modification of the mortgage debt secured by the Dunes Plaza Shopping Center. In the third quarter of 1995, a gain on sale of real estate of $1.6 million was recognized on the paydown of the mortgage note receivable secured by land in Maumelle, Arkansas, such gain having been previously deferred. In the fourth quarter of 1995, a gain on sale of real estate of $4.1 million was recognized on the sale of the Summerchase Apartments and a gain on sale of real estate of $76,000 was recognized on the sale of the Heritage Square Center.
NOTE 17. SUBSEQUENT EVENTS
In January 1997, the Company received a final insurance settlement totaling $10.0 million from 1995 hail storm and flood damage to the Republic Towers Office Building in Dallas, Texas.
In January 1997, the Company refinanced the mortgage debt secured by 74 New Montgomery, an office building in San Francisco, California, in the amount of $6.3 million. The Company received net cash of $1.0 million after the payoff of $5.2 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund a tax escrow and to pay various closing costs associated with the refinancing. The new mortgage bears interest at a variable rate, currently 9.25% per annum, requires monthly principal and interest of $53,996 and matures in January 2004.
TRANSCONTINENTAL REALTY INVESTORS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 17. SUBSEQUENT EVENTS (Continued)
Also in January 1997, the Company refinanced the mortgage debt secured by the Woods Edge Apartments in Rockville, Maryland in the amount of $6.2 million. The Company received no net cash. The refinancing proceeds being used to payoff $5.9 million in existing mortgage debt, fund a tax escrow and pay various closing costs associated with the refinancing. The new mortgage bears interest at 8.125% per annum, requires monthly payments of principal and interest of $46,035 and matures in February 2007.
At December 31, 1996, the Fiesta Mart, a 29,000 square foot shopping center in San Angelo, Texas, was under contract for sale. In February 1997, the Company completed the sale for $544,000 in cash. The Company received net cash of $403,000 after the payoff of $90,000 in existing mortgage debt and various closing costs associated with the sale. The Company incurred no gain or loss on the sale.
In February 1997, the Company also completed the sale of a .9976 acre parcel of land, in Dallas, Texas, under contract for sale at December 31, 1996 for $2.7 million. The Company received net cash of $2.6 million after paying various closing costs associated with the sale. The Company will recognize a gain of approximately $1.4 million on the sale.
Also in February 1997, the Company refinanced the mortgage debt secured by the Spa Cove Apartments in Annapolis, Maryland in the amount of $12.2 million. The Company received net cash of $249,000 after the payoff of $11.6 million in existing mortgage debt. The remainder of the refinancing proceeds were used to fund a tax escrow and pay various closing costs associated with the refinancing. The new mortgage bears interest at 8.015% per annum, requires monthly payments of principal and interest of $89,529 and matures in March 2007.
In March 1997, the Company purchased the Terrace Hills Apartments, a 310 unit apartment complex in El Paso, Texas, for $6.2 million. The Company paid $1.4 million in cash and obtained new mortgage financing of $4.8 million. The mortgage bears interest at 8.07% per annum, requires monthly principal and interest of $35,086 and matures in April 2007.
SCHEDULE III
TRANSCONTINENTAL REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1996
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1996
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1996
- ------------------ (1) The aggregate cost for federal income tax purposes is $272.0 million.
(2) Writedown of property to estimated net realizable value.
(3) Escrow deposits deducted from the basis of the property.
(4) Construction period interest and taxes.
(5) Cash from receiver deducted from the basis of the property, offset by land acquired in 1992.
(6) Adjustment to purchase price.
(7) Adjustment to purchase price, offset by the proceeds from the sale of all but 114 residential lots.
SCHEDULE III (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC. REAL ESTATE AND ACCUMULATED DEPRECIATION
SCHEDULE IV
TRANSCONTINENTAL REALTY INVESTORS, INC. MORTGAGE LOANS ON REAL ESTATE December 31, 1996
SCHEDULE IV (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC. MORTGAGE LOANS ON REAL ESTATE December 31, 1995
_____________________
(1) The aggregate cost for federal income tax purposes is $10.0 million.
(2) An allowance for loss has been provided to reduce the carryin value of this loan to the Company's estimate of fair value of the underlying collateral minus estimated costs of sale.
SCHEDULE IV (Continued)
TRANSCONTINENTAL REALTY INVESTORS, INC. MORTGAGE LOANS ON REAL ESTATE
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
___________________________________
PART III
ITEM 10.

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT
Directors
The affairs of Transcontinental Realty Investors, Inc. (the "Company" or the "Registrant") are managed by a Board of Directors. The Directors are elected at the annual meeting of stockholders or appointed by the incumbent Board of Directors and serve until the next annual meeting of stockholders or until a successor has been elected or approved.
The Directors of the Company are listed below, together with their ages, terms of service, all positions and offices with the Company or its advisor, Basic Capital Management, Inc. ("BCM" or the "Advisor"), their principal occupations, business experience and directorships with other companies during the last five years or more. The designation "Affiliated", when used below with respect to a Director, means that the Director is an officer, director or employee of the Advisor or an officer of the Company. The designation "Independent", when used below with respect to a Director, means that the Director is neither an officer of the Company nor a director, officer or employee of the Advisor, although the Company may have certain business or professional relationships with such Director as discussed in ITEM 13. "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships."
TED P. STOKELY: Age 63, Director (Independent) (since April 1990) and Chairman of the Board (since January 1995).
General Manager (since January 1995) of ECF Senior Housing Corporation, a nonprofit corporation; General Manager (since January 1993) of Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid Consultant (since January 1993) and paid Consultant (April 1992 to December 1992) of Eldercare Housing Foundation ("Eldercare"), a nonprofit corporation engaged in the acquisition of low income and elderly housing; President (April 1992 to April 1994) of PSA Group (real estate management and consulting); Executive Vice President (1987 to 1991) of Key Companies Inc., a publicly traded company that develops, acquires and sells water and minerals; Trustee (since April 1990) and Chairman of the Board (since January 1995) of Continental Mortgage and Equity Trust ("CMET"); Director (since April 1990) and Chairman of the Board (since January 1995) of Income Opportunity Realty Investors, Inc. ("IORI"); and Trustee (April 1990 to August 1994) of National Income Realty Trust ("NIRT").
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Directors (Continued)
EDWARD L. TIXIER: Age 67, Director (Independent) (since July 1996).
Executive President (since 1996) of Tasa American Homes; Vice Chairman Planning and Zoning Commission (since 1996) of Dripping Springs, Texas; Director (since 1995) of Ryokachi Corporation, a Japanese company; Cattle Rancher (since 1988); President (1988 to 1994) of Tixier, Inc., an Austin, Texas based corporation; Senior Executive Advisor (1988 to 1994) to the President of Regency International Trading Company, a Japanese company; Commander (1984 to 1988) of U.S. Forces, Japan and Commander, 5th Air Force; Retired (1988) Lt. General, United States Air Force; Trustee (since July 1996) of CMET; and Director (since July 1996) of IORI.
MARTIN L. WHITE: Age 57, Director (Independent) (since January 1995).
Chairman and Chief Executive Officer (since 1993) of North American Trading Company Ltd.; President and Chief Operating Officer (since 1992) of Community Based Developers, Inc.; Development Officer and Loan Manager (1986 to 1992) of the City of San Jose, California; Vice President and Director of Programs (1967 to 1986) of Arpact, Inc., a government contractor for small business development and trade; Trustee (since January 1995) of CMET; and Director (since January 1995) of IORI.
EDWARD G. ZAMPA: Age 62, Director (Independent) (since January 1995).
General Partner (since 1976) of Edward G. Zampa and Company; and Trustee (since January 1995) of CMET; and Director (since January 1995) of IORI.
Board Committees
The Company's Board of Directors held thirteen meetings during 1996. For such year, no incumbent Director attended fewer than 75% of the aggregate of (i) the total number of meetings held by the Company's Board of Directors during the period for which he had been a Director and (ii) the total number of meetings held by all committees of the Board of Directors on which he served during the period that he served.
The Company's Board of Directors has an Audit Committee, the function of which is to review the Company's operating and accounting procedures. The current members of the Audit Committee, all of whom are Independent Directors, are Messrs. Stokely, Tixier and White. The Audit Committee met twice during 1996.
The Company's Board of Directors has a Relationship with Advisor Committee and a Board Development Committee. The current members of the Relationship with Advisor Committee are Messrs. Stokely and Zampa. The
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Board Committees (Continued)
Relationship with Advisor Committee reviews and reports to the Company's Board of Directors on the services provided to the Company by the Advisor and its affiliates and the terms of any engagement or compensation of the Advisor or its affiliates. The Relationship with Advisor Committee met twice in 1996. The Board Development Committee reviews and reports to the Company's Board of Directors on the membership, compensation and functions of the Board of Directors. The current member of the Board Development Committee is Mr. White. The Board Development Committee met twice in 1996.
The Company's Board of Directors does not have Nominating or Compensation Committees.
Executive Officers
The following persons currently serve as executive officers of the Company: Randall M. Paulson, President; Bruce A. Endendyk, Executive Vice President; and Thomas A. Holland, Executive Vice President and Chief Financial Officer. Their positions with the Company are not subject to a vote of stockholders. Their ages, terms of service, all positions and offices with the Company or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.
RANDALL M. PAULSON: Age 50, President (since August 1995)and Executive Vice President (January 1995 to August 1995).
President (since August 1995) and Executive Vice President (January 1995 to August 1995) of CMET, IORI and Syntek Asset Management, Inc. ("SAMI"), the managing general partner of Syntek Asset Management, L.P. ("SAMLP"), which is the general partner of National Realty, L.P. and National Operating, L.P. ("NOLP") and (October 1994 to August 1995) of BCM; Director (since August 1995) of SAMI; Executive Vice President (since January 1995) of American Realty Trust, Inc. ("ART"); Vice President (1993 to 1994) of GSSW, LP, a joint venture of Great Southern Life and Southwestern Life; Vice President (1990 to 1993) of Property Company of America Realty, Inc.; President (1990) of Paulson Realty Group; President (1983 to 1989) of Johnstown Management Company; and Vice President (1979 to 1982) of Lexton-Ancira.
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Executive Officers (Continued)
BRUCE A. ENDENDYK: Age 48, Executive Vice President (since January 1995).
President (since January 1995) of Carmel Realty, Inc. ("Carmel Realty"), a company owned by Syntek West, Inc. ("SWI"); Executive Vice President (since January 1995) of BCM, SAMI, ART, CMET and IORI; Management Consultant (November 1990 to December 1994); Executive Vice President (January 1989 to November 1990) of Southmark Corporation ("Southmark"); President and Chief Executive Officer (March 1988 to January 1989) of Southmark Equities Corporation; and Vice President/Resident Manager (December 1975 to March 1988) of Coldwell Banker Commercial/Real Estate Services in Houston, Texas.
THOMAS A. HOLLAND: Age 54, Executive Vice President and Chief Financial Officer (since August 1995); Secretary (since February 1997); and Senior Vice President and Chief Accounting Officer (June 1990 to August 1995).
Executive Vice President and Chief Financial Officer (since August 1995) and Senior Vice President and Chief Accounting Officer (July 1990 to August 1995) of BCM, SAMI, ART, CMET and IORI; Secretary (since February 1997) of CMET and IORI; Senior Vice President and Chief Accounting Officer (July 1990 to February 1994) of NIRT and Vinland Property Trust ("VPT"); Vice President and Controller (December 1986 to June 1990) of Southmark; Vice President-Finance (January 1986 to December 1986) of Diamond Shamrock Chemical Company; Assistant Controller (May 1976 to January 1986) of Maxus Energy Corporation (formerly Diamond Shamrock Corporation); Trustee (August 1989 to June 1990) of Arlington Realty Investors; and Certified Public Accountant (since 1970).
Officers
Although not executive officers of the Company, the following persons currently serve as officers of the Company: Mark W. Branigan, Senior Vice President - Residential Asset Management; Lynn W. Humphries, Senior Vice President - Commercial Asset Management; Robert A. Waldman, Senior Vice President and General Counsel; and Drew D. Potera, Vice President and Treasurer. Their positions with the Company are not subject to a vote of stockholders. Their ages, terms of service, all positions and
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Officers (Continued)
offices with the Company or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.
MARK W. BRANIGAN: Age 42, Senior Vice President - Residential Asset Management (since December 1996) and Vice President (February 1994 to December 1996).
Senior Vice President - Residential Asset Management (since December 1996) and Vice President (February 1994 to December 1996) of SAMI, ART, CMET and IORI; Executive Vice President (since May 1995) and Real Estate Analyst (January 1992 to May 1995) of BCM; Executive Vice President (1984 to 1991) of Byron Investments, Inc.; Director (May 1989 to August 1990) and Manager of Treasury Services (May 1981 to 1983) of Southmark; and Director (1977 to April 1981) of Investor Relations for Syntek Corp.
LYNN W. HUMPHRIES: Age 46, Senior Vice President - Commercial Asset Management (since May 1996).
Senior Vice President - Commercial Asset Management (since May 1996) of BCM, ART, IORI, TCI and SAMI; Vice President (January 1994 to May 1996) of the Amend Group; Vice President (1980 to 1993) of Equitable Real Estate Investment Management, Inc.; and Senior Vice President (1975 to 1980) of Sanders Campbell & Company.
ROBERT A. WALDMAN: Age 44, Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997).
Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (December 1993 to February 1997) of CMET and IORI; Senior Vice President and General Counsel (since January 1995), Vice President (January 1993 to January 1995) and Secretary (since December 1989) of ART; Senior Vice President and General Counsel (since November 1994), Vice President and Corporate Counsel (November 1989 to November 1994), and Secretary (since November 1989) of BCM; Senior Vice President and General Counsel (since January 1995), Vice President (April 1990 to January 1995) and Secretary (since December 1990) of SAMI; Vice President (December 1990 to February 1994) and Secretary (December 1993 to February 1994) of NIRT and VPT; and Director (February 1987 to October 1989) and General Counsel and Secretary (1985 to October 1989) of Red Eagle Resources Corporation (oil and gas).
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
Officers (Continued)
DREW D. POTERA: Age 37, Vice President (since December 1996) and Treasurer (since December 1990).
Vice President (since December 1996) and Treasurer (since December 1990) of CMET and IORI; Treasurer (since August 1991) and Assistant Treasurer (December 1990 to August 1991) of ART; Vice President, Treasurer and Securities Manager (since July 1990) of BCM; Vice President and Treasurer (since February 1992) of SAMI; Treasurer (December 1990 to February 1994) of NIRT and VPT; and Financial Consultant with Merrill Lynch, Pierce, Fenner & Smith Incorporated (June 1985 to June 1990).
In addition to the foregoing officers, the Company has several vice presidents and assistant secretaries who are not listed herein.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Under the securities laws of the United States, the Company's Directors, executive officers, and any persons holding more than ten percent of the Company's shares of Common Stock are required to report their ownership of the Company's shares and any changes in that ownership to the Securities and Exchange Commission (the "Commission"). Specific due dates for these reports have been established and the Company is required to report any failure to file by these dates during 1996. All of these filing requirements were satisfied by the Company's Directors and executive officers and ten percent holders. In making these statements, the Company has relied on the written representations of its incumbent Directors and executive officers and its ten percent holders and copies of the reports that they have filed with the Commission.
The Advisor
Although the Company's Board of Directors is directly responsible for managing the affairs of the Company and for setting the policies which guide it, the day-to-day operations of the Company are performed by a contractual advisor under the supervision of the Company's Board of Directors. The duties of the advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities as well as financing and refinancing sources to the Company. The advisor also serves as a consultant to the Company's Board of Directors in connection with the business plan for the Company and investment policy decisions.
BCM has served as the Company's advisor since March 1989. BCM is a corporation of which Messrs. Paulson, Endendyk and Holland serve as executive officers. BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a director of BCM until December 22, 1989, and as Chief Executive Officer of BCM until September 1, 1992. Mr. Phillips serves as a representative of his
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
The Advisor (Continued)
children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Company.
At the Company's annual meeting of stockholders held on May 31, 1996, the Company's stockholders approved the renewal of the Company's Advisory Agreement with BCM through the next annual meeting of the Company's stockholders. Subsequent renewals of the Advisory Agreement with BCM do not require the approval of the Company's stockholders but do require the approval of the Company's Board of Directors.
Under the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Company's Board of Directors a budget and business plan for the Company containing a twelve-month forecast of operations and cash flow, a general plan for asset sales or acquisitions, lending, foreclosure and borrowing activity, and other investments, and the Advisor is required to report quarterly to the Company's Board of Directors on the Company's performance against the business plan. In addition, all transactions or investments by the Company shall require prior approval by the Company's Board of Directors unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Company's Board of Directors.
The Advisory Agreement also requires prior approval of the Company's Board of Directors for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that the Advisor shall be deemed to be in a fiduciary relationship to the Company's stockholders; contains a broad standard governing the Advisor's liability for losses by the Company; and contains guidelines for the Advisor's allocation of investment opportunities as among itself, the Company and other entities it advises.
The Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Company and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Company (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Company's net income.
The Advisory Agreement also provides for BCM to receive an annual incentive sales fee equal to 10% of the amount, if any, by which the aggregate sales consideration for all real estate sold by the Company during such fiscal year exceeds the sum of: (i) the cost of each such property as originally recorded in the Company's books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (ii) capital improvements made to such assets during the period owned by the Company, and (iii) all closing costs, (including real
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
The Advisor (Continued)
estate commissions) incurred in the sale of such real estate; provided, however, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8% simple annual return on the Company's net investment including capital improvements, calculated over the Company's holding period before depreciation and inclusive of operating income and sales consideration and (b) the aggregate net operating income from all real estate owned by the Company for each of the prior and current fiscal years shall be at least 5% higher in the current fiscal year than in the prior fiscal year.
Additionally, pursuant to the Advisory Agreement BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Company equal to the lesser of (i) up to 1% of the cost of acquisition, inclusive of commissions, if any, paid to nonaffiliated brokers or (ii) the compensation customarily charged in arm's-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property, provided that the aggregate purchase price of each property (including acquisition fees and real estate brokerage commissions) may not exceed such property's appraised value at acquisition.
The Advisory Agreement requires BCM or any affiliate of BCM to pay to the Company, one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Company; provided, however, that the compensation retained by BCM or any affiliate of BCM shall not exceed the lesser of (i) 2% of the amount of the loan committed by the Company or (ii) a loan brokerage and commitment fee which is reasonable and fair under the circumstances.
The Advisory Agreement also provides that BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Company equal to the lesser of (i) 1% of the amount of the loan purchased or (ii) a brokerage or commitment fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding by the Company of any mortgage loan.
Under the Advisory Agreement, BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Company or refinancing on Company properties equal to the lesser of (i) 1% of the amount of the loan or the amount refinanced or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from BCM or an affiliate of BCM without the approval of the Company's Board of Directors. No fee shall be paid on loan extensions.
Under the Advisory Agreement, BCM is to receive reimbursement of certain expenses incurred by it in the performance of advisory services to the Company.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
The Advisor (Continued)
Under the Advisory Agreement, all or a portion of the annual advisory fee must be refunded by the Advisor to the Company if the Operating Expenses of the Company (as defined in the Advisory Agreement) exceed certain limits specified in the Advisory Agreement based on the book value, net asset value and net income of the Company during such fiscal year. The effect of the limitation was to require that BCM refund $87,000 of the annual advisory fee for 1996.
Additionally, if the Company were to request that BCM render services to the Company other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed below, under "Property Management", the Company has hired Carmel Realty Services, Ltd. ("Carmel, Ltd."), an affiliate of BCM, to provide property management services for the Company's properties. Also as discussed below, under "Real Estate Brokerage" the Company has engaged, on a non-exclusive basis, Carmel Realty, also an affiliate of BCM, to perform brokerage services for the Company.
BCM may only assign the Advisory Agreement with the prior consent of the Company.
The directors and principal officers of BCM are set forth below.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)
The Advisor (Continued)
Mickey N. Phillips is Gene E. Phillips' brother and Ryan T. Phillips is Gene E. Phillips' son. Gene E. Phillips serves as a representative of the trust established for the benefit of his children which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company.
Property Management
Since February 1, 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel, Ltd. provides such property management services for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Company at various rates. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of 28 of the Company's commercial properties and its hotel and the commercial properties owned by a real estate partnership in which the Company and IORI are partners to Carmel Realty, which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.
Real Estate Brokerage
Since December 1, 1992, Carmel Realty has been engaged, on a non-exclusive basis, to provide brokerage services for the Company. Carmel Realty is entitled to receive a real estate commission for property acquisitions and sales by the Company in accordance with the following sliding scale of total fees to be paid by the Company: (i) maximum fee of 5% on the first $2.0 million of any purchase or sale transaction of which no more than 4% would be paid to Carmel Realty or affiliates; (ii) maximum fee of 4% on transaction amounts between $2.0 million - $5.0 million of which no more than 3% would be paid to Carmel Realty or affiliates; (iii) maximum fee of 3% on transaction amounts between $5.0 million - $10.0 million of which no more than 2% would be paid to Carmel Realty or affiliates; and (iv) maximum fee of 2% on transaction amounts in excess of $10.0 million of which no more than 1.5% would be paid to Carmel Realty or affiliates.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The Company has no employees, payroll or benefit plans and pays no compensation to the executive officers of the Company. The executive officers of the Company, who are also officers or employees of BCM, the Company's Advisor, are compensated by the Advisor. Such executive officers of the Company perform a variety of services for the Advisor and the amount of their compensation is determined solely by the
ITEM 11. EXECUTIVE COMPENSATION (Continued)
Advisor. BCM does not allocate the cash compensation of its officers among the various entities for which it serves as advisor. See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor" for a more detailed discussion of the compensation payable to BCM by the Company.
The only remuneration paid by the Company is to the Directors who are not officers or directors of BCM or its affiliated companies. The Independent Directors (i) review the investment policies of the Company to determine that they are in the best interest of the Company's stockholders, (ii) review the Company's contract with the advisor, (iii) supervise the performance of the Company's advisor and review the reasonableness of the compensation which the Company pays to its advisor in terms of the nature and quality of services performed, (iv) review the reasonableness of the total fees and expenses of the Company and (v) select, when necessary, a qualified independent real estate appraiser to appraise properties purchased by the Company.
Each Independent Director receives compensation in the amount of $15,000 per year, plus reimbursement for expenses and the Chairman of the Board receives an additional $1,500 per year for serving in such position. In addition, each Independent Director receives an additional fee of $1,000 per day for any special services rendered by him to the Company outside of his ordinary duties as Director, plus reimbursement of expenses.
During 1996, $128,170 was paid to the Independent Directors in total Directors' fees for all services, including the annual fee for service during the period January 1, 1996 through December 31, 1996, and 1996 special service fees as follows: Geoffrey C. Etnire, $20,833 John P. Parsons, $23,362; Bennett B. Sims, $19,917; Ted P. Stokely, $18,167; Edward L. Tixier, $8,167; Martin L. White, $21,057; and Edward G. Zampa, $16,667.
[THIS SPACE INTENTIONALLY LEFT BLANK.]
ITEM 11. EXECUTIVE COMPENSATION (Continued)
Performance Graph
The following performance graph compares the cumulative total stockholder return on the Company's shares of Common Stock with the Standard & Poor's 500 Stock Index ("S&P 500 Index") and the National Association of Real Estate Investment Trusts, Inc. Hybrid REIT Total Return Index ("REIT Index"). The comparison assumes that $100 was invested on December 31, 1991 in the Company's shares of Common Stock and in each of the indices and further assumes the reinvestment of all dividends. Past performance is not necessarily an indicator of future performance.
[CHART]
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Certain Beneficial Owners. The following table sets forth the ownership of the Company's Common Stock, both beneficially and of record, both individually and in the aggregate, for those persons or entities known by the Company to be beneficial owners of more than 5% of its shares of Common Stock as of the close of business on March 7, 1997.
___________________________
(1) Percentage is based upon 3,926,445 shares of Common Stock outstanding at March 7, 1997.
Security Ownership of Management. The following table sets forth the ownership of the Company's Common Stock, both beneficially and of record, both individually and in the aggregate, for the Directors and executive officers of the Company as of the close of business on March 7, 1996.
___________________________
(1) Percentage is based upon 3,926,445 shares of Common Stock outstanding at March 7, 1997.
(2) Includes 79,500 shares owned by CMET of which the Company's Directors may be deemed to be beneficial owners by virtue of their positions as trustees of CMET. The Directors of the Company disclaim beneficial ownership of such shares.
(3) Includes 26,475 shares owned by SAMLP, 406,212 shares owned by BCM and 1,193,767 shares owned by ART, of which the executive officers of the Company may be deemed to be beneficial owners by virtue of their positions as executive officers or directors of SAMI, BCM and ART. The executive officers of the Company disclaim beneficial ownership of such shares. Each of the directors of ART may be deemed to be beneficial owners of the shares owned by ART by virtue of their positions as directors of ART. Each of the
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued)
directors of BCM may be deemed to be beneficial owners by virtue of their positions as directors of BCM. The directors of ART and BCM disclaim such beneficial ownership.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain Business Relationships
In February 1989, the Company's Board of Directors voted to retain BCM as the Company's advisor. See ITEM 10. "DIRECTORS, EXECUTIVE OFFICERS AND ADVISOR TO THE REGISTRANT - The Advisor." BCM is a corporation of which Messrs. Paulson, Endendyk and Holland serve as executive officers. Gene E. Phillips served as a director of BCM until December 22, 1989 and as Chief Executive Officer of BCM until September 1, 1992. BCM is owned by a trust for the benefit of the children of Mr. Phillips. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to BCM's performance of advisory services to the Company.
Since February 1990, affiliates of BCM have provided property management services to the Company. Currently, Carmel, Ltd. provides such property management services. The general partner of Carmel, Ltd. is BCM. The limited partners of Carmel, Ltd. are (i) SWI, of which Mr. Phillips is the sole shareholder, (ii) Mr. Phillips and (iii) a trust for the benefit of the children of Mr. Phillips. Carmel, Ltd. subcontracts the property-level management and leasing of 28 of the Company's commercial properties and its hotel and the commercial properties owned by a real estate partnership in which the Company and IORI are partners to Carmel Realty, which is a company owned by SWI.
Prior to December 1, 1992, affiliates of BCM provided brokerage services to the Company and received brokerage commissions in accordance with the advisory agreement. Since December 1, 1992, the Company has engaged, on a non- exclusive basis, Carmel Realty to perform brokerage services for the Company. Carmel Realty is a company owned by SWI.
The Directors and officers of the Company also serve as trustees or directors and officers of CMET and IORI. The Directors owe fiduciary duties to such entities as well as to the Company under applicable law. CMET and IORI have the same relationship with BCM as the Company. The Company owned approximately 22.5% of the outstanding shares of common stock of IORI at December 31, 1996. Gene E. Phillips is a general partner of SAMLP, the general partner of NRLP and NOLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to ART. Mr. Phillips served as Chairman of the Board and director of ART until November 16, 1992. Messrs. Paulson, Endendyk and Holland serve as executive officers of ART.
From April 1992 to December 31, 1992, Mr. Stokely was employed as a paid Consultant and since January 1, 1993 as a part-time unpaid Consultant for Eldercare, a nonprofit corporation engaged in the acquisition of low
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)
Certain Business Relationships (Continued)
income and elderly housing. Eldercare has a revolving loan commitment from SWI, of which Mr. Phillips is the sole shareholder. Eldercare filed for bankruptcy protection in July 1993, and was dismissed from bankruptcy in October 1994. Eldercare filed again for bankruptcy protection in May 1995, and was dismissed from bankruptcy in February 1996.
Related Party Transactions
Historically, the Company has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. The Company's management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to the Company as could have been obtained from unrelated third parties.
As more fully described in ITEM 2. "PROPERTIES - Real Estate," the Company is a partner with IORI in the Tri-City Limited Partnership and Nakash Income Associates. The Company owns 341,500 shares of the common stock of IORI, an approximate 22.5% interest.
In 1996, the Company paid BCM and its affiliates $1.8 million in advisory fees, $136,000 in mortgage brokerage and equity refinancing fees, $339,000 in property acquisition fees, $283,000 in real estate brokerage commissions and $1.9 million in property and construction management fees and leasing commissions, net of property management fees paid to subcontractors, other than Carmel Realty. In addition, as provided in the Advisory Agreement, BCM received cost reimbursements from the Company of $1.0 million in 1996.
Restrictions on Related Party Transactions
Article FOURTEENTH of the Company's Articles of Incorporation provides that the Company shall not, directly or indirectly, contract or engage in any transaction with (i) any director, officer or employee of the Company, (ii) any director, officer or employee of the advisor, (iii) the advisor or (iv) any affiliate or associate (as such terms are defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended) of any of the aforementioned persons, unless (a) the material facts as to the relationship among or financial interest of the relevant individuals or persons and as to the contract or transaction are disclosed to or are known by the Board of Directors or the appropriate committee thereof and (b) the Board of Directors or committee thereof determines that such contract or transaction is fair to the Company and simultaneously authorizes or ratifies such contract or transaction by the affirmative vote of a majority of independent directors of the Company entitled to vote thereon.
Article FOURTEENTH defines an "Independent Director" as one who is neither an officer or employee of the Company nor a director, officer or employee of the Company's advisor.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)
Restrictions on Related Party Transactions (Continued)
Pursuant to the terms of the Modification of Stipulation of Settlement (the "Modification") in the Olive Litigation, as more fully discussed in ITEM 3. "LEGAL PROCEEDINGS - Olive Litigation," which became effective on January 11, 1995, certain related party transactions which the Company may enter into prior to April 28, 1999, require the unanimous approval of the Company's Board of Directors. In addition, such related party transactions are to be discouraged and may only be entered into in exceptional circumstances and after a determination by the Company's Board of Directors that the transaction is in the best interests of the Company and that no other opportunity exists that is as good as the opportunity presented by such transaction.
The Modification requirements for related party transactions do not apply to direct contractual agreements for services between the Company and the Advisor or one of its affiliates (including the Advisory Agreement, the Brokerage Agreement and the property management contracts). These agreements, pursuant to the specific terms of the Modification, require the prior approval by two-thirds of the Directors of the Company, and if required, approval by a majority of the Company's stockholders. The Modification requirements for related party transactions also do not apply to joint ventures between or among the Company and CMET, IORI or NIRT or any of their affiliates or subsidiaries and a third party having no prior or intended future business or financial relationship with Mr. Phillips, William S. Friedman, the Advisor, or any affiliate of such parties. Such joint ventures may be entered into on the affirmative vote of a majority of the Directors of the Company.
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Consolidated Financial Statements
Report of Independent Certified Public Accountants
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Operations - Years Ended December 31, 1996, 1995 and 1994
Consolidated Statements of Stockholders' Equity - Years Ended December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows - Years Ended December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)
2. Financial Statement Schedules
Schedule III - Real Estate and Accumulated Depreciation
Schedule IV - Mortgage Loans on Real Estate
All other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the Notes thereto.
3. Incorporated Financial Statements
Consolidated Financial Statements of Income Opportunity Realty Investors, Inc. (Incorporated by reference to Item 8 of Income Opportunity Realty Investors, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1995).
4. Exhibits
The following documents are filed as Exhibits to this Report:
(b) Reports on Form 8-K:
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.
TRANSCONTINENTAL REALTY INVESTORS, INC.
Dated: March 26, 1997 By: /s/ Randall M. Paulson -------------------------- ------------------------------ Randall M. Paulson President
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 date indicated.
By: /s/ Ted P. Stokely By: /s/ Martin L. White ------------------------------ ------------------------------ Ted P. Stokely Martin L. White Chairman of the Board Director and Director
By: /s/ Edward L. Tixier By: /s/ Edward G. Zampa ------------------------------ ------------------------------ Edward L. Tixier Edward G. Zampa Director Director
By: /s/ Thomas A. Holland ------------------------------ Thomas A. Holland Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
Dated: March 26, 1997 ---------------------------
TRANSCONTINENTAL REALTY INVESTORS, INC.
EXHIBITS TO ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 1996