UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
20549

Form 10-Q

Quarterly Report under Section 13 or 15(d)
of the Securities Exchange Act of 1934

For Quarter Ended July 31, 2006

Commission File Number 0-14851

INVESTORS REAL ESTATE TRUST
(Exact name of registrant as specified in its charter 

(701) 837-4738
(Registrant’s telephone number, including area code)

N/A

(Former name, former address, and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 

Yes þ                            No o

 

Indicate by check mark whether the Registrant is a large accelerated filer, or accelerated filer, or a non-accelerated filer See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one): 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 

Yes o                            No þ

Registrant is a North Dakota Real Estate Investment Trust. As of August 31, 2006, it had 47,320,892.936 common shares of beneficial interest outstanding.

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TABLE OF CONTENTS

 

	Page
Part I Financial Information
Item 1. Financial Statements - First Quarter - Fiscal 2007:..............................................................................................................................	3
Condensed Consolidated Balance Sheets (unaudited)
July 31, 2006 and April 30, 2006..............................................................................................................................................................	3
Condensed Consolidated Statements of Operations  (unaudited)
For the Three Months ended July 31, 2006 and 2005..........................................................................................................................	4
Condensed Consolidated Statement of Shareholders’ Equity (unaudited)
For the Three Months ended July 31, 2006..........................................................................................................................................	5
Condensed Consolidated Statements of Cash Flows  (unaudited)
For the Three Months ended July 31, 2006 and 2005..........................................................................................................................	6
Notes to Condensed Consolidated Financial  Statements (unaudited)...............................................................................................	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations....................................................	14
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........................................................................................................	25
Item 4. Controls and Procedures........................................................................................................................................................................	26
Part II Other Information
Item 1.      Legal Proceedings..............................................................................................................................................................................	27
Item 1A.   Risk Factors.........................................................................................................................................................................................	27
Item 2.      Unregistered Sales of Equity Securities and Use of Proceeds....................................................................................................	27
Item 3.      Defaults Upon Senior Securities - None.........................................................................................................................................	27
Item 4.      Submission of Matters to a Vote of Security Holders-None.......................................................................................................	27
Item 5.      Other Information...............................................................................................................................................................................	27
Item 6.      Exhibits.................................................................................................................................................................................................	27
Signatures.....................................................................................................................................................................................................	28

 

2

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Table Of Contents

PART I

ITEM 1. FINANCIAL STATEMENTS – FIRST QUARTER – FISCAL 2007

INVESTORS REAL ESTATE TRUST AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

	(in thousands)
	July 31, 2006		April 30, 2006
ASSETS
Real estate investments
Property owned	$	1,282,157	$	1,269,423
Less accumulated depreciation		(155,779)		(148,607)
		1,126,378		1,120,816
Undeveloped land		4,031		5,175
Mortgage loans receivable, net of allowance		416		409
Total real estate investments		1,130,825		1,126,400
Other assets
Cash and cash equivalents		19,956		17,485
Marketable securities – available-for-sale		1,549		2,402
Receivable arising from straight-lining of rents, net of allowance		9,701		9,474
Accounts receivable, net of allowance		2,810		2,364
Real estate deposits		1,646		1,177
Prepaid and other assets		1,875		436
Intangible assets, net of accumulated amortization		24,972		26,449
Tax, insurance, and other escrow		7,169		8,893
Property and equipment, net		1,485		1,506
Goodwill		1,441		1,441
Deferred charges and leasing costs, net		9,859		9,288
TOTAL ASSETS	$	1,213,288	$	1,207,315
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES
Accounts payable and accrued expenses	$	21,225	$	24,223
Notes payable		6,500		3,500
Mortgages payable		776,305		765,890
Investment certificates issued		1,764		2,451
Other		1,010		1,075
TOTAL LIABILITIES		806,804		797,139
COMMITMENTS AND CONTINGENCIES (NOTE 6)
MINORITY INTEREST IN PARTNERSHIPS		16,342		16,403
MINORITY INTEREST OF UNIT HOLDERS IN OPERATING PARTNERSHIP		102,258		104,213
(13,631,659 units at July 31, 2006 and 13,685,522 units at April 30, 2006)
SHAREHOLDERS’ EQUITY
Preferred Shares of Beneficial Interest (Cumulative redeemable preferred shares, no par value, 1,150,000 shares issued and outstanding at July 31, 2006 and April 30, 2006, aggregate liquidation preference of $28,750,000)		27,317		27,317
Common Shares of Beneficial Interest (Unlimited authorization, no par value, 47,319,709 shares issued and outstanding at July 31, 2006 and 46,915,352 shares issued and outstanding at April 30, 2006)		342,912		339,384
Accumulated distributions in excess of net income		(82,302)		(77,093)
Accumulated other comprehensive loss		(43)		(48)
Total shareholders’ equity		287,884		289,560
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,213,288	$	1,207,315

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

INVESTORS REAL ESTATE TRUST AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
for the three months ended July 31, 2006 and 2005

	Three Months Ended July 31
	(in thousands, except per share data)
	2006		2005
REVENUE
Real estate rentals	$	36,779	$	33,908
Tenant reimbursement		8,006		7,375
TOTAL REVENUE		44,785		41,283
OPERATING EXPENSE
Interest		13,077		12,378
Depreciation/amortization related to real estate investments		10,024		9,172
Utilities		2,915		2,875
Maintenance		5,043		5,044
Real estate taxes		5,379		4,961
Insurance		579		667
Property management expenses		3,296		3,134
Administrative expense		908		916
Advisory and trustee services		72		48
Other operating expenses		285		292
Amortization related to non-real estate investments		218		146
Loss on impairment of real estate investments		330		0
TOTAL OPERATING EXPENSE		42,126		39,633
Operating income		2,659		1,650
Non-operating income		279		202
Income before minority interest and discontinued operations and gain on sale of other investments		2,938		1,852
Gain on sale of other investments		0		1
Minority interest portion of operating partnership income		(533)		(270)
Minority interest portion of other partnerships’ income (loss)		12		(78)
Income from continuing operations		2,417		1,505
Discontinued operations, net		696		167
NET INCOME		3,113		1,672
Dividends to preferred shareholders		(593)		(593)
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$	2,520	$	1,079
Earnings per common share from continuing operations	$	.04	$	.02
Earnings per common share from discontinued operations		.01		.00
NET INCOME PER COMMON SHARE – BASIC and DILUTED	$	.05	$	.02

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

INVESTORS REAL ESTATE TRUST AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (unaudited)
for the three months ended July 31, 2006

	(in thousands)
	NUMBER OF PREFERRED SHARES		PREFERRED SHARES			NUMBER OF COMMON SHARES		COMMON SHARES			ACCUMULATED DISTRIBUTIONS IN EXCESS OF NET INCOME			ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)			TOTAL SHAREHOLDERS’ EQUITY
Balance May 1, 2006	1,150		$	27,317		46,915		$	339,384		$	(77,093)		$	(48)		$	289,560
Comprehensive Income
Net income												3,113						3,113
Unrealized gain on securities available-for- sale															5			5
Total comprehensive income																		3,118
Distributions – common shares												(7,729)						(7,729)
Distributions – preferred shares												(593)						(593)
Distribution reinvestment plan						334			2,914									2,914
Sale of shares						17			155									155
Redemption of units for common shares						54			464									464
Fractional shares repurchased									(5)									(5)
Balance July 31, 2006	1,150		$	27,317		47,320		$	342,912		$	(82,302)		$	(43)		$	287,884

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

 

 

The remainder of this page has been left blank intentionally.

 

INVESTORS REAL ESTATE TRUST AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
for the three months ended July 31, 2006 and 2005

	(in thousands)
	2006		2005
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income	$	3,113	$	1,672
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		10,443		9,624
Minority interest portion of income		721		396
Gain on sale of real estate, land and other investments		(820)		(1)
Interest reinvested in investment certificates		0		42
Loss on impairment of real estate investments		330		0
Bad debt expense, net of recoveries		65		13
Changes in other assets and liabilities:
Increase in receivable arising from straight-lining of rents		(237)		(394)
Increase in accounts receivable		(513)		(1,085)
Increase in prepaid and other assets		(1,439)		(1,005)
Decrease in tax, insurance and other escrow		1,724		1,660
Increase in deferred charges and leasing costs		(1,020)		(577)
Decrease in accounts payable, accrued expenses and other liabilities		(2,998)		(2,446)
Net cash provided by operating activities		9,367		7,899
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of marketable securities – available-for-sale		875		88
Proceeds/payments of real estate deposits		(469)		1,564
Principal proceeds on mortgage loans receivable		6		194
Purchase of marketable securities – available-for-sale		(16)		(12)
Proceeds from sale of real estate and other investments		4,915		0
Payments for acquisitions and improvements of real estate investments		(17,387)		(23,032)
Net cash used by investing activities		(12,076)		(21,198)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common shares, net of issue costs		155		67
Proceeds from mortgages payable		30,200		30,200
Proceeds from notes payable		15,500		0
Repurchase of fractional shares and minority interest units		(5)		(1)
Distributions paid to common shareholders, net of reinvestment		(4,999)		(4,565)
Distributions paid to preferred shareholders		(593)		(593)
Distributions paid to unitholders of operating partnership		(2,039)		(1,909)
Distributions paid to other minority partners		(49)		0
Redemption of investment certificates		(686)		(687)
Principal payments on mortgages payable		(19,786)		(4,721)
Principal payments on notes payable and other debt		(12,518)		(20)
Net cash provided by financing activities		5,180		17,771
NET INCREASE IN CASH AND CASH EQUIVALENTS		2,471		4,472
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		17,485		23,538
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	19,956	$	28,010

 

INVESTORS REAL ESTATE TRUST AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited, continued)
for the three months ended July 31, 2006 and 2005

	(in thousands)
	2006		2005
SUPPLEMENTARY SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES FOR THE PERIOD
Distribution reinvestment plan	$	2,730	$	2,586
UPREIT distribution reinvestment plan		184		223
Assets acquired through the issuance of minority interest units in the operating partnership		0		1,083
Operating partnership units converted to shares		464		176
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest on mortgages		13,039		12,046
Interest on investment certificates		56		74
Interest on margin account and other		102		54
	$	13,197	$	12,174

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

 

 

 

The remainder of this page has been left blank intentionally.

 

 

INVESTORS REAL ESTATE TRUST AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
for the three months ended July 31, 2006 and 2005 

NOTE 1 • ORGANIZATION 

Investors Real Estate Trust (“IRET” or the “Company”) is a self-advised real estate investment trust engaged in acquiring, owning and leasing multi-family and commercial real estate. IRET has elected to be taxed as a Real Estate Investment Trust (“REIT”) under Sections 856-860 of the Internal Revenue Code of 1986, as amended. REITs are subject to a number of organizational and operational requirements, including a requirement to distribute 90% of ordinary taxable income to shareholders, and, generally, are not subject to federal income tax on net income. IRET’s multi-family residential properties and commercial properties are located mainly in the states of North Dakota and Minnesota, but also in the states of Colorado, Idaho, Iowa, Kansas, Montana, Nebraska, South Dakota, Texas, Michigan and Wisconsin. As of July 31, 2006, IRET owned 67 multi-family residential properties with 8,840 apartment units and 146 commercial properties, consisting of office, medical, industrial and retail properties, totaling 8.8 million net rentable square feet. IRET conducts a majority of its business activities through its consolidated operating partnership, IRET Properties, a North Dakota Limited Partnership (the “Operating Partnership”), as well as through a number of other consolidated subsidiary entities. 

All references to IRET or the Company refer to Investors Real Estate Trust and its consolidated subsidiaries. 

NOTE 2 • BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES 

BASIS OF PRESENTATION 

The accompanying condensed consolidated financial statements include the accounts of IRET and all its subsidiaries in which it maintains a controlling interest. All significant intercompany balances and transactions are eliminated in consolidation. The Company’s fiscal year ends April 30^th. 

The accompanying condensed consolidated financial statements include the accounts of IRET and its general partnership interest in the Operating Partnership. The Company’s interest in the Operating Partnership was 77.6% as of July 31, 2006, and 77.4% as of April 30, 2006, which includes 100% of the general partnership interest. The limited partners have a redemption option that they may exercise. Upon exercise of the redemption option by the limited partners, IRET has the choice of redeeming the limited partners’ interests (“Units”) for IRET common shares of beneficial interest, on a one-for-one basis, or making a cash payment to the unitholder. The redemption generally may be exercised by the limited partners at any time after the first anniversary of the date of the acquisition of the Units (provided, however, that in general not more than two redemptions by a limited partner may occur during each calendar year, and each limited partner may not exercise the redemption for less than 1,000 Units, or, if such limited partner holds less than 1,000 Units, for all of the Units held by such limited partner). The Operating Partnership and some limited partners have contractually agreed to a holding period of greater than one year and/or a greater number of redemptions during a calendar year. 

The condensed consolidated financial statements also reflect the ownership by the Operating Partnership of certain joint venture entities in which the Operating Partnership has a general partner or controlling interest. These entities are consolidated into IRET’s other operations, with minority interests reflecting the minority partners’ share of ownership and income and expenses. 

UNAUDITED INTERIM FINANCIAL STATEMENTS 

The interim condensed consolidated financial statements of IRET have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain disclosures accompanying annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America are omitted. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments, consisting solely of normal recurring adjustments, necessary for the fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods have been included. 

The current period’s results of operations are not necessarily indicative of results which ultimately may be achieved for the year. The interim consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial

statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2006, filed with the SEC. 

RECLASSIFICATIONS 

Certain previously reported amounts have been reclassified to conform to the current financial statement presentation. The Company reports, in discontinued operations, the results of operations of a property that has either been disposed of or is classified as held for sale and the related gains or losses, and as a result of discontinued operations, retroactive reclassifications that change prior year numbers have been made. 

NOTE 3 • EARNINGS PER SHARE 

Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. The Company has no outstanding options, warrants, convertible stock or other contractual obligations requiring issuance of additional common shares that would result in a dilution of earnings. While Units can be exchanged for common shares on a one-for-one basis after a minimum holding period of one year, the exchange of Units for common shares has no effect on net income per share, as Unitholders and common shareholders effectively share equally in the net income of the Operating Partnership. The following table presents a reconciliation of the numerator and denominator used to calculate basic and diluted earnings per share reported in the condensed consolidated financial statements for the three months ended July 31, 2006 and 2005:

	Three Months Ended July 31
	(in thousands, except per share data)
	2006			2005
NUMERATOR
Income from continuing operations	$	2,417		$	1,505
Discontinued operations, net		696			167
Net income		3,113			1,672
Dividends to preferred shareholders		(593)			(593)
Numerator for basic earnings per share – net income available to common shareholders		2,520			1,079
Minority interest portion of operating partnership income		733			318
Numerator for diluted earnings per share	$	3,253		$	1,397
DENOMINATOR
Denominator for basic earnings per share weighted average shares		47,043			45,224
Effect of dilutive securities – convertible operating partnership units		13,762			13,250
Denominator for diluted earnings per share		60,805			58,474
Earnings per common share from continuing operations – basic and diluted	$	.04		$	.02
Earnings per common share from discontinued operations – basic and diluted		.01			.00
NET INCOME PER COMMON SHARE – BASIC and DILUTED	$	.05		$	.02

 

NOTE 4 • SHAREHOLDERS’ EQUITY 

During the three months ended July 31, 2006, the Company issued approximately 333,788 common shares, pursuant to the Company’s distribution reinvestment plan, for total value of approximately $2.9 million. In addition, as of July 31, 2006, approximately 53,866 Units have been converted to common shares during fiscal year 2007, with a total value of $463,838 included in shareholders’ equity. 

NOTE 5 • SEGMENT REPORTING 

IRET is engaged in acquiring, owning and leasing multi-family residential and commercial real estate. Each property is considered a separate operating segment. Each segment on a stand-alone basis is less than 10% of the revenues, profit or loss, and assets of the combined reported operating segments, and meets the aggregation criteria under SFAS 131. IRET reports its results in five segments: multi-family residential properties, and office, industrial (including miscellaneous commercial properties), retail, and medical (including assisted living facilities) properties. 

The revenues, expenses and profit (loss) for these reportable segments are summarized as follows as of and for the three-month periods ended July 31, 2006 and 2005, along with reconciliations to the condensed consolidated financial statements:

Three Months Ended July 31, 2006 

	(in thousands)
		Multi-Family			Commercial-			Commercial-			Commercial-			Commercial-
		Residential			Office			Medical			Industrial			Retail			Total
Real Estate Revenue	$	16,344		$	14,828		$	8,450		$	1,735		$	3,428		$	44,785
Expenses
Mortgage interest		4,508			3,830			2,799			559			1,011			12,707
Depreciation related to real estate investments		2,957			3,884			2,036			395			692			9,964
Utilities		1,360			1,069			397			7			82			2,915
Maintenance		2,367			1,758			608			55			255			5,043
Real estate taxes		1,814			2,237			601			198			529			5,379
Insurance		285			162			70			18			44			579
Property management		1,920			745			434			28			169			3,296
Total segment expense		15,211			13,685			6,945			1,260			2,782			39,883
Segment operating profit	$	1,133		$	1,143		$	1,505		$	475		$	646			4,902
Reconciliation to consolidated operations
Interest discounts and fee revenue																	279
Amortization and other interest expense																	(370)
Depreciation – furniture and fixtures																	(60)
Administrative, advisory and trustee fees																	(980)
Operating expenses																	(285)
Amortization related to non-real estate investments and related party costs																	(218)
Loss on impairment (commercial-retail segment) *																	(330)
Income before minority interest and discontinued operations and gain on sale of other investments																$	2,938

 

*      During the first quarter ended July 31, 2006, impairment testing indicated that the fair market value of two of the Company’s commercial retail properties was less than net book value. Accordingly, the Company recorded a loss of $330,000 due to the impairment of these two properties.  

Three Months Ended July 31, 2005 

	(in thousands)
		Multi-Family			Commercial-			Commercial-			Commercial-			Commercial-
		Residential			Office			Medical			Industrial			Retail			Total
Real Estate Revenue	$	15,409		$	13,957		$	6,856		$	1,565		$	3,496		$	41,283
Expenses
Mortgage interest		4,591			3,564			2,252			566			1,031			12,004
Depreciation related to real estate investments		2,890			3,626			1,542			387			669			9,114
Utilities		1,423			1,086			264			11			91			2,875
Maintenance		2,400			1,773			503			36			332			5,044
Real estate taxes		1,829			1,947			540			202			443			4,961
Insurance		363			168			68			20			48			667
Property management		1,955			589			408			34			148			3,134
Total segment expense		15,451			12,753			5,577			1,256			2,762			37,799
Segment operating profit	$	(42)		$	1,204		$	1,279		$	309		$	734			3,484
Reconciliation to consolidated operations
Interest discounts and fee revenue																	202
Amortization and other interest expense																	(374)
Depreciation – furniture and fixtures																	(58)
Administrative, advisory and trustee fees																	(964)
Operating expenses																	(292)
Amortization related to non-real estate investments and related party costs																	(146)
Income before minority interest and discontinued operations and gain on sale of other investments																$	1,852

 

Segment Assets and Accumulated Depreciation 

Segment assets are summarized as follows as of and for the three month period ended July 31, 2006, and for the fiscal year ended April 30, 2006, along with reconciliations to the condensed consolidated financial statements: 

July 31, 2006 

	(in thousands)
	Multi-Family			Commercial-			Commercial-			Commercial-			Commercial-
	Residential			Office			Medical			Industrial			Retail			Total
Segment Assets
Property owned	$	462,196		$	384,523		$	261,977		$	59,681		$	113,780		$	1,282,157
Less accumulated depreciation		(82,107)			(34,656)			(19,730)			(7,004)			(12,282)			(155,779)
Total property owned	$	380,089		$	349,867		$	242,247		$	52,677		$	101,498			1,126,378
Cash and cash equivalents																	19,956
Marketable securities																	1,549
Receivables and other assets																	60,958
Undeveloped land																	4,031
Mortgage receivables																	416
Total Assets																$	1,213,288

 

April 30, 2006 

	(in thousands)
	Multi-Family			Commercial-			Commercial-			Commercial-			Commercial-
	Residential			Office			Medical			Industrial			Retail			Total
Segment Assets
Property owned	$	452,251		$	383,280		$	263,300		$	59,583		$	111,009		$	1,269,423
Less accumulated depreciation		(79,150)			(32,193)			(18,954)			(6,625)			(11,685)			(148,607)
Total property owned	$	373,101		$	351,087		$	244,346		$	52,958		$	99,324			1,120,816
Cash and cash equivalents																	17,485
Marketable securities																	2,402
Receivables and other assets																	61,028
Undeveloped land																	5,175
Mortgage receivables																	409
Total Assets																$	1,207,315

 

NOTE 6 • COMMITMENTS AND CONTINGENCIES 

Litigation. IRET is involved in various lawsuits arising in the normal course of business. Management believes that such matters will not have a material effect on the Company’s financial statements.

Insurance. IRET carries insurance coverage on its properties in amounts and types that the Company believes are customarily obtained by owners of similar properties and are sufficient to achieve IRET’s risk management objective. 

Purchase Options. The Company has granted options to purchase certain Company properties to various parties. In general, the options grant the parties the right to purchase these properties at the greater of their appraised value or an annual compounded increase of 2% to 2.5% of the initial cost of the property to the Company. As of July 31, 2006, the total property cost of the 17 properties subject to purchase options was approximately $113.9 million, and the gross rental revenue from these properties was approximately $2.8 million for the three months ended July 31, 2006. 

Environmental Matters. Under various federal, state and local laws, ordinances and regulations, a current or previous owner or operator of real estate may be liable for the costs of removal of, or remediation of, certain hazardous or toxic substances in, on, around or under the property. While IRET currently has no knowledge of any violation of environmental laws, ordinances or regulations at any of its properties, there can be no assurance that areas of contamination will not be identified at any of the Company’s properties, or that changes in environmental laws, regulations or cleanup requirements would not result in significant costs to the Company.

 

Pending Acquisitions and Dispositions.  As of July 31, 2006, the Company had signed purchase agreements to acquire two small parcels of vacant land in Minnesota and Wisconsin, respectively, for purchase prices totaling $875,000; an apartment complex in Rochester, Minnesota, for a purchase price of approximately $15.5 million; and an office portfolio comprised of nine properties consisting of fifteen buildings located in Omaha, Nebraska; Maryland Heights, Missouri; Leawood, Kansas; Eden Prairie, Minnesota and Woodbury, Minnesota, for a purchase price of approximately $140.8 million (the “Magnum Portfolio”).  The Company closed on its purchase of the vacant land in Wisconsin in August 2006.  See Note 9, Subsequent Events, for additional information.  The Company expects to close on its purchase of the Magnum Portfolio on or about September 15, 2006, and on its purchase of the apartment complex in Rochester, Minnesota, and the parcel of vacant land in Minnesota, in September 2006.  However, these pending acquisitions are subject to certain closing conditions and contingencies, and no assurances can be given that these transactions will be consummated.  During the first quarter of fiscal year 2007, the Company signed a lease agreement with Allina Health Systems obligating the Company to construct an approximately 10,800 square foot, build-to-suit medical facility to be leased by Allina.  The facility will be built on a parcel of vacant land in St. Michael, Minnesota acquired by the Company during the quarter.  The Company expects construction of this facility to be completed during the fourth quarter of fiscal year 2007, for total project costs of approximately $3,000,000. 

During the first quarter of fiscal year 2007, the Company signed agreements for the sale of one office property located in Greenwood, Minnesota; two apartment complexes, located in Boise, Idaho and Fargo, North Dakota, respectively, and  five small retail properties and a small parcel of vacant land located in Minnesota, for sale prices totaling approximately $15.5 million.  The Company closed on its sales of three of these properties in August 2006.   See Note 9, Subsequent Events, for additional information.  The Company expects to close on the remaining sales in the second and third quarters of the Company’s fiscal year 2007.  However, these pending dispositions are subject to certain closing conditions and contingencies, and no assurances can be given that these transactions will be consummated. 

NOTE 7 • DISCONTINUED OPERATIONS 

SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets,” requires the Company to report in discontinued operations the results of operations of a property that has either been disposed of or is classified as held for sale. It also requires that any gains or losses from the sale of a property be reported in discontinued operations. There were no properties held for sale as of July 31, 2006 or April 30, 2006. The following information shows the effect on net income, net of minority interest, and the gains or losses from the sale of properties classified as discontinued operations for the three months ended July 31, 2006 and 2005: 

	Three Months		Three Months
	Ended July 31		Ended July 31
	(in thousands)		(in thousands)
	2006		2005
REVENUE
Real estate rentals	$	118	$	397
Tenant reimbursements		0		73
Total Revenue		118		470
OPERATING EXPENSE
Interest		18		79
Depreciation/amortization		24		72
Utilities		0		4
Maintenance		0		51
Real estate taxes		0		41
Insurance		0		2
Property management expense		0		5
Operating expenses		0		1
Total operating expense		42		255
Operating income (loss)		76		215
Non-operating income		0		0
Income (loss) before minority interest and gain on sale		76		215
Minority interest		(200)		(48)
Gain on sale of discontinued operations		820		0
Discontinued operations, net	$	696	$	167

 

NOTE 8 • ACQUISITIONS AND DISPOSITIONS 

Acquisitions and Dispositions During Three Months Ended July 31, 2006: 

During the three months ended July 31, 2006, IRET acquired a small retail property and also completed construction on an additional commercial retail property. The Company also acquired two parcels of vacant land, an apartment complex and a senior housing complex with adjoining land for a total purchase price of $13,294,000, excluding closing costs.  The Company disposed of an assisted living facility and a small retail property during the first quarter of fiscal year 2007.  

Acquisitions 

	(in thousands)
	Acquisition Cost
Commercial Property-Retail
Dakota West Plaza – Minot, ND	$	625
*Weston Walgreens – Weston, WI		2,144
Multi-Family Residential
Arbors Apartments – Sioux City, NE		7,000
Commercial Property-Medical (Assisted Living)
Fox River Cottages – Grand Chute, WI		3,200
Vacant Land
Monticello Parcel – Monticello, MN		5
St. Michaels Undeveloped – St. Michael, MN		320
Total Property Acquisitions	$	13,294

 

Dispositions 

	(in thousands)
	Sale Price		Book Value and Sales Cost		Gain/Loss
Commercial Property-Medical (Assisted Living)
Wedgewood Sweetwater – Lithia Springs, GA	$	4,550	$	3,823	$	727
Commercial Property-Retail
Moundsview Bakery – Mounds View, MN		380		287		93
Total Property Dispositions	$	4,930	$	4,110	$	820

 

*      Development property placed in service May 1, 2006. 

NOTE 9 • SUBSEQUENT EVENTS 

Acquisitions and Dispositions.  The Company closed on its acquisition of a small parcel of vacant land in Weston, Wisconsin in August 2006, for a purchase price of $800,000.  Also in August 2006, the Company closed on its sale of a small office building in Greenwood, Minnesota, a convenience store in Howard Lake, Minnesota and an apartment complex in Boise, Idaho for sale prices totaling approximately $6 million. 

Common and Preferred Share Distributions. On August 22, 2006, the Company’s Board of Trustees declared a regular quarterly distribution of 16.50 cents per share on the Company’s common shares and Units, payable October 2, 2006, to common shareholders and Unitholders of record on September 15, 2006. The Company’s Board of Trustees also declared a distribution of 51.56 cents per share on the Company’s preferred shares of beneficial interest, payable October 2, 2006, to preferred shareholders of record on September 15, 2006.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements included in this report, as well as the Company’s audited financial statements for the fiscal year ended April 30, 2006, which are included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. 

Forward Looking Statements. Certain matters included in this discussion are forward looking statements within the meaning of the federal securities laws. Although we believe that the expectations reflected in the following statements are based on reasonable assumptions, we can give no assurance that the expectations expressed will actually be achieved. Many factors may cause actual results to differ materially from our current expectations, including general economic conditions, local real estate conditions, the general level of interest rates and the availability of financing and various other economic risks inherent in the business of owning and operating investment real estate. 

Overview. IRET is a self-advised equity real estate investment trust engaged in owning and operating income-producing real properties. Our investments include multi-family residential properties and office, industrial, medical and retail properties located primarily in the upper Midwest states of Minnesota and North Dakota. Our properties are diversified by type and location. As of July 31, 2006, our real estate portfolio consisted of 67 multi-family residential properties containing 8,840 apartment units and having a total real estate investment amount (net of accumulated depreciation) of $380.1 million, and 146 commercial properties containing approximately 8.8 million square feet of leasable space and having a total real estate investment amount (net of accumulated depreciation) of $746.3 million. Our commercial properties consist of: 

•   56 office properties containing approximately 3.8 million square feet of leasable space and having a total real estate investment amount (net of accumulated depreciation) of $349.9 million; 

•   33 medical properties (including assisted living facilities) containing approximately 1.7 million square feet of leasable space and having a total real estate investment amount (net of accumulated depreciation) of $242.2 million; 

•   11 industrial properties (including miscellaneous commercial properties) containing approximately 1.8 million square feet of leasable space and having a total real estate investment amount (net of accumulated deprecation) of $52.7 million; and 

•   46 retail properties containing approximately 1.5 million square feet of leasable space and having a total real estate investment amount (net of accumulated depreciation) of $101.5 million. 

Our primary source of income and cash is rents associated with multi-family residential and commercial leases. Our business objective is to increase shareholder value by employing a disciplined investment strategy. This strategy is focused on growing assets in desired geographical markets, achieving diversification by property type and location, and adhering to targeted returns in acquiring properties. We intend to continue to achieve our business objective by investing in multi-family residential properties and in office, industrial, retail and medical commercial properties that are leased to single or multiple tenants, usually for five years or longer, and are located throughout the upper Midwest. We operate mainly within the states of North Dakota and Minnesota, although we also have real estate investments in South Dakota, Montana, Nebraska, Colorado, Idaho, Iowa, Kansas, Michigan, Texas and Wisconsin. 

We compete with other owners and developers of multi-family and commercial properties to attract tenants to our properties, and we compete with other real estate investors to acquire properties. Principal areas of competition for tenants are in respect of rents charged and the attractiveness of location and quality of our properties. Competition for investment properties affects our ability to acquire properties we want to add to our portfolio, and the price we pay for acquisitions. 

Critical Accounting Policies. In preparing the condensed consolidated financial statements management has made estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. A summary of the Company’s critical accounting policies is included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 30, 2006, in Management’s Discussion and Analysis of Financial Condition and Results of Operations. There have been no significant changes to those policies during the first quarter of fiscal year 2007.

 

RECENT ACCOUNTING PRONOUNCEMENTS 

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”).  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes.  FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  FIN 48 is effective for fiscal years beginning after December 15, 2006, and accordingly will be effective for the Company on May 1, 2007.  We are currently evaluating the impact of adopting this Interpretation, but we do not believe it will have a material effect on our financial position or results of operations.   

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JULY 31, 2006 AND 2005 

Throughout this section, we have provided certain information on a “stabilized property” basis. Information provided on a stabilized property basis is provided only for those properties owned for the entirety of both periods being compared, and includes properties which were redeveloped or expanded during the periods being compared. Properties purchased or sold, and properties under development during the periods being compared, are excluded from our stabilized property analysis. Results presented on a stabilized property basis are not determined in accordance with GAAP; see the section of this report entitled “Results on a ‘Stabilized Property’ Basis” below for a statement of the reasons management believes that presenting certain information on a stabilized property basis is useful to investors. 

REVENUES 

Total IRET revenues for the first quarter of fiscal year 2007 were $44.8 million, compared to $41.3 million received in the first quarter of the prior fiscal year. This is an increase of $3.5 million or 8.5%. This increase in revenue resulted primarily from the additional investments in real estate made by IRET during the fiscal year 2006, as well as other factors shown by the following analysis: 

	(in thousands)
	Increase in Total Revenue Three Months ended
	July 31, 2006
Rent in Fiscal 2007 from 15 properties acquired in Fiscal 2006 in excess of that received in Fiscal 2006 from the same 15 properties	$	2,375
Rent from 4 properties acquired in Fiscal 2007		113
Increase in rental income on existing properties		1,179
Decrease in straight-line rents		(165)
Net increase in total revenue	$	3,502

SEGMENT EXPENSES AND OPERATING PROFIT 

The following table shows the changes in revenues, operating expenses, interest, and depreciation by reportable operating segment for the three months ended July 31, 2006, as compared to the three months ended July 31, 2005. For a reconciliation of segment revenues, profit (loss) and assets to the condensed consolidated financial statements, see Note 5 of the Notes to Condensed Consolidated Financial Statements.

 

Three Months Ended July 31 

	(in thousands)
	2006			2005			Change			%Change
Multi-Family Residential
Real estate revenue	$	16,344		$	15,409		$	935		6.1%
Expenses
Mortgage interest		4,508			4,591			(83)		(1.8%)
Depreciation and amortization		2,957			2,890			67		2.3%
Utilities		1,360			1,423			(63)		(4.4%)
Maintenance		2,367			2,400			(33)		(1.4%)
Real estate taxes		1,814			1,829			(15)		(0.8%)
Insurance		285			363			(78)		(21.5%)
Property management		1,920			1,955			(35)		(1.8%)
Total expenses		15,211			15,451			(240)		(1.6%)
Property Segment operating profit	$	1,133		$	(42)		$	1,175		2,797.6%

 

	(in thousands)
	2006			2005			Change			%Change
Commercial-Office
Real estate revenue	$	14,828		$	13,957		$	871		6.2%
Expenses
Mortgage interest		3,830			3,564			266		7.5%
Depreciation and amortization		3,884			3,626			258		7.1%
Utilities		1,069			1,086			(17)		(1.6%)
Maintenance		1,758			1,773			(15)		(0.8%)
Real estate taxes		2,237			1,947			290		14.9%
Insurance		162			168			(6)		(3.6%)
Property management		745			589			156		26.5%
Total expenses		13,685			12,753			932		7.3%
Property Segment operating profit	$	1,143		$	1,204		$	(61)		(5.1%)

 

	(in thousands)
	2006			2005			Change			%Change
Commercial-Medical
Real estate revenue	$	8,450		$	6,856		$	1,594		23.2%
Expenses
Mortgage interest		2,799			2,252			547		24.3%
Depreciation and amortization		2,036			1,542			494		32.0%
Utilities		397			264			133		50.4%
Maintenance		608			503			105		20.9%
Real estate taxes		601			540			61		11.3%
Insurance		70			68			2		2.9%
Property management		434			408			26		6.4%
Total expenses		6,945			5,577			1,368		24.5%
Property Segment operating profit	$	1,505		$	1,279		$	226		17.7%

 

 

	(in thousands)
	2006			2005			Change			%Change
Commercial-Industrial
Real estate revenue	$	1,735		$	1,565		$	170		10.9%
Expenses
Mortgage interest		559			566			(7)		(1.2%)
Depreciation and amortization		395			387			8		2.1%
Utilities		7			11			(4)		(36.4%)
Maintenance		55			36			19		52.8%
Real estate taxes		198			202			(4)		(2.0%)
Insurance		18			20			(2)		(10.0%)
Property management		28			34			(6)		(17.6%)
Total expenses		1,260			1,256			4		0.3%
Property Segment operating profit	$	475		$	309		$	166		53.7%

 

	(in thousands)
	2006			2005			Change			%Change
Commercial-Retail
Real estate revenue	$	3,428		$	3,496		$	(68)		(1.9%)
Expenses
Mortgage interest		1,011			1,031			(20)		(1.9%)
Depreciation and amortization		692			669			23		3.4%
Utilities		82			91			(9)		(9.9%)
Maintenance		255			332			(77)		(23.2%)
Real estate taxes		529			443			86		19.4%
Insurance		44			48			(4)		(8.3%)
Property management		169			148			21		14.2%
Total expenses		2,782			2,762			20		0.7%
Property Segment operating profit	$	646		$	734		$	(88)		(12.0%)

 

FACTORS IMPACTING NET INCOME: 

Our results during the first three months of fiscal year 2007 compared to the first quarter of fiscal year 2006 show continued overall improvement in both occupancy levels and rental revenues.  Economic occupancy rates in each of our five segments increased or were stable compared to the year-earlier period, and real estate revenue increased in the first three months of fiscal year 2007 compared to the year-earlier period in all of our reportable segments except for commercial retail. Our maintenance and administrative expenses decreased slightly during the first quarter of fiscal year 2007 compared to the same period in fiscal year 2006.  Net income increased to $3,113,000 during the first three months of fiscal year 2007 compared to $1,672,000 in the first three months of fiscal year 2006, an increase of 86.2%.  Revenue increases in the first quarter of fiscal year 2007 compared to the first quarter of fiscal year 2006 were offset somewhat by increases in utility and mortgage interest expense, and by a continued increase in the level of tenant concessions. 

•     Economic Occupancy and Concessions.  Economic occupancy rates on a stabilized property basis improved or remained stable in each of our five reportable segments in the first quarter of fiscal year 2007 compared to the first quarter of fiscal year 2006: 

		Three Months Ended July 31:
		2006	2005	Change
	Multi-Family Residential	92.9%	90.4%	2.5%
	Commercial Office	91.7%	91.7%	0.0%
	Commercial Medical	96.3%	94.5%	1.8%
	Commercial Industrial	91.7%	86.6%	5.1%
	Commercial Retail	88.1%	88.0%	0.1%

 

While economic occupancy levels in our five reportable segments improved or remained stable this quarter, our level of tenant concessions continued to increase.  To maintain physical occupancy levels at our properties, we may offer tenant incentives, generally in the form of lower rents, which results in decreased revenues and income from operations at our stabilized properties.  We estimate that rent concessions offered during the three months ended July 31, 2006 lowered our operating revenues by approximately $1.5 million, as compared to an estimated approximately $1.3 million reduction in operating revenues attributable to rent concessions offered in the three months ended July 31, 2005. 

During the first quarter of fiscal year 2007, we have seen an improvement in results at our multi-family residential properties as interest rates on home mortgage loans have risen, slowing demand for single-family homes among prospective home buyers.  We have also seen during this period an increase in demand for industrial space and medical office space.  Despite some positive economic developments during the quarter, however, we have yet to see a significant increase in demand for commercial office or retail space, and our expectation is that demand in IRET’s markets for our office and retail locations will improve only slightly through the second quarter of fiscal year 2007.    

•     Decreased Maintenance Expense.  The maintenance expense category decreased by approximately $1,000 or .1% for the three months ended July 31, 2006, compared to the corresponding period in fiscal year 2006, to $5.043 million from $5.044 million.   Of the maintenance costs for the three months ended July 31, 2006, $239,000 or 4.7% is attributable to new real estate acquired in fiscal year 2006 and 2007.  Maintenance costs at our existing real estate assets decreased by $240,000, or 4.8%, in the first quarter of fiscal year 2007 compared to the first quarter of fiscal year 2006. 

•     Increased Utility Expense.  Utility expenses at properties newly acquired in fiscal year 2006 and 2007 added $144,000 to the utility expenses category, while utility expenses at existing properties decreased by $104,000, resulting in a net increase in utility expenses of $40,000 in the first quarter of fiscal year 2007, a 1.4% increase over utility expenses in the first quarter of fiscal year 2006.  

•     Decreased Administrative and Operating Expense.  Administrative and operating expenses decreased by $15,000, or 1.2%, for the three months ended July 31, 2006, as compared to the corresponding period of fiscal year 2006, primarily because of a decrease in expenditures for Sarbanes-Oxley Act compliance.  We added two employees in the first quarter of fiscal year 2007. 

•     Increased Mortgage Interest Expense.  Our mortgage debt increased $10.4 million, or 1.4%, to $776.3 million as of July 31, 2006, compared to $765.9 million on April 30, 2006.  Our mortgage interest expense increased by $703,000, or 5.9%, for the three months ended July 31, 2006.  Of the increased mortgage interest expense for the three months ended July 31, 2006, $840,000 or 7.0% is attributable to the addition of new real estate acquired in fiscal years 2006 and 2007, while mortgage interest expense declined $137,000, or 1.1%, at our existing real estate assets.  Our overall weighted average interest rate on all outstanding mortgage debt is 6.57% as of July 31, 2006, compared to 6.04% as of July 31, 2005. 

RESULTS ON A “STABILIZED PROPERTY” BASIS 

The following table presents results on a stabilized property basis for the three months ended July 31, 2006 and 2005, for our multi-family residential and commercial properties, consisting of office, medical, industrial and retail properties. Property Segment Operating Profit should not be considered as an alternative to operating net income as determined in accordance with GAAP as a measure of IRET’s performance. The Company analyzes and compares results of operations on properties owned and in operation for the entirety of the periods being compared (including properties that were redeveloped or expanded during the periods being compared, with properties purchased or sold during the periods being compared being excluded from this analysis). This comparison allows the Company to evaluate the performance of existing properties and their contribution to net income. 

Management believes that measuring performance on a stabilized property basis is useful to investors because it enables evaluation of how the Company’s properties are performing year over year. Management uses this measure to assess whether or not it has been successful in increasing net operating income, renewing the leases of existing tenants, controlling operating costs and appropriately handling capital improvements.

 

	(in thousands)
	For the Three Months
	Ended July 31,
	2006			2005			% Change
Multi-family residential
Real Estate Revenue	$	16,206		$	15,371		5.4%
Expenses:
Mortgage interest		4,507			4,591		(1.8%)
Depreciation and amortization		2,927			2,874		1.8%
Utilities		1,353			1,420		(4.7%)
Maintenance		2,358			2,398		(1.7%)
Real estate taxes		1,795			1,814		(1.0%)
Insurance		283			362		(21.8%)
Property management		1,913			1,951		(1.9%)
Total expenses		15,136			15,410		(1.8%)
Property segment operating profit	$	1,070		$	(39)		2,843.6%
Commercial – office
Real Estate Revenue	$	13,823		$	13,957		(1.0%)
Expenses:
Mortgage interest		3,609			3,564		1.3%
Depreciation and amortization		3,528			3,626		(2.7%)
Utilities		1,016			1,086		(6.4%)
Maintenance		1,620			1,772		(8.6%)
Real estate taxes		2,076			1,947		6.6%
Insurance		150			167		(10.2%)
Property management		687			589		16.6%
Total expenses		12,686			12,751		(0.5%)
Property segment operating profit	$	1,137		$	1,206		(5.7%)
Commercial – medical
Real Estate Revenue	$	6,541		$	6,310		3.7%
Expenses:
Mortgage interest		2,184			2,252		(3.0%)
Depreciation and amortization		1,379			1,361		1.3%
Utilities		300			253		18.6%
Maintenance		453			441		2.7%
Real estate taxes		471			458		2.8%
Insurance		64			65		(1.5%)
Property management		380			374		1.6%
Total expenses		5,231			5,204		0.5%
Property segment operating profit	$	1,310		$	1,106		18.4%
Commercial – Industrial
Real Estate Revenue	$	1,736		$	1,565		10.9%
Expenses:
Mortgage interest		559			566		(1.2%)
Depreciation and amortization		395			387		2.1%
Utilities		7			11		(36.4%)
Maintenance		55			36		52.8%
Real estate taxes		198			202		(2.0%)
Insurance		18			20		(10.0%)
Property management		28			34		(17.6%)
Total expenses		1,260			1,256		0.3%
Property segment operating profit	$	476		$	309		54.0%
Commercial – Retail
Real Estate Revenue	$	3,381		$	3,496		(3.3%)

 

	(in thousands)
	For the Three Months
	Ended July 31,
	2006			2005			% Change
Commercial – Retail – continued
Expenses:
Mortgage interest		1,009			1,031		(2.1%)
Depreciation and amortization		665			669		(0.6%)
Utilities		82			91		(9.9%)
Maintenance		253			332		(23.8%)
Real estate taxes		522			443		17.8%
Insurance		44			48		(8.3%)
Property management		168			148		13.5%
Total expenses		2,743			2,762		(0.7%)
Property segment operating profit	$	638		$	734		(13.1%)
Total Stabilized Segment Operating Profit	$	4,631		$	3,316		39.7%
Reconciliation to Segment Operating Profit
Real Estate Revenue - Non-Stabilized	$	3,098		$	584
Expenses - Non-Stabilized
Mortgage interest	$	839		$	0
Depreciation and amortization		1,070			197
Utilities		157			14
Maintenance		304			65
Real estate taxes		317			97
Insurance		20			5
Property management		120			38
Total Segment Operating Profit	$	4,902		$	3,484
Reconciliation to consolidated operations
Interest discounts and fee revenue	$	279		$	202
Other interest expense		(370)			(374)
Depreciation - furniture and fixtures		(60)			(58)
Administrative, advisory and trustee fees		(980)			(964)
Operating expenses		(285)			(292)
Amortization		(218)			(146)
Loss on impairment		(330)			0
Income before minority interest and discontinued operations and gain on sale of other investments	$	2,938		$	1,852

 

ECONOMIC OCCUPANCY RATES 

Economic occupancy represents actual rental revenues recognized for the period indicated as a percentage of scheduled rental revenues for the period.  Percentage rents and expense reimbursements are not considered in computing either actual revenues or scheduled rent revenues. The following tables compare economic occupancy rates on a “stabilized property” basis for the three months ended July 31, 2006 and 2005: 

Three Months Ended July 31: 

	(in thousands)
	2006		2005		Change
Multi-Family Residential	92.9%		90.4%		2.5%
Commercial-Office	91.7%		91.7%		0.0%
Commercial-Medical	96.3%		94.5%		1.8%
Commercial-Industrial	91.7%		86.6%		5.1%
Commercial-Retail	88.1%		88.0%		0.1%

 

CREDIT RISK 

The following table lists our top ten commercial tenants on July 31, 2006, for all commercial properties owned by us. No single tenant accounted for more than 10% of revenues from commercial properties during the first quarter of fiscal year 2007. 

		% of Total Commercial
		Segment Minimum Rents
Lessee		as of July 31, 2006
Edgewood Living Communities, Inc.		7.8%
St. Lukes		4.8%
Best Buy		2.9%
Healtheast - Woodbury & Maplewood		2.3%
Allina Health		2.3%
Microsoft Great Plains		2.1%
Smurfit - Stone Container Corporation		2.0%
Nebraska Orthopaedic Hospital		1.9%
Wilson's The Leather Experts, Inc.		1.7%
Alliant Techsystems		1.7%
All Others		70.5%
Total Monthly Rent as of July 31, 2006		100.0%

 

PROPERTY ACQUISITIONS AND DISPOSITIONS 

During the three months ended July 31, 2006, IRET acquired a small retail property and also completed construction on an additional commercial retail property. The Company also acquired two parcels of vacant land, an apartment complex and a senior housing complex with adjoining land for a total purchase price of $13,294,000, excluding closing costs.  The Company disposed of an assisted living facility and a small retail property during the first quarter of fiscal year 2007.  

Acquisitions and Dispositions During Three Months Ended July 31, 2006: 

Acquisitions 

	(in thousands)
	Acquisition Cost
Commercial Property-Retail
Dakota West Plaza - Minot, ND	$	625
*Weston Walgreens – Weston, WI		2,144
Multi-Family Residential
Arbors Apartments - Sioux City, NE		7,000
Commercial Property-Medical (Assisted Living)
Fox River Cottages - Grand Chute, WI		3,200
Vacant Land
Monticello Parcel - Monticello, MN		5
St. Michaels Undeveloped – St. Michael, MN		320
Total Property Acquisitions	$	13,294

 

Dispositions 

	(in thousands)
	Sale Price		Book Value and Sales Cost		Gain/Loss
Commercial Property-Medical (Assisted Living)
Wedgewood Sweetwater - Lithia Springs, GA	$	4,550	$	3,823	$	727
Commercial Property-Retail
Moundsview Bakery - Mounds View, MN		380		287		93
Total Property Dispositions	$	4,930	$	4,110	$	820

 

*      Development property placed in service May 1, 2006. 

FUNDS FROM OPERATIONS FOR THE THREE MONTHS ENDED JULY 31, 2006 AND 2005

IRET considers Funds from Operations (“FFO”) a useful measure of performance for an equity REIT. IRET uses the definition of FFO adopted by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) in 1991, as clarified in 1995, 1999 and 2002. NAREIT defines FFO to mean “net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.” Because of limitations of the FFO definition adopted by NAREIT, IRET has made certain interpretations in applying the definition. IRET believes all such interpretations not specifically provided for in the NAREIT definition are consistent with the definition. 

IRET management considers that FFO, by excluding depreciation costs, the gains or losses from the sale of operating real estate properties and extraordinary items as defined by GAAP, is useful to investors in providing an additional perspective on IRET’s operating results. Historical cost accounting for real estate assets in accordance with GAAP assumes, through depreciation, that the value of real estate assets decreases predictably over time. However, real estate asset values have historically risen or fallen with market conditions. NAREIT’s definition of FFO, by excluding depreciation costs, reflects the fact that real estate, as an asset class, generally appreciates over time and that depreciation charges required by GAAP may not reflect underlying economic realities. Additionally, the exclusion, in NAREIT’s definition of FFO, of gains and losses from the sales of previously depreciated operating real estate assets, allows IRET management and investors better to identify the operating results of the long-term assets that form the core of IRET’s investments, and assists in comparing those operating results between periods. FFO is used by IRET management and investors to identify trends in occupancy rates, rental rates and operating costs. 

While FFO is widely used by REITs as a primary performance metric, not all real estate companies use the same definition of FFO or calculate FFO in the same way. Accordingly, FFO presented here is not necessarily comparable to FFO presented by other real estate companies. 

FFO should not be considered as an alternative to net income as determined in accordance with GAAP as a measure of IRET’s performance, but rather should be considered as an additional, supplemental measure, and should be viewed in conjunction with net income as presented in the consolidated financial statements included in this report. FFO does not represent cash generated from operating activities in accordance with GAAP, and is not necessarily indicative of sufficient cash flow to fund all of IRET’s needs or its ability to service indebtedness or make distributions. 

FFO applicable to common shares and Units for the three months ended July 31, 2006 increased to $12.6 million, compared to $10.7 million for the comparable period ended July 31, 2005, an increase of 17.8%.

 

RECONCILIATION OF NET INCOME TO FUNDS FROM OPERATIONS 

	(in thousands, except per share amounts)
Three Months Ended July 31,	2006							2005
	Amount			Weighted Avg Shares and Units(2)		Per Share and Unit(3)			Amount			Weighted Avg Shares and Units(2)		Per Share and Unit(3)
Net income	$	3,113				$			$	1,672				$
Less dividends to preferred shareholders		(593)								(593)
Net income available to common shareholders		2,520		47,043			.05			1,079		45,224			.02
Adjustments:
Minority interest in earnings of Unitholders		733		13,762						318		13,250
Depreciation and Amortization (1)		10,205								9,332
Gains on depreciable property sales		(820)								(1)
Funds from operations applicable to common shares and Units	$	12,638		60,805		$	.21		$	10,728		58,474		$	.18

 

(1)   Real estate depreciation and amortization consists of the sum of depreciation/amortization related to real estate investment and amortization related to non-real estate investments from the Condensed Consolidated Statements of Operations, totaling $10,242 and $9,318, and depreciation/amortization from Discontinued Operations of $24 and $72,  less corporate-related depreciation and amortization on office equipment and other assets of $61 and $58, for the three months ended July 31, 2006 and July 31, 2005, respectively.

(2)   UPREIT Units of the Operating Partnership are exchangeable for common shares of beneficial interest on a one-for-one basis.

(3)   Net income is calculated on a per share basis. FFO is calculated on a per share and unit basis. 

DISTRIBUTIONS 

The following distribution per common share and unit were paid during the three months ended July 31 of fiscal years 2007 and 2006: 

Three months ended	July 31, 2006			July 31, 2005
	$	.1645		$	.1625

In addition, during the three months ended July 31, 2006, the Company paid, on June 30, 2006, a distribution of 51.56 cents per share on the Company’s 1,150,000 preferred shares of beneficial interest (issued April 26, 2004), to preferred shareholders of record on June 15, 2006. 

LIQUIDITY AND CAPITAL RESOURCES 

OVERVIEW 

The Company’s principal liquidity demands are distributions to the holders of the Company’s common and preferred shares of beneficial interest and UPREIT Units, capital improvements and repairs and maintenance for the properties, redemption of outstanding investment certificates, acquisition of additional properties, property development, tenant improvements and debt repayments. 

The Company expects to meet its short-term liquidity requirements through net cash flows provided by its operating activities, and through draws from time to time on its unsecured lines of credit. Management considers the Company’s ability to generate cash to be adequate to meet all operating requirements and to make distributions to its shareholders in accordance with the REIT provisions of the Internal Revenue Code. Budgeted expenditures for ongoing maintenance and capital improvements and renovations to our real estate portfolio are expected to be funded from cash flow generated from operations of current properties. 

To the extent the Company does not satisfy its long-term liquidity requirements, which consist primarily of maturities under the Company’s long-term debt, maturing investment certificates, construction and development activities and potential acquisition opportunities, through net cash flows provided by operating activities and its credit facilities, the Company intends to satisfy such requirements through a combination of funding sources which the Company believes will be available to it, including the issuance of UPREIT Units, additional common or preferred equity, proceeds from the sale of properties, and additional long-term secured or unsecured indebtedness.

 

SOURCES AND USES OF CASH 

As of July 31, 2006, the Company had three unsecured lines of credit, each in the amount of $10.0 million, from (1) Bremer Bank, Minot, ND; (2) First Western Bank and Trust, Minot, ND; and (3) First International Bank and Trust, Watford City, ND. The Company had $6.5 million borrowed on the First International Bank and Trust line of credit as of July 31, 2006. Borrowings under the lines of credit bear interest based on the following for each of the lines of credit described above: (1) Wall Street Journal prime rate, or Libor plus 2.30% for periods of 90 days or more, (2) Wall Street Journal prime rate, and (3) Wall Street Journal prime rate. Increases in interest rates will increase the Company’s interest expense on any borrowings under its lines of credit and as a result will affect the Company’s results of operations and cash flows. The Company’s lines of credit with Bremer Bank and First Western Bank expire in September 2006 and October 2006, respectively.  The Company’s line of credit with First International Bank and Trust expires in December 2006. The Company will seek to renew each of these three lines of credit prior to their expiration. 

The issuance of UPREIT Units for property acquisitions continues to be a potential source of capital for the Company. In the first quarter of fiscal year 2007, no Units were issued in connection with property acquisitions, compared to 106,693 Units issued in connection with property acquisitions during the first quarter of fiscal year 2006. 

The Company has a Distribution Reinvestment Plan (“DRIP”). The DRIP provides common shareholders and UPREIT Unitholders of the Company an opportunity to invest their cash distributions in common shares of the Company at a discount of 5% from the market price. The Company issued 333,788 common shares under its DRIP during the first quarter of fiscal year 2007. 

Cash and cash equivalents on July 31, 2006 totaled $20.0 million, compared to $28.0 million on July 31, 2005. The decrease of $8.0 million in cash and cash equivalents was due to the following: net cash provided by operating activities increased to $9.4 million in the first quarter of fiscal year 2007, from $7.9 million in the first quarter of fiscal year 2006; net cash used for investing activities decreased by $9.1 million, primarily due to proceeds from sales of properties and less cash used for acquisitions compared to the first quarter of fiscal year 2007; and net cash provided by financing activities decreased to $5.2 million during the first quarter of fiscal year 2007 from $17.8 million in the first quarter of fiscal year 2006. Net cash provided by financing activities was lower in the first three months of fiscal year 2007 due primarily to increased principal payments on mortgage payable, note payable and other debt. 

FINANCIAL CONDITION 

Mortgage Loan Indebtedness. Mortgage loan indebtedness increased to $776.3 million on July 31, 2006, due to new debt placed on new and existing properties, from $765.9 million on April 30, 2006. Approximately 97% of such mortgage debt is at fixed rates of interest, with staggered maturities. This limits the Company’s exposure to changes in interest rates, which minimizes the effect of interest rate fluctuations on the Company’s results of operations and cash flows. As of July 31, 2006, the weighted average rate of interest on the Company’s mortgage debt was 6.57%, compared to 6.03% on April 30, 2006. 

Real Estate Owned. Real estate owned increased to $1,282.2 million at July 31, 2006 from $1,269.4 million at April 30, 2006. The increase resulted primarily from the acquisition of the additional investment properties net of dispositions as described above in the “Property Acquisitions and Dispositions” subsection of this Management’s Discussion and Analysis of Financial Condition and Results of Operations. 

Investment Certificates. The Company discontinued the issuance of investment certificates in April 2002. As of July 31, 2006, investment certificates outstanding totaled $1.8 million, compared to $2.5 million of such certificates outstanding on April 30, 2006. This decrease resulted from the redemption of maturing investment certificates during the three months ended July 31, 2006. 

Cash and Cash Equivalents. Cash and cash equivalents on hand on July 31, 2006 were $20.0 million, compared to $17.5 million on April 30, 2006. The increase in cash on hand on July 31, 2006, as compared to April 30, 2006, was due primarily to the refinancing of mortgage debt. 

Marketable Securities. The Company’s investment in marketable securities classified as available-for-sale was $1.5 million on July 31, 2006 and 2.4 million on April 30, 2006. Marketable securities are held available for sale and, from time to time, the Company invests excess funds in such securities or uses the funds so invested for operational purposes. 

Operating Partnership Units. Outstanding units in the Operating Partnership decreased to 13.6 million Units on July 31, 2006, compared to 13.7 million Units outstanding on April 30, 2006. This decrease resulted primarily from Units converted to common shares.

 

Common and Preferred Shares of Beneficial Interest. Common shares of beneficial interest outstanding on July 31, 2006 totaled 47.3 million, compared to 46.9 million outstanding on April 30, 2006. This increase in common shares outstanding was primarily due to the issuance of common shares pursuant to our Distribution Reinvestment Plan, consisting of approximately 333,788 common shares issued on July 1, 2006, for total value of $2.9 million. Conversions of 53,866 UPREIT Units to common shares, for a total of $463,838 in shareholders’ equity, also increased the Company’s common shares of beneficial interest outstanding during the three months ended July 31, 2006. Preferred shares of beneficial interest outstanding on July 31, 2006 and April 30, 2006 totaled 1.15 million. 

PENDING ACQUISITIONS AND DISPOSITIONS 

As of July 31, 2006, the Company had signed purchase agreements to acquire two small parcels of vacant land in Minnesota and Wisconsin, respectively, for purchase prices totaling $875,000; an apartment complex in Rochester, Minnesota, for a purchase price of approximately $15.5 million; and an office portfolio comprised of nine properties consisting of fifteen buildings located in Omaha, Nebraska; Maryland Heights, Missouri; Leawood, Kansas; Eden Prairie, Minnesota and Woodbury, Minnesota, for a purchase price of approximately $140.8 million (the “Magnum Portfolio”).  The Company closed on its purchase of the vacant land in Wisconsin in August 2006.  See Note 9, Subsequent Events, for additional information.  The Company expects to close on its purchase of the Magnum Portfolio on or about September 15, 2006, and on its purchase of the apartment complex in Rochester, Minnesota, and the parcel of vacant land in Minnesota, in September 2006.  However, these pending acquisitions are subject to certain closing conditions and contingencies, and no assurances can be given that these transactions will be consummated. During the first quarter of fiscal year 2007, the Company signed a lease agreement with Allina Health Systems obligating the Company to construct an approximately 10,800 square foot, build-to-suit medical facility to be leased by Allina.  The facility will be built on a parcel of vacant land in St. Michael Minnesota acquired by the Company during the quarter.  The Company expects construction of this facility to be completed during the fourth quarter of fiscal year 2007, for total project costs of approximately $3,000,000.

During the first quarter of fiscal year 2007, the Company signed agreements for the sale of one office property located in Greenwood, Minnesota; two apartment complexes, located in Boise, Idaho and Fargo, North Dakota, respectively, and  five small retail properties and a small parcel of vacant land located in Minnesota, for sale prices totaling approximately $15.5 million.  The Company closed on its sales of three of these properties in August 2006.   See Note 9, Subsequent Events, for additional information.  The Company expects to close on the remaining sales in the second and third quarters of the Company’s fiscal year 2007.  However, these pending dispositions are subject to certain closing conditions and contingencies, and no assurances can be given that these transactions will be consummated. 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 

Our exposure to market risk is limited primarily to fluctuations in the general level of interest rates on our current and future fixed and variable rate debt obligations. 

Variable interest rates. Because approximately 97% of our debt, as of July 31, 2006 (96% as of July 31, 2005), is at fixed interest rates, we have little exposure to interest rate fluctuation risk on our existing debt, and accordingly interest rate increases during the first quarter of fiscal year 2007 did not have a material effect on the Company.  However, even though our goal is to maintain a fairly low exposure to interest rate risk, we are still vulnerable to significant fluctuations in interest rates on any future repricing or refinancing of our fixed or variable rate debt, and on future debt.  We primarily use long-term (more than nine years) and medium term (five to seven years) debt as source of capital.  We do not currently use derivative securities, interest-rate swaps or any other type of hedging activity to manage our interest rate risk.  As of July 31, 2006, we had the following amount of future principal and interest payments due on mortgages secured by our real estate: 

	Future Principal Payments (in thousands)
Long Term Debt	2007			2008			2009			2010			2011			Thereafter			Total
Fixed Rate	$	16,045		$	41,081		$	43,213		$	107,623		$	99,763		$	444,333		$	752,058
Variable Rate		839			1,177			3,098			1,179			1,250			16,704			24,247
																			$	776,305(1)
Average Interest Rate (%)		(1)			(1)			(1)			(1)			(1)			(1)			(1)

 

 

	Future Interest Payments (in thousands)
Long Term Debt	2007			2008			2009			2010			2011			Thereafter			Total
Fixed Rate	$	32,023		$	44,122		$	42,839		$	39,617		$	35,220		$	138,158		$	331,979
Variable Rate		1,829			2,128			2,021			1,807			1,712			4,102			13,599
																			$	345,578(1)
Average Interest Rate (%)		(1)			(1)			(1)			(1)			(1)			(1)			(1)

 

(1) The weighted average interest rate on our debt as of July 31, 2006, was 6.57%. Any fluctuations in variable interest rates could increase or decrease our interest expenses. For example, an increase of one percent per annum on our $24.2 million of variable rate indebtedness would increase our annual interest expense by $242,000. 

ITEM 4. CONTROLS AND PROCEDURES 

IRET carried out an evaluation, under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of IRET’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that IRET’s disclosure controls and procedures are effective in timely alerting them to material information required to be disclosed in our periodic reports filed with the Securities and Exchange Commission. 

There were no changes in IRET’s internal control over financial reporting that occurred during IRET’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II — OTHER INFORMATION 

Item 1. Legal Proceedings 

In the course of our operations, we become involved in litigation. At this time, we know of no pending or threatened proceedings that would have a material impact upon us. 

Item 1A. Risk Factors 

There have been no material changes in our risk factors disclosed in our Annual Report on Form 10-K for the year ended April 30, 2006. 

Items 2. Unregistered Sales of Equity Securities and Use of Proceeds  

During the first quarter of fiscal year 2007, the Company issued an aggregate of 11,897 unregistered common shares to holders of limited partnership units of IRET Properties, on a one-for-one basis upon redemption and conversion of an equal number of limited partnership units. All such issuances of common shares were exempt from registration as private placements under Section 4(2) of the Securities Act, including Regulation D promulgated thereunder. The Company has registered the re-sale of such common shares under the Securities Act. 

Item 3 is not applicable and has been omitted. 

Item 4 is not applicable and has been omitted.

Item 5. Other Information. 

On July 12, 2006, the Board of Trustees approved a recommendation of the Compensation Committee to increase the compensation paid to the Company’s independent trustees, retroactive to the start of fiscal year 2007.   A table setting forth the compensation levels approved by the Board of Trustees for the Company’s independent trustees for fiscal year 2007 is filed as Exhibit 10 to this Quarterly Report on Form 10-Q, and is incorporated herein by reference. 

Item 6. Exhibits

Exhibit No.	Description
10	Material Contracts
31.1	Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

Signatures 

Pursuant to the requirements 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. 

INVESTORS REAL ESTATE TRUST

(Registrant)   

/s/ Thomas A. Wentz, Sr.

Thomas A. Wentz, Sr.

President and Chief Executive Officer

/s/ Diane K. Bryantt

Diane K. Bryantt

Senior Vice President and Chief Financial Officer

 

Date: September 11, 2006