| AMERICA FIRST APARTMENT INVESTORS INC Item 1A Risk Factors |
| The financial condition and results of operations of the Company and its ability to pay dividends are affected by various factors, many of which are beyond the Company’s control |
| These include the following: The Company’s financial results are substantially dependent upon the performance of the multifamily apartment complexes |
| The performance of the multifamily apartment complexes is affected by a number of factors, some of which are beyond the Company’s control |
| These include general and local economic conditions, the relative supply of apartments and other homes in the market area, interest rates on single family mortgages and its effect on home buying, the need for and costs of repairs and maintenance of the properties, government regulations and the cost of complying with them, property tax rates imposed by local taxing authorities, utility rates and property insurance rates |
| If interest rates on single-family mortgages continue to remain low, it could further increase home buying and continue to reduce the number of quality tenants available |
| In addition, the financing costs, operating costs and the costs of any necessary improvements and repairs to the apartment properties may exceed expectations |
| As a result, the amount of cash available for distribution to the shareholders could decrease and the market price of the Company’s common stock could decline |
| The Company is not completely insured against damages to its properties |
| The Company owns several apartment complexes and other properties that are in areas that are prone to damage from hurricanes and other major storms, including five apartment complexes and one commercial property located in Florida |
| Due to the significant losses incurred by insurance companies on policies written on properties in Florida damaged by hurricanes, property and casualty insurers in Florida have modified their approach to underwriting policies |
| As a result, the Company assumes the risk of first loss on a larger percentage of the value of its Florida real estate |
| If any of these properties were damaged in a hurricane or other major storm, the losses incurred could be significant |
| The Company’s current policies carry a 3prca deductible on the insurable value of the properties |
| The current insurable value of the Florida properties is approximately dlra44dtta2 million |
| Additionally, the Company does not carry flood insurance for those properties located outside of designated flood zones |
| The Company also does not carry specific insurance for losses resulting from acts of terrorism and such losses may be excluded from coverage under its existing insurance policies |
| The Company is subject to the risk normally associated with debt financing |
| The Company’s real estate investments are financed with mortgage debt and this subjects it to the risk that the cash flow may not be sufficient to meet required payments of principal and interest on the debt |
| In addition, the terms of some of the mortgage debt does not require that the principal of the debt be repaid prior to maturity |
| Therefore, it is likely that the Company will need to refinance at least a portion of this debt as it matures |
| There is a risk that the terms of any such refinancing will not be as favorable as the existing debt |
| In addition, the Company may not be able to refinance the entire amount of the existing debt |
| This could happen, for example, if the collateral value of the financed real estate has declined or if lenders require a lower loan to value ratio at the time of refinancing |
| The Company’s obligations to make principal debt service payments, which are not treated as deductions for federal income tax purposes, does not relieve it from the obligation of distributing at least 90prca of its REIT taxable income to the stockholders |
| In addition, the Company’s borrowings will be secured by first mortgages on the Company’s real estate assets and security interests in the agency securities and other assets |
| This exposes the Company to a risk of losing its interests in the assets given as collateral for secured borrowings if it is unable to make the required principal and interest payments when due |
| In addition, pledged assets may not be available to stockholders in the event of the liquidation of the Company to the extent that they are used to satisfy the amounts due to creditors |
| The ability to pay dividends to the shareholders is subordinated to the payment of debt service on the Company’s debt and other borrowings |
| Real estate financed with tax-exempt debt is subject to certain restrictions |
| A number of the Company’s multifamily apartment complexes are financed with tax-exempt bond financing |
| This type of financing is designed to promote the supply of affordable rental housing and, accordingly, it subjects the financed property to certain restrictive covenants, including a requirement that a percentage of the apartment units in each property be occupied by residents whose income does not exceed a percentage of the median income for the area in which the property is located |
| 4 _________________________________________________________________ [42]Table of Contents It is possible that such covenants may cause the rents charged by these properties to be lowered, or rent increases foregone, in order to attract enough residents meeting the income requirements |
| In the event the Company does not comply with these restrictions, the interest on the bonds could become subject to federal and state income tax, which would result in either an increase in the interest rate on the bonds or an early redemption of these bonds that would force the Company to obtain alternative financing or sell the property financed by the bond |
| Fluctuating interest rates may affect earnings |
| The short-term rate on this variable rate mortgage debt is tied to an index that is reset on a weekly basis |
| Increases in the short-term interest rates increases interest expense on these borrowings |
| Likewise, the borrowings under repurchase agreements bear interest at short-term fixed rates |
| An increase in market interest rates would cause the interest rates of the obligations to increase when and if they are renewed upon maturity |
| If interest rates increase, the Company will have to pay more interest on its debt, but would not necessarily be able to increase rental income from the multifamily apartment properties |
| In addition, even though the single family mortgages underlying the agency securities also bear interest at adjustable rates, the interest payable on the agency securities may not adjust upward as quickly as the interest on the repurchase agreements used to finance the agency securities |
| This will result in a narrowing of the spread between the average interest rate earned on agency securities and the average interest paid to finance the Agency Securities |
| As this spread narrows, our earnings will decline |
| Therefore, an increase in interest rates may reduce earnings and this may reduce the amount of funds that the Company has available for distribution to stockholders |
| This may also affect the market price of the common stock |
| The use of derivatives to mitigate interest rate risks may not be effective |
| The Company’s policies permit it to enter into interest rate swaps, caps and floors and other derivative transactions to help mitigate interest rate risks |
| No hedging strategy, however, can completely insulate the Company from the interest rate risks to which it is exposed |
| Furthermore, certain of the federal income tax requirements that the Company must satisfy in order to qualify as a REIT limit its ability to hedge against such risks |
| Multifamily apartment properties are illiquid and their value may decrease |
| A substantial amount of the Company’s assets consist of investments in multifamily apartment properties |
| These investments are relatively illiquid |
| The ability to sell these assets, and the price received upon sale are affected by a number of factors including the number of potential and interested buyers, the number of competing properties on the market in the area and a number of other market conditions |
| As a result, the Company may not be able to recover its entire investment in an apartment complex upon sale |
| The Company is subject to risks associated with investments in agency securities that differ from those involved with owning multifamily apartment properties |
| Prepayments are the primary feature of agency securities that distinguishes them from other types of fixed income investments and can occur when a homeowner sells or refinances his home |
| Prepayments usually can be expected to increase when mortgage interest rates decrease significantly and decrease when mortgage interest rates increase, although such effects are not entirely predictable |
| While a certain percentage of the pool of mortgage loans underlying agency securities are expected to prepay during a given period of time, the prepayment rate can, and often does, vary significantly from the anticipated rate of prepayment |
| Prepayments generally have a negative impact on the Company’s financial results, the effects of which depends on, among other things, the amount of unamortized premium on the securities, the reinvestment lag and the reinvestment opportunities |
| The Company’s financing strategy for its portfolio of agency securities uses a leverage rate of approximately eight times equity capital and by borrowing against a substantial portion of the market value of the agency securities in the form of repurchase agreements |
| If interest income on the agency securities purchased with borrowed funds fails to cover the cost of the borrowings, the Company will experience net interest expense |
| The return earned on the agency securities may be reduced if the interest rates on the underlying mortgage loans do not adjust as quickly or as much as necessary in order to match interest rate increases that may occur on the borrowings used to finance the agency securities |
| In addition, fluctuations in the market value of the agency securities may result from changing interest rates |
| Accordingly, investments in agency securities may result in lower earnings per share or losses and, as a result, could reduce the amount of cash available for distribution to stockholders |
| There are risks associated with making mezzanine investments that differ from those involved with owning multifamily apartment properties |
| In general, mezzanine level financing provided by the Company will be subordinate to senior lenders on the financed properties |
| Accordingly, in the event of a default on investments of this type, senior lenders will have a first right to the proceeds from the sale of the property securing their loan and this may result in the Company receiving less than all principal and interest it is owed on the mezzanine level financing |
| 5 _________________________________________________________________ [43]Table of Contents Also, since mezzanine level financings are expected to participate in the cash flow or sale proceeds from a financed property, they may carry a base interest rate different than a non-participating financing |
| However, there can be no assurance that an apartment complex financed with such a participating feature will generate excess cash flow or sale proceeds that will require any payments over the base return payable on the mezzanine financing |
| Accordingly, investments in mezzanine financings will not necessarily generate any additional earnings and may result in lower earnings or losses and, as a result, the amount of cash available for distribution to stockholders and the market price of the common stock could decline |
| The Company may not be able to successfully implement its business plan |
| There can be no assurance that the Company will be able to successfully implement its business plan of raising capital and making additional investments in multifamily apartment properties, agency securities and other residential real estate assets |
| Among other things, it may not be able to locate additional real estate assets that can be acquired on acceptable terms, and it may not be able to raise additional equity capital or obtain additional debt financing on terms that would be acceptable in order to finance the acquisition of additional real estate assets |
| If additional equity capital is raised, but the Company is not able to invest it in additional apartment complexes, agency securities or other real estate assets that generate net income at least equivalent to the levels generated by other then existing assets, earnings per share could decrease |
| In that case, the level of dividends that the Company is able to pay may be reduced and the market price of the common stock may decline |
| Because of competition, the Company may not be able to acquire investment assets |
| In acquiring investment assets, the Company competes with a variety of other investors including other REITs and real estate companies, insurance companies, mutual funds, pension funds, investment banking firms, banks and other financial institutions |
| Many of the entities with which the Company competes have greater financial and other resources |
| In addition, many of the Company’s competitors are not subject to REIT tax compliance and may have greater flexibility to make certain investments |
| As a result, the Company may not be able to acquire apartment complexes, agency securities or other investment assets or it may have to pay more for these assets than it otherwise would |
| Company policies may be changed without stockholder approval |
| The Board of Directors establishes all of the Company’s fundamental operating policies; including the investment, financing and distribution policies, and any revisions to such policies would require the approval of the Board |
| Although the Board of Directors has no current plans to do so, it may amend or revise these policies at any time without a vote of the stockholders |
| Policy changes could adversely affect the Company’s financial condition, results of operations, the market price of the common stock or the Company’s ability to pay dividends or distributions |
| The Company has not established a minimum dividend payment level |
| The Company intends to pay dividends on its common stock in an amount equal to at least 90prca of its REIT taxable income (determined with regard to the dividends paid deduction and by excluding net capital gains) in order to maintain its status as a REIT for federal income tax purposes |
| Dividends will be declared and paid at the discretion of the Board of Directors and will depend on earnings, financial condition, maintenance of REIT status and such other factors as the Board of Directors may deem relevant from time to time |
| The Company has not established a minimum dividend payment level and its ability to pay dividends may be adversely affected for the reasons set forth in this section |
| The concentration of real estate in a geographical area may make the Company vulnerable to adverse changes in local economic conditions |
| The Company does not have specific limitations on the total percentage of real estate investments that may be located in any one geographical area |
| Consequently, real estate investments that it owns may be located in the same or a limited number of geographical regions |
| As a result, adverse changes in the economic conditions of the geographic regions in which the real estate investments are concentrated may have an adverse effect on real estate values, rental rates and occupancy rates |
| Any of these could reduce the income earned from, or the market value of, these real estate investments |
| Owning real estate may subject the Company to liability for environmental contamination |
| The owner or operator of real estate may become liable for the costs of removal or remediation of hazardous substances released on the Company’s property |
| Various federal, state and local laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances |
| The Company cannot make any assurances that the multifamily apartment properties which it currently owns, or those it may acquire in the future, will not be contaminated |
| The costs associated with the remediation of any such contamination may be significant and may exceed the value of the property causing the Company to lose its entire investment |
| In addition, environmental laws may materially limit the use of the properties underlying the real estate investments and future laws, or more stringent interpretations or enforcement policies of existing environmental requirements, may increase the Company’s exposure to environmental liability |
| 6 _________________________________________________________________ [44]Table of Contents Compliance with the requirements of Governmental Laws and Regulations could be costly |
| Many laws and governmental regulations are applicable to our properties and changes in these laws and regulations, or their interpretation by agencies and the courts, occur frequently |
| Under the Americans with Disabilities Act of 1990 (the “ADA”), all places of public accommodation are required to meet certain federal requirements related to access and use by disabled persons |
| These requirements became effective in 1992 |
| Compliance with the ADA requires removal of structural barriers to handicapped access in certain public areas where such removal is “readily achievable |
| ” The ADA does not, however, consider residential properties, such as apartment communities, to be public accommodations or commercial facilities, except to the extent portions of such facilities, such as a leasing office, are open to the public |
| A number of additional federal, state and local laws exist which also may require modifications to the properties, or restrict certain further renovations thereof, with respect to access thereto by disabled persons |
| For example, the Fair Housing Amendments Act of 1988 (the “FHAA”) requires apartment communities first occupied after March 13, 1990 to be accessible to the handicapped |
| Noncompliance with the ADA or the FHAA could result in the imposition of fines or an award of damages to private litigants |
| The issuance of additional shares of stock could cause the price of the Company’s stock to decline |
| The Company has the authority to issue additional equity |
| These may be shares of common stock or shares of one or more classes of preferred stock |
| Shares of preferred stock, if any, would have rights and privileges different from common stock, which may include preferential rights to receive dividends |
| The issuance of additional common stock or other forms of equity could cause dilution of the existing shares of common stock and a decrease in the market price of the common stock |
| There are a number of risks associated with being taxed as a REIT The Company’s status as a REIT subjects it and its stockholders to a number of risks, including the following: • Failure to qualify as a REIT would have adverse tax consequences |
| In order to maintain its status as a REIT, the Company must meet a number of requirements |
| These requirements are highly technical and complex and often require an analysis of various factual matters and circumstances that may not be totally within the Company’s control |
| Even a technical or inadvertent mistake could jeopardize the Company’s status as a REIT Furthermore, Congress and the Internal Revenue Service (the “IRS”) might make changes to the tax laws and regulations, and the courts might issue new rulings, that make it more difficult or impossible to remain qualified as a REIT If the Company fails to qualify as a REIT, it would be subject to federal income tax at regular corporate rates |
| Therefore, it could have less funds available for investments and for distributions to the stockholders and it would no longer be required to make any distributions to the stockholders |
| This may also have a significant adverse effect on the market value of the common stock |
| In general, the Company would not be able to elect REIT status for four years after a year in which it loses that status as a result of a failure to comply with one or more of the applicable requirements |
| • If the Company fails to qualify as a REIT, the dividends will not be deductible, and the Company’s income will be subject to taxation |
| If the Company were to fail to qualify as a REIT in any taxable year, it would not be allowed a deduction for distributions to the stockholders in computing taxable income and would be subject to federal income tax (including any applicable alternative minimum tax) on taxable income at regular corporate rates |
| Unless entitled to relief under certain provisions of the Code, the Company would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost |
| As a result, amounts available for distribution to stockholders would be reduced for each of the years involved |
| Although the Company currently intends to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax or other considerations could cause it to revoke its election to be taxed as a REIT 7 _________________________________________________________________ [45]Table of Contents • Failure to make required distributions would subject the Company to income taxation |
| In order to qualify as a REIT, each year the Company must distribute to stockholders at least 90prca of REIT taxable income (determined without regard to the dividend paid deduction and by excluding net capital gains) |
| To the extent that the Company satisfies the distribution requirement, but distributes less than 100prca of taxable income, it will be subject to federal corporate income tax on the undistributed income |
| In addition, the Company will incur a 4prca nondeductible excise tax on the amount, if any, by which the distributions in any year are less than the sum of: o 85prca of ordinary income for that year; o 95prca of capital gain net income for that year; and o 100prca of undistributed taxable income from prior years |
| Differences in timing between the recognition of income and the related cash receipts or the effect of required debt amortization payments could require the Company to borrow money or sell assets to pay out enough of the taxable income to satisfy the distribution requirement and to avoid corporate income tax and the 4prca nondeductible excise tax in a particular year |
| Loss of Investment Company Act exemption would adversely affect the Company |
| The Company intends to conduct its business so as not to become regulated as an investment company under the Investment Company Act |
| If it fails to qualify for this exemption, the Company’s ability to use borrowings would be substantially reduced and it would be unable to conduct its business |
| The Investment Company Act exempts entities that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate |
| Under the current interpretation of the SEC staff, in order to qualify for this exemption, the Company must maintain at least 55prca of its assets directly in these qualifying real estate interests |
| Mortgage-backed securities that do not represent all the certificates issued with respect to an underlying pool of mortgages may be treated as securities separate from the underlying mortgage loans and, thus, may not qualify for purposes of the 55prca requirement |
| Therefore, the ownership of these mortgage-backed securities is limited by the provisions of the Investment Company Act |
| In meeting the 55prca requirement under the Investment Company Act, the Company treats, as qualifying interests, mortgage-backed securities issued with respect to an underlying pool as to which the Company holds all issued certificates |
| If the SEC or its staff adopts a contrary interpretation, the Company could be required to sell a substantial amount of its mortgage-backed securities under potentially adverse market conditions |
| Further, in order to insure that the Company at all times qualifies for the exemption from the Investment Company Act, it may be precluded from acquiring mortgage-backed securities whose yield is somewhat higher than the yield on mortgage-backed securities that could be purchased in a manner consistent with the exemption |
| The net effect of these factors may be to lower net income |