| ENTERTAINMENT PROPERTIES TRUST ITEM 1A RISK FACTORS There are many risks and uncertainties that can affect our future business, financial performance or share price |
| Here is a brief description of some of the important factors which could cause our future business, operating results, financial condition or share price to be materially different than our expectations |
| You should refer to the description of the qualifications and limitations on forward-looking statements on page 28 of this report |
| We may not be able to evict a tenant solely because of its bankruptcy |
| On the other hand, a bankruptcy court might authorize the tenant to terminate its leases with us |
| If that happens, our claim against the bankrupt tenant for unpaid future rent would be subject to statutory limitations that might be substantially less than the remaining rent owed under the leases |
| In addition, any claim we have for unpaid past rent would likely not be paid in full and we would also have to take a charge against earnings for any accrued straight-line rent receivable related to the leases |
| Two of our tenants, Edwards Theatre Circuit, Inc |
| (now part of the Regal Entertainment Group), which operates two of our theatre properties, and Loews 4 Cineplex Entertainment (now merged with AMC), which operates two of our theatres, filed for, and emerged from, bankruptcy reorganization in 2002 |
| We did not incur any significant expenses or loss of revenue as a result of those bankruptcy reorganizations |
| WE COULD BE ADVERSELY AFFECTED BY A MORTGAGOR &apos S BANKRUPTCY OR DEFAULT If a mortgagor becomes bankrupt or insolvent or defaults under its mortgage, that could force us to declare a default and foreclose on the underlying property |
| There is a risk that the fair value of the property will be less than the carrying value of the propertyapstas debt at the time of the foreclosure and we may have to take a charge against earnings |
| We may experience costs and delays in recovering a property in foreclosure or finding a substitute operator for the property |
| If the mortgage we hold is subordinated to senior financing secured by the property, our recovery would be limited to any amount remaining after satisfaction of all amounts due to the holder of the senior financing |
| We have agreed to subordinate our Canadian mortgage financing to any bank construction financing to be obtained by the borrower |
| OUR THEATRE TENANTS MAY BE ADVERSELY AFFECTED BY THE OBSOLESCENCE OF ANY OLDER MULTIPLEX THEATRES THEY OWN OR BY ANY OVERBUILDING OF MEGAPLEX THEATRES IN THEIR MARKETS The development of megaplex movie theatres has rendered many older multiplex theatres obsolete |
| To the extent our tenants own a substantial number of multiplexes, they have been, or may in the future be, required to take significant charges against their earnings resulting from the impairment of these assets |
| Megaplex theatre operators have also been and could in the future be adversely affected by any overbuilding of megaplex theatres in their markets and the cost of financing, building and leasing megaplex theatres |
| OPERATING RISKS IN THE ENTERTAINMENT INDUSTRY MAY AFFECT THE ABILITY OF OUR TENANTS TO PERFORM UNDER THEIR LEASES The ability of our tenants to operate successfully in the entertainment industry and remain current on their lease obligations depends on a number of factors, including the availability and popularity of motion pictures, the performance of those pictures in tenants &apos markets, the allocation of popular pictures to tenants and the terms on which the pictures are licensed |
| Neither we nor our tenants control the operations of motion picture distributors |
| Megaplex theatres represent a greater capital investment, and generate higher rents, than the previous generation of multiplex theatres |
| For this reason, the ability of our tenants to operate profitably and perform under their leases could be dependent on their ability to generate higher revenues per screen than multiplex theatres typically produce |
| The success of "e out-of-home "e entertainment venues such as megaplex theatres and entertainment retail centers also depends on general economic conditions and the willingness of consumers to spend time and money on out-of-home entertainment |
| A SINGLE TENANT REPRESENTS A SUBSTANTIAL PORTION OF OUR LEASE REVENUES Approximately 54prca of our megaplex theatre properties are leased to AMC, one of the nationapstas largest movie exhibition companies |
| AMCE has guaranteed AMCapstas performance under substantially all of their leases |
| We have diversified and expect to continue to diversify our real estate portfolio by entering into lease transactions with a number of other leading operators |
| Nevertheless, our revenues and our continuing ability to pay shareholder dividends are currently substantially dependent on AMCapstas performance under its leases and AMCEapstas performance under its guaranty |
| We believe AMC occupies a strong position in the industry and we intend to continue acquiring and leasing back AMC theatres |
| However, if for any reason AMC failed to perform under its lease obligations and AMCE did not perform under its guaranty, we could be required to reduce or suspend our shareholder dividends and may not have sufficient funds to support operations until substitute tenants are obtained |
| If that happened, we cannot predict when or whether we could obtain substitute quality tenants on acceptable terms |
| 5 THERE IS RISK IN USING DEBT TO FUND PROPERTY ACQUISITIONS We have used leverage to acquire properties and expect to continue to do so in the future |
| Although the use of leverage is common in the real estate industry, our use of debt to acquire properties does expose us to some risks |
| If a significant number of our tenants fail to make their lease payments and we donapstat have sufficient cash to pay principal and interest on the debt, we could default on our debt obligations |
| A substantial amount of our debt financing is secured by mortgages on our properties |
| If we fail to meet our mortgage payments, the lenders could declare a default and foreclose on those properties |
| Our unsecured revolving variable rate credit facility also exposes us to the risk of higher interest rates on amounts borrowed under that facility |
| If the tenants of properties in the borrowing base for our unsecured revolving variable rate credit facility default on their lease obligations or the properties otherwise fail to qualify for inclusion in the borrowing base, that could limit the amount we could borrow under the facility |
| A PORTION OF OUR SECURED DEBT HAS A "e HYPER-AMORTIZATION "e PROVISION WHICH MAY REQUIRE US TO REFINANCE THE DEBT OR SELL THE PROPERTIES SECURING THE DEBT PRIOR TO MATURITY As of December 31, 2005, we had approximately dlra94dtta9 million outstanding under a single secured mortgage loan agreement that contains a "e hyper-amortization "e feature, in which the principal payment schedule is rapidly accelerated, and our principal payments are substantially increased, if we fail to pay the balance on the anticipated prepayment date of July 11, 2008 |
| We undertook this debt on the assumption that we will be able to refinance the debt prior to these hyper-amortization payments becoming due |
| If we cannot obtain acceptable refinancing at the appropriate time, the hyper-amortization payments will require substantially all of the revenues from those properties securing the debt to be applied to the debt repayment, which could substantially reduce our common share dividend rate and could adversely affect our financial condition and liquidity |
| WE MUST OBTAIN NEW FINANCING IN ORDER TO GROW As a REIT, we are required to distribute at least 90prca of our taxable net income to shareholders in the form of dividends |
| This means we are limited in our ability to use internal capital to acquire properties and must continually raise new capital in order to continue to grow and diversify our real estate portfolio |
| Our ability to raise new capital depends in part on factors beyond our control, including conditions in equity and credit markets, conditions in the industries in which our tenants are engaged and the performance of real estate investment trusts generally |
| We continually consider and evaluate a variety of potential transactions to raise additional capital, but we cannot assure that attractive alternatives will always be available to us, nor that our share price will increase or remain at a level that will permit us to continue to raise equity capital publicly or privately |
| IF WE FAIL TO QUALIFY AS A REIT, WE WOULD BE TAXED AS A CORPORATION, WHICH WOULD SUBSTANTIALLY REDUCE FUNDS AVAILABLE FOR PAYMENT OF DIVIDENDS TO OUR SHAREHOLDERS If we fail to qualify as a REIT for federal income tax purposes, we will be taxed as a corporation |
| We are organized and believe we qualify as a REIT, and intend to operate in a manner that will allow us to continue to qualify as a REIT However, we cannot assure you that we will remain qualified in the future |
| This is because qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code on which there are only limited judicial and administrative interpretations, and depends on facts and circumstances not entirely within our control |
| In addition, future legislation, new regulations, administrative interpretations or court decisions may significantly change the tax laws, the application of the tax laws to our qualification as a REIT or the federal income tax consequences of that qualification |
| 6 If we fail to qualify as a REIT we will face tax consequences that will substantially reduce the funds available for payment of dividends: - We would not be allowed a deduction for dividends paid to shareholders in computing our taxable income and would be subject to federal income tax at regular corporate rates - We could be subject to the federal alternative minimum tax and possibly increased state and local taxes - Unless we are entitled to relief under statutory provisions, we could not elect to be treated as a REIT for four taxable years following the year in which we were disqualified - We could be subject to tax penalties and interest In addition, if we fail to qualify as a REIT, we will no longer be required to pay dividends |
| As a result of these factors, our failure to qualify as a REIT could adversely affect the market price for our shares |
| OUR DEVELOPMENT FINANCING ARRANGEMENTS EXPOSE US TO FUNDING AND PURCHASE RISKS Our ability to meet our construction financing obligations which we have undertaken or may enter into in the future depends on our ability to obtain equity or debt financing in the required amounts |
| There is no assurance we can obtain this financing at rates which will ensure a spread between our cost of capital and the rent payable to us under the leases to be entered into upon completion of construction |
| We will be obligated to purchase and lease-back the theatres that are subject to our development financing at predetermined rates (See Item 7 - "e Managementapstas Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Liquidity Requirements "e ) |
| RISKS THAT APPLY TO OUR REAL ESTATE BUSINESS THERE ARE RISKS ASSOCIATED WITH OWNING AND LEASING REAL ESTATE Although our lease terms obligate the tenants to bear substantially all of the costs of operating the properties, investing in real estate involves a number of risks, including: - The risk that tenants will not perform under their leases, reducing our income from the leases or requiring us to assume the cost of performing obligations (such as taxes, insurance and maintenance) that are the tenantapstas responsibility under the lease - The risk that changes in economic conditions or real estate markets may adversely affect the value of our properties - The risk that local conditions could adversely affect the value of our properties - We may not always be able to lease properties at favorable rates - We may not always be able to sell a property when we desire to do so at a favorable price - Changes in tax, zoning or other laws could make properties less attractive or less profitable If a tenant fails to perform on its lease covenants, that would not excuse us from meeting any debt obligation secured by the property and could require us to fund reserves in favor of our lenders, thereby reducing funds available for payment of dividends |
| We cannot be assured that tenants will elect to renew their leases when the terms expire |
| If a tenant does not renew its lease or if a tenant defaults on its lease obligations, there is no assurance we could obtain a substitute tenant on acceptable terms |
| If we cannot obtain another quality movie exhibitor to lease a megaplex theatre property, we may be required to modify the property for a different use, which may involve a significant capital expenditure and a delay in re-leasing the property |
| SOME POTENTIAL LOSSES ARE NOT COVERED BY INSURANCE Our leases require the tenants to carry comprehensive liability, casualty, workers &apos compensation, extended coverage and rental loss insurance on our properties |
| We believe the required coverage is of the type, and amount, customarily obtained by an owner of similar properties |
| We believe all of our properties are 7 adequately insured |
| However, there are some types of losses, such as catastrophic acts of nature, for which we or our tenants cannot obtain insurance at an acceptable cost |
| If there is an uninsured loss or a loss in excess of insurance limits, we could lose both the revenues generated by the affected property and the capital we have invested in the property |
| We would, however, remain obligated to repay any mortgage indebtedness or other obligations related to the property |
| Since September 11, 2001, the cost of insurance protection against terrorist acts has risen dramatically |
| There can be no assurance our tenants will be able to obtain terrorism insurance coverage, or that any coverage they do obtain will adequately protect our properties against loss from terrorist attack |
| JOINT VENTURES MAY LIMIT FLEXIBILITY WITH JOINTLY OWNED INVESTMENTS We may continue to acquire or develop properties in joint ventures with third parties when those transactions appear desirable |
| We would not own the entire interest in any property acquired by a joint venture |
| Major decisions regarding a joint venture property may require the consent of our partner |
| If we have a dispute with a joint venture partner, we may feel it necessary or become obligated to acquire the partnerapstas interest in the venture |
| However, we cannot ensure that the price we would have to pay or the timing of the acquisition would be favorable to us |
| If we own less than a 50prca interest in any joint venture, or if the venture is jointly controlled, the assets and financial results of the joint venture may not be reportable by us on a consolidated basis |
| To the extent we have commitments to, or on behalf of, or are dependent on, any such "e off-balance sheet "e arrangements, or if those arrangements or their properties or leases are subject to material contingencies, our liquidity, financial condition and operating results could be adversely affected by those commitments or off-balance sheet arrangements |
| OUR MULTI-TENANT PROPERTIES EXPOSE US TO ADDITIONAL RISKS Our entertainment retail centers in Westminster, Colorado, New Rochelle, New York, Burbank, California and Ontario, Canada, and similar properties we may seek to acquire or develop in the future, involve risks not typically encountered in the purchase and lease-back of megaplex theatres which are operated by a single tenant |
| The ownership or development of multi-tenant retail centers could expose us to the risk that a sufficient number of suitable tenants may not be found to enable the center to operate profitably and provide a return to us |
| Retail centers are also subject to tenant turnover and fluctuations in occupancy rates, which could affect our operating results |
| Multi-tenant retail centers also expose us to the risk of potential "e CAM slippage, "e which may occur when CAM fees paid by tenants are exceeded by the actual cost of taxes, insurance and maintenance at the property |
| FAILURE TO COMPLY WITH THE AMERICANS WITH DISABILITIES ACT AND OTHER LAWS COULD RESULT IN SUBSTANTIAL COSTS Our theatres must comply with the Americans with Disabilities Act (ADA) |
| The ADA requires that public accommodations reasonably accommodate individuals with disabilities and that new construction or alterations be made to commercial facilities to conform to accessibility guidelines |
| Failure to comply with the ADA can result in injunctions, fines, damage awards to private parties and additional capital expenditures to remedy noncompliance |
| Our leases require the tenants to comply with the ADA Recent rulings in lawsuits brought by the United States Department of Justice have found AMC, our most significant tenant, to be in violation of certain provisions of the ADA AMC has advised us it estimates that it will cost approximately dlra63 million over the next five years to remedy these conditions |
| A portion of the rulings is being appealed by AMC Regardless of the outcome of such appeal, the cost of remediation is the responsibility of AMC Our properties are also subject to various other federal, state and local regulatory requirements |
| With the exception of the ADA issues discussed above, we believe our properties are in material compliance with all applicable regulatory requirements |
| However, we do not know whether existing requirements will change or whether compliance with future requirements will involve significant unanticipated expenditures |
| Although these expenditures would be the responsibility of our tenants, if tenants fail to perform these obligations, we may be required to do so |
| 8 POTENTIAL LIABILITY FOR ENVIRONMENTAL CONTAMINATION COULD RESULT IN SUBSTANTIAL COSTS Under federal, state and local environmental laws, we may be required to investigate and clean up any release of hazardous or toxic substances or petroleum products at our properties, regardless of our knowledge or actual responsibility, simply because of our current or past ownership of the real estate |
| If unidentified environmental problems arise, we may have to make substantial payments, which could adversely affect our cash flow and our ability to make distributions to our shareholders |
| This is so because: - As owner we may have to pay for property damage and for investigation and clean-up costs incurred in connection with the contamination - The law may impose clean-up responsibility and liability regardless of whether the owner or operator knew of or caused the contamination - Even if more than one person is responsible for the contamination, each person who shares legal liability under environmental laws may be held responsible for all of the clean-up costs - Governmental entities and third parties may sue the owner or operator of a contaminated site for damages and costs These costs could be substantial and in extreme cases could exceed the value of the contaminated property |
| The presence of hazardous substances or petroleum products or the failure to properly remediate contamination may adversely affect our ability to borrow against, sell or lease an affected property |
| In addition, some environmental laws create liens on contaminated sites in favor of the government for damages and costs it incurs in connection with a contamination |
| Most of our loan agreements require the Company or a subsidiary to indemnify the lender against environmental liabilities |
| Our leases require the tenants to operate the properties in compliance with environmental laws and to indemnify us against environmental liability arising from the operation of the properties |
| We believe all of our properties are in material compliance with environmental laws |
| However, we could be subject to strict liability under environmental laws because we own the properties |
| There is also a risk that tenants may not satisfy their environmental compliance and indemnification obligations under the leases |
| Any of these events could substantially increase our cost of operations, require us to fund environmental indemnities in favor of our lenders, limit the amount we could borrow under our unsecured revolving variable rate credit facility, and reduce our ability to service our debt and pay dividends to shareholders |
| REAL ESTATE INVESTMENTS ARE RELATIVELY NON-LIQUID We may desire to sell a property in the future because of changes in market conditions, poor tenant performance or default of any mortgage we hold, or to avail ourselves of other opportunities |
| We may also be required to sell a property in the future to meet debt obligations or avoid a default |
| Specialty real estate projects such as megaplex theatres cannot always be sold quickly, and we cannot assure you that we could always obtain a favorable price |
| We may be required to invest in the restoration or modification of a property before we can sell it |
| THERE ARE RISKS IN OWNING ASSETS OUTSIDE THE UNITED STATES Our properties in Canada and the property securing our Canadian mortgage financing are subject to the risks normally associated with international operations |
| The rentals under our Canadian leases, the debt service on our Canadian mortgage financing and the payments to be received on our Canadian mortgage receivable are payable or collectible (as applicable) in Canadian dollars, which could expose us to losses resulting from fluctuations in exchange rates |
| Canadian real estate and tax laws are complex and subject to change, and we cannot assure you we will always be in compliance with those laws or that compliance will not expose us to additional expense |
| We may also be subject to fluctuations in Canadian real estate values or markets or the Canadian economy as a whole, which may adversely affect our Canadian investments |
| 9 RISKS THAT MAY AFFECT THE MARKET PRICE OF OUR SHARES WE CANNOT ASSURE YOU WE WILL CONTINUE PAYING DIVIDENDS AT HISTORICAL RATES Our ability to continue paying dividends on our common shares at historical rates, to pay dividends on our preferred shares at their stated rates or to increase our common share dividend rate will depend on a number of factors, including our financial condition and results of future operations, the performance of lease terms by tenants, our ability to acquire, finance and lease additional properties at attractive rates, and provisions in our loan covenants |
| If we do not maintain or increase our common share dividend rate, that could have an adverse effect on the market price of our common shares and possibly our preferred shares |
| MARKET INTEREST RATES MAY HAVE AN EFFECT ON THE VALUE OF OUR SHARES One of the factors that investors may consider in deciding whether to buy or sell our common shares or preferred shares is our dividend rate as a percentage of our share price, relative to market interest rates |
| If market interest rates increase, prospective investors may desire a higher dividend on our common shares or seek securities paying higher dividends or interest |
| MARKET PRICES FOR OUR SHARES MAY BE AFFECTED BY PERCEPTIONS ABOUT THE FINANCIAL HEALTH OR SHARE VALUE OF OUR TENANTS OR THE PERFORMANCE OF REIT STOCKS GENERALLY To the extent any of our tenants or other movie exhibitors report losses or slower earnings growth, take charges against earnings resulting from the obsolescence of multiplex theatres or enter bankruptcy proceedings, the market price for our shares could be adversely affected |
| The market price for our shares could also be affected by any weakness in movie exhibitor stocks generally |
| We believe these trends had an adverse impact on our common share price during 2001 and 2000 |
| LIMITS ON CHANGES IN CONTROL MAY DISCOURAGE TAKEOVER ATTEMPTS WHICH MAY BE BENEFICIAL TO OUR SHAREHOLDERS There are a number of provisions in our Declaration of Trust, Maryland law and agreements we have with others which could make it more difficult for a party to make a tender offer for our shares or complete a takeover of the Company which is not approved by our Board of Trustees |
| These include: - A staggered Board of Trustees that can be increased in number without shareholder approval - A limit on beneficial ownership of our shares, which acts as a defense against a hostile takeover or acquisition of a significant or controlling interest, in addition to preserving our REIT status - The ability of the Board of Trustees to issue preferred or common shares, to reclassify preferred or common shares, and to increase the amount of our authorized preferred or common shares, without shareholder approval - Limits on the ability of shareholders to remove trustees without cause - Requirements for advance notice of shareholder proposals at annual shareholder meetings - Provisions of Maryland law restricting business combinations and control share acquisitions not approved by the Board of Trustees - Provisions of Maryland law protecting corporations (and by extension REITs) against unsolicited takeovers by limiting the duties of the trustees in unsolicited takeover situations - Provisions in Maryland law providing that the trustees are not subject to any higher duty or greater scrutiny than that applied to any other director under Maryland law in transactions relating to the acquisition or potential acquisition of control - Provisions of Maryland law creating a statutory presumption that an act of the trustees satisfies the applicable standards of conduct for trustees under Maryland law 10 - Provisions in loan or joint venture agreements putting the Company in default upon a change in control - Provisions of employment agreements with our officers calling for share purchase loan forgiveness, severance compensation and vesting of equity compensation upon a change in control Any or all of these provisions could delay or prevent a change in control of the Company, even if the change was in our shareholders &apos interest or offered a greater return to our shareholders |
| CHANGES IN FOREIGN CURRENCY EXCHANGE RATES MAY HAVE AN IMPACT ON THE VALUE OF OUR SHARES The functional currency for our Canadian operations and mortgage note receivable is the Canadian dollar |
| As a result, our future earnings could be affected by fluctuations in the exchange rate between US and Canadian dollars, which in turn could affect our share price |
| We have attempted to mitigate our exposure to Canadian currency exchange risk by having both our Canadian lease rentals and the debt service on our Canadian mortgage financing payable in the same currency |
| We may also from time to time enter into foreign exchange contracts to hedge our transaction exposures |
| We had no outstanding foreign exchange contracts as of December 31, 2005 and 2004 |
| If we enter into any such contracts in the future, we could be subject to the risk of loss on those contracts |
| We do not engage in purchasing forward exchange contracts for speculative purposes |
| TAX REFORM COULD ADVERSELY AFFECT THE VALUE OF OUR SHARES There have been a number of proposals in Congress for major revision of the federal income tax laws, including proposals to adopt a flat tax or replace the income tax system with a national sales tax or value-added tax |
| Any of these proposals, if enacted, could change the federal income tax laws applicable to REITS, subject us to federal tax or reduce or eliminate the current deduction for dividends paid to our shareholders, any of which could negatively affect the market for our shares |