PAC-10-Q 3Q2013

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File No. 001-34995
 
Preferred Apartment Communities, Inc.
(Exact name of registrant as specified in its charter)
 
Maryland
27-1712193
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
3625 Cumberland Boulevard, Suite 1150, Atlanta, GA 30339
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (770) 818-4100
 
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  x    No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
Large accelerated filer  ¨            Accelerated filer  ¨            Non-accelerated filer  x            Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No  x
The number of shares outstanding of the registrant’s Common Stock, as of November 5, 2013 was 11,044,715.


 
 
INDEX
 
 
 
 
 
 
Page No. 
 
PART I - FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
Consolidated Balance Sheets (unaudited) – as of September 30, 2013 and December 31, 2012
1

 
 
 
 
Consolidated Statements of Operations (unaudited) – Three Months and Nine Months Ended September 30, 2013 and 2012
2

 
 
 
 
Consolidated Statements of Stockholders' Equity (unaudited) – Nine Months Ended September 30, 2013 and 2012
3

 
 
 
 
Consolidated Statements of Cash Flows (unaudited) – Nine Months Ended September 30, 2013 and 2012
4

 
 
 
 
Notes to Consolidated Financial Statements (unaudited)
6

 
 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
31

 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
51

 
 
 
Item 4.
Controls and Procedures
51

 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
51

 
 
 
Item 1A
Risk Factors
51

 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
52

 
 
 
Item 3.
Defaults Upon Senior Securities
52

 
 
 
Item 4.
Mine Safety Disclosures
52

 
 
 
Item 5.
Other Information
52

 
 
 
Item 6.
Exhibits
52

 
 
SIGNATURES     
53

 
 
EXHIBIT INDEX     
54









i
PART I - FINANCIAL INFORMATION


Item 1. Financial Statements
Preferred Apartment Communities, Inc.
Consolidated Balance Sheets
(Unaudited)
 
 
 
 
 
 
 
September 30, 2013
 
December 31, 2012
Assets
 
 
 
 
 
 
 
 
 
Real estate
 
 
 
 
Land
 
$
31,300,000

 
$
13,052,000

Building and improvements
 
134,309,132

 
60,284,587

Furniture, fixtures, and equipment
 
19,374,423

 
8,771,346

Construction in progress
 
208,527

 
3,023

Gross real estate
 
185,192,082

 
82,110,956

Less: accumulated depreciation
 
(12,077,716
)
 
(6,288,998
)
Net real estate
 
173,114,366

 
75,821,958

Real estate loans, net
 
68,368,471

 
35,106,197

Real estate loans to related parties, net
 
3,645,069

 
—

Total real estate and real estate loans, net
 
245,127,906

 
110,928,155

 
 
 
 
 
Cash and cash equivalents
 
5,453,006

 
2,973,509

Restricted cash
 
2,286,117

 
540,232

Notes receivable
 
11,210,388

 
2,450,000

Note receivable from related party
 
1,500,000

 
—

Revolving line of credit to related party
 
4,079,877

 
936,827

Accrued interest receivable on real estate loans
 
2,523,449

 
718,901

Tenant receivables, net of allowance of $60,006 and $18,623
 
13,271

 
11,453

Acquired intangible assets, net of amortization of $12,093,210 and $5,537,067
 
596,745

 
—

Deferred loan costs, net of amortization of $755,848 and $258,492
 
1,725,369

 
681,632

Deferred offering costs
 
4,614,113

 
3,347,965

Other assets
 
695,899

 
703,256

 
 
 
 
 
Total assets
 
$
279,826,140

 
$
123,291,930

 
 
 
 
 
Liabilities and equity
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
Mortgage notes payable
 
$
127,516,000

 
$
55,637,000

Accounts payable and accrued expenses
 
2,666,698

 
1,110,964

Revolving credit facility
 
24,910,667

 
14,801,197

Accrued interest payable
 
421,258

 
202,027

Dividends and partnership distributions payable
 
2,025,591

 
851,484

Security deposits and prepaid rents
 
567,847

 
330,108

Other deferred income
 
29,459

 
301,575

Total liabilities
 
158,137,520

 
73,234,355

 
 
 
 
 
Commitments and contingencies (Note 11)
 
 
 
 
 
 
 
 
 
Equity
 
 
 
 
 
 
 
 
 
Stockholders' equity
 
 
 
 
Series A Redeemable Preferred Stock, $0.01 par value per share; 150,000 shares authorized;
 
 
 
 
72,030 and 19,762 shares issued; 71,960 and 19,762 shares
 
 
 
 
 outstanding at September 30, 2013 and December 31, 2012, respectively
 
720

 
198

Common Stock, $0.01 par value per share; 400,066,666 shares authorized; 11,044,715 and
 
 
 
 
5,288,444 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively
 
110,447

 
52,885

Additional paid in capital
 
135,483,844

 
59,412,744

Accumulated deficit
 
(15,020,422
)
 
(9,408,253
)
Total stockholders' equity
 
120,574,589

 
50,057,574

Non-controlling interest
 
1,114,031

 
1

Total equity
 
121,688,620

 
50,057,575

 
 
 
 
 
Total liabilities and equity
 
$
279,826,140

 
$
123,291,930


The accompanying notes are an integral part of these consolidated financial statements.
1


Preferred Apartment Communities, Inc.
Consolidated Statements of Operations
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
 
Rental revenues
 
$
5,426,402

 
$
2,309,943

 
$
14,789,074

 
$
6,783,328

Other property revenues
 
630,970

 
297,159

 
1,596,022

 
843,379

Interest income on loans and notes receivable
 
2,531,116

 
634,224

 
5,819,146

 
1,110,501

Interest income on loans and note from related party
 
163,787

 
1,925

 
207,700

 
1,925

Total revenues
 
8,752,275

 
3,243,251

 
22,411,942

 
8,739,133

 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
Property operating and maintenance
 
922,762

 
350,872

 
2,402,837

 
1,051,880

Property salary and benefits reimbursement to related party
 
600,547

 
247,165

 
1,633,530

 
738,643

Property management fees to related party
 
238,026

 
104,320

 
643,387

 
304,827

Real estate taxes
 
640,627

 
191,262

 
1,656,204

 
558,170

General and administrative
 
159,646

 
41,394

 
446,251

 
132,496

Equity compensation to directors and executives
 
290,860

 
315,600

 
889,946

 
921,207

Depreciation and amortization
 
3,682,087

 
905,988

 
12,678,709

 
2,800,404

Acquisition costs
 
10,682

 
—

 
212,818

 
912

Acquisition fees to related party
 
—

 
—

 
1,029,487

 
—

Management fees to related party
 
536,738

 
214,684

 
1,388,369

 
583,660

Insurance, professional fees and other
 
161,747

 
107,745

 
740,799

 
520,282

Total operating expenses
 
7,243,722

 
2,479,030

 
23,722,337

 
7,612,481

 
 
 
 
 
 
 
 
 
Operating income (loss)
 
1,508,553

 
764,221

 
(1,310,395
)
 
1,126,652

Interest expense
 
1,538,567

 
615,300

 
3,923,331

 
1,688,957

Loss on early extinguishment of debt
 
—

 
—

 
604,337

 
—

 
 
 
 
 
 
 
 
 
Net (loss) income
 
(30,014
)
 
148,921

 
(5,838,063
)
 
(562,305
)
 
 
 
 
 
 
 
 
 
Consolidated net loss attributable
 
 
 
 
 
 
 
 
to non-controlling interests
 
127,738

 
—

 
225,894

 
—

 
 
 
 
 
 
 
 
 
Net income (loss) attributable to the Company
 
97,724

 
148,921

 
(5,612,169
)
 
(562,305
)
 
 
 
 
 
 
 
 
 
Dividends declared to preferred stockholders
 
(973,069
)
 
(163,059
)
 
(2,769,001
)
 
(242,744
)
Deemed non-cash dividend to holders of
 
 
 
 
 
 
 
 
 Series B Preferred Stock
 
—

 
—

 
(7,028,557
)
 
—

Earnings attributable to unvested restricted stock
(4,352
)
 
(4,626
)
 
(13,496
)
 
(12,302
)
 
 
 
 
 
 
 
 
 
Net loss attributable to common stockholders
 
$
(879,697
)
 
$
(18,764
)
 
$
(15,423,223
)
 
$
(817,351
)
 
 
 
 
 
 
 
 
 
Net loss per share of Common Stock attributable to
 
 
 
 
 
 
 
 
common stockholders, basic and diluted
 
$
(0.08
)
 
$
—

 
$
(1.88
)
 
$
(0.16
)
 
 
 
 
 
 
 
 
 
Dividends per share declared on Common Stock
 
$
0.15

 
$
0.14

 
$
0.445

 
$
0.40

 
 
 
 
 
 
 
 
 
Weighted average number of shares of Common
 
 
 
 
 
 
 
 
 Stock outstanding, basic and diluted
 
11,041,359

 
5,178,822

 
8,197,531

 
5,169,467


The accompanying notes are an integral part of these consolidated financial statements.
2

Preferred Apartment Communities, Inc.
Consolidated Statements of Stockholders' Equity
For the nine months ended September 30, 2013 and 2012
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Series A Redeemable Preferred Stock
 
Common Stock
 
Additional Paid in Capital
 
Accumulated (Deficit)
 
Total Stockholders' Equity
 
Non Controlling Interest
 
Total Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2012
 
$
—

 
$
51,493

 
$
43,828,030

 
$
(9,261,623
)
 
$
34,617,900

 
$
1

 
$
34,617,901

Issuance of Units
 
122

 
—

 
12,165,498

 
—

 
12,165,620

 
—

 
12,165,620

Syndication and offering costs
 
—

 
—

 
(1,231,698
)
 
—

 
(1,231,698
)
 
—

 
(1,231,698
)
Equity compensation to executives and directors
 
—

 
38

 
921,169

 
—

 
921,207

 
—

 
921,207

Vesting of restricted stock
 
—

 
260

 
(260
)
 
—

 
—

 
—

 
—

Net loss
 
—

 
—

 
—

 
(562,305
)
 
(562,305
)
 
—

 
(562,305
)
Dividends to series A preferred stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($5.00 per share per month)
 
—

 
—

 
(242,744
)
 
—

 
(242,744
)
 
—

 
(242,744
)
Dividends to common stockholders ($0.40 per share)
 
—

 
—

 
(2,080,357
)
 
—

 
(2,080,357
)
 
—

 
(2,080,357
)
Balance at September 30, 2012
 
$
122

 
$
51,791

 
$
53,359,638

 
$
(9,823,928
)
 
$
43,587,623

 
$
1

 
$
43,587,624

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2013
 
$
198

 
$
52,885

 
$
59,412,744

 
$
(9,408,253
)
 
$
50,057,574

 
$
1

 
$
50,057,575

Issuance of Units
 
522

 
—

 
51,304,427

 
—

 
51,304,949

 
—

 
51,304,949

Syndication and offering costs
 
—

 
—

 
(7,816,159
)
 
—

 
(7,816,159
)
 
—

 
(7,816,159
)
Equity compensation to executives and directors
 
—

 
28

 
889,918

 
—

 
889,946

 
—

 
889,946

Vesting of restricted stock
 
—

 
330

 
(330
)
 
—

 
—

 
—

 
—

Vesting of Class B Units and conversion to Class A Units
 
—

 
—

 
(479,841
)
 
—

 
(479,841
)
 
479,841

 
—

Conversion of Class A Units to Common Stock
 
—

 
61

 
25,562

 
—

 
25,623

 
(25,623
)
 
—

Class B Units current period amortization
 
—

 
—

 
(672,549
)
 
—

 
(672,549
)
 
672,549

 
—

Conversion of Series B Preferred Stock to Common Stock
 
—

 
57,143

 
39,942,857

 
—

 
40,000,000

 
—

 
40,000,000

Net loss
 
—

 
—

 
—

 
(5,612,169
)
 
(5,612,169
)
 
(225,894
)
 
(5,838,063
)
Reallocation adjustment to non-controlling interests
 
—

 
—

 
(260,767
)
 
—

 
(260,767
)
 
260,767

 
—

Distributions to non-controlling interests
 
—

 
—

 
—

 
—

 
—

 
(47,610
)
 
(47,610
)
Dividends to series A preferred stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($5.00 per share per month)
 
—

 
—

 
(2,078,525
)
 
—

 
(2,078,525
)
 
—

 
(2,078,525
)
Dividends to series B preferred stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($17.26 per share)
 
—

 
—

 
(690,476
)
 
—

 
(690,476
)
 
—

 
(690,476
)
Dividends to common stockholders ($0.445 per share)
 
—

 
—

 
(4,093,017
)
 
—

 
(4,093,017
)
 
—

 
(4,093,017
)
Balance at September 30, 2013
 
$
720

 
$
110,447

 
$
135,483,844

 
$
(15,020,422
)
 
$
120,574,589

 
$
1,114,031

 
$
121,688,620


The accompanying notes are an integral part of these consolidated financial statements.
3

Preferred Apartment Communities, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
Nine months ended September 30,
 
 
2013
 
2012
Operating activities:
 
 
 
 
Net loss
 
$
(5,838,063
)
 
$
(562,305
)
Reconciliation of net loss to net cash provided by operating activities:
 
 
 
 
Depreciation expense
 
5,788,718

 
2,796,950

Amortization expense
 
6,889,991

 
3,454

Amortization of below market lease
 
(330,394
)
 
—

Deferred fee income amortization
 
(241,732
)
 
(41,236
)
Deferred loan cost amortization
 
571,721

 
91,473

Deferred interest income on real estate loans
 
(1,804,548
)
 
(318,296
)
Equity compensation to executives and directors
 
889,946

 
921,207

Deferred cable income amortization
 
(8,201
)
 
—

Changes in operating assets and liabilities:
 
 
 
 
(Increase) in tenant receivables
 
(1,818
)
 
(2,127
)
Decrease (increase) in other assets
 
84,430

 
(338,579
)
Increase in accounts payable and accrued expenses
 
13,829

 
291,743

Increase in accrued interest payable
 
28,892

 
40,103

(Decrease) increase in security deposits
 
(11,025
)
 
10,079

Increase in prepaid rents
 
43,309

 
114,155

Increase in deferred income
 
—

 
16,275

Net cash provided by operating activities
 
6,075,055

 
3,022,896

 
 
 
 
 
Investing activities:
 
 
 
 
Investments in real estate loans
 
(43,720,651
)
 
(25,190,708
)
Notes receivable issued
 
(11,155,618
)
 
(1,580,544
)
Notes receivable repaid
 
956,665

 
650,000

Draws on line of credit by related party
 
(6,538,982
)
 
(590,233
)
Repayments of line of credit by related party
 
3,168,909

 
245,032

Acquisition fees received on real estate loans
 
1,410,098

 
517,057

Acquisition fees paid on real estate loans
 
(705,049
)
 
(258,528
)
Acquisition of properties, net
 
(33,447,617
)
 
—

Additions to real estate assets - improvements
 
(1,129,263
)
 
(290,051
)
(Increase) in restricted cash
 
(701,770
)
 
(124,566
)
Net cash used in investing activities
 
(91,863,278
)
 
(26,622,541
)
 
 
 
 
 
Financing activities:
 
 
 
 
Proceeds from mortgage notes payable
 
59,045,000

 
—

Payments for mortgage extinguishment
 
(56,594,389
)
 
—

Payments for mortgage loan costs
 
(1,607,394
)
 
(309,500
)
Proceeds from revolving lines of credit
 
48,909,149

 
15,000,000

Payments on revolving lines of credit
 
(38,799,679
)
 
—

Proceeds from sales of Series B Preferred Stock, net of offering costs
 
36,959,366

 
—

Proceeds from sales of Units, net of offering costs
 
47,560,602

 
10,951,202

Common Stock dividends paid
 
(3,203,573
)
 
(1,997,573
)
Preferred stock dividends paid
 
(2,500,386
)
 
(184,552
)
Class A Unit distributions
 
(31,561
)
 
—

Payments for deferred offering costs
 
(1,469,415
)
 
(1,911,644
)
Net cash provided by financing activities
 
88,267,720

 
21,547,933

 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
 
2,479,497

 
(2,051,712
)
Cash and cash equivalents, beginning of period
 
2,973,509

 
4,548,020

Cash and cash equivalents, end of period
 
$
5,453,006

 
$
2,496,308

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

The accompanying notes are an integral part of these consolidated financial statements.
4

Preferred Apartment Communities, Inc.
Consolidated Statements of Cash Flows (unaudited) - continued
 
Supplemental cash flow information:
 
 
 
 
Cash paid for interest
 
$
4,175,177

 
$
1,636,010

 
 
 
 
 
Supplemental disclosure of non-cash activities:
 
 
 
 
Accrued capital expenditures
 
$
94,747

 
$
26,967

Dividends payable - common
 
$
1,661,060

 
$
729,699

Dividends payable - preferred
 
$
348,483

 
$
58,062

Deemed non-cash dividend to holders of Series B Preferred Stock
 
$
7,028,557

 
$
—

Partnership distributions to non-controlling interest
 
$
16,048

 
$
—

Accrued and payable deferred offering costs
 
$
452,874

 
$
291,329

Reclass of offering costs from deferred asset to equity
 
$
362,511

 
$
31,158

Receivable from third party for offering costs
 
$
—

 
$
234,679

Mortgage loans assumed on acquisitions
 
$
69,428,389

 
$
—

Mezzanine loan balance applied to purchase of property
 
$
6,326,898

 
$
—


The accompanying notes are an integral part of these consolidated financial statements.
5
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements
September 30, 2013
(Unaudited)


1.
Organization

Preferred Apartment Communities, Inc. was formed as a Maryland corporation on September 18, 2009, and elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code, effective with its tax year ended December 31, 2011. Unless the context otherwise requires, references to the "Company", "we", "us", or "our" refer to Preferred Apartment Communities, Inc., together with its consolidated subsidiaries, including Preferred Apartment Communities Operating Partnership, L.P., or the Operating Partnership. The Company was formed primarily to acquire and operate multifamily properties in select targeted markets throughout the United States. As part of its business strategy, the Company may enter into forward purchase contracts or purchase options for to-be-built multifamily communities and may make mezzanine loans, provide deposit arrangements, or provide performance assurances, as may be necessary or appropriate, in connection with the construction of multifamily communities and other properties. As a secondary strategy, the Company also may acquire or originate senior mortgage loans, subordinate loans or mezzanine debt secured by interests in multifamily properties, membership or partnership interests in multifamily properties and other multifamily related assets and invest not more than 10% of its total assets in other real estate related investments, as determined by its Manager (as defined below) as appropriate for the Company. The Company is externally managed and advised by Preferred Apartment Advisors, LLC, or its Manager, a Delaware limited liability company and related party (see Note 6).

The Company completed its initial public offering, or IPO, on April 5, 2011. As of September 30, 2013, the Company had 11,044,715 shares of common stock, par value $0.01 per share, or Common Stock, issued and outstanding and owned units in the Operating Partnership which represented a weighted-average ownership percentage of 99.04% for the three-month period ended September 30, 2013. The number of partnership units not owned by the Company totaled 106,988 at September 30, 2013 and represent Class A OP Units of the Operating Partnership. On January 3, 2012, Class B OP Units of the Operating Partnership were granted to the Company's four executive officers for annual service to be provided in 2012. On January 3, 2013, these Class B Units became vested and earned and automatically converted to Class A OP Units. The Class A OP Units are convertible at any time at the option of the holder into the Company's choice of either cash or Common Stock. In the case of cash, the value is determined based upon the trailing 20-day volume weighted average price of the Company's Common Stock.

The consolidated financial statements include the accounts of the Company and the Operating Partnership. The Company controls the Operating Partnership through its sole general partner interest and plans to conduct substantially all of its business through the Operating Partnership.

2.
Summary of Significant Accounting Policies

Basis of Presentation

The unaudited consolidated financial statements include all of the accounts of the Company and the Operating Partnership presented in accordance with accounting principles generally accepted in the United States of America, or GAAP. All significant intercompany transactions have been eliminated in consolidation. Certain adjustments have been made consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair presentation of the Company's financial condition and results of operations. These financial statements should be read in conjunction with our audited financial statements and notes thereto included in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2013.

Out of Period Adjustment

During the three months ended September 30, 2013, we recorded an out of period adjustment in the amount of $118,069 to correct the allocation of net loss to the non-controlling interest in the Company’s statement of operations.  The corrections, which related to the first and second quarters of 2013 in the amount of $20,761 and $97,308, respectively, increased the amount of net loss that was previously allocated to the non-controlling interest.  The Company has concluded the amounts were not material to those periods nor to the three-month period ended September 30, 2013 and has accordingly recorded the correction in the third quarter of 2013.  This out of period adjustment had no impact to the reported amount of net income/loss, statement of financial position, or cash flows for any prior periods.



6
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

    
Use of Estimates

The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Acquisitions and Impairments of Real Estate Assets

The Company generally records its initial investments in income-producing real estate at fair value at the acquisition date in accordance with ASC 805-10, Business Combinations. The aggregate purchase price of acquired properties is apportioned to the tangible and identifiable intangible assets and liabilities acquired at their estimated fair values. The value of acquired land, buildings and improvements is estimated by formal appraisals, observed comparable sales transactions, and information gathered during pre-acquisition due diligence activities and the valuation approach considers the value of the property as if it were vacant. The values of furniture, fixtures, and equipment are estimated by calculating their replacement cost and reducing that value by factors based upon estimates of their remaining useful lives. Intangible assets include the values of in-place leases and customer relationships. In-place lease values are estimated by calculating the estimated time to fill a hypothetically empty apartment complex to its stabilization level (estimated to be 92% occupancy) based on historical observed move-in rates for each property. Carrying costs during these hypothetical expected lease-up periods are estimated, considering current market conditions and include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates. The intangible assets are calculated by estimating the net cash flows of the in-place leases to be realized, as compared to the net cash flows that would have occurred had the property been vacant at the time of acquisition and subject to lease-up. The acquired in-place lease values are amortized to operating expense over the average remaining non-cancelable term of the respective in-place leases. The values of customer relationships are estimated by calculating the product of the avoided hypothetical lost revenue and the average renewal probability and are amortized to operating expense over the average remaining historical period of residency, plus an estimate of the average expected renewal period. The above-market or below-market lease values are recorded as a reduction or increase, respectively, to rental income over the remaining average non-cancelable term of the respective leases. Acquired intangible assets have no residual value.

The Company evaluates its tangible and identifiable intangible real estate assets for impairment when events such as declines in a property’s operating performance, deteriorating market conditions, or environmental or legal concerns bring recoverability of the carrying value of one or more assets into question. The total undiscounted cash flows of the asset group, including proceeds from disposition, are compared to the net book value of the asset group. If this test indicates that impairment exists, an impairment loss is recorded in earnings equal to the shortage of the book value to the discounted net cash flows of the asset group.

Loans Held for Investment

The Company carries its investments in real estate loans at amortized cost with assessments made for impairment in the event recoverability of the principal amount becomes doubtful. If, upon testing for impairment, the fair value result is lower than the carrying amount of the loan, a valuation allowance is recorded to lower the carrying amount to fair value, with a loss recorded in earnings. Recoveries of valuation allowances are only recognized in the event of maturity or a sale or disposition in an amount above carrying value. The balances of real estate loans presented on the consolidated balance sheets consist of drawn amounts on the loans, net of deferred loan fee revenue. See the ‘Revenue Recognition’ section of this note for other loan-related policy disclosures required by ASC 310-10-50-6.

Cash and Cash Equivalents and Restricted Cash

The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Restricted cash includes cash restricted by state law or contractual requirement and relates primarily to tax and insurance escrows and resident security deposits.



7
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

Fair Value Measurements

Certain assets and liabilities are required to be carried at fair value, or if they are deemed impaired, to be adjusted to reflect this condition. The Company follows the guidance provided by ASC 820, Fair Value Measurements and Disclosures, in accounting and reporting for real estate assets where appropriate, as well as debt instruments both held for investment and as liabilities. The standard requires disclosure of fair values calculated under each level of inputs within the following hierarchy:

•Level 1 – Quoted prices in active markets for identical assets or liabilities at the measurement date.
•Level 2 – Inputs other than quoted prices that are observable for the asset or liability, either directly or
indirectly.
•Level 3 – Unobservable inputs for the asset or liability.

Deferred Loan Costs

Deferred loan costs are amortized using the straight-line method, which approximates the effective interest method, over the terms of the related indebtedness.

Deferred Offering Costs

Deferred offering costs represent costs incurred by the Company related to current equity offerings, excluding costs specifically identifiable to a closing, such as commissions, dealer-manager fees, and other registration fees. For issuances of equity that occur on one specific date, associated offering costs are reclassified as a reduction of proceeds raised on the date of issue. Our ongoing offering of units, consisting of one share of Series A Redeemable Preferred Stock, or Series A Preferred Stock, and one warrant, or Warrant, to purchase 20 shares of Common Stock, or Units, generally closes on a bimonthly basis in variable amounts. Such offering is referred to herein as the Primary Series A Offering, pursuant to our registration statement on Form S-11 (registration number 333-176604), as may be amended from time to time. Deferred offering costs related to the Primary Series A Offering are reclassified to the stockholders’ equity section of the consolidated balance sheet as a reduction of proceeds raised on a pro-rata basis equal to the ratio of total Units issued to the maximum number of Units that are expected to be issued.

Non-controlling Interest

Non-controlling interest represents the equity interest of the Operating Partnership that is not owned by the Company. Non-controlling interest is adjusted for contributions, distributions and earnings or loss attributable to the non-controlling interest in the consolidated entity in accordance with the Agreement of Limited Partnership of the Operating Partnership, as amended.

Redeemable Preferred Stock

Shares of the Series A Preferred Stock issued pursuant to the Primary Series A Offering (further described in note 5) are redeemable at the option of the holder, subject to a declining redemption fee schedule. Redemptions are therefore outside the control of the Company. However, the Company retains the right to fund any redemptions of Series A Preferred Stock in either Common Stock or cash at its option. Therefore, the Company records the Series A Preferred Stock as a component of permanent stockholders’ equity.

Revenue Recognition

Rental revenue is recognized when earned from residents, which is over the terms of rental agreements, typically of 13 months’ duration. Differences from the straight-line method, which recognize the effect of any up-front concessions and other adjustments ratably over the lease term, are not material. The Company evaluates the collectability of amounts due from residents and maintains an allowance for doubtful accounts for estimated losses resulting from the inability of residents to make required payments then due under lease agreements. The balance of amounts due from residents are generally deemed uncollectible 30 days beyond the due date, at which point they are fully reserved.

Interest income on real estate loans and notes receivable is recognized on an accrual basis over the lives of the loans using the effective interest method. In the event that a loan or note is refinanced with the proceeds of another loan issued by the Company,


8
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

any unamortized loan fee revenue from the first loan will be recognized as interest revenue over the term of the new loan. Direct loan origination fees and origination or acquisition costs applicable to real estate loans are amortized over the lives of the loans as adjustments to interest income. The accrual of interest on all these instruments is stopped when there is concern as to the ultimate collection of principal or interest, which is generally a delinquency of 30 days in required payments of interest or principal. Any payments received on such non-accrual loans are recorded as interest income when the payments are received. Real estate loan assets are reclassified as accrual-basis once interest and principal payments become current. Certain real estate loan assets include limited purchase options and exit fees or additional interest payments that are due the Company at maturity or in the event of a sale of the property or refinancing of the loan by the borrower to a third party. If the Company purchases the subject property, any accrued exit fee will be treated as additional consideration for the acquired project.

Promotional fees received from service providers at the Company’s properties are deferred and recognized on a straight-line basis over the term of the agreement.

The PAC Rewards program, implemented in the first quarter of 2012, allows residents to accumulate reward points on a monthly basis for actions such as resident referrals and making rent payments online. A resident must rent an apartment from the Company for at least 14 months before reward points may be redeemed for services or upgrades to a resident’s unit. The Company accrues a liability for the estimated cost of these future point redemptions, net of a 35% breakage fee, which is the Company’s current estimate of rewards points that will not be redeemed. In accordance with Staff Accounting Bulletin 13.A.3c, the Company deems its obligations under PAC Rewards as inconsequential to the delivery of services according to the lease terms. Therefore, the expense related to the PAC Rewards Program is included in property operating and maintenance expense on the consolidated statements of operations.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with guidance provided by ASC 505, Equity-Based Payments to Non-Employees and ASC 718, Stock Compensation. We calculate the fair value of equity compensation instruments at the date of grant based upon estimates of their expected term, the expected volatility of and dividend yield on our Common Stock over this expected term period and the market risk-free rate of return. We will also estimate forfeitures of these instruments and accrue the compensation expense, net of estimated forfeitures, over the vesting period(s). We record the fair value of restricted stock awards based upon the closing stock price on the trading day immediately preceding the date of grant.

Acquisition Costs

The Company expenses property acquisition costs as incurred, which include costs such as due diligence, legal, certain accounting, environmental and consulting, when the acquisition constitutes a business combination. The Company capitalizes these costs for transactions deemed to be asset acquisitions.
    
Capitalization and Depreciation

The Company capitalizes replacements of furniture, fixtures and equipment, as well as carpet, appliances, air conditioning units, certain common area items, and other assets. Significant repair and renovation costs that improve the usefulness or extend the useful life of the properties are also capitalized. These assets are then depreciated on a straight-line basis over their estimated useful lives, as follows:

•Buildings                    30 - 40 years
•Furniture, fixtures & equipment            5 - 10 years
•Improvements to buildings and land        5 - 10 years    

Operating expenses related to unit turnover costs, such as carpet cleaning, mini-blind replacements, and minor repairs are expensed as incurred.



9
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

Income Taxes

The Company has elected to be taxed as a REIT under the Code. To continue to qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company's annual REIT taxable income to its stockholders (which is computed without regard to the dividends paid deduction or net capital gain which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, the Company generally will not be subject to federal income tax to the extent it distributes qualifying dividends to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect the Company's net income and net cash available for distribution to stockholders. The Company intends to operate in such a manner as to maintain its election for treatment as a REIT.

The Company's provision for income taxes is based on income before taxes reported for financial statement purposes after adjustment for transactions that do not have tax consequences. Deferred tax assets and liabilities are realized according to the estimated future tax consequences attributable to differences between the carrying value of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates as of the date of the balance sheet. The effect of a change in tax rates on deferred tax assets and liabilities is reflected in the period that includes the statutory enactment date. A deferred tax asset valuation allowance is recorded when it has been determined that it is more likely than not that deferred tax assets will not be realized. If a valuation allowance is needed, a subsequent change in circumstances in future periods that causes a change in judgment about the realization of the related deferred tax amount could result in the reversal of the deferred tax valuation allowance.

The Company recognizes a liability for uncertain tax positions. An uncertain tax position is defined as a position taken or expected to be taken in a tax return that is not based on clear and unambiguous tax law and which is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company measures the tax benefits recognized based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes.

Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income or loss available to common stockholders by the weighted average number of shares of Common Stock outstanding for the period. Net income or loss attributable to common stockholders is calculated by deducting dividends due to preferred stockholders, as well as nonforfeitable dividends due to holders of unvested restricted stock, which are participating securities under the two-class method of calculating earnings per share. Diluted earnings (loss) per share is computed by dividing earnings or net loss available to common stockholders by the weighted average number of shares of Common Stock outstanding adjusted for the effect of dilutive securities such as share grants or warrants. No adjustment is made for potential Common Stock equivalents that are anti-dilutive during the period.

3. Real Estate Assets
On June 25, 2013, the Company completed the acquisition of a 96-unit townhome-style multifamily community adjacent to our Trail Creek community in Hampton, Virginia, or Trail II, for approximately $18.2 million, less a capital improvements reserve of $250,000, which approximated the fair value of the assets. The construction of Trail II was partially financed by a $6.0 million mezzanine loan held by the Company, which was applied to the purchase at the closing of the property acquisition, along with an exit fee for accrued interest of $283,062.



10
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

The Company allocated the purchase price of Trail II to the acquired assets and liabilities based upon their fair values, as follows:
 
Trail II
Land
$
1,548,000

Buildings and improvements
13,411,080

Furniture, fixtures and equipment
1,968,402

In-place leases
908,286

Customer relationships
129,316

Restricted cash and security deposits
264,689

Prepaids, reserves and other assets
62,517

Security deposit liabilities
(14,803
)
Accounts payable, accrued expenses and other liabilities
(14,505
)
Below market leases
(106,398
)
 
 
Net assets acquired
$
18,156,584

 
 
Cash paid
$
11,829,686

Reinvested mezzanine funds
6,326,898

 
 
Total consideration
$
18,156,584


Discrete operating results are not available for Trail II subsequent to the acquisition date. The combined Trail Creek community contributed approximately $1,138,297 and $2,508,912 of revenue and approximately $475,553 and $875,679 of net loss to the Company's consolidated results for the three-month and nine-month periods ended September 30, 2013, respectively.

See note 6 for details regarding the acquisition fee paid related to this transaction.

On January 23, 2013, the Company completed the acquisition of the following three entities from Williams Multifamily Acquisition Fund, LP, a Delaware limited partnership, or WMAF, an entity whose properties were also managed by Preferred Residential Management LLC.

•
Ashford Park REIT, Inc, the fee-simple owner of a 408-unit multifamily community located in Atlanta, Georgia, or Ashford Park, for a total purchase price of approximately $39.6 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.

•
Lake Cameron REIT, Inc, the fee-simple owner of a 328-unit multifamily community located in suburban Raleigh, North Carolina, or Lake Cameron, for a total purchase price of approximately $30.5 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.

•
McNeil Ranch REIT, Inc, the fee-simple owner of a 192-unit multifamily community located in Austin, Texas, or McNeil Ranch, for a total purchase price of approximately $21.0 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.



11
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

The purchase price for each of these three underlying properties was established by the 95% unaffiliated third party equity investor in WMAF, pursuant to terms of the WMAF partnership agreement. The Company allocated the purchase prices of the three properties to the acquired assets and liabilities based upon their fair values, as follows:
 
Ashford Park
 
Lake Cameron
 
McNeil Ranch
 
Total
Land
$
10,600,000

 
$
4,000,000

 
$
2,100,000

 
$
16,700,000

Buildings and improvements
23,067,264

 
21,248,442

 
15,962,582

 
60,278,288

Furniture, fixtures and equipment
3,226,260

 
3,195,131

 
1,593,637

 
8,015,028

In-place leases
2,445,317

 
1,787,929

 
1,414,373

 
5,647,619

Customer relationships
375,859

 
313,498

 
161,903

 
851,260

Restricted cash
405,437

 
110,019

 
528,659

 
1,044,115

Prepaids, reserves and other assets
67,642

 
41,609

 
36,153

 
145,404

Security deposit liabilities
(57,825
)
 
(57,606
)
 
(60,931
)
 
(176,362
)
Intangible liabilities
(164,700
)
 
—

 
(112,495
)
 
(277,195
)
Accounts payable, accrued expenses and other
 
 
 
 
 
 
 
 liabilities
(363,226
)
 
(138,950
)
 
(650,350
)
 
(1,152,526
)
 
 
 
 
 
 
 
 
Net assets acquired
$
39,602,028

 
$
30,500,072

 
$
20,973,531

 
$
91,075,631


 
Ashford Park
 
Lake Cameron
 
McNeil Ranch
 
Total
Cash Paid
$
902,028

 
$
13,000,072

 
$
7,745,142

 
$
21,647,242

Mortgage Assumed
38,700,000

 
17,500,000

 
13,228,389

 
69,428,389

 
 
 
 
 
 
 
 
Total consideration
$
39,602,028

 
$
30,500,072

 
$
20,973,531

 
$
91,075,631


The combined entities of Ashford Park, Lake Cameron, and McNeil Ranch contributed approximately $2.9 million and $8.0 million of revenue and approximately $1.2 million and $6.7 million of net loss to the Company's consolidated results for the three-month and nine-month periods ended September 30, 2013, respectively.

The Company recorded depreciation and amortization of tangible and intangible assets on all its multifamily communities as follows:
 
Three months ended September 30,
 
Nine months ended September 30,
 
2013
 
2012
 
2013
 
2012
Depreciation:
 
 
 
 
 
 
 
Buildings and improvements
$
1,027,767

 
$
412,091

 
$
2,845,693

 
$
1,235,725

Furniture, fixtures, and equipment
1,077,922

 
492,746

 
2,943,025

 
1,561,225

 
2,105,689

 
904,837

 
5,788,718

 
2,796,950

Amortization:
 
 
 
 
 
 
 
Acquired intangible assets
1,575,247

 
—

 
6,886,537

 
—

Website development costs
1,151

 
1,151

 
3,454

 
3,454

Total depreciation and amortization
$
3,682,087

 
$
905,988

 
$
12,678,709

 
$
2,800,404

Amortization of acquired intangible assets for the nine-month period ended September 30, 2013 commenced on January 23, 2013, the date of acquisition of the three newly-acquired WMAF communities, and on June 25, 2013, the acquisition date of Trail II. The intangible assets will be amortized over a period ranging from the average remaining lease term, which was approximately six to seven months, to the average remaining lease term plus the average estimated renewal period. See note 15 for pro forma operating results of the Company, including the newly-acquired properties.


12
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)


4.     Real Estate Loans, Notes Receivable, and Line of Credit

At September 30, 2013, our portfolio of real estate loans consisted of:
 
Project/Property
 
Location
 
Date of loan
 
Maturity date
 
Optional extension date
 
Total loan commitments
 
Approved senior loan held by unrelated third party
 
(1) 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Summit II
 
Suburban Atlanta, GA
 
5/7/2012
 
5/8/2017
 
N/A
 
$
6,103,027

 
$
12,384,000

 
City Park
 
Charlotte, NC
 
9/6/2012
 
9/5/2017
 
N/A
 
10,000,000

 
$
18,600,000

 
City Vista
 
Pittsburgh, PA
 
8/31/2012
 
6/1/2016
 
7/1/2017
 
12,153,000

 
$
28,400,000

 
Madison - Rome
 
Rome, GA (2)
 
11/13/2012
 
9/20/2015
 
N/A
 
5,360,042

 
$
11,500,000

 
Lely
 
Naples, FL
 
3/28/2013
 
2/28/2016
 
2/28/2018
 
12,713,242

 
$
25,000,000

 
Crosstown Walk
 
Suburban Tampa, FL (3)
 
4/30/2013
 
11/1/2016
 
5/1/2018
 
10,962,000

 
$
25,900,000

 
Overton
 
Atlanta, GA
 
5/8/2013
 
11/1/2016
 
5/1/2018
 
16,600,000

 
$
31,700,000

 
Haven West
 
Carrollton, GA (4) (6)
 
7/15/2013
 
6/2/2016
 
6/2/2018
 
6,940,795

 
$
16,195,189

 
Starkville
 
Starkville, MS (5) (6)
 
8/21/2013
 
5/31/2014
 
N/A
 
1,730,000

 
 N/A

 
Newtown
 
Williamsburg, VA
 
8/29/2013
 
8/29/2018
 
N/A
 
10,346,000

 
$
26,936,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
92,908,106

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) 
All loans are mezzanine loans pertaining to developments of multifamily communities, except as otherwise indicated. The borrowers for each of these projects are as follows: "Summit II" - Oxford Summit II Apartments LLC; "City Park" - Oxford City Park Development LLC; "City Vista" - Oxford City Vista Development LLC; "Madison - Rome" - Madison Retail - Rome LLC; "Lely" - Lely Apartments LLC; "Crosstown Walk" - Iris Crosstown Partners LLC; "Overton" - Newport Overton Holdings, LLC; "Haven West" - Haven Campus Communities Member, LLC; "Starkville" - Haven Campus Communities - Starkville, LLC; and "Newtown" - Oxford NTW Apartments LLC.
(2) 
Madison-Rome is a mezzanine loan for an 88,351 square foot retail development project. On October 16, 2013, the anchor tenant obtained a certificate of occupancy and took possession of approximately 54,340 square feet of space.
(3) 
Crosstown Walk was a land acquisition bridge loan that was converted to a mezzanine loan in April 2013.
(4) 
Planned 568 bed student housing community.
 
 
(5) 
A land acquisition loan which pays 8% current interest only, in support of a planned 168-unit, 536-bed student housing community.
(6) 
See note 6 - Related Party Transactions
The mezzanine real estate loans held by the Company pay current monthly interest of 8% per annum, and except for the Starkville loan, which pays no deferred interest, and except for the Newtown loan, which accrues an additional 5% interest and a 1% exit fee, accrue an additional 6% interest which will be due at maturity or if the property is sold to, or refinanced by, a third party. There are no contingent events that are necessary to occur for the Company to realize the additional interest amounts. If the Company exercises a purchase option and acquires the property, the additional interest described below will be treated as additional consideration for the acquired project. The Company receives a fee of 2% of the aggregate amount of the loan at loan inception as partial inducement to offer the funds. The Company concurrently pays half of the 2% loan fee to its Manager as an acquisition fee (see note 6). The net 1% retained is recognized as revenue over the term of the loan. Except for the Starkville loan, the Company's real estate loans are collateralized by 100% of the membership interests of the underlying project entity, and, where necessary, by unconditional joint and several repayment guaranties and performance guaranties by the principal(s) of the borrower. These guaranties generally remain in effect until the receipt of a final certificate of occupancy. All of the guaranties are subject to the rights held by the senior lender pursuant to a standard intercreditor agreement. The Starkville loan is also collateralized by the acquired land. The Haven West loan is additionally collateralized by an assignment by the developer of security interests in an unrelated project. Prepayment of the mezzanine loans are permitted in whole, but not in part, without the Company's consent.


13
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

Management monitors the level of credit quality for each of the Company's mezzanine real estate loans by tracking the timeliness of scheduled interest and principal payments relative to the due dates as specified in the loan documents, as well as draw requests on the loans relative to the project budgets. In addition, management monitors the actual progress of development and construction relative to the construction plan, as well as local, regional, and national economic conditions as may bear on our current and target markets. The credit quality of the Company’s borrowers is primarily based on their payment history on an individual loan basis, as such, the Company does not assign quantitative credit value measures or categories to its real estate loans and notes receivable in credit quality categories.
 
 
Amount drawn
 
Loan Fee received from borrower - 2%
 
Acquisition fee paid to Manager - 1%
 
Unamortized deferred loan fee revenue
 
Carrying amount
Project/Property
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Summit II
 
$
6,103,027

 
$
122,061

 
$
61,030

 
$
(39,376
)
 
$
6,063,651

City Park
 
10,000,000

 
200,000

 
100,000

 
(78,349
)
 
9,921,651

City Vista
 
12,153,000

 
243,060

 
121,530

 
(97,023
)
 
12,055,977

Madison - Rome
 
5,360,042

 
107,201

 
53,600

 
(40,492
)
 
5,319,550

Lely
 
8,018,423

 
254,267

 
127,133

 
(99,793
)
 
7,918,630

Crosstown Walk
 
9,844,642

 
219,240

 
109,620

 
(52,566
)
 
9,792,076

Overton
 
11,789,478

 
332,000

 
166,000

 
(142,511
)
 
11,646,967

Haven West
 
2,130,569

 
138,816

 
69,408

 
(63,424
)
 
2,067,145

Starkville
 
1,590,600

 
34,600

 
17,300

 
(12,676
)
 
1,577,924

Newtown
 
5,745,036

 
206,920

 
103,460

 
(95,067
)
 
5,649,969

 
 
 
 
 
 
 
 
 
 
 
 
 
$
72,734,817

 
$
1,858,165

 
$
929,081

 
$
(721,277
)
 
$
72,013,540

The Company holds options, but not obligations, to purchase certain of the properties which are partially financed by its mezzanine loans, as shown in the table below. The option purchase prices are negotiated at the time of the loan closing.
 
 
Purchase option window
 
Purchase option price
 
Total units upon completion
Project/Property
 
Begin
 
End
 
 
 
 
 
 
 
 
 
 
 
Summit II
 
10/1/2014
 
2/28/2015
 
$
19,254,155

 
140

City Park
 
11/1/2015
 
3/31/2016
 
$
30,945,845

 
284

City Vista
 
2/1/2016
 
5/31/2016
 
$
43,560,271

 
272

Madison - Rome
 
N/A
 
N/A
 
N/A

 
N/A

Lely
 
4/1/2016
 
8/30/2016
 
$
43,500,000

 
308

Crosstown Walk
 
7/1/2016
 
12/31/2016
 
$
39,654,273

 
342

Overton
 
7/8/2016
 
12/8/2016
 
$
51,500,000

 
294

Haven West
 
8/1/2016
 
1/31/2017
 
$
26,138,466

 
160

Starkville
 
N/A
 
N/A
 
N/A

 
—

Newtown
 
2/1/2016
 
9/15/2016
 
$
44,266,000

 
247

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2,047



14
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)


At September 30, 2013, our portfolio of notes and line of credit receivable consisted of:
Borrower
 
Type of instrument
 
Date of loan
 
Maturity date
 
Total loan commitments
 
Amount drawn
 
Interest rate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
360 Residential, LLC
 
Bridge loan
 
6/25/2013
 
3/20/2014
 
$
1,000,000

 
$
872,747

 
8
%
(1) 
TPKG 13th Street Development, LLC
 
Land acquisition loan
 
7/24/2013
 
1/15/2014
 
6,400,000

 
6,241,484

 
8
%
(2) 
Preferred Capital Marketing Services, LLC
 
Promissory note
 
1/24/2013
 
1/23/2015
 
1,500,000

 
1,500,000

 
10
%
 
Riverview Associates, Ltd.
 
Promissory note
 
12/17/2012
 
12/31/2013
 
1,300,000

 
1,300,000

 
8
%
(3) 
International Assets Advisory, LLC
 
Subordinated loan
 
11/15/2012
 
11/15/2013
 
650,000

 
650,000

 
10
%
(4) 
Oxford Properties LLC
 
Promissory note
 
8/27/2013
 
4/30/2017
 
1,500,000

 
1,475,000

 
8
%
 
Riverview Office, LLC
 
Promissory note
 
8/20/2013
 
10/31/2013
 
1,000,000

 
671,156

 
8
%
(5) 
Preferred Apartment Advisors, LLC
 
Revolving credit line
 
6/12/2013
 
12/31/2015
 
6,000,000

 
4,079,878

 
8
%
(6 
) 
 
 
 
 
 
 
 
 
$
19,350,000

 
$
16,790,265

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) Amendment of the bridge loan which was originated on March 20, 2013. The amounts payable under the terms of the loan, which include an additional 6% deferred interest, are collateralized by guaranties of payment and performance by the principals of the borrower.
(2) Note pays current interest at 8% per annum, plus an additional interest amount necessary to provide the Company with a 14% cumulative simple rate of return through August 31, 2013, scaling upward to 20% per annum on January 1, 2014 and thereafter. The amounts payable under the terms of the loan are collateralized by a pledge of 100% of the membership interests of the project entity.
(3) The amounts payable under the terms of the loan are collateralized by an assignment of project documents and guaranties of payment and performance by the principal of the borrower.
(4) The amounts payable under the terms of the loan are collateralized by rights of withholding commissions due IAA from the Company in connection with securing placements of the Primary Series A Offering.
(5) Amendment of the promissory note which was originated on April 30, 2013. See note 17 for discussion of increase in loan amount and an extension of the maturity date.
(6) The amounts payable under the credit line are collateralized by an assignment of the Manager's rights to fees due under the third amended and restated management agreement between the Company and the Manager.
On July 26, 2013, the amount owed to the Company by Pecunia Management, LLC under the terms of the Company's $1.5 million loan to Pecunia which closed on January 24, 2013 was transferred by a novation to Preferred Capital Marketing Services, LLC, a Georgia limited liability company, or PCMS, which will be performing certain marketing services for the Company related to its capital raising efforts. PCMS is 100% owned by NELL Partners, Inc., a related party.
The Company recorded interest income and other revenue from these instruments as follows:

 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Real estate loans:
 
 
 
 
 
 
 
 
Current interest payments
 
$
1,258,636

 
$
374,445

 
$
2,966,721

 
$
689,806

Additional accrued interest
 
932,461

 
198,449

 
2,054,297

 
318,295

Deferred loan fee revenue
 
64,603

 
27,455

 
180,297

 
38,884

Total real estate loan revenue
 
2,255,700

 
600,349

 
5,201,315

 
1,046,985

Interest income on notes and line of credit
 
439,203

 
35,800

 
825,531

 
65,441

Interest income on loans and notes receivable
 
$
2,694,903

 
$
636,149

 
$
6,026,846

 
$
1,112,426


The Company extends loans for purposes such as to partially finance the development of multifamily residential communities, to acquire land in anticipation of developing and constructing multifamily residential communities, and for other real estate or real estate related projects. Certain of these loans include characteristics such as exclusive options to purchase the project at a fixed price within a specific time window following project completion and stabilization, the rights to incremental exit fees over and above the amount of periodic interest paid during the life of the loans, or both. These characteristics can cause the loans to create variable interests to the Company and require further evaluation as to whether the variable interest creates a variable interest entity, or VIE, which would necessitate consolidation of the project. The Company considers the facts and circumstances pertinent to each entity borrowing under


15
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)


the loan, including the relative amount of financing the Company is contributing to the overall project cost, decision making rights or control held by the Company, guarantees provided by third parties, and rights to expected residual gains or obligations to absorb expected residual losses that could be significant from the project. If the Company is deemed to be the primary beneficiary of a VIE, consolidation treatment would be required.
The Company has evaluated its real estate loans, where appropriate, for accounting treatment as loans versus real estate development projects, as required by ASC 310. For each loan, the majority of the characteristics and the facts and circumstances indicate that loan accounting treatment is appropriate.
The Company's real estate loans partially finance the development activities of the borrowers' associated legal entities. Each of these loans create variable interests in each of these entities, and according to the Company's analysis, are deemed to be VIEs, due to the combined factors of the sufficiency of the borrowers' investment at risk, the existence of payment and performance guaranties provided by the borrowers, as well as the limitations on the fixed-price purchase options on the Summit II, City Park, City Vista, Overton, Crosstown Walk, Lely, Haven West and Newtown loans. The Company has concluded that it is not the primary beneficiary of the borrowing entities. It has no decision making authority or power to direct activity, except normal lender rights, which are subordinate to the senior loans on the projects. Therefore, since the Company has concluded it is not the primary beneficiary, it has not consolidated these entities in its consolidated financial statements. The Company's maximum exposure to loss from these loans is their drawn amount as of September 30, 2013 of approximately $72.7 million. The maximum aggregate amount of loans to be funded as of September 30, 2013 was approximately $92.9 million.
The Company is subject to a concentration of credit risk that could be considered significant with regard to the Summit II, Crosstown Walk, City Park, City Vista and Newtown real estate loans, as identified specifically by the two named principals of the borrowers, W. Daniel Faulk, Jr. and Richard A. Denny, and as evidenced by repayment guaranties offered in support of these loans. The drawn amount of these loans total approximately $43.8 million (with a total commitment amount of $49.6 million) and in the event of a total failure to perform by the borrowers and guarantors, would subject the Company to a total possible loss of that amount. The Company generally requires secured interests in one or a combination of the membership interests of the borrowing entity or the entity holding the project, guaranties of loan repayment, and project completion performance guaranties as credit protection with regard to its real estate loans, as is customary in the mezzanine loan industry. The Company has performed assessments of the guaranties with regard to the obligors' ability to perform according to the terms of the guaranties if needed and has concluded that the guaranties reduce the Company's risk and exposure to the above-described credit risk in place as of September 30, 2013.

The borrowers and guarantors behind these real estate loans (excluding the Madison-Rome, Overton, Lely, Haven West and Starkville loans) collectively qualify as a major customer as defined in ASC 280-10-50, as the revenue recorded from this customer exceeded ten percent of the Company's total revenues. The Company recorded revenue from transactions with this major customer for the three-month and nine-month periods ended September 30, 2013 of approximately $1.4 million and $3.6 million.

5. Redeemable Preferred Stock
On November 18, 2011, the Securities and Exchange Commission declared effective our registration statement on Form S-11 (registration number 333-176604) for our Primary Series A Offering of up to a maximum of 150,000 Units, with each Unit consisting of one share of Series A Preferred Stock and one Warrant to purchase 20 shares of our Common Stock, which is being offered and sold by IAA on a "reasonable best efforts" basis. Each share of Preferred Stock ranks senior to Common Stock and carries a cumulative annual 6% dividend of the stated per share value of $1,000, payable monthly as declared by the Company’s board of directors. Dividends begin accruing on the date of issuance. The Preferred Stock is redeemable at the option of the holder beginning two years following the date of issue subject to a 10% redemption fee. After year three the redemption fee decreases to 5%, after year four it decreases to 3%, and after year five there is no redemption fee. Any redeemed shares of Preferred Stock are entitled to any accrued but unpaid dividends at the time of redemption and any redemptions may be in cash or Common Stock, at the Company’s discretion. The Warrant is exercisable by the holder at an exercise price of 120% of the current market price per share of the Common Stock on the date of issuance of such warrant with a minimum exercise price of $9.00 per share. The current market price per share is determined using the volume weighted average closing market price for the 20 trading days prior to the date of issuance of the Warrant. The Warrants are not exercisable until one year following the date of issuance and expire four years following the date of issuance.
On August 16, 2012, the Company filed a registration statement on Form S-11 (registration number 333-183355) for a follow-on offering of an additional 850,000 Units, or Follow-On Offering .  On August 29, 2013, the Company filed Pre-Effective Amendment No. 1 for the Follow-On Offering registration statement on Form S-3 increasing the Follow-On Offering to 900,000 Units (see


16
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

Note 17).  The terms of the Follow-On Offering and features of the Units in the Follow-On Offering are substantially the same as the Primary Series A Offering. See note 17.

As of September 30, 2013, offering costs specifically identifiable to Unit offering closing transactions, such as commissions, dealer manager fees, and other registration fees, totaled approximately $6.6 million. These costs are reflected as a reduction of stockholders' equity at the time of closing. In addition, the costs related to the offering not related to a specific closing transaction totaled approximately $4.7 million. As of September 30, 2013, the Company had issued 72,030 Units and collected net proceeds of approximately $65.4 million from the Primary Series A Offering after commissions.  A total of 70 shares of Series A Preferred Stock were subsequently redeemed. The number of Units issued was approximately 7.2% of the maximum number of Units anticipated to be issued under the Primary Series A Offering and the Follow-On Offering. Consequently, the Company cumulatively recognized approximately 7.2% of the approximate $4.7 million deferred to date, or approximately $340,000 as a reduction of stockholders' equity.  The remaining balance of offering costs not yet reflected as a reduction of stockholder's equity, approximately $4.6 million, are reflected in the asset section of the consolidated balance sheet  as deferred offering costs at September 30, 2013.  The remainder of current and future deferred offering costs related to the Primary Series A Offering will likewise be recognized as a reduction of stockholders' equity in the proportion of the number of Units issued to the maximum number of Units anticipated to be issued. Offering costs not related to a specific closing transaction are subject to an overall cap of 1.5% of the total gross proceeds raised during the Unit offerings.

On January 17, 2013, the Company issued 40,000 shares of its Series B Preferred Stock at a purchase price of $1,000 per share through a private placement transaction. The net proceeds totaled approximately $37.6 million after commissions. On May 9, 2013, the common stockholders approved the issuance of Common Stock upon the conversion of the Series B Preferred Stock. As a result of such approval, the Series B Preferred Stock was converted into 5,714,274 shares of Common Stock on May 16, 2013.
On May 17, 2013, the Company filed with the SEC a universal shelf registration statement on Form S-3 (File No. 333-188677), or the Shelf Registration Statement. The Shelf Registration Statement permits the Company to engage in offerings of shares of common stock or preferred stock, debt securities, depositary shares, warrants and units and any combination of the foregoing. The Shelf Registration Statement was declared effective on July 19, 2013. The amount of securities registered was $200 million, all of which is currently available for future offerings. Deferred offering costs related to the establishment of this offering totaled $206,921 as of September 30, 2013. These costs will likewise be recognized as a reduction of stockholders' equity in the proportion of the proceeds from securities issued to the maximum amount of securities registered.

The conversion price of the Series B Preferred Stock created a beneficial conversion feature ("BCF") as a result of the conversion price being less than the market price of the Common Stock on January 16, 2013. The BCF of approximately $7.0 million was recorded when the Series B Preferred Stock became convertible in May 2013. As required by ASC 480, the BCF was recorded as a deemed distribution to the holders upon conversion, with a corresponding increase in additional paid-in capital, with no net effect on total stockholders' equity. The deemed distribution was also recorded as a deemed non-cash preferred dividend in the Company's earnings per share calculations, and due to the Company's deficit position of retained earnings, the deemed non-cash dividend was also recorded as a reduction of additional paid-in capital.
6. Related Party Transactions
John A. Williams, the Company's Chief Executive Officer and Chairman of the Board, and Leonard A. Silverstein, the Company's President and Chief Operating Officer and a member of the Board, are also executive officers and directors of NELL Partners, Inc., which controls the Manager. Mr. Williams is the Chief Executive Officer and President and Mr. Silverstein is the President and Chief Operating Officer of the Manager.

Mr. Williams, Mr. Silverstein and Michael J. Cronin, the Company's Executive Vice President, Chief Accounting Officer and Treasurer are executive officers of Williams Realty Advisors, LLC, or WRA.



17
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

The Management Agreement entitles the Manager to receive compensation for various services it performs related to acquiring assets and managing properties on the Company's behalf:

 
 
 
 
Three months ended
 
Nine months ended
Type of Compensation
 
Basis of Compensation
 
September 30, 2013
 
September 30, 2012
 
September 30, 2013
 
September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Acquisition fees
 
1% of the gross purchase price of real estate assets acquired or loans advanced
 
$
195,833

 
$
168,813

 
$
1,734,040

 
$
258,528

Asset management fees
 
Monthly fee equal to one-twelfth of 0.50% of the total book value of assets, as adjusted
 
363,595

 
148,573

 
944,087

 
409,964

Property management fees
 
Monthly fee equal to 4% of the monthly gross revenues of the properties managed
 
238,026

 
104,320

 
643,387

 
304,827

General and administrative expense fees
 
Monthly fee equal to 2% of the monthly gross revenues of the Company
 
173,143

 
66,111

 
444,282

 
173,696

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
970,597

 
$
487,817

 
$
3,765,796

 
$
1,147,015


In addition to property management fees, the Company incurred the following reimbursable on-site personnel salary and related benefits expenses at the properties, which are included in property operating and maintenance expense on the Consolidated Statements of Operations:
Three months ended September 30,
 
Nine months ended September 30,
2013
 
2012
 
2013
 
2012
$
600,547

 
$
247,165

 
$
1,633,530

 
$
738,643


The Manager utilizes its own personnel and certain personnel of its affiliates to accomplish certain tasks related to raising capital that would typically be performed by third parties, including, but not limited to, legal and marketing functions. As permitted under the Management Agreement, the Manager requested reimbursement of $93,776 and $43,747 for the three-month periods ended September 30, 2013 and 2012, respectively and $242,530 and $120,618 for the nine-month periods ended September 30, 2013 and 2012, respectively. These costs are recorded as deferred offering costs until such time as additional closings occur on the Unit offerings, at which time they are reclassified on a pro-rata basis as a reduction of offering proceeds within stockholders’ equity.

In addition to the fees described above, the Management Agreement also entitles the Manager to other potential fees, as follows:

•
Disposition fees - Based on the lesser of (A) one-half of the commission that would be reasonable and customary; and (B) 1% of the sale price of the asset
•
Construction, development, and landscaping fees - Customary and competitive market rates in light of the size, type and location of the asset
•
Special limited partnership interest in the Operating Partnership - distributions from the Operating Partnership equal to 15% of any net proceeds from the sale of a property and prior operations that are remaining after the payment of (i) the capital and expenses allocable to all realized investments (including the sold asset), and (ii) a 7% priority annual return on such capital and expense; provided that all accrued and unpaid dividends on the Series A Preferred Stock have been paid in full

The Company did not incur any of these other potential fees during the three-month or nine-month periods ended September 30, 2013 or 2012.



18
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

The Company has extended a mezzanine loan to partially finance the development of a student housing project in Carrollton, Georgia, and a real estate loan for the acquisition of land for the development of another student housing project in Starkville, Mississippi. The principals of the borrowers of these two loans include a relative of John A. Williams, the Company's Chief Executive Officer.

7. Dividends and Distributions

The Company declares and pays monthly cash dividend distributions on its Series A Preferred Stock in the amount of $5.00 per share per month, prorated for partial months at issuance as necessary. The Company's cash distributions on its Series A Preferred Stock for the nine month periods ended September 30, 2013 and 2012 were:
2013
 
2012
Declaration date
 
Number of shares
 
Aggregate dividends declared
 
Declaration date
 
Number of shares
 
Aggregate dividends declared
 
 
 
 
 
 
 
 
 
 
 
January 24, 2013
 
19,732

 
$
107,551

 
N/A
 
—

 
$
—

February 7, 2013
 
23,094

 
119,885

 
N/A
 
—

 
—

February 7, 2013
 
25,755

 
132,603

 
N/A
 
—

 
—

April 20, 2013
 
41,492

 
220,874

 
April 13, 2012
 
2,155

 
11,486

May 20, 2013
 
48,098

 
247,597

 
May 10, 2012
 
4,985

 
25,406

June 27, 2013
 
53,749

 
276,946

 
June 22, 2012
 
8,441

 
42,793

July 19, 2013
 
59,121

 
302,532

 
July 22, 2012
 
10,682

 
50,878

August 23, 2013
 
63,359

 
322,368

 
August 2, 2012
 
11,491

 
54,119

September 24, 2013
 
68,198

 
348,483

 
September 18, 2012
 
12,178

 
58,062

 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
2,078,839

 
 
 
Total
 
$
242,744


In addition, the Company declared on February 7, 2013 and paid a cash dividend on its Series B Preferred Stock at the same rate and frequency as those dividends declared on the Common Stock, equal to 5,714,274 as-converted shares of Common Stock, in an aggregate amount of $690,476.

The Company's dividend activity on its Common Stock for the nine-month periods ended September 30, 2013 and 2012 was:
2013
 
2012
Record date
 
Number of shares
 
Dividend per share
 
Aggregate dividends paid
 
Record date
 
Number of shares
 
Dividend per share
 
Aggregate dividends paid
March 28, 2013
 
5,323,605

 
$
0.145

 
$
771,923

 
March 30, 2012
 
5,178,315

 
$
0.13

 
$
673,180

June 26, 2013
 
11,066,895

 
0.15

 
1,660,034

 
June 29, 2012
 
5,211,362

 
0.13

 
677,477

September 16, 2013
 
11,073,731

 
0.15

 
1,661,060

 
September 28, 2012
 
5,212,139

 
0.14

 
729,700

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
$
0.445

 
$
4,093,017

 
 
 
 
 
$
0.40

 
$
2,080,357

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

The holders of Class A OP Units of the Operating Partnership are entitled to equivalent distributions as those declared on the Common Stock. At September 30, 2013, the Company had 106,988 Class A OP Units outstanding, which are exchangeable on a one-for-one basis for shares of Common Stock. On February 7, 2013, the Operating Partnership declared cash distributions to its Class A unitholders totaling $15,513, which were paid on April 25, 2013. On May 9, 2013, the Operating Partnership declared cash distributions to its Class A OP Unitholders totaling $16,048, which were paid on July 31, 2013. On August 8, 2013, the Operating Partnership declared cash distributions to its Class A OP Unitholders totaling $16,048, which were paid on October 29, 2013.



19
Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
September 30, 2013
(Unaudited)

8. Equity Compensation
Stock Incentive Plan
On February 25, 2011, the Company’s board of directors adopted, and the Company’s stockholders approved, the Preferred Apartment Communities, Inc. 2011 Stock Incentive Plan, or, as amended, the 2011 Plan, to incentivize, compensate and retain eligible officers, consultants, and non-employee directors. A maximum of 567,500 shares of Common Stock may be issued under the 2011 Plan. Awards may be made in the form of issuances of Common Stock, restricted stock, stock appreciation rights (“SARs”), performance shares, incentive stock options, non-qualified stock options, or other forms. Eligibility for receipt of, amounts, and all terms governing awards pursuant to the 2011 Plan, such as vesting periods and voting and dividend rights on unvested awards, are determined by the Compensation Committee of the Company’s Board of Directors.

On May 9, 2013, the Company's stockholders approved the second amendment to the 2011 Plan, to increase the number of authorized shares by 750,000 and to extend the expiration date of the 2011 Plan to December 31, 2016.