| INVESTORS REAL ESTATE TRUST Item 1A Risk Factors Risks Related to Our Properties and Business Our performance and share value are subject to risks associated with the real estate industry |
| Our results of operations and financial condition, the value of our real estate assets, and the value of an investment in us are subject to the risks normally associated with the ownership and operation of real estate properties |
| These risks include, but are not limited to, the following factors which, among others, may adversely affect the income generated by our properties: • downturns in national, regional and local economic conditions (particularly increases in unemployment); • competition from other commercial and multi-family residential properties; • local real estate market conditions, such as oversupply or reduction in demand for commercial and multi-family residential space; • changes in interest rates and availability of attractive financing; • declines in the economic health and financial condition of our tenants and our ability to collect rents from our tenants; • vacancies, changes in market rental rates and the need periodically to repair, renovate and re-lease space; • increased operating costs, including real estate taxes, state and local taxes, insurance expense, utilities, and security costs; • significant expenditures associated with each investment, such as debt service payments, real estate taxes and insurance and maintenance costs, which are generally not reduced when circumstances cause a reduction in revenues from a property; • weather conditions, civil disturbances, natural disasters, or terrorist acts or acts of war which may result in uninsured or underinsured losses; and • decreases in the underlying value of our real estate |
| Our property acquisition activities subject us to various risks which could adversely affect our operating results |
| We have acquired in the past and intend to continue to pursue the acquisition of properties and portfolios of properties, including large portfolios that could increase our size and result in alterations to our capital structure |
| Our acquisition activities and their success are subject to numerous risks, including, but not limited to: • even if we enter into an acquisition agreement for a property, it is subject to customary closing conditions, including completion of due diligence investigations, and we may be unable to complete that acquisition after making a non-refundable deposit and incurring other acquisition-related costs; 2006 Annual Report 11 _________________________________________________________________ [32]Index • we may be unable to obtain financing for acquisitions on favorable terms or at all; • acquired properties may fail to perform as expected; • the actual costs of repositioning or redeveloping acquired properties may be greater than our estimates; and • we may be unable quickly and efficiently to integrate new acquisitions into our existing operations |
| These risks could have an adverse effect on our results of operations and financial condition |
| Acquired properties may subject us to unknown liabilities which could adversely affect our operating results |
| We may acquire properties subject to liabilities and without any recourse, or with only limited recourse against prior owners or other third parties, with respect to unknown liabilities |
| As a result, if liability were asserted against us based upon ownership of these properties, we might have to pay substantial sums to settle or contest it, which could adversely affect our results of operations and cash flows |
| Unknown liabilities with respect to acquired properties might include liabilities for clean-up of undisclosed environmental contamination; claims by tenants, vendors or other persons against the former owners of the properties; liabilities incurred in the ordinary course of business; and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties |
| Our geographic concentration in Minnesota and North Dakota may result in losses due to our significant exposure to the effects of economic and real estate conditions in those markets |
| For the fiscal year ended April 30, 2006, we received approximately 73dtta4prca of our gross revenue from properties in Minnesota and North Dakota |
| As a result of this concentration, we are subject to substantially greater risk than if our investments were more geographically dispersed |
| Specifically, we are more significantly exposed to the effects of economic and real estate conditions in those particular markets, such as building by competitors, local vacancy and rental rates and general levels of employment and economic activity |
| To the extent that weak economic or real estate conditions affect Minnesota and/or North Dakota more severely than other areas of the country, our financial performance could be negatively impacted |
| If we are not able to renew leases or enter into new leases on favorable terms or at all as our existing leases expire, our revenue, operating results and cash flows will be reduced |
| We may be unable to renew leases with our existing tenants or enter into new leases with new tenants due to economic and other factors as our existing leases expire or are terminated prior to the expiration of their current terms |
| As a result, we could lose a significant source of revenue while remaining responsible for the payment of our obligations |
| In addition, even if we were able to renew existing leases or enter into new leases in a timely manner, the terms of those leases may be less favorable to us than the terms of expiring leases, because the rental rates of the renewal or new leases may be significantly lower than those of the expiring leases, or tenant installation costs, including the cost of required renovations or concessions to tenants, may be significant |
| If we are unable to enter into lease renewals or new leases on favorable terms or in a timely manner for all or a substantial portion of space that is subject to expiring leases, our revenue, operating results and cash flows will be adversely affected |
| As a result, our ability to make distributions to the holders of our shares of beneficial interest may be adversely affected |
| As of April 30, 2006, approximately 0dtta78 million square feet, or 9dtta0prca of our total commercial property square footage, was vacant |
| Approximately 583 of our 8cmam648 apartment units, or 6dtta7prca, were vacant |
| As of April 30, 2006, leases on approximately 10dtta1prca of our total commercial segments leased net rentable square footage will expire in fiscal year 2007, 9dtta8prca in fiscal year 2008, 10dtta0prca in fiscal year 2009, 9dtta7prca in fiscal year 2010, and 13dtta2prca in fiscal year 2011 |
| We face potential adverse effects from commercial tenant bankruptcies or insolvencies |
| The bankruptcy or insolvency of our commercial tenants may adversely affect the income produced by our properties |
| If a tenant defaults, we may experience delays and incur substantial costs in enforcing our rights as landlord |
| If a tenant files for bankruptcy, we cannot evict the tenant solely because of such bankruptcy |
| A court, however, may authorize the tenant to reject and terminate its lease with us |
| In such a case, our claim against the tenant for unpaid future rent would be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease, and it is unlikely that a bankrupt tenant would pay in full amounts it owes us under a lease |
| This shortfall could adversely affect our cash flow and results of operations |
| If a tenant experiences a downturn in its business or other t ypes of financial distress, it may be unable to make timely rental payments |
| Under some circumstances, we 2006 Annual Report 12 _________________________________________________________________ [33]Index may agree to partially or wholly terminate the lease in advance of the termination date in consideration for a lease termination fee that is less than the agreed rental amount |
| Additionally, without regard to the manner in which a lease termination occurs, we are likely to incur additional costs in the form of tenant improvements and leasing commissions in our efforts to lease the space to a new tenant, as well as possibly lower rental rates reflective of declines in market rents |
| Because real estate investments are generally illiquid, and various factors limit our ability to dispose of assets, we may not be able to sell properties when appropriate |
| Real estate investments are relatively illiquid and, therefore, we have limited ability to vary our portfolio quickly in response to changes in economic or other conditions |
| In addition, the prohibitions under the federal income tax laws on REITs holding property for sale and related regulations may affect our ability to sell properties |
| Our ability to dispose of assets may also be limited by constraints on our ability to utilize disposition proceeds to make acquisitions on financially attractive terms, and the requirement that we take additional impairment charges on certain assets |
| More specifically, we are required to distribute or pay tax on all capital gains generated from the sale of assets, and, in addition, a significant number of our properties were acquired using limited partnership units of IRET Properties, our operating partnership, and are subject to certain agreements which restrict our ability to sell such properties in transactions that would create current taxable income to the former owners |
| To accomplish this we must identify attractive re-investment opportunities |
| Recently, while capital market conditions have been favorable for dispositions, investment yields on acquisitions have been less attractive due to the abundant capital inflows into the real estate sector |
| These considerations impact our decisions on whether or not to dispose of certain of our assets |
| Inability to manage our rapid growth effectively may adversely affect our operating results |
| We have experienced significant growth in recent years, increasing our total assets from approximately dlra885dtta7 million at April 30, 2003, to dlra1cmam207dtta3 million at April 30, 2006, principally through the acquisition of additional real estate properties |
| Subject to our continued ability to raise equity capital and issue limited partnership units of IRET Properties and identify suitable investment properties, we intend to continue our acquisition of real estate properties |
| Effective management of this level of growth presents challenges, including: • the need to expand our management team and staff; • the need to enhance internal operating systems and controls; • increased reliance on outside advisors and property managers; and • the ability to consistently achieve targeted returns on individual properties |
| We may not be able to maintain similar rates of growth in the future, or manage our growth effectively |
| Our failure to do so may have a material adverse effect on our financial condition and results of operations and ability to make distributions to the holders of our shares of beneficial interest |
| Competition may negatively impact our earnings |
| We compete with many kinds of institutions, including other REITs, private partnerships, individuals, pension funds and banks, for tenants and investment opportunities |
| Many of these institutions are active in the markets in which we invest and have greater financial and other resources that may be used to compete against us |
| With respect to tenants, this competition may affect our ability to lease our properties, the price at which we are able to lease our properties and the cost of required renovations or tenant improvements |
| With respect to acquisition and development investment opportunities, this competition may cause us to pay higher prices for new properties than we otherwise would have paid, or may prevent us from purchasing a desired property at all |
| An inability to make accretive property acquisitions may adversely affect our ability to increase our operating income |
| From our fiscal year ended April 30, 2004, to our fiscal year ended April 30, 2006, our operating income decreased from dlra10dtta0 million to dlra9dtta8 million |
| Our basic and diluted net income per common share was $ |
| The acquisition of additional real estate properties is critical to our ability to increase our operating income |
| If we are unable to continue to make real estate acquisitions on terms that meet our financial and strategic objectives, whether due to 2006 Annual Report 13 _________________________________________________________________ [34]Index market conditions, a changed competitive environment or unavailability of capital, our ability to increase our operating income may be materially and adversely affected |
| High leverage on our overall portfolio may result in losses |
| As of April 30, 2006, our ratio of total indebtedness to total Net Assets (as that term is used in our Bylaws, which usage is not in accordance with GAAP, “Net Assets” means our total assets at cost before deducting depreciation or other non-cash reserves, less total liabilities) was approximately 138dtta0prca |
| As of April 30, 2005 and 2004, our percentage of total indebtedness to total Net Assets was approximately 133dtta9prca and 136dtta8prca, respectively |
| Under our Bylaws we may increase our total indebtedness up to 300dtta0prca of our Net Assets, or by an additional approximately dlra906 million |
| There is no limitation on the increase that may be permitted if approved by a majority of the independent members of our board of trustees and disclosed to the holders of our shares of beneficial interest in the next quarterly report, along with justification for any excess |
| This amount of leverage may expose us to cash flow problems if rental income decreases |
| Under those circumstances, in order to pay our debt obligations we might be required to sell properties at a loss or be unable to make distributions to the holders of our shares of beneficial interest |
| A failure to pay amounts due may result in a default on our obligations and the loss of the property through foreclosure |
| Additionally, our degree of leverage could adversely affect our ability to obtain additional financing and may have an adverse effect on the market price of our common shares |
| Our inability to renew, repay or refinance our debt may result in losses |
| We incur a significant amount of debt in the ordinary course of our business and in connection with acquisitions of real properties |
| In addition, because we are unable to retain earnings as a result of the REIT distribution requirements, we will generally be required to refinance debt that matures with additional debt or equity |
| We are subject to the normal risks associated with debt financing, including the risk that: • our cash flow will be insufficient to meet required payments of principal and interest; • we will not be able to renew, refinance or repay our indebtedness when due; and • the terms of any renewal or refinancing will be less favorable than the terms of our current indebtedness |
| We anticipate that only a small portion of the principal of our debt will be repaid prior to maturity |
| Therefore, we are likely to need to refinance at least a portion of our outstanding debt as it matures |
| We cannot guarantee that any refinancing of debt with other debt will be possible on terms that are favorable or acceptable to us |
| If we cannot refinance, extend or pay principal payments due at maturity with the proceeds of other capital transactions, such as new equity capital, our cash flows may not be sufficient in all years to repay debt as it matures |
| Additionally, if we are unable to refinance our indebtedness on acceptable terms, or at all, we may be forced to dispose of one or more of our properties on disadvantageous terms, which may result in losses to us |
| These losses could have a material adverse effect on us, our ability to make distributions to the holders of our shares of beneficial interest and our ability to pay amounts due on our debt |
| Furthermore, if a property is mortgaged to secure payment of indebtedness and we are unable to meet mortgage payments, the mortgagee could foreclose upon the property, appoint a receiver and receive an assignment of rents and leases or pursue other remedies, all with a consequent loss of our revenues and asset value |
| Foreclosures could also create taxable income without accompanying cash proceeds, thereby hindering our ability to meet the REIT distribution requirements of the Internal Revenue Code |
| The cost of our indebtedness may increase |
| We have incurred, and we expect to continue to incur, indebtedness that bears interest at a variable rate |
| As of April 30, 2006, dlra24dtta3 million, or approximately 3dtta2prca, of the principal amount of our total mortgage indebtedness was subject to variable interest rate agreements |
| If short-term interest rates rise, our debt service payments on adjustable rate debt would increase, which would lower our net income and could decrease our distributions to the holders of our shares of beneficial interest |
| In addition, portions of our fixed-rate indebtedness incurred for past property acquisitions come due on a periodic basis |
| Rising interest rates could limit our ability to refinance this existing debt when it matures, and would increase our interest costs, which could have a material adverse effect on us, our ability to make distributions to the holders of our shares of beneficial interest and our ab ility to pay amounts due on our debt |
| We depend on distributions and other payments from our subsidiaries that they may be prohibited from making to us, which could impair our ability to make distributions to holders of our shares of beneficial interest |
| Substantially 2006 Annual Report 14 _________________________________________________________________ [35]Index all of our assets are held through IRET Properties, our operating partnership, and other of our subsidiaries |
| As a result, we depend on distributions and other payments from our subsidiaries in order to satisfy our financial obligations and make distributions to the holders of our shares of beneficial interest |
| The ability of our subsidiaries to make such distributions and other payments depends on their earnings, and may be subject to statutory or contractual limitations |
| As an equity investor in our subsidiaries, our right to receive assets upon their liquidation or reorganization effectively will be subordinated to the claims of their creditors |
| To the extent that we are recognized as a creditor of such subsidiaries, our claims may still be subordinate to any security interest in or other lien on their assets and to any of their debt or other obligations that are senior to our claims |
| Our current or future insurance may not protect us against possible losses |
| We carry comprehensive liability, fire, extended coverage and rental loss insurance with respect to our properties at levels that we believe to be adequate and comparable to coverage customarily obtained by owners of similar properties |
| However, the coverage limits of our current or future policies may be insufficient to cover the full cost of repair or replacement of all potential losses |
| Moreover, this level of coverage may not continue to be available in the future or, if available, may be available only at unacceptable cost or with unacceptable terms |
| Additionally, there may be certain extraordinary losses, such as those resulting from civil unrest, terrorism or environmental contamination, that are not generally, or fully, insured against because they are either uninsurable or not economically insurable |
| For example, we do not currently carry insurance against loss es as a result of environmental contamination |
| Should an uninsured or underinsured loss occur to a property, we could be required to use our own funds for restoration or lose all or part of our investment in, and anticipated revenues from, the property |
| In any event, we would continue to be obligated on any mortgage indebtedness on the property |
| Any loss could have a material adverse effect on us, our ability to make distributions to the holders of our shares of beneficial interest and our ability to pay amounts due on our debt |
| In addition, in most cases we have to renew our insurance policies on an annual basis and negotiate acceptable terms for coverage, exposing us to the volatility of the insurance markets, including the possibility of rate increases |
| Any material increase in insurance rates or decrease in available coverage in the future could adversely affect our business and financial condition and results of operations, which could cause a decline in the market value of our securities |
| &n bsp; We have significant investments in medical properties and adverse trends in healthcare provider operations may negatively affect our lease revenues from these properties |
| We have acquired a significant number of specialty medical properties (including assisted living facilities) and may acquire more in the future |
| As of April 30, 2006, our real estate portfolio consisted of 33 medical properties, with a total real estate investment amount, net of accumulated depreciation, of dlra244dtta3 million, or approximately 21dtta8prca of the total real estate investment amount, net of accumulated depreciation, of our entire real estate portfolio |
| The healthcare industry is currently experiencing changes in the demand for, and methods of delivery of, healthcare services; changes in third-party reimbursement policies; significant unused capacity in certain areas, which has created substantial competition for patients among healthcare providers in those a reas; continuing pressure by private and governmental payors to reduce payments to providers of services; and increased scrutiny of billing, referral and other practices by federal and state authorities |
| Sources of revenue for our medical property tenants may include the federal Medicare program, state Medicaid programs, private insurance carriers and health maintenance organizations, among others |
| Efforts by such payors to reduce healthcare costs will likely continue, which may result in reductions or slower growth in reimbursement for certain services provided by some of our tenants |
| These factors may adversely affect the economic performance of some or all of our medical services tenants and, in turn, our lease revenues |
| In addition, if we or our tenants terminate the leases for these properties, or our tenants lose their regulatory authority to operate such properties, we may not be able to locate suitable replacement tenants to lease the properties for their specialized uses |
| Alternatively, we may be required to spend substantial amounts to adapt the properties to other uses |
| Any loss of revenues and/or additional capital expenditures occurring as a result could hinder our ability to make distributions to the holders of our shares of beneficial interest |
| Adverse changes in applicable laws may affect our potential liabilities relating to our properties and operations |
| Increases in real estate taxes and income, service and transfer taxes cannot always be passed through to all tenants in the form of higher rents |
| As a result, any increase may adversely affect our cash available for distribution, our ability to make distributions to the holders of our shares of beneficial interest and our ability to pay amounts due on our debt |
| Similarly, changes in laws that increase the potential liability for environmental conditions existing on properties, that increase the restrictions on discharges or other conditions or that affect development, construction and safety requirements may result in significant unanticipated expenditures that could have a material adverse effect on us, our ability to make distributions to the holders of our shares of beneficial interest and our ability to pay 2006 Annual Report 15 _________________________________________________________________ [36]Index amounts due on our debt |
| In addition, future enactment of rent control or rent stabilization laws or other laws regulating multi-family residential properties may reduce rental revenues or increase operating costs |
| Complying with laws benefiting disabled persons or other safety regulations and requirements may affect our costs and investment strategies |
| Federal, state and local laws and regulations designed to improve disabled persons’ access to and use of buildings, including the Americans with Disabilities Act of 1990, may require modifications to, or restrict renovations of, existing buildings |
| Additionally, these laws and regulations may require that structural features be added to buildings under construction |
| Legislation or regulations that may be adopted in the future may impose further burdens or restrictions on us with respect to improved access to, and use of these buildings by, disabled persons |
| Noncompliance could result in the imposition of fines by government authorities or the award of damages to private litigants |
| The costs of complying with these laws and regulations may be substantial, and limits or restrictions on con struction, or the completion of required renovations, may limit the implementation of our investment strategy or reduce overall returns on our investments |
| This could have an adverse effect on us, our ability to make distributions to the holders of our shares of beneficial interest and our ability to pay amounts due on our debt |
| Our properties are also subject to various other federal, state and local regulatory requirements, such as state and local fire and life safety requirements |
| If we fail to comply with these requirements, we could incur fines or private damage awards |
| Additionally, in the event that existing requirements change, compliance with future requirements may require significant unanticipated expenditures that may adversely affect our cash flow and results of operations |
| We may be responsible for potential liabilities under environmental laws |
| Under various federal, state and local laws, ordinances and regulations, we, as a current or previous owner or operator of real estate may be liable for the costs of removal of, or remediation of, hazardous or toxic substances in, on, around or under that property |
| These laws may impose liability without regard to whether we knew of, or were responsible for, the presence of the hazardous or toxic substances |
| The presence of these substances, or the failure to properly remediate any property containing these substances, may adversely affect our ability to sell or rent the affected property or to borrow funds using the property as collateral |
| In arranging for the disposal or treatment of hazardous or toxic substances, we may also be liable for the costs of removal of, or remediation of, these substances at that disposal or treatment facility, whether or not we own or operate the facility |
| In connection with our current or former ownership (direct or indirect), operation, management, development and/or control of real properties, we may be potentially liable for removal or remediation costs with respect to hazardous or toxic substances at those properties, as well as certain other costs, including governmental fines and claims for injuries to persons and property |
| A finding of liability for an environmental condition as to any one or more properties could have a material adverse effect on us, our ability to make distributions to the holders of our shares of beneficial interest and our ability to pay amounts due on our debt |
| Environmental laws also govern the presence, maintenance and removal of asbestos, and require that owners or operators of buildings containing asbestos properly manage and maintain the asbestos; notify and train those who may come into contact with asbestos; and undertake special precautions if asbestos would be disturbed during renovation or demolition of a building |
| Indoor air quality issues may also necessitate special investigation and remediation |
| These air quality issues can result from inadequate ventilation, chemical contaminants from indoor or outdoor sources, or biological contaminants such as molds, pollen, viruses and bacteria |
| Such asbestos or air quality remediation programs could be costly, necessitate the temporary relocation of some or all of the property’s tenants or require rehabilitation of an affected property |
| It is generally our policy to obtain a Phase I environmental study on each property that we seek to acquire |
| A Phase I environmental study generally includes a visual inspection of the property and the surrounding areas, an examination of current and historical uses of the property and the surrounding areas and a review of relevant state and federal documents, but does not involve invasive techniques such as soil and ground water sampling |
| If the Phase I indicates any possible environmental problems, our policy is to order a Phase II study, which involves testing the soil and ground water for actual hazardous substances |
| However, Phase I and Phase II environmental studies, or any other environmental studies undertaken with respect to any of our current or future properties, may not reveal the full extent of potential environmental liabilities |
| We currently do not carry insurance for environmental liabilities |
| We may be unable to retain or attract qualified management |
| We are dependent upon our senior officers for essentially all aspects of our business operations |
| Our senior officers have experience in the specialized business 2006 Annual Report 16 _________________________________________________________________ [37]Index segments in which we operate, and the loss of them would likely have a material adverse effect on our operations, and could adversely impact our relationships with lenders, industry personnel and potential tenants |
| We do not have employment contracts with any of our senior officers |
| As a result, any senior officer may terminate his or her relationship with us at any time, without providing advance notice |
| If we fail to manage effectively a transition to new personnel, or if we fail to attract and retain qualified and experienced personnel on acceptable terms, our business and prospects could be harmed |
| The location of our company headquarters in Minot, North Dakota, may make it more difficult and expensive to attract, relocate and retain current and future officers and employees |
| Failure to comply with changing regulation of corporate governance and public disclosure could have a material adverse effect on our business, operating results and stock price, and continuing compliance will result in additional expenses |
| The Sarbanes-Oxley Act of 2002, as well as new rules and standards subsequently implemented by the Securities and Exchange Commission and NASDAQ, have required changes in some of our corporate governance and accounting practices, and are creating uncertainty for us and many other public companies, due to varying interpretations of the rules and their evolving application in practice |
| We expect these laws, rules and regulations to increase our legal and financial compliance costs, and to subject us to additional risks |
| In particular, if we fail to maintain the adequacy of our internal controls in accordance with Section 404 of the Sarbanes-Oxley Act of 2002, as such standards may be modified, suppl emented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting |
| Failure to maintain an effective internal control environment could have a material adverse effect on our business, operating results, and stock price |
| Additionally, our efforts to comply with Section 404 of the Sarbanes-Oxley Act and the related regulations have required, and we believe will continue to require, the commitment of significant financial and managerial resources |
| Risks Related to Our Structure and Organization We may incur tax liabilities as a consequence of failing to qualify as a REIT Although our management believes that we are organized and have operated and are operating in such a manner to qualify as a “real estate investment trust,” as that term is defined under the Internal Revenue Code, we may not in fact have operated, or may not be able to continue to operate, in a manner to qualify or remain so qualified |
| Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which there are only limited judicial or administrative interpretations |
| Even a technical or inadvertent mistake could endanger our REIT status |
| The determination that we qualify as a REIT requires an ongoing analysis of various factual matters and circumstances, some of which may not be within our control |
| For example, in order to qualify as a REIT, at least 95prca of our gross income in any year must com e from qualifying sources that are itemized in the REIT tax laws, and we are prohibited from owning specified amounts of debt or equity securities of some issuers |
| Thus, to the extent revenues from non-qualifying sources, such as income from third-party management services, represent more than five percent of our gross income in any taxable year, we will not satisfy the 95prca income test and may fail to qualify as a REIT, unless certain relief provisions contained in the Internal Revenue Code apply |
| Even if relief provisions apply, however, a tax would be imposed with respect to excess net income |
| We are also required to make distributions to the holders of our shares of beneficial interest of at least 90prca of our REIT taxable income, excluding net capital gains |
| The fact that we hold substantially all of our assets (except for qualified REIT subsidiaries) through IRET Properties, our operating partnership, and its subsidiaries, and our ongoing reliance on factual determinations, such as determinati ons related to the valuation of our assets, further complicates the application of the REIT requirements for us |
| Additionally, if IRET Properties, our operating partnership, or one or more of our subsidiaries is determined to be taxable as a corporation, we may fail to qualify as a REIT Either our failure to qualify as a REIT, for any reason, or the imposition of taxes on excess net income from non-qualifying sources, could have a material adverse effect on us, our ability to make distributions to the holders of our shares of beneficial interest and our ability to pay amounts due on our debt |
| Furthermore, new legislation, regulations, administrative interpretations or court decisions could change the tax laws with respect to our qualification as a REIT or the federal income tax consequences of our qualification |
| If we failed to qualify as a REIT, we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at corporate rates, which would likely have a material adverse effect on us, our ability to make distributions to the holders of our shares of beneficial interest and our ability to pay amounts due on our debt |
| In addition, we could be subject to increased state and local taxes, and, unless entitled to relief under applicable statutory provisions, we would also be disqualified from treatment as a REIT for the four taxable years following the year during which we lost our qualification |
| This treatment would reduce funds available for 2006 Annual Report 17 _________________________________________________________________ [38]Index investment or distributions to the holders of our shares of beneficial interest because of the additional tax liability to us for the year or years involved |
| In addition, we would no longer be able to deduct, and would not be required to make, distributions to holders of our common shares |
| To the extent that distributions to the holders of our shares of beneficial interest had been made in anticipation of qualifying as a REIT, we might be required to borrow funds or to liquidate certain investments to pay the applicable tax |
| Failure of our operating partnership to qualify as a partnership would have a material adverse effect on us |
| We believe that IRET Properties, our operating partnership, qualifies as a partnership for federal income tax purposes |
| No assurance can be given, however, that the Internal Revenue Service will not challenge its status as a partnership for federal income tax purposes, or that a court would not sustain such a challenge |
| If the Internal Revenue Service were to be successful in treating IRET Properties as an entity that is taxable as a corporation, we would cease to qualify as a REIT because the value of our ownership interest in IRET Properties would exceed 5prca of our assets, and because we would be considered to hold more than 10prca of the voting securities of another corporation |
| Also, the imposition of a corporate tax on IRET Properties would reduce significantly the amount of cash available for distribution by it |
| Certain provisions of our Articles of Amendment and Third Restated Declaration of Trust may limit a change in control and deter a takeover |
| In order to maintain our qualification as a REIT, our Third Restated Declaration of Trust provides that any transaction, other than a transaction entered into through the NASDAQ National Market, (recently renamed the NASDAQ Global Market), or other similar exchange, that would result in our disqualification as a REIT under Section 856 of the Internal Revenue Code, including any transaction that would result in (i) a person owning in excess of the ownership limit of 9dtta8prca, in number or value, of our outstanding shares of beneficial interest, (ii) less than 100 people owning our shares of beneficial interest, (iii) our being “closely held” within the meaning of Section 856(h) of the Internal Revenue Code, or (iv) 50prca or more of the fair market value of our shares of beneficial interest being held by persons other than “United States persons,” as defined in Section 7701(a)(30) of the Internal Revenue Code, will be void ab initio |
| If the transaction is not void ab initio, then the shares of beneficial interest in excess of the ownership limit, that would cause us to be closely held, that would result in 50prca or more of the fair market value of our shares of beneficial interest to be held by persons other than United States persons or that otherwise would result in our disqualification as a REIT, will automatically be exchanged for an equal number of excess shares, and these excess shares will be transferred to an excess share trustee for the exclusive benefit of the charitable beneficiaries named by our board of trustees |
| These limitations may have the effect of preventing a change in control or takeover of us by a third party, even if the change in control or takeover would be in the best interests of the holders of our shares of beneficial interest |
| In order to maintain our REIT status, we may be forced to borrow funds during unfavorable market conditions |
| In order to maintain our REIT status, we may need to borrow funds on a short-term basis to meet the REIT distribution requirements, even if the then-prevailing market conditions are not favorable for these borrowings |
| To qualify as a REIT, we generally must distribute to our shareholders at least 90prca of our net taxable income each year, excluding net capital gains |
| In addition, we will be subject to a 4prca nondeductible excise tax on the amount, if any, by which certain distributions made by us with respect to the calendar year are less than the sum of 85prca of our ordinary income, 95prca of our capital gain net income for that year, and any undistributed taxable income from prior periods |
| We intend to make distributions to our shareholders to comply with the 90prca distribution requirement and to avoid the nondeductible excise t ax and will rely for this purpose on distributions from our operating partnership |
| However, we may need short-term debt or long-term debt or proceeds from asset sales or sales of common shares to fund required distributions as a result of differences in timing between the actual receipt of income and the recognition of income for federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt or amortization payments |
| The inability of our cash flows to cover our distribution requirements could have an adverse impact on our ability to raise short and long-term debt or sell equity securities in order to fund distributions required to maintain our REIT status |
| Our board of trustees may make changes to our major policies without approval of the holders of our shares of beneficial interest |
| Our operating and financial policies, including policies relating to development and acquisition of real estate, financing, growth, operations, indebtedness, capitalization and distributions, are exclusively determined by our board of trustees |
| Our board of trustees may amend or revoke those policies, and other policies, without advance notice to, or the approval of, the holders of our shares of beneficial interest |
| Accordingly, our shareholders do not control these policies, and policy changes could adversely affect our financial condition and results of operations |
| 2006 Annual Report 18 _________________________________________________________________ [39]Index Risks Related to the Purchase of our Shares of Beneficial Interest Our future growth depends, in part, on our ability to raise additional equity capital, which will have the effect of diluting the interests of the holders of our common shares |
| Our future growth depends upon, among other things, our ability to raise equity capital and issue limited partnership units of IRET Properties |
| The issuance of additional common shares, and of limited partnership units for which we subsequently issue common shares upon the redemption of the limited partnership units, will dilute the interests of the current holders of our common shares |
| Additionally, sales of substantial amounts of our common shares or preferred shares in the public market, or issuances of our common shares upon redemption of limited partnership units in our operating partnership, or the perception that such sales or issuances might occur, could adversely affect the market price of our common shares |
| We may issue additional classes or series of our shares of beneficial interest with rights and preferences that are superior to the rights and preferences of our common shares |
| Without the approval of the holders of our common shares, our board of trustees may establish additional classes or series of our shares of beneficial interest, and such classes or series may have dividend rights, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences or other rights and preferences that are superior to the rights of the holders of our common shares |
| Payment of distributions on our shares of beneficial interest is not guaranteed |
| Our board of trustees must approve our payment of distributions and may elect at any time, or from time to time, and for an indefinite duration, to reduce the distributions payable on our shares of beneficial interest or to not pay distributions on our shares of beneficial interest |
| Our board of trustees may reduce distributions for a variety of reasons, including, but not limited to, the following: • operating and financial results below expectations that cannot support the current distribution payment; • unanticipated costs or cash requirements; or • a conclusion that the payment of distributions would cause us to breach the terms of certain agreements or contracts, such as financial ratio covenants |
| Our distributions are not eligible for the lower tax rate on dividends except in limited situations |
| The tax rate applicable to qualifying corporate dividends received by individuals prior to 2009 has been reduced to a maximum rate of 15prca |
| This special tax rate is generally not applicable to distributions paid by a REIT, unless such distributions represent earnings on which the REIT itself had been taxed |
| As a result, distributions (other than capital gain distributions) paid by us to individual investors will generally be subject to the tax rates that are otherwise applicable to ordinary income which, currently, are as high as 35prca |
| This law change may make an investment in our common shares comparatively less attractive relative to an investment in the shares of other entities which pay dividends but are not formed as REITs |
| Changes in market conditions could adversely affect the price of our shares of beneficial interest |
| As is the case with any publicly-traded securities, certain factors outside of our control could influence the value of our common shares, Series A preferred shares and any other classes or series of preferred shares of beneficial interest to be issued in the future |
| These conditions include, but are not limited to: • market perception of REITs in general; • market perception of REITs relative to other investment opportunities; • market perception of our financial condition, performance, distributions and growth potential; • prevailing interest rates; • general economic and business conditions; • government action or regulation, including changes in the tax laws; and 2006 Annual Report 19 _________________________________________________________________ [40]Index • relatively low trading volumes in securities of REITS Higher market interest rates may adversely affect the market price of our common shares, and low trading volume on the NASDAQ Global Select Market may prevent the timely resale of our common shares |
| One of the factors that investors may consider important in deciding whether to buy or sell shares of a REIT is the distribution with respect to such REIT’s shares as a percentage of the price of those shares, relative to market interest rates |
| If market interest rates go up, prospective purchasers of REIT shares may expect a higher distribution rate in order to maintain their investment |
| Higher market interest rates would likely increase our borrowing costs and might decrease funds available for distribution |
| Thus, higher market interest rates could cause the market price of our common shares to decline |
| In addition, although our common shares of beneficial interest are listed on the NASDAQ Global Select Market, the d aily trading volume of our shares may be lower than the trading volume for other companies and industries |
| The average daily trading volume for the period of May 1, 2005, through April 30, 2006, was 63cmam094 shares and the average monthly trading volume for the period of May 1, 2005 through April 30, 2006 was 1cmam319cmam871 shares |
| As a result of this trading volume, an owner of our common shares may encounter difficulty in selling our shares in a timely manner and may incur a substantial loss |