PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT - FORM 10-Q - August 11, 2016

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EX-31.2 - EXHIBIT 31.2 - PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNTprudentialvariable2q-qxex312.htm
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 _________________________________________
FORM 10-Q
  __________________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 033-20083-01
____________________________________________________
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
in respect of
THE PRUDENTIAL VARIABLE CONTRACT
REAL PROPERTY ACCOUNT
(Exact name of registrant as specified in its charter)
____________________________________________________ 
New Jersey
22-1211670
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
751 Broad Street
Newark, New Jersey 07102
(973) 802-6000
(Address and Telephone Number of Registrant’s Principal Executive Offices)
____________________________________________________ 
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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
x  (Do not check if a smaller reporting company)
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 PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT
(Registrant)
INDEX

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Forward-Looking Statement Disclosure
Certain of the statements included in this Quarterly Report on Form 10-Q, including but not limited to those in Management’s Discussion and Analysis of Financial Condition and Results of Operations, constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as “expects,” “believes,” “anticipates,” “includes,” “plans,” “assumes,” “estimates,” “projects,” “intends,” “should,” “will,” “shall” or variations of such words are generally part of forward-looking statements. Forward-looking statements are made based on management’s current expectations and beliefs concerning future developments and their potential effects upon The Prudential Insurance Company of America, or the “Company”, or The Prudential Variable Contract Real Property Account, or the “Real Property Account”. There can be no assurance that future developments affecting the Company and the Real Property Account will be those anticipated by management. These forward-looking statements are not a guarantee of future performance and involve risks and uncertainties, and there are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements, including, among others: (1) general economic, market and political conditions, including the performance and fluctuations of fixed income, equity, real estate and other financial markets; (2) interest rate fluctuations or prolonged periods of low interest rates; (3) reestimates of our reserves for future policy benefits and claims; (4) differences between actual experience regarding mortality, morbidity, persistency, utilization, interest rates, or market returns and the assumptions we use in pricing our products, establishing liabilities and reserves or for other purposes; (5) changes in our financial strength or credit ratings; (6) investment losses and defaults; (7) competition in our product lines and for personnel; (8) changes in tax law; (9) regulatory or legislative changes, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the U.S. Department of Labor's fiduciary rules; (10) adverse determinations in litigation or regulatory matters, and our exposure to contingent liabilities; (11) domestic or international military actions, natural or man-made disasters including terrorist activities or pandemic disease, or other events resulting in catastrophic loss of life; (12) ineffectiveness of risk management policies and procedures in identifying, monitoring and managing risks; (13) changes in statutory or accounting principles, practices or policies generally accepted in the United States of America; and (14) interruption in telecommunication, information technology or other operational systems or failure to maintain the security, confidentiality or privacy of sensitive data on such systems. The Company and the Real Property Account do not intend, and are under no obligation, to update any particular forward-looking statement included in this document. See “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2015, for discussion of certain risks relating to the operation of The Prudential Variable Contract Real Property Partnership, or the “Partnership”, and investment in our securities.


3

Throughout this Quarterly Report on Form 10-Q, the "Real Property Account" and the "Registrant" refer to The Prudential Variable Contract Real Property Account. "Prudential" or the "Company" refers to The Prudential Insurance Company of America.

PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
UNAUDITED INTERIM FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

STATEMENTS OF NET ASSETS
June 30, 2016 and December 31, 2015
 
June 30, 2016
 
December 31, 2015
ASSETS
 
 
 
Investment in The Prudential Variable Contract Real Property Partnership
$
86,144,912

 
$
84,380,032

Net Assets
$
86,144,912

 
$
84,380,032

NET ASSETS, representing:
 
 
 
Equity of contract owners
$
70,649,951

 
$
69,744,715

Equity of The Prudential Insurance Company of America
15,494,961

 
14,635,317

 
$
86,144,912

 
$
84,380,032

Units outstanding
26,968,937

 
26,861,466

Portfolio shares held
1,910,381

 
1,910,381

Portfolio net asset value per share
$
45.09

 
$
44.17


STATEMENTS OF OPERATIONS
For the three and six months ended June 30, 2016 and 2015
 
Six Months Ended
 
Three Months Ended
 
June 30, 2016
 
June 30, 2015
 
June 30, 2016
 
June 30, 2015
INVESTMENT INCOME
 
 
 
 
 
 
 
Net investment income allocated from The Prudential Variable Contract Real Property Partnership
$
1,221,320

 
$
1,208,305

 
$
598,338

 
$
644,456

EXPENSES
 
 
 
 
 
 
 
Charges to contract owners for assuming mortality and expense risk and for administration
271,307

 
251,076

 
136,596

 
126,799

NET INVESTMENT INCOME
950,013

 
957,229

 
461,742

 
517,657

NET RECOGNIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
 
 
 
 
 
 
 
Net unrealized gain (loss) on investments allocated from The Prudential Variable Contract Real Property Partnership
651,944

 
963,221

 
65,984

 
25,269

Net recognized gain (loss) on investments allocated from The Prudential Variable Contract Real Property Partnership
(108,384
)
 
53,008

 
—

 
53,008

NET GAIN (LOSS) ON INVESTMENTS
543,560

 
1,016,229

 
65,984

 
78,277

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS
$
1,493,573

 
$
1,973,458

 
$
527,726

 
$
595,934


STATEMENTS OF CHANGES IN NET ASSETS
For the three and six months ended June 30, 2016 and 2015
 
Six Months Ended
 
Three Months Ended
 
June 30, 2016
 
June 30, 2015
 
June 30, 2016
 
June 30, 2015
OPERATIONS
 
 
 
 
 
 
 
Net investment income
$
950,013

 
$
957,229

 
$
461,742

 
$
517,657

Net unrealized gain (loss) on investments allocated from The Prudential Variable Contract Real Property Partnership
651,944

 
963,221

 
65,984

 
25,269

Net recognized gain (loss) on investments allocated from The Prudential Variable Contract Real Property Partnership
(108,384
)
 
53,008

 
—

 
53,008

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS
1,493,573

 
1,973,458

 
527,726

 
595,934

CAPITAL TRANSACTIONS
 
 
 
 
 
 
 
Net contributions (withdrawals) by contract owners
(283,267
)
 
(1,003,206
)
 
(318,258
)
 
(542,069
)
Net contributions (withdrawals) by The Prudential Insurance Company of America
554,574

 
(545,851
)
 
454,854

 
668,868

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM CAPITAL TRANSACTIONS
271,307

 
(1,549,057
)
 
136,596

 
126,799

TOTAL INCREASE (DECREASE) IN NET ASSETS
1,764,880

 
424,401

 
664,322

 
722,733

NET ASSETS
 
 
 
 
 
 
 
Beginning of period
84,380,032

 
79,093,169

 
85,480,590

 
78,794,837

End of period
$
86,144,912

 
$
79,517,570

 
$
86,144,912

 
$
79,517,570


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

4
NOTES TO THE UNAUDITED INTERIM FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT
June 30, 2016


Note 1: General

The Prudential Variable Contract Real Property Account (the “Real Property Account” or the “Registrant”) was established on November 20, 1986 by resolution of the Board of Directors of The Prudential Insurance Company of America (“Prudential” or the “Company”), as a separate investment account pursuant to New Jersey law and is registered under the Securities Act of 1933, as amended. Prudential is a wholly-owned subsidiary of Prudential Financial, Inc. (“Prudential Financial”). The assets of the Real Property Account are segregated from Prudential’s other assets. The Real Property Account is used to fund benefits under certain variable life insurance and variable annuity contracts issued by Prudential. These products are Variable Appreciable Life (“PVAL”, “PVAL $100,000+ Face Value,” and “CVAL”), Discovery Plus (“PDISCO+”), and Variable Investment Plan (“VIP”).
The assets of the Real Property Account are invested in The Prudential Variable Contract Real Property Partnership (the “Partnership”). The Partnership is the investment vehicle for assets allocated to the real estate investment option under certain variable life insurance and variable annuity contracts. The Real Property Account, along with the Pruco Life Variable Contract Real Property Account and the Pruco Life of New Jersey Variable Contract Real Property Account, are the sole investors in the Partnership. These financial statements should be read in conjunction with the accompanying unaudited consolidated financial statements of the Partnership.

Note 2: Summary of Significant Accounting Policies
 
A.
Basis of Accounting

The Unaudited Interim Financial Statements as of June 30, 2016 and the statement of net assets as of December 31, 2015, which has been derived from Audited Financial Statements, have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) on a basis consistent with reporting interim financial information in accordance with instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission.

In the opinion of management, all adjustments necessary for a fair statement of the financial position and results of operations have been made. All such adjustments are of a normal, recurring nature. Interim results are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the Real Property Account’s Audited Financial Statements included in the Real Property Account’s Annual Report on Form 10-K for the year ended December 31, 2015.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates include valuation of investment in the Partnership.

B.
Investment in Partnership Interest

The investment in the Partnership is based on the Real Property Account’s proportionate interest of the Partnership’s fair value measured using the Partnership's net asset value as a practical expedient. At June 30, 2016 and December 31, 2015, the Real Property Account’s share of the general partners' controlling interest of the Partnership was 42.2% or 1,910,381 shares and 42.2% or 1,910,381 shares, respectively.

C.
Income Recognition

Net investment income or loss, and recognized and unrealized gains and losses are allocated based upon the monthly average net assets for the investment in the Partnership. Amounts are based on the Real Property Account’s proportionate interest in the Partnership.


5
NOTES TO THE UNAUDITED INTERIM FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT
June 30, 2016

Note 2: Summary of Significant Accounting Policies (continued)

D.
Equity of The Prudential Insurance Company of America
Prudential maintains a position in the Real Property Account for liquidity purposes, including unit purchases and redemptions, Partnership share transactions, and expense processing. The position does not affect contract owners’ accounts or the related unit values.
There were no cash transactions at the Real Property Account level for the six months ended June 30, 2016 and 2015 as all of the transactions are settled by Prudential on behalf of the Real Property Account through a redemption or an issuance of units. Therefore, no statement of cash flows is presented for the six months ended June 30, 2016 and 2015.

Note 3: Charges and Expenses

A.
Mortality Risk and Expense Risk Charges

Mortality risk and expense risk charges are determined daily using an effective annual rate of 1.2%, 0.9%, 0.6% and 1.2% for PDISCO+, PVAL, PVAL $100,000 + Face Value and VIP, respectively (for PDISCO+, the 1.2% includes a 0.20% administrative charge). CVAL used the same fees and charges as the PVAL $100,000 + Face Value. Mortality risk is the risk that life insurance contract owners may not live as long as estimated or annuitants may live longer than estimated and expense risk is the risk that the cost of issuing and administering the contracts may exceed related charges by Prudential. The mortality risk and expense risk charges are assessed through reduction in unit values.

B.
Cost of Insurance and Other Related Charges

Contract owner contributions are subject to certain deductions prior to being invested in the Real Property Account. The deductions for PVAL and PVAL $100,000 + Face Value are: (1) taxes attributable to premiums; and (2) transaction costs which are deducted from each premium payment to cover premium collection and processing costs. Contracts are subject to charges on each basic premium for assuming a guaranteed minimum death benefit risk. This charge compensates Prudential for the risk that an insured may die at a time when the death benefit exceeds the benefit that would have been payable in the absence of a minimum guarantee. These charges are assessed through the redemption of units.

C.
Deferred Sales Charge

A deferred sales charge is imposed upon the withdrawals of certain purchase payments to compensate Prudential for sales and other marketing expenses for PDISCO+ and VIP. The amount of any deferred sales charge will depend on the amount withdrawn and the number of contract years that have elapsed since the contract owner or annuitant made the purchase payments deemed to be withdrawn. As the amount of time that has elapsed since a given purchase payment made increases, the deferred sales charge applicable to that purchase payment generally decreases. No deferred sales charge is made against the withdrawal of investment income. No deferred sales charge is imposed upon death benefit payments or upon transfers made between subaccounts. This deferred sales charge is assessed through the redemption of units.

D.
Partial Withdrawal Charge

A charge is imposed by Prudential on partial withdrawals of the cash surrender value for PVAL and PVAL $100,000 + Face Value. A charge equal to the lesser of $15 or 2% will be made in connection with each partial withdrawal of the cash surrender value of a contract. This charge is assessed through the redemption of units.

E.
Annual Maintenance Charge

An annual maintenance charge, applicable to PDISCO+ and VIP, of $30 will be deducted if and only if the contract account value is less than $10,000 on a contract anniversary or at the time a full withdrawal is effected, including a withdrawal to effect an annuity. The charge is made by reducing accumulation units credited to a contract owner’s account.


6
NOTES TO THE UNAUDITED INTERIM FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT
June 30, 2016

Note 4: Taxes

Prudential is taxed as a “life insurance company,” as defined by the Internal Revenue Code. The results of operations of the Real Property Account form a part of Prudential Financial’s consolidated federal tax return. Under current federal, state, and local law, no federal, state or local income taxes are payable by the Real Property Account. As such, no provision for a tax liability has been recorded in these financial statements. Prudential management will review periodically the status of the policy in the event of changes in the tax law.

Note 5: Net Contributions (Withdrawals) by Contract Owners

Net contributions (withdrawals) by contract owners for the Real Property Account by product for the three and six months ended June 30, 2016 and 2015 were as follows:
 
Six Months Ended June 30,
 
2016
 
2015
PVAL/PVAL $100,000+ Face Value/CVAL
$
(62,542
)
 
$
(962,657
)
PDISCO+/VIP
(220,725
)
 
(40,549
)
TOTAL
$
(283,267
)
 
$
(1,003,206
)
 
Three Months Ended June 30,
 
2016
 
2015
PVAL/PVAL $100,000+ Face Value/CVAL
$
(105,106
)
 
$
(524,997
)
PDISCO+/VIP
(213,152
)
 
(17,072
)
TOTAL
$
(318,258
)
 
$
(542,069
)

Note 6: Partnership Distributions

For the six months ended June 30, 2016, the Partnership made no distribution. For the six months ended June 30, 2015, the Partnership distributed a total of $5.0 million, which occurred on March 30, 2015. The Real Property Account’s share of this distribution was $1.8 million.

For the six months ended June 30, 2016 and 2015, there were no purchases of the Partnership by the Real Property Account.

Note 7: Unit Information

All products referred to in Note 1 for outstanding units and unit values at June 30, 2016 and December 31, 2015 were as follows:
 
June 30, 2016
 
December 31, 2015
Units Outstanding:
26,968,937
 
26,861,466
Unit Value:
$2.89685
to
$3.37325
 
$2.85437
to
$3.31402















7
NOTES TO THE UNAUDITED INTERIM FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT
June 30, 2016

Note 8: Financial Highlights

The range of total return for the three and six months ended June 30, 2016 and 2015 were as follows:
 
Six Months Ended June 30,
 
2016
 
2015
Total Return
1.49%
to
1.79%
 
2.23%
to
2.53%
 
Three Months Ended June 30,
 
2016
 
2015
Total Return
0.48%
to
0.63%
 
0.62%
to
0.77%

Note 9: Related Party

The Real Property Account has transactions and relationships with Prudential and other affiliates. Due to these relationships, it is possible that the terms of these transactions are not the same as those that would result from transactions among unrelated parties.

Prudential and its affiliates perform various services on behalf of the Partnership in which the Real Property Account invests and may receive fees for the services performed. These services include, among other things, shareholder communications, postage, transfer agency and various other record keeping and customer service functions.

Note 10: Fair Value Measurements

Fair value represents the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Real Property Account values its investment in the Partnership using the net asset value provided by the Partnership as a practical expedient. Effective January 1, 2016, the Real Property Account adopted Accounting Standards Update (“ASU”) 2015-07 Fair Value Measurement (Topic 820): Disclosure for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), which removes the requirement to classify the investment in the Partnership in the fair value hierarchy. As a result, certain tables and additional disclosures related to the leveling of assets and liabilities are no longer applicable. ASU 2015-07 was applied retrospectively to all periods presented.
Properties owned by the Partnership are illiquid and fair value is based on estimates from property appraisal reports prepared by independent real estate appraisers as discussed in the notes to the Partnership’s unaudited consolidated financial statements. The purpose of an appraisal is to estimate the fair value of real estate as of a specific date. The estimate of fair value of real estate is based on the conventional approaches to value, all of which require the exercise of subjective judgment. The three approaches are: (1) current cost of reproducing the real estate less deterioration and functional and economic obsolescence; (2) discounting a series of income streams and reversion at a specific yield or by directly capitalizing a single year period income estimate by an appropriate factor; and (3) value indicated by recent sales of comparable real estate in the market. In the reconciliation of these three approaches, the independent appraiser uses one or a combination of them, to come up with the approximate value for the type of real estate in the market.
The following is a summary of the investment strategy, risks, and redemption provisions of the Partnership.
The Partnership has a policy of investing at least 65% of its assets in direct ownership interests in income-producing real estate, such as office buildings, shopping centers, hotels, apartments or industrial properties, and participating mortgage loans. The Partnership is subject to the risks inherent in the ownership of real property such as fluctuations in occupancy rates and operating expenses and variations in rental schedules. The Partnership properties are also subject to the risk of loss due to certain types of damage, which are either uninsurable or not economically insurable. The Partnership enters into loan agreements with certain lenders to finance its real estate investment transactions. Unfavorable economic conditions could increase related borrowing costs, limit access to the capital markets or result in a decision by lenders not to extend credit to the Partnership. Refer to the Partnership’s unaudited consolidated financial statements for other related risks.
The Partnership allows for withdrawal of cash, in any amount up to a partner’s value of the Partnership. Ordinarily payment of the amount requested will be made on the day following the request. The Partnership reserves the right to defer such payments for a period of up to six months if the partners or the investment manager determine that there is insufficient cash available and prompt disposition of investments held by the Partnership cannot be made on commercially reasonable terms.
The Real Property Account had no unfunded capital commitments as of June 30, 2016.

8



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9

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES


June 30, 2016(Unaudited)

December 31, 2015
ASSETS



REAL ESTATE INVESTMENTS - At estimated fair value:



Real estate and improvements (cost: 06/30/2016 -- $229,471,724; 12/31/2015 -- $255,844,718)
$
263,086,513


$
264,925,433

CASH AND CASH EQUIVALENTS
47,310,798


14,423,867

OTHER ASSETS, NET
2,688,978


2,925,378

Total assets
$
313,086,289


$
282,274,678

LIABILITIES & PARTNERS’ EQUITY



INVESTMENT LEVEL DEBT (net of deferred financing costs:



6/30/2016 -- $1,122,195; 12/31/2015 -- $571,719)
$
92,421,758


$
66,026,362

ACCOUNTS PAYABLE AND ACCRUED EXPENSES
2,823,578


2,550,010

DUE TO AFFILIATES
800,999


745,769

OTHER LIABILITIES
584,501


809,256

Total liabilities
96,630,836


70,131,397

COMMITMENTS AND CONTINGENCIES



NET ASSETS, REPRESENTING PARTNERS’ EQUITY:



GENERAL PARTNERS’ CONTROLLING INTEREST
204,253,067


200,068,466

NONCONTROLLING INTEREST
12,202,386


12,074,815

         Total partners' equity
216,455,453


212,143,281

Total liabilities and partners’ equity
$
313,086,289


$
282,274,678

NUMBER OF SHARES OUTSTANDING AT END OF PERIOD
4,529,591


4,529,591

GENERAL PARTNERS' SHARE VALUE AT END OF PERIOD
$
45.09


$
44.17

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


10

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
For the Six Months Ended
June 30,
 
For the Three Months Ended June 30,
 
2016

2015
 
2016

2015
INVESTMENT INCOME:



 



Revenue from real estate and improvements
$
11,103,207


$
10,915,095

 
$
5,600,394


$
5,602,066

Interest income
31,706


7,099

 
9,626


2,298

Total investment income
11,134,913


10,922,194

 
5,610,020


5,604,364

INVESTMENT EXPENSES:



 



Operating
1,585,997


1,759,245

 
826,168


882,797

Investment management fee
1,564,226


1,378,984

 
800,998


701,488

Real estate taxes
1,371,334


1,315,210

 
692,076


641,144

Administrative
1,601,903


1,591,288

 
777,459


821,025

Interest expense
1,758,335


1,695,680

 
904,782


865,019

Total investment expenses
7,881,795


7,740,407

 
4,001,483


3,911,473

NET INVESTMENT INCOME (LOSS)
3,253,118


3,181,787

 
1,608,537


1,692,891

RECOGNIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:



 



Net proceeds from real estate investments sold
5,743,019


12,668,032

 
—


12,668,032

Less: Cost of real estate investments sold
28,943,348


14,114,940

 
—


14,114,940

Gain (loss) realized from real estate investments sold
(23,200,329
)

(1,446,908
)
 
—


(1,446,908
)
Less: Reversal of prior periods’ unrealized gain (loss) on real estate investments sold
(22,943,347
)

(1,572,787
)
 
—


(1,572,787
)
Net gain (loss) recognized on real estate investments sold
(256,982
)

125,879

 
—


125,879

 Change in unrealized gain (loss) on real estate investments
1,590,731


2,895,611

 
153,569


364,119

 Change in unrealized gain (loss) on interest rate cap
649


—

 
(5,174
)

—

         Net unrealized gain (loss) on investments
1,591,380


2,895,611

 
148,395


364,119

NET RECOGNIZED AND UNREALIZED GAIN (LOSS)
1,334,398


3,021,490

 
148,395


489,998

INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS
$
4,587,516


$
6,203,277

 
$
1,756,932


$
2,182,889

Amounts attributable to noncontrolling interest:



 



Net investment income (loss) attributable to noncontrolling interest
$
357,318


$
312,386

 
$
189,852


$
164,392

Net unrealized gain (loss) attributable to noncontrolling interest
45,597


603,156

 
(8,055
)

304,869

          Net increase (decrease) in net assets resulting from operations attributable to noncontrolling interest
$
402,915


$
915,542

 
$
181,797


$
469,261

Amounts attributable to general partners’ controlling interest:



 



Net investment income (loss) attributable to general partners' controlling interest
$
2,895,800


$
2,869,401

 
$
1,418,685


$
1,528,499

Net recognized gain (loss) attributable to general partners' controlling interest
(256,982
)

125,879

 
—


125,879

Net unrealized gain (loss) attributable to general partners' controlling interest
1,545,783


2,292,455

 
156,450


59,250

          Net increase (decrease) in net assets resulting from operations attributable to general partners' controlling interest
$
4,184,601


$
5,287,735

 
$
1,575,135


$
1,713,628

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

11

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS
(Unaudited)
 
For the Six Months Ended June 30,
 
2016
 
2015
 
General Partners’
Controlling Interest
 
Noncontrolling
Interest
 
Total
 
General Partners’
Controlling Interest
 
Noncontrolling
Interest
 
Total
INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS:
 
 
 
 
 
 
 
 
 
 
 
Net investment income (loss)
$
2,895,800

 
$
357,318

 
$
3,253,118

 
$
2,869,401

 
$
312,386

 
$
3,181,787

Net recognized and unrealized gain (loss)
1,288,801

 
45,597

 
1,334,398

 
2,418,334

 
603,156

 
3,021,490

Increase (decrease) in net assets resulting from operations
4,184,601

 
402,915

 
4,587,516

 
5,287,735

 
915,542

 
6,203,277

INCREASE (DECREASE) IN NET ASSETS RESULTING FROM CAPITAL TRANSACTIONS:
 
 
 
 
 
 
 
 
 
 
 
Distributions
—

 
(275,344
)
 
(275,344
)
 
(5,000,000
)
 
(63,681
)
 
(5,063,681
)
Increase (decrease) in net assets resulting from capital transactions
—

 
(275,344
)
 
(275,344
)
 
(5,000,000
)
 
(63,681
)
 
(5,063,681
)
INCREASE (DECREASE) IN NET ASSETS
4,184,601

 
127,571

 
4,312,172

 
287,735

 
851,861

 
1,139,596

NET ASSETS - Beginning of period
200,068,466

 
12,074,815

 
212,143,281

 
188,251,636

 
9,422,311

 
197,673,947

NET ASSETS - End of period
$
204,253,067

 
$
12,202,386

 
$
216,455,453

 
$
188,539,371

 
$
10,274,172

 
$
198,813,543

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


12

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

For the Six Months Ended June 30,

2016

2015
CASH FLOWS FROM OPERATING ACTIVITIES:



Increase (decrease) in net assets resulting from operations
$
4,587,516


$
6,203,277

Adjustments to reconcile increase (decrease) in net assets resulting from operations to net cash provided by (used in) operating activities



Net recognized and unrealized loss (gain)
(1,334,398
)

(3,021,490
)
Amortization of deferred financing costs
18,670


33,374

Bad debt expense
8,725


1,070

(Increase) decrease in:



Other assets
484,658


(290,698
)
Increase (decrease) in:



Accounts payable and accrued expenses
66,048


503,880

Due to affiliates
55,230


47,933

Other liabilities
(167,103
)

(305,871
)
Net cash flows provided by (used in) operating activities
3,719,346


3,171,475

CASH FLOWS FROM INVESTING ACTIVITIES:



Net proceeds from real estate investments sold
5,743,019


12,668,032

Acquisition of real estate and improvements
—


(20,490,522
)
Additions to real estate and improvements
(2,362,834
)

(764,067
)
Restricted cash
(256,330
)

—

Net cash flows provided by (used in) investing activities
3,123,855


(8,586,557
)
CASH FLOWS FROM FINANCING ACTIVITIES:



Principal payments on investment level debt
(567,708
)

(534,776
)
Proceeds from investment level debt
27,513,580


10,175,000

Payment of deferred financing costs
(569,146
)

—

Distributions to general partners' controlling interest
—


(5,000,000
)
Distributions to noncontrolling interest
(275,344
)

(63,681
)
Security deposits payable
(57,652
)

—

Net cash flows provided by (used in) financing activities
26,043,730


4,576,543

NET CHANGE IN CASH AND CASH EQUIVALENTS
32,886,931


(838,539
)
CASH AND CASH EQUIVALENTS - Beginning of period
14,423,867


32,308,210

CASH AND CASH EQUIVALENTS - End of period
$
47,310,798


$
31,469,671

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


13

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED SCHEDULES OF REAL ESTATE INVESTMENTS

 
 
 
 
 
 
2016 Total 
Rentable
Square Feet
Unless Otherwise Indicated (Unaudited)
 
June 30, 2016
(Unaudited)
 
December 31, 2015
Property Name
 
June 30, 2016 Ownership
 
City, State
 
 
Cost
 
Estimated Fair
Value
 
Cost
 
Estimated Fair
Value
OFFICES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
750 Warrenville Road
 
WO
 
Lisle, IL
 
Sold
 
$
—

 
$
—

 
$
28,943,348

 
$
6,000,000

 
 
 
 
Offices % as of 6/30/16
 
—%
 
—

 
—

 
28,943,348

 
6,000,000

APARTMENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
700 Broadway
 
CJV
 
Seattle, WA
 
59 Units
 
23,019,334

 
27,000,000

 
22,982,297

 
26,300,000

Broadstone Crossing
 
WO
 
Austin, TX
 
225 Units
 
23,278,617

 
30,400,000

 
23,156,042

 
30,300,000

Vantage Park
 
CJV
 
Seattle, WA
 
91 Units
 
21,887,253

 
29,700,000

 
21,830,762

 
30,300,000

Station House Apartments of Maplewood
 
WO
 
Maplewood, NJ
 
50 Units
 
20,534,552

 
20,200,000

 
20,534,552

 
20,600,000

1325 N. Wells
 
CJV
 
Chicago, IL
 
N/A
 
7,176,513

 
7,176,513

 
6,485,433

 
6,485,433

The Reserve At Waterford Lakes
 
WO
 
Charlotte, NC
 
140 Units
 
14,966,664

 
16,700,000

 
14,852,929

 
16,100,000

 
 
 
 
Apartments % as of 6/30/16
 
64%
 
110,862,933

 
131,176,513

 
109,842,015

 
130,085,433

RETAIL
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hampton Towne Center
 
WO
 
Hampton, VA
 
174,540
 
19,682,299

 
20,600,000

 
18,968,928

 
21,100,000

White Marlin Mall
 
CJV
 
Ocean City, MD
 
197,098
 
25,783,770

 
34,500,000

 
25,701,926

 
33,800,000

Westminster Crossing East, LLC
 
CJV
 
Westminster, MD
 
89,890
 
15,326,055

 
20,600,000

 
15,326,055

 
20,400,000

Village Walk
 
WO
 
Roswell, GA
 
88,504
 
20,796,113

 
20,600,000

 
20,796,113

 
20,500,000

Harnett Crossing
 
WO
 
Dunn, NC
 
189,143
 
9,337,366

 
5,510,000

 
8,598,045

 
3,640,000

Peachtree Corners Market
 
WO
 
Norcross, GA
 
42,185
 
19,282,716

 
20,700,000

 
19,282,716

 
20,300,000

Publix at Eagle Landing
 
WO
 
North Fort Myers, FL
 
57,840
 
8,400,472

 
9,400,000

 
8,385,572

 
9,100,000

 
 
 
 
Retail % as of 6/30/16
 
65%
 
118,608,791

 
131,910,000

 
117,059,355

 
128,840,000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Real Estate Investments at Estimated Fair Values as a Percentage of General Partners’ Controlling Interest as of June 30, 2016
 
129%
 
$
229,471,724

 
$
263,086,513

 
$
255,844,718

 
$
264,925,433

WO - Wholly-Owned Investment
CJV - Consolidated Joint Venture
The accompanying notes are an integral part of these consolidated financial statements.

14

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED SCHEDULES OF INVESTMENTS

 
June 30, 2016
(Unaudited)
 
December 31, 2015
 
Face
Amount
 
Maturity Date
 
Cost
 
Estimated
Fair Value
 
Cost
 
Estimated
Fair Value
CASH EQUIVALENTS - Percentage of General Partners' Controlling Interest
 
 
 
—
%
 
 
 
5.7
%
Investments in Prudential
Investment Liquidity Pool:
 
 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank, 0 coupon bond
$
—

 

 
$
—

 
$
—

 
$
10,000,000

 
$
10,000,000

Federal Home Loan Bank, 0 coupon bond
—

 

 
—

 
—

 
1,500,000

 
1,500,000

Total Cash Equivalents
 
 
 
$
—

 
$
—

 
$
11,500,000

 
$
11,500,000

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

15
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)



Note 1: Summary of Significant Accounting Policies

A.
Basis of Presentation - The consolidated financial statements of The Prudential Variable Contract Real Property Partnership (the “Partnership”) have been prepared in accordance with accounting principles generally accepted in the United States of America that are applicable to investment companies. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement have been made. Operating results for the three and six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. For further information, refer to the audited consolidated financial statements and notes of the Partnership for the year ended December 31, 2015. The Partnership has evaluated subsequent events through August 11, 2016, the date these consolidated financial statements were available to be issued. The partners in the Partnership are The Prudential Insurance Company of America, Pruco Life Insurance Company and Pruco Life Insurance Company of New Jersey (collectively, the “General Partners”).

As a result of adopting Accounting Standards Update (“ASU”) 2015-03, as of December 31, 2015 the Partnership reclassified $571,719 of deferred financing costs from other assets to investment level debt. The new guidance was applied retrospectively. The Partnership's adoption of the guidance did not have a significant effect on the Partnership's consolidated financial statements.

B.
New Accounting Pronouncements - In February 2016, the Financial Accounting Standards Board (“FASB”) issued updated guidance in ASU 2016-02 Leases (Topic 842) to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The new guidance is effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The Partnership is currently assessing the impact of the guidance on the Partnerships’ consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09 Revenue from Contracts with Customers (Topic 606). ASU 2014-09 is a comprehensive new revenue recognition model requiring an entity to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. In adopting ASU 2014-09, entities may use either a full retrospective or a modified retrospective approach. Additionally, this guidance modifies disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. This new revenue standard applies to sales of real estate assets to customers, such as sales by homebuilders, merchant builders, land developers, condominium sellers and timeshare sellers. Sales of real estate that constitute a business, when those sales are made to customers, are also within the scope of this new standard. Leasing transactions are not within the scope of this new standard. In August 2015, the FASB issued ASU 2015-14 which deferred the original effective date of ASU 2014-09. As a result of the deferral, the guidance in ASU 2014-09 for public business entities is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted for fiscal years beginning after December 15, 2016, including interim periods within that reporting period. This new standard is not expected to have a significant impact on the Partnership’s consolidated financial statements.

C.
Accounting Pronouncements Adopted - In April 2015, the FASB issued ASU 2015-03 Interest-Imputation of Interest (Subtopic 835-30) which requires entities to present debt issuance costs as a direct deduction from the carrying amount of the related debt liability. Prior to the issuance of ASU 2015-03, debt issuance costs were required to be presented as deferred charge assets, separate from the related debt liability. This guidance does not address how debt issuance costs related to line-of-credit arrangements should be presented on the balance sheet or amortized. Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the FASB issued ASU 2015-15 Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements. ASU 2015-15 clarifies that the Securities and Exchange Commission staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The new guidance is effective for public business entities for fiscal years and interim periods beginning after December 15, 2015. The new guidance must be applied retrospectively, and early adoption is permitted for financial statements that have not been previously issued. The adoption of this accounting guidance did not have a material impact on the Partnership’s consolidated financial statements.





16
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 1: Summary of Significant Accounting Policies (continued)

In February 2015, the FASB issued updated guidance in ASU 2015-02 Consolidation (Topic 810) that changes the rules regarding consolidation. The pronouncement eliminates specialized guidance for limited partnerships and similar legal entities, and removes the indefinite deferral for certain investment funds. The new guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, with early adoption permitted. The adoption of this accounting guidance did not have a material impact on the Partnership’s consolidated financial statements.

Note 2: Disclosure of Supplemental Cash Flow Information and Non-Cash Investing and Financing Activities

Cash paid for interest during the six months ended June 30, 2016 and 2015 was $1,731,175 and $1,662,306, respectively.

As of June 30, 2016, $2,362,834 was paid for additions to real estate and improvements, which includes $691,080 related to 1325 North Wells’ development.

Note 3: Fair Value Measurements

Valuation Methods:

Real estate investments are carried at fair value. Properties owned are initially recorded at the purchase price plus closing costs. Development costs and major renovations are capitalized as a component of cost, and routine maintenance and repairs are charged to expense as incurred. Real estate costs include the cost of acquired property, including all the tangible and intangible assets. Tangible assets include the value of all land, building and tenant improvements at the time of acquisition. Intangible assets include the value of any above or below market leases, in-place leases, and tenant relationships at the time of acquisition.
 
In general, fair value estimates are based upon property appraisal reports prepared by independent real estate appraisers (members of the Appraisal Institute or an equivalent organization) within a reasonable amount of time following acquisition of the real estate and no less frequently than annually thereafter. The Chief Real Estate Appraiser of PGIM, Inc. ("PGIM"), which is an indirectly owned subsidiary of Prudential Financial, Inc., is responsible to assure that the valuation process provides independent and reasonable property fair value estimates. An unaffiliated third party has been appointed by PGIM to assist the Chief Real Estate Appraiser in maintaining and monitoring the independence and the accuracy of the appraisal process. The fair value of real estate investments does not reflect the transaction sale costs, which may be incurred upon disposition of the real estate investments.
  
The purpose of an appraisal is to estimate the fair value of real estate as of a specific date. In accordance with the FASB authoritative guidance on fair value measurements and disclosures, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The estimate of fair value is based on the conventional approaches to value, all of which require the exercise of subjective judgment. The three approaches are: (1) current cost of reproducing the real estate less deterioration and functional and economic obsolescence; (2) discounting a series of income streams and reversion at a specific yield or by directly capitalizing a single year period income estimate by an appropriate factor; and (3) value indicated by recent sales of comparable real estate in the market. Key inputs and assumptions include rental income and expense amounts, related rental income and expense growth rates, discount rates and capitalization rates. In the reconciliation of these three approaches, the independent appraiser uses one or a combination of them, to come up with the approximate value for the type of real estate in the market. In general, the inputs used in the appraisal process are unobservable; therefore, unless indicated otherwise, real estate investments are classified as Level 3 under the FASB authoritative guidance for fair value measurements.

Cash equivalents include short-term investments with maturities of three months or less when purchased. Short-term investments are generally valued using unadjusted quoted prices in active markets that are accessible for identical assets and are primarily classified as Level 1. See below for a description of the levels of the fair value hierarchy.

Interest rate caps are recorded at fair value which is determined using discounted cash flow models. The models’ key assumptions include the contractual terms of the contract, along with significant observable inputs, including interest rates, liquidity, credit spreads and other factors including nonperformance risk as well as that of counterparties. These derivatives are traded in the over-the-counter ("OTC") market and are classified within Level 2 in the fair value hierarchy.



17
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 3: Fair Value Measurements (continued)

FASB authoritative guidance on fair value measurements and disclosures establishes a fair value measurement framework, provides a single definition of fair value and requires expanded disclosure summarizing fair value measurements. This guidance provides a three-level hierarchy based on the inputs used in the valuation process. The levels in the fair value hierarchy within which the fair value measurements fall are determined based on the lowest level input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:

Level 1 - Fair value is based on unadjusted quoted prices in active markets that are accessible to the entity for identical assets or liabilities. These generally provide the most reliable evidence and should be used to measure fair value whenever available.

Level 2 - Fair value is based on inputs, other than Level 1 inputs, that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability through corroboration with observable market data.

Level 3 - Fair value is based on significant unobservable inputs for the asset or liability. These inputs reflect the entity’s own assumptions about how market participants would price the asset or liability.

During the six months ended June 30, 2016 and 2015 and year ended December 31, 2015, there were no transfers between Level 1, Level 2 and Level 3.

Table 1 below summarizes the assets measured at fair value on a recurring basis and their respective levels in the fair value hierarchy.

 
 
 
(in 000’s)
 
 
 
Fair value measurements at June 30, 2016 using
Assets:
Cost at
June 30, 2016
 
Amounts measured at fair value June 30, 2016
 
Quoted prices in
active markets
for identical
assets (Level 1)
 
Significant other
observable
inputs (Level 2)
 
Significant
unobservable
inputs (Level 3)
Real estate and improvements
$
229,472

 
$
263,087

 
$
—

 
$
—

 
$
263,087

Interest rate cap
—

 
1

 
—

 
1

 
—

Total
$
229,472

 
$
263,088

 
$
—

 
$
1

 
$
263,087

 
 
 
 
 
 
 
 
 
 
 
 
 
(in 000’s)
 
 
 
Fair value measurements at December 31, 2015 using
Assets:
Cost at
December 31, 2015
 
Amounts measured at fair value December 31, 2015
 
Quoted prices in
active markets
for identical
assets (Level 1)
 
Significant other
observable
inputs (Level 2)
 
Significant
unobservable
inputs (Level 3)
Real estate and improvements
$
255,845

 
$
264,925

 
$
—

 
$
—

 
$
264,925

Cash equivalents
11,500

 
11,500

 
11,500

 
—

 
—

Total
$
267,345

 
$
276,425

 
$
11,500

 
$
—

 
$
264,925


18
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 3: Fair Value Measurements (continued)

Table 2 below provides a reconciliation of the beginning and ending balances for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2016 and 2015.

(in 000's)
Fair value measurements using significant unobservable
inputs for the six months ended June 30, 2016
(Level 3)


Real estate and
improvements
Beginning balance, January 1, 2016
$
264,925

Net recognized and unrealized gains (losses) included in earnings (or changes in net assets)
1,334

Acquisitions, issuances and contributions
2,571

Dispositions, settlements and distributions
(5,743
)
Ending balance, June 30, 2016
$
263,087

Unrealized gains (losses) for the period relating to Level 3 assets still held at the reporting date
$
1,591


(in 000's)
Fair value measurements using significant unobservable
inputs for the six months ended June 30, 2015
(Level 3)


Real estate and
improvements
Beginning balance, January 1, 2015
$
235,690

Net recognized and unrealized gains (losses) included in earnings (or changes in net assets)
3,021

Acquisitions, issuances and contributions
21,538

Dispositions, settlements and distributions
(12,668
)
Ending balance, June 30, 2015
$
247,581

Unrealized gains (losses) for the period relating to Level 3 assets still held at the reporting date
$
2,896



















19
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 3: Fair Value Measurements (continued)

(in 000's)
Fair value measurements using significant unobservable
inputs for the three months ended June 30, 2016
(Level 3)


Real estate and
improvements
Beginning balance, April 1, 2016
$
261,586

Net recognized and unrealized gains (losses) included in earnings (or changes in net assets)
154

Acquisitions, issuances and contributions
1,347

Dispositions, settlements and distributions
—

Ending balance, June 30, 2016
$
263,087

Unrealized gains (losses) for the period relating to Level 3 assets still held at the reporting date
$
154



(in 000's)
Fair value measurements using significant unobservable
 inputs for the three months ended June 30, 2015
(Level 3)


Real estate and
improvements
Beginning balance, April 1, 2015
$
238,430

Net recognized and unrealized gains (losses) included in earnings (or changes in net assets)
490

Acquisitions, issuances and contributions
21,329

Dispositions, settlements and distributions
(12,668
)
Ending balance, June 30, 2015
$
247,581

Unrealized gains (losses) for the period relating to Level 3 assets still held at the reporting date
$
364



20
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 3: Fair Value Measurements (continued)

Quantitative Information Regarding Level 3 Assets:

The tables below represent quantitative information about the significant unobservable inputs used in the fair value measurement of Level 3 assets. Significant changes in any of those inputs in isolation would result in a significant change in the fair value measurement.

 
As of June 30, 2016
Category
Fair Value
(in 000’s)
 
Number of
properties
in this
property type
 
Valuation Techniques
 
Unobservable Input
 
Range (Weighted Average)
Real estate and improvements:
 
 
 
 
 
 
 
 
 
Apartment
$
131,177

 
5
 
Discounted cash flow
 
Exit capitalization rate
 
5.00% - 6.25% (5.29%)
 
 
 
 
 
 
 
Discount rate
 
6.25% - 7.50% (6.66%)
 
 
 
1
 
Market Value *
 
 
 
 
Retail
131,910

 
7
 
Discounted cash flow
 
Exit capitalization rate
 
5.75% - 9.50% (6.74%)
 
 
 
 
 
 
 
Discount rate
 
6.25% - 10.50% (7.26%)
 
$
263,087

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2015
Category
Fair Value
(in 000’s)
 
Number of
properties
in this
property type
 
Valuation Techniques
 
Unobservable Input
 
Range (Weighted Average)
Real estate and improvements:
 
 
 
 
 
 
 
 
 
Apartment
$
130,085

 
5
 
Discounted cash flow
 
Exit capitalization rate
 
4.75% - 6.25% (5.31%)
 
 
 
 
 
 
 
Discount rate
 
6.00% - 7.50% (6.54%)
 
 
 
1
 
Market Value *
 
 
 
 
Office
6,000

 
1
 
Discounted cash flow
 
Exit capitalization rate
 
8.75%
 
 
 
 
 
 
 
Discount rate
 
10.25%
Retail
128,840

 
7
 
Discounted cash flow
 
Exit capitalization rate
 
6.00% - 10.00% (6.65%)
 
 
 
 
 
 
 
Discount rate
 
6.25% - 11.00% (7.17%)
 
$
264,925

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

* The market value approach represents assets/liabilities in which estimated fair value represents subjective estimates by management based on the investment's specific facts and circumstances. For example, development assets and recent acquisitions may heavily weight investment cost while pending sales may heavily weight negotiated sales prices in the related fair value estimates.
Fair Value of Financial Instruments Carried at Cost:

The Partnership’s financial instruments include cash and cash equivalents, accounts payable, accrued expenses and mortgages. The carrying amount of cash and cash equivalents, accounts payable and accrued expenses approximate their fair value due to the instruments’ short-term nature. As of June 30, 2016 and December 31, 2015, the Partnership’s mortgages on wholly-owned properties and consolidated joint ventures have an estimated fair value of approximately $93.9 million and $66.9 million, respectively, and an outstanding principal balance of $93.5 million and $66.6 million, respectively. The estimated fair value is based on the amount at which the Partnership would pay to transfer the debt at the reporting date taking into consideration the effect of nonperformance risk, including the Partnership’s own credit risk. The fair value of debt is determined using the discounted cash flow method, which applies certain key assumptions including the contractual terms of the agreement, market interest rates, interest spreads, credit risk, liquidity and other factors. Different assumptions or changes in future market conditions could significantly affect the estimated fair value. The input values used in determining the fair value on investment level debt are unobservable, and therefore, would be considered as Level 3 under the fair value hierarchy.

21
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 4: Interest Rate Caps

Certain of the Partnership’s consolidated joint ventures entered into an interest rate cap transaction ("Cap") with an unrelated major financial institution. The Partnership uses Caps in order to reduce the effect of interest rate fluctuations or interest rate risk of certain real estate investments’ interest expense on variable rate debt.

The Partnership has recorded the fair value of the Cap in “Other Assets” on the Consolidated Statements of Assets and Liabilities. The resulting unrealized gain (loss) is included in the Consolidated Statements of Operations in “Change in unrealized gain (loss) on interest rate cap.”

The Partnership’s Cap is collateralized by the asset attributable to the related investment level debt.

Note 5: Risk

A.
Valuation Risk

The estimated fair value of real estate and real estate related assets is generally determined through an appraisal process. These estimated fair values may vary significantly from the prices at which the real estate investments would sell, since market prices of real estate investments can only be determined by negotiation between a willing buyer and seller. These differences could be material to the consolidated financial statements. Although the estimated fair values represent subjective estimates, management believes that these estimated fair values are reasonable approximations of market prices and the aggregate estimated value of investments in real estate and improvements are fairly presented as of June 30, 2016 and December 31, 2015.

B.
Credit Risk

In the normal course of business, the Partnership maintains cash and cash equivalents in financial institutions, which at times may exceed federally insured limits. The Partnership is subject to credit risk to the extent any financial institution with which it conducts business is unable to fulfill contractual obligations on its behalf. The Partnership monitors the financial condition of such financial institutions to minimize credit risk exposure.

C.
Financing, Covenant, and Repayment Risks

In the normal course of business, the Partnership enters into loan agreements with certain lenders to finance its real estate investment transactions. Unfavorable economic conditions could increase related borrowing costs, limit access to the capital markets or result in a decision by lenders not to extend credit to the Partnership. There is no guarantee that the Partnership’s borrowing arrangements or ability to obtain leverage will continue to be available, or if available, will be on terms and conditions acceptable to the Partnership. Further, these loan agreements contain, among other conditions, events of default and various covenants and representations. In the normal course of business, the Partnership may be in the process of renegotiating terms for loans outstanding that have passed their maturity dates. At June 30, 2016, the Partnership had no outstanding matured loans.

A decline in market value of the Partnership’s assets may also have particular adverse consequences in instances where the Partnership borrowed money based on the fair value of specific assets. A decrease in market value of these assets may result in the lender requiring the Partnership to post additional collateral or otherwise repay these loans.

In the event the Partnership’s current portfolio and investment obligations are not refinanced or extended when they become due, management anticipates that the repayment of these obligations will be provided by operating cash flow, new debt refinancing, and real estate investment sales.





22
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 6: Concentration of Risk on Real Estate Investments and Other Concentrated Risks

Concentration of risk on real estate investments represents the risk associated with investments that are concentrated in certain geographic regions and industries. The Partnership mitigates this risk by diversifying its investments in various regions and different types of real estate investments. Please refer to the Consolidated Schedules of Real Estate Investments for the Partnership’s diversification on the types of real estate investments.

At June 30, 2016, the Partnership had real estate investments located throughout the United States. The diversification of the Partnership’s holdings based on the estimated fair values and established National Council of Real Estate Investment Fiduciaries ("NCREIF") regions is as follows:
Region
 
 
Estimated Fair Value (in 000's)
 
Region %
Northeast: NJ
 
$
20,200

 
7.68
%
East North Central: IL
 
 
7,177

 
2.73
%
Mideast: MD, NC, VA
 
 
97,910

 
37.22
%
Pacific: WA
 
 
56,700

 
21.55
%
Southeast: FL, GA
 
 
50,700

 
19.27
%
Southwest: TX
 
 
30,400

 
11.55
%
Total
 
$
263,087

 
100.00
%
 
 
 
 
 
 

The allocations above are based on 100% of the estimated fair value of wholly-owned properties and consolidated joint ventures. The Partnership has no significant concentrations of tenants as no single tenant has annual contract rent that makes up more than 15% of the rental income of the Partnership.

At June 30, 2016 and December 31, 2015, there were two partners who each held investments in the Partnership that represented greater than 10% of the Partnership's net asset value.
Note 7: Commitments and Contingencies

The Partnership is subject to various legal proceedings and claims arising in the ordinary course of business. These matters are generally covered by insurance. In the opinion of the Partnership’s management, the outcome of such matters will not have a significant effect on the financial position of the Partnership.

The Partnership has private real estate equity investments for which it is contractually obligated to fund additional capital after its initial investments as well as those in which capital is provided without being contractually obligated to do so. Such additional capital is generally provided in the ordinary course of business to fund recurring and non-recurring capital improvement activities of underlying real estate investments. For the periods ended June 30, 2016 and December 31, 2015, the Partnership did not fund any contractual obligations on committed capital. The Partnership does not typically provide material non-contractual financial support to investees.

As of June 30, 2016, the Partnership's share of unfunded debt obligations related to Real Estate and Improvements is $12 million. The Partnership does not have equity commitments to fund properties under development.


23
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 8: Related Party Transactions

Pursuant to an investment management agreement, PGIM charges the Partnership a daily investment management fee at an annual rate of 1.25% of the average daily gross asset valuation of the Partnership. For the six months ended June 30, 2016 and 2015, management fees incurred by the Partnership were $1,564,226 and $1,378,984, respectively. The Partnership also reimburses PGIM for certain administrative services rendered by PGIM. The amounts incurred for the six months ended June 30, 2016 and 2015 were $0 and $26,814, respectively, and are classified as administrative expenses in the consolidated statements of operations. For the three month periods ended June 30, 2016 and 2015, management fees incurred by the Partnership were $800,998 and $701,488, respectively. The amounts incurred for administrative services rendered by PGIM and reimbursed by the Partnership for the three month periods ended June 30, 2016 and 2015 were $0 and $13,407, respectively.

Note 9: Share Values and Shares Outstanding

The share value and shares outstanding at June 30, 2016 and December 31, 2015 are as follows:

 
 
 
 
 
 
 
 
June 30, 2016

 
December 31, 2015

 
Share Value
 
$45.09
 
$44.17
 
Shares Outstanding
 
4,529,591

 
4,529,591

 
 
 
 
 
 
 

The capital share transactions for the six and twelve months ended June 30, 2016 and December 31, 2015, respectively, are as follows:

 
 
Outstanding shares for the six months ended June 30, 2016
 
Outstanding shares for the twelve months ended December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning of Period
 
4,529,591

 
4,650,878

 
Distributions
 
—

 
(121,287
)
 
End of Period
 
4,529,591

 
4,529,591

 




24
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF
THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP
June 30, 2016
(Unaudited)


Note 10: Financial Highlights
 
 
    For The Six Months Ended June 30,
 
 
2016
 
2015
 
2014
 
2013
 
2012
Per Share (Unit) Operating Performance:
 
 
 
 
 
 
 
 
 
 
Net asset value attributable to general partners' controlling interest, beginning of period
 
$
44.17

 
$
40.48

 
$
37.78

 
$
34.49

 
$
32.27

Income From Investment Operations:
 
 
 
 
 
 
 
 
 
 
Net investment income attributable to general partners' controlling interest, before management fee
 
0.98

 
0.93

 
0.98

 
1.09

 
0.96

Investment management fee attributable to general partners' controlling interest
 
(0.35
)
 
(0.31
)
 
(0.26
)
 
(0.25
)
 
(0.22
)
Net recognized and unrealized gain (loss) on investments attributable to general partners' controlling interest
 
0.29

 
0.52

 
0.25

 
0.28

 
0.03

Net increase (decrease) in net assets resulting from operations attributable to general partners' controlling interest
 
0.92

 
1.14

 
0.97

 
1.12

 
0.77

Net asset value attributable to general partners' controlling interest, end of period
 
$
45.09

 
$
41.62

 
$
38.75

 
$
35.61

 
$
33.04

Total return attributable to general partners' controlling interest, before management fee (a):
 
2.88
%
 
3.58
%
 
3.28
%
 
3.99
%
 
3.07
%
Total return attributable to general partners' controlling interest, after management fee (a):
 
2.09
%
 
2.84
%
 
2.57
%
 
3.27
%
 
2.37
%
Ratios/Supplemental Data:
 
 
 
 
 
 
 
 
 
 
Net assets attributable to general partners' controlling interest, end of period (in millions)
 
$
204

 
$
189

 
$
185

 
$
179

 
$
171

Ratios to average net assets for the period ended (b) (c):
 
 
 
 
 
 
 
 
 
 
      Management fees
 
0.78
%
 
0.74
%
 
0.69
%
 
0.70
%
 
0.69
%
     Other portfolio level expenses
 
0.18
%
 
0.16
%
 
0.10
%
 
0.11
%
 
0.13
%
     Total portfolio level expenses
 
0.96
%
 
0.90
%
 
0.79
%
 
0.81
%
 
0.82
%
     Net investment income, before management fee
 
2.22
%
 
2.27
%
 
2.60
%
 
3.16
%
 
2.97
%
     Net investment income, after management fee
 
1.44
%
 
1.53
%
 
1.91
%
 
2.45
%
 
2.27
%

(a)
Total Return, before/after management fee, is calculated by geometrically linking quarterly returns which are calculated using the formula below:
  Net Investment Income before/after Management Fee + Net Recognized and Unrealized Gains/(Losses)
Beginning Net Asset Value + Time Weighted Contributions - Time Weighted Distributions

(b)
Average net assets are based on beginning of quarter net assets.

(c)
The income and expense ratios are not annualized.





25

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

All of the assets of The Prudential Variable Contract Real Property Account (the "Real Property Account") are invested in The Prudential Variable Contract Real Property Partnership (the "Partnership"). Accordingly, the liquidity and capital resources and results of operations for the Real Property Account are contingent upon those of the Partnership. Therefore, this Management’s Discussion and Analysis of Financial Condition and Results of Operations addresses these items at the Partnership level. The general partners in the Partnership are The Prudential Insurance Company of America, Pruco Life Insurance Company, and Pruco Life Insurance Company of New Jersey (collectively, the “General Partners”).

The following discussion and analysis of the liquidity and capital resources and results of operations of the Partnership should be read in conjunction with the unaudited financial statements of the Real Property Account and the unaudited consolidated financial statements of the Partnership and the related Notes included in this filing.

(a) Liquidity and Capital Resources

As of June 30, 2016, the Partnership’s liquid assets, consisting of cash and cash equivalents, were approximately $47.3 million, an increase of approximately $32.9 million from $14.4 million as of December 31, 2015. The increase was primarily due to the following activities: (a) $27.5 million of proceeds from investment level debt; (b) $5.7 million of proceeds from the sale of an office property in Lisle, IL; and (c) $3.6 million of cash flow generated from property operations. Partially offsetting the increase was a decrease due to: (a) $0.6 million of principal payments on financed properties; (b) $0.6 million of deferred financing payments on financed properties; (c) $0.3 million in distributions to joint venture partners; (d) $0.3 million increase in restricted cash; and (e) $2.4 million paid for capital improvements. The $2.4 million paid for capital improvements included the following items: (a) $0.7 million for construction costs at the development property in Chicago, IL; (b) $0.7 million for space renovations at the retail property in Hampton, Virginia; (c) $0.7 million for space renovations at the retail property in Dunn, NC; and (d) $0.3 million for capital improvements and transaction costs associated with leasing expenses at various properties.

Sources of liquidity included net cash flow from property operations and interest from cash equivalents. The Partnership uses cash for its real estate investment activities and for distributions to its partners. As of June 30, 2016, approximately 15.1% of the Partnership’s total assets consisted of cash and cash equivalents.

(b) Results of Operations

The following is a comparison of the Partnership’s results of operations for the three and six month periods ended June 30, 2016 and 2015.

Net investment income/(loss) overview

The Partnership’s net investment income attributable to the General Partners’ controlling interest for the six month period ended June 30, 2016 was approximately $2.9 million, an increase of less than $0.1 million from the prior year period. The increase in net investment income attributable to the General Partners’ controlling interest was primarily due to an increase of $0.3 million in the office sector investment’s net investment income from the prior year period and an increase of approximately $0.1 million in the retail sector investments’ net investment income from the prior year period. Partially offsetting this increase was a decrease of approximately $0.2 million from the prior year period in net investment income attributable to the General Partners’ controlling interest from the apartment sector and an increase of approximately $0.2 million from prior year period in portfolio level expenses.

The Partnership’s net investment income attributable to the General Partners’ controlling interest for the three month period ended June 30, 2016 was approximately $1.4 million, a decrease of approximately $0.1 million from the prior year period. The decrease in net investment income attributable to the General Partners’ controlling interest was primarily due to a decrease of $0.2 million in the apartment sector investments’ net investment income from the prior year period and an increase of approximately $0.1 million to other net investment expenses. Partially offsetting the decrease was an increase of approximately $0.2 million from the prior year period in net investment income attributable to the General Partners’ controlling interest from the office sector.




  


26

Valuation overview

The Partnership recorded a net recognized and unrealized gain attributable to the General Partners’ controlling interest of approximately $1.3 million for the six month period ended June 30, 2016. This is compared with a net recognized and unrealized gain attributable to the General Partners’ controlling interest of approximately $2.4 million for the prior year period. The unrealized gains attributable to the General Partners’ controlling interest for the six month period ended June 30, 2016 were due to valuation increases in the apartment and retail investments of $1.5 million. Partially offsetting the unrealized gains was a recognized loss of $0.2 million in the office sector investments.

The Partnership recorded net unrealized gains attributable to the General Partners’ controlling interest of approximately $0.2 million for the three month period ended June 30, 2016. This is compared with a net recognized and unrealized gain attributable to the General Partners’ controlling interest of approximately $0.2 million for the prior year period. The unrealized gains attributable to the General Partners’ controlling interest for the three month period ended June 30, 2016 were due to valuation increases in the apartment and retail sector investments.

The following table presents a comparison of the Partnership’s sources of net investment income (loss) attributable to the General Partners’ controlling interest and net recognized and unrealized gains (losses) attributable to the General Partners’ controlling interest for the six and three month periods ended June 30, 2016 and 2015.


Six Months Ended June 30,

Three Months Ended June 30,

2016

2015

2016

2015
Net Investment Income (Loss):







Office properties
$
(1,433
)

$
(300,404
)

$
(6,686
)

$
(196,779
)
Apartment properties
1,848,682


2,090,064


946,472


1,154,416

Retail properties
2,912,763


2,808,064


1,415,935


1,418,175

Hotel property
(4,587
)

(54,857
)

—


(29,273
)
Other (including interest income, investment management fee, etc.)
(1,859,625
)

(1,673,466
)

(937,036
)

(818,040
)
Total Net Investment Income
$
2,895,800


$
2,869,401


$
1,418,685


$
1,528,499

Net Recognized Gain (Loss) on Real Estate Investments:







Office properties
$
(256,982
)

$
125,879


$
—


$
125,879

Net Recognized Gain (Loss) on Real Estate Investments
$
(256,982
)

$
125,879


$
—


$
125,879

Net Unrealized Gain (Loss) on Real Estate Investments:







Office properties
$
—


$
(773,375
)

$
—


$
(668,483
)
Apartment properties
942,788


1,825,979


111,892


1,190,504

Retail properties
602,995


1,239,851


44,558


(462,771
)
Net Unrealized Gain (Loss) on Real Estate Investments
$
1,545,783


$
2,292,455


$
156,450


$
59,250

Net Recognized and Unrealized Gain (Loss) on Real Estate Investments
$
1,288,801


$
2,418,334


$
156,450


$
185,129



27

OFFICE PROPERTIES
Six Months Ended June 30,

Net Investment
Income/(Loss)
2016

Net Investment
Income/(Loss)
2015

Recognized
Gain/(Loss)
2016

Recognized and Unrealized
Gain/(Loss)
2015

Occupancy
2016

Occupancy
2015
Property












Lisle, IL (1)

$
(1,433
)

$
(59,932
)

$
(256,982
)

$
(773,375
)

N/A

55
%
Beaverton, OR (2)

—


(240,472
)

—


125,879


N/A

N/A



$
(1,433
)

$
(300,404
)

$
(256,982
)

$
(647,496
)





















Three Months Ended June 30,
















Property












Lisle, IL

$
(6,686
)

$
(12,685
)

$
—


$
(568,483
)





Beaverton, OR

—


(184,094
)

—


25,879








$
(6,686
)

$
(196,779
)

$
—


$
(542,604
)




(1) The Lisle, Illinois property was sold on January 21, 2016.
(2) The Beaverton, Oregon property was sold on June 8, 2015.

Net investment income/(loss)

Net investment income attributable to the General Partners’ controlling interest for the Partnership’s office properties was a loss of less than $0.1 million for the six and three month periods ended June 30, 2016, respectively, which represents an increase of approximately $0.3 million and $0.2 million from the prior year periods, respectively. The increase in net investment income is due to selling the properties in Lisle, Illinois and Beaverton, Oregon. The two properties had large vacancies and were providing negative cash flow resulting in losses in 2015.

Recognized and unrealized gain/(loss)

The office property formerly owned by the Partnership recorded a recognized loss attributable to the General Partners’ controlling interest of approximately $0.3 million for the six month period ended June 30, 2016, compared with a recognized and net unrealized loss attributable to the General Partners’ controlling interest of approximately $0.6 million from the prior year period. The recognized loss attributable to the General Partners’ controlling interest for the six month period ended June 30, 2016 was due to the sale of the property located in Lisle, Illinois.




28

APARTMENT PROPERTIES
Six Months Ended June 30,

Net Investment
Income/(Loss)
2016

Net Investment
Income/(Loss)
2015

Unrealized
Gain/(Loss)
2016


Unrealized
Gain/(Loss)
2015

Occupancy
2016

Occupancy
2015
Property












Austin, TX

590,953


730,420


(22,575
)

433,636


97
%

94
%
Charlotte, NC

363,037


437,626


486,265


123,242


95
%

99
%
Seattle, WA #1

297,948


267,621


563,516


53,603


90
%

92
%
Seattle, WA #2

378,857


397,517


(285,029
)

1,215,498


100
%

98
%
Maplewood, NJ

217,887


256,880


200,000


—


92
%

86
%
Chicago, IL

—


—


611


—


N/A


N/A



$
1,848,682


$
2,090,064


$
942,788


$
1,825,979






















Three Months Ended June 30,
















Property
















Austin, TX

297,207


372,357


225,825


573,296







Charlotte, NC

167,870


216,098


131,633


(41,654
)






Seattle, WA #1

151,181


112,176


153,136


65,870







Seattle, WA #2

214,959


196,905


(393,810
)

592,992







Maplewood, NJ

115,255


256,880


—


—







Chicago, IL

—


—


(4,892
)

—









$
946,472


$
1,154,416


$
111,892


$
1,190,504






Net investment income/(loss)

Net investment income attributable to the General Partners’ controlling interest for the Partnership’s apartment properties was approximately $1.8 million and $1.0 million for the six and three month periods ended June 30, 2016, respectively, which represents a decrease of approximately $0.2 million from each of the prior year periods. The decrease over the six month period was primarily due to the interest expense associated with the property in Austin, Texas. The decrease over the three month period was primarily due to increased real estate taxes at the apartment complex in Maplewood, New Jersey.

Unrealized gain/(loss)

The apartment properties owned by the Partnership recorded a net unrealized gain attributable to the General Partners’ controlling interest of approximately $1.0 million and $0.1 million for the six and three month periods ended June 30, 2016, respectively, compared with a net unrealized gain attributable to the General Partners’ controlling interest of approximately $1.8 million and $1.2 million from the prior year periods, respectively. The net unrealized gain attributable to the General Partners’ controlling interest for the six month period ended June 30, 2016 was primarily due to favorable market leasing assumptions at the property #1 located in Seattle, Washington and at the property in Charlotte, North Carolina. Partially offsetting the increase was a decrease at the property #2 in Seattle, Washington for near term capital expenditures related to unit renovations. The net unrealized gain attributable to the General Partners’ controlling interest for the three month period ended June 30, 2016 was primarily due to favorable market leasing assumptions at the properties in Charlotte, North Carolina, Austin, Texas and property # 1 in Seattle, Washington. Partially offsetting the increase was a decrease at the property #2 in Seattle, Washington for near term capital expenditures related to unit renovations.



29

RETAIL PROPERTIES
Six Months Ended June 30,

Net Investment
Income/(Loss)
2016

Net Investment
Income/(Loss)
2015

Unrealized
Gain/(Loss)
2016

Unrealized
Gain/(Loss)
2015

Occupancy
2016

Occupancy
2015
Property












Hampton, VA

$
681,509


$
702,465


$
(1,213,365
)

$
1,068,478


99
%

96
%
Ocean City, MD

481,970


458,658


300,581


9,807


95
%

96
%
Westminster, MD

637,392


641,827


200,000


(57,400
)

100
%

100
%
Dunn, NC

(92,759
)

174,789


530,679


(493,018
)

38
%

27
%
Roswell, GA

587,537


222,987


100,000


200,000


94
%

94
%
North Fort Myers, FL

242,187


237,490


285,100


394,700


88
%

85
%
Norcross, GA

374,927


369,848


400,000


117,284


100
%

100
%


$
2,912,763


$
2,808,064


$
602,995


$
1,239,851






















Three Months Ended June 30,
















Property
















Hampton, VA

$
330,470


$
352,634


$
(1,058,740
)

$
(708,338
)






Ocean City, MD

248,379


246,140


319,301


14,611







Westminster, MD

293,789


343,585


200,000


(518
)






Dunn, NC

(58,885
)

85,816


698,897


36,774







Roswell, GA

281,222


85,697


—


100,000







North Fort Myers, FL

124,948


114,152


(114,900
)

94,700







Norcross, GA

196,011


190,151


—


—









$
1,415,934


$
1,418,175


$
44,558


$
(462,771
)





Net investment income/(loss)

Net investment income attributable to the General Partners’ controlling interest for the Partnership’s retail properties was approximately $2.9 million for the six month period ended June 30, 2016, which represents an increase of approximately $0.1 million from the prior year period. The increase was largely due to interest expense savings from the loan payoff at the property in Roswell, Georgia. Partially offsetting the increase was a decrease at the property in Dunn, North Carolina due to increased operating expenses for repairs and maintenance. Net investment income attributable to the General Partners’ controlling interest for the Partnership’s retail properties was approximately $1.4 million for the three month period ended June 30, 2016, which remained relatively flat from the prior year period. An increase from interest expense savings from the loan payoff at the property in Roswell, Georgia, was offset from increased operating expenses at the property in Dunn, North Carolina.

Unrealized gain/(loss)
The retail properties owned by the Partnership recorded a net unrealized gain attributable to the General Partners’ controlling interest of approximately $0.6 million for the six month period ended June 30, 2016, compared with a net unrealized gain attributable to the General Partners’ controlling interest of approximately $1.2 million from the prior year period. The net unrealized gain attributable to the General Partners’ controlling interest for the six month period ended June 30, 2016 was primarily due to decreased investment rates for the entire retail sector with the exception of the property in Hampton, Virginia. Investment rates include direct and terminal capitalization rates, and discount rates, which reflect investors’ yield requirements on investments. Additional gains were provided by favorable market leasing assumptions at the properties in Norcross, Georgia, Dunn, North Carolina, and Westminster, Maryland. The retail properties owned by the Partnership recorded a net unrealized gain attributable to the General Partners’ controlling interest of less than $0.1 million for the three month period ended June 30, 2016, compared with a net unrealized loss attributable to the General Partners’ controlling interest of approximately $0.5 million at the prior year period. The net unrealized gain attributable to the General Partners’ controlling interest for the three month period ended June 30, 2016 was primarily due to lower investment rates at the property in Dunn, North Carolina. Additional gains were provided by the property in Ocean City, Maryland due to recapturing space previously used as a walkway, which increases the net leasable area for the property as well as renewing current tenants at the site. Partially offsetting the increase was a decrease at the property in Hampton, Virginia due to an anticipated increase in property operating expenses from rent concessions for a tenant moving into the space in August 2016.

30

HOTEL PROPERTY
Six Months Ended June 30,

Net Investment
Income/(Loss)
2016

Net Investment
Income/(Loss)
2015

Recognized
Gain/(Loss)
2016

Recognized
Gain/(Loss)
2015

Occupancy
2016

Occupancy
2015
Property












Lake Oswego, OR (1)

$
(4,587
)

$
(54,857
)

$
—


$
—


N/A

N/A

















Three Months Ended June 30,
















Property
















Lake Oswego, OR (1)

$
—


$
(29,273
)

$
—


$
—





(1) The property was sold on October 29, 2014. The net investment loss in 2016 and 2015 represents post closing expenses.

Net investment income/(loss)

Net investment loss attributable to the General Partners’ controlling interest for the Partnership’s hotel property was less than $0.1 million for the six and three month periods ended June 30, 2016, respectively, which remained relatively flat from the prior year periods. This property was sold on October 29, 2014. The net investment loss in both periods represents post closing expenses.


OTHER

Other net investment expense mainly includes investment management fees, other portfolio level expenses and interest income. Other net investment expense attributable to the General Partners’ controlling interest was approximately $1.9 million and $0.9 million for the six and three month periods ended June 30, 2016, respectively, which represents an increase of approximately $0.2 million and $0.1 million from prior year periods, respectively. The increases are primarily due to investment management fees.



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(c) Inflation

A majority of the Partnership’s leases with its commercial tenants provide for recoveries of expenses based upon the tenant’s proportionate share of, and/or increases in, real estate taxes and certain operating costs, which may partially reduce the Partnership’s exposure to increases in operating costs resulting from inflation.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP"), requires the application of accounting policies that often involve a significant degree of judgment. Management reviews critical estimates and assumptions on an ongoing basis. If management determines, as a result of its consideration of facts and circumstances, that modifications in assumptions and estimates are appropriate, results of operations and financial position as reported in the unaudited financial statements of the Real Property Account and the unaudited consolidated financial statements of the Partnership may change significantly.
The following sections discuss those critical accounting policies applied in preparing the unaudited financial statements of the Real Property Account and the unaudited consolidated financial statements of the Partnership that are most dependent on the application of estimates and assumptions.

Valuation of Investments

Real estate investments are carried at fair value. Properties owned are initially recorded at the purchase price plus closing costs. Development costs and major renovations are capitalized as a component of cost, and routine maintenance and repairs are charged to expense as incurred. Real estate costs include the cost of acquired property, including all the tangible and intangible assets. Tangible assets include the value of all land, building and tenant improvements at the time of acquisition. Intangible assets include the value of any above and below market leases, in-place leases, and tenant relationships at the time of acquisition.

In general, fair value estimates are based upon property appraisal reports prepared by independent real estate appraisers (members of the Appraisal Institute or an equivalent organization) within a reasonable amount of time following acquisition of the real estate and no less frequently than annually thereafter. PGIM, Inc. (“PGIM”), which is an indirectly owned subsidiary of Prudential Financial, Inc., appoints a Chief Real Estate Appraiser who is responsible for assuring that the valuation process provides independent and reasonable property fair value estimates. An unaffiliated third party has been appointed by PGIM to assist the Chief Real Estate Appraiser in maintaining and monitoring the independence and the accuracy of the appraisal process. The fair value of real estate investments does not reflect the transaction sale costs, which may be incurred upon disposition of the real estate investments.

The purpose of an appraisal is to estimate the fair value of real estate as of a specific date. In accordance with Financial Accounting Standards Board (“FASB”) authoritative guidance on fair value measurements and disclosures, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The estimate of fair value is based on the conventional approaches to value, all of which require the exercise of subjective judgment. The three approaches are: (1) current cost of reproducing the real estate less deterioration and functional and economic obsolescence; (2) discounting a series of income streams and reversion at a specific yield or by directly capitalizing a single year period income estimate by an appropriate factor; and (3) value indicated by recent sales of comparable real estate in the market. Key inputs and assumptions include rental income and expense amounts, related rental income and expense growth rates, discount rates and capitalization rates. In the reconciliation of these three approaches, the independent appraiser uses one, or a combination, of them to determine the approximate value for the type of real estate in the market.

Cash equivalents include short-term investments with maturities of three months or less when purchased.

Other Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the unaudited financial statements of the Real Property Account and the unaudited consolidated financial statements of the Partnership, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.


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ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

The table below discloses the Partnership’s investment level debt as of June 30, 2016. The fair value of the Partnership’s long-term investment level debt is affected by changes in market interest rates. The following table presents principal cash flows based upon maturity dates of the debt obligations and the related weighted-average interest rates by expected maturity dates for the debt.

Investment level debt (in $ 000s),
including current portion
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
 
Total
 
Estimated
Fair Value
Weighted Average Fixed Interest Rate
 
3.84
%
 
4.12
%
 
4.06
%
 
4.02
%
 
4.03
%
 
3.76
%
 
3.97
%
 
 
Future Annual Principal Payment
 
$
586

 
$
1,326

 
$
3,107

 
$
1,680

 
$
1,916

 
$
84,929

 
$
93,544

 
$
93,900



Credit Risk - The Partnership is exposed to market risk from tenants. While the Partnership has not experienced any significant credit losses, in the event of significant increases in interest rates and/or an economic downturn, tenant delinquencies could increase and result in losses to the Partnership and the Real Property Account that could adversely affect their operating results and liquidity.

ITEM 4. Controls and Procedures

In order to ensure that the information we must disclose in our filings with the Securities and Exchange Commission is recorded, processed, summarized, and reported on a timely basis, the Company’s management, including our Chief Executive Officer and Chief Financial Officer, have reviewed and evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e), as amended under the Securities Exchange Act of 1934 (“Exchange Act”), as of June 30, 2016. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2016, our disclosure controls and procedures were effective. No change in our internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f), occurred during the quarter ended June 30, 2016, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II – OTHER INFORMATION
Item 1A. Risk Factors

You should carefully consider the risks described under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015. These risks could materially affect our business, results of operations or financial condition, or cause our actual results to differ materially from those expected or those expressed in any forward looking statements. These risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under “Forward-Looking Statements” above and the risks of our business described elsewhere in this Quarterly Report on Form 10-Q.

Item 6. Exhibits

31.1 Section 302 Certification of the Chief Executive Officer.
31.2 Section 302 Certification of the Chief Financial Officer.
32.1 Section 906 Certification of the Chief Executive Officer.
32.2 Section 906 Certification of the Chief Financial Officer.
101.INS - XBRL Instance Document.
101.INS - XBRL Taxonomy Extension Schema Document.
101.CAL - XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB - XBRL Taxonomy Extension Label Linkbase Document.
101.PRE - XBRL Taxonomy Extension Label Linkbase Document.
101.DEF - XBRL Taxonomy Extension Definition Linkbase Document.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA
in respect of
The Prudential Variable Contract Real Property Account
(Registrant)

 

Date: August 11, 2016
By:
/s/ Robert M. Falzon
 
Robert M. Falzon
 
Executive Vice President and Chief Financial Officer
 
(Authorized Signatory and Principal Financial Officer)


35

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT Reports