PART I

 

ITEM 1. BUSINESS

 

Description of SB Partners (the “Registrant”)

 

The Registrant is a New York limited partnership formed to engage in acquiring, operating and holding for investment a varying portfolio of real estate interests. The Registrant's initial public offering was in 1971, the year it began operations. As of December 31, 2017, the Registrant owns an industrial flex property in Maple Grove, Minnesota. In addition, the Registrant has a thirty percent interest in Sentinel Omaha, LLC (“Omaha”). Omaha is a real estate investment company which as of December 31, 2017 owned 11 multifamily properties in 8 markets. Omaha is an affiliate of the Registrant’s general partner.

 

The principal objectives of the Registrant are, first, to obtain capital appreciation through equity investments in real estate; second, to generate cash available for distribution, a portion of which may not be currently taxable; and third, to the extent still permitted under the Internal Revenue Code of 1986, as amended, to generate tax losses which may offset the limited partners' income from the Registrant and certain other sources.

 

The Registrant’s filings with the Securities and Exchange Commission (the “SEC”) are available on the SEC’s Website at www.sec.gov and type in 0000087047 for the Registrant’s CIK.

 

Recent Developments and Real Estate Investment Factors

 

Omaha’s portfolio consists exclusively of multi-family properties located in secondary and tertiary markets. During 2017, physical and economic occupancy remained stable at most of Omaha’s properties. However average net rental income increased at a much slower rate of 1.1% for 2017 vs. 5.7% for 2016 and 7.2% for 2015 (see Item 2. Properties). All of Omaha’s property mortgages and bank loans pay interest based on floating interest rates. During 2017 the floating rates on these loans increased as short term LIBOR rates increased as their rates are based on one month LIBOR. The one month LIBOR rate increased from an average of (0.7164%) during December 2016 to an average of (1.4925%) during December 2017. During 2017 Omaha was able to pay down a portion of its unsecured bank loan using net sales proceeds from the sale of three properties and cash generated from real estate operations. During 2017, Omaha sold its garden apartment property in Daytona, Florida and sold both garden apartment properties located in Fayetteville, North Carolina. Net sales proceeds in each transaction were used to first pay selling expenses and pay off each property’s secured mortgage loan. Remaining net sales proceeds were used to reduce Omaha’s unsecured loan. As of December 31, 2017 Omaha’s unsecured loan had a balance of $20,359,322. Omaha’s unsecured loan had a maturity date of December 31, 2017. Prior to maturity, Omaha exercised its one option to extend the maturity date to June 30, 2018. During the second half of 2017 Omaha began marketing three of its properties for a sale in early 2018. If the sales close successfully, sales proceeds from these sales will be used first to pay selling expenses and pay off each property’s secured mortgage loan.  During the first quarter of 2018, sales of two of the properties were completed while the sales contract for the third was cancelled. Remaining proceeds from the two sales were used to pay off the remaining balance on the unsecured loan.

 

Omaha reports on a fair value basis and for the year ended December 31, 2017 Omaha reported an increase of $31,440,000 in the value of its portfolio over the same properties as of the year ended December 31, 2016. The total real estate portfolio value of $366,225,000 as of December 31, 2017 consists of the same properties which made up Omaha’s portfolio as of December 31, 2016 less the three properties sold during 2017. Omaha is precluded from making distributions to its investors until its unsecured loans are paid in full. As of December 31, 2015, barring any unforeseen downturn in the real estate and capital markets, Registrant anticipated Omaha had a more likely than not chance to continue to improve the operations of the real estate assets, sell the assets at values sufficient to pay off the underlying mortgages and after paying off the balance of the unsecured bank loan at maturity, make distributions to its investors thereby returning a portion of the original invested capital. Registrant as of the year ended December 31, 2015 recognized a value in the Omaha investment equal to Registrant’s 30% portion of the equity reported on Omaha’s balance sheet as of December 31, 2015 less a 50% reserve for possible unforeseen disruptions in the property and capital markets. As a result of the overall increase in Omaha’s real estate values and the further pay down of its unsecured bank loan, Registrant reduced the reserve of Omaha’s equity value from 50% to 35% as of December 31, 2016.

 

4

 

For the year ended December 31, 2017 Sentinel Omaha reported a 10.2% increase in real estate values. Omaha anticipates the net operating income from its remaining portfolio to be flat during 2018 as compared to 2017. As noted above, all of Omaha’s property mortgages and banks loans use floating rates based on one month LIBOR rates plus the credit spread.

 

As noted earlier, during 2017 the floating rates on Omaha loans increased as short term LIBOR rates increased. The one month LIBOR rate increased from an average of (0.7164%) during December 2016 to an average of (1.4925%) during December 2017. Fixed mortgage interest rates for multi-family properties of similar class and location as Omaha’s portfolio also increased during 2017 from an approximate range of 4.10% to 4.15% in early 2017 to 4.35% to 4.50% near the end of 2017. Mortgage interest rates are expected to continue to increase in 2018 as the U.S. Federal Reserve continues a policy to increase the Federal Funds Rate. Although increases in fixed mortgage rates do not impact the operating cash flow of the Omaha properties directly, increases in fixed and floating rates on commercial mortgage debt can have a negative impact on capitalization rates and the sales prices Sentinel Omaha may achieve in the future.

 

Registrant has only one wholly owned property which is located in Maple Grove, Minnesota. It is 100% leased to a single tenant whose lease is scheduled to expire October 31, 2019. However, the tenant has on ongoing option to terminate the lease under certain conditions as set forth in the lease terms as amended. One of the conditions is the payment of an early termination penalty; the calculation of which is based on the remaining time period in the lease. Another condition is the tenant must provide notice twelve months prior to the termination. The tenant pays fixed base rent which increases approximately 3% each year. The tenant pays directly or reimburses Registrant for all utilities, real estate taxes, insurance and most of the property operating expenses and property management fees. If the tenant does not renew or if the tenant exercises its termination option, the Registrant would have no internal source of funds until the space is released to a new tenant or Registrant receives distributions from Sentinel Omaha. Registrant may have to consider that it would be in the best interests of the limited partners to sell its investment in Sentinel Omaha and/or sell its wholly owned property. Registrant would not have considered a sale of its 30% non-controlling investment in Omaha in prior years due to Omaha’s unsecured debt. Selling the investment in Omaha while Omaha had a significant unsecured loan with an upcoming maturity would have likely realized a sale price for the investment that would be heavily discounted reflecting the unsecured debt risk. However, since Sentinel Omaha has in the past two years paid down a significant portion of the unsecured debt along with improving performance at the properties, the debt risk is estimated to be lower. The investment in a 30% non-controlling interest would still be valued at a discount due to the lack of liquidity. Registrant will continue to report a reserve on the value of Omaha on its books but due to continuing the pay down of Omaha's unsecured loan in 2017, the reserve is reduced from 35% to 25%.

 

(Please refer to Item 7. – Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

 

ITEM 1A. Risks Factors

 

This report on Form 10-K includes statements that constitute "forward looking statements" within the meaning of Section 27(A) of the Securities Act of 1933 and Section 21(E) of the Securities Exchange Act of 1934 and that are intended to come within the safe harbor protection provided by those sections. By their nature, all forward looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated by the forward looking statements for a number of reasons, including, but not limited to, those risks described below:

 

General

 

The Registrant's investments consist of direct or indirect investments in real property and as such will be subject to varying degrees of risk generally incident to the ownership of real estate assets. The underlying value of the Registrant's direct real property and the Registrant's financial condition will be dependent upon its ability to operate the property in a manner sufficient to maintain or increase revenues and to generate sufficient income in excess of ownership and operating expenses. The underlying value of the Registrant's real estate investment will be dependent upon the investment’s managing partner’s ability to operate its properties in a manner sufficient to maintain or increase revenues and to generate sufficient income in excess of ownership and operating expenses. Income from the properties may be adversely affected by changes in national and local economic conditions such as oversupply of industrial flex space or apartments in the Registrant's markets, the attractiveness of the properties to tenants, changes in interest rates and in the availability, cost and terms of mortgage financing, the ongoing need for capital improvements, particularly in older structures, changes in real estate tax rates, adverse changes in governmental rules and fiscal policies, adverse changes in zoning laws, civil unrest, acts of God, including natural disasters (which may result in uninsured losses), and other factors which are beyond the control of the Registrant. If the Registrant were unable to promptly renew the leases of a significant number of tenants, re-lease vacant spaces or, if the rental rates upon such renewal or re-letting were significantly lower than expected rates, the Registrant's results of operations, financial condition and ability to make distributions to Unit holders may be adversely affected.

 

5

 

Risks of Liability and Loss

 

The development and ownership of real estate may result in liability to third parties due to conditions existing on a property which may result in injury. In addition, real estate may suffer a loss in value due to casualties such as fire or natural disaster. Such liability or loss may be uninsurable in some circumstances, such as a loss caused by the presence of mold, or may exceed the limits of insurance maintained at typical amounts for the type and condition of the property. Real estate may also be taken, in whole or in part, by public authorities for public purposes in eminent domain proceedings. Awards resulting from such proceedings may not adequately compensate the Registrant for the value lost.

 

Value and Non-liquidity of Real Estate

 

Real estate investments are relatively non-liquid. The Registrant's ability to vary its portfolio in response to changes in economic and other conditions will therefore be limited. If the Registrant must sell an investment, there can be no assurance that it will be able to dispose of the investment in the time period it desires or that the sales price of the investment will recoup or exceed the amount of the Registrant's cost of the investment.

 

Potential Adverse Effect on Results of Operations Due to Operating Risks

 

The Registrant's real estate invesments are subject to operating risks common to real estate in general, any and all of which may adversely affect occupancy or rental rates.

 

Debt Servicing and Financing

 

Total outstanding debt at December 31, 2017 consists of a bank loan with a balance of $5,726,590. The loan matures on April 29, 2018. Registrant has three 1-year options to extend the maturity date if certain conditions are satisfied. On January 30, 2018, Registrant sent a notice to the Holder of the loan to extend the maturity to April 29, 2019 which the Holder has acknowledged. If the Registrant does not have funds on hand sufficient to repay its indebtedness at maturity, the Registrant may need to refinance such indebtedness with new debt financing or provide necessary funds through equity offering(s). The Registrant may be unable to obtain a loan which will be sufficient to retire the existing loan. If it is unable to refinance this indebtedness on acceptable terms, the Registrant may be forced to liquidate assets upon disadvantageous terms or the Holder could foreclose on its security interest in the industrial flex property or its title holding entity which is a wholly-owned subsidiary of Registrant. This could result in losses to the Registrant and adversely affect the amount of cash reserves. If general economic conditions result in higher interest rates at a time when the Registrant must refinance its indebtedness, the Registrant's interest expense could increase, which would adversely affect the Registrant's results of operations and financial condition. The Registrant has no other debt except normal trade accounts payable, a security deposit held for the tenant leasing the space at the Maple Grove property and accrued investment management fees.

 

On April 29, 2011, the Holder (“Holder”) and Registrant executed a new Loan Agreement (“Loan Agreement”) related to Registrant’s $22,000,000 unsecured debt. Registrant paid down a portion of the bank loan using the net sales proceeds from the sale of 175 Ambassador Drive in 2011 and a further pay down using the net sales proceeds from the sale of Lino Lakes in 2015. The terms of the remaining bank loan are:

 

1)

Note B in the amount of $5,726,590 has a maturity date of April 29, 2018. Registrant has three 1-year options to extend the maturity date if certain conditions are satisfied. On January 30, 2018, Registrant sent a notice to the holder of the loan to extend the maturity to April 29, 2019, which Holder has acknowledged. Note B previously accrued interest at an annual fixed rate of 5% but only until all interest and principal had been paid in full on Note A. Accrued interest related to Note B in the amount of $1,335,833 was paid off in full on September 18, 2015 using sales proceeds from the sale of the property in Lino Lakes. Thereafter Note B does not accrue any interest. Except as discussed below, payments of principal are deferred until Registrant’s investment in Sentinel Omaha LLC (“Omaha”) pays distributions to the Partnership or the Partnership sells Eagle Lake Business Center IV or its investment in Omaha. Distributions from Omaha or net proceeds from the sale of Eagle IV or Omaha would be used first to pay the outstanding principal balance of Note B. If there are no distributions from Omaha prior to the Note B maturity, principal is due at maturity, subject to the above mentioned extensions.

 

6

 

2)

Note B may be voluntarily prepaid upon notice to the Holder, subject to certain requirements as to the application of payments. Registrant’s obligations under the Notes may be accelerated upon default.

 

3)

Until Registrant’s obligations under Note B are satisfied in full, Registrant is required to pay a portion of its net operating income (after payment of certain permitted expenses), and the net proceeds from the sale, transfer or refinancing of its remaining property and investment, toward the repayment of Note B while retaining the other portion to increase cash reserves. On May 26, 2017, the Registrant paid $33,883 to the Holder to pay down a portion of the outstanding balance of Note B. The proceeds represented excess net operating income, as defined, for the twelve months ended April 30, 2017. On May 16, 2016, the Registrant paid $26,415 to the Holder to pay down a portion of the outstanding balance of Note B. The proceeds represented excess net operating income, as defined, for the twelve months ended April 30, 2016. While the obligations under the Notes are outstanding, Registrant is precluded from making distributions to its partners.

 

4)

Registrant, its general partner and the Holder also entered into a Management Subordination Agreement accruing a portion of the investment management fee payable by Registrant to its general partner so long as the Note B remains outstanding. As of December 31, 2017 and 2016, $2,922,943 and $2,460,857, respectively of investment management fees have been accrued and are included in accrued expenses on the balance sheet.

 

	5)	As additional security for Registrant’s payment of its obligations under the Loan Agreement, Registrant, through its wholly-owned subsidiary Eagle IV Realty, LLC, has executed a Mortgage, Security Agreement, Assignment of Leases and Rents and Fixture Financing Statement (“Eagle IV Security Agreement”) and a Pledge Agreement (“Eagle IV Pledge Agreement”) in favor of Holder.
		The Eagle IV Security Agreement provides Holder with a security interest on Registrant’s property located in Maple Grove, Minnesota (“Eagle IV”) of up to $5,000,000. The Eagle IV Pledge Agreement pledges to Holder Registrant’s membership interest in Eagle IV Realty, LLC, the direct owner of Eagle IV. Registrant has no other debt obligation secured by Eagle IV. The Loan Agreement also provides for a negative pledge on Registrant’s remaining properties and investments.

 

Environmental Issues

 

Under various federal, state and local environmental laws, ordinances and regulations, an owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on such property. These laws often impose environmental liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. The presence of such substances, or the failure to properly remediate their presence, may adversely affect the owner's or operator's ability to sell or rent the property or to borrow using the property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of such substances at a disposal or treatment facility, whether or not such facility is owned or operated by such person. Certain third parties may seek recovery from owners or operators of such properties or persons who arranged for the disposal or treatment of hazardous or toxic substances and, therefore, are potentially liable for removal or remediation costs, as well as certain other related costs, including governmental fines and injuries to persons and property.

 

Competition

 

The Registrant competes for tenants with many other real estate owners. The success of the Registrant in attracting tenants for its property will depend upon its ability to maintain its property and its attractiveness to tenants, new property developments, local conditions, and changing demographic trends. The Registrant's property is located in a developed area that includes other, similar properties. The number of competitive properties in a particular area could have a material effect on the Registrant's ability to lease industrial flex space and on the rents charged at such property.

 

7

 

Tax Matters

 

On December 22, 2017, the Tax Cuts and Jobs Act (the Act) was signed into law.  The Act is a complex revision to U.S. federal income tax laws with various impacts on different categories of taxpayers and industries, and will require subsequent rulemaking and interpretation in a number of areas.  The long term impact of the Act on the overall economy, the real estate industry, the Registrant, and the Unit holders cannot be reliably predicted at this time.  Unit holders are urged to consult their own tax advisors with respect to the tax consequences arising under the federal law (including the Act) and the laws of any state, municipality or other taxing jurisdiction, including tax consequences arising from such Unit holders own tax characteristics.

 

General

 

Efforts required in complying with federal, state and local environmental regulations may have and may continue to have an adverse effect on the Registrant's operations in the future, although such costs have not historically been significant in amount.

 

The Registrant considers itself to be engaged in only one industry segment, real estate investment, and therefore information regarding industry segments is not applicable and has not been provided.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

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ITEM 2. PROPERTIES

 

The property owned by the Registrant as of December 31, 2017 is as follows:

 

Description

Acquisition

Percent

Occupancy at

Mortgagee

Property

Location

Sq. Ft.

Units

Acres

Date

Ownership

12/31/2017

Payable

Industrial Flex:

Eagle Lake Business Center IV

Maple Grove, MN

60,000

n/a

5.15

Jun 02

100

%

100

%

$

0

Eagle Lake Business Center IV is 100% leased to a single tenant whose lease was scheduled to expire July 31, 2015. On February 12, 2015, Registrant and the tenant executed an amendment to the lease to, among other items, extend the maturity of the lease to October 31, 2019. However, the tenant has an ongoing option to terminate the lease under certain conditions including the payment of an early termination penalty and twelve months prior notice, as set forth in the amended lease terms.

 

Investment in Sentinel Omaha LLC:
10 garden apartment properties and one high-rise apartment property	8 U.S. markets			n/a				3,305				n/a		Sept. 07			30	%			92	%			n/a

 

Additional information regarding properties owned by the Registrant:

		2017				2016				2015				2014				2013
Average Occupancy (a)
Eagle Lake Business Center IV (b)			100.00	%			100.00	%			100.00	%			100.00	%			100.00	%
435 Park Court (c)(e)			n/a				n/a				100.00	%			100.00	%			100.00	%
Investment in Sentinel Omaha, LLC (d)			92.00	%			91.00	%			93.00	%			91.00	%			90.00	%
Effective Annual Rent (a)
Eagle Lake Business Center IV (b) (f)		$	18			$	18			$	17			$	18			$	15
435 Park Court (c) (e) (f)			n/a				n/a			$	6			$	6			$	6
Investment in Sentinel Omaha, LLC (d) (g)		$	10,126			$	10,012			$	9,474			$	8,834			$	8,152

 

(a) For period of ownership.

(b) Property was purchased June 12, 2002.

(c) Property was purchased on October 5, 2005.

(d) Investment was purchased September 2007.

(e) Property was sold on September 17, 2015.

(f) Average per square foot per annum. Base rent plus operating expense reimbursements from tenant, divided by the total number of square feet at the property. Expense reimbursements include only expenses paid by Registrant in accordance with the terms of each lease. Reimbursements by the tenant include real estate taxes, insurance and certain operating expenses. Amounts are annualized for periods of ownership of less than one year.

(g) Average per apartment unit per annum. Gross potential rent, less concessions and vacancies, divided by the total number of apartment units at the property. Amounts are annualized for periods of ownership of less than one year.

 

ITEM 3. LEGAL PROCEEDINGS

None

 

ITEM 4.

(Removed and Reserved).

 

9

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT'S UNITS OF PARTNERSHIP INTEREST AND RELATED UNITHOLDER MATTERS

 

The transfer of Units or Participations (equivalent to one-half Unit) is subject to certain limitations, including the consent of the General Partner. There is no public market for the Units and it is not anticipated that any such public market will develop. The number of Unit holders as of December 31, 2017 was 2,313.

 

At various times, the Registrant has generated and distributed cash to the Unit holders. Registrant did not declare a distribution for 2017, 2016 or 2015. Cumulative distributions since inception have totaled $111,747,950. However, there is no requirement to make such distributions nor can there be any assurance that future operations will generate cash available for distribution. In addition, while the obligations under the Loan Agreement are outstanding, Registrant is precluded from making distributions to its partners.

 

10

 

ITEM 6. SELECTED FINANCIAL DATA

 

The following table sets forth selected financial data regarding the Registrant's financial condition and results of operations determined in accordance with accounting principles generally accepted in the United States of America. This data should be read in conjunction with the Audited Consolidated Financial Statements and Notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations, included elsewhere in this annual report on Form 10-K.

 

		For the Years Ended December 31,
		2017				2016				2015				2014				2013
			(In Thousands, Except Unit Data)
Income Statement Data:
Rental, Interest and Other Revenues		$	1,081			$	1,059			$	1,016			$	1,087			$	896
Operating Expenses, Less Depreciation and Amortization			(1,418	)			(1,412	)			(1,834	)			(2,002	)			(1,983	)
Depreciation and Amortization			(179	)			(179	)			(161	)			(167	)			(190	)
Loss from Operations			(516	)			(532	)			(979	)			(1,082	)			(1,277	)
Equity in Net Income of Investment			11,320				9,895				22,142				5,081				1,669
Reserve for Value of Investment			1,048				870				(7,696	)			(5,081	)			(1,669	)
Income (Loss) from Continuing Operations			11,852				10,233				13,467				(1,082	)			(1,277	)
Income from Discontinued Operations			-				-				401				207				174
Gain on Sale of Investments in Real Estate			-				-				3,569				-				-
Net Income (Loss)		$	11,852			$	10,233			$	17,437			$	(875	)		$	(1,103	)
Income (Loss) from Continuing Operations per Unit of Partnership Interest:		$	1,529			$	1,320			$	1,737			$	(140	)		$	(165	)
Income from Discontinued Operations per Unit of Partnership Interest:		$	-			$	-			$	52			$	27			$	22
Distributions paid per Unit of Partnership Interest		$	-			$	-			$	-			$	-			$	-
Weighted Average Number of Partnership Units Outstanding			7,754				7,754				7,754				7,754				7,754
Balance Sheet Data at Year End:
Real Estate, net		$	3,467			$	3,559			$	3,716			$	3,706			$	3,833
Real Estate Assets Held for Sale		$	-			$	-			$	-			$	12,026			$	12,379
Investment in Sentinel Omaha, LLC, net		$	37,580			$	25,211			$	14,446			$	-			$	-
Other Assets in Discontinued Operations		$	-			$	-			$	-			$	23			$	22
Total Assets		$	43,008			$	30,606			$	20,083			$	17,272			$	17,482
Loan Payable		$	5,719			$	5,731			$	5,936			$	9,953			$	9,967
Mortgage Note in Discontinued Operations		$	-			$	-			$	-			$	10,000			$	10,000
Other Liabilities in Discontinued Operations		$	-			$	-			$	-			$	25			$	25
Partners' Equity (Deficit)		$	33,748			$	21,895			$	11,662			$	(5,775	)		$	(4,900	)

 

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ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

COMPANY OVERVIEW

 

The Registrant is a New York limited partnership formed to engage in acquiring, operating and holding for investment a varying portfolio of real estate interests. The Registrant's initial public offering was in 1971, the year it began operations. As of December 31, 2017, the Registrant owned an industrial flex property in Maple Grove, Minnesota and the Registrant has a thirty percent interest in Sentinel Omaha, LLC. Omaha is a real estate investment company which as of December 31, 2017 owns 11 multifamily properties in 8 markets. Omaha is an affiliate of the Registrant’s general partner.

 

The principal objectives of the Registrant are, first, to obtain capital appreciation through equity investments in real estate; second, to generate cash available for distribution, a portion of which may not be currently taxable; and third, to the extent still permitted under the Internal Revenue Code of 1986, as amended, to generate tax losses which may offset the limited partners' income from the Registrant and certain other sources.

 

The consolidated financial statements for the years ended December 31, 2017 and 2016 reflect the operations of one industrial flex property located in Maple Grove, Minnesota as well as a 30% interest in Omaha. The consolidated financial statements for the year ended December 31, 2015 reflects the operations of one warehouse distribution center located in Lino Lakes, Minnesota and one industrial flex property located in Maple Grove, Minnesota as well as a 30% interest in Omaha. Registrant’s property located in Lino Lakes, MN was encumbered by a $10,000,000 mortgage which was scheduled to mature on October 5, 2015. On September 17, 2015, Registrant completed the sale of the warehouse distribution property. Sales proceeds were used to pay selling expenses, retire the $10,000,000 mortgage encumbering the property and pay down a portion of the Registrant’s bank loan. Closing expenses included a sale commission of $80,250 paid to an affiliate of the general partner. The results of operations for 2015 are reflected as income from discontinued operations in the accompanying consolidated statements of operations. See note 4 to the accompanying consolidated financial statements.

 

CRITICAL ACCOUNTING ESTIMATES

 

In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

 

Set forth below is a summary of the accounting policies that management believes are critical to the preparation of the consolidated financial statements. The summary should be read in conjunction with the more complete discussion of significant accounting policies included in Note 1 to the consolidated financial statements for the year ended December 31, 2017.

 

Real Estate

 

Real estate is carried at cost, net of accumulated depreciation and amortization. Maintenance and repairs are charged to operations as incurred. Depreciation requires an estimate by management of the useful life of each property as well as an allocation of the costs associated with a property to its various components. If Registrant does not allocate these costs appropriately or incorrectly estimates the useful lives of its real estate, depreciation expense may be misstated.

 

Registrant’s wholly owned property located in Maple Grove, Minnesota is 100% leased to a single tenant whose lease is scheduled to expire on October 31, 2019. However, tenant has on ongoing option to terminate the lease under certain conditions as set forth in the lease terms as amended. One of the conditions is the payment of an early termination penalty the calculation of which is based on the remaining time period in the lease. Another condition is the tenant must provide notice twelve months prior to the termination. The tenant pays fixed base rent which increases approximately 3% each year. The tenant pays directly or reimburses Registrant for all utilities, real estate taxes, insurance and most of the property operating expenses and property management fees.

 

12

 

Sentinel Omaha LLC’s portfolio consists of 10 garden apartment properties and one high rise apartment property. Leases are generally one year or less. Tenants generally pay fixed rent plus utilities used by tenant.

 

Registrant's property is regularly evaluated for impairment. Impairment is determined by calculating the sum of the estimated undiscounted future cash flows including the projected undiscounted future net proceeds from the sale of the property. In the event such sum is less than the net carrying value of the property, the property will be written down to estimated fair value. If the Partnership incorrectly estimates the value of the asset or the undiscounted cash flows, the impairment charges may be different from those, if any, in the consolidated financial statements.

 

Investment in Sentinel Omaha, LLC

 

The Registrant has a 30% non-controlling interest in Omaha that is accounted for on a fair value basis. Due to the global financial crisis, stagnant real estate market and slowing economy, Omaha reported a net write-down of the value of its real estate portfolio of approximately $100,852,000 during 2008 to 2014. During 2015 and 2016 capitalization rates for older properties in tertiary markets where Omaha owns most of its properties, generally were lower than for the prior years. Physical and economic occupancy improved at the properties during 2015 and market rates increased during 2016. However, occupancy at two large properties which rely on tenants from a local military base declined due to deployments during 2016. Job growth continued to improve but at a slow pace. For the years 2015 and 2016, as real estate values recovered Omaha reported an increase in the value of its portfolio of $88,512,000. During 2016, the net operating income reported for Omaha’s properties continued to improve which allowed Omaha to continue to make payments on its unsecured loan. During the twelve months ended December 31, 2017, Omaha sold its garden apartment property in Daytona, Florida and sold both garden apartment properties located in Fayetteville, North Carolina. Net sales proceeds in each transaction were used to first pay selling expenses and pay off each property’s secured mortgage. Remaining net sales proceeds were used to reduce Omaha’s unsecured loan. During the twelve months ended December 31, 2017, Omaha reported a net increase in its remaining real estate portfolio of $33,815,000. However, Omaha’s mortgages and unsecured loan are encumbered with floating interest rates which started to increase near the end of 2016 and continued to increase during 2017. Omaha’s unsecured loan which as of December 31, 2017 had a balance of $20,359,322 had a maturity date of December 31, 2017. Prior to maturity Omaha exercised its one option to extend the maturity date to June 30, 2018. During the second half of 2017 Omaha began marketing three of its properties for a sale in early 2018. If the sales close successfully, net sales proceeds from these sales will be used first to pay selling expenses and pay off each property’s secured mortgage loan. During the first quarter of 2018, sales of two of the properties were completed while the sales contract for the third was cancelled. Remaining proceeds were used to pay off the remaining balance of the unsecured loan. Registrant had in 2015 recognized a value in the Omaha investment equal to Registrant’s 30% portion of the equity reported on Omaha’s balance sheet as of December 31, 2015 less a 50% reserve. The improvement in Omaha’s real estate values and operations allowed Registrant to reduce the reserve in 2016 to 35% as of December 31, 2016 with further improvement in 2017. Registrant as of December 31, 2017 has recognized a value in the Omaha investment equal to Registrant’s 30% portion of the equity reported on Omaha’s balance sheet as of December 31, 2017 less a 25% reserve.

 

For the year ended December 31, 2017 Sentinel Omaha reported a 10.2% increase in real estate values. Omaha anticipates the net operating income from its remaining portfolio to be flat during 2018 as compared to 2017. As noted above, all of Omaha’s property mortgages and banks loans use float rates based on one month LIBOR rates plus the credit spread.

 

As noted earlier, during 2017 the floating rates on Omaha loans increased as short term LIBOR rates increased. The one month LIBOR rate increased from an average of (0.7164%) during December 2016 to an average of (1.4925%) during December 2017. Fixed mortgage interest rates for multi-family properties of similar class and location as Omaha’s portfolio also increased during 2017 from an approximate range of 4.10% to 4.15% in early 2017 to 4.35% to 4.50% near the end of 2017. Mortgage interest rates are expected to continue to increase in 2018 as the U.S. Federal Reserve continues a policy to increase the Federal Funds Rate. Although increases in fixed mortgage rates do not impact the operating cash flow of the Omaha properties directly, increases in fixed and floating rates on commercial mortgage debt can have a negative impact on capitalization rates and the sales prices Sentinel Omaha may achieve in the future.

 

13

 

As noted earlier, the tenant for Registrant's wholly owned property has on ongoing option to terminate the lease under certain conditions as set forth in the lease terms as amended. If the tenant does not renew or if the tenant exercises its termination option, the Registrant would have no source of internal funds until the space is released to a new tenant or Registrant receives distributions from Sentinel Omaha. Registrant may have to consider that it would be in the best interests of the limited partners to sell its investment in Sentinel Omaha and/or sell its wholly owned property. Registrant would not have considered a sale of its 30% non-controlling investment in Omaha in prior years due to Omaha’s unsecured debt. Selling the investment in Omaha while Omaha had a significant unsecured loan with an upcoming maturity would have likely realized a sale price for the investment that would be heavily discounted reflecting the unsecured debt risk. However, since Sentinel Omaha has in the past two years paid down a significant portion of the unsecured debt along with improving performance at the properties, the debt risk is estimated to be lower. The investment in a 30% non-controlling interest would still be valued at a discount due to the lack of liquidity. Registrant will continue to report a reserve on the value of Omaha on its books but due to the continuing pay down of Omaha's unsecured loan in 2017, the reserve is reduced from 35% to 25%.

 

For the year ended December 31, 2017, Omaha reported net investment income of $14,151,469 of which the Registrant’s interest was $4,245,442. In addition, Omaha reported net unrealized appreciation of real estate properties and interest rate protection agreements of $44,074,122 of which the Registrant’s interest was $13,222,237. Also Omaha reported net realized loss on the sale of three real estate properties of $20,492,141 of which the Registrant’s interest was $6,147,642.

 

For the year ended December 31, 2016, Omaha reported net investment income of approximately $16,379,734 of which the Registrant’s interest was $4,913,920. In addition, Omaha reported net unrealized appreciation of real estate properties and interest rate protection agreements of $16,602,744 of which Registrant’s interest was $4,980,823 for 2016.

 

For the year ended December 31, 2015, Omaha reported net investment income of $10,027,589 of which the Registrant’s interest was $3,008,277. In addition, Omaha reported net unrealized appreciation of real estate properties, mortgages, and interest rate protection agreements of $63,779,408 of which Registrant’s interest was $19,133,822 for 2015.

 

Determination of the fair value of Omaha involves numerous estimates and subjective judgments that are subject to change in response to current and future economic and market conditions, including, among other things, demand for residential apartments, competition, and operating cost levels such as labor, energy costs, real estate taxes and market interest rates. Judgments regarding these factors are not subject to precise quantification or verification and may change from time to time as economic and market factors change.

 

The accounting guidance for fair value measurements establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in determining fair value. The hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three levels. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level of input that is significant to the fair value measurement.

 

Fair value is defined as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value is calculated based on the assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity.

 

14

 

The three levels of fair value hierarchy are described below:

 

    Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical unrestricted assets or liabilities;

 

    Level 2 - Quoted prices in active markets for similar assets and liabilities or quoted prices in less active dealer or broker markets;

 

    Level 3 - Prices or valuations that require inputs that are both significant to the fair value measurement and are unobservable.

 

Estimated fair value was determined utilizing Level 3 inputs based upon independent appraisals or utilizing Level 2 inputs based upon sales contracts or bona fide sales offers.

 

Further, the investment in Omaha is not consolidated because other investors have substantive ownership and participative rights regarding Omaha’s operations and therefore control does not vest in the Registrant. Were the Registrant deemed to control Omaha, it would have to be consolidated and therefore would impact the financial statements and related ratios.

 

Revenue Recognition

 

Rental income is recognized when earned pursuant to the terms of the leases. Base rents and reimbursement of the tenants' share of certain operating expenses are generally recognized when due from tenants. Before Registrant can recognize revenue, it is required to assess, among other things, its collectability. Registrant continually analyzes the collectability of its revenue and will reserve against its revenue if conditions warrant such action.

 

Off-Balance Sheet Arrangements

 

None.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-9, Revenue from Contracts with Customers (ASU 2014-9).  ASU 2014-9 is a comprehensive new revenue recognition model requiring an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration expected to be received in exchange for those goods and services.  ASU 2014-9 specifically excludes revenues derived from lease contracts within the scope of Leases (Topic 840) and is effective for annual periods beginning after December 15, 2017.  Since the Partnership’s revenue is primarily generated through leasing arrangements, the adoption of ASU 2014-9 on January 1, 2018 is not expected to have a material impact on the Partnership’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-2, Leases (ASU 2016-2), which amends the existing accounting standards for lease accounting, including requiring lessees to recognize a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term on their balance sheet.  The accounting for lessors will remain largely unchanged from existing standards; however ASU 2016-02 requires that lease procurement costs, which were previously capitalized, be expensed as-incurred. ASU 2016-2 is effective for annual periods beginning after December 15, 2018, and requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application.  The Partnership is currently evaluating the impact of adopting the new lease standard on its consolidated financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15).  ASU 2016-15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows.  The amendments in ASU 2016-15 provide guidance on eight specific cash flow issues including the following that may be relevant to the Partnership: (i) debt prepayment or debt extinguishment costs and (ii) distributions received from equity method investments.  ASU 2016-15 is effective for annual periods beginning after December 31, 2017 and requires a full retrospective approach.  The adoption of ASU 2016-15 on January 1, 2018 is not expected to have a material impact on the Partnership’s consolidated financial statements.

 

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash (ASU 2016-18).  ASU 2016-18 is intended to reduce diversity in practice for the classification and presentation of changes in restricted cash by requiring the statement of cash flows to explain the change during the period in the total of cash and cash equivalents and amounts generally described as restricted cash.  Accordingly, amounts generally described as restricted cash should be included with cash and cash equivalents when reconciling beginning-of-period and end-of period totals on the statement of cash flows.  ASU 2016-18 is effective for annual periods beginning after December 15, 2017.  The adoption of ASU 2016-18 on January 1, 2018 is not expected to have a material impact on the Partnership’s consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-2, Leases (ASU 2016-2), which amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. ASU 2016-2 is effective for annual periods beginning after December 15, 2018, and requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application. The Partnership is currently evaluating the impact of adopting the new lease standard on its consolidated financial statements and disclosures.

 

CONTRACTUAL OBLIGATIONS

 

As of December 31, 2017, the Registrant’s contractual obligations consisted of a loan payable. Principal payments under the loan payable are due as follows:

 

For the year ending December 31,
2018		$	-
2019			5,726,590
2020			-
2021			-
2022			-
Thereafter			-
Total		$	5,726,590

 

LIQUIDITY AND CAPITAL RESOURCES

 

As of December 31, 2017, Registrant had cash and cash equivalents of approximately $1,450,000 as compared to approximately $1,327,000 as of December 31, 2016. Cash and cash equivalents increased during the year ended December 31, 2017 primarily due to rental income received from the tenant leasing space at Registrant’s property less operating expenses and capital improvements at Registrants wholly owned property, partnership expenses paid and debt service obligations.

 

As of December 31, 2017, Registrant’s only source of cash is rental income received from the tenant who leases 100% of the leasable space at Registrant’s wholly owned property in Maple Grove. The tenant reimburses Registrant for real estate taxes, insurance and most of the property’s operating expenses leaving a significant portion of the base rent received available to pay capital improvements and partnership administrative expenses. A portion of any remaining annual cash flow is used to pay down the principal balance of Note B in accordance with the Loan Agreement while the remaining cash income is retained by Registrant as cash reserves. On May 26, 2017, Registrant paid $33,883 to the Holder to pay down a portion of the outstanding balance of Note B. As part of Registrant and the Holder restructuring the bank loan in 2011, Registrant set aside $500,000 in escrow to be held and used only to pay the costs to re-tenant the space at Registrant’s wholly owned property if Registrant’s tenant defaults on its lease or exercises its right to terminate the lease early or fails to renew.

 

15

 

Total outstanding debt at December 31, 2017 consisted of Note B at $5,726,590. Under the terms of the Bank Loan Agreement, once the A Note was paid off, interest on the B Note stopped accruing. The loan matures on April 29, 2018. Registrant has three 1-year options to extend the maturity of the loan under certain conditions. On January 30, 2018 Registrant sent notification to the Holder of the loan that Registrant was exercising its first one year option to extend the maturity date to April 29, 2019 which the Holder has acknowledged. If the Registrant does not have funds on hand sufficient to repay its indebtedness at maturity, the Registrant may need to refinance such indebtedness with new debt financing or provide necessary funds through equity offering(s). The Registrant may be unable to obtain a loan which will be sufficient to retire the existing loan. If it is unable to refinance this indebtedness on acceptable terms, the Registrant may be forced to liquidate assets upon disadvantageous terms, or the Holder could foreclose on its security interest in the industrial flex property or its title holding entity which is a wholly-owned subsidiary of Registrant. This could result in losses to the Registrant and adversely affect the amount of cash reserves. If general economic conditions result in higher interest rates at a time when the Registrant must refinance its indebtedness, the Registrant's interest expense could increase, which would adversely affect the Registrant's results of operations and financial condition. The Registrant has no other debt except normal trade accounts payable, a security deposit held for the tenant leasing the space at the Maple Grove property and accrued investment management fees.

 

Inflation and changing prices during the current period did not significantly affect the markets in which the Registrant conducts its business, or the Registrant’s business overall.

 

Omaha reports on a fair value basis and for 2017, Omaha reported an increase in the value of its remaining portfolio of $33,815,000 over 2017. The total real estate portfolio value of $368,400,000 as of December 31, 2017 consists of the same properties which made up Omaha’s portfolio as of December 31, 2016 except as follows. Omaha sold its garden apartment property located in Daytona, Florida on May 11, 2017 and Omaha sold both its two properties located in Fayetteville, North Carolina on May 25, 2017. Although the remaining commercial property owned by the Registrant is 100% occupied, it is occupied by a single tenant. The national industrial market improved in 2017 however Registrant may still require a longer time period to replace the tenant at its property should a default occur or should the tenant not renew its lease at the end of the lease term.

 

Registrant did not pay a distribution in 2017. There is no requirement to make such distributions, nor can there be any assurance that future operations will generate cash available for distribution. While the obligations under the Bank Loan Agreement are outstanding, the Registrant is precluded from making distributions to its Unit holders.

 

Registrant anticipates cash flow generated from the property located in Maple Grove and current cash reserves will be sufficient to cover operating and capital improvement costs and other working capital requirements of the Registrant so long as the tenant remains in place.

 

MANAGEMENT’S DISCUSSION OF RESULTS OF OPERATIONS 2017 VS. 2016

 

Total revenues from operations increased $22,000 to approximately $1,081,000 in 2017 from approximately $1,059,000 in 2016 primarily due to higher rental income. Rental income increased due to a scheduled increase in base rent for the tenant at the Maple Grove property. Other income decreased slightly while interest income increased slightly.

 

The Registrant reported a net loss from operations of approximately $516,000 in 2017, an improvement of $16,000 as compared to a net loss from operations of approximately $532,000 in 2016. Net loss from operations consists of net income from the Maple Grove property combined with partnership income and expenses. The decrease of loss from operations was due to higher total revenues partially offset by higher operating expenses. Total expenses from operations for 2017 increased $6,000 to approximately $1,597,000 from approximately $1,591,000 in 2016, due to increases in administration costs and investment fees partially offset by decreases in real estate taxes, professional fees and repairs and maintenance.

 

16

 

Omaha reports on a fair value basis and due to the mortgage crisis, stagnant real estate market and slow economy, Omaha reported a significant write-down in the value of its real estate portfolio of approximately $100,852,000 during the years ended December 31, 2008 through 2014. For the years 2015 and 2016, as real estate values recovered Omaha reported an increase in the value of its real estate portfolio of $88,512,000. During the twelve months ended December 31, 2017, Omaha sold its garden apartment property in Daytona, Florida and sold both garden apartment properties located in Fayetteville, North Carolina. Net sales proceeds in each transaction were used to first pay selling expenses and pay off each property’s secured mortgage. Remaining net sales proceeds were used to reduce Omaha’s unsecured loan. During the twelve months ended December 31, 2017, Omaha reported a net increase in its remaining real estate portfolio of $33,815,000.

 

Equity in net increase in net assets increased $1,425,000 to an income of approximately $11,320,000 for 2017 compared to income of approximately $9,895,000 for 2016. Under the terms of the unsecured loan extension Omaha signed effective July 1, 2009, as extended and modified, Omaha is precluded from making distributions to its investors until its unsecured loan is paid. As a result of the aforementioned, Registrant did not anticipate receiving any distributions from Omaha during the foreseeable future and had reserved 100% of the reported value prior to 2015. During 2016, the net operating income reported for Omaha’s properties continued to improve which allowed Omaha to continue to make payments on its unsecured loan. However, Omaha’s mortgages and unsecured loan are encumbered with floating interest rates which started to increase near the end of 2016 and continued to increase during 2017. Omaha’s unsecured loan which as of December 31, 2017 has a balance of $20,359,322 has a maturity date of December 31, 2017. Prior to maturity Omaha exercised its one option to extend the maturity date to June 30, 2018. During the second half of 2017 Omaha began marketing three of its properties for a sale in early 2018. If the sales close successfully, net sales proceeds from these sales will be used first to pay selling expenses and pay off each property’s secured mortgage. During the first quarter of 2018, sales of two of the properties were completed while the sales contract for the third was cancelled. Remaining proceeds were used to pay off the remaining balance of the unsecured loan. Registrant had in 2015 recognized a value in the Omaha investment equal to Registrant’s 30% portion of the equity reported on Omaha’s balance sheet as of December 31, 2015 less a 50% reserve. The improvement in Omaha’s real estate values and operations allowed Registrant to reduce the reserve in 2016 to 35% as of December 31, 2016.

 

For the year ended December 31, 2017 Sentinel Omaha reported a 10.2% increase in real estate values. Omaha anticipates the net operating income from its remaining portfolio to be flat during 2018 as compared to 2017. As noted above, all of Omaha’s property mortgages and banks loans use float rates based on one month LIBOR rates plus the credit spread.

 

As noted earlier, during 2017 the floating rates on Omaha loans increased as short term LIBOR rates increased. The one month LIBOR rate increased from an average of (0.7164%) during December 2016 to an average of (1.4925%) during December 2017. Fixed mortgage interest rates for multi-family properties of similar class and location as Omaha’s portfolio also increased during 2017 from an approximate range of 4.10% to 4.15% in early 2017 to 4.35% to 4.50% near the end of 2017. Mortgage interest rates are expected to continue to increase in 2018 as the U.S. Federal Reserve continues a policy to increase the Federal Funds Rate. Although increases in fixed mortgage rates do not impact the operating cash flow of the Omaha properties directly, increases in fixed and floating rates on commercial mortgage debt can have a negative impact on capitalization rates and the sales prices Sentinel Omaha may achieve in the future.

 

Registrant has only one wholly owned property which is located in Maple Grove, Minnesota. It is 100% leased to a single tenant whose lease is scheduled to expire October 31, 2019. However, the tenant has on ongoing option to terminate the lease under certain conditions as set forth in the lease terms as amended. One of the conditions is the payment of an early termination penalty; the calculation of which is based on the remaining time period in the lease. Another condition is the tenant must provide notice twelve months prior to the termination. The tenant pays fixed base rent which increases approximately 3% each year. The tenant pays directly or reimburses Registrant for all utilities, real estate taxes, insurance and most of the property operating expenses and property management fees. If the tenant does not renew or if the tenant exercises its termination option, the Registrant would have no internal source of funds until the space is released to a new tenant or Registrant receives distributions from Sentinel Omaha. Registrant may have to consider that it would be in the best interests of the limited partners to sell its investment in Sentinel Omaha and/or sell its wholly owned property. Registrant would not have considered a sale of its 30% non-controlling investment in Omaha in prior years due to Omaha’s unsecured debt. Selling the investment in Omaha while Omaha had a significant unsecured loan with an upcoming maturity would have likely realized a sale price for the investment that would be heavily discounted reflecting the unsecured debt risk. However, since Sentinel Omaha has in the past two years paid down a significant portion of the unsecured debt along with improving performance at the properties, the debt risk is estimated to be lower. The investment in a 30% non-controlling interest would still be valued at a discount due to the lack of liquidity. Registrant will continue to report a reserve on the value of Omaha on its books but due to the continuing pay down of Omaha's unsecured loan in 2017, the reserve is reduced from 35% to 25%.

 

17

 

On September 17, 2015, Registrant completed the sale of its warehouse distribution property located in Lino Lakes, Minnesota. Sales proceeds were used to pay selling expenses, retire the $10,000,000 mortgage encumbering the property and pay down a portion of the Registrant’s bank loan. Closing expenses included a sale commission of $80,250 paid to an affiliate of the general partner. The results of operations for the years ended December 31, 2015 are reflected as income from discontinued operations in the accompanying consolidated statements of operations. Registrant has reported a gain on the sale of the property of $3,569,246 in the accompanying financial statements over the carrying value. See note 5 to the accompanying consolidated financial statements.

 

For additional analysis, please refer to the discussions of the individual properties below.

 

Eagle Lake Business Center IV (Maple Grove, Minnesota)

 

Total revenues increased $18,000, to approximately $1,074,000 in 2017 compared with approximately $1,056,000 in 2016. Net income, which includes deductions for depreciation, increased $25,000 to approximately $656,000 in 2017 from approximately $631,000 in 2016. The property has been 100% leased and occupied by the same single tenant for both years. The increase in total revenue was primarily due to higher rental income. Rental income increased due to a scheduled increase in base rent for the tenant. Other income decreased slightly from 2016 to 2017. The increase in net income was due to the increase in revenues combined with a decrease in operating expenses. The decrease in operating expenses was primarily due to decreases in repairs and maintenance of $5,000 and real estate taxes of $3,000.

 

According to a market report by CBRE, the Minneapolis Metropolitan Statistical Area’s industrial market reported that during 2017 vacancy rates for industrial space remained the same and rental rates decreased. Net absorption of industrial space increased in 2017.

 

Investments

 

During 2007, the Registrant made a total investment in the amount of $37,200,000 in Omaha representing a thirty percent ownership interest. The Registrant’s investment in Omaha is accounted for at fair value.

 

On September 18, 2007, Omaha acquired all the outstanding common shares of America First Apartment Investors, Inc., a publicly held real estate investment trust, in a transaction valued at approximately $532 million, including the assumption of outstanding debt and excluding transactions costs. Omaha consisted of 31 wholly owned multifamily residential properties, a wholly owned commercial property and a wholly owned multifamily property that was under development. During 2017 Omaha sold its garden apartment property located in Dayton, Florida. and Omaha sold both its garden apartments located in Fayetteville, North Carolina. Sales proceeds from all three sales were first used to pay selling expenses and the mortgages encumbering each property. Remaining sales proceeds were used to pay down Omaha’s unsecured bank loan.

 

Omaha reported total revenues for 2017 of approximately $41,488,000. Net investment income before net unrealized appreciation was $14,151,000. Major expenses included $6,391,000 of interest expense, $3,806,000 for repairs and maintenance, $5,409,000 for payroll and $4,645,000 for real estate taxes. In addition, Omaha reported a net unrealized appreciation based on the valuation of the remaining real estate assets and interest rate protection agreements of $44,074,000. Also Omaha reported net realized loss on the sale of three real estate properties of $20,492,141. For the year ended December 31, 2017, the Registrant’s equity interest in the income of Omaha was approximately $11,320,000.

 

MANAGEMENT’S DISCUSSION OF RESULTS OF OPERATIONS 2016 VS. 2015

 

Total revenues from operations increased $43,000 to approximately $1,059,000 in 2016 from approximately $1,016,000 in 2015 due to higher rental income. Rental income increased due to a scheduled increase in base rent for the tenant at the Maple Grove property. Other income and interest income increased slightly.

 

18

 

The Registrant reported a net loss from operations of approximately $532,000 in 2016, an improvement of $447,000 as compared to a net loss from operations of approximately $979,000 in 2015. Net loss from operations consists of net income from the Maple Grove property combined with partnership income and expenses. The decrease of loss from operations was due to lower total expenses combined with higher total revenues. Total expenses from operations for 2016 decreased $404,000 to approximately $1,591,000 from approximately $1,995,000 in 2015, due to decreases in interest expense of $365,000, real estate operating expenses of $28,000 and other expense of $22,000.

 

Equity in net increase in net assets decreased $12,254,000 to an income of approximately $9,895,000 for 2016 compared to income of approximately $22,142,000 for 2015.

 

On September 17, 2015, Registrant completed the sale of its warehouse distribution property located in Lino Lakes, Minnesota. Sales proceeds were used to pay selling expenses, retire the $10,000,000 mortgage encumbering the property and pay down a portion of the Registrant’s bank loan. Closing expenses includes a sale commission of $80,250 paid to an affiliate of the general partner. The results of operations for the years ended December 31, 2015 and 2014 are reflected as income from discontinued operations in the accompanying consolidated statements of operations. Registrant has reported a gain on the sale of the property of $3,569,246 in the accompanying financial statements over the carrying value. See note 5 to the accompanying consolidated financial statements.

 

For additional analysis, please refer to the discussions of the individual properties below.

 

Eagle Lake Business Center IV (Maple Grove, Minnesota)

 

Total revenues increased $41,000, to approximately $1,056,000 in 2016 compared with approximately $1,015,000 in 2015. Net income, which includes deductions for depreciation, increased $50,000 to approximately $631,000 in 2016 from approximately $581,000 in 2015. The property has been 100% leased and occupied by the same single tenant for both years. The increase in total revenue was primarily due to higher rental income. Rental income increased due to a scheduled increase in base rent for the tenant. Other income increased slightly from 2015 to 2016. The increase in net income was due to the increase in revenues combined with a decrease in operating expenses. The decrease in operating expenses was primarily due to decreases in repairs and maintenance of $13,000 and utilities of $15,000. Depreciation and amortization increased $18,000 due to an increase in amortization of leasing commissions.

 

According to a market report by CBRE, the Minneapolis Metropolitan Statistical Area’s industrial market reported that vacancy rates for industrial space declined and rental rates increased. Net absorption of industrial space increased in 2016.

 

Investments

 

During 2016 Omaha did not purchase or sell any properties in its portfolio.

 

Total revenues for 2016 were approximately $44,266,000. Net investment income before net unrealized appreciation was $16,379,000. Major expenses included $6,538,000 of interest expense, $3,987,000 for repairs and maintenance, $5,768,000 for payroll and $4,284,000 for real estate taxes. In addition, Omaha reported a net unrealized appreciation based on the valuation of the remaining real estate assets and interest rate protection agreements of $16,603,000. For the year ended December 31, 2016, the Registrant’s equity interest in the income of Omaha was approximately $9,895,000.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

NONE

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The Financial Statements required by this item, together with the Report of Independent Registered Public Accounting Firm thereon, are contained herein on pages 25 through 39 of this Annual Report on Form 10-K. Supplementary financial information required by this item is contained herein on pages 40 through 41 of this report.

 

19

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None

 

ITEM 9A. CONTROLS AND PROCEDURES

 

(a)

The Chief Executive Officer and the Chief Financial Officer of the general partner of Registrant have evaluated the disclosure controls and procedures relating to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2017 as filed with the Securities and Exchange Commission and have judged such controls and procedures to be effective.

 

(b)	There have been no changes in the Registrant’s internal controls during the year ended December 31, 2017 that could significantly affect those controls subsequent to the date of evaluation.
(c)	Management’s Report on Internal Control Over Financial Reporting

   

Registrant’s management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Chief Executive Officer and Chief Financial Officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

 

Our evaluation of internal control over financial reporting includes using the COSO framework, an integrated framework for the evaluation of internal controls issued by the Committee of Sponsoring Organizations of the Treadway Commission, to identify the risks and control objectives related to the evaluation of our control environment.

 

Based on our evaluation under the frameworks described above, our management has concluded that our internal control over financial reporting was effective as of December 31, 2017.

 

This Annual Report does not include an attestation report of the Registrant’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Registrant’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit Registrant to provide only management’s report in this Annual Report.

 

ITEM 9B. OTHER INFORMATION

 

NONE

 

20

 

PART III

 

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

 

The Registrant has no executive officers or directors. All of its business affairs are handled by its General Partner, SB Partners Real Estate Corporation (the "General Partner").

 

The directors and executive officers of the General Partner are elected by Sentinel Holdings Corporation ("SHC") as its sole shareholder to serve until their successors are duly elected and qualified. The limited partners of the Registrant are not entitled to vote in their election.

 

The directors and executive officers of the General Partner who are active in the Registrant's operations are:

 

Name	Age	Position
John H. Streicker	75	Director
Millie C. Cassidy	72	President & Director
George N. Tietjen III	57	Chief Executive Officer
Martin Cawley	61	Vice President
Leland J. Roth	54	Treasurer & Director
John H. Zoeller	58	Chief Financial Officer

 

Mr. Streicker joined the General Partner in May 1976. He has been a Director since April 1984. He is Chairman of SHC and its parent company, The Sentinel Corporation.

 

Ms. Cassidy joined the General Partner in August 1982. She has been a Director of the General Partner since March 1988. She is President of SHC and its parent company, The Sentinel Corporation.

 

Mr. Tietjen joined the General Partner in 1990 and served as its Chief Accounting Officer until 2006 and Chief Financial Officer and Treasurer from 2004 to 2007. He is a certified public accountant with over 33 years of real estate related financial, management, accounting and reporting experience.

 

Mr. Cawley joined the General Partner in 1994. He is the regional manager responsible for commercial property transactions and management.

 

Mr. Roth joined the General Partner in 1994 and serves as its treasurer. He is a certified public accountant with over 32 years of real estate related financial, accounting and reporting experience.

 

Mr. Zoeller joined the General Partner in 1994 and serves as its principal financial and accounting officer. He is a certified public accountant with over 36 years of real estate related financial, accounting and reporting experience.

 

21

 

ITEM 11. EXECUTIVE COMPENSATION

 

The Registrant has no executive officers or directors.

 

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

(a)

At December 31, 2017, an institutional investor of record owned 7.13% of the outstanding Units of Limited Partnership Interests. On January 13, 1993, a group of Unit holders of record, including the institutional investor referred to above, entered into a collective agreement with respect to their ownership interest in the Registrant. The aggregate number of Units beneficially owned by the group is 606 Units, representing 7.8% of the total number of outstanding Units of Limited Partnership Interest on that date. Each Unit holder has disclaimed beneficial ownership of all Units owned by the other Unit holders in this group. The foregoing information is based upon a 13-D filing made by the respective Unit holders.

 

(b)

As of December 31, 2017, none of the Directors of the General Partner owned any outstanding Units of Limited Partnership Interest. No Officers or Directors of SHC owned any outstanding Units of Limited Partnership Interest. SRE Clearing Services, Inc., an affiliate of the General Partner, owned 3,427.0 Units of Limited Partnership Interest, representing 44.2% of the outstanding number of Units on December 31, 2017. In accordance with SEC regulations, SRE Clearing Services, Inc. filed Form 13-D/A on December 7, 2017, when the total number of Units held reached 44% of the outstanding number of Units.

 

(c)	During the year ended December 31, 2017, there were no changes in control of the Registrant or the General Partner.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

The General Partner, among other things, furnishes services and advice to the Registrant and is paid a variable annual fee for such services based on calculations prescribed in the Registrant's Partnership Agreement. For these services, the General Partner receives a management fee equal to 2% of the average amount of capital invested in real estate plus cumulative mortgage amortization payments, and 0.5% of capital not invested in real estate, as defined in the Partnership Agreement. The management fee amounted to $888,325, $867,859 and $875,788 for the years ended December 31, 2017, 2016, and 2015, respectively. Of the amounts earned in 2017, 2016 and 2015, $462,086, $441,618 and $449,548, respectively have been deferred while the obligations under the Loan Agreement are outstanding. The deferred amounts total $2,922,943 and $2,460,857 and are included in accrued expenses on the balance sheet as of December 31, 2017 and 2016, respectively. In addition, the General Partner is entitled to 25% of cash distributions in excess of the annual distribution preference, as defined in the Partnership Agreement. No such amounts were due for the years ended December 31, 2017, 2016 or 2015.

 

Certain affiliates of the General Partner oversee the management and operations of various real estate properties, including those owned by the Registrant. Services performed by these affiliates applicable to the Registrant's properties are billed at actual or allocated cost, or percentage of revenues. The costs of such services are believed to be competitive with charges for similar services provided by unrelated management companies. Fees charged by these affiliates totaled $54,311, $53,242 and $117,004 in 2017, 2016, and 2015, respectively.

 

On September 17, 2015, Registrant completed the sale of the warehouse distribution property. Sales proceeds were used to pay selling expenses, retire the $10,000,000 mortgage encumbering the property and pay down a portion of the Registrant’s bank loan. Closing expenses includesda sale commission of $80,250 paid to an affiliate of the General Partner.

 

In 2012 an affiliate of the General Partner commenced maintaining and updating the investor database and preparing the tax K-1 forms and related schedules which previously had been prepared by an unaffiliated company. The fee charged by the affiliate for the similar service is lower than the fee previously charged by the unaffiliated company. Fees charged for 2017, 2016 and 2015 were $54,000 each year.

 

In 2007 the Registrant made an investment of $37,200,000, representing a thirty percent ownership interest in Omaha. For the years 2017, 2016 and 2015, the Registrant’s equity interest in the net income of Omaha was approximately $11,320,000, $9,895,000 and $22,142,000, respectively.

 

22

 

In connection with the mortgage financing of certain properties, the respective lenders required the Registrant to place the assets and liabilities of these properties into single asset limited partnerships or land trusts which hold title to these properties. A trust company affiliated with the General Partner holds the general partner interest in each single asset limited partnership as trustee for the Registrant. An affiliate of the General Partner is also the trustee of the land trust. For its services, the affiliate was not paid an annual fee in 2017, 2016 or 2015.

 

Reference is made to Items 10 and 11, and Notes 2, 4, 5, 6 and 10 in the consolidated financial statements.

 

23

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

1.

Audit Fees. The aggregate fees billed for professional services rendered by the principal accountant for the audit of the Registrant’s annual financial statements and review of financial statements included in the Partnership’s Form 10-Q or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years were approximately $100,000 and $105,000 for each of the years ended December 31, 2017 and 2016, respectively.

 

2.

Audit-Related Fees. No fees were billed by the principal accountant during the years ended December 31, 2017 and 2016 for assurance and related services that are reasonably related to the performance of the audit or review of Registrant's financial statements that are not reported under subparagraph (1) of this section.

 

3.

Tax Fees. The aggregate fees billed for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning were approximately $15,000 for each for the years ended December 31, 2017 and 2016, respectively. This work included reviewing year-end tax projections as well as the Registrant’s tax returns prepared by the Registrant for the respective years.

 

4.	All Other Fees. No other fees were billed in either of the last two fiscal years for products and services provided by the principal accountant, other than the services reported in subparagraphs (1) through (3) of this section.
5.	(i)The selection of the independent auditors to audit the annual financial statements and perform review procedures on the quarterly reports filed with the SEC by the Registrant is made by the general partner of Registrant. Fees quoted by the independent auditors are approved by the general partner prior to their acceptance by the Registrant.
	(ii) Not Applicable.
6.	Not Applicable.

 

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a)	(1)	Financial statements - The Registrant's 2017 Annual Audited Consolidated Financial Statements are included in this Annual Report on Form 10-K.
	(2)	Financial statement schedules - See Index to Consolidated Financial Statement Schedules on page 25. All other financial statement schedules are inapplicable or the required subject matter is contained in the consolidated financial statements or notes thereto.

     

(b)     Exhibits -

Exhibit No.	Description
3.1	Agreement of Limited Partnership (incorporated by reference to Exhibit A to Registration Statement on form S-11 as filed with the Securities and Exchange Commission on May 16, 1985)
31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1	Audited Financial Statements of Sentinel Omaha, LLC December 31, 2017
101.INS **	XBRL Instance
101.SCH **	XBRL Taxonomy Extension Schema
101.CAL **	XBRL Taxonomy Extension Calculation
101.DEF **	XBRL Taxonomy Extension Definition
101.LAB **	XBRL Taxonomy Extension Labels
101.PRE **	XBRL Taxonomy Extension Presentation

 

**XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

24

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15 (d) 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.

 

		SB PARTNERS
	By:	SB PARTNERS REAL ESTATE CORPORATION
		General Partner
		Chief Executive Officer
Dated: March 28, 2018	By:	/s/ George N. Tietjen III
		George N. Tietjen III
		Principal Financial & Accounting Officer
Dated: March 28, 2018	By:	/s/ John H. Zoeller
		John H. Zoeller
		Chief Financial Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

Signature				Position				Date
/s/ George N. Tietjen III				Chief Executive Officer				March 28, 2018
George N. Tietjen III
				Chief Financial Officer
/s/ John H. Zoeller				(Principal Financial & Accounting Officer)				March 28, 2018
John H. Zoeller

 

25

 

SB PARTNERS
ITEMS 8 and 14 (a) (1) and (2)
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
SUPPLEMENTAL FINANCIAL STATEMENT SCHEDULE
Report of Independent Registered Public Accounting Firm	26
Consolidated Balance Sheets as of December 31, 2017 and 2016	27
Consolidated Statements of Operations for the years ended December 31, 2017, 2016 and 2015	28
Consolidated Statements of Changes in Partners' Equity (Deficit) for the years ended December 31, 2017, 2016 and 2015	29
Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015	30
Notes to Consolidated Financial Statements	31 – 39
Supplemental Financial Statement schedule:
Schedule III – Real Estate and Accumulated Depreciation as of December 31, 2017	40-41

 

26

 

Report of Independent Registered Public Accounting Firm

 

 

To the Partners

SB Partners

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of SB Partners and subsidiaries (collectively, the “Partnership”) as of December 31, 2017 and 2016, and the related consolidated statements of operations, changes in partners’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and the schedule of Real Estate and Accumulated Depreciation as of December 31, 2017 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Partnership as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Partnership’s general partner. Our responsibility is to express an opinion on the financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Partnership in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Partnership is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.

 As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Partnership’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risk of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by the general partner, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

We have served as the Partnership’s auditor since 2006.

 

/s/ Dworken, Hillman, LaMorte and Sterczala, P.C.

Shelton, Connecticut

March 28, 2018

 

27

 

SB PARTNERS

(A New York Limited Partnership)

CONSOLIDATED BALANCE SHEETS

 

 

See notes to consolidated financial statements

 

28

 

SB PARTNERS

(A New York Limited Partnership)

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See notes to consolidated financial statements

 

29

 

SB PARTNERS

(A New York Limited Partnership)

CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' EQUITY (DEFICIT)

For the years ended December 31, 2017, 2016 and 2015

 

 

 

 

 

 

See notes to consolidated financial statements.

 

30

 

SB PARTNERS

(A New York Limited Partnership)

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See notes to consolidated financial statements

 

31

 

SB PARTNERS

Notes to Consolidated Financial Statements