All of the assets of Prudential Variable Contract Real Property Account (the "Account") are invested in the Prudential Variable Contract Real Property Partnership (the "Partnership"). Correspondingly, the liquidity, capital resources and results of operations for the Real Property Account are contingent upon the Partnership. Therefore, all of management's discussion of these items is at the Partnership level. 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 "Partners").
The following analysis of the liquidity and capital resources and results of operations of the Partnership should be read in conjunction with the audited financial statements and the accompanying footnotes and other financial information included elsewhere herein.
As of December 31, 1998, the Partnership's liquid assets consisting of cash, cash equivalents and marketable securities were $73.5 million, an increase of $46.7 million from December 31, 1997. This increase was due to net proceeds from the sales of the Partnership's industrial property located in Pomona, CA and an apartment complex located in Farmington Hills, MI. In addition, continuing operations from the Partnership's investment properties contributed $20.6 million to cash during 1998. Sources of liquidity include net cash flow from property operations, interest from short-term investments, and dividends from REIT shares.
The following is a brief discussion of the Partnership's results of operations for the years ended December 31, 1998, 1997 and 1996.
The following table presents a comparison of the Partnership's property results of operations, and realized and unrealized gains or losses by investment type, for the twelve months ended December 31, 1998 and December 31, 1997.
The Partnership's net investment income for 1998 was $15.8 million, an increase of $2.0 million from the prior year. This increase was primarily the result of increased revenues from real estate and improvements partially offset by increased operating expenses.
Administrative expenses decreased $0.3 million or 16.1%. This decrease was due primarily to a reduction in legal expenses.
There was no interest expense during 1998 due to the Partnership's exercise of its purchase option under the capital lease obligation.
Net investment income from property operations for the apartment complexes increased $0.6 million, or 15.5%, from 1997. The majority of this increase was due to increased rental rates at the Atlanta, GA apartment complex.
The Partnership held 506,894 shares of Meridian Industrial REIT throughout 1998. As of December 31, 1998, the REIT shares experienced an unrealized loss of $1.0 million. The Valuation Unit of Prudential applies a 3% discount to the market value of the REIT shares. This discount is applied because of the restriction which limits the number of shares that can be publicly traded during any six month period to 30% of the total shares originally acquired.
Other net investment loss, which includes interest income from short-term investments, investment management fees, and expenses not related to property activities, narrowed by $0.5 million. The improved result was due to increased investment management fee in addition to a reduction in administrative expenses.
The following table presents a comparison of the Partnership's property results of operations, and realized and unrealized gains or losses by investment type, for the twelve months ended December 31, 1997 and December 31, 1996.
Property operating expenses for 1997 were $3.3 million, an increase of $0.4 million, or 13.5%, from 1996. This increase was primarily due to a full year of ownership in 1997 of the office property in Beaverton, OR, and expenses incurred in 1997 for new acquisitions, such as, the industrial buildings in Salt Lake City, UT and Aurora, CO. Together these three properties contributed $0.3 million to the increased operating expenses. The acquisition of the office building in Brentwood, TN contributed $0.1 million to the increase.
The office properties experienced a net unrealized gain of $1.9 million in 1997. The office property in Oakbrook Terrace, IL experienced the largest unrealized gain that was attributable to the improving office market conditions in suburban Chicago. In addition, the Morristown, NJ and Brentwood, TN office properties also experienced net unrealized gains of $0.5 million and $0.6 million, respectively.
In 1997, net investment income from apartment property operations was $3.9 million which was unchanged from the prior year.
Weighted average occupancy at the Partnership's residential communities increased from 93.1% to 94.3% from December 31, 1996. Occupancy at the Atlanta, GA and Farmington Hills, MI communities improved from 93% and 89%, respectively, as of December 31, 1996 to 99% and 93%, respectively, at year end 1997. Occupancy at the Raleigh, NC community decreased from 97% to 91% in 1997.
Net investment income for the Partnership's retail property decreased by $0.3 million, or 8.7%, to $2.9 million in 1997. This decrease was primarily the result of decreased occupancy at the shopping center earlier in the year. The shopping center was 96% occupied as of December 31, 1997, unchanged from the prior year.
The industrial properties (including the recently purchased land) had $1.9 million of net unrealized appreciation in 1997. The largest single gain of $1.7 million was attributable to the purchase of the land under the Pomona, CA property. The Salt Lake City, UT and Aurora, CO properties experienced negative net appreciation as a result of softer market conditions.
As of December 31, 1997 occupancy at the Partnership's Pomona, CA and Bolingbrook, IL industrial properties remained unchanged from December 31,1996 at 100%. As of December 31, 1997, both the Salt Lake City, UT and Aurora, CO properties were 100% vacant.
The partnership sold its interest in the Jacksonville, FL warehouses for net sales proceeds of $6.3 million, resulting in a gain of $0.3 million.
Dividend income from REITs totaled $0.1 million in 1997. The Partnership acquired 506,894 shares Meridian for $10.0 million on September 24, 1997. Meridian is a self-administered and self-managed equity real estate investment trust engaged in owning, operating, and leasing high quality, modern industrial properties nationwide. As of December 31, 1997, these shares experienced a $2.5 million net unrealized gain.
Following is an analysis of the Partnership's net investment income and net realized and unrealized gain (loss) on investments, presented on a per share basis:
The Partnership utilizes many of the same business applications, infrastructure and business partners as Prudential. Prudential has addressed the Year 2000 issue on an enterprise-wide basis. Therefore, it is not possible to differentiate the Partnership's Year 2000 issue from that of Prudential. The accompanying discussion of the Year 2000 issue reflects steps taken by Prudential to mitigate the Year 2000 risks.
Of Prudential's total application portfolio, approximately 70% of the applications are being renovated, 13% are being replaced by Year 2000 compliant systems, and the remaining 17% are being retired from production. At December 31, 1998, the percentage of business applications (based on application count) in the implementation phase for Year 2000 compliance for renovation, replacement and retirement are 99%, 96% and 99%, respectively. The overall completion date for Business Applications is June 1999.
Prudential is funding the Year 2000 program from operating cash flows. Some of the expenses of Prudential's Year 2000 readiness are allocated across its various businesses and subsidiaries, including the Partnership. Expenses related to the Year 2000 initiatives allocated to the Partnership are part of systems overhead costs and are included in the Partnership's general and administrative expenses. The Year 2000 costs allocated to the Partnership to date are not material to its operations and financial conditions. Moreover, the forecasted allocated Year 2000 costs are not expected to have a material impact on the Partnership's ability to meet its contractual commitments.
The major portion of Prudential's transactions are of such volume that they can only be effectively processed through the use of automated systems. Therefore, substantially all of Prudential's contingency plans include the ultimate resolution of any causative technology failures that may be encountered.
Prudential believes that the Business Application, Infrastructure and Business Partners components of the Year 2000 project are substantially on schedule. While management expects a small number of the projects may not meet their targeted completion date, it is anticipated that these projects will be completed by September 1999 so that any delays, if experienced, would not have a significant impact on the timing of the project as a whole. During the course of the Year 2000 program, some discretionary technology projects have been delayed in favor of the completion of Year 2000 projects. However, this impact has been minimized by Prudential's strategic decision to outsource most of the Year 2000 renovation work.
competitive, regulatory or tax changes that affect the cost or demand for the Company's products; and adverse litigation results. While the Company reassesses material trends and uncertainties affecting its financial condition and results of operations, it does not intend to review or revise any particular forward-looking statement referenced in this Management's Discussion and Analysis in light of future events. The information referred to above should be considered by readers when reviewing any forward-looking statements contained in this Management's Discussion and Analysis.
The financial statements and supplementary data are listed in the accompanying Index to the Financial Statements and Supplementary Data on and.