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EX-31.1 - SECTION 302 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER - PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNTd437760dex311.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 033-20083-01

 

 

THE PRUDENTIAL INSURANCE COMPANY OF AMERICA

in respect of

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

(Exact name of registrant as specified in its charter)

 

 

 

New Jersey   22-1211670

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

751 Broad Street

Newark, New Jersey 07102

(973) 802-6000

(Address and Telephone Number of Registrant’s Principal Executive Offices)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

(Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

 

 

 


Table of Contents

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

(Registrant)

INDEX

 

     Page  

Forward Looking Statement Disclosure

     3   

Part I - Financial Information

  

Item 1. Financial Statements (Unaudited)

  

A. THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

  

Statements of Net Assets – September 30, 2012 and December 31, 2011

     4   

Statements of Operations – Three and Nine Months Ended September 30, 2012 and 2011

     4   

Statements of Changes in Net Assets – Three and Nine Months Ended September 30, 2012 and 2011

     4   

Notes to the Financial Statements of the Real Property Account

     5   

B. THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

  

Consolidated Statements of Assets and Liabilities – September 30, 2012 and December 31, 2011

     13   

Consolidated Statements of Operations – Three and Nine Months Ended September 30, 2012 and 2011

     14   

Consolidated Statements of Changes in Net Assets– Nine Months Ended September 30, 2012 and 2011

     15   

Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2012 and 2011

     16   

Consolidated Schedules of Investments – September 30, 2012 and December 31, 2011

     17   

Notes to Consolidated Financial Statements of the Partnership

     19   

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

     29   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     37   

Item 4. Controls and Procedures

     37   

Part II - Other Information

  

Item 1A. Risk Factors

     38   

Item 6. Exhibits

     38   

Signatures

     39   

 

2


Table of Contents

Forward-Looking Statement Disclosure

Certain of the statements included in this Quarterly Report on Form 10-Q, including but not limited to those in Management’s Discussion and Analysis of Financial Condition and Results of Operations, constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as “expects,” “believes,” “anticipates,” “includes,” “plans,” “assumes,” “estimates,” “projects,” “intends,” “should,” “will,” “shall” or variations of such words are generally part of forward-looking statements. Forward-looking statements are made based on management’s current expectations and beliefs concerning future developments and their potential effects upon The Prudential Insurance Company of America, or the “Company”, or the Prudential Variable Contract Real Property Account, or the “Real Property Account”. There can be no assurance that future developments affecting the Company and the Real Property Account will be those anticipated by management. These forward-looking statements are not a guarantee of future performance and involve risks and uncertainties, and there are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements, including, among others: (1) general economic, market and political conditions, including the performance and fluctuations of fixed income, equity, real estate and other financial markets; (2) interest rate fluctuations or prolonged periods of low interest rates; (3) reestimates of our reserves for future policy benefits and claims; (4) differences between actual experience regarding mortality, morbidity, persistency, surrender experience, interest rates, or market returns and the assumptions we use in pricing our products, establishing liabilities and reserves or for other purposes; (5) changes in our assumptions related to deferred policy acquisition costs and value of business acquired; (6) changes in our financial strength or credit ratings; (7) investment losses and defaults; (8) competition in our product lines and for personnel; (9) changes in tax law; (10) regulatory or legislative changes, including the Dodd-Frank Wall Street Reform and Consumer Protection Act; (11) adverse determinations in litigation or regulatory matters and our exposure to contingent liabilities; (12) domestic or international military actions, natural or man-made disasters including terrorist activities or pandemic disease, or other events resulting in catastrophic loss of life; (13) ineffectiveness of risk management policies and procedures in identifying, monitoring and managing risks; (14) changes in statutory or “U.S. GAAP” accounting principles, practices or policies; (15) interruption in telecommunication, information technology or other operational systems or failure to maintain the security, confidentially or privacy of sensitive data on such systems. The Company and the Real Property Account do not intend, and are under no obligation, to update any particular forward-looking statement included in this document. See “Risk Factors” included in the Annual Report on Form 10-K for the year ended December 31, 2011, for discussion of certain risks relating to the operation of the Partnership and investment in our securities.

 

3


Table of Contents

FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

STATEMENTS OF NET ASSETS

September 30, 2012 and December 31, 2011

 

     September 30, 2012
(unaudited)
     December 31, 2011  

ASSETS

     

Investment in The Prudential Variable Contract Real Property Partnership

   $ 72,451,676      $ 71,040,873  
  

 

 

    

 

 

 

Net Assets

   $ 72,451,676      $ 71,040,873  
  

 

 

    

 

 

 

NET ASSETS, representing:

     

Equity of contract owners

   $ 57,668,714      $ 55,564,740  

Equity of The Prudential Insurance Company of America

     14,782,962        15,476,133  
  

 

 

    

 

 

 
   $ 72,451,676      $ 71,040,873  
  

 

 

    

 

 

 

Units outstanding

     29,466,250        30,072,478  
  

 

 

    

 

 

 

Portfolio shares held

     2,145,062        2,201,200  

Portfolio net asset value per share

   $ 33.78      $ 32.27  

STATEMENTS OF OPERATIONS

For the three and nine month periods ended September 30, 2012 and 2011

 

     1/1/2012-9/30/2012      1/1/2011-9/30/2011      7/1/2012-9/30/2012      7/1/2011-9/30/2011  
     (unaudited)      (unaudited)      (unaudited)      (unaudited)  

INVESTMENT INCOME

           

Net investment income from Partnership operations

   $ 2,575,539      $ 2,531,071      $ 977,204      $ 822,125  
  

 

 

    

 

 

    

 

 

    

 

 

 

EXPENSES

           

Charges to contract owners for assuming mortality risk and expense risk and for administration

     330,580        305,397        111,226        105,454  
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INVESTMENT INCOME

     2,244,959        2,225,674        865,978        716,671  
  

 

 

    

 

 

    

 

 

    

 

 

 

NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS

           

Net change in unrealized gain (loss) on investments in Partnership

     540,316        4,430,931        610,154        1,367,800  

Net realized gain (loss) on sale of investments in Partnership

     144,195        —           57        —     
  

 

 

    

 

 

    

 

 

    

 

 

 

NET GAIN (LOSS) ON INVESTMENTS

     684,511        4,430,931        610,211        1,367,800  
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS

   $ 2,929,470      $ 6,656,605      $ 1,476,189      $ 2,084,471  
  

 

 

    

 

 

    

 

 

    

 

 

 

STATEMENTS OF CHANGES IN NET ASSETS

For the three and nine month periods ended September 30, 2012 and 2011

 

     1/1/2012-9/30/2012     1/1/2011-9/30/2011     7/1/2012-9/30/2012     7/1/2011-9/30/2011  
     (unaudited)     (unaudited)     (unaudited)     (unaudited)  

OPERATIONS

        

Net investment income

   $ 2,244,959     $ 2,225,674     $ 865,978     $ 716,671  

Net change in unrealized gain (loss) on investments in Partnership

     540,316       4,430,931       610,154       1,367,800  

Net realized gain (loss) on sale of investments in Partnership

     144,195       —          57       —     
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS

     2,929,470       6,656,605       1,476,189       2,084,471  
  

 

 

   

 

 

   

 

 

   

 

 

 

CAPITAL TRANSACTIONS

        

Net contributions (withdrawals) by contract owners

     (147,547     (394,678     (280,782     (211,006

Net contributions (withdrawals) by The Prudential Insurance Company of America

     (1,371,120     (3,042,068     392,008       (1,548,581
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM CAPITAL TRANSACTIONS

     (1,518,667     (3,436,746     111,226       (1,759,587
  

 

 

   

 

 

   

 

 

   

 

 

 

TOTAL INCREASE (DECREASE) IN NET ASSETS

     1,410,803       3,219,859       1,587,415       324,884  
  

 

 

   

 

 

   

 

 

   

 

 

 

NET ASSETS

        

Beginning of period

     71,040,873       67,547,308       70,864,261       70,442,283  
  

 

 

   

 

 

   

 

 

   

 

 

 

End of period

   $ 72,451,676     $ 70,767,167     $ 72,451,676     $ 70,767,167  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

4


Table of Contents

NOTES TO THE FINANCIAL STATEMENTS OF

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

September 30, 2012

(Unaudited)

Note 1: General

The Prudential Variable Contract Real Property Account (the “Account”) was established on November 20, 1986 by resolution of the Board of Directors of The Prudential Insurance Company of America (“Prudential” or the “Company”), which is an indirect wholly-owned subsidiary of Prudential Financial, Inc. (“PFI”) as a separate investment account pursuant to New Jersey law and is registered under the Securities Act of 1933, as amended. The assets of the Account are segregated from Prudential’s other assets. The Account is used to fund benefits under certain variable life insurance and variable annuity contracts issued by Prudential. These products are Variable Appreciable Life (“PVAL and PVAL $100,000+ Face Value”), Discovery Plus (“PDISCO+”), and Variable Investment Plan (“VIP”).

The assets of the Account are invested in The Prudential Variable Contract Real Property Partnership (the “Partnership”). The Partnership is the investment vehicle for assets allocated to the real estate investment option under certain variable life insurance and variable annuity contracts. The Account, along with the Pruco Life Variable Contract Real Property Account and the Pruco Life of New Jersey Variable Contract Real Property Account, are the General Partners in the Partnership. These financial statements should be read in conjunction with the financial statements of the Partnership.

The Partnership has a policy of investing at least 65% of its assets in direct ownership interests in income-producing real estate and participating mortgage loans.

Note 2: Summary of Significant Accounting Policies and Pronouncements

A. Basis of Accounting

The Unaudited Interim Financial Statements as of September 30, 2012 and the condensed balance sheet as of December 31, 2011, which has been derived from Audited Financial Statements, have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) on a basis consistent with reporting interim financial information in accordance with instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (“SEC”).

In the opinion of management, all adjustments necessary for a fair statement of the financial position and results of operations have been made. All such adjustments are of a normal, recurring nature. Interim results are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the Account’s Audited Financial Statements included in the Account’s Annual Report on Form 10-K for the year ended December 31, 2011.

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

Use of Estimates

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

Adoption of Accounting Pronouncements

Effective January 1, 2012, the Account adopted, prospectively, updated guidance regarding the fair value measurements and disclosure requirements. The updated guidance clarifies existing guidance related to the application of fair value measurement methods and requires expanded disclosures. The expanded disclosures required by this guidance are included in Note 9. Adoption of this guidance did not have a material effect on the Account’s consolidated financial position or results of operations.

 

5


Table of Contents

NOTES TO THE FINANCIAL STATEMENTS OF

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

September 30, 2012

(Unaudited)

 

Note 2: Summary of Significant Accounting Policies and Pronouncements (continued)

 

B. Investment in Partnership Interest

The investment in the Partnership is based on the Account’s proportionate interest of the Partnership’s fair value. At September 30, 2012 and December 31, 2011 the Account’s interest in the General Partners Controlling Interest was 41.4% or 2,145,062 shares and 41.3% or 2,201,200 shares, respectively. Properties owned by the Partnership are illiquid and their value is based on estimated fair value as discussed in the notes to the Partnership’s audited financial statements.

C. Income Recognition

Net investment income, realized and unrealized gains and losses are recognized daily for the investments in the Partnership. Amounts are based on the Account’s proportionate interest in the Partnership.

D. Equity of The Prudential Insurance Company of America

Prudential maintains a position in the Account for liquidity purposes, including unit purchases and redemptions, Partnership share transactions, and expense processing. The position does not affect contract owners’ accounts or the related unit values.

Note 3: Charges and Expenses

A. Mortality Risk and Expense Risk Charges

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

B. Cost of Insurance and Other Related Charges

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

C. Deferred Sales Charge

A deferred sales charge, applicable to PVAL and PVAL $100,000 + Face Value, and not to exceed 50% of the first year’s primary annual premium for PVAL contracts, is imposed upon surrenders of certain variable life insurance contracts to compensate Prudential for sales and other marketing expenses. The amount of any sales charge will depend on the number of years that have elapsed since the contract was issued. No sales charge will be imposed after the tenth year of the contract. No sales charge will be imposed on death benefits. Also a deferred sales charge is imposed upon the withdrawals of certain purchase payments to compensate Prudential for sales and other marketing expenses for PDISCO+ and VIP. The amount of any sales charge will depend on the amount withdrawn and the number of contract years that have elapsed since the contract owner or annuitant made the purchase payments deemed to be withdrawn. As the amount of time that has elapsed since a given purchase payment made increases, the sales charge applicable to that purchase payment generally decreases. No sales charge is made against the withdrawal of investment income. No sales charge is imposed upon death benefit payments or upon transfers made between subaccounts. This deferred sales charge is assessed through the redemption of units.

 

6


Table of Contents

NOTES TO THE FINANCIAL STATEMENTS OF

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

September 30, 2012

(Unaudited)

 

Note 3: Charges and Expenses (continued)

 

D. Partial Withdrawal Charge

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

E. Annual Maintenance Charge

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

Note 4: Taxes

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

Note 5: Net Contributions (Withdrawals) by Contract Owners

Net contract owner contributions (withdrawals) for the real estate investment option in Prudential’s variable insurance and variable annuity products for the three and nine months ended September 30, 2012 and 2011, were as follows:

 

     Three Months Ended September 30,  
     (Unaudited)  
     2012     2011  

PVAL/PVAL $100,000+ face value

   $ (258,748   $ (122,765

PDISCO+/VIP

     (22,034     (88,241
  

 

 

   

 

 

 

TOTAL

   $ (280,782   $ (211,006
  

 

 

   

 

 

 
     Nine Months Ended September 30,  
     (Unaudited)  
     2012     2011  

PVAL/PVAL $100,000+ face value

   $ (155,803   $ (210,801

PDISCO+/VIP

     8,256       (183,877
  

 

 

   

 

 

 

TOTAL

   $ (147,547   $ (394,678
  

 

 

   

 

 

 

 

7


Table of Contents

NOTES TO THE FINANCIAL STATEMENTS OF

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

September 30, 2012

(Unaudited)

 

Note 6: Partnership Distributions

For the nine months ended September 30, 2012, the Partnership made one distribution, $5 million on March 28, 2012. The Account’s share of this distribution was $1.8 million. During the year ended December 31, 2011, the Partnership made a total of $15 million in distributions. The distributions occurred on May 31st, September 26th, and December 27th for $5 million each. The Account’s share of these distributions were $1.9 million each or a total of $5.7 million.

Note 7: Unit Information

All products referred to in Note 1 for outstanding units and unit values at September 30, 2012 and December 31, 2011 were as follows:

 

     September 30, 2012    December 31, 2011
     (Unaudited)     

Units Outstanding:

   29,466,250    30,072,478

Unit Value:

   2.26901 to 2.58396    2.18743 to 2.48007

Note 8: Financial Highlights

The range of total return for the three and nine months ended September 30, 2012 and 2011 were as follows:

 

     Three Months Ended September 30,  
     (Unaudited)  
     2012      2011  

Total Return

     1.94% to 2.09%         2.80% to 2.95%   
     Nine Months Ended September 30,  
     (Unaudited)  
     2012      2011  

Total Return

     3.73% to 4.19%         9.43% to 9.92%   

 

8


Table of Contents

NOTES TO THE FINANCIAL STATEMENTS OF

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

September 30, 2012

(Unaudited)

 

Note 9: Fair Value Disclosure

FASB guidance on fair value measurements and disclosures establishes a framework for measuring fair value that includes a hierarchy used to classify the inputs used in 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 input that is significant to the fair value measurement. The levels of the fair value hierarchy are as follows:

Level 1 – Fair value is based on unadjusted quoted prices in active markets that are accessible to the Company for identical assets or liabilities. These generally provide the most reliable evidence and should be used to measure fair value whenever available. The Account had no Level 1 assets or liabilities.

Level 2 – Fair value is based on inputs, other than Level 1 inputs, that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability through corroboration with observable market data. The Account had no Level 2 assets or liabilities.

Level 3 – Fair value is based on significant unobservable inputs for the asset or liability. These inputs reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the asset or liability. The Account’s Level 3 assets consist of the investment in the Partnership which is based on the Account’s proportionate interest of the Partnership’s fair value which approximates the Partnership’s net asset value. Properties owned by the Partnership are illiquid and fair value is based on estimates from property appraisal reports prepared by independent real estate appraisers as discussed in the notes to the Partnership’s unaudited financial statements.

The purpose of an appraisal is to estimate the fair value of real estate as of a specific date. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The estimate of fair value is based on the conventional approaches to value, all of which require the exercise of subjective judgment. The three approaches are: (1) current cost of reproducing the real estate less deterioration and functional and economic obsolescence; (2) discounting a series of income streams and reversion at a specific yield or by directly capitalizing a single year income estimate by an appropriate factor; and (3) value indicated by recent sales of comparable real estate in the market. In the reconciliation of these three approaches, the one most heavily relied upon is the one then recognized as the most appropriate by the independent appraiser for the type of real estate in the market. Appraisals for the Account’s Level 3 assets generally utilize a discounted cash flow model.

 

9


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NOTES TO THE FINANCIAL STATEMENTS OF

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

September 30, 2012

(Unaudited)

 

In general, the input values used in the appraisal process are unobservable; therefore unless indicated otherwise, the underlying investments in the Partnership are classified as Level 3 under the fair value hierarchy. The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities.

Level 3 Assets by Hierarchy

The table below summarizes the assets measured at fair value on a recurring basis and their respective position in the fair value hierarchy.

Table 1:

 

     ($ in 000’s)  
     Fair Value Measurements at September 30, 2012  
Assets:    Amounts Measured
at Fair Value
09/30/2012
     (Level 1)      (Level 2)      Unaudited
(Level 3)
 

Investment in The Prudential Variable Contract Real Property Partnership

   $ 72,452       $ —         $ —         $ 72,452   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     ($ in 000’s)  
     Fair Value Measurements at December 31, 2011  
Assets:    Fair Value
Measurements at
December 31, 2011
     (Level 1)      (Level 2)      (Level 3)  

Investment in The Prudential Variable Contract Real Property Partnership

   $ 71,041       $ —         $ —         $ 71,041   
  

 

 

    

 

 

    

 

 

    

 

 

 

Quantitative Information Regarding Internally-Priced Level 3 Assets

The Account’s Level 3 assets consist of the investment in the Partnership which is based on the Account’s proportionate interest of the Partnership’s fair value which approximates the Partnership’s net asset value. The fair value of properties owned by the Partnership is determined through an independent appraisal process. The appraisals generally utilize a discounted cash flow model. Quantitative information on significant internally priced Level 3 assets are discussed in Note 3 of the Partnership’s unaudited financial statements.

 

10


Table of Contents

NOTES TO THE FINANCIAL STATEMENTS OF

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

September 30, 2012

(Unaudited)

 

Changes in Level 3 assets and liabilities

The following table provides a summary of the changes in fair value of Level 3 assets and liabilities for the nine months ended September 30, 2012 and 2011, as well as the portion of gains or losses included in income for the nine months ended September 30, 2012 and 2011, attributable to unrealized gains or losses related to those assets and liabilities still held at September 30th.

 

     ($ in 000’s)  
     Nine months  ending
September 30, 2012 (Unaudited)
 

Beginning balance @ 01/01/12

   $ 71,041   

Total gains or losses (realized/unrealized) included in earnings (or changes in net assets) from Partnership operations

     685  

Net Investment Income from Partnership operations

     2,576  

Acquisition/Additions

     —     

Equity Income

     —     

Contributions

     —     

Disposition/Settlements

     —     

Equity losses

     —     

Distributions

     (1,850
  

 

 

 

Ending balance @ 09/30/2012

   $ 72,452   
  

 

 

 

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

   $ 540   
  

 

 

 
     ($ in 000’s)  
     Nine months ending
September 30, 2011 (Unaudited)
 

Beginning balance @ 01/01/11

   $ 67,547   

Total gains or losses (realized/unrealized) included in earnings (or changes in net assets) from Partnership operations

     4,431  

Net Investment Income from Partnership operations

     2,531  

Acquisition/Additions

     —     

Equity Income

     —     

Contributions

     —     

Disposition/Settlements

     —     

Equity losses

     —     

Distributions

     (3,742
  

 

 

 

Ending balance @ 09/30/11

   $ 70,767   
  

 

 

 

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

   $ 4,431   
  

 

 

 

 

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NOTES TO THE FINANCIAL STATEMENTS OF

PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY ACCOUNT

September 30, 2012

(Unaudited)

 

Changes in Level 3 assets and liabilities

The following table provides a summary of the changes in fair value of Level 3 assets and liabilities for the three months ended September 30, 2012 and 2011, as well as the portion of gains or losses included in income for the three months ended September 30, 2012 and 2011, attributable to unrealized gains or losses related to those assets and liabilities still held at September 30th.

 

     ($ in 000’s)  
     Three months ending
September 30, 2012 (Unaudited)
 

Beginning balance @ 07/01/12

   $ 70,864   

Total gains or losses (realized/unrealized) included in earnings (or changes in net assets) from Partnership operations

     610  

Net Investment Income from Partnership operations

     978  

Acquisition/Additions

     —     

Equity Income

     —     

Contributions

     —     

Disposition/Settlements

     —     

Equity losses

     —     

Distributions

     —     
  

 

 

 

Ending balance @ 09/30/2012

   $ 72,452   
  

 

 

 

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

   $ 610   
  

 

 

 
     ($ in 000’s)  
     Three months ending
September 30, 2011 (Unaudited)
 

Beginning balance @ 07/01/11

   $ 70,442   

Total gains or losses (realized/unrealized) included in earnings (or changes in net assets) from Partnership operations

     1,368  

Net Investment Income from Partnership operations

     822  

Acquisition/Additions

     —     

Equity Income

     —     

Contributions

     —     

Disposition/Settlements

     —     

Equity losses

     —     

Distributions

     (1,865
  

 

 

 

Ending balance @ 09/30/11

   $ 70,767   
  

 

 

 

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

   $ 1,368   
  

 

 

 

 

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THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES

 

     September 30, 2012         
     (Unaudited)      December 31, 2011  

ASSETS

     

REAL ESTATE INVESTMENTS - At estimated fair value:

     

Real estate and improvements

     

(cost: 9/30/2012 — $241,327,309; 12/31/2011 — $196,297,813)

   $ 221,651,521      $ 174,533,231  

Preferred equity investments

     

(cost: 9/30/2012 — $0; 12/31/2011 — $8,554,984)

     —           8,277,037  
  

 

 

    

 

 

 

Total real estate investments

     221,651,521        182,810,268  

CASH AND CASH EQUIVALENTS

     24,768,429        27,404,667  

OTHER ASSETS, NET

     3,555,319        2,765,427  
  

 

 

    

 

 

 

Total assets

   $ 249,975,269      $ 212,980,362  
  

 

 

    

 

 

 

LIABILITIES & PARTNERS’ EQUITY

     

INVESTMENT LEVEL DEBT (net of unamortized discount: 9/30/12 $2,325; 12/31/11 $4,956)

   $ 57,004,908      $ 33,464,270  

ACCOUNTS PAYABLE AND ACCRUED EXPENSES

     2,739,352        2,148,095  

DUE TO AFFILIATES

     605,803        612,946  

OTHER LIABILITIES

     8,267,278        952,223  
  

 

 

    

 

 

 

Total liabilities

     68,617,341        37,177,534  
  

 

 

    

 

 

 

COMMITMENTS AND CONTINGENCIES (Note 5)

     

NET ASSETS, REPRESENTING PARTNERS’ EQUITY:

     

GENERAL PARTNERS’ CONTROLLING INTEREST

     175,077,249        172,188,679  

NONCONTROLLING INTEREST

     6,280,679        3,614,149  
  

 

 

    

 

 

 

Total equity

     181,357,928        175,802,828  
  

 

 

    

 

 

 

Total liabilities and equity

   $ 249,975,269      $ 212,980,362  
  

 

 

    

 

 

 

NUMBER OF SHARES OUTSTANDING AT END OF PERIOD

     5,183,476        5,335,263  
  

 

 

    

 

 

 

SHARE VALUE AT END OF PERIOD

   $ 33.78      $ 32.27  
  

 

 

    

 

 

 

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

 

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THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

     For the Nine Months Ending
September 30,
     For the Three Months Ending
September 30,
 
     2012     2011      2012      2011  

INVESTMENT INCOME:

          

Revenue from real estate and improvements

   $ 18,978,666     $ 17,350,103      $ 6,961,322      $ 6,135,420  

Equity in income on preferred equity investments

     127,288       923,815        —           183,477  

Interest income

     13,717       22,283        4,988        4,526  
  

 

 

   

 

 

    

 

 

    

 

 

 

Total investment income

     19,119,671       18,296,201        6,966,310        6,323,423  
  

 

 

   

 

 

    

 

 

    

 

 

 

INVESTMENT EXPENSES:

          

Operating

     4,565,555       4,553,048        1,649,197        1,588,940  

Investment management fee

     1,775,323       1,773,588        592,396        604,298  

Real estate taxes

     1,792,606       1,523,906        607,173        568,514  

Administrative

     3,161,204       3,032,161        1,164,189        1,094,623  

Interest expense

     1,353,544       973,182        516,058        391,415  
  

 

 

   

 

 

    

 

 

    

 

 

 

Total investment expenses

     12,648,232       11,855,885        4,529,013        4,247,790  
  

 

 

   

 

 

    

 

 

    

 

 

 

NET INVESTMENT INCOME

     6,471,439       6,440,316        2,437,297        2,075,633  
  

 

 

   

 

 

    

 

 

    

 

 

 

REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:

          

Net proceeds from real estate investments sold

     8,571,929       —           —           —     

Less: Cost of real estate investments sold

     8,501,116       —           —           —     
  

 

 

   

 

 

    

 

 

    

 

 

 

Gain (loss) realized from real estate investments sold

     70,813       —           —           —     

Less: Reversal of prior periods’ unrealized gain (loss) on real estate investments sold

     (277,947     —           —           —     
  

 

 

   

 

 

    

 

 

    

 

 

 

Net gain (loss) recognized on real estate investments sold

     348,760       —           —           —     
  

 

 

   

 

 

    

 

 

    

 

 

 

Change in unrealized gain (loss) on real estate investments held

     2,088,794       11,686,305        2,734,230        3,719,468  
  

 

 

   

 

 

    

 

 

    

 

 

 

NET REALIZED AND UNREALIZED GAIN (LOSS)

     2,437,554       11,686,305        2,734,230        3,719,468  
  

 

 

   

 

 

    

 

 

    

 

 

 

INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS

   $ 8,908,993     $ 18,126,621      $ 5,171,527      $ 5,795,101  
  

 

 

   

 

 

    

 

 

    

 

 

 

Amounts attributable to noncontrolling interest:

          

Net investment income (loss) attributable to noncontrolling interest

     242,059       265,734        75,288        73,346  

Net unrealized gain (loss) attributable to noncontrolling interest

     778,364       867,284        1,260,301        384,592  
  

 

 

   

 

 

    

 

 

    

 

 

 

Net increase (decrease) in net assets resulting from operations attributable to noncontrolling interest

   $ 1,020,423     $ 1,133,018      $ 1,335,589      $ 457,938  
  

 

 

   

 

 

    

 

 

    

 

 

 

Amounts attributable to general partners’ controlling interest:

          

Net investment income attributable to general partners’ controlling interest

     6,229,380       6,174,582        2,362,009        2,002,287  

Net recognized gain (loss) attributable to general partners’ controlling interest

     348,760       —           —           —     

Net unrealized gain (loss) attributable to general partners’ controlling interest

     1,310,430       10,819,021        1,473,929        3,334,876  
  

 

 

   

 

 

    

 

 

    

 

 

 

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

   $ 7,888,570     $ 16,993,603      $ 3,835,938      $ 5,337,163  
  

 

 

   

 

 

    

 

 

    

 

 

 

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

 

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THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

(Unaudited)

 

     For the Nine Months Ending September 30,  
     2012     2011  
     General Partners’
Controlling Interest
    Noncontrolling
Interest
    Total     General Partners’
Controlling Interest
    Noncontrolling
Interest
    Total  

INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS:

            

Net investment income (loss)

   $ 6,229,380     $ 242,059     $ 6,471,439     $ 6,174,582     $ 265,734     $ 6,440,316  

Net realized and unrealized gain (loss) from real estate investments

     1,659,190       778,364       2,437,554       10,819,021       867,284       11,686,305  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in net assets resulting from operations

     7,888,570       1,020,423       8,908,993       16,993,603       1,133,018       18,126,621  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

            

Distributions

     (5,000,000     —          (5,000,000     (10,000,000     —          (10,000,000

Contributions from noncontrolling interest

     —          1,688,870       1,688,870       —          —          —     

Distributions to noncontrolling interest

     —          (42,763     (42,763     —          (228,649     (228,649
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in net assets resulting from capital transactions

     (5,000,000     1,646,107       (3,353,893     (10,000,000     (228,649     (10,228,649
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

INCREASE (DECREASE) IN NET ASSETS

     2,888,570       2,666,530       5,555,100       6,993,603       904,369       7,897,972  

NET ASSETS - Beginning of period

     172,188,679       3,614,149       175,802,828       165,027,953       2,699,821       167,727,774  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET ASSETS - End of period

   $ 175,077,249     $ 6,280,679     $ 181,357,928     $ 172,021,556     $ 3,604,190     $ 175,625,746  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the Nine Months Ended September 30,  
     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net increase (decrease) in net assets from operations

   $ 8,908,993     $ 18,126,621  

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

    

Net realized and unrealized loss (gain)

     (2,437,554     (11,686,305

Amortization of discount on investment level debt

     2,630       7,187  

Amortization of deferred financing costs

     33,511       25,785  

(Increase) decrease in accrued interest included in preferred equity investment

     53,868       (253,153

Bad debt expense

     97,156       49,306  

(Increase) decrease in:

    

Other assets

     (920,558     (503,809

Increase (decrease) in:

    

Accounts payable and accrued expenses

     826,581       233,585  

Due to affiliates

     (7,143     20,568  

Other liabilities

     (113,757     (22,716
  

 

 

   

 

 

 

Net cash flows provided by (used in) operating activities

     6,443,727       5,997,069  
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Net proceeds from real estate investments sold

     8,571,929       —     

Acquisition of real estate and improvements

     (30,462,591     —     

Additions to real estate and improvements

     (2,302,230     (1,713,343

Return of investment in real estate partnerships

     —          5,868,661  
  

 

 

   

 

 

 

Net cash flows provided by (used in) investing activities

     (24,192,892     4,155,318  
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Distributions

     (5,000,000     (10,000,000

Proceeds from investment level debt

     11,700,000       19,000,000  

Principal payments on investment level debt

     (661,992     (15,891,050

Net change in financing arrangements (maturities 90 days or less)

     7,428,812       —     

Contributions from noncontrolling interest

     1,688,870       —     

Distributions to noncontrolling interest

     (42,763     (228,649
  

 

 

   

 

 

 

Net cash flows provided by (used in) financing activities

     15,112,927       (7,119,699
  

 

 

   

 

 

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

     (2,636,238     3,032,688  

CASH AND CASH EQUIVALENTS - Beginning of period

     27,404,667       28,881,784  
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS - End of period

   $ 24,768,429     $ 31,914,472  
  

 

 

   

 

 

 

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

 

16


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THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED SCHEDULE OF INVESTMENTS

 

     September  30
2012
Owner-
ship
    City, State                              
                                    
         2012 Total  Rentable
Square Feet
Unless Otherwise
Indicated
(Unaudited)
    September 30, 2012
(Unaudited)
    December 31, 2011  

Property Name

        Cost     Estimated
Fair Value
    Cost     Estimated
Fair Value
 

OFFICES

             

750 Warrenville

    WO      Lisle, IL     103,193     $ 26,767,930     $ 7,400,000     $ 26,406,742     $ 7,200,000  

Summit @ Cornell Oaks

    WO      Beaverton , OR     72,109       13,642,455       8,022,446       13,488,141       8,569,729  

Westpark

    WO      Brentwood, TN     97,199       15,159,954       14,200,000       15,144,132       13,363,502  

Financial Plaza

    WO      Brentwood, TN     98,049       13,439,266       9,900,000       12,950,174       10,700,000  
     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
 

 

Offices % as of 9/30/12

    23     69,009,605       39,522,446       67,989,189       39,833,231  

APARTMENTS

             

700 Broadway

    CJV      Seattle, WA     59 Units        22,333,516       22,200,000       —          —     

Dunhill Trace Apartments

    WO      Raleigh, NC     250 Units        17,065,658       21,200,000       16,829,100       20,200,000  

Broadstone Crossing

    WO      Austin, TX     225 Units        22,919,384       26,000,000       22,872,160       25,300,000  

The Reserve At Waterford Lakes

    WO      Charlotte, NC     140 Units        14,128,802       11,600,000       13,992,552       11,200,000  
     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
 

 

Apartments % as of 9/30/12

    46     76,447,360       81,000,000       53,693,812       56,700,000  

RETAIL

             

Hampton Towne Center

    WO      Hampton, VA     174,540       18,229,681       18,000,000       18,209,961       17,700,000  

White Marlin Mall

    CJV      Ocean City, MD     197,098       24,064,992       29,600,000       23,905,783       27,800,000  

Westminster Crossing East, LLC

    CJV      Westminster, MD     89,890       15,079,798       15,600,000       15,077,125       15,200,000  

CARS Preferred Equity

    PE      Various     N/A        —          —          8,554,984       8,277,037  

Harnett Crossing

    WO      Dunn, NC     193,325       6,726,968       3,300,000       6,429,474       3,300,000  

Village Walk

    WO      Roswell, GA     81,159       20,629,075       20,629,075       —          —     
     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
 

 

Retail % as of 9/30/12

    50     84,730,514       87,129,075       72,177,327       72,277,037  

HOTEL

             

Portland Crown Plaza

    CJV      Lake Oswego, OR     161 Rooms        11,139,830       14,000,000       10,992,469       14,000,000  
     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
 

 

Hotel % as of 9/30/12

    8     11,139,830       14,000,000       10,992,469       14,000,000  

Total Real Estate Investments at Estimated Fair Values as a Percentage of General Partners’ Controlling Interest as of 9/30/12

    127     241,327,309       221,651,521       204,852,797       182,810,268  
     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 WO - Wholly Owned Investment

CJV - Consolidated Joint Venture

 PE - Preferred equity investment

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

 

17


Table of Contents

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

CONSOLIDATED SCHEDULE OF INVESTMENTS

 

            September 30, 2012               
            (Unaudited)     December 31, 2011  
                          Estimated            Estimated  
     Face
Amount
     Maturity Date      Cost      Fair Value     Cost      Fair Value  

CASH AND CASH EQUIVALENTS - Percentage of General Partner’s Controlling Interest

   

           9.9        15.9
Investments in Prudential Investment Liquidity Pool:                 

Federal Home Loan Bank, 0 coupon bond

   $ 4,190,000        October, 2012       $ 4,190,000      $ 4,190,000     $ 697,000      $ 697,000  

Federal Home Loan Bank, 0 coupon bond

     10,000,000        October, 2012         10,000,000        10,000,000       10,000,000        10,000,000  

Federal Home Loan Bank, 0 coupon bond

     8,000,000        November, 2012         7,998,671        7,998,671       15,999,413        15,999,413  
        

 

 

    

 

 

   

 

 

    

 

 

 
Total Cash Equivalents            22,188,671        22,188,671       26,696,413        26,696,413  
Cash            2,579,758        2,579,758       708,254        708,254  
        

 

 

    

 

 

   

 

 

    

 

 

 
Total Cash and Cash Equivalents          $ 24,768,429      $ 24,768,429     $ 27,404,667      $ 27,404,667  
        

 

 

    

 

 

   

 

 

    

 

 

 

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

 

18


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

Note 1: Summary of Significant Accounting Policies

 

  A. Basis of Presentation - The accompanying consolidated financial statements of The Prudential Variable Contract Real Property Partnership (the “Partnership”) included herein have been prepared in accordance with accounting principles generally accepted in the United States of America that are applicable to investment companies. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement have been included. Operating results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012. For further information, refer to the audited consolidated financial statements and notes of the Partnership for the year ended December 31, 2011. The Partnership has evaluated subsequent events through November 9, 2012, the date these financial statements were available to be issued.

 

  B. Accounting Pronouncements Adopted - In May 2011, the FASB issued updated guidance regarding the fair value measurements and disclosure requirements. The updated guidance clarifies existing guidance related to the application of fair value measurement methods and requires expanded disclosures. This new guidance is effective for the first interim or annual reporting period beginning after December 15, 2011 and is applied prospectively. Effective January 1, 2012, the Partnership adopted this updated guidance regarding the fair value measurements and disclosure requirements. The expanded disclosures required by this guidance are included in Note 3. Adoption of this guidance did not have a material effect on the Partnership’s consolidated financial position or results of operations.

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

During third quarter of 2012, in conjunction with the acquisition of a real estate investment, the Partnership assumed a variable rate mortgage loan payable in the amount of $12.5 million.

Cash paid for interest during the nine months ended September 30, 2012 and September 30, 2011, was $1,320,033, and $947,396 respectively.

 

19


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 3: Fair Value Measurements

Valuation Methods:

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

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

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

Cash equivalents include short term investments. Short term investments are generally valued using unadjusted quoted prices in active markets that are accessible for identical assets and are primarily classified as Level 1.

See below for a description of the levels of fair value hierarchy.

 

20


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 3: Fair Value Measurements (continued)

Fair Value Measurements:

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

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

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

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

For items classified as Level 3, a reconciliation of the beginning and ending balances, as shown in table 2 below, is also required.

During the nine months ended September 30, 2012 and 2011, there were no transfers between Level 1 and Level 2.

 

21


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 3: Fair Value Measurements (continued)

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

 

Table 1

                                  
                   

(in 000’s)

 
            Fair value measurements at September 30, 2012 using  
      Cost at
09/30/12
     Amounts
measured at
fair value
09/30/2012
     Quoted prices in
active markets
for identical
assets

(level 1)
     Significant other
observable inputs
(level 2)
     Significant
unobservable inputs
(level 3)
 

Assets:

              

Real estate and improvements

   $ 241,327       $ 221,651       $ —         $ —         $ 221,651   

Cash equivalents

     22,189         22,189         22,189         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 263,516       $ 243,840       $ 22,189       $ —         $ 221,651   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

                   

(in 000’s)

 
            Fair value measurements at December 31, 2011 using  
      Cost at
12/31/11
     Amounts
measured at
fair value
12/31/2011
     Quoted prices in
active markets
for identical
assets (level 1)
     Significant other
observable inputs
(level 2)
     Significant
unobservable inputs
(level 3)
 

Assets:

              

Real estate and improvements

   $ 196,298       $ 174,533       $ —         $ —         $ 174,533   

Preferred equity investments

     8,555         8,277         —           —           8,277   

Cash equivalents

     26,696         26,696         26,696         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 231,549       $ 209,506       $ 26,696       $ —         $ 182,810   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 3: Fair Value Measurements (continued)

 

Table 2 below provides a reconciliation of the beginning and ending balances for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine month periods ended September 30, 2012 and September 30, 2011.

Table 2

 

(in 000’s)

                   

Fair value measurements using significant unobservable inputs

for the nine months ending September 30, 2012

(Level 3)

                   
     Real estate and
improvements
     Preferred equity
investments
    Total  

Beginning balance @ 1/1/12

   $ 174,533       $ 8,277      $ 182,810   

Net gains (losses) realized/unrealized included in earnings (or changes in net assets)

     2,089         349        2,438   

Equity income (losses)/interest income

     —           127        127   

Acquisitions, issuances and contributions

     45,029         —          45,029   

Disposition, settlements and distributions

     —           (8,753     (8,753
  

 

 

    

 

 

   

 

 

 

Ending balance @ 9/30/12

   $ 221,651       $ —        $ 221,651   
  

 

 

    

 

 

   

 

 

 

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

   $ 2,089       $ —        $ 2,089   
  

 

 

    

 

 

   

 

 

 

 

(in 000’s)

                   

Fair value measurements using significant unobservable inputs

for the nine months ending September 30, 2011

(Level 3)

                   
     Real estate and
improvements
     Preferred equity
investments
    Total  

Beginning balance @ 1/1/11

   $ 158,900       $ 12,591      $ 171,491   

Net gains (losses) realized/unrealized included in earnings (or changes in net assets)

     10,437         1,249        11,686   

Equity income (losses)/interest income

     —           924        924   

Acquisitions, issuances and contributions

     1,263         —          1,263   

Disposition, settlements and distributions

     —           (6,539     (6,539
  

 

 

    

 

 

   

 

 

 

Ending balance @ 9/30/11

   $ 170,600       $ 8,225      $ 178,825   
  

 

 

    

 

 

   

 

 

 

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

   $ 10,437       $ 1,249      $ 11,686   
  

 

 

    

 

 

   

 

 

 

 

23


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 3: Fair Value Measurements (continued)

 

Table 2

 

  

 

(in 000’s)

      

Fair value measurements using significant unobservable inputs

for the three months ending September 30, 2012

(Level 3)

      
     Real
estate and
 
     improvements  

Beginning balance @ 7/1/12

   $ 198,052   

Net gains (losses) realized/unrealized included in earnings (or changes in net assets)

     2,734   

Equity income (losses)/interest income

     —     

Acquisitions, issuances and contributions

     20,865   

Disposition, settlements and distributions

     —     
  

 

 

 

Ending balance @ 9/30/12

   $ 221,651   
  

 

 

 

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

   $ 2,734   
  

 

 

 

 

(in 000’s)

                   

Fair value measurements using significant unobservable inputs

for the three months ending September 30, 2011

(Level 3)

                   
     Real estate and
improvements
     Preferred equity
investments
    Total  

Beginning balance @ 7/1/11

   $ 166,550       $ 8,130      $ 174,680   

Net gains (losses) realized/unrealized included in earnings (or changes in net assets)

     3,624         95        3,719   

Equity income (losses)/interest income

     —           183        183   

Acquisitions, issuances and contributions

     426         —          426   

Disposition, settlements and distributions

     —           (183     (183
  

 

 

    

 

 

   

 

 

 

Ending balance @ 9/30/11

   $ 170,600       $ 8,225      $ 178,825   
  

 

 

    

 

 

   

 

 

 

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

   $ 3,624       $ 95      $ 3,719   
  

 

 

    

 

 

   

 

 

 

 

24


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 3: Fair Value Measurements (continued)

Quantitative Information Regarding Level 3 Assets:

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

 

     As of September 30, 2012
     Fair Value
(in 000’s)
     Number of
property(ies) in
this property
type
   Valuation Techniques    Unobservable Input    Range (Weighted Average)

Real estate and improvements:

  

           

Apartment

   $ 81,000       4   

Third party appraisal’s

discounted cash flow

  

Exit capitalization rate

Discount rate

   5.50% - 6.25% (5.96%)

7.00% - 8.00% (7.40%)

Hotel

     14,000       1   

Third party appraisal’s

discounted cash flow

  

Exit capitalization rate

Discount rate

   9.25% (9.25%)

11.50% (11.50%)

Office

     39,522       4   

Third party appraisal’s

discounted cash flow

  

Exit capitalization rate

Discount rate

   7.75% - 9.00% (8.50%)

8.50% -10.00% (9.18%)

Retail

     87,129       5   

Third party appraisal’s

discounted cash flow

  

Exit capitalization rate

Discount rate

   7.75% - 9.50% (8.10%)

8.50% -10.50% (8.80%)

   $ 221,651               
  

 

 

             

 

25


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 3: Fair Value Measurements (continued)

Fair Value of Financial Instruments Carried at Cost:

The Partnership’s mortgages on wholly owned properties and consolidated partnerships have an estimated fair value of approximately $57.2 million, and a carrying value (amortized cost) of $57.0 million. The estimated fair value is based on the amount at which the Partnership would pay to transfer the debt at the reporting date taking into consideration the effect of nonperformance risk, including the Partnership’s own credit risk. The fair value of debt is determined using the discounted cash flow method, which applies certain key assumptions including the contractual terms of the contract, market interest rates, interest spreads, credit risk, liquidity and other factors. Different assumptions or changes in future market conditions could significantly affect the estimated fair value. The input values used in the determining the fair value on investment level debt are unobservable, therefore would be considered as Level 3 under the fair value hierarchy.

Note 4: Risk

A. Valuation Risk

The estimated fair value of real estate and real estate related assets is generally determined through an appraisal process. These estimated fair values may vary significantly from the prices at which the real estate investments would sell, since market prices of real estate investments can only be determined by negotiation between a willing buyer and seller. These differences could be material to the financial statements. Although the estimated fair values represent subjective estimates, management believes that these estimated fair values are reasonable approximations of market prices and the aggregate estimated value of investments in real estate are fairly presented as of September 30, 2012 and December 31, 2011.

B. Financing, Covenant, and Repayment Risks

In the normal course of business, the Partnership enters into loan agreements with certain lenders to finance its real estate investment transactions. Unfavorable economic conditions could increase related borrowing costs, limit access to the capital markets or result in a decision by lenders not to extend credit to the Partnership. There is no guarantee that the Partnership’s borrowing arrangements or ability to obtain leverage will continue to be available, or if available, will be available on terms and conditions acceptable to the Partnership. Further, these loan agreements contain, among other conditions, events of default and various covenants and representations. In the normal course of business, the Partnership may be in the process of renegotiating terms for loans outstanding that have passed their maturity dates. At September 30, 2012 the Partnership had no outstanding matured loans.

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

 

26


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 4: Risk (continued)

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

Note 5: Commitments and Contingencies

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

Note 6: Related Party Transactions

Pursuant to an investment management agreement, PIM charges the Partnership a daily investment management fee at an annual rate of 1.25% of the average daily gross asset valuation of the Partnership. For the three month periods ended September 30, 2012 and September 30, 2011, management fees incurred by the Partnership were $592,396 and $604,298, respectively. For the nine month periods ended September 30, 2012 and September 30, 2011, management fees incurred by the Partnership were $1,775,323 and $1,773,588, respectively. The Partnership also reimburses PIM for certain administrative services rendered by PIM. The amounts incurred for the three months ended September 30, 2012 and September 30, 2011, were $13,407 and $13,407, respectively, and are classified as administrative expenses in the Consolidated Statement of Operations. The amounts incurred for the nine months ended September 30, 2012 and September 30, 2011, were $40,221 and $40,221, respectively, and are classified as administrative expenses in the Consolidated Statements of Operations.

 

27


Table of Contents

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF

THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP

September 30, 2012 and December 31, 2011

(Unaudited)

 

Note 7: Financial Highlights

 

     For The Nine Months Ended September 30,                       
     2012     2011     2010     2009     2008  

Per Share(Unit) Operating Performance:

          

Net Asset Value attributable to general partners’ controlling interest, beginning of period

   $ 32.27      $ 28.38      $ 25.88      $ 31.65      $ 36.55   

Income From Investment Operations:

          

Net investment income attributable to general partners’ controlling interest, before management fee

     1.53        1.38        1.24        1.09        1.55   

Investment Management fee attributable to general partners’ controlling interest

     (0.33     (0.31     (0.26     (0.30     (0.39

Net realized and unrealized gain (loss) on investments attributable to general partners’ controlling interest

     0.31        1.88        0.85        (6.73     (1.31
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Increase (decrease) in Net Assets Resulting from Operations attributable to general partners’ controlling interest

     1.51        2.95        1.83        (5.94     (0.15
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Asset Value attributable to general partners’ controlling interest, end of period

   $ 33.78      $ 31.33      $ 27.71      $ 25.71      $ 36.40   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Return attributable to general partners’ controlling interest, before Management Fee:

     5.73     11.51     8.11     -17.85     0.64

Total Return attributable to general partners’ controlling interest, after Management Fee (a):

     4.65     10.39     7.09     -18.75     -0.41

Ratios/Supplemental Data:

          

Net Assets attributable to general partners’ controlling interest, end of period (in millions)

   $ 175      $ 172      $ 171      $ 166      $ 246   

Ratios to average net assets for the period ended (b):

          

Management fees

     1.04     1.06     1.04     1.05     1.05

Other portfolio Level Expense

     0.20     0.20     0.18     0.18     0.03
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Portfolio Level Expenses

     1.24     1.26     1.22     1.23     1.08
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Investment Income, before Management Fee

     4.75     4.68     4.73     3.76     4.20

 

(a)    Total Return, after management fee is calculated by geometrically linking quarterly returns which are calculated using the formula below:

Net Investment Income + Net Realized and Unrealized Gains/(Losses)

            Beg. Net Asset Value + Time Weighted Contributions

                         - Time WeightedDistributions

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

 

28


Table of Contents

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

All of the assets of the Real Property Account are invested in the Partnership. Accordingly, the liquidity and capital resources and results of operations for the Real Property Account are contingent upon those of the Partnership. Therefore, this management’s discussion and analysis addresses these items at the Partnership level. The general partners in the Partnership are The Prudential Insurance Company of America, Pruco Life Insurance Company, and Pruco Life Insurance Company of New Jersey, or collectively, the “Partners”.

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

(a) Liquidity and Capital Resources

As of September 30, 2012, the Partnership’s liquid assets, consisting of cash and cash equivalents, were approximately $24.8 million, a decrease of approximately $2.6 million from $27.4 million as of December 31, 2011. The decrease was primarily due to the following activities: (a) $22.3 million for an acquisition of a 59-unit apartment property located in Seattle, Washington; (b) $20.6 million for an acquisition of an 81,159 square foot retail property located in Roswell, Georgia; (c) $5.0 million distribution to general partners’ controlling interest; (d) $0.7 million of principal payments made on financed properties; and (e) $2.3 million paid for capital improvements. Partially offsetting this decrease was the (a) net cash flow generated from property operations of $6.4 million; (b) net proceeds of $8.6 million from the final payment of the Capital Automotive Real Estate Services (or “CARS”) preferred equity investment; (c) $11.7 million of loan proceeds associated with the apartment acquisition in Seattle, Washington; (d) $12.5 million in a loan assumption associated with the retail acquisition in Roswell, Georgia; (e) $7.4 million in proceeds from changes in financing arrangements on maturities of 90 days or less; and (f) contributions from noncontrolling interest of $1.7 million. The $2.3 million payment for capital improvements included the following items: (a) $0.5 million for building renovations at one of the office buildings in Brentwood, Tennessee; (b) $0.4 million for tenant improvements and leasing costs at the office property in Beaverton, Oregon; (c) $0.4 million for tenant improvements and leasing costs at the office building in Lisle, Illinois; (d) $0.3 million for roof replacements at the retail property in Dunn, North Carolina; (e) $0.2 million for exterior painting at the apartment property in Raleigh, North Carolina; and (f) $0.5 million for capital improvements and transaction costs associated with leasing expenses at various properties.

Sources of liquidity included net cash flow from property operations, capital redemptions, loans on properties, and interest from cash equivalents. The Partnership uses cash for its real estate investment activities and for its distributions to its partners. As of September 30, 2012, approximately 9.9% of the Partnership’s total assets consisted of cash and cash equivalents.

 

29


Table of Contents

(b) Results of Operations

The following is a comparison of the Partnership’s results of operations for the nine and three month periods ended September 30, 2012 and 2011.

Net Investment Income Overview

The Partnership’s net investment income attributable to the general partners’ controlling interest for the nine months ended September 30, 2012 was approximately $6.2 million, a $0.1 million increase from the prior year period. The increase in net investment income attributable to the general partners’ controlling interest was primarily due to increases of $0.6 million, $0.4 million and $0.1 million in the office, apartment and hotel sector investments’ net investment income, respectively, from the prior year period. Partially offsetting the increase was a decrease of approximately $1.0 million from the prior year period in net investment income attributable to the general partners’ controlling interest from the retail sector.

The Partnership’s net investment income attributable to the general partners’ controlling interest for the three months ended September 30, 2012 was approximately $2.4 million, an increase of approximately $0.4 million from the prior year period. The components of this net investment income and/or loss attributable to the general partners’ controlling interest are discussed below by investment type.

Valuation Overview

The Partnership recorded a net recognized gain attributable to the general partner’s controlling interest of $0.3 million for the nine month period ended September 30, 2012, compared with no recognized gains/losses for the prior year period. The net recognized gain attributable to the partner’s controlling interest was due to the final payment of the CARS preferred equity investment. The Partnership recorded net unrealized gains attributable to the general partners’ controlling interest of approximately $1.3 million for the nine month period ended September 30, 2012. This is compared with net unrealized gains attributable to the general partners’ controlling interest of approximately $10.8 million for the prior year period. The net unrealized gains attributable to the general partners’ controlling interest for the nine month period ended September 30, 2012 were primarily due to valuation increases in the apartment and retail sector investments. Offsetting the net unrealized gains were net unrealized losses at the office and hotel sector investments.

The Partnership recorded net unrealized gains attributable to the general partner’s controlling interest of $1.5 million for the three month period ended September 30, 2012, compared with $3.3 million of unrealized gains for the prior year period. The components of these valuation gains and/or losses attributable to the general partners’ controlling interest are discussed below by property type.

 

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The following table presents a comparison of the Partnership’s sources of net investment income attributable to the general partners’ controlling interest, and net recognized and unrealized gains or losses attributable to the general partners’ controlling interest for the nine and three month periods ended September 30, 2012 and 2011.

 

     Nine Months Ended September 30,     Three Months Ended September 30,  
     2012     2011     2012     2011  

Net Investment Income:

        

Office properties

   $ 2,370,985      $ 1,795,162      $ 758,467      $ 583,520   

Apartment properties

     2,475,766        2,110,501        914,853        708,266   

Retail properties

     2,699,092        3,731,890        853,243        1,041,663   

Hotel property

     769,159        646,255        522,194        397,893   

Other (including interest income, investment management fee, etc.)

     (2,085,622     (2,109,226     (686,748     (729,055
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Net Investment Income

   $ 6,229,380      $ 6,174,582      $ 2,362,009      $ 2,002,287   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Recognized Gain (Loss) on Real Estate Investments:

        

Retail properties

     348,760        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Recognized Gain (Loss) on Real Estate Investments

     348,760        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Unrealized Gain (Loss) on Real Estate Investments:

        

Office properties

     (1,331,202     4,436,604        (1,095,681     2,503,212   

Apartment properties

     1,566,482        3,053,940        1,288,311        1,263,906   

Retail properties

     1,212,894        3,158,682        1,630,929        (118,273

Hotel property

     (137,744     169,795        (349,630     (313,969
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Unrealized Gain (Loss) on Real Estate Investments

     1,310,430        10,819,021        1,473,929        3,334,876   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Recognized and Unrealized Gain (Loss) on Real Estate Investments

   $ 1,659,190        10,819,021      $ 1,473,929        3,334,876   
  

 

 

   

 

 

   

 

 

   

 

 

 

Increase/(Decrease) in Net Assets

   $ 7,888,570      $ 16,993,603      $ 3,835,938      $ 5,337,163   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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OFFICE PROPERTIES

 

Nine Months Ended

September 30,

   Net Investment
Income/(Loss)
2012
     Net Investment
Income/(Loss)
2011
     Unrealized
Gain/(Loss)
2012
    Unrealized
Gain/(Loss)
2011
    Occupancy
2012
    Occupancy
2011
 

Property

              

Lisle, IL

   $ 218,130       $ 233,343       $ (161,188   $ (67,058     57     55

Brentwood, TN

     857,740         429,060         820,676        2,205,889        100     100

Beaverton, OR

     367,873         297,168         (701,598     1,078,796        91     88

Brentwood, TN

     927,242         835,591         (1,289,092     1,218,977        100     100
  

 

 

    

 

 

    

 

 

   

 

 

     
   $ 2,370,985       $ 1,795,162       $ (1,331,202   $ 4,436,604       
  

 

 

    

 

 

    

 

 

   

 

 

     

Three Months Ended

September 30,

                                      

Property

              

Lisle, IL

   $ 61,217       $ 93,684       $ (13,282   $ (20,298    

Brentwood, TN

     282,957         203,397         191,142        512,206       

Beaverton, OR

     119,294         27,329         (213,399     856,298       

Brentwood, TN

     294,999         259,110         (1,060,142     1,155,006       
  

 

 

    

 

 

    

 

 

   

 

 

     
   $ 758,467       $ 583,520       $ (1,095,681   $ 2,503,212       
  

 

 

    

 

 

    

 

 

   

 

 

     

Net Investment Income

Net investment income attributable to the general partners’ controlling interest for the Partnership’s office properties was approximately $2.4 million and $0.8 million for the nine and three month periods ended September 30, 2012, respectively, which represents an increase of approximately $0.6 million and $0.2 million, respectively, from the prior year period. The increase in net investment income attributable to the general partners’ controlling interest for the nine and three month periods ended September 30, 2012 were primarily due to rental rate increases from new and existing tenants at one of the properties in Brentwood, Tennessee and an increase in occupancy at the property in Beaverton, Oregon.

Unrealized Gain/(Loss)

The office properties owned by the Partnership recorded net unrealized losses attributable to the general partners’ controlling interest of approximately $1.3 million and $1.1 million for the nine and three month periods ended September 30, 2012, respectively, compared with a net unrealized gain attributable to the general partners’ controlling interest of approximately $4.4 million and $2.5 million, respectively, from the prior year period. The net unrealized losses attributable to the general partners’ controlling interest for the nine and three month periods ended September 30, 2012 were primarily due to (a) valuation loss at one of the properties in Brentwood, Tennessee due to the likelihood that the tenant will not renew upon lease expiration in 2015; (b) valuation loss at the property in Beaverton, Oregon due to a reconciliation of costs spent on tenant improvements and less favorable market leasing assumptions; and (c) increased capital expenditures related to leasing and tenant improvement costs and increased real estate taxes at the property in Lisle, Illinois. Partially offsetting the decrease was an increase at one of the Brentwood, Tennessee properties due to increased contract rents and more favorable market leasing assumptions.

 

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APARTMENT PROPERTIES

 

Nine Months Ended

September 30,

   Net Investment
Income/(Loss)
2012
     Net Investment
Income/(Loss)
2011
    Unrealized
Gain/(Loss)
2012
    Unrealized
Gain/(Loss)
2011
    Occupancy
2012
    Occupancy
2011
 

Property

             

Atlanta, GA (1)

   $ —         $ (5,515   $ —        $ —          N/A        N/A   

Raleigh, NC

     828,222         754,609        763,444        1,395,582        98     98

Austin, TX

     1,053,301         933,254        652,776        987,489        97     98

Charlotte, NC

     503,784         428,153        263,750        670,869        99     97

Seattle, WA

     90,459         —          (113,488     —          93     N/A   
  

 

 

    

 

 

   

 

 

   

 

 

     
   $ 2,475,766       $ 2,110,501      $ 1,566,482      $ 3,053,940       
  

 

 

    

 

 

   

 

 

   

 

 

     

Three Months Ended

September 30,

                                     

Property

             

Atlanta, GA (1)

   $ —         $ (312   $ —        $ —         

Raleigh, NC

     264,101         253,151        430,859        789,849       

Austin, TX

     359,167         315,456        998,701        494,415       

Charlotte, NC

     174,037         139,971        (27,762     (20,358    

Seattle, WA

     117,548         —          (113,487     —         
  

 

 

    

 

 

   

 

 

   

 

 

     
   $ 914,853       $ 708,266      $ 1,288,311      $ 1,263,906       
  

 

 

    

 

 

   

 

 

   

 

 

     

 

(1) 

The Atlanta, Georgia property was sold on September 29, 2010. The loss for the nine and three month periods ended September 30, 2011 is a result of post-closing adjustments.

Net Investment Income

Net investment income attributable to the general partners’ controlling interest for the Partnership’s apartment properties was approximately $2.5 million and $0.9 million for the nine and three month periods ended September 30, 2012, respectively, which represents increases of approximately $0.4 million and $0.2 million, respectively from the prior year period. The increase in net investment income attributable to the general partners’ controlling interest for the nine and three month periods ended September 30, 2012 was primarily due to increased rental rates and reduced concessions at the properties in Raleigh, North Carolina, Austin, Texas, and Charlotte, North Carolina.

Unrealized Gain/(Loss)

The apartment properties owned by the Partnership recorded net unrealized gains attributable to the general partners’ controlling interest of approximately $1.6 million and $1.3 million for the nine and three month periods ended September 30, 2012, respectively, compared with net unrealized gains attributable to the general partners’ controlling interest of approximately $3.1 million and $1.3 million, respectively, for the prior year period. The net unrealized gains attributable to the general partners’ controlling interest for the nine months ended September 30, 2012 were generally due to favorable market leasing assumptions at the properties in Charlotte, North Carolina; Raleigh, North Carolina and Austin, Texas. The net unrealized gains attributable to the general partners’ controlling interest for the three months ended September 30, 2012 were generally due to (a) more favorable market rents and decreased real estate taxes at the property in Austin, Texas; and (b) more favorable market rents, decreased future capital expenditures and operating expenses at the property in Raleigh, North Carolina.

 

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RETAIL PROPERTIES

 

Nine Months Ended

September 30,

   Net Investment
Income/(Loss)
2012
     Net Investment
Income/(Loss)
2011
     Recognized/
Unrealized
Gain/(Loss)
2012
    Unrealized
Gain/(Loss)
2011
    Occupancy
2012
    Occupancy
2011
 

Property

              

Roswell, GA(1)

   $ —         $ 72,833       $ —        $ —          N/A        N/A   

Hampton, VA

     755,123         771,687         280,278        891,184        83     96

Ocean City, MD

     554,591         698,284         832,783        599,409        92     98

Westminster, MD

     986,090         1,000,351         397,327        597,074        98     100

Dunn, NC

     261,132         265,641         (297,494     (178,506     36     35

CARS Preferred Equity (2)

     124,134         923,094         348,760        1,249,521        N/A        N/A   

Roswell, GA

     18,022         —           —          —          95     N/A   
  

 

 

    

 

 

    

 

 

   

 

 

     
   $ 2,699,092       $ 3,731,890       $ 1,561,654      $ 3,158,682       
  

 

 

    

 

 

    

 

 

   

 

 

     

Three Months Ended

September 30,

                                      

Property

              

Roswell, GA(1)

   $ —         $ —         $ —        $ —         

Hampton, VA

     253,939         275,110         (9,766     (6,456    

Ocean City, MD

     164,860         184,400         1,253,086        (181,529    

Westminster, MD

     321,975         359,825         398,011        (599    

Dunn, NC

     91,735         39,572         (10,402     (24,929    

CARS Preferred Equity (2)

     2,712         182,756         —          95,240       

Roswell, GA

     18,022         —           —          —         
  

 

 

    

 

 

    

 

 

   

 

 

     
   $ 853,243       $ 1,041,663       $ 1,630,929      $ (118,273    
  

 

 

    

 

 

    

 

 

   

 

 

     

 

(1)

The Roswell, Georgia retail property was sold on May 1, 2009. The income in 2011 is a result of post-closing adjustments.

(2)

A partial capital redemption of the CARS preferred equity position was paid on March 11, 2011. On March 5, 2012, the Partnership received final payment on the position which is reflected as a recognized gain.

Net Investment Income

Net investment income attributable to the general partners’ controlling interest for the Partnership’s retail properties was approximately $2.7 million and $0.9 million for the nine and three month periods ended September 30, 2012, respectively, which represents a decrease of approximately $1.0 million and $0.2 million, respectively from the prior year period. The decrease in net investment income attributable to the general partners’ controlling interest for the nine and three month periods ended September 30, 2012 was largely due to (a) reduced interest income from the CARS preferred equity investment due to the final payment of the investment which occurred in the first quarter of 2012; and (b) increased interest expense as a result of refinancing the loan for the Ocean City, Maryland property.

Recognized and Unrealized Gain/(Loss)

The retail properties owned by the Partnership recorded a net recognized gain and unrealized gains attributable to the general partners’ controlling interest of approximately $1.6 million for the nine months ended September 30, 2012, compared with a net unrealized gain attributable to the general partners’ controlling interest of approximately $3.2 million for the prior year period. The net recognized and unrealized gains attributable to the general partners’ controlling interest for the nine months ended September 30, 2012 were primarily due to (a) more favorable market rent assumptions for the property in Ocean City, Maryland; (b) increased rent at the property in Westminster, Maryland; (c) recognized gains on the CARS preferred equity investment as a result of the sale of the investment; and (d) more favorable market leasing assumptions at the property in Hampton, Virginia. Partially offsetting the gains was a loss at the property in Dunn, North Carolina due to capital expenditures for roof replacements. The retail properties owned by the Partnership recorded net unrealized gains attributable to the general partners’ interest of $1.6 million for the three months ended September 30, 2012, compared with net unrealized losses attributable to the general partners’ controlling interest of approximately $0.1 million for the prior year period. The net unrealized gains attributable to the general partners’ controlling interest for the three months ended September 30, 2012 were primarily due to (a) more favorable market leasing assumptions and a reduction in future required capital expenditures at the Ocean City, Maryland property; and (b) increased rent at the property in Westminster, Maryland.

 

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HOTEL PROPERTY

 

Nine Months Ended

September 30,

   Net Investment
Income/(Loss)
2012
     Net Investment
Income/(Loss)
2011
     Unrealized
Gain/(Loss)
2012
    Unrealized
Gain/(Loss)
2011
    Occupancy
2012
    Occupancy
2011
 

Property

              

Lake Oswego, OR

   $ 769,159       $ 646,255       $ (137,744   $ 169,795        83     80

Three Months Ended

September 30,

                                      

Property

              

Lake Oswego, OR

   $ 522,194       $ 397,893       $ (349,630   $ (313,969    

Net Investment Income

Net investment income attributable to the general partners’ controlling interest for the Partnership’s hotel property was approximately $0.8 million and $0.5 million for the nine and three month periods ended September 30, 2012, respectively, which represents an increase of approximately $0.2 million and $0.1 million from the prior year periods, respectively, due to an increase in average daily rate and occupancy.

Unrealized Gain/(Loss)

The Partnership’s hotel property recorded a net unrealized loss attributable to the general partners’ controlling interest of approximately $0.1 million for the nine months ended September 30, 2012, compared with a net unrealized gain attributable to the general partners’ controlling interest of approximately $0.2 million for the prior year period. The unrealized loss attributable to the general partners’ controlling interest for the nine months ended September 30, 2012 was primarily due to a decrease in the growth rates applied to average daily rate projections. The Partnership’s hotel property recorded a net unrealized loss attributable to the general partners’ controlling interest of approximately $0.3 million for the three months ended September 30, 2012, which remained relatively unchanged from the prior year period. The unrealized loss attributable to the general partners’ controlling interest for the three months ended September 30, 2012 was primarily due to a decrease in the growth rates applied to the average daily rate projections.

Other

Other net investment loss mainly includes investment management fees, other portfolio level expenses and interest income. Other net investment loss attributable to the general partners’ controlling interest was approximately $2.1 million and $0.7 million for the nine and three month periods ended September 30, 2012, which remained relatively unchanged from the prior year periods, respectively.

 

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Table of Contents

(c) Inflation

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

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or “U.S. GAAP”, requires the application of accounting policies that often involve a significant degree of judgment. Management reviews critical estimates and assumptions on an ongoing basis. If management determines, as a result of its consideration of facts and circumstances, that modifications in assumptions and estimates are appropriate, results of operations and financial position as reported in the unaudited Consolidated Financial Statements of the Real Property Account and the Partnership may change significantly.

The following sections discuss those critical accounting policies applied in preparing the unaudited Consolidated Financial Statements of the Real Property Account and the Partnership that are most dependent on the application of estimates and assumptions.

Accounting Pronouncements Adopted

See Note 1B to the Partnership’s unaudited Consolidated Financial Statements for a discussion of recently adopted accounting pronouncements.

Valuation of Investments

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

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

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

Cash equivalents include short term investments. Short term investments are generally valued using unadjusted quoted prices in active markets that are accessible for identical assets and primarily are classified as Level 1.

Other Estimates

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

 

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Table of Contents
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk – The general partners’ controlling interest exposure to market rate risk for changes in interest rates relates to approximately 45.23% of its investment portfolio as of September 30, 2012, which consists primarily of short-term commercial paper and fixed and variable interest rate debt. The Partnership does not use derivative financial instruments. As a matter of policy, the Partnership places its investments with high quality debt security issuers, limits the amount of credit exposure to any one issuer, limits duration by restricting the term, and holds investments to maturity except under unusual circumstances.

The table below presents the amounts and related weighted interest rates of the Partnership’s cash, cash equivalents and short term investments at September 30, 2012:

 

     Maturity      Estimated Market  Value
(millions)
     Average
Interest Rate
 

Cash and cash equivalents

     0-3 months       $ 24.8         0.06

The table below discloses the Partnership’s debt as of September 30, 2012. The fair value of the Partnership’s long-term debt is affected by changes in market interest rates. The following table presents principal cash flows based upon maturity dates of the debt obligations and the related weighted-average interest rates by expected maturity dates for the debt.

 

Investment level debt (in $ thousands),

including current portion

   2012     2013     2014     2015     2016     Thereafter     Total     Estimated
Fair Value
 

Weighted Average Fixed Interest Rate

     5.46     5.46     5.46     5.46     5.46     5.46     5.46  

Fixed Rate

   $ 230      $ 954      $ 1,017      $ 1,084      $ 1,153      $ 31,069      $ 35,507      $ 35,739   

Variable Rate

     —          9,000        —          12,500          —          21,500      $ 21,500   

Premium/(Discount) on Investment Level Debt

     (2             —          (2     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Investment Level Debt

   $ 228      $ 9,954      $ 1,017      $ 13,584      $ 1,153      $ 31,069      $ 57,005      $ 57,239   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

Item 4. Controls and Procedures

In order to ensure that the information we must disclose in our filings with the SEC is recorded, processed, summarized, and reported on a timely basis, the Company’s management, including our Chief Executive Officer and Chief Financial Officer, have reviewed and evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e), under the Securities Exchange Act of 1934, as amended, as of September 30, 2012. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2012, our disclosure controls and procedures were effective. No change in our internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(e) occurred during the quarter ended September 30, 2012, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

PART II – OTHER INFORMATION

Item 1A. Risk Factors

You should carefully consider the risks described under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011. These risks could materially affect our business, results of operations or financial condition, or cause our actual results to differ materially from those expected or those expressed in any forward looking statements made by or on behalf of the Company. These risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under “Forward-Looking Statements” above and the risks of our business described elsewhere in this Quarterly Report on Form 10-Q.

The risk factor contained in our 2011 Form 10-K titled “The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act will subject us to substantial additional federal regulation and we cannot predict the effect on our business, results of operations, cash flows or financial condition” is hereby updated to note that on October 19, 2012, PFI received notice that it is under consideration by the Financial Stability Oversight Council for designation as a non-bank financial company to be subject to stricter prudential regulatory standards and supervision by the Board of Governors of the Federal Reserve System pursuant to the Dodd-Frank Act.

Item 6. Exhibits

31.1 Section 302 Certification of the Chief Executive Officer.

31.2 Section 302 Certification of the Chief Financial Officer.

32.1 Section 906 Certification of the Chief Executive Officer.

 

32.2 Section 906 Certification of the Chief Financial Officer.

101. INS -XBRL Instance Document.

101. SCH -XBRL Taxonomy Extension Schema Document.

101. CAL -XBRL Taxonomy Extension Calculation Linkbase Document.

101. LAB -XBRL Taxonomy Extension Label Linkbase Document.

101. PRE -XBRL Taxonomy Extension Presentation Linkbase Document.

101. DEF-XBRL Taxonomy Extension Definition Linkbase Document.

In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to the Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

THE PRUDENTIAL INSURANCE COMPANY OF AMERICA

in respect of

The Prudential Variable Contract Real Property Account

(Registrant)

 

Date: November 13, 2012     By:  

/s/ Richard J. Carbone

      Richard J. Carbone
     

Executive Vice President and Chief Financial Officer

(Authorized Signatory and Principal Financial Officer)

 

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