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Is

AIMCo's

accounting too aggressive?

That's a question some analysts are asking as

Apartment Investment and Management

(AIV) - Get Apartment Investment & Management Co Class A Report

, or AIMco, continues to build its multifamily real estate empire. AIMCo's aggressive growth strategy has been featured in

this column before, but accounting issues raise new questions about the company's ability to sustain its impressive earnings growth.

Jim Kammert of

Goldman Sachs

is one of the critics. "AIMCo's reported

funds from operations or FFO inadequately portray the company's sustained earnings power and true economic value," he says. FFO generally provides a better measure of a real estate investment trust's operating performance than earnings alone. FFO measures cash flow by adding depreciation expense back to earnings, and excluding capital gains and losses from property sales. Kammert rates AIMCo "market performer," and his firm has not recently provided banking services to the company.

Kammert questions the accounting-for-partnership rollups, a strategy AIMCo has used to push FFO higher, and a tactic which the company defends. In 1999, AIMCo reported $69 million in interest and transactional income, of which $32.5 million was categorized as recurring. The remaining $37 million is what the company calls "transactional" income from the recovery of accrued interest and loan discounts from the debt of partnerships in which AIMCo holds an interest.

Here's how the strategy works: When the company acquires partnerships, it also acquires the partnerships' notes receivable, which are discounted from face value. The discount results from the notes' nonperforming status, because the underlying real estate did not produce cash flow necessary to service the debt.

However, after the acquisitions, AIMCo determines that accrued interest can be collected because the health of the real estate tied to many of the notes has improved so much, thanks to AIMCo's management. In the past year, AIMCo has recognized $32.5 million in interest income, representing 41 cents per share in FFO. Kammert acknowledges this practice is acceptable under current GAAP standards.

AIMCo booked this income straight to bottom-line FFO. That would be fine, except the company's 1999 10-K indicates none of the recognized income was actually collected, only that such collections are "probable and estimable." That, says Kammert, is a meritless way to boost reported cash flow. "Until the income stream is actually realized as cash we place little value on it

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either historically or prospectively."

AIMCo told analysts it expects an additional $25 million income in 2000 and $17 million in 2001 from this strategy, again with no disclosure of the actual cash flow associated with these earnings.

AIMCo CFO Paul McAuliffe says the company is comfortable with its accounting standards. "The report

of aggressive interest income recognition is erroneous," he says. "We couldn't have been more clear. We will collect the interest and discounts, when properties are sold or refinanced. That is occurring, in some cases, with more income than we anticipated." McAuliffe says the company plans to provide additional information in the coming weeks.

However, even those who like the company's prospects concede the accounting is aggressive. "It's a complicated story that raises questions," says one mutual fund manager who holds a position in the stock. "It's an aggressive stance, especially if they never collect the cash, which is quite possible."

"It really comes down to how aggressive the company wants to be, and how aggressive you are comfortable with," says Craig Silvers, head of REIT research at

Sutro and Company

. "It does seem the company is being somewhat aggressive here. It's also a question of sustainability. This type of revenue is not recurring. How they make it up in future years is a fair question." Silvers rates AIMCo a buy with a 12-month price target of 45. Sutro has not provided banking services to the company.

A Steeper Road Ahead

AIMCo remains one of only a handful of REITs that continue to benefit from external growth, largely from partnership buyouts. However, the favorable economics of the rollups may be slipping away.

With other players taking cues from AIMCo, competition is growing for available partnerships. As those competitors bid partnership prices higher additional pressure on margins is likely in future rollups. And, as interest rates rise, the cost of financing the rollups will escalate, especially as AIMCo looks to debt financing for future deals. "We suspect the average returns to AIMCo from limited partner tenders are becoming less attractive," says Kammert.

With equity capital too costly to liberally use in rollup and acquisition activities, AIMCo has resorted to issuing debt and preferred equity to complete deals. To fund a recent $56.6 million transaction, AIMCo used $33.5 million in debt, $19.7 in convertible preferreds, and only $3.4 million in cash. While the company says that means only 50% of the acquisitions was paid for with debt, conservative analysts suggest otherwise. "This deal was almost entirely financed with debt," says one buy-side manager. "In today's equity-starved environment, it's hard to consider preferred issues anything but debt."

Kammert calculates AIMCo's outstanding debt and preferred securities at 57% of the company's $4.5 billion book value of its real estate. Moreover, he calculates that AIMCo's fixed charge coverage ratio (debt plus preferred equity) amounts to only 1.7 times cash flow, as measured by EBIDTA (earnings before interest, depreciation, taxes and amortization), which falls at the low end of the REITs he follows. "Most of our REITs have EBIDTA coverage of interest and preferred dividends of two times or greater."

All that adds up to fewer choices for AIMCo in the months to come. Once a company admired for its financial flexibility, the aggressive rollup and acquisition program combined with slipping equity values have painted AIMCo into a box. "For AIMCo to continue its acquisition program, it will have to raise capital, largely through asset sales," says the buy-sider.

However, the mutual fund manager thinks the company can grow at a good clip from just internal sources. "Only about 2% of the projected growth in the coming year assumes acquisitions," he says. "That leaves 11% internal growth, not bad for a REIT."

For a company where success has been defined by acquisitions and external growth, a dramatic shift to dependency on internal growth may be both frustrating and unsatisfying for management and, potentially, investors.

Don't forget to check in this weekend for my interview with real estate magnate Sam Zell.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds had no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback at

invest@cjnetworks.com .