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CHCI > SEC Filings for CHCI > Form 10-K on 27-Mar-2013All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Please see "Cautionary Notes Regarding Forward-looking Statements" for more information. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including, but not limited to, those discussed below and elsewhere in this report, particularly under the headings "Risk Factors" and "Cautionary Notes Regarding Forward-looking Statements."


We are a multi-faceted real estate development and services company. We have substantial experience with building a diverse range of products including apartments, single-family homes, townhouses, mid-rise condominiums, high-rise multi-family condominiums and mixed-use (residential and commercial) developments. We operate our business through three segments: Homebuilding, Apartment Buildings and Real Estate Services as further discussed in Note 2 of our consolidated financial statements. We are currently focused on the Washington, D.C. market, which is the eighth largest metropolitan statistical area in the United States.


Our expertise in developing traditional and non-traditional housing products enables us to focus on a wide range of opportunities within our core market. For our homebuilding operations, we develop properties with the intent that they be sold either as fee-simple properties or condominiums to individual unit buyers or as investment properties sold to private or institutional investors. Our for-sale products are designed to attract first-time, early move-up, and secondary move-up buyers. We focus on products that we are able to offer for sale in the middle price points within the markets where we operate, avoiding the very low-end and high-end products. We believe our middle market strategy positions our products such that they are affordable to a significant segment of potential home buyers in our market.

Apartment Buildings

For Comstock's apartment sector, we develop projects ranging from approximately 75 to 200 units in locations that are supply constrained with demonstrated demand for stabilized assets. We seek opportunities in the multi-family rental market where our experience and core capabilities can be leveraged. We will either position the assets for sale when completed or operate the assets within our own portfolio. Operating the assets for our own account affords us the flexibility of converting the units to condominiums in the future. When developing rental communities, we design our products to be affordable for tenants that fit one of two groups: (i) young first-time renters or (ii) renters by choice.

Real Estate Services

Our management team has significant experience in all aspects of real estate management including strategic planning, land development, entitlement, property management, sales and marketing, workout and turnaround strategies, financing and general construction. We are able to provide a wide range of construction management, general contracting and other real estate related services to other property owners. This business line not only allows us to generate fee income from our highly qualified personnel but also serves as a potential catalyst for joint venture and acquisition opportunities.

We believe that our significant experience over the past 27 years, combined with our ability to navigate through two major housing downturns (early 1990s and late 2000s), have provided us the experience necessary to capitalize on attractive opportunities in our core market of Washington, D.C. and to rebuild shareholder value. We believe that our focus on the Washington, D.C. market, which has historically been characterized by economic conditions less volatile than many other major homebuilding markets, should provide an opportunity to generate attractive returns on investment and for growth.

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Recent Developments

New Hampshire Ave. Ventures, LLC

On August 23, 2012, the Company formed New Hampshire Ave. Ventures, LLC, a consolidated joint venture of its subsidiary Comstock Ventures XVI, L.C. and 6000 New Hampshire Avenue, LLC, to acquire, develop and construct 111 residential units, consisting of 38 single-family homes and 73 townhomes, in Washington, D.C. (the "NHA Project"). The Company, through New Hampshire Ave. Ventures, LLC, entered into a $3.0 million mezzanine loan (the "NHA Mezzanine Loan") in connection with the NHA Project with the Rosalie K. Stahl Trust, utilized to acquire the fully entitled land. Concurrent with the formation of the joint venture, the Company entered into a three-year loan agreement with Eagle Bank pursuant to which the Company secured a $6.0 million revolving development loan and a $4.0 million revolving construction loan (collectively, the "Eagle NHA Revolver") to finance the development and construction of the NHA Project. Refer to Note 9 within the Notes to the Consolidated Financial Statements for further discussion of the terms of these financing arrangements.

Comstock Eastgate, L.C.

On September 27, 2012, the Company formed Comstock Eastgate, L.C., a consolidated joint venture of Comstock Holding Companies, Inc. and BridgeCom Development II, LLC, to acquire, develop and construct 66 residential condominium units in Loudoun County, VA (the "Eastgate Project"). Concurrent with the formation of the joint venture, the Company entered into a loan agreement with Cardinal Bank to which the Company secured a $2.5 million revolving construction loan to finance the construction of the units. Refer to Note 9 within the Notes to the Consolidated Financial Statements for further discussion of the terms of the financing arrangement.

Comstock Redland Road, L.C.

On December 27, 2012, the Company formed Comstock Redland Road, L.C., a wholly owned subsidiary, to acquire, develop and construct 3 single-family moderately priced dwelling units, 36 townhome units and a 117-unit multi-family residential building. Concurrent with formation of the entity, the Company completed the acquisition through securing a $2.5 million acquisition bridge loan with Eagle Bank and a $5.75 million Deferred Purchase Money Promissory Note with TSR-Shady Grove, LLC, a Maryland limited liability Company. Refer to Note 9 within the Notes to the Consolidated Financial Statements for further discussion of the terms of these financing arrangements. Further, these financing arrangements were repaid in full on March 25, 2013 through new arrangements with Eagle Bank. Refer to Note 20 within the Notes to the Consolidated Financial Statement for further discussion of the terms of the new arrangement with Eagle Bank.

Comstock Investors VII, L.C.

On March 14, 2013, Comstock Investors VII, L.C. ("Investors VII"), a subsidiary of the Company entered into subscription agreements (each a "Subscription Agreement") with certain accredited investors (the "Purchasers," and each a "Purchaser"), pursuant to which the Purchasers purchased membership interests ("Interests") in Investors VII for an initial aggregate principal amount of $6,925 of an up to $7,000 capital raise (the "Private Placement"). Purchasers included unrelated third-party accredited investors along with members of the Company's Board of Directors and the Chief Operating Officer, Chief Financial Officer and General Counsel of the Company. The Subscription Agreement provides that the Purchasers are entitled to a cumulative, compounded, preferred return of 20% per annum, compounded annually on their capital account balances. After six months, the Company has the right to repurchase the Interests of the Purchasers, provided that (i) all of the Purchasers' Interests are acquired,
(ii) the purchase is made in cash and (iii) the purchase price equals the Purchasers' capital account plus an amount necessary to cause the preferred return to equal a cumulative cash on cash return equal to 20% per annum. The Private Placement provides capital related to the current and planned construction of the Company's following projects: The Residences at Shady Grove in Rockville, Maryland consisting of 36 townhomes, The Hampshires project in Washington, D.C. consisting of 38 single family residences and 73 townhomes, and the Falls Grove project in Prince William County, Virginia consisting of 110 townhomes and 19 single family homes (collectively, the "Projects"). Proceeds of the Private Placement are to be utilized (i) to provide capital needed to complete the Projects in conjunction with project financing for the Projects,
(ii) to reimburse the Company for prior expenditures incurred on behalf of the Projects, and (iii) for general corporate purposes of the Company.

As part of the Private Placement, the Company also issued warrants to purchase shares of the Company's Class A Common Stock ("Class A Common stock") ("Warrants," and each a "Warrant") to Purchasers who are not officers, directors or affiliates of the Company that purchased Interests that equaled or exceeded an initial investment amount of $250. The Warrants represent the right to purchase up to 224 shares of Class A Common Stock, the maximum aggregate amount of warrants approved for issuance under the Private Placement. The Warrants have an initial exercise price which is equal to the average of the closing price of the Class A Common Stock of the 20 trading days preceding the issuance of the Warrant. The Warrants contain a cashless exercise provision. In the event the Purchasers exercise the Warrants on a cashless basis, the Company will not receive any proceeds. Warrants may be exercised at any time prior to March 14, 2023.

Recent Accounting Pronouncements

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, "Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standard ("IFRS")," which provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. The guidance changes certain fair value measurement principles and expands the disclosure requirements, particularly for Level 3 fair value measurements. The guidance was effective for the Company beginning February 1, 2012 and is applied prospectively. The adoption of this guidance, which relates primarily to disclosure, did not have a material impact on our Consolidated Financial Statements.

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In June 2011, the FASB issued Accounting Standards Update No. 2011-05, "Statement of Comprehensive Income" ("ASU2011-05"), which requires entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The guidance was effective for the Company beginning January 1, 2012 and is applied prospectively. The adoption of this guidance did not have a material impact on our Consolidated Financial Statements.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. GAAP, which require us to make certain estimates and judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates, including those related to the consolidation of variable interest entities, revenue recognition, impairment of real estate held for development and sale, warranty reserve and our environmental liability exposure. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates.

A summary of significant accounting policies is provided in Note 2 to our audited consolidated financial statements. The following section is a summary of certain aspects of those accounting policies that require our most difficult, subjective or complex judgments and estimates.

Real estate held for development and sale

Real estate held for development and sale includes land, land development costs, construction and other costs. Real estate held for development and use is stated at cost, or when circumstances or events indicate that the real estate is impaired, at estimated fair value. Real estate held for sale is carried at the lower of cost or fair value less estimated costs to sell. Land, land development and indirect land development costs are accumulated by specific project and allocated to various units within that project using specific identification and allocation based upon the relative sales value, unit or area methods. Direct construction costs are assigned to units based on specific identification. Construction costs primarily include direct construction costs and capitalized field overhead. Other costs are comprised of fees, capitalized interest and real estate taxes. Costs incurred to sell real estate are capitalized to the extent they are reasonably expected to be recovered from the sale of the project and are tangible assets or services performed to obtain regulatory approval of sales. Other selling costs are expensed as incurred.

If the project is considered held for sale, it is valued at the lower of cost or fair value less estimated selling costs. For assets held for development and use, estimated fair value is based on comparable sales of real estate in the normal course of business under existing and anticipated market conditions. The evaluation takes into consideration the current status of the property, various restrictions, carrying costs, costs of disposition and any other circumstances that may affect fair value including management's plans for the property. A write-down to estimated fair value is recorded when the net carrying value of the property exceeds its estimated undiscounted future cash flows. These evaluations are made on a property-by-property basis whenever events or changes in circumstances indicate that the net book value may not be recoverable.

The Company has classified its Eclipse and Penderbrook projects as held for sale and accordingly, carries the projects at fair value less costs to sell as determined by discounted cash flow models, by reference to comparable market transactions, or relevant purchase offers. Discounted cash flow models are dependent upon several subjective factors, including estimated average sales prices, estimated sales pace, and the selection of an appropriate discount rate. The estimates of sales prices, sales pace and discount rates used by the Company are based on the best information available at the time the estimates are made.

In the third quarter of 2012, management evaluated its strategic alternatives with respect to its real estate projects classified as held for sale with the objective of creating additional near term liquidity. As a result, a decision was made to market the Potomac Yard project in a bulk sale transaction, rather than by selling directly to prospective home buyers, significantly accelerating absorption. The impairment charge of $2,358 for the year ended December 31, 2012, reflects the write down to estimated fair value less costs to sell under the revised disposition strategy, however, there can be no assurance that the Company will be successful in the sale of the Potomac Yard project in a bulk sale and in the absence thereof, the Company will continue selling to prospective home buyers. There were no impairment charges recorded during the year ended December 31, 2011.

After impairments and write-offs, real estate held for development and sale consists of the following:

                                                       December 31,           December 31,
                                                           2012                   2011
Land and land development costs                       $       19,378         $        4,693
Cost of construction (including capitalized
interest and real estate taxes)                                8,403                 16,519

                                                      $       27,781         $       21,212

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Warranty reserve

Warranty reserves for units settled are established to cover potential costs for materials and labor with regard to warranty-type claims expected to arise during the typical one-year warranty period provided by the Company or within the two-year statutorily mandated structural warranty period for condominiums. Since the Company typically subcontracts its homebuilding work, subcontractors are required to provide the Company with an indemnity and a certificate of insurance prior to receiving payments for their work. Claims relating to workmanship and materials are generally the primary responsibility of the subcontractors and product manufacturers. The warranty reserve is established at the time of closing, and is calculated based upon historical warranty cost experience and current business factors. This reserve is an estimate and actual warranty costs could vary from these estimates. Variables used in the calculation of the reserve, as well as the adequacy of the reserve based on the number of homes still under warranty, are reviewed on a periodic basis. Warranty claims are directly charged to the reserve as they arise. The following table is a summary of warranty reserve activity which is included in accounts payable and accrued liabilities:

                                               Years ended December 31,
                                               2012                2011
         Balance at beginning period        $     1,009         $     1,110
         Additions                                   52                 110
         Releases and/or charges incurred           (98 )              (211 )

         Balance at end of period           $       963         $     1,009

Revenue recognition

We recognize revenues and related profits or losses from the sale of residential properties, including multiple units to the same buyer, finished lots and land sales when closing has occurred, full payment has been received, title and possession of the property has transferred to the buyer and we have no significant continuing involvement in the property. Other revenues include revenue from land sales, rental revenue from leased apartments, which is recognized over the terms of the respective leases, and revenue earned from management and administrative support services provided to related parties, which is recognized as the services are provided.

Income taxes

The effective tax rate for the years ended December 31, 2012 and 2011 was 0% and 3%, respectively. This resulted in zero and $33 in tax expense for the twelve month periods ended December 31, 2012 and 2011, respectively.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company previously recorded valuation allowances for certain tax attributes and other deferred tax assets. At this time, sufficient uncertainty exists regarding the future realization of these deferred tax assets through future taxable income. In the future, if the Company believes that it is more likely than not that these deferred tax benefits will be realized, the valuation allowances will be reversed. With a full valuation allowance, any change in the deferred tax asset or liability is fully offset by a corresponding change in the valuation allowance.

The Company currently has approximately $116 million in federal and state NOLs, which based on current statutory tax rates, has a potential fair value of approximately $45 million in tax savings. If unused, these NOLs will begin expiring in 2028. Under Section 382 rules, if a change of ownership is triggered, the Company's NOL assets and possibly certain other deferred tax assets may be impaired. We estimate that as of December 31, 2012, the cumulative shift in ownership of the Company's stock would not cause an impairment of our NOL asset. However, if an ownership change were to occur, the Section 382 limitation would not be expected to materially impact the Company's financial position or results of operations as of December 31, 2012, because of the Company's full valuation allowance on its net deferred tax assets.

The Company's ability to use its NOLs (and in certain circumstances, future built-in losses and depreciation deductions) can be negatively affected if there is an "ownership change" as defined under Section 382. In general, an ownership change occurs whenever there is a shift in ownership by more than 50 percentage points by one or more 5% shareholders over a specified time period (generally three years). Given Section 382's broad definition, an ownership change could be the unintended consequence of otherwise normal market trading in the Company's stock that is outside of the Company's control. In an effort to preserve the availability of these NOLs, Comstock adopted a Section 382 stockholder rights plan (the "Rights Plan"). The Rights Plan was adopted to reduce the likelihood of such an unintended "ownership change" and thus assist in preserving the value of these tax benefits. Similar plans have been adopted by a number of companies holding similar significant tax assets over the past several years. This plan was submitted to a vote of the Company's shareholders on June 17, 2011, and the plan was approved at that meeting.

The Company has not recorded any accruals for tax uncertainties as of December 31, 2012 and 2011, respectively. We file U.S. and state income tax returns in jurisdictions with varying statutes of limitations. The 2009 through 2011 tax years remain subject to examination by federal and most state tax authorities.

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Use of estimates

The preparation of the financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates are utilized in the valuation of real estate held for development and sale, valuation of deferred tax assets, capitalization of costs, consolidation of variable interest entities and warranty reserves.

Results of Operations

Year ended December 31, 2012 compared to year ended December 31, 2011

Orders, backlog and cancellations

Gross new order revenue, revenue from all units sold, for the year ended December 31, 2012 increased $4.4 million to $18.9 million on 57 units, including condominium units, single-family units and townhome units, as compared to $14.5 million on 50 units for the year ended December 31, 2011. Net new order revenue, revenue for all units sold less revenue from cancellations, for the year ended December 31, 2012 increased $2.3 million to $16.4 million on 51 units as compared to $14.1 million on 48 units for the year ended December 31, 2011. The average gross new order revenue per unit for the year ended December 31, 2012 increased by $42 to $332, as compared to $290 for the year ended December 31, 2011. Our backlog at December 31, 2012 increased $4.8 million to $5.4 million on 9 units as compared to our backlog at December 31, 2011 of $0.6 million on 3 units.

We have four Washington, D.C. projects where we have units available for sale:
Penderbrook Square in Fairfax, VA, the Eclipse at Potomac Yard in Arlington, VA, The Hampshires in Northeast, Washington D.C. and Eastgate in Chantilly, VA. As of December 31, 2012, there were 4 units in backlog for a total of $1.8 million related to the Penderbrook and Eclipse projects. Because unit sales at these projects are generated from completed inventory, we do not need to construct units after a sales contract is executed with a unit purchaser. As a result, we are able to quickly execute on a sales contract and deliver the unit to the purchaser with deliveries typically made within thirty days of contract execution. The Hampshires project opened its first model home and began sales in August 2012 and at December 31, 2012, there were 5 units in backlog for a total of $3.6 million. The first model is expected at Eastgate in the 1st quarter of 2013, with sales anticipated to begin concurrently with the opening. Unit sales at The Hampshires and Eastgate projects are generated from inventory that must be developed and constructed, thus the delivery of the units to the purchaser typically is made in 90 - 120 days from execution of the sales contract with the purchaser.

Revenue - homebuilding

The number of units delivered for the year ended December 31, 2012 decreased by 3 to 45 as compared to 48 units for the year ended December 31, 2011. Average revenue per unit delivered decreased by approximately $34 to $259 for the year ended December 31, 2012 as compared to $293 for the year ended December 31, 2011. Revenue from homebuilding decreased by $2.5 million to $11.6 million for the year ended December 31, 2012 as compared to $14.1 million for the year ended December 31, 2011. For the year ended December 31, 2012, 37 units were settled at Penderbrook and 8 units at Eclipse, as compared to 29 units at Penderbrook and 17 units at Eclipse for the year ended December 31, 2011. The decrease in settlements and decrease in average sales price is largely a function of the available product mix at condominium projects. As of December 31, 2012, there are 19 units remaining in our Eclipse project and 2 units remaining in our Penderbrook project. This compares to 27 units and 39 units, respectively, for Eclipse and Penderbrook at December 31, 2011.

Revenue - other

Revenue - other decreased approximately $5.2 million to $2.7 million during the year ended December 31, 2012, as compared to $7.9 million for the year ended December 31, 2011. These decreases are directly attributable to the completion of several general contracting projects in the latter quarters of 2011 and through 2012, as well as from the reduction in rental operations at the Penderbrook and Eclipse developments due to absorption of the units. The Company has encountered a slowdown in general contracting services, but it continues to pursue opportunities within the Real Estate Services segment as they become available.

Revenue - other includes $0.4 million and $1.2 million of revenue generated by our rental communities during the twelve months ended December 31, 2012 and 2011, respectively. For the year ended December 31, 2012 and 2011, other revenue includes $1.9 million and $4.9 million, respectively, of related party real estate service revenue as further discussed in Note 12 to the consolidated financial statements.

We consider revenue to be from homebuilding when there is a structure built or being built on the lot when delivered. Sales of lots occur, and are included in other revenues, when we sell raw land or finished home sites in advance of any home construction.

Cost of sales - homebuilding

Cost of sales - homebuilding for the year ended December 31, 2012 decreased by $2.5 million, to $9.7 million as compared to $12.2 million for the year ended . . .

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