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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011 

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the transition period from _________ to _________

Commission file number 000-53841

AmREIT, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code:  (713) 850-1400

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 ☒   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 ☐   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):

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

AmREIT, Inc.

Quarterly Report on Form 10-Q

Quarter Ended March 31, 2011

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Part I – Financial Information

Item 1.  Financial Statements.

AMREIT, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands except share data)

See Notes to Consolidated Financial Statements.

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AMREIT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share data)

(unaudited)

See Notes to Consolidated Financial Statements.

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AMREIT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the three months ended March 31, 2011

(in thousands)

(unaudited)

See Notes to Consolidated Financial Statements.

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AMREIT, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

In 2011, we issued 70,900 restricted shares of common stock to employees as part of their compensation arrangements.  The restricted shares vest over a seven-year period.  We recorded approximately $674,000 in deferred compensation related to the issuance of the restricted shares.

In 2010, we issued 171,400 restricted shares of common stock to employees and directors as part of their compensation arrangements.  The restricted shares vest over a three to seven-year period. We recorded approximately $1.6 million in deferred compensation related to the issuance of the restricted shares.

See Notes to Consolidated Financial Statements.

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AmREIT, Inc. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(unaudited)

1.  OUR RECENT HISTORY AND OUR BUSINESS

OUR BUSINESS

We are a full service, vertically integrated and self-administered real estate investment trust, or REIT, that primarily owns, operates, acquires and selectively develops and redevelops premium-quality retail and mixed-use properties in high-traffic, densely populated, affluent areas with high barriers to entry.  We have elected to be taxed as a REIT for federal income tax purposes.  We seek to own properties in major cities in the United States that contain submarkets with characteristics comparable to our existing markets.  Our shopping centers are typically anchored by national or regional supermarket chains, with the remaining tenant base being comprised predominantly of select national and local retailers.  Over our 25-year history, we have acquired, owned and operated retail properties across 19 states. 

Today, our investment focus is predominantly concentrated in the affluent high-growth submarkets of Houston, Dallas, San Antonio, Austin and Atlanta which represent five of the top ten population and job growth markets in the United States.  We believe these metropolitan areas are compelling real estate markets given their favorable demographics, robust job growth and large and diverse economies. The Texas economy is diverse, with employment spread broadly over sectors such as government services (including defense), professional and business services, education, healthcare and leisure and hospitality.  As part of our ongoing investment strategy, we intend to acquire properties located in submarkets within other major U.S. cities outside of Texas that have market characteristics similar to our existing Texas markets. Our targeted properties will include premier retail frontage locations in high-traffic, highly populated, affluent areas with high barriers to entry.

As of March 31, 2011, our portfolio consisted of 26 wholly-owned properties totaling approximately 1.1 million gross rentable square feet which was 93% leased with a weighted average remaining lease term of 6.1 years.  In addition to our portfolio, we have an advisory services business which provides a full complement of real estate services to the properties within our portfolio as well as to eight real estate funds in which we have varying ownership interests in and manage on behalf of institutional and individual high-net-worth investors.  We refer to these real estate funds as the advised funds whose investment strategy is focused upon the development and re-development of retail and mixed-use properties situated on premium-quality locations. As of March 31, 2011, our advised funds held 20 properties with approximately 2.2 million gross rentable square feet which is 75% leased.

RECENT HISTORY

We were organized by our predecessor, AmREIT, in April 2007 as REITPlus, Inc. (“REITPlus”), a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”). REITPlus was structured as an externally managed and advised REIT, with a wholly owned subsidiary of AmREIT providing investment advisory and property and corporate management services.

In November 2009, we completed a restructuring, which consisted of the merger of AmREIT with and into REITPlus, wherein AmREIT acquired REITPlus’s net assets, and the surviving entity was renamed AmREIT, Inc.  The restructuring resulted in the combination of AmREIT’s three classes of common shares of beneficial interest into a single common class of common stock.  All of the independent members of the boards of both AmREIT and REITPlus, as well as H. Kerr Taylor, who served as chairman and chief executive officer of both companies, now form our seven-member Board of Directors.

For accounting purposes, the transaction was treated as an asset acquisition, with AmREIT being the accounting acquirer deemed to have acquired the net assets of REITPlus. As a result, the financial statements beginning on page 1 reflect the historical position and results of operations of AmREIT prior to the merger and those of the combined company following the merger.

In these notes to the financial statements, “we”, “us”, “our”, or “the Company”, refers to AmREIT, Inc., the combined company following the merger of REITPlus with AmREIT, together with its predecessors and subsidiaries, including joint ventures, unless the context requires otherwise.

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2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

Our financial records are maintained on the accrual basis of accounting whereby revenues are recognized when earned and expenses are recorded when incurred.  The consolidated financial statements include our accounts as well as the accounts of any wholly- or majority-owned subsidiaries in which we have a controlling financial interest.  Investments in joint ventures and partnerships where we have the ability to exercise significant influence but do not exercise financial and operating control, are accounted for using the equity method. All significant inter-company accounts and transactions have been eliminated through consolidation. 

The accompanying consolidated financial statements included in this Report for the three months ended March 31, 2011 and 2010, are unaudited. In our opinion, all adjustments necessary for a fair presentation of such financial statements have been included, and such adjustments consisted of normal recurring items.

REVENUE RECOGNITION

We lease space to tenants under agreements with varying terms.  Our leases are accounted for as operating leases and, although certain leases of the properties provide for tenant occupancy during periods for which no rent is due and/or for increases or decreases in the minimum lease payments over the terms of the leases, revenue is recognized on a straight-line basis over the terms of the individual leases. Revenue recognition under a lease begins when the lessee takes possession of or controls the physical use of the leased asset.  Generally, possession or control occurs on the lease commencement date.  In all cases we have determined we are the owner of any tenant improvements that we fund pursuant to the lease terms. In cases where significant tenant improvements are made prior to lease commencement, the leased asset is considered to be the finished space, and revenue recognition therefore begins when the improvements are substantially complete.  Accrued rents are included in tenant receivables. Revenue from tenant reimbursements of taxes, maintenance expenses and insurance is recognized in the period the related expense is recorded. Additionally, certain of the lease agreements contain provisions that grant additional rents based on tenants’ sales volumes (contingent or percentage rent). Percentage rents are recognized when the tenants achieve the specified targets as defined in their lease agreements. During the three months ended March 31, 2011 and 2010, we recognized percentage rents of $10,000 and $82,000, respectively. 

We recognize lease termination fees in the period that the lease is terminated and collection of the fees is reasonably assured. Upon early lease termination, we provide for losses related to unrecovered intangibles and other assets.  We did not recognize any lease termination fees during the three months ended March 31, 2011 or 2010.

We have investments in advised funds and other affiliates that are accounted for under the equity method because we exercise significant influence over such entities.  We record our percentage interest in the earnings and losses of these entities in income (loss) from advised funds and other affiliates in our statement of operations.  We serve as the general partner of our advised funds and receive asset management fees for such service, which are calculated as a percentage of equity under management.

We account for profit recognition on sales of real estate in accordance with ASC 360, Property, Plant and Equipment. Pursuant to ASC 360, profits from sales will not be recognized under the full accrual method by the Company until certain criteria are met.  Gains relating to transactions which do not meet the criteria for full accrual method of accounting are deferred and recognized when the full accrual method of accounting criteria are met or by using the installment or deposit methods of profit recognition, as appropriate in the circumstances.

We provide various real estate services, including development, construction management, property management, leasing and brokerage. The fees for these services are recognized as services are provided and are generally calculated as a percentage of revenues earned or to be earned or of property cost, as appropriate. Construction management contracts are recognized only to the extent of the fee revenue.

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REAL ESTATE INVESTMENTS

Development Properties – Land, buildings and improvements are recorded at cost.  Expenditures related to the development of real estate are carried at cost which includes capitalized carrying charges, acquisition costs and development costs.  Carrying charges, primarily interest, real estate taxes and loan acquisition costs, and direct and indirect development costs related to buildings under construction, are capitalized as part of construction in progress.  The capitalization of such costs ceases at the earlier of one year from the date of completion of major construction or when the property, or any completed portion, becomes available for occupancy. We capitalize as incurred costs associated with pending acquisitions of raw land.  We did not capitalize any interest or taxes during the three months ended March 31, 2011 or 2010.

Acquired Properties and Acquired Lease Intangibles – We account for operating real estate acquisitions pursuant to ASC 805, Business Combinations as we believe most operating real estate meets the definition of a “business” pursuant to this guidance.  Accordingly, we allocate the purchase price of the acquired properties to land, building and improvements, identifiable intangible assets and to the acquired liabilities based on their respective fair values.  Identifiable intangibles include amounts allocated to acquired above and below market leases, out of market debt, the value of in-place leases and customer relationship value, if any.  We determine fair value based on estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information.  Estimates of future cash flows are based on a number of factors including the historical operating results, known trends and specific market and economic conditions that may affect the property.  Factors considered by management in our analysis of determining the as-if-vacant property value include (i) an estimate of carrying costs during the expected lease-up periods, considering market conditions, and (ii) costs to execute similar leases.  In estimating carrying costs, management includes real estate taxes, insurance and estimates of lost rentals at market rates during the expected lease-up periods, tenant demand and other economic conditions.  Management also estimates costs to execute similar leases including leasing commissions, tenant improvements, legal and other related expenses.  Intangibles related to above market and in-place lease value are recorded as acquired lease intangibles and are amortized as an adjustment to rental revenue or amortization expense, as appropriate, over the remaining terms of the underlying leases.  Below market leases include fixed-rate renewal periods. Premiums or discounts on debt are amortized to interest expense over the remaining term of such debt. Costs related to acquiring operating properties are expensed as incurred.

Depreciation - Depreciation is computed using the straight-line method over an estimated useful life of up to 39 years for buildings, up to 20 years for site improvements and over the term of lease for tenant improvements.  Leasehold estate properties, properties on which we own the building and improvements but not the related ground, are amortized over the life of the lease.

Properties Held for Sale - Properties are classified as held for sale if we have decided to market the property for immediate sale in its present condition with the belief that the sale will be completed within one year.  Properties held for sale are carried at the lower of cost or fair value less cost to sell.  Depreciation and amortization are suspended during the held for sale period.  As of March 31, 2011 and 2010, we owned no properties which were classified as real estate held for sale.

Our properties generally have operations and cash flows that can be clearly distinguished from the rest of the Company.  The operations and gains on sales reported in discontinued operations include those properties that have been sold or are held for sale and for which operations and cash flows have been clearly distinguished.  The operations of these properties have been eliminated from ongoing operations, and we will not have continuing involvement after disposition.  Prior period operating activity related to such properties has been reclassified as discontinued operations in the accompanying statements of operations. 

Impairment – We review our properties for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets, including accrued rental income, may not be recoverable through operations. We determine whether an impairment in value has occurred by comparing the estimated future cash flows (undiscounted and without interest charges), including the residual value of the property, with the carrying value of the individual property. If impairment is indicated, a loss will be recorded for the amount by which the carrying value of the asset exceeds its fair value. During the three months ended March 31, 2011 and 2010, we did not recognize any impairment charges related to any of our properties. Both the estimated undiscounted cash flow analysis and fair value determination are based upon various factors which require complex and subjective judgments to be made by management.  Such assumptions include projecting lease-up periods, holding periods, cap rates, rental rates, operating expenses, lease terms, tenant credit-worthiness, tenant improvement allowances, terminal sales value and certain macroeconomic factors among other assumptions to be made for each property.

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RECEIVABLES AND ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS

Tenant receivables - Included in tenant receivables are base rents, tenant reimbursements and receivables attributable to recording rents on a straight-line basis.  An allowance for the uncollectible portion of accrued rents and accounts receivable is determined based upon customer credit-worthiness (including expected recovery of our claim with respect to any tenants in bankruptcy), historical bad debt levels, and current economic trends.  Bad debt expenses and any recoveries related to tenant receivables are included in property expense.  Following is a summary of activity within our allowance for uncollectible accounts ($ in thousands):

Accounts receivable – Included in accounts receivable are various receivables that arise in the normal course of operating our business, including a $1.2 million receivable from the City of Pearland, Texas.  We acquired this receivable in June 2008 in conjunction with the acquisition of Shadow Creek Ranch Shopping Center by our affiliated funds in February 2008.  The receivable is to be funded by 1/3 of the 1.5% sales tax that the City of Pearland collects from the shopping center.  We did not record any bad debt expense related to accounts receivable during the three months ended March 31, 2011 or 2010.  Bad debt expense and any related recoveries on accounts receivable are included in general and administrative expense.

Notes receivable – Included in notes receivable is $4.6 million due from the sale of a tract of land adjacent to our Uptown Plaza – Dallas property located outside of downtown Dallas, Texas. In January 2010, we granted an extension to the buyer and extended the loan to December 31, 2010.  Included was an option to extend to December 31, 2011 if the borrower could provide a commitment for a construction loan on the property.  The borrower was unable to obtain a commitment for a construction loan, and the note matured, unpaid, on December 31, 2010.  The borrower is making principal and interest payments as if the loan had been extended.  We are currently in discussions with the borrower as to possible remedies and recorded a $1.3 million impairment on the note in 2010.  The impairment reduced the note receivable to the fair value of the underlying collateral which was determined by calculating an average, per-acre price of vacant tracts of land sold near downtown Dallas, Texas within the past three years.  Interest accruals are recorded directly to the reserve balance. Interest income is recorded to the extent that cash is received from the borrower.  During the three months ended March 31, 2011, we collected $96,000 from the borrower on this note, and we have recorded all of such payments in interest income in the accompanying consolidated statements of operations.

Also included in notes receivable is $190,000 in notes receivable from various tenants.  An allowance for the uncollectible portion of notes receivable from tenants is determined based upon customer credit-worthiness (including expected recovery of our claim with respect to any tenants in bankruptcy), historical bad debt levels, and current economic trends.  As of March 31, 2011, and December 31, 2010, we had an allowance for uncollectible notes receivable of $88,000 and $99,000, respectively.  During the three months ended March 31, 2011 and 2010, we recorded bad debt recoveries related to tenant notes receivable of $11,000 and $0, respectively.

Notes receivable – related party – Included in related party notes receivable are loans made to our affiliated advised funds related to the acquisition or development of properties.  These loans bear interest at LIBOR plus a spread and are due upon demand. The notes are secured by the funds’ ownership interests in various unencumbered properties.  During the year ended December 31, 2010, we, as the general partner of AmREIT Income and Growth Fund (“AIGF”), approved a plan to begin marketing the fund’s assets for sale, and recorded a $500,000 impairment on the note from AIGF as we believe that the fund will be unable to repay the full balance after settlement of its other obligations.  As a result of the impairment, we have ceased recording interest income on the note.  Instead, interest accruals are recorded directly to the reserve balance. Interest income is recorded to the extent that cash is received from the borrower.

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The following is a summary of the notes receivable due from related parties ($ in thousands):

DERIVATIVE FINANCIAL INSTRUMENTS

We account for our derivative financial instruments pursuant to ASC 815, Derivatives and Hedging.  ASC 815 requires that all derivative instruments, whether designated in hedging relationships or not, be recorded on the balance sheet at their fair value. Gains or losses resulting from changes in the values of those derivatives are accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. Our use of derivative financial instruments to date has been limited to the use of interest rate swaps to mitigate our interest rate risk on variable-rate debt. We have designated our interest rate swaps as cash flow hedges for financial reporting purposes and have therefore recorded any changes in their fair value to other comprehensive income.

ASC 815 requires that changes in fair value of derivatives that qualify as cash flow hedges be recognized in other comprehensive income (“OCI”) while the ineffective portion of the derivative’s change in fair value be recognized in the income statement as interest expense. Upon the settlement of a hedge, gains and losses associated with the transaction are recorded in OCI and amortized over the underlying term of the hedge transaction. We assess, both at inception of the hedge and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in the cash flows of the hedged items.  All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.

DEFERRED COSTS, NET

Deferred costs include deferred leasing costs and deferred loan costs, net of amortization.  Deferred loan costs are incurred in obtaining financing and are amortized using a method that approximates the effective interest method to interest expense over the term of the debt agreements. Deferred leasing costs consist of internal and external commissions associated with leasing our properties and are amortized to depreciation and amortization expense over the lease term.  Accumulated amortization related to deferred loan costs totaled $1.4 million and $1.3 million as of March 31, 2011, and December 31, 2010, respectively.  Accumulated amortization related to leasing costs totaled $1.3 million and $1.2 million as of March 31, 2011, and December 31, 2010, respectively.

DEFERRED COMPENSATION

Our deferred compensation and long term incentive plan is designed to attract and retain the services of our directors and employees that we consider essential to our long-term growth and success. As such, it is designed to provide them with the opportunity to own restricted common stock in us. All long-term compensation awards are designed to vest over a period of three to seven years and promote retention of our team.

Restricted Stock Issuances – Deferred compensation includes grants of restricted stock to our directors and employees as a form of long-term compensation. The stock grants vest over a period of three to seven years.  We determine the fair value of the restricted stock as the number of shares awarded multiplied by the fair value per share of our common shares on the grant date. We amortize such fair value ratably over the vesting periods of the respective awards.  The following table presents restricted stock activity during the three months ended March 31, 2011:

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The weighted-average grant date fair value of restricted stock issued during the three months ended March 31, 2011 was $9.50 per share.  The total fair value of shares of restricted vested during the three months ended March 31, 2011 was $716,000.  Total compensation cost recognized related to restricted stock during the three months ended March 31, 2011 and 2010, was $132,000 and $130,000, respectively.  As of March 31, 2011, total unrecognized compensation cost related to restricted stock was $3.0 million, and the weighted average period over which we expect this cost to be recognized is 4.4 years.

Tax-Deferred Retirement Plan (401k) - We maintain a defined contribution 401k retirement plan for our employees. This plan is available for all employees immediately upon employment.  The plan allows for contributions to be invested in an array of large, mid and small cap mutual funds.  We match 50% of the employee’s contribution, up to a maximum employee contribution of 4%.  As of March 31, 2011, and December 31, 2010,, there were 33 and 36 participants, respectively, enrolled in the plan.

INCOME TAXES

We account for federal and state income taxes under the asset and liability method.

Federal – We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”) and are, therefore, not subject to Federal income taxes to the extent of dividends paid, provided we meet all conditions specified by the Internal Revenue Code for retaining our REIT status, including the requirement that at least 90% of our real estate investment trust taxable income be distributed to stockholders.

Our real estate development and operating business, AmREIT Realty Investment Corporation and subsidiaries (“ARIC”), is a fully integrated and wholly-owned business consisting of brokers and real estate professionals that provide development, acquisition, brokerage, leasing, construction, asset and property management services to our portfolio and advised funds as well as to third parties. ARIC and its subsidiaries are treated for federal income tax purposes as taxable REIT subsidiaries (collectively, the “Taxable REIT Subsidiaries”).

State – In May 2006, the State of Texas adopted House Bill 3, which modified the state’s franchise tax structure, replacing the previous tax based on capital or earned surplus with one based on margin (often referred to as the “Texas Margin Tax”) effective with franchise tax reports filed on or after January 1, 2008. The Texas Margin Tax is computed by applying the applicable tax rate (1% for us) to the profit margin, which, generally, will be determined for us as total revenue less a 30% standard deduction.  Although House Bill 3 states that the Texas Margin Tax is not an income tax, we believe ASC 740, Income Taxes, applies to the Texas Margin Tax.  We recorded a margin tax provision of $51,000 and $58,000 for the Texas Margin Tax for the three months ended March 31, 2011 and 2010, respectively.

Deferred Tax Assets – To the extent that we have deferred tax assets at period end, we will determine whether it is more likely than not that we will generate sufficient future taxable income in order to realize those assets. In making that determination, we will consider our current financial position, our results of operations for the current and preceding years, and our expectation of future operations. As of March 31, 2011, and December 31, 2010, we had a valuation allowance of $2.5 million, which represents the full balance of our deferred tax asset as we believe it is not more likely than not to be realized.

EARNINGS PER SHARE

Effective January 1, 2009, we report both basic and diluted earnings per share using the two-class method as prescribed by ASC 260, Earnings Per Share. The two-class method is an earnings allocation method for computing EPS when an entity’s capital structure includes either two or more classes of common stock or includes common stock and participating securities. The two-class method determines EPS based on distributed earnings (i.e. dividends declared on common stock and any participating securities) and undistributed earnings. Undistributed losses are not allocated to participating securities under the two-class method unless the participating security has a contractual obligation to share in losses on a basis that is objectively determinable.  Our unvested shares of restricted stock contain rights to receive non-forfeitable dividends and thus are participating securities.  However, our unvested shares of restricted stock do not have a contractual obligation to share in losses and therefore are not allocated any undistributed losses.

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In 2010, we determined that undistributed losses had been allocated to both our common and unvested shares of restricted stock in prior periods.   As such, prior period amounts have been adjusted to reflect our EPS using the two-class method.  EPS for the three months ended March 31, 2010, was initially reported at $0.03 in previously filed financial statements.  This adjustment was not material to any current or prior period financial statements.

The following table provides a reconciliation of net (loss) income from continuing operations and the number of common shares used in the computations of basic and diluted EPS under the two-class method (in thousands, except per share amounts):

Weighted average shares outstanding do not include unvested shares of restricted totaling 413 and 420 at March 31, 2011 and 2010, respectively.

USE OF ESTIMATES

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

FAIR VALUE MEASUREMENTS

We account for assets and liabilities measured at fair value in accordance with ASC 820, Fair Value Measurement and Disclosures. ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). The three levels of inputs used to measure fair value are as follows:

  Ÿ   Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.

  Ÿ   Level 2 - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

  Ÿ   Level 3 - Unobservable inputs for the asset or liability, which are typically based on the Company’s own assumptions, as there is little, if any, related market activity.

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ASC 820 requires the use of observable market data, when available, in making fair value measurements.  Observable inputs are inputs that the market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of ours. Unobservable inputs are inputs that reflect our assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.

Notes Payable and Other Financial Instruments

We disclose the fair value of our financial instruments in accordance with ASC 825, Financial Instruments, on a recurring basis. Our consolidated financial instruments consist of cash and cash equivalents, tenant receivables, accounts receivable, accounts receivable – related party, notes receivable, notes receivable – related party, notes payable, and accounts payable and other liabilities.  The carrying values of all but the notes payable are representative of the fair values due to the short term nature of the instruments and/or recent impairments.  Our notes payable consist of both variable-rate and fixed-rate notes.  The fair value of the variable-rate notes and revolving line of credit approximate their carrying values.  In determining the fair value of our fixed-rate notes, we determine the appropriate Treasury Bill Rate based on the remaining time to maturity for each of the debt instruments. We then add the appropriate yield spread to the Treasury Bill Rate. The yield spread is a risk premium estimated by investors to account for credit risk involved in debt financing. The spread is typically estimated based on the property type and loan-to-value ratio of the debt instrument. The result is an estimate of the market interest rate a typical investor would expect to receive given the underlying subject asset (property type) and remaining time to maturity.  Fixed-rate loans assumed in connection with real estate acquisitions are recorded in the accompanying consolidated financial statements at fair value at the time of acquisition.  We believe the fair value of our notes payable is classified in Level 2 of the fair value hierarchy.

Derivative Financial Instruments

We measure our derivative financial instruments at fair value on a recurring basis. In determining the fair value of our derivative instruments, we consider whether credit valuation adjustments are necessary to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.  Although we have determined that the majority of the inputs used to value our derivatives fall within level 2 of the fair value hierarchy, the credit valuation assumptions associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties.  However, as of March 31, 2011, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we have determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

Notes Receivable

In 2010, we recorded an impairment on a note receivable related to the disposition of a tract of land adjacent to our Uptown Plaza – Dallas property. As of December 31, 2010, the fair value of that note was $3.3 million and was determined by calculating an average, per-acre price of vacant tracts of land sold near Downtown Dallas, Texas, within the last three years. The valuation was classified in Level 2 of the fair value hierarchy.

The following table presents our assets and liabilities and related valuation inputs within the fair value hierarchy utilized to measure fair value as of March 31, 2011, and December 31, 2010 (in thousands):

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