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EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - Black Creek Diversified Property Fund Inc.dex311.htm
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EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - Black Creek Diversified Property Fund Inc.dex321.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - Black Creek Diversified Property Fund Inc.dex322.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 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 No. 000-52596

 

 

DIVIDEND CAPITAL TOTAL REALTY TRUST INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   30-0309068

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

518 Seventeenth Street, 17th Floor

Denver, CO

  80202
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (303) 228-2200

 

 

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  ¨    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 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

As of May 6, 2011, 184,161,847 shares of common stock of Dividend Capital Total Realty Trust Inc., par value $0.01 per share, were outstanding.

 

 

 


Table of Contents

Dividend Capital Total Realty Trust Inc.

Form 10-Q

March 31, 2011

TABLE OF CONTENTS

 

         Page  
PART I. FINANCIAL INFORMATION   
Item 1.    Financial Statements:  
   Condensed Consolidated Balance Sheets     3   
   Condensed Consolidated Statements of Operations     4   
   Condensed Consolidated Statement of Equity     5   
   Condensed Consolidated Statements of Cash Flows     6   
   Notes to Condensed Consolidated Financial Statements     7   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations     21   
Item 3.    Quantitative and Qualitative Disclosures About Market Risk     31   
Item 4.    Controls and Procedures     31   
PART II. OTHER INFORMATION   
Item 1.    Legal Proceedings     32   
Item 1A.    Risk Factors     32   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds     32   
Item 3.    Defaults upon Senior Securities     34   
Item 4.    Removed and Reserved     34   
Item 5.    Other Information     34   
Item 6.    Exhibits     35   


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

DIVIDEND CAPITAL TOTAL REALTY TRUST INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share information)

 

     As of  
     March 31, 2011     December 31, 2010  
     (Unaudited)        

ASSETS

    

Investments in real property:

    

Land

   $ 555,236      $ 539,844   

Building and improvements

     1,750,196        1,740,144   

Intangible lease assets

     582,613        578,319   

Accumulated depreciation and amortization

     (281,825     (247,608
                

Total net investments in real property*

     2,606,220        2,610,699   

Debt related investments, net

     149,969        217,492   
                

Total net investments

     2,756,189        2,828,191   

Cash and cash equivalents

     64,808        83,559   

Restricted cash

     25,075        31,019   

Other assets, net

     55,484        56,438   
                

Total Assets

   $ 2,901,556      $ 2,999,207   
                

LIABILITIES AND EQUITY

    

Liabilities:

    

Accounts payable and accrued expenses

   $ 18,958      $ 16,307   

Distributions and redemptions payable

     35,948        43,732   

Mortgage notes**

     1,463,627        1,465,955   

Other secured borrowings

     77,979        126,825   

Financing obligations

     40,288        49,799   

Intangible lease liabilities, net

     101,796        99,973   

Other liabilities

     34,101        39,642   
                

Total Liabilities

     1,772,697        1,842,233   

Equity:

    

Stockholders’ Equity:

    

Preferred stock, $0.01 par value; 200,000,000 shares authorized; none outstanding

     —          —     

Common stock, $0.01 par value; 1,000,000,000 shares authorized; 182,781,769 and 182,716,712 shares issued and outstanding, as of March 31, 2011 and December 31, 2010, respectively

     1,828        1,827   

Additional paid-in capital

     1,645,529        1,644,249   

Distributions in excess of earnings

     (616,963     (580,981

Accumulated other comprehensive (loss)

     (20,434     (22,352
                

Total stockholders’ equity

     1,009,960        1,042,743   

Noncontrolling interests

     118,899        114,231   
                

Total Equity

     1,128,859        1,156,974   
                

Total Liabilities and Equity

   $ 2,901,556      $ 2,999,207   
                

 

* Includes approximately $662.4 million and $667.2 million, after accumulated depreciation and amortization, in consolidated real property variable interest entity investments as of March 31, 2011 and December 31, 2010, respectively.
** Includes approximately $480.5 million and $484.4 million in consolidated mortgage notes in variable interest entity investments as of March 31, 2011 and December 31, 2010, respectively.

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

 

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Table of Contents

DIVIDEND CAPITAL TOTAL REALTY TRUST INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share information)

 

     For the Three Months Ended March 31,  
     2011     2010  

REVENUE:

    

Rental revenue

   $ 65,633      $ 38,570   

Debt related income

     4,486        3,441   
                

Total Revenue

     70,119        42,011   

EXPENSES:

    

Rental expense

     14,430        11,030   

Real estate depreciation and amortization expense

     32,147        15,751   

General and administrative expenses

     1,757        1,364   

Asset management fees, related party

     5,253        3,619   

Acquisition-related expenses net of other gains*

     455        5   
                

Total Operating Expenses

     54,042        31,769   

Operating Income

     16,077        10,242   

Other Income (Expenses):

    

Equity in earnings of unconsolidated joint venture

     —          545   

Interest and other income

     414        1,640   

Interest expense

     (23,100     (14,756

Other-than-temporary impairment on securities

     —          (1,693

Provision for loss on debt related investments

     (2,500     (2,984
                

Loss from continuing operations

     (9,109     (7,006

Income from discontinued operations, net of taxes

     —          171   
                

Net loss

     (9,109     (6,835

Net loss attributable to noncontrolling interests

     673        320   
                

NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS

   $ (8,436   $ (6,515
                

Net (loss) income per basic and diluted common share:

    

Continuing operations

   $ (0.05   $ (0.04

Discontinued operations

     —          0.00   
                

NET LOSS PER BASIC AND DILUTED COMMON SHARE

   $ (0.05   $ (0.04
                

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING

    

Basic

     183,633        184,061   
                

Diluted

     197,077        191,064   
                

 

* Includes approximately $218,000 paid to our Advisor during the three months ended March 31, 2011.

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

 

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Table of Contents

DIVIDEND CAPITAL TOTAL REALTY TRUST INC.

CONDENSED CONSOLIDATED STATEMENT OF EQUITY

(Unaudited)

(In thousands)

 

    Stockholders’ Equity                    
   

 

Common Stock

    Additional
Paid-in
Capital
    Distributions  in
Excess of
Earnings
    Accumulated
Other
Comprehensive

Income (Loss)
    Noncontrolling
Interests
    Comprehensive
Income (Loss)
    Total
Equity
 
    Shares     Amount              

Balances, December 31, 2010

    182,717      $ 1,827      $ 1,644,249      $ (580,981   $ (22,352   $ 114,231        $ 1,156,974   
                                                         

Comprehensive loss:

               

Net income

    —          —          —          (8,436     —          (673     (9,109     (9,109

Net unrealized change from available-for-sale securities

    —          —          —          —          1,245        91        1,336        1,336   

Cash flow hedging derivatives

    —          —          —          —          673        49        722        722   
                           

Comprehensive gain

                (7,051     (7,051

Common stock:

               

Issuance of common stock, net of offering costs

    1,243        12        11,782        —          —          —            11,794   

Conversion of OP Units to common stock

    98        1        938        —          —          (939       —     

Redemptions of common stock

    (1,276     (12     (11,448     —          —          —            (11,460

Amortization of stock based compensation

    —          —          8        —          —          —            8   

Distributions on common stock

    —          —          —          (27,546     —          —            (27,546

Noncontrolling interests:

                  —     

Contributions of noncontrolling interests

    —          —          —          —          —          8,668          8,668   

Distributions to noncontrolling interests

    —          —          —          —          —          (2,528       (2,528
                                                         

Balances, March 31, 2011

    182,782      $ 1,828      $ 1,645,529      $ (616,963   $ (20,434   $ 118,899        $ 1,128,859   
                                                         

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

 

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DIVIDEND CAPITAL TOTAL REALTY TRUST INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

     For the Three Months Ended March 31,  
     2011     2010  

OPERATING ACTIVITIES:

    

Net loss

   $ (9,109   $ (6,835

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Real estate depreciation and amortization expense

     32,147        15,798   

Net amortization of real estate securities discounts and premiums

     (16     1,112   

Other depreciation and amortization

     1,662        759   

Loss on derivatives

     57        —     

Net other-than-temporary impairment on securities

     —          1,693   

Provision for loss on debt related investments

     2,500        2,984   

Changes in operating assets and liabilities:

    

Decrease in restricted cash

     313        474   

Decrease in other assets

     372        308   

Increase (decrease) in accounts payable and accrued expenses

     1,846        (1,145

(Decrease) increase in other liabilities

     (3,139     364   
                

Net cash provided by operating activities

     26,633        15,512   

INVESTING ACTIVITIES:

    

Acquisition of real property

     (21,325     —     

Capital expenditures in real property

     (3,299     (1,216

Principal collections on debt related investments

     16,272        8   

Decrease (increase) in restricted cash

     3,171        (30

Other investing activities

     257        —     
                

Net cash used in investing activities

     (4,924     (1,238

FINANCING ACTIVITIES:

    

Mortgage note principal repayments

     (2,611     (1,350

Repayment of other secured borrowings

     (96     (7,952

Settlement of cash flow hedging derivatives

     (80     (66

Redemption of common shares

     (19,455     (15,326

Distributions to common stockholders

     (15,773     (13,853

Distributions to noncontrolling interest holders

     (2,257     (1,564

Other financing activities

     (188     (21
                

Net cash used in financing activities

     (40,460     (40,132

NET DECREASE IN CASH AND CASH EQUIVALENTS

     (18,751     (25,858

CASH AND CASH EQUIVALENTS, beginning of period

     83,559        514,786   

CASH AND CASH EQUIVALENTS, end of period

   $ 64,808      $ 488,928   
                

Supplemental Disclosure of Cash Flow Information:

    

Amount issued pursuant to the distribution reinvestment plan

   $ 11,830      $ 13,782   

Cash paid for interest

   $ 19,072      $ 13,308   

Issuances of OP Units for beneficial interests

   $ 8,699      $ —     

Conversion of OP Units to common shares

   $ 939      $ —     

Non-cash principal collection on debt related investments

   $ 48,750      $ —     

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

 

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DIVIDEND CAPITAL TOTAL REALTY TRUST INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

1. ORGANIZATION

Dividend Capital Total Realty Trust Inc. is a Maryland corporation formed on April 11, 2005 to invest in a diverse portfolio of real property and real estate related investments. As used herein, “the Company,” “we,” “our” and “us” refer to Dividend Capital Total Realty Trust Inc. and its consolidated subsidiaries and partnerships except where the context otherwise requires.

We operate in a manner intended to qualify as a real estate investment trust (“REIT”) for federal income tax purposes, commencing with the taxable year ended December 31, 2006, when we first elected REIT status. We utilize an Umbrella Partnership Real Estate Investment Trust (“UPREIT”) organizational structure to hold all or substantially all of our assets through our operating partnership, Dividend Capital Total Realty Operating Partnership, L.P. (our “Operating Partnership”). Furthermore, our Operating Partnership wholly owns a taxable REIT subsidiary, DCTRT Leasing Corp. (the “TRS”), through which we execute certain business transactions that might otherwise have an adverse impact on our status as a REIT if such business transactions were to occur directly or indirectly through our Operating Partnership.

Our day-to-day activities are managed by Dividend Capital Total Advisors LLC (our “Advisor”), an affiliate, under the terms and conditions of an advisory agreement (as amended from time to time the “Advisory Agreement”). Our Advisor and its affiliates receive various forms of compensation, reimbursements and fees for services relating to the investment and management of our real estate assets.

We are currently invested in a diverse portfolio of real properties and debt related investments. Our investment in real property consists of office, industrial, and retail properties located in North America. Additionally, we are invested in certain debt related investments, including originating and participating in mortgage loans secured by real estate, junior portions of first mortgages on commercial properties (“B-notes”), and mezzanine debt.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Interim Financial Statements

The accompanying interim condensed consolidated financial statements (herein referred to as “financial statements”) have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with the Securities and Exchange Commission (the “Commission”) instructions to Form 10-Q and Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, these statements do not include all the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the accompanying financial statements include all adjustments and eliminations, consisting only of normal recurring items necessary for their fair presentation in conformity with GAAP. Interim results are not necessarily indicative of operating results for a full year. The unaudited information included in this Quarterly Report on Form 10-Q should be read in conjunction with our audited financial statements and notes thereto, included in our Annual Report on Form 10-K for the year ended December 31, 2010, filed with the Commission on March 25, 2011.

Reclassifications

Certain amounts included in the accompanying financial statements for 2010 have been reclassified to conform to the 2011 financial statements presentation.

Use of Estimates

The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions relating to the reported amounts of assets and liabilities and 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. Actual results could differ materially from those estimates. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the periods during which such revisions are determined to be necessary.

New Accounting Pronouncements

The Financial Accounting Standards Board (the “FASB”) recently issued FASB Accounting Standards Update No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (“ASU 11-02”), which provides additional guidance clarifying when the restructuring of a receivable should be considered a troubled debt restructuring (“TDR”). Specifically,

 

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ASU 11-02 provides additional guidance for determining whether the creditor has granted a concession and whether the debtor is experiencing financial difficulty. This may significantly change how some creditors evaluate whether a restructuring constitutes a TDR, which may impact specific impairment-measurement methods and disclosures for receivables restructured in a TDR. ASU 11-02 generally will result in creditors identifying more TDRs and ends the deferral of activity-based disclosures about TDRs that are part of the new credit-quality disclosure requirements. We are required to adopt ASU 11-02 for interim and annual periods beginning on or after June 15, 2011. We are currently evaluating the impact that ASU 11-02 will have on our financial statements upon adoption.

In January 2010, the FASB issued a new accounting standard improving disclosure about fair value. The guidance requires additional disclosure about transfers in and out of Levels 1 and 2 fair value measurements in the fair value hierarchy and the reasons for such transfer. In addition, for fair value measurements using significant unobservable inputs (Level 3), the reconciliation of beginning and ending balances shall be presented on a gross basis, with separate disclosure of gross purchases, sales, issuances, and settlements, and transfers in and out of Level 3. The guidance was effective for annual periods beginning after December 15, 2009, except for the additional disclosure requirements applicable to the reconciliation of Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010. The required disclosures have been implemented in our accompanying footnotes.

In July 2010, the FASB issued a new accounting standard that expands existing disclosures about the credit quality of financing receivables and the related allowance for credit losses. The expanded disclosure requirements, which are effective for ending balances beginning December 31, 2010, are applicable to our debt related investments, and have been included in Note 4 to our financial statements below.

 

3. INVESTMENTS IN REAL PROPERTY

Our consolidated investments in real property consist of investments in office, industrial and retail properties. The following tables summarize our consolidated investments in real property as of March 31, 2011 and December 31, 2010 (amounts in thousands).

 

Real Property Type

   Land      Building and
Improvements
    Intangible
Lease Assets
    Total
Investment
Amount
    Intangible
Lease
Liabilities
    Net
Investment
Amount
 

As of March 31, 2011:

             

Office

   $ 266,122       $ 968,437      $ 434,328      $ 1,668,887      $ (63,393   $ 1,605,494   

Industrial

     58,820         361,774        68,861        489,455        (8,952     480,503   

Retail

     230,294         419,985        79,424        729,703        (51,336     678,367   
                                                 

Total gross book value

     555,236         1,750,196        582,613        2,888,045        (123,681     2,764,364   

Accumulated depreciation/amortization

     —           (120,425     (161,400     (281,825     21,885        (259,940
                                                 

Total net book value

   $ 555,236       $ 1,629,771      $ 421,213      $ 2,606,220      $ (101,796   $ 2,504,424   
                                                 

As of December 31, 2010:

             

Office

   $ 266,122       $ 966,750      $ 434,497      $ 1,667,369      $ (63,393   $ 1,603,976   

Industrial

     58,820         359,755        68,861        487,436        (8,952     478,484   

Retail

     214,902         413,639        74,961        703,502        (47,076     656,426   
                                                 

Total gross book value

     539,844         1,740,144        578,319        2,858,307        (119,421     2,738,886   

Accumulated depreciation/amortization

     —           (108,145     (139,463     (247,608     19,448        (228,160
                                                 

Total net book value

   $ 539,844       $ 1,631,999      $ 438,856      $ 2,610,699      $ (99,973   $ 2,510,726   
                                                 

Acquisitions

During the three months ended March 31, 2011, we acquired two retail properties in the New England market aggregating approximately 147,000 square feet with a combined purchase price of approximately $21.8 million.

Rental Revenue

The following table summarizes the adjustments to rental revenue related to the amortization of above-market lease assets and, below-market lease liabilities and for straight-line rental adjustments for the three months ended March 31, 2011 and 2010 (amounts in thousands).

 

     For the Three Months Ended March 31,  
     2011     2010  

Straight-line rent adjustments

   $ 2,793      $ 983   

Above-market lease assets

     (2,260     (738

Below-market lease liabilities

     2,437        1,320   
                

Total

   $ 2,970      $ 1,565   
                

 

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Tenant recovery income includes payments from tenants for real estate taxes, insurance and other property operating expenses and is recognized as rental revenue. Tenant recovery income recognized as rental revenue for the three months ended March 31, 2011 and 2010 was approximately $8.6 million and $7.2 million, respectively.

 

4. DEBT RELATED INVESTMENTS

As of March 31, 2011 and December 31, 2010, we had invested in ten and 11 debt investments, respectively, with net investment amounts of approximately $150.0 million and $217.5 million, respectively. The weighted average maturity of our debt investments as of March 31, 2011 was 3.1 years, based on our recorded net investment. The following table describes our debt related income, including equity in earnings of an unconsolidated joint venture, for the three months ended March 31, 2011 and 2010 (dollar amounts in thousands).

 

     For the Three Months Ended
March 31,
     Weighted Average
Yield as of
 

Investment Type

   2011      2010      March 31, 2011 (1)  

Mortgage notes (2)

   $ 3,072       $ 1,890         7.0

B-notes

     887         958         6.8

Mezzanine debt

     527         593         10.5
                          

Subtotal

     4,486         3,441         7.4

Unconsolidated joint venture

     —           545         N/A   
                          

Total

   $ 4,486       $ 3,986         7.4
                          

 

(1) Weighted average yield is calculated on an unlevered basis using the amount invested, current interest rates and accretion of premiums or discounts realized upon the initial investment for each investment type as of March 31, 2011. Yields for LIBOR-based, floating-rate investments have been calculated using the one-month LIBOR rate as of March 31, 2011 for purposes of this table. We have assumed a yield of zero on the debt related investment for which we have recognized a full allowance for loss as of March 31, 2011.
(2) During the three months ended March 31, 2011 we received full and complete repayment of one of our mortgage note investments. This includes an early prepayment fee received of approximately $813,000, accelerated amortization of origination fees of approximately $488,000, offset by accelerated amortization of deferred due diligence costs of approximately $163,000 related to this repayment.

Repayment of Westin-Galleria Loan

During the three months ended March 31, 2011, we received full and complete repayment of a debt investment structured as a mortgage note that was collateralized by two hotel properties located in the Houston, Texas market (the “Westin Galleria Loan”). Our investment in the Westin Galleria Loan was approximately $65.0 million as of December 31, 2010. Upon repayment of this loan to us, the borrower paid us a prepayment fee of approximately $813,000, which has been included in debt related income in the statement of operations. The Westin Galleria Loan effectively secured approximately $48.8 million in other secured borrowings that we repaid upon the repayment of this debt investment. We realized net proceeds upon repayment of approximately $17.6 million, including the receipt of accrued interest payable to us. The prepayment of this debt investment caused us to accelerate net unamortized origination fee and deferred due diligence costs that were included in the carrying value of the investment of approximately $325,000, which was recorded as an increase to debt related income.

 

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Impairment

We review each of our debt related investments individually on a quarterly basis, and more frequently when such an evaluation is warranted, to determine if impairment exists. Accordingly, we do not group our debt related investments into classes by credit quality indicator. A debt related investment is impaired when, based on current information and events including economic, industry and geographical factors, it is probable that we will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the agreement. When our investment is deemed impaired, the impairment is measured based on the expected future cash flows discounted at the investment’s effective interest rate. As a practical expedient, we may measure impairment based on the fair value of the collateral of an impaired collateral-dependent investment or to measure impairment based on an observable market price for the impaired investment as an alternative to discounting expected future cash flows. Regardless of the measurement method, we measure impairment based on the fair value of the collateral when it is determined that foreclosure is probable. During the three months ended March 31, 2011 and 2010, we recognized approximately $2.5 million and $3.0 million, respectively, in provision losses in the accompanying statements of operations. The table below presents a reconciliation of the beginning and ending balances, between December 31, 2010 and March 31, 2011, of our allowance for loan loss (amounts in thousands).

 

     Allowance for Loan Loss  

Beginning balance as of December 31, 2010:

   $ 14,984   

Provision for loss on debt related investments

     2,500   
        

Ending balance as of March 31, 2011:

   $ 17,484   
        

As of both March 31, 2011 and December 31, 2010, we had one B-note debt investment on non-accrual status, related to which we had recorded a complete allowance for loan loss. When we determine that a debt investment is impaired, we record income on the investment using the cash basis of accounting. The following table describes our recorded investment in debt related investments before allowance for loan loss, and the related allowance for loan loss (amounts in thousands).

 

     Debt Investments
Individually Evaluated
for Impairment
 

As of March 31, 2011:

  

Debt investments

   $ 167,453   

Less: Allowance for loan losses

     (17,484
        

Total

   $ 149,969   
        

As of December 31, 2010:

  

Debt investments

   $ 232,476   

Less: Allowance for loan losses

     (14,984
        

Total

   $ 217,492   
        

The following table describes our recorded investment in impaired debt related investments, by type, before allowance for loan loss, and the related allowance for loan loss (amounts in thousands).

 

     As of March 31, 2011     As of December 31, 2010  
     Recorded
Investment
     Related
Allowance
    Recorded
Investment
     Related
Allowance
 

Subordinate debt investments

   $ 37,942       $ (17,484   $ 17,987       $ (14,984
                                  

Total

   $ 37,942       $ (17,484   $ 17,987       $ (14,984
                                  

The following table describes our average recorded investment in impaired debt related investments, by type, and the related interest income recorded (amounts in thousands).

 

     For the Three Months Ended March 31,  
     2011      2010  
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 

Subordinate debt investments

   $ 22,957       $ 924       $ 2,984       $ 135   
                                   

Total

   $ 22,957       $ 924       $ 2,984       $ 135   
                                   

 

5. DEBT OBLIGATIONS

As of March 31, 2011 and December 31, 2010, our borrowings comprised mortgage notes of approximately $1.5 billion and other secured borrowings of approximately $78.0 million and $126.8 million, respectively. The following table describes our borrowings in more detail as of March 31, 2011 and December 31, 2010 (dollar amounts in thousands).

 

     Weighted Average Stated
Interest Rate as of
    Outstanding Balance as of (1)      Gross Investment Amount
Securing Borrowings as of (2)
 
     March 31,
2011
    December 31,
2010
    March 31,
2011
     December 31,
2010
     March 31,
2011
     December 31,
2010
 

Fixed rate mortgages

     5.8     5.8   $ 1,085,069       $ 1,087,377       $ 2,009,021       $ 2,006,437   

Floating rate mortgages (3)

     4.1     4.0     378,558         378,578         784,088         783,157   
                                                   

Total mortgage notes

     5.4     5.3     1,463,627         1,465,955         2,793,109         2,789,594   

Repurchase facility

     3.2     3.5     51,209         99,990         79,094         144,101   

Other secured borrowings (4)

     5.5     5.5     26,770         26,835         —           —     
                                                   

Total other secured borrowings

     4.0     4.0     77,979         126,825         79,094         144,101   
                                                   

Total

     5.3     5.2   $ 1,541,606       $ 1,592,780       $ 2,872,203       $ 2,933,695   
                                                   

 

(1) Amounts presented are net of unamortized discounts to the face value of our outstanding fixed-rate mortgages of $4.9 million and $5.2 million as of March 31, 2011 and December 31, 2010, respectively.
(2) “Gross Investment Amount” as used here and throughout this document represents the allocated gross basis of real property and debt related investments, after certain adjustments. Gross Investment Amount for real property (i) includes the effect of intangible lease liabilities of approximately $123.7 million and $119.4 million, as of March 31, 2011 and December 31, 2010, respectively, (ii) excludes accumulated depreciation and amortization on assets of approximately $281.8 million and $247.6 million as of March 31, 2011 and December 31, 2010, respectively, and (iii) includes the impact of impairments of approximately $3.9 million as of March 31, 2011 and December 31, 2010. Amounts reported for debt related investments represent our net accounting basis of the debt investments, which includes (i) unpaid principal balances, (ii) unamortized discounts, premiums, and deferred charges, and (iii) allowances for loan loss of approximately $17.5 million and $15.0 million as of March 31, 2011 and December 31, 2010, respectively.
(3) As of March 31, 2011 and December 31, 2010, floating-rate mortgage notes were subject to interest rates at spreads ranging from 1.40% to 3.50% over one-month LIBOR, certain of which are subject to a 1.0% LIBOR floor.
(4) As of March 31, 2011 and December 31, 2010, other secured borrowings consisted of mezzanine loan financing obtained from the seller of the NOIP Portfolio.

 

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As of March 31, 2011, 18 mortgage notes were interest only and 25 mortgage notes were fully amortizing with outstanding balances of approximately $829.1 million and $639.5 million, respectively. We were in compliance with all financial debt covenants as of March 31, 2011.

As of March 31, 2011, certain consolidated subsidiaries had defaulted on four mortgage note borrowings totaling $51.2 million, all of which were collateralized by office properties with gross investment amounts totaling $75.8 million that we hold in joint ventures in which we are not the managing partner. Our ownership of these joint ventures ranges from 80.0% to 97.5% and our defaults occurred either due to us not repaying the outstanding loan balance upon the contractual maturity date of the mortgage loan or as a result of us not making monthly debt service payments as required by the respective loan agreements. We are in various stages of communication with the respective lenders in an effort to restructure the loan terms so that they would be mutually agreeable to both parties. However, there are no assurances that we will be successful in our negotiations with the lenders. Accordingly, pursuant to the terms of the respective loan agreements, should the respective lenders enforce their rights, we may be subject to interest rates increasing to a higher default rate and/or the lenders foreclosing on the underlying real property collateral. With the exception of customary “carve-outs” (none of which we believe apply to these loans), these loans are not recourse to us, therefore only our equity investments in such properties are at risk of loss. These defaults do not impact our remaining debt covenants.

 

6. HEDGING ACTIVITIES

Risk Management Objective of Using Derivatives

We maintain risk management control systems to monitor interest rate risk attributable to both our outstanding and forecasted debt obligations. We generally seek to limit the impact of interest rate changes on earnings and cash flows by selectively utilizing derivative instruments to hedge exposures to changes in interest rates on loans secured by our assets. While this hedging strategy is designed to minimize the impact on our net income (loss) and cash provided by operating activities from changes in interest rates, the overall returns on our investments may be reduced. Our board of directors has established policies and procedures regarding our use of derivative instruments for hedging or other purposes to achieve these risk management objectives.

Cash Flow Hedges of Interest Rate Risk

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we primarily use interest rate swaps and caps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium payment. In connection with the borrowing activity noted in Note 5 to these financial statements, above, we have entered into and plan to enter into certain interest rate derivatives with the goal of mitigating our exposure to adverse fluctuations in the interest payments on our one-month LIBOR-indexed debt.

 

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The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges under Accounting Standards Codification (“ASC”) Topic 815 “Derivatives and Hedging” is recorded in accumulated other comprehensive income (loss) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the next 12 months, we estimate that approximately $2.6 million will be reclassified as an increase to interest expense related to terminated hedges of fixed rate debt, and we estimate that approximately $299,000 will be reclassified as an increase to interest expense related to active hedges of floating rate debt issuances. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The table below presents a reconciliation of the beginning and ending balances, between December 31, 2010 and March 31, 2011, of our accumulated other comprehensive loss (“OCI”) related to the effective portion of our cash flow hedges as presented on our financial statements (amounts in thousands).

 

     Accumulated Other
Comprehensive Loss
 

Beginning balance as of December 31, 2010:

   $ (21,007

Amortization of interest expense

     709   

Change in fair value

     13   

Attribution of OCI to noncontrolling interests

     (49
        

Ending balance as of March 31, 2011:

   $ (20,334
        

Fair Values of Derivative Instruments

The table below presents the gross fair value of our derivative financial instruments as well as their classification on our accompanying balance sheet as of March 31, 2011 and December 31, 2010 (amounts in thousands).

 

    

Asset Derivatives

    

Liability Derivatives

 
    

Balance Sheet

Location

   As of
March 31,
2011

Fair Value
     As of
December 31,
2010

Fair Value
    

Balance Sheet
Location

   As of
March 31,
2011

Fair Value
    As of
December 31,
2010

Fair Value
 

Derivatives designated as hedging instruments under ASC Topic 815

                

Interest rate contracts

   Other assets, net (1)    $ 114       $ 54       Other Liabilities    $ (6   $ (45
                                        

Total derivatives designated as hedging instruments under ASC Topic 815

        114         54            (6     (45

Derivatives not designated as hedging instruments under ASC Topic 815

                

Interest rate contracts

   Other assets, net (1)      21         76       Other Liabilities      —          —     
                                        

Total derivatives not designated as hedging instruments under ASC Topic 815

        21         76            —          —     

Total derivatives

      $ 135       $ 130          $ (6   $ (45
                                        

 

(1) The fair values of our derivative assets and liabilities are presented at their gross values in the accompanying financial statements.

Designated Hedges

As of March 31, 2011, we had four outstanding interest rate caps and three outstanding interest rate swaps that were designated as cash flow hedges of interest rate risk, with a total notional amount of $163.2 million. As of December 31, 2010, we had three outstanding interest rate caps and three outstanding interest rate swaps that were designated as cash flow hedges of interest rate risk, with a total notional amount of $154.0 million.

Undesignated Hedges

Derivatives not designated as hedges are not speculative and are used to hedge our exposure to interest rate movements and other identified risks but do not meet hedge accounting requirements. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings and resulted in a loss of approximately $55,000 for the three months ended March 31, 2011. As of March 31, 2011 and December 31, 2010, respectively, we had one outstanding interest rate cap that was not designated as a hedge with a notional amount of approximately $321.1 million. As of March 31, 2011 and December 31, 2010, this interest rate cap was recorded as an asset on our financial statements with a fair value of approximately $21,000 and $76,000, respectively.

 

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Effect of Derivative Instruments on the Statement of Operations

The table below presents the effect of our derivative financial instruments on our accompanying financial statements for the three months ended March 31, 2011 and 2010 (amounts in thousands).

 

     For the Three Months Ended March 31,  
     2011     2010  

Derivatives Destingated as Hedging Instruments

    

Derivative type

     Interest rate contracts        Interest rate contracts   

Amount of gain recognized in OCI (effective portion)

   $ 13      $ —     

Location of gain or (loss) reclassified from accumulated OCI into income (effective portion)

     Interest expense        Interest expense   

Amount of loss reclassified from accumulated OCI into income (effective portion)

   $ (709   $ (682

Location of gain or (loss) recognized in income (ineffective portion and amount excluded from effectiveness testing)

     Interest and other income        Interest and other income   

Amount of loss recognized in income due to missed forecast (ineffective portion and amount excluded from effectiveness testing)

   $ (2   $ —     

Derivatives Not Destingated as Hedging Instruments

    

Derivative type

     Interest rate contracts        Interest rate contracts   

Location of gain or (loss) recognized in income

     Interest and other income        Interest and other income   

Amount of loss recognized in income

   $ (55   $ —     

7. FAIR VALUE DISCLOSURES

The table below presents certain of our significant assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010, aggregated by the level in the fair value hierarchy set forth by ASC Topic 820 “Fair Value Measurements and Disclosures” within which those measurements fall (amounts in thousands).

 

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     Level 1      Level 2     Level 3      Total  

As of March 31, 2011:

          

Assets

          

Real estate securities

   $ —         $ —        $ 5,334       $ 5,334   

Derivative instruments

     —           135        —           135   
                                  

Total assets

   $ —         $ 135      $ 5,334       $ 5,469   
                                  

Liabilities

          

Derivative instruments

   $ —         $ (6   $ —         $ (6
                                  

As of December 31, 2010:

          

Assets

          

Real estate securities

   $ —         $ —        $ 3,981       $ 3,981   

Derivative instruments

     —           130        —           130   
                                  

Total assets

   $ —         $ 130      $ 3,981       $ 4,111   
                                  

Liabilities

          

Derivative instruments

   $ —         $ (45   $ —         $ (45
                                  

With regards to our assets carried at fair value, we did not have any transfers between Levels 1, 2 or 3 during the three months ended March 31, 2011. The table below presents a reconciliation of the beginning and ending balances, between December 31, 2010 and March 31, 2011, of certain of our significant assets having fair value measurements (amounts in thousands).

 

     Real Estate
Securities
     Derivative
Instruments
 

Beginning balance as of December 31, 2010

   $ 3,981       $ 85   

Included in net loss

     —           (65

Included in other comprehensive loss

     1,353         76   

Purchases

     —           33   
                 

Total change in fair value

     1,353         44   

Transfers in and/or out of Level 3

     —           —     
                 

Ending balance as of March 31, 2011

   $ 5,334       $ 129   
                 

Fair Value of Investments in Real Estate Securities

Our real estate securities comprise commercial mortgage-backed securities (“CMBS”) and commercial real estate collateralized debt obligation (“CRE-CDO”) securities. Our pricing procedures for each of the two categories are applied to each specific investment within their respective categories. We estimate the fair value of our CMBS and CRE-CDO securities using a combination of observable market information and unobservable market assumptions. Observable market information considered in these fair market valuations include benchmark interest rates, interest rate curves, credit market indexes and swap curves. Unobservable market assumptions considered in the determination of the fair market valuations of our CMBS and CRE-CDO investments include market assumptions related to discount rates, default rates, prepayment rates, reviews of trustee or investor reports and nonbinding broker quotes and pricing services in what is currently an inactive secondary market. Additionally, we consider security-specific characteristics in determining the fair values of our CMBS and CRE-CDO investments, which include consideration of credit enhancements, the underlying collateral’s average default rates, the average delinquency rate and loan-to-value and several other characteristics. As a result, both Level 2 and Level 3 inputs are used in arriving at the valuation of our investments in CMBS and CRE-CDOs. We determined the Level 3 inputs used in determining the fair value of its investments in CMBS and CRE-CDO securities to be significant. As such, all investments in CMBS and CRE-CDO securities fall under the Level 3 category of the fair value hierarchy.

 

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8. FAIR VALUE OF FINANCIAL INSTRUMENTS

We are required to disclose the fair value of our financial instruments for which it is practicable to estimate the value. The fair value of a financial instrument is the amount at which such financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. For certain of our financial instruments, fair values are not readily available since there are no active trading markets as characterized by current exchanges between willing parties. Accordingly, we derive our estimated fair value using various valuation techniques, such as computing the present value of estimated future cash flows using discount rates commensurate with the risks involved. However, the determination of estimated cash flows may be subjective and imprecise and changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In that regard, the fair value estimates may not be substantiated by comparison to independent markets, and in many cases, may not be realized in immediate settlement of the instrument.

The fair values estimated below are indicative of certain interest rate and other assumptions as of March 31, 2011 and December 31, 2010, and may not take into consideration the effects of subsequent interest rate or other assumption fluctuations, or changes in the values of underlying collateral. The fair values of cash and cash equivalents, restricted cash, accounts receivable, and accounts payable and accrued expenses approximate their carrying values because of the short-term nature of these instruments. In addition, we determined that the fair values of our other secured borrowings approximate their carrying values as of March 31, 2011 and December 31, 2010, since the floating rates on the balances approximate market rates.

The carrying amounts and estimated fair values of our other financial instruments as of March 31, 2011 and December 31, 2010 were as follows (amounts in thousands):

 

     As of March 31, 2011      As of December 31, 2010  
     Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Assets:

           

Investments in real estate securities

   $ 5,334       $ 5,334       $ 3,981       $ 3,981   

Fixed-rate debt related investments, net

     71,541         73,713         138,975         139,634   

Floating-rate debt related investments, net

     78,428         73,345         78,517         72,854   

Derivative instruments

     135         135         130         130   

Liabilities:

           

Fixed-rate mortgage notes

   $ 1,085,069       $ 1,100,908       $ 1,087,377       $ 1,147,001   

Floating-rate mortgage notes

     378,558         381,569         378,578         378,578   

Fixed-rate other secured borrowings

     26,770         26,770         26,835         26,835   

Floating-rate other secured borrowings

     51,209         51,209         99,990         99,990   

Derivative liabilities

     6         6         45         45   

See Note 7 to these financial statements above for details regarding methodologies and key assumptions applied to determining the fair value of our investments in real estate securities and derivative instruments. The methodologies used and key assumptions made to estimate fair values of the other financial instruments described in the above table are as follows:

Debt Related Investments — The fair value of our debt investments as of March 31, 2011 and December 31, 2010 was estimated using a discounted cash flow analysis that utilized estimates of scheduled cash flows and discount rates estimated to approximate those that a willing buyer and seller might use.

Mortgage Notes — The fair value of our fixed-rate mortgage notes as of March 31, 2011 and December 31, 2010 was estimated using a discounted cash flow analysis, based on our estimate of market interest rates. Credit spreads relating to the underlying instruments are based on unobservable Level 3 inputs, which we have determined to be our best estimate of current market spreads of similar instruments.

 

9. NONCONTROLLING INTERESTS

Our noncontrolling interests consist of three components: (i) joint venture partnership interests held by our partners, (ii) non-voting units of limited partnership interests of our Operating Partnership (“OP Units”) held by third parties and (iii) OP Units held by the parent of our Advisor that constitute a separate series of partnership interests with special distribution rights (“Special Units”). The following table summarizes noncontrolling interest balances as of March 31, 2011 and December 31, 2010 in terms of cumulative contributions, distributions and cumulative allocations of net loss and comprehensive loss (amounts in thousands).

 

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Table of Contents
     As of March 31,
2011
    As of December 31,
2010
 

OP Units:

    

Contributions

   $ 124,390      $ 116,897   

Distributions

     (14,663     (12,646

Share of net loss

     (10,008     (9,390

Share of comprehensive loss

     2,459        2,318   
                

Subtotal

     102,178        97,179   

Joint Venture Partner Interests:

    

Contributions

     35,852        35,617   

Distributions

     (16,187     (15,676

Share of net loss

     (2,945     (2,890
                

Subtotal

     16,720        17,051   

Special Units:

    

Contributions

     1        1   

Distributions

     —          —     

Share of net loss

     —          —     
                

Subtotal

     1        1   
                

Total

   $ 118,899      $ 114,231   
                

As of March 31, 2011 and December 31, 2010, we owned approximately 93.1% and 93.4% of our Operating Partnership, respectively, and the remaining interests in our Operating Partnership were owned by third-party investors and our Advisor. After a period of one year from the date of issuance, holders of OP Units may request the Operating Partnership to redeem their OP Units. We have the option of redeeming the OP Units with cash, shares of our common stock, or with a combination of cash and shares of our common stock. During the three months ended March 31, 2011, we issued approximately 98,000 shares of our common stock in redemption of approximately 99,000 OP Units in accordance with this option. In May 2005, our Operating Partnership issued 20,000 OP Units to our Advisor for gross proceeds of $200,000, which represented less than a 0.1% ownership interest in our Operating Partnership as of March 31, 2011. In addition, as of March 31, 2011 and December 31, 2010, our Operating Partnership had issued approximately 13.6 million and 12.8 million OP Units, respectively, to third-party investors in connection with its private placement offerings, and such units had a maximum approximate redemption value of $115.3 million and $128.1 million, respectively, based on our most recently announced estimated value per share for the OP Units outstanding as of March 31, 2011, and based on the most recent selling price of our common stock pursuant to a primary offering for the OP Units outstanding as of December 31, 2010. During the three months ended March 31, 2011, our Operating Partnership issued approximately 961,000 OP Units pursuant to our Operating Partnerships private placements.

 

10. STOCKHOLDERS’ EQUITY

Common Stock

On May 27, 2005, we filed a registration statement on Form S-11 with the Commission in connection with an initial public offering of our common stock, which was declared effective on January 27, 2006. As of the close of business on September 30, 2009, we terminated the primary portion of our public offering of shares of our common stock and ceased accepting new subscriptions to purchase shares of our common stock. However, we have offered and will continue to offer shares of common stock through the Distribution Reinvestment Plan (the “DRIP Plan”). Effective March 11, 2011, we amended the DRIP Plan to offer shares of our common stock at the estimated per share value of $8.45, which we announced on March 11, 2011 in order to assist broker dealers with certain obligations under Financial Industry Regulatory Authority (“FINRA”) regulations.

The following table summarizes shares sold, gross proceeds received and the commissions and fees paid in connection with our offerings as of March 31, 2011 (amounts in thousands).

 

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Table of Contents
     Shares     Gross
Proceeds
    Commissions
and Fees
    Net
Proceeds
 

Shares sold in the initial offering

     114,742      $ 1,136,968      $ (104,295   $ 1,032,673   

Shares sold in the follow-on offering

     67,140        659,831        (55,332     604,499   

Shares sold pursuant to our DRIP Plan in the initial offering

     3,455        32,825        (309     32,516   

Shares sold pursuant to our DRIP Plan in the follow-on offering

     16,076        152,720        (476     152,244   

Shares issued in connection with OP Unit redemption program

     98        965        —          965   

Shares repurchased pursuant to our share redemption program

     (18,729     (175,255     (285     (175,540
                                

Total

     182,782      $ 1,808,054      $ (160,697   $ 1,647,357   
                                

Distributions

We accrue and pay distributions on a quarterly basis. Each quarter, our board of directors declares and authorizes the following quarter’s distribution. We calculate individual payments of distributions to each stockholder or OP Unit holder based upon daily record dates during each quarter, so that investors are eligible to earn distributions immediately upon purchasing shares of our common stock or upon purchasing OP Units. During the three months ended March 31, 2011 and 2010, we declared distributions to our common stockholders of approximately $27.5 million and $27.6 million, respectively. Of these amounts, for the three months ended March 31, 2011 and 2010, approximately $15.9 million and $14.3 million, respectively, were paid or payable in cash and approximately $11.6 million and $13.3 million, respectively, were reinvested in shares of our common stock pursuant to the DRIP Plan.

During the three months ended March 31, 2011 and 2010, approximately 1.2 million and 1.5 million shares of our common stock were issued, respectively, in connection with the DRIP Plan for proceeds of approximately $11.8 million and $13.8 million, respectively, relating to our fourth quarter 2010 and 2009 distributions, respectively.

Redemptions

During the three months ended March 31, 2011 and 2010, we redeemed approximately 1.3 million and 1.3 million shares of common stock, respectively, pursuant to our share redemption program for approximately $11.5 million and $12.8 million, respectively.

 

11. RELATED PARTY TRANSACTIONS

Our day-to-day activities are managed by our Advisor, an affiliate, under the terms and conditions of the Advisory Agreement. Our Advisor is considered to be a related party as certain indirect owners and employees of our Advisor serve as our executive officers. The responsibilities of our Advisor include the selection and underwriting of our real property and debt related investments, the negotiations for these investments, the asset management and financing of these investments and the selection of prospective joint venture partners. As of March 31, 2011 and December 31, 2010, we owed approximately $99,000 and $77,000, respectively, to our Advisor and affiliates of our Advisor for such services and reimbursement of certain expenses.

The following table summarizes fees and other amounts earned by our Advisor in connection with services performed for us during the three months ended March 31, 2011, and 2010 (amounts in thousands).

 

     For the Three Months Ended March 31,  
     2011      2010  

Acquisition fees

   $ 218       $ —     

Asset management fees

     5,253         3,619   

Other reimbursements

     373         256   
                 

Total

   $ 5,844       $ 3,875   
                 

 

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12. NET INCOME (LOSS) PER COMMON SHARE

Reconciliations of the numerator and denominator used to calculate basic net loss per common share to the numerator and denominator used to calculate diluted net loss per common share for the three months ended March 31, 2011 and 2010 are described in the following table (amounts in thousands, except per share information).

 

     For the Three Months Ended March 31,  
     2011     2010  

Numerator

    

Loss from continuing operations

   $ (9,109   $ (7,006

Loss from continuing operations attributable to noncontrolling interests

     673        343   
                

Loss from continuing operations attributable to common stockholders

     (8,436     (6,663

Dilutive noncontrolling interests share of loss from continuing operations

     (622     (254

Numerator for diluted earnings per share – adjusted loss from continuing operations

   $ (9,058   $ (6,917
                

Income from discontinued operations

   $ —        $ 171   

Income from discontinued operations attributable to noncontrolling interests

     —          (23
                

Income from discontinued operations attributable to common stockholders

     —          148   

Dilutive noncontrolling interests share of discontinued operations

     —          6   

Numerator for diluted earnings per share – adjusted income from discontinued operations

   $ —        $ 154   
                

Denominator

    

Weighted average shares outstanding-basic

     183,633        184,061   

Incremental weighted average shares effect of conversion of OP units

     13,444        7,003   
                

Weighted average shares outstanding-diluted

     197,077        191,064   
                

NET INCOME PER COMMON SHARE-BASIC

    

Net loss from continuing operations

   $ (0.05   $ (0.04

Net income from discontinued operations, net of noncontrolling interest

     —          0.00   
                

Net loss

   $ (0.05   $ (0.04
                

NET INCOME PER COMMON SHARE-DILUTED

    

Net loss from continuing operations

   $ (0.05   $ (0.04

Net income from discontinued operations, net of noncontrolling interest

     —          0.00   
                

Net loss

   $ (0.05   $ (0.04
                

 

13. SEGMENT INFORMATION

We have two reportable operating segments: investments in real property and debt related investments. We organize and analyze the operations and results of each of these segments independently, due to inherently different considerations for each segment. Such considerations include, but are not limited to, the nature and characteristics of the investment, investment strategies and objectives and distinct management of each segment. The following table sets forth revenue and the components of net operating income (“NOI”) of our segments for the three months ended March 31, 2011 and 2010 (amounts in thousands).

 

     Revenues      NOI  
     2011      2010      2011      2010  

Real property (1)

   $ 65,633       $ 38,570       $ 51,203       $ 27,540   

Debt related investments (2)

     4,486         3,986         4,486         3,986   
                                   

Total

   $ 70,119       $ 42,556       $ 55,689       $ 31,526   
                                   

 

(1) Does not include results of operations of real property assets categorized as discontinued operations.
(2) Includes operating results from our investment in an unconsolidated joint venture.

 

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We consider NOI to be an appropriate supplemental financial performance measure because NOI reflects the specific operating performance of our real properties and debt related investments, and excludes certain items that are not considered to be controllable in connection with the management of each property, such as interest income, depreciation and amortization, general and administrative expenses, asset management fees, interest expense and noncontrolling interests. However, NOI should not be viewed as an alternative measure of our financial performance as a whole, since it does exclude such items that could materially impact our results of operations. Further, our NOI may not be comparable to that of other real estate companies, as they may use different methodologies for calculating NOI. Therefore, we believe net income, as defined by GAAP, to be the most appropriate measure to evaluate our overall financial performance.

The following table is a reconciliation of our NOI to our reported net loss from continuing operations for the three months ended March 31, 2011 and 2010 (amounts in thousands).

 

     For the Three Months Ended March 31,  
     2011     2010  

Net operating income

   $ 55,689      $ 31,526   

Interest and other income

     414        1,640   

Depreciation and amortization expense

     (32,147     (15,751

General and administrative expenses

     (1,757     (1,364

Asset management fees, related party

     (5,253     (3,619

Interest expense

     (23,100     (14,756

Acquisition-related expenses net of other (losses) gains

     (455     (5

Other-than-temporary impairment on securities

     —          (1,693

Provision for loss on debt related investments

     (2,500     (2,984

Discontinued operations

     —          171   

Net loss attributable to noncontrolling interests

     673        320   
                

Net loss attributable to common stockholders

   $ (8,436   $ (6,515
                

The following table reflects our total assets by business segment as of March 31, 2011 and December 31, 2010 (amounts in thousands).

 

     As of March 31,
2011
     As of December 31,
2010
 

Segment assets:

     

Net investments in real property

   $ 2,606,220       $ 2,610,699   

Debt related investments, net

     149,969         217,492   
                 

Total segment assets, net

     2,756,189         2,828,191   

Non-segment assets:

     

Cash and cash equivalents

     64,808         83,559   

Other non-segment assets (1)

     80,559         87,457   
                 

Total assets

   $ 2,901,556       $ 2,999,207   
                 

 

(1) Other non-segment assets primarily consist of corporate assets including restricted cash, investments in real estate securities, and certain loan costs, including loan costs associated with our financing obligations.

 

14. COMMITMENTS AND CONTINGENCIES

Litigation

On July 14, 2010, Northrop Grumman Systems Corporation (“Northrop”), filed a complaint in the Circuit Court of Fairfax County, Virginia against iStar NG, LP, TRT Acquisitions, LLC, TRT NOIP Colshire—McLean LLC, and Dividend Capital Total

 

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Realty Trust Inc. (together, the “Dividend Capital Defendants”) and iStar Financial Inc. (“iStar Financial” and, together with Dividend Capital Defendants, the “Defendants”). Northrop’s Complaint pertains to a real estate project containing two commercial office buildings and a parking garage located at 7555-7575 Colshire Drive in McLean, Virginia (the “Project”). TRT NOIP Colshire—McLean LLC, a wholly-owned subsidiary of Dividend Capital Total Realty Trust Inc., acquired iStar NG LP as part of the National Office and Industrial Portfolio which was acquired from several subsidiaries of iStar Financial on June 25, 2010. Northrop, a holder of a leasehold interest in the Project, alleges that iStar Financial and the Dividend Capital Defendants knowingly completed the sale of the Project (rather than a sale of the owner of the Project, iStar NG LP). Northrop’s Complaint claims that the alleged sale of the Project violated Northrop’s right of first offer (“ROFO”) contained in the relevant deed of lease. Northrop’s Complaint seeks specific performance of the ROFO, other injunctive relief, compensatory damages in the amount of $250 million, $350,000 in punitive damages, treble damages under the Virginia Business Conspiracy Statute, costs, and attorneys’ fees.

On August 10, 2010, Defendants filed demurrers with the Fairfax County Circuit Court seeking dismissal of Northrop’s Complaint as a matter of law. On January 7, 2011, the court sustained the Dividend Capital Defendants’ demurrers and dismissed Northrop’s claims for tortious interference, unjust enrichment, violation of the Virginia Business Conspiracy Act and conversion, without prejudice. On January 28, 2011, Northrop filed an amended complaint, reasserting the dismissed counts. On February 18, 2011, the Defendants filed renewed demurrers and a plea in bar seeking dismissal of the claims for tortious interference, unjust enrichment, violation of the Virginia Business Conspiracy Act and conversion. The Defendants’ demurrers are scheduled for hearing on May 13, 2011. In addition to defending Northrop’s amended complaint generally and asserting counterclaims, the Dividend Capital Defendants have obtained indemnities from iStar Financial and insurance coverage that are subject to certain terms, conditions, and limitations.

On September 15, 2010, the Dividend Capital Defendants asserted counterclaims against Northrop based in part on Northrop’s intentional interference with the sale of the Project, its interference with contracts and prospective contracts, and its breach of the contract between iStar NG and Northrop. The Dividend Capital Defendants seek specific performance, damages in an amount yet to be determined, costs, and attorneys’ fees. Northrop has filed demurrers seeking dismissal of the Dividend Capital Defendants’ counterclaims, which are also scheduled for hearing on May 13, 2011.

Due to uncertainty regarding the outcome of these proceedings, we cannot estimate the effect that any potential settlement would have on our business, financial condition, or results of operations.

Discovery between the parties is ongoing, and, under the current scheduling order, set to be completed by August 15, 2011. A bench trial has been set to commence on September 12, 2011.

 

15. SUBSEQUENT EVENTS

We have evaluated subsequent events for the period from March 31, 2011, the date of these financial statements, through the date these financial statements are issued, and determined that there have been no significant subsequent events.

 

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

Forward-Looking Statements

This Quarterly Report on Form 10-Q includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Such forward-looking statements relate to, without limitation, our future capital expenditures, distributions and acquisitions (including the amount and nature thereof), other development trends of the real estate industry, business strategies, and the growth of our operations. These statements are based on certain assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Exchange Act. Such statements are subject to a number of assumptions, risks and uncertainties which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward-looking statements. Forward-looking statements are generally identifiable by the use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,” “project,” “continue,” or the negative of these words, or other similar words or terms. Readers are cautioned not to place undue reliance on these forward-looking statements. Among the factors that may cause our results to vary are general economic and business (particularly real estate and capital market) conditions being less favorable than expected, the business opportunities that may be presented to and pursued by us, changes in laws or regulations (including changes to laws governing the taxation of REITs), risk of acquisitions, availability and creditworthiness of prospective tenants, availability of capital (debt and equity), interest rate fluctuations, competition, supply and demand for properties in our current and any proposed market areas, tenants’ ability to pay rent at current or increased levels, accounting principles, policies and guidelines applicable to REITs, environmental, regulatory and/or safety requirements, tenant bankruptcies and defaults, the availability and cost of comprehensive insurance, including coverage for terrorist acts, and other factors, many of which are beyond our control. For a further discussion of these factors and other risk factors that could lead to actual results materially different from those described in the forward-looking statements, see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010, filed with the Commission on March 25, 2011. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of future events, new information or otherwise.

This section of our Quarterly Report on Form 10-Q provides an overview of what management believes to be the key elements for understanding (i) our company and how we manage our business, (ii) how we measure our performance and our operating results, (iii) our liquidity and capital resources, and (iv) the financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.

Overview

Dividend Capital Total Realty Trust Inc. is a Maryland corporation formed on April 11, 2005 to invest in a diverse portfolio of real property and real estate related investments.

We believe we have operated in such a manner to qualify as a REIT for federal income tax purposes, commencing with the taxable year ended December 31, 2006, when we first elected REIT status. We utilize an UPREIT organizational structure to hold all or substantially all of our assets through our Operating Partnership. Furthermore, our Operating Partnership wholly owns a taxable REIT subsidiary, DCTRT Leasing Corp., through which we execute certain business transactions that might otherwise have an adverse impact on our status as a REIT if such business transactions were to occur directly or indirectly through our Operating Partnership. We are an externally managed REIT and have no employees. Our day-to-day activities are managed by our Advisor, an affiliate, under the terms and conditions of the Advisory Agreement.

The primary source of our revenue and earnings is comprised of rent received from customers under long-term operating leases of our properties, including reimbursements from customers for certain operating costs, and interest payments from our debt related investments. Our primary expenses include rental expenses, depreciation and amortization expenses, general and administrative expenses, asset management fees and interest expense.

The cornerstone of our investment strategy is to provide investors seeking a general real estate allocation with a broadly diversified portfolio of assets. Our current investments include:

 

  (1) direct investments in real properties, consisting of office, industrial, and retail properties, located in North America; and

 

  (2) certain debt related investments, including originating and participating in whole mortgage loans secured by commercial real estate, B-notes and mezzanine debt.

 

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As of March 31, 2011, we had total gross investments of approximately $3.0 billion (before accumulated depreciation of approximately $281.8 million), comprised of:

 

  (1) 101 operating properties located in 31 geographic markets in the United States, aggregating approximately 19.2 million net rentable square feet. As of March 31, 2011, our real property portfolio was approximately 95% leased. Our operating real property portfolio includes an aggregate gross investment amount of approximately $2.9 billion and consists of:

 

   

37 office properties located in 16 geographic markets, aggregating approximately 7.1 million net rentable square feet, with an aggregate gross investment amount of approximately $1.7 billion;

 

   

33 retail properties located in 7 geographic markets, aggregating approximately 3.1 million net rentable square feet, with an aggregate gross investment amount of approximately $729.7 million; and

 

   

31 industrial properties located in 17 geographic markets, aggregating approximately 9.0 million net rentable square feet, with an aggregate gross investment amount of approximately $489.5 million.

  (2) Approximately $150.0 million in net debt related investments, including (i) investments in mortgage notes of approximately $95.6 million, (ii) investments in B-notes of approximately $36.9 million, and (iii) investments in mezzanine debt of approximately $17.5 million.

Consistent with our investment strategy, we have two business segments: (i) investments in real property and (ii) debt related investments. For a discussion of our business segments and the associated revenue and net operating income by segment, see Note 13 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.

Any future and near-term investment activity is expected to be funded primarily through the use of cash on hand, cash generated from operations, proceeds from the DRIP Plan, proceeds from the sale of existing investments, and the issuance and assumption of debt obligations.

 

   

Cash on hand — As of March 31, 2011, we had approximately $64.8 million of cash and cash equivalents.

 

   

Cash generated from operations — During the three months ended March 31, 2011, we generated approximately $26.6 million from operations of our real properties and income from debt related investments.

 

   

Proceeds from the DRIP Plan — During the three months ended March 31, 2011, we received approximately $11.8 million in proceeds from the DRIP Plan.

 

   

Proceeds from sales of existing investments — During the year ended December 31, 2010, we sold 12 properties for total net sales proceeds of $207.0 million (excluding net proceeds from the sale of collateral related to our foreclosed debt investment). We did not sell any properties during the three months ended March 31, 2011, however, one of our debt related investments matured, upon which we received net proceeds of approximately $17.6 million.

 

   

The issuance and assumption of debt obligations — During the year ended December 31, 2010, we incurred total debt obligations of approximately $1.1 billion, prior to the repayment of approximately $277.7 million, for net borrowings of approximately $791.9 million. We did not incur any debt obligations during the three months ended March 31, 2011.

We believe that our existing cash balance, cash generated from operations, proceeds from our DRIP Plan and our ability to sell investments and to issue debt obligations, remains adequate to meet our expected capital obligations for the next twelve months. Maintaining a strong balance sheet remains critical in the current market to position us well to preserve the value of our portfolio and to take advantage of investment opportunities. Currently, we anticipate our 2011 investment activity to be substantially less than our investment activity in 2010. Historically, we have been prudent in the deployment of our capital, resulting in a slower pace of investments. This resulted in us carrying higher cash balances over the past couple of years, which in turn diluted our goal of funding the payment of quarterly distributions to our investors entirely from our operations over time. With our acquisition of a portfolio of 32 office and industrial properties (the “NOIP Portfolio”) in June 2010, we have made significant progress towards this goal and we believe that this investment should continue to have a positive impact on our operating results.

Significant Transactions During the Three Months Ended March 31, 2011

Real Property Acquisitions

During the three months ended March 31, 2011, we acquired two retail properties in the New England market aggregating 147,000 square feet with a combined purchase price of $21.8 million.

Westin Loan Repayment

During the three months ended March 31, 2011, we received full and complete repayment of a debt investment structured as a mortgage note that was collateralized by two hotel properties located in the Houston, Texas market (the “Westin Galleria Loan”).

 

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Our investment in the Westin Galleria Loan was approximately $65.0 million as of December 31, 2010. Upon repayment of this loan to us, the borrower paid us a prepayment fee of approximately $813,000, which has been included in debt related income in the statement of operations. The Westin Galleria Loan effectively secured approximately $48.8 million in other secured borrowings that we repaid upon the repayment of this debt investment. We realized net proceeds upon repayment of approximately $17.6 million, including the receipt of accrued interest payable to us. The prepayment of this debt investment caused us to accelerate net unamortized origination fee and deferred due diligence costs that were included in the carrying value of the investment of approximately $325,000, which was recorded as an increase to debt related income.

How We Measure Our Performance

Funds From Operations

NAREIT-defined FFO (“FFO”)

We believe that FFO, as defined by the National Association of Real Estate Investment Trusts (“NAREIT”), is a meaningful supplemental measure of our operating performance because historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time, as reflected through depreciation and amortization expense. However, since real estate values have historically risen or fallen with market and other conditions, many industry investors and analysts have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient. Thus, NAREIT created FFO as a supplemental measure of operating performance for real estate investment trusts that consists of net income (loss), calculated in accordance with GAAP, plus real estate-related depreciation and amortization, less gains (or losses) from dispositions of real estate held for investment purposes.

 

     For the Three Months Ended,
March 31,
 
     2011     2010  

Reconciliation of net earnings to FFO:

    

Net loss attributable to common stockholders

   $ (8,436   $ (6,514

Add (deduct) NAREIT-defined adjustments:

    

Depreciation and amortization expense

     32,147        15,751   

Depreciation attributable to discontinued operations

     —          47   

Noncontrolling interests’ share of net loss

     (673     (320

Noncontrolling interests’ share of FFO

     (2,108     (902
                

FFO attributable to common shares-basic

     20,930        8,062   

FFO attributable to dilutive OP units

     1,532        307   
                

FFO attributable to common shares-diluted

   $ 22,462      $ 8,369   
                

FFO per share-basic

   $ 0.11      $ 0.04   
                

FFO per share-diluted

   $ 0.11      $ 0.04   
                

 

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Company-Defined FFO

As part of its guidance concerning FFO, NAREIT has stated that the “management of each of its member companies has the responsibility and authority to publish financial information that it regards as useful to the financial community.” As a result, modifications to FFO are common among REITs as companies seek to provide financial measures that meaningfully reflect the specific characteristics of their businesses. We believe that investors and other stakeholders who review our operating results are best served by providing them with the same performance metrics used by management to gauge operating performance. Therefore, we provide a Company-Defined FFO measure in addition to the NAREIT definition of FFO and other GAAP measures. However, no single measure can provide users of financial information with sufficient information and only our disclosures read as a whole can be relied upon to adequately portray our financial position, liquidity and results of operations.

Certain GAAP measures, as well as FFO, include items that may affect comparability from period to period. Our primary objective for Company-Defined FFO is to provide investors with a supplemental earnings metric that indicates the performance of our operations before certain non-cash charges, non-operating or other items that management believes affects the comparability of our operating results from period to period. Our Company-Defined FFO is derived by adjusting FFO for the following items: gains or loss associated with provisions for loss on debt related investments, acquisition related expenses, and gains and losses on derivatives.

Gains and loss associated with provision for loss on debt related investments — Currently, our investment strategy does not include purchasing and selling debt related investments for the purpose of generating short-term gains. Rather, our investment strategy is to hold our investments for the long-term for the purpose of earning current income. As a result, management believes that any gains or losses generated from the sale or impairment of such debt related investments are non-routine and intermittent and result in a disproportionate impact to our earnings in the period in which such gains or losses are recorded compared to prior or future periods.

Acquisition related expenses — For GAAP purposes, expenses associated with the acquisition of real property, including acquisition fees paid to our Advisor and gains or losses related to the change in fair value of contingent consideration related to the acquisition of real property are recorded to earnings. Management does not include acquisition-related expenses in its evaluation of operating performance because our level of acquisition activity varies from period to period and such expenses do not recur subsequent to acquisition. As a result, our operating performance may not be comparable period to period without adjusting for such acquisition-related expenses.

Gains and losses on derivatives — Gains and losses on derivatives represent the gains or losses on the fair value of derivative instruments that are not accounted for as hedges of the underlying financing transactions. Such gains and losses may be due to the nonoccurrence of forecasted financings or ineffectiveness due to changes in the expected terms of financing transactions. These types of charges are not unusual or infrequent but management believes that any gains or losses on derivatives are not reflective of our operating performance and can have an inconsistent impact to our operating results derived from our core business operations.

 

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     For the Three Months Ended,
March 31,
 
     2011     2010  

Reconciliation of FFO to Company-Defined FFO:

    

FFO attributable to common shares-basic

     20,930        8,062   

Add (deduct) our adjustments:

    

Other-than-temporary impairment and related amortization on securities

     126        2,936   

Provision for loss on debt related investments

     2,500        2,984   

Acquisition-related expenses (gains)

     455        5   

(Gain) loss on derivatives

     57        —     

Noncontrolling interests’ share of NAREIT-defined FFO

     2,108        902   

Noncontrolling interest share of Company-Defined FFO

     (2,322     (1,119
                

Company-Defined FFO attributable to common shares-basic

     23,854        13,770   

Company-Defined FFO attributable to dilutive OP units

     1,744        524   
                

Company-Defined FFO attributable to common shares-diluted

   $ 25,598      $ 14,294   
                

Company-Defined FFO per share-basic

   $ 0.13      $ 0.07   
                

Company-Defined FFO per share-diluted

   $ 0.13      $ 0.07   
                

Weighted Average Number of Shares Outstanding

    

Basic

     183,633        184,061   
                

Diluted

     197,077        191,064   
                

Limitations of FFO and Company-Defined FFO

FFO (as discussed above, “FFO” includes NAREIT-defined FFO and Company-Defined FFO) is presented herein as a supplemental financial measure and has inherent limitations. We do not use FFO as, nor should it be considered to be, an alternative to net income (loss) computed under GAAP as an indicator of our operating performance, or as an alternative to cash from operating activities computed under GAAP, or as an indicator of our ability to fund our short or long-term cash requirements. Management uses FFO as an indication of our operating performance and as a guide to making decisions about future investments. Our FFO calculations do not present, nor do we intend them to present, a complete picture of our financial condition and operating performance. In addition, other REITs may define FFO differently and choose to treat impairment charges, acquisition related expenses and potentially other accounting line items in a manner different from us due to specific differences in investment strategy or for other reasons. Our Company-Defined FFO calculation is limited by its exclusion of certain items previously discussed, but we continuously evaluate our investment portfolio and the usefulness of our Company-Defined FFO measure in relation thereto. We believe that net income (loss) computed under GAAP remains the primary measure of performance and that FFO is only meaningful when it is used in conjunction with net income (loss) computed under GAAP. Further, we believe that our consolidated financial statements, prepared in accordance with GAAP, provide the most meaningful picture of our financial condition and operating performance.

Public Conference Call

We will be hosting a public conference call on Tuesday, May 31, 2011, to review our quarterly financial and operating results for the three months ended March 31, 2011. Guy Arnold, our President, and Kirk Scott, our Chief Financial Officer, will present performance data and provide management commentary. The conference call will take place at 4:15 p.m. EDT and can be accessed by dialing 888.482.0024 and referencing “Dividend Capital Passcode 51219761.”

Net Operating Income (“NOI”)

We also use NOI as a supplemental financial performance measure because NOI reflects the specific operating performance of our real properties and debt related investments and excludes certain items that are not considered to be controllable in connection with the management of each property, such as gains on the disposition of securities, other-than-temporary impairment, gains and losses related to provisions for losses on debt related investments, gains or losses on derivatives, acquisition related expenses, losses

 

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on financing commitments, interest income, depreciation and amortization, general and administrative expenses, asset management fees, interest expense and noncontrolling interests. However, NOI should not be viewed as an alternative measure of our financial performance as a whole, since it does exclude such items that could materially impact our results of operations. Further, our NOI may not be comparable to that of other real estate companies, as they may use different methodologies for calculating NOI. Therefore, we believe net income, as defined by GAAP, to be the most appropriate measure to evaluate our overall financial performance.

Our Operating Results

The following series of tables and discussions describe in more detail our results of operations for the three months ended March 31, 2011 compared to the three months ended March 31, 2010.

The following table illustrates the changes in rental revenues, rental expenses and net operating income for the three months ended March 31, 2011 compared to the three months ended March 31, 2010. Our same store portfolio includes all operating properties that we owned for the entirety of both the current and prior year reporting periods. The same store portfolio includes 75 properties acquired prior to January 1, 2010 and owned through March 31, 2011, comprising approximately 12.9 million square feet. A discussion of these changes follows the table (dollar amounts in thousands).

 

     For the Three Months
Ended March 31,
              
     2011      2010      $ Change     % Change  

Revenues

          

Base rental revenue-same store (1)

   $ 28,572       $ 29,603       $ (1,031     -3

Other rental revenue- same store

     8,810         8,967         (157     -2
                                  

Total rental revenue-same store

     37,382         38,570         (1,188     -3

Rental revenue-2010 acquisitions

     28,251         —           28,251        100
                                  

Total rental revenue

     65,633         38,570         27,063        70

Debt related income (2)

     4,486         3,986         500        13
                                  

Total revenues

   $ 70,119       $ 42,556       $ 27,563        65
                                  

Rental Expenses

          

Same store

   $ 11,049       $ 11,030       $ 19        0

2010 acquisitions

     3,381         —           3,381        100
                                  

Total rental expenses

   $ 14,430       $ 11,030       $ 3,400        31
                                  

Net Operating Income (3)

          

Real property - same store

   $ 26,333       $ 27,540       $ (1,207     -4

Real property - 2010/2009 acquisitions

     24,870         —           24,870        100

Debt related income

     4,486         3,986         500        13
                                  

Total net operating income

   $ 55,689       $ 31,526       $ 24,163        77
                                  

 

(1) Base rental revenue represents contractual base rental revenue earned by us from our tenants and does not include the impact of certain GAAP adjustments to rental revenue, such as straight-line rent adjustments, amortization of above-market intangible lease assets or the amortization of below-market lease intangible liabilities. Such GAAP adjustments and other rental revenue such as expense recovery revenue are included in the line item, referred to as “other rental revenue.”
(2) Includes equity-in-earnings from an unconsolidated joint venture of approximately $545,000 for the three months ended March 31, 2010.
(3) For a discussion as to why we view net operating income to be an appropriate supplemental performance measure, refer to “—How We Measure Our Performance—Net Operating Income” above.

Rental Revenue

The increase in rental revenue is primarily attributable to our acquisition and continued ownership of 26 additional operating real properties subsequent to December 31, 2009. Our operating portfolio was approximately 94.6% leased as of March 31, 2011, compared to approximately 93.1% as of March 31, 2010.

Same store base rental revenues decreased slightly for the three months ended March 31, 2011 compared to the same period in 2010. This decrease was primarily due to decreased leased square footage in the same store portfolio of assets, partially offset by scheduled rent increases and the expiration of certain rent abatement terms during the year ended December 31, 2010. As of March 31, 2011 and 2010, our same store portfolio was approximately 92.0% and 93.3% leased, respectively.

Same store other rental revenue decreased for the three months ended March 31, 2011 compared to the same period in 2010. This decrease was attributable to lower tenant recovery income, which was the result of lower percent leased square footage and lower recoverable expenses.

 

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Debt Related Income

Debt related income increased for the three months ended March 31, 2011, compared to the same period in 2010. The increase was primarily attributable to our investment of $160.6 million in debt related investments subsequent to December 31, 2009, offset by (i) the repayment of a debt related investment, structured as a redeemable preferred equity security and recorded as an investment in an unconsolidated joint venture of approximately $17.4 million, (ii) our foreclosure on and subsequent sale of a property that we had previously held as a debt related investment of approximately $17.3 million, and (iii) the full and complete repayment of an approximately $65.0 million investment, that occurred subsequent to December 31, 2009.

Rental Expenses

Rental expenses increased for the three months ended March 31, 2011, compared to the same period in 2010. This increase is primarily attributable to our acquisition and continued ownership of 26 additional operating real properties subsequent to December 31, 2009.

Same store rental expenses increased slightly for the three months ended March 31, 2011, compared to the same period in 2010. This increase is due primarily to severe winter weather in the New England and Chicago markets in the current year causing an increase in snow removal costs over the same period in 2010, offset by generally lower expenses due to lower occupancy. These declines were primarily the result of lower occupancy, cost reduction measures and a larger property portfolio, which reduces insurance premiums for each property. Lower property tax expense resulted from lower assessed valuations applied by local taxing authorities in determining our property tax liabilities.

Other Operating Expenses

Depreciation and Amortization Expense: Depreciation and amortization expense increased by approximately $16.4 million, or 104%, for the three months ended March 31, 2011, compared to the same period in 2010. This increase is primarily attributable to our acquisition and continued ownership of 26 additional operating real properties subsequent to December 31, 2009.

General and Administrative Expenses: General and administrative expenses increased by approximately $393,000, or 29%, for the three months ended March 31, 2011, compared to the same period in 2010. This increase is primarily attributable to increases in accounting and legal fees and other general overhead expenses, primarily related to the growth of the portfolio.

Asset Management Fees, Related Party: Asset management fees paid to our Advisor increased by approximately $1.6 million, or 45%, for the three months ended March 31, 2011, compared to the same period in 2010. This increase resulted from our investment activity subsequent to December 31, 2009, including our acquisition of the NOIP Portfolio, and the origination of additional debt investments.

Acquisition Related Expenses: Acquisition related expenses, including fees paid to our Advisor, increased by approximately $450,000, from approximately $5,000, for the three months ended March 31, 2011, compared to the same period in 2010, due to the acquisition of two operating real properties during the three months ended March 31, 2011, which exceeded the acquisition activity during the three months ended March 31, 2010.

Other Income (Expenses)

Interest and Other Income: Interest and other income decreased by approximately $1.2 million, or 75%, for the three months ended March 31, 2011, compared to the same period in 2010. This decrease is primarily attributable to the sale of our preferred equity securities portfolio and continued deterioration in the performance of our CMBS and CRE-CDO securities portfolio, our significantly reduced average cash balance during the year due to the acquisition of the NOIP Portfolio, and lower average yields on our floating-rate interest-bearing bank accounts and money market mutual fund investments.

Interest Expense: Interest expense increased by approximately $8.3 million, or 57%, for the three months ended March 31, 2011, compared to the same period in 2010. This increase resulted primarily from additional mortgage note and other financings we assumed or incurred subsequent to December 31, 2009, partially offset by the effects of repayments of certain of these obligations. Our total borrowings, including financing obligations, increased by 68% to approximately $1.6 billion as of March 31, 2011 from approximately $941.2 million as of March 31, 2010, principally due to financing incurred in connection with our investment activities. The following table further describes our interest expense by debt obligation, including amortization of loan cost, amortization related to our derivatives, and amortization of discounts and premiums, for the three months ended March 31, 2011 and 2010 (amounts in thousands).

 

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     For the Three Months Ended March 31,  
     2011      2010  

Debt Obligation

     

Mortgage notes

   $ 21,396       $ 12,942   

Other secured borrowings

     1,008         33   

Financing obligations

     696         1,781   
                 

Total interest expense

   $ 23,100       $ 14,756   
                 

Other-than-Temporary Impairment on Securities: During the three months ended March 31, 2010, we recorded net other-than-temporary impairment charges of approximately $1.7 million related to two of our CMBS and CRE-CDO securities. We did not record any net other-than-temporary impairment charges during the same period in 2011.

Provision for loss on debt related investments: During the three months ended March 31, 2011 and 2010, we recognized provisions for loan loss of approximately $2.5 million and 3.0 million, respectively, related to two of our debt related investments.

Liquidity and Capital Resources

Liquidity Outlook

We believe our existing cash balance, cash from operations, additional proceeds from the DRIP Plan, proceeds from the sale of existing investments and prospective debt or equity issuances will be sufficient to meet our liquidity and capital needs for the foreseeable future, including the next 12 months. Our capital requirements over the next 12 months are anticipated to include, but are not limited to, operating expenses, distribution payments, debt service payments, including debt maturities of approximately $27.7 million, redemption payments, acquisitions of real property and debt related investments. The following discussion summarizes the sources and uses of our cash during the three months ended March 31, 2011.

Operating Activities

Net cash provided by operating activities was approximately $26.6 million for the three months ended March 31, 2011, compared to net cash provided by operating activities of approximately $15.5 million for the same period in 2010. This increase is primarily due to increased income due to additional real property and debt investments made subsequent to December 31, 2009.

Lease Expirations

Our primary source of funding for our property-level operating expenses and debt service payments is rent collected pursuant to our tenant leases. Our properties are generally leased to tenants for terms ranging from three to ten years. As of March 31, 2011, the weighted average remaining term of our leases was approximately 8.4 years, based on contractual remaining base rent, and 5.6 years, based on square footage. The following is a schedule of expiring leases for our consolidated operating properties by annualized base rent and square footage as of March 31, 2011 and assuming no exercise of lease renewal options (amounts in thousands).

 

      Lease Expirations  

Year

   Annualized
Base Rent (1)
     %     Square Feet      %  

2011

   $ 10,859         5.0     1.290         7.1

2012

     16,499         7.6     1,677         9.3

2013

     15,824         7.3     1,359         7.5

2014

     18,889         8.7     2,290         12.6

2015

     16,680         7.7     1,605         8.8

2016

     26,157         12.1     1,997         11.0

2017

     47,906         22.1     2,860         15.7

2018

     5,690         2.6     1,239         6.8

2019

     13,126         6.1     654         3.6

2020

     6,854         3.2     370         2.0

Thereafter

     38,331         17.6     2,846         15.6
                                  

Total

   $ 216,815         100.0     18,187         100.0
                                  

 

(1) Annualized base rent represents the annualized monthly base rent of leases in place as of March 31, 2011, based on their respective non-cancellable terms.

 

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Investing Activities

Net cash used in investing activities was approximately $4.9 million for the three months ended March 31, 2011, compared to approximately $1.2 million for the same period in 2010. This increase was primarily attributable to our acquisition of two real properties during the three months ended March 31, 2011, offset by the repayment of one of our debt related investments.

Financing Activities

Net cash used in financing activities during the three months ended March 31, 2011 was approximately $40.5 million and primarily comprised the redemption of common shares, distributions to common stockholders and noncontrolling interest holders, and scheduled repayment of our mortgage notes and other secured borrowings. Net cash used in financing activities during the same period in 2010 was approximately $40.1 million and primarily comprised the redemption of common shares, distributions to common stockholders, and the repayment of other secured borrowings.

Debt Maturities

The following table reflects our contractual debt maturities as of March 31, 2011, specifically our obligations under mortgage note agreements and other secured borrowings (amounts in thousands).

 

     As of March 31, 2011  

Year Ending December 31,

   Number of
Borrowings
Maturing (1)
     Outstanding
Balance (2) (3) (4)
 

2011

     2       $ 15,216   

2012

     4         391,468   

2013

     3         85,228   

2014

     2         92,092   

2015

     7         164,770   

2016

     14         310,349   

2017

     8         308,371   

2018

     0         4,999   

2019

     0         5,292   

2020

     1         157,944   

Thereafter

     3         10,772   
                 

Total

     44       $ 1,546,501   

 

(1) Borrowings presented include other secured borrowings of approximately $51.2 million related to our master repurchase facility account, which matures in June 2013 and is subject to two one-year extensions and mezzanine borrowings of approximately $26.8 million, which mature in June, 2015.
(2) Eight of our mortgage notes with an aggregate outstanding principal balance as of March 31, 2011 of approximately $406.3 million have initial maturities before January 1, 2014. Three of these notes with an aggregate outstanding principal balance as of March 31, 2011 of approximately $322.4 million have extension options beyond December 31, 2013. These extension options are subject to certain lender covenants and restrictions that we must meet to extend the respective maturity dates. We currently have not determined whether we will exercise our options to extend these notes and we cannot assert with any degree of certainty that we will meet the requirements to extend the notes upon the initial maturity dates of the mortgage notes.
(3) Outstanding balance represents expected cash outflows for contractual amortization and scheduled balloon payment maturities, and does not include our mark-to-market adjustment on assumed debt of approximately $4.9 million as of March 31, 2011.
(4) As of March 31, 2011, our mortgage notes and secured borrowings are secured by real properties and debt investments totaling approximately $2.9 billion.

Distributions

To obtain the favorable tax treatment accorded to REITs, we normally will be required each year to distribute to our stockholders at least 90% of our real estate investment trust taxable income, determined without regard to the deduction for distributions paid and by excluding net capital gains. The payment of distributions is determined by our board of directors and may be adjusted at its discretion at any time. Distribution levels are set by our board of directors at a level it believes to be appropriate and

 

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sustainable based upon a review of a variety of factors including, but not limited to, REIT requirements, the evaluation of existing assets within our portfolio, anticipated acquisitions, projected levels of additional capital to be raised, debt to be incurred in the future and the anticipated results of operations.

Distributions declared payable to common stockholders totaled approximately $27.5 million for the three months ended March 31, 2011 compared to approximately $27.6 million for the same period in 2010. Such distributions were paid following the respective quarters for which they were declared and approximately $15.9 million and $14.3 million, respectively, were paid in cash and approximately $11.6 million and $13.3 million, respectively, were reinvested in shares of our common stock pursuant to the DRIP Plan.

For the three months ended March 31, 2011 and 2010, we reported $26.6 million and $15.5 million, respectively, of cash provided by our operating activities. In accordance with ASC Topic 805 “Business Combinations” (“ASC Topic 805”), which became effective for the year ended December 31, 2009, these amounts were reduced by approximately $455,000 and $5,000, respectively, of acquisition related expenses, which were funded from the net proceeds received from our public offerings. As a result, the distributions declared payable to common stockholders for the three months ended March 31, 2011 and 2010, as described above, were funded with approximately $27.1 million and $15.5 million, respectively (excluding the impact of ASC Topic 805 as described above), from our operating activities, and the remaining amounts of approximately $400,000 and $12.1 million, respectively, were funded from our borrowings. Our long-term strategy is to fund the payment of quarterly distributions to investors entirely from our operations. There can be no assurance that we will achieve this strategy.

Redemptions

During the three months ended March 31, 2011 and 2010, we redeemed approximately 1.3 million and 1.3 million shares of common stock, respectively, pursuant to our share redemption program. Cash used to redeem such shares decreased approximately $1.3 million to $11.5 million during the three months ended March 31, 2011, from $12.8 million for the same period in 2010. In addition to the above-mentioned redemptions, during the three months ended March 31, 2011, we redeemed approximately 28,000 OP Units from our OP Unit holders for approximately $267,000 during the three months ended March 31, 2011, we redeemed approximately 99,000 OP Units from our OP Unit holders for approximately 98,000 shares of our common stock. We did not redeem any OP Units during the three months ended March 31, 2010. See “Part II, Item 2. Unregistered Sales of Equity Securities and Use of Proceeds” of this Quarterly Report on Form 10-Q for more information regarding redemptions of shares and OP units during the three months ended March 31, 2011.

Subsequent Events

For information regarding subsequent events, see Note 15 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.

New Accounting Pronouncements

For information regarding new accounting pronouncements, see Note 2 to our financial statements included in “Item 1. Financial Statements” of this Quarterly Report on Form 10-Q.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the adverse effect on the value of assets and liabilities that results from a change in the applicable market resulting from a variety of factors such as perceived risk, interest rate changes, inflation and overall general economic changes. Accordingly, we manage our market risk by matching projected cash inflows from operating, investing and financing activities with projected cash outflows for debt service, acquisitions, capital expenditures, distributions to stockholders and unit holders, and other cash requirements. Our investments in real estate securities and debt related investments are our financial instruments that are most significantly and directly impacted by changes in their respective market conditions. In addition, our outstanding borrowings are also directly impacted by changes in market conditions. This impact is largely mitigated by the fact that the majority of our outstanding borrowings have fixed interest rates, which minimize our exposure to the risk that fluctuating interest rates may pose to our operating results and liquidity.

As of March 31, 2011, we had approximately $429.8 million of variable rate borrowings outstanding indexed to LIBOR rates. If the LIBOR rates relevant to our remaining variable rate borrowings were to increase 10%, we estimate that our quarterly interest expense would increase by approximately $7,000 based on our outstanding floating-rate debt as of March 31, 2011.

We may seek to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs by selectively utilizing derivative instruments to hedge exposures to changes in interest rates on loans secured by our assets. We maintain risk management control systems to monitor interest rate cash flow risk attributable to both our outstanding and forecasted debt obligations as well as our potential offsetting hedge positions. While this hedging strategy is designed to minimize the impact on our net income (loss) and funds from operations from changes in interest rates, the overall returns on our investments may be reduced. Our board of directors has established policies and procedures regarding our use of derivative instruments for hedging or other purposes.

In addition to the above described risks, we are subject to additional credit risk. Credit risk refers to the ability of each individual borrower under our debt related investments or issuer of our real estate securities to make required interest and principal payments on the scheduled due dates. We seek to reduce credit risk by actively monitoring our debt related investments and real estate securities portfolio and the underlying credit quality of our holdings. In the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may continue to increase and result in further credit losses that would continue to, or more severely, adversely affect our liquidity and operating results.

 

ITEM 4. CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s President and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2011. Based on that evaluation, the Company’s President and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2011. There were no material changes in the Company’s internal control over financial reporting during the three months ended March 31, 2011.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

On July 14, 2010, Northrop Grumman Systems Corporation (“Northrop”), filed a complaint in the Circuit Court of Fairfax County, Virginia against iStar NG, LP, TRT Acquisitions, LLC, TRT NOIP Colshire—McLean LLC, and Dividend Capital Total Realty Trust Inc. (together, the “Dividend Capital Defendants”) and iStar Financial Inc. (“iStar Financial” and, together with Dividend Capital Defendants, the “Defendants”). Northrop’s Complaint pertains to a real estate project containing two commercial office buildings and a parking garage located at 7555-7575 Colshire Drive in McLean, Virginia (the “Project”). TRT NOIP Colshire—McLean LLC, a wholly-owned subsidiary of Dividend Capital Total Realty Trust Inc., acquired iStar NG LP as part of the National Office and Industrial Portfolio which was acquired from several subsidiaries of iStar Financial on June 25, 2010. Northrop, a holder of a leasehold interest in the Project, alleges that iStar Financial and the Dividend Capital Defendants knowingly completed the sale of the Project (rather than a sale of the owner of the Project, iStar NG LP). Northrop’s Complaint claims that the alleged sale of the Project violated Northrop’s right of first offer (“ROFO”) contained in the relevant deed of lease. Northrop’s Complaint seeks specific performance of the ROFO, other injunctive relief, compensatory damages in the amount of $250 million, $350,000 in punitive damages, treble damages under the Virginia Business Conspiracy Statute, costs, and attorneys’ fees.

On August 10, 2010, Defendants filed demurrers with the Fairfax County Circuit Court seeking dismissal of Northrop’s Complaint as a matter of law. On January 7, 2011, the court sustained the Dividend Capital Defendants’ demurrers and dismissed Northrop’s claims for tortious interference, unjust enrichment, violation of the Virginia Business Conspiracy Act and conversion, without prejudice. On January 28, 2011, Northrop filed an amended complaint, reasserting the dismissed counts. On February 18, 2011, the Defendants filed renewed demurrers and a plea in bar seeking dismissal of the claims for tortious interference, unjust enrichment, violation of the Virginia Business Conspiracy Act and conversion. The Defendants’ demurrers are scheduled for hearing on May 13, 2011. In addition to defending Northrop’s amended complaint generally and asserting counterclaims, the Dividend Capital Defendants have obtained indemnities from iStar Financial and insurance coverage that are subject to certain terms, conditions, and limitations.

On September 15, 2010, the Dividend Capital Defendants asserted counterclaims against Northrop based in part on Northrop’s intentional interference with the sale of the Project, its interference with contracts and prospective contracts, and its breach of the contract between iStar NG and Northrop. The Dividend Capital Defendants seek specific performance, damages in an amount yet to be determined, costs, and attorneys’ fees. Northrop has filed demurrers seeking dismissal of the Dividend Capital Defendants’ counterclaims, which are also scheduled for hearing on May 13, 2011.

Discovery between the parties is ongoing, and, under the current scheduling order, set to be completed by August 15, 2011. A bench trial has been set to commence on September 12, 2011.

 

ITEM 1A. RISK FACTORS

As of March 31, 2011, no material changes had occurred in our risk factors as discussed in Item 1A of our Annual Report on Form 10-K filed with the Commission on March 25, 2011.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

We are the general partner of our Operating Partnership. As of March 31, 2011, we owned approximately 93.1% of our Operating Partnership, and the remaining interests in our Operating Partnership (“OP Units”) were owned by our Advisor and by certain third-party investors (“Limited Partners”). Pursuant to the Limited Partnership Agreement of the Operating Partnership, Limited Partners may request the Operating Partnership to redeem their OP Units, and we, as the general partner of the Operating Partnership, may elect to redeem any OP Units for cash or for shares of our common stock. The number of shares issuable by us in redemption of OP Units is currently equal to the number of OP Units redeemed, less an amount of shares to cover a redemption fee.

During the three months ended March 31, 2011, we issued an aggregate of 97,678 shares of our common stock to Limited Partners in redemption of their OP Units. The issuances were made under the exemption from registration pursuant to Section 4(2) of the Securities Act. The following table describes these transactions in more detail:

 

Date

  

Title of Shares Sold

   Total Number of
Shares Sold
    

Consideration

   Number of OP Units
Redeemed
 

March 4, 2011

   Common shares      27,528       OP Units      27,947   

March 9, 2011

   Common shares      70,150       OP Units      71,218   
                       

Total

        97,678            99,165   
                       

 

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Share Redemption Program

As of March 31, 2011, no material changes had occurred to our share redemption program (the “Program”) as discussed in Item 2 of our Annual Report on Form 10-K filed with the Commission on March 25, 2011. In aggregate, for the three months ended March 31, 2011, we redeemed approximately 1.3 million shares of common stock pursuant to the Program for approximately $11.5 million, as described further in the table below.

 

Period

  Total Number of
Shares Redeemed
    Average Price
Paid per
Share
    Pro-rata Percentage
of Redemption
Requests Redeemed
by Us
    Total Number of
Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs
    Maximum Number
of Shares that May
Yet Be Purchased
Pursuant to the
Program (1)
 

January 1 - January 31, 2011

    —        $ —          —          —          —     

February 1 - February 28, 2011

    —          —          —          —          —     

March 1 - March 31, 2011

    1,276,333        8.97        7     1,276,333        —     
                                       

Total

    1,276,333      $ 8.97        7     1,276,333        900,431   
                                       

 

(1) This represents the number of shares that could be redeemed for the three months ended June 30, 2011 without exceeding our limitations discussed above.

 

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. REMOVED AND RESERVED

 

ITEM 5. OTHER INFORMATION

None.

 

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ITEM 6. EXHIBITS

 

  3.1

   Dividend Capital Total Realty Trust Inc. Fifth Articles of Amendment and Restatement.†

  3.2

   Dividend Capital Total Realty Trust Inc. Second Amended and Restated Bylaws. †

  4.1

   Third Amended and Restated Distribution Reinvestment Plan. †

  4.2

   Sixth Amended and Restated Share Redemption Program†

31.1

   Rule 13a-14(a) Certification of Principal Executive Officer*

31.2

   Rule 13a-14(a) Certification of Chief Financial Officer*

32.1

   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

32.2

   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

 

Previously filed.
* Filed herewith.

 

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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.

 

      DIVIDEND CAPITAL TOTAL REALTY TRUST INC.
Date: May 13, 2011      

/S/ GUY M. ARNOLD

     

Guy M. Arnold

President

Date: May 13, 2011      

/S/ M. KIRK SCOTT

     

M. Kirk Scott

Chief Financial Officer and Treasurer

 

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