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Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
Commission File Number: 333-157688
NORTHSTAR REAL ESTATE INCOME TRUST, INC.
(Exact Name of Registrant as Specified in its Charter)
     
Maryland   26-4141646
(State or Other Jurisdiction of   (IRS Employer
Incorporation or Organization)   Identification No.)
399 Park Avenue, 18th Floor New York, NY 10022
(Address of Principal Executive Offices, Including Zip Code)
(212) 547-2600
(Registrant’s Telephone Number, Including Area Code)
Indicate by the 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 þ No o
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
        (Do not check if a 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 o No þ
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
The Company has one class of common stock, par value $0.01 per share, 11,537,289 shares outstanding as of November 8, 2011.
 
 

 

 


 

NORTHSTAR REAL ESTATE INCOME TRUST, INC.
QUARTERLY REPORT
For the Three and Nine Months Ended September 30, 2011
TABLE OF CONTENTS
         
Index   Page  
 
       
       
 
       
       
 
       
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    33  
 
       
    33  
 
       
    34  
 
       
    35  
 
       
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

2


Table of Contents

NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
                 
    September 30,     December 31,  
    2011     2010  
    (Unaudited)          
 
               
Assets
               
Cash
  $ 40,588,178     $ 20,404,832  
Restricted cash
    4,945,802        
Real estate securities, available for sale
    34,255,310       31,264,331  
Real estate debt investments, net
    29,225,791        
Interest receivable
    273,784       128,287  
Subscriptions receivable, net
    721,598       234,267  
Deferred financing costs, net
    38,332       46,216  
Other assets
    7,375        
 
           
Total assets
  $ 110,056,170     $ 52,077,933  
 
           
 
               
Liabilities
               
Borrowings
  $ 24,061,212     $ 24,061,212  
Accounts payable and accrued expenses
    1,000,300       255,874  
Escrow deposits payable
    4,945,802        
Distribution payable
    559,507       208,594  
 
           
Total liabilities
    30,566,821       24,525,680  
 
               
Equity
               
NorthStar Real Estate Income Trust, Inc. Stockholders’ Equity
               
Preferred stock, $0.01 par value per share; 50,000,000 shares authorized, no shares issued and outstanding at September 30, 2011 and December 31, 2010
           
Common stock, $0.01 par value per share; 400,000,000 shares authorized, 9,349,865 and 3,193,414 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively
    93,498       31,934  
Additional paid-in capital
    81,448,420       26,775,538  
Retained (deficit) earnings
    (2,100,369 )     740,547  
Accumulated other comprehensive income
    43,527        
 
           
Total NorthStar Real Estate Income Trust, Inc. stockholders’ equity
    79,485,076       27,548,019  
Non-controlling interests
    4,273       4,234  
 
           
Total equity
    79,489,349       27,552,253  
 
           
Total liabilities and equity
  $ 110,056,170     $ 52,077,933  
 
           
See accompanying notes to consolidated financial statements.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2011     2010     2011     2010  
 
                               
Revenues
                               
Interest income
  $ 849,522     $ 413,107     $ 1,902,266     $ 1,118,356  
 
                       
Total revenues
    849,522       413,107       1,902,266       1,118,356  
Expenses
                               
Interest expense
    227,480       227,383       674,978       572,504  
Advisory fees — related party
    178,296       13,938       456,912       37,011  
Auditing and professional fees
    54,789       60,227       144,254       190,650  
General and administrative expenses
    97,455       274,130       584,874       550,185  
 
                       
Total expenses
    558,020       575,678       1,861,018       1,350,350  
Income (loss) from operations
    291,502       (162,571 )     41,248       (231,994 )
Realized gain on investments and other
                      199,604  
Unrealized gains (losses) on investments and other
    (278,519 )     1,109,603       302,793       2,213,850  
 
                       
Consolidated net income
    12,983       947,032       344,041       2,181,460  
Less: net income attributable to non-controlling interests
          132       35       421  
 
                       
Net income attributable to NorthStar Real Estate Income Trust, Inc. common stockholders
  $ 12,983     $ 946,900     $ 344,006     $ 2,181,039  
 
                       
 
                               
Net income per share of common stock, basic
  $ 0.00     $ 0.32     $ 0.06     $ 1.33  
 
                       
Weighted average number of shares of common stock outstanding, basic
    7,444,451       2,991,261       5,350,793       1,641,038  
See accompanying notes to consolidated financial statements.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2011     2010     2011     2010  
Consolidated net income
  $ 12,983     $ 947,032     $ 344,041     $ 2,181,460  
Other comprehensive income:
                               
Unrealized gain on real estate securities, available for sale
    43,531             43,531        
 
                       
Total other comprehensive income
    43,531             43,531        
 
                               
Comprehensive income
    56,514       947,032       387,572       2,181,460  
Less:
                               
Net income attributable to non-controlling interests
          132       35       421  
Other comprehensive income attributable to non-controlling interests
    4             4        
 
                       
Comprehensive income attributable to NorthStar Real Estate Income Trust, Inc.
  $ 56,510     $ 946,900     $ 387,533     $ 2,181,039  
 
                       
See accompanying notes to consolidated financial statements.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
                                                                 
                            Accumulated                              
                            Other             Total Company’s             Total  
    Common Stock     Additional     Comprehensive     Retained     Stockholders’     Non-controlling     Stockholders’  
    Shares     Amount     Paid-in Capital     Income     Earnings (Deficit)     Equity     Interests     Equity  
 
                                                               
Balance, December 31, 2009
    113,828     $ 1,138     $ 998,862     $     $ 680,530     $ 1,680,530     $ 3,361     $ 1,683,891  
 
                                               
 
                                                               
Activity prior to the merger:
                                                               
Proceeds from issuance of common stock
    3,669,919       36,699       35,032,407                   35,069,106             35,069,106  
Cost of capital
                (3,459,410 )                 (3,459,410 )           (3,459,410 )
Stock distribution reinvestment
    7,915       79       74,262                   74,341             74,341  
Distributions declared
                            (1,075,268 )     (1,075,268 )           (1,075,268 )
Shares redeemed for cash
    (893,968 )     (8,939 )     (8,233,445 )                 (8,242,384 )           (8,242,384 )
 
                                               
 
                                                               
Balance, October 18, 2010
    2,897,694     $ 28,977     $ 24,412,676     $     $ (394,738 )   $ 24,046,915     $ 3,361     $ 24,050,276  
 
                                               
 
                                                               
Shares of the accounting acquiree(1)
    39,039       390       62,326                   62,716       545       63,261  
Proceeds from issuance of common stock
    250,467       2,505       2,493,805                   2,496,310             2,496,310  
Cost of capital
                (260,678 )                 (260,678 )           (260,678 )
Stock distribution reinvestment
    6,214       62       58,970                   59,032             59,032  
Distributions declared
                            (494,307 )     (494,307 )           (494,307 )
Amortization of equity-based compensation
                8,439                   8,439             8,439  
Net income
                            1,629,592       1,629,592       328       1,629,920  
 
                                               
 
                                                               
Balance, December 31, 2010
    3,193,414     $ 31,934     $ 26,775,538     $     $ 740,547     $ 27,548,019     $ 4,234     $ 27,552,253  
 
                                               
 
                                                               
Proceeds from issuance of common stock
    6,082,467       60,825       60,456,128                   60,516,953             60,516,953  
Cost of capital
                (6,437,347 )                 (6,437,347 )           (6,437,347 )
Shares redeemed for cash
    (14,748 )     (148 )     (147,332 )                 (147,480 )           (147,480 )
Stock distribution reinvestment
    81,232       812       770,895                   771,707             771,707  
Distributions declared
                            (3,184,922 )     (3,184,922 )           (3,184,922 )
Issuance of equity-based compensation
    7,500       75                         75             75  
Amortization of equity-based compensation
                30,538                   30,538             30,538  
Other comprehensive income
                      43,527             43,527       4       43,531  
Net income
                            344,006       344,006       35       344,041  
 
                                               
Balance, September 30, 2011
(Unaudited)
    9,349,865     $ 93,498     $ 81,448,420     $ 43,527     $ (2,100,369 )   $ 79,485,076     $ 4,273     $ 79,489,349  
 
                                               
 
     
(1)  
NorthStar Real Estate Income Trust, Inc., the surviving legal entity, issued 24,039 shares for its initial capitalization and 15,000 shares to its Board of Directors prior to the merger with Northstar Income Opportunity REIT I, Inc.
See accompanying notes to consolidated financial statements.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
                 
    Nine Months Ended September 30,  
    2011     2010  
 
   
Cash flows from operating activities:
               
Consolidated net income
  $ 344,041     $ 2,181,460  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Amortization of premiums, discounts and fees on investments
    64,454       12,147  
Amortization of deferred financing costs
    7,884       6,471  
Realized gain on investments and other
          (199,604 )
Unrealized (gains) losses on investments and other
    (302,793 )     (2,213,850 )
Equity-based compensation
    30,613        
Origination fees on real estate debt investments
    142,500        
Changes in assets and liabilities:
               
Interest receivable
    (145,497 )     (130,951 )
Other assets
    (16,604 )     (4,962 )
Accounts payable and accrued expenses
    215,279       68,738  
 
           
Net cash provided by (used in) operating activities
    339,877       (280,551 )
 
               
Cash flows from investing activities:
               
Origination of real estate debt investments
    (29,357,400 )      
Acquisition of real estate securities
    (2,720,000 )     (29,616,265 )
Sale of real estate security
          1,852,500  
 
           
Net cash (used in) investing activities
    (32,077,400 )     (27,763,765 )
 
               
Cash flows from financing activities:
               
Proceeds from issuance of common stock
    59,992,506       35,068,415  
Proceeds from distribution reinvestment plan
    771,707       74,341  
Redemption of common stock
    (147,480 )      
Cost of capital
    (5,861,855 )     (3,459,410 )
Distributions paid on common stock
    (2,834,009 )     (353,808 )
Borrowings under secured term loans
          24,089,417  
Repayment of secured term loans
          (28,205 )
Payment of deferred financing costs
          (55,287 )
 
           
Net cash provided by financing activities
    51,920,869       55,335,463  
 
               
Net increase in cash
    20,183,346       27,291,147  
Cash, beginning of period
    20,404,832       55,630  
 
           
Cash, end of period
  $ 40,588,178     $ 27,346,777  
 
           
 
               
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 669,526     $ 526,906  
 
   
Supplemental disclosure of non-cash financing activities:
               
Distribution payable
  $ 559,507     $ 582,759  
Accrued cost of capital
    602,549        
Subscriptions receivable, gross
    795,000        
See accompanying notes to consolidated financial statements.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Formation and Organization
NorthStar Real Estate Income Trust, Inc. (the “Company”) was formed on January 26, 2009, and elected to qualify as a real estate investment trust (“REIT”) beginning with the taxable year ended December 31, 2010. The Company was organized primarily to originate, acquire and manage portfolios of commercial real estate debt, commercial real estate securities and select commercial real estate equity investments. Commercial real estate debt investments may include first mortgage loans, subordinate mortgage and mezzanine loans and participations in such loans. Commercial real estate securities will primarily consist of commercial mortgage-backed securities (“CMBS”) and may include unsecured REIT debt, collateralized debt obligations and other securities. The Company is externally managed by NS Real Estate Income Trust Advisor, LLC (the “Advisor”) and has no employees.
Substantially all of the Company’s business is conducted through NorthStar Real Estate Income Trust Operating Partnership, LP, the Company’s operating partnership (the “OP”). The Company is the sole general partner of the OP. The initial limited partners of the OP are the Advisor and NorthStar OP Holdings, LLC (the “Special Unit Holder”). The Advisor invested $1,000 in the OP in exchange for common units and the Special Unit Holder invested $1,000 in the OP and has been issued a separate class of limited partnership units (the “Special Units”), which are collectively recorded as non-controlling interests in the consolidated balance sheets as of September 30, 2011 and December 31, 2010. As the Company accepts subscriptions for shares, it will transfer substantially all of the net proceeds from the continuous public offering to the OP as a capital contribution.
The Company’s charter authorizes the issuance of up to 400,000,000 shares of common stock with a par value of $0.01 per share, and 50,000,000 shares of preferred stock, $0.01 par value per share. The Company’s board of directors is authorized to amend its charter, without the approval of the stockholders, to increase the aggregate number of authorized shares of capital stock or the number of shares of any class or series that the Company has authority to issue. On February 19, 2009, the Company was initially capitalized through the sale of 24,039 shares of common stock to NRFC Sub-REIT Corp., a wholly-owned subsidiary of NorthStar Realty Finance Corp. (the “Sponsor”), for $200,004.
On March 4, 2009, the Company filed a registration statement on Form S-11 with the Securities and Exchange Commission (the “SEC”) to offer a minimum of 200,000 shares and a maximum of 110,526,315 shares of common stock in a continuous, public offering (the “Offering”), of which 10,526,315 shares could be offered pursuant to the Company’s distribution reinvestment plan (“DRP”). The SEC declared the Company’s registration statement effective on July 19, 2010, and the Company retained NorthStar Realty Securities, LLC (the “Dealer Manager”), formerly known as NRF Capital Markets, LLC, and an affiliate of the Company, to serve as the dealer manager of the Offering. The Dealer Manager is responsible for marketing the Company’s shares being offered pursuant to the Offering. As described above, the Company intends to use substantially all of the net proceeds from the Offering to invest in a diverse portfolio of commercial real estate debt, commercial real estate securities and select commercial real estate equity investments.
On October 18, 2010, the Company completed a merger, accounted for as a reverse merger and recapitalization, with NorthStar Income Opportunity REIT I, Inc., (“NSIO REIT”) also sponsored by the Sponsor (the “Merger Transaction”). The Company was considered the surviving legal entity and NSIO REIT (the “Accounting Acquirer”) was considered the accounting acquirer and the surviving accounting entity. As the surviving accounting entity, NSIO REIT’s financial information is presented in these financial statements on a historical carryover basis.
2,828,552 shares of NSIO REIT, par value $0.01 per share, issued and outstanding immediately prior to the Merger Transaction were converted into 2,897,694 shares of the Company’s common stock, par value $0.01, at a conversion rate of 1.02444444 shares of the Company’s stock for every one share of NSIO REIT stock and 893,968 shares of NSIO REIT, par value $0.01 per share, issued and outstanding immediately prior to the Merger Transaction were converted into cash, without interest, in an amount of $9.22 per share. All NSIO REIT stockholders who would otherwise have been entitled to a fractional share of the Company’s shares received cash in an amount equal to such fraction of the Company’s shares based on a conversion price of $9.22. The Company used $8,242,384 of the cash received from NSIO REIT in connection with the closing of the Merger Transaction to satisfy the Company’s obligation to pay the cash consideration. On the closing date, 411 NSIO REIT stockholders became stockholders of the Company with each of their shares of NSIO REIT common stock being converted to unregistered shares of the Company’s common stock at the ratio set forth above.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
In addition, as a result of the Merger Transaction, the Company eliminated the minimum offering requirement and terminated its escrow agreement with Wells Fargo Bank, N.A.
2. Summary of Significant Accounting Policies
Basis of Quarterly Presentation
The accompanying consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in consolidated financial statements prepared under U.S. GAAP have been condensed or omitted. In the opinion of management, all adjustments considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows have been included and are of a normal and recurring nature. The operating results presented for interim periods are not necessarily indicative of the results that may be expected for any other interim period or for the entire year. These consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2010, which was filed with the Securities and Exchange Commission. Capitalized terms used herein, and not otherwise defined, are defined in the Company’s December 31, 2010 consolidated financial statements included in its annual report on Form 10-K.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries, which are majority-owned and controlled by the Company. All significant intercompany balances have been eliminated in consolidation.
Estimates
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could materially differ from those estimates.
Restricted Cash
Restricted cash consists of escrow deposits for future debt service payments, taxes, insurance, tenant improvements and other costs collected in connection with first mortgage loan originations.
Real Estate Debt Investments
Real estate debt investments are intended to be held to maturity and, accordingly, are carried at cost, net of unamortized origination fees, discounts and unfunded commitments unless such loan or investment is deemed to be impaired. Interest income is recorded on the accrual basis and related discounts, premiums, origination costs and fees on assets are amortized over the life of the investment using the effective interest method. The amortization is reflected as an adjustment to interest income in our consolidated statements of operations.
Real Estate Securities
The Company classifies its real estate securities as available for sale on the acquisition date. Available for sale securities are carried at fair value, with any unrealized gains (losses) reported as a component of accumulated other comprehensive income (loss) in the Company’s consolidated statements of stockholders’ equity. However, the Company may elect the fair value option for certain of our available for sale securities, and as a result, any unrealized gains (losses) on such securities are recorded in unrealized gains (losses) on investments and other in the Company’s consolidated statements of operations. The Company recognizes interest income on real estate securities using the effective interest method and any related premiums or discounts are amortized as an adjustment to interest income in our consolidated statements of operations.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Credit Losses and Impairment on Investments
Real Estate Debt Investments
The Company will maintain a provision for losses on its real estate debt investments as appropriate. A provision is established for loans that are either non-performing or where there are any indicators of possible impairment. A loan is generally categorized as non-performing if it is in maturity default or it is past due at least 90 days on its contractual debt service payments. The Company assesses the credit quality of the portfolio and adequacy of reserves on a quarterly basis, or more frequently as necessary. Significant judgment of the Company is required in this analysis. The Company considers the estimated net recoverable value of the loan as well as other factors, including but not limited to fair value of any collateral, the amount and the status of any senior debt, the prospects for the borrower and the economic situation of the region where the borrower does business. Because this determination is based upon projections of future economic events, which are inherently subjective, the amounts ultimately realized may differ materially from the carrying value as of the balance sheet date.
Income recognition is suspended for the loans at the earlier of the date at which payments become 90-days past due or when, in the opinion of the Company, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the suspended loan becomes contractually current and performance is demonstrated to be resumed. A loan is written off when it is no longer realizable and legally discharged.
Real Estate Securities
Periodically, the Company assesses unrealized losses on the change in fair value on the real estate securities to determine if a decline in value is other-than-temporary. As defined under U.S. GAAP, impairment of a security is considered to be other-than-temporary when: (i) the holder has the intent to sell the impaired security; (ii) it is more likely than not the holder will be required to sell the security; or (iii) the holder does not expect to recover the entire amortized cost of the security. If an other-than-temporary impairment exists, the security is written down to fair value. The total other-than-temporary impairment is then bifurcated into the credit loss component and losses relating to other factors. The credit loss component is recognized in the consolidated statements of operations and the losses relating to other factors are recognized in accumulated other comprehensive income (loss) in the consolidated statements of stockholders’ equity.
Real estate securities for which the fair value option was elected are not evaluated for other-than-temporary impairment as changes in fair value are recorded in the Company’s consolidated statements of operations. Realized losses on such securities are reclassified to the realized gains (losses) on investments and other as losses occur.
Organization and Offering Costs
The Advisor and certain affiliates of the Advisor are entitled to receive reimbursement for costs paid on behalf of the Company in connection with the Offering. The Company is obligated to reimburse the Advisor for organization and offering costs to the extent the aggregate of selling commissions, dealer manager fees and other organization and offering expenses do not exceed 15% of gross offering proceeds from the primary offering. The Advisor does not expect reimbursable organization and offering costs to exceed $15 million, or 1.5% of the total proceeds available to be raised from the primary offering. The Company records organization and offering costs each period to the extent primary offering proceeds are raised based upon an allocation determined by the Company’s expectation of total organization and offering costs to be reimbursed. Organization costs are recorded as an expense in general and administrative expenses in the consolidated statements of operations and offering costs are recorded as a reduction to stockholders’ equity.
Comprehensive Income
The Company reports consolidated statements of comprehensive income in separate statements consecutive to the consolidated statements of operations. Comprehensive income is defined as the change in stockholders’ equity resulting from net income (loss) and other comprehensive income (loss) (“OCI”). The Company’s principal component of OCI is unrealized gain (loss) on real estate securities for which the fair value option of accounting was not elected.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Recently Issued Pronouncements
In May 2011, the Financial Accounting Standards Board (“FASB”) issued an accounting update to amend existing guidance concerning fair value measurements and disclosures. The update is intended to achieve common fair value measurements and disclosure requirements under U.S. GAAP and International Financial Reporting Standards and is effective for the first interim or annual period beginning after December 15, 2011. The Company is currently evaluating the impact of this accounting update and does not expect it will have a material impact on the consolidated financial statements.
In June 2011, the FASB issued an accounting update concerning the presentation of comprehensive income. The update requires either a single, continuous statement of comprehensive income be included on the statement of operations or an additional statement of other comprehensive income immediately follow the statement of operations. The update does not change the components of other comprehensive income that must be reported but it eliminates the option to present other comprehensive income on the statement of stockholders’ equity. The accounting update is effective for the Company the first quarter 2012 and should be applied retrospectively to all periods reported after the effective date. There is no impact as the Company currently complies with this update.
3. Fair Value Measurements
The Company has categorized its financial instruments in accordance with U.S. GAAP based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
Financial assets and liabilities recorded on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1. Quoted prices for identical assets or liabilities in an active market.
Level 2. Financial assets and liabilities whose values are based on the following:
  a)  
Quoted prices for similar assets or liabilities in active markets.
  b)  
Quoted prices for identical or similar assets or liabilities in non-active markets.
  c)  
Pricing models whose inputs are observable for substantially the full term of the asset or liability.
  d)  
Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.
Level 3. Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Determination of Fair Value
The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.
Real Estate Securities
Real estate securities are generally valued using a third-party pricing service or broker quotations. These quotations are based on observable inputs that can be validated, and as such, are classified as Level 2 of the fair value hierarchy. Certain real estate securities that may be valued based on a single broker quote or an internal pricing model, and have less observable pricing will be classified as Level 3 of the fair value hierarchy. For real estate securities using an internal pricing model, inputs include assumptions related to the timing and amount of expected future cash flows, the discount rate, prepayments and losses.
Fair Value Hierarchy
Financial assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth the Company’s financial assets that were accounted for at fair value on a recurring basis as of September 30, 2011 and December 31, 2010 by level within the fair value hierarchy:
                                                                 
    September 30, 2011     December 31, 2010  
    Level 1     Level 2     Level 3     Total     Level 1     Level 2     Level 3     Total  
Real estate securities CMBS
  $     $ 34,255,310     $     $ 34,255,310     $     $ 31,264,331     $     $ 31,264,331  
At September 30, 2011, the Company had no financial assets or liabilities that were accounted for at fair value on a non-recurring basis.
Fair Value Option
The Company generally will not elect the fair value option of accounting for its financial assets and liabilities. However, the Company may elect to apply the fair value option of accounting to certain of its real estate security investments at the time of initial recognition of the investments. As of September 30, 2011, the fair value option of accounting was elected for two of the Company’s real estate securities.
Changes in fair value for assets and liabilities for which the election is made will be recognized in income as they occur. The fair value option may be elected on an instrument-by-instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. The following table sets forth fair value of the Company’s financial instruments for which the fair value option was elected and the aggregate contractual amounts of those real estate securities as of September 30, 2011 and December 31, 2010:
                 
    September 30,     December 31,  
    2011     2010  
Real estate securities(1)
               
CMBS, at fair value
  $ 31,470,157     $ 31,264,331  
CMBS, contractual amount due upon maturity
    28,856,000       28,856,000  
 
           
Difference
  $ 2,614,157     $ 2,408,331  
 
           
 
     
(1)  
As of September 30, 2011, excludes one security with a principal amount of $4.0 million for which the fair value option was not elected.
For the three months ended September 30, 2011 and 2010, the Company recognized a net unrealized gain (loss) of ($278,519) and $1,109,603, respectively, from the change in fair value of financial assets for which the fair value option was elected. For the nine months ended September 30, 2011 and 2010, the Company recognized a net unrealized gain of $302,793 and $2,213,850, respectively. These amounts are recorded as unrealized gains (losses) on investments and other in the Company’s consolidated statements of operations.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Fair Value of Financial Instruments
In addition to the above disclosures regarding assets or liabilities which are recorded at fair value, U.S. GAAP requires disclosure of fair value about all financial instruments. The following disclosures of estimated fair value of financial instruments were determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The following table shows the principal amount, carrying value and fair value of our financial assets and liabilities at September 30, 2011:
                         
    September 30, 2011  
    Principal     Carrying     Fair  
    Amount     Value     Value  
Financial assets:
                       
Cash(1)
  $ 40,588,178     $ 40,588,178     $ 40,588,178  
Restricted cash(1)
    4,945,802       4,945,802       4,945,802  
Real estate securities, available for sale(2)
    32,856,000       34,255,310       34,255,310  
Real estate debt investments
    29,357,400       29,225,791       29,357,400  
Receivables(1)
    273,784       273,784       273,784  
 
                       
Financial liabilities:
                       
Borrowings
    24,061,212       24,061,212       25,571,699  
Accounts payable and accrued expenses(1)
    1,000,300       1,000,300       1,000,300  
Escrow deposits payable(1)
    4,945,802       4,945,802       4,945,802  
Distribution payable(1)
    559,507       559,507       559,507  
 
     
(1)  
As of September 30, 2011, carrying value approximates fair value due to the short-term maturities of these items.
 
(2)  
Refer to the “Determination of Fair Value” above for a discussion of methodologies used to determine fair value.
Disclosure about fair value of financial instruments is based on pertinent information available to management at the time. Although management is not aware of any factors that would significantly affect the fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.
Real Estate Debt Investments
For real estate debt investments, fair value was approximated by comparing yields at which the investments are held to estimated yields at which loans originated with similar credit risks or market yields at which a third party might require to purchase the investment by discounting future cash flows at such market yields. Prices were calculated assuming fully-extended maturities regardless of structural or economic tests required to achieve such extended maturities.
Borrowings
The estimated fair value is based on interest rates available for issuance of debt with similar terms and remaining maturities. The estimated fair value of the Company’s secured term loans is not necessarily indicative of the amounts that the Company could realize in a current market exchange.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
4. Real Estate Securities
Real estate securities are comprised of CMBS backed by a pool of commercial real estate loans which are typically well-diversified by type and geography. The following is a summary of the Company’s real estate securities as of September 30, 2011 and December 31, 2010:
                                                         
                            Cumulative                      
                            Unrealized             Weighted     Weighted  
            Principal     Amortized     Gain (Loss) on     Fair     Average     Average  
CMBS   Number     Amount     Cost     Investments     Value     Coupon     Yield(1)  
September 30, 2011
  3     $ 32,856,000     $ 32,184,348     $ 2,070,962     $ 34,255,310     5.70%     9.21%  
December 31, 2010
  2     $ 28,856,000     $ 29,539,693     $ 1,724,638     $ 31,264,331     5.55%     9.62%  
 
     
(1)  
Represents the weighted average levered yield.
At September 30, 2011 and December 31, 2010, the contractual maturities of the real estate securities averaged 34 and 35 years, respectively, with a weighted average expected life of 3.5 years and 4.9 years, respectively.
On June 30, 2010 the Company sold a real estate security for proceeds of $1,852,500. In connection with the sale, the Company recorded a realized gain on investments and other for $199,604 in its consolidated statements of operations.
5. Real Estate Debt Investments
The following is a summary of the Company’s real estate debt investments, all of which have been directly originated by the Company, as of September 30, 2011:
                                                         
                            Weighted Average     Floating Rate as  
            Principal     Carrying     Spread over                     % of Principal  
Asset Type:   Number     Amount     Value     LIBOR(1)     Coupon(2)     Yield     Amount  
First mortgage loans
  3     $ 29,357,400     $ 29,225,791     4.32%     8.08%     8.63%     100.0%  
 
     
(1)  
Represents the weighted average spread over one-month LIBOR.
 
(2)  
All loans are subject to a LIBOR floor.
As of September 30, 2011, all of the Company’s real estate debt investments were performing in accordance with the terms of the loan agreements. The Company did not own any real estate debt investments as of December 31, 2010.
6. Borrowings
The following is a summary of the Company’s Term Asset-Backed Securities Loan Facility (“TALF”) as of September 30, 2011:
                                 
        Final Stated   Contractual     Principal     Carrying  
Secured term loans:   Type   Maturity   Interest Rate     Amount     Value  
TALF I
  Non-recourse   Jan-15   3.73%     $ 11,629,213     $ 11,629,213  
TALF II
  Non-recourse   Feb-15   3.69%       12,431,999       12,431,999  
 
                         
Weighted Average/Total
          3.71%     $ 24,061,212     $ 24,061,212  
 
                         
The TALF borrowings were used to finance two of the Company’s CMBS investments with a fair value of $31,470,157 as of September 30, 2011.
7. Related Party Arrangements
NS Real Estate Income Trust Advisor, LLC
Subject to certain restrictions and limitations, the Advisor, an indirect subsidiary of the Sponsor, is responsible for managing the Company’s affairs on a day-to-day basis and for identifying, originating, acquiring and asset managing investments on behalf of the Company. For such services, the Advisor receives fees and compensation from the Company. Below is a summary of the fees due the Advisor.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Organization and Offering Costs
The Advisor and certain affiliates of the Advisor are entitled to receive reimbursement for costs paid on behalf of the Company in connection with the Offering. The Company is obligated to reimburse the Advisor for organization and offering costs to the extent the aggregate of selling commissions, dealer manager fees and other organization and offering expenses do not exceed 15% of gross offering proceeds from the primary offering. The Advisor does not expect reimbursable organization and offering costs to exceed $15 million, or 1.5% of the total proceeds available to be raised from the primary offering. The Company shall not reimburse the Advisor for any organization and offering costs that the independent directors determine are not fair and commercially reasonable to the Company.
As of September 30, 2011, the Advisor had unreimbursed organization and offering costs of $2,836,386 which it has incurred on behalf of the Company. For the nine months ended September 30, 2011, the Company raised gross primary offering proceeds of $60,516,953 and, accordingly, was obligated to reimburse up to a total of $885,195 of organization and offering costs, which was allocated $222,599 to organization and $662,596 to offering costs. As of September 30, 2011, $489,839 of organization and offering costs are recorded in accounts payable and accrued expenses in the consolidated balance sheets.
Prior to the Merger Transaction, organization and offering costs (other than selling commissions and the dealer manager fee) of the Accounting Acquirer were being paid by the Advisor or its affiliates, subject to reimbursement. These fees were reimbursable up to a maximum of $1,000,000, which is 1.0% of the maximum gross offering proceeds of $100,000,000 or a minimum of $60,000. For the nine months ended September 30, 2010, the Accounting Acquirer incurred organization and offering costs of $351,428, which was reimbursed to the Advisor in the third quarter of 2010.
Operating Costs
The Advisor and certain affiliates of the Advisor are entitled to receive reimbursement for operating costs incurred by the Advisor in connection with services provided to the Company. The Company will reimburse the Advisor for operating costs (including the asset management fee) at the end of the four preceding fiscal quarters not to exceed the greater of: (i) 2.0% of its average invested assets; or (ii) 25% of its net income determined without reduction for any additions to reserves for depreciation, bad debt or other similar non-cash reserves and excluding any gain from the sale of the Company’s assets for that period. Notwithstanding the above, the Company may reimburse the Advisor for expenses in excess of this limitation if a majority of the independent directors determines that such excess expenses are justified based on unusual and non-recurring factors.
The Company calculates the expense reimbursement quarterly and will true-up the calculation at the end of the twelve-month period. As of September 30, 2011, the Advisor has incurred unreimbursed operating expenses of $1,623,727 on behalf of the Company. For the three months ended September 30, 2011, the Company accrued $143,352 of operating costs, which is recorded in accounts payable and accrued expenses in the consolidated balance sheets. For the three months ended September 30, 2011, operating costs were allocated $54,789 to auditing and professional fees and $88,563 to general and administrative expenses. For the nine months ended September 30, 2011, operating costs were allocated $144,254 to auditing and professional fees and $180,848 to general and administrative expenses.
For the four quarters ended September 30, 2011, the Company incurred $418,000 of operating costs reimbursable to the Advisor based upon the preliminary expense calculation described above, of which $274,648 has been reimbursed as of September 30, 2011.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Advisory Fees
Asset Management Fee
The Company pays the Advisor a monthly asset management fee equal to one-twelfth of 1.25% of the sum of the cost of all investments made and of the Company’s investments in joint ventures, including acquisition fees, origination and acquisition expenses and any debt attributable to such investments, less any principal repaid by borrowers on the Company’s debt investments (or the Company’s proportionate share thereof in the case of debt investments made through joint ventures). For the three and nine months ended September 30, 2011, the Company incurred $84,518 and $164,763 respectively, in asset management fees, which was recorded in advisory fees — related party in the consolidated statements of operations. As of September 30, 2011, a total of $2,913 of asset management fees are recorded in accounts payable and accrued expenses in the consolidated balance sheets.
Prior to the Merger Transaction, the Accounting Acquirer paid the Advisor a monthly asset management fee equal to one-twelfth of 1.0% of the sum of the cost of all investments. For the three and nine months ended September 30, 2010, the Accounting Acquirer incurred $13,938 and $37,011 respectively, in asset management fees, which was recorded in advisory fees — related party in the consolidated statements of operations.
Asset Acquisition Fee
The Advisor also receives an acquisition fee equal to 1.0% of the amount funded by the Company to originate or acquire commercial real estate debt or the amount invested in the case of other real estate investments including any origination and acquisition expenses and any borrowings attributable to such investments. For the three and nine months ended September 30, 2011, the Company incurred $93,778 and $292,149, respectively, in acquisition fees to the Advisor which is included in advisory fees — related party in the consolidated statements of operations. As of September 30, 2011, a total of $93,778 of asset acquisition fees are recorded in accounts payable and accrued expenses in the consolidated balance sheets.
Asset Disposition Fee
For substantial assistance in connection with the sale of investments, the Company will pay the Advisor or its affiliate a disposition fee of 1.0% of the contract sales price of each commercial real estate debt, commercial real estate security or select commercial real estate equity investment sold, including mortgage-backed securities or collateralized debt obligations issued by a subsidiary of the Company as part of a securitization transaction. The Company will not pay a disposition fee upon the maturity, prepayment, workout modification or extension of a loan or other debt-related investment unless there is a corresponding fee paid by the borrower, in which case the disposition fee will be the lesser of: (i) 1.0% of the principal amount of the loan or debt-related investment prior to such transaction; or (ii) the amount of the fee paid by the borrower in connection with such transaction. If the Company takes ownership of a property as a result of a workout or foreclosure of a loan, the Company will pay a disposition fee upon the sale of such property. The Company has not incurred any asset disposition fees to the Advisor for the nine months ended September 30, 2011.
NorthStar Realty Securities, LLC
Pursuant to a dealer manager agreement, the Company pays the Dealer Manager, an indirect subsidiary of the Sponsor, selling commissions of up to 7.0% of gross offering proceeds, all of which are reallowed by the Dealer Manager to participating broker-dealers. In addition, the Company will pay the Dealer Manager a dealer manager fee of 3.0% of gross offering proceeds, a portion of which may be reallowed by the Dealer Manager to participating broker-dealers. No selling commissions or dealer manager fee will be paid for sales under the distribution reinvestment plan. For the nine months ended September 30, 2011, the Company incurred $5,774,751 in selling commissions and dealer manager fees, which are recorded as a cost of capital in the consolidated statements of stockholders’ equity. For the nine months ended September 30, 2010, the Company incurred $2,233,090 in selling commissions and dealer manager fees, which are recorded as a cost of capital in the consolidated statements of stockholders’ equity.
8. Stockholders’ Equity
Common Stock
For the nine months ended September 30, 2011, the Company sold 6,082,467 shares of common stock pursuant to its Offering, generating gross proceeds of $60,516,953.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
Sponsor Purchase of Common Stock
The Sponsor has committed to purchase up to $10 million of shares of the Company’s common stock during the two-year period following commencement of the Company’s Offering under certain circumstances to provide additional funds to support distributions to stockholders. For the three and nine months ended September 30, 2011, the Company’s board of directors approved the sale of 79,629 and 181,633 shares, respectively, of the Company’s common stock, $0.01 par value per share, to a subsidiary of the Sponsor, at a price of $9.00 per Share.
Distribution Reinvestment Plan
The Company has adopted a DRP through which common stockholders may elect to reinvest an amount equal to the distributions declared on their shares in additional shares of the Company’s common stock in lieu of receiving cash distributions. The initial purchase price per share under the DRP is $9.50. Once the Company establishes an estimated value per share, shares issued pursuant to the DRP will be priced at the estimated value per share of the Company’s common stock, as determined by the Advisor or another firm chosen for that purpose. The Company expects to establish an estimated value per share after the completion of its offering stage. The offering stage will be considered complete when the Company is no longer publicly offering equity securities, whether through the Offering or follow-on public offerings, and has not done so for 18 months. No selling commissions or dealer manager fees will be paid on shares sold under the DRP. The board of directors of the Company may amend or terminate the DRP for any reason upon ten-days’ notice to participants. For the nine months ended September 30, 2011, the Company issued 81,232 shares totaling $771,707 of gross offering proceeds pursuant to the DRP.
Distributions
Distributions to stockholders are approved by the Company’s board of directors and are paid based on a daily amount of $.002191781 per share. The following table summarizes distributions for the nine months ended September 30, 2011.
                                 
            Distributions  
Month   Declaration Date   Payment Date   Cash     DRP     Total  
January 2011
  December 21, 2010   February 1, 2011   $ 172,974     $ 47,036     $ 220,010  
February 2011
  December 21, 2010   March 1, 2011     160,892       49,112       210,004  
March 2011
  December 21, 2010   April 1, 2011     193,221       65,463       258,684  
April 2011
  March 23, 2011   May 2, 2011     212,462       80,214       292,676  
May 2011
  March 23, 2011   June 1, 2011     242,179       99,560       341,739  
June 2011
  March 23, 2011   July 1, 2011     262,019       106,633       368,652  
July 2011
  May 12, 2011   August 1, 2011     307,023       125,555       432,578  
August 2011
  May 12, 2011   September 1, 2011     347,260       153,811       501,071  
September 2011
  May 12, 2011   October 3, 2011     380,642       178,865       559,507  
Share Repurchase Program
The Company has adopted a share repurchase program that may enable stockholders to sell their shares to the Company in limited circumstances. Share repurchases will be made at the sole discretion of the board of directors. During the first quarter 2011, the Company repurchased 14,748 shares for a total of $147,480 or $10 per share. The Company did not repurchase any other common shares in 2011.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
9. Equity-Based Compensation
Directors Shares
On July 19, 2010, each of the Company’s three independent directors received 5,000 shares of restricted stock in connection with the commencement of the Offering. On June 7, 2011, each of the Company’s three independent directors were re-elected to the board and received 2,500 shares of restricted stock in connection with their re-election. The non-vested stock will generally vest over four years; provided, however, that the non-vested stock will become fully vested on the earlier occurrence of: (i) the termination of the independent director’s service as a director due to his or her death or disability; or (ii) a change in control of the Company. The total compensation cost recognized in connection with the granting of the non-vested stock is $202,500, which will be recorded in income ratably over the four-year vesting period.
For the three and nine months ended September 30, 2011, the Company recognized $12,658 and $30,613 of compensation expense, respectively, related to the issuance of restricted stock, which was recorded in general and administrative expenses in the consolidated statements of operations.
Long-Term Incentive Plan
The Company adopted a long-term incentive plan, which it uses to attract and retain qualified directors. The Company’s long-term incentive plan offers these individuals an opportunity to participate in its growth through awards in the form of, or based on, its common stock. The Company currently intends to issue awards only to its independent directors under its long-term incentive plan.
The long-term incentive plan authorizes the granting of restricted stock, stock options, stock appreciation rights, restricted or deferred stock units, performance awards, dividend equivalents, limited partnership interests in the Company’s operating partnership, other stock-based awards and cash-based awards to directors of the Company. Stock options granted under the long-term incentive plan will not exceed an amount equal to 10% of the outstanding shares of the Company’s common stock on the date of grant of any such stock options. Any stock options and stock appreciation rights granted under the long-term incentive plan will have an exercise price or base price that is not less than the fair market value of the Company’s common stock on the date of grant.
The Company’s board of directors, or a committee of the board, administers the long-term incentive plan, with sole authority to determine all of the terms and conditions of the awards, including whether the grants, vesting or settlement of awards may be subject to the attainment of one or more performance goals.
The Company accounts for equity-based compensation in accordance with the FASB’s fair value recognition provisions. Under these provisions, equity-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. Equity-based compensation is classified within general and administrative expense in the consolidated statements of operations. Equity-based compensation expense is recorded based on awards ultimately expected to vest, the amount of expense is reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated on experience of other companies in the same industry until entity-specific information is available.
10. Non-controlling Interests
Operating Partnership
Non-controlling interests represent the aggregate limited partnership interests in the OP held by limited partners. Income allocated to the non-controlling interests is based on the limited partners’ ownership percentage of the OP. Income allocated to the operating partnership non-controlling interests for the three and nine months ended September 30, 2011 was $0 and $35, respectively. Income allocated to the operating partnership non-controlling interests for the three and nine months ended September 30, 2010 was $132 and $421, respectively.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
11. Segment Reporting
The Company conducts its business through the following segments:
   
The real estate debt business is focused on originating, acquiring and asset managing commercial real estate debt investments including first mortgage loans, subordinate mortgage and mezzanine loans and participations in such loans.
   
The real estate securities business is focused on investing in and asset managing commercial real estate securities primarily consisting of CMBS and may include unsecured REIT debt, collateralized debt obligations and other securities.
The following summarizes segment reporting for the three and nine months ended September 30, 2011 and 2010:
                                 
    Real Estate     Real Estate              
Three Months Ended September 30, 2011   Debt     Securities     Unallocated(1)     Total  
Revenues
                               
Interest income
  $ 418,084     $ 431,438     $     $ 849,522  
 
                       
Total revenues
    418,084       431,438             849,522  
Expenses
                               
Interest expense
          227,480             227,480  
Advisory fees — related party
    93,778             84,518       178,296  
Auditing and professional fees
                54,789       54,789  
General and administrative expenses
    3,609       875       92,971       97,455  
 
                       
Total expenses
    97,387       228,355       232,278       558,020  
Income (loss) from operations
    320,697       203,083       (232,278 )     291,502  
Unrealized gains (losses) on investments and other
          (278,519 )           (278,519 )
 
                       
Consolidated net income (loss)
    320,697       (75,436 )     (232,278 )     12,983  
Less: net income attributable to non-controlling interests
                       
 
                       
Net income (loss) attributable to NorthStar Real Estate Income Trust, Inc. common stockholders
  $ 320,697     $ (75,436 )   $ (232,278 )   $ 12,983  
 
                       
Total assets as of September 30, 2011
  $ 34,830,500     $ 34,710,897     $ 40,514,773     $ 110,056,170  
 
                       
 
     
(1)  
Unallocated includes corporate level general and administrative expenses.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
                                 
    Real Estate     Real Estate              
Three Months Ended September 30, 2010   Debt     Securities     Unallocated(1)     Total  
 
                               
Revenues
                               
Interest income
  $     $ 413,107     $     $ 413,107  
 
                       
Total revenues
          413,107             413,107  
Expenses
                               
Interest expense
          227,383             227,383  
Advisory fees — related party
                13,938       13,938  
Auditing and professional fees
                60,227       60,227  
General and administrative expenses
          875       273,255       274,130  
 
                       
Total expenses
          228,258       347,420       575,678  
Income (loss) from operations
          184,849       (347,420 )     (162,571 )
Unrealized gains (losses) on investments and other
          1,109,603             1,109,603  
 
                       
Consolidated net income (loss)
          1,294,452       (347,420 )     947,032  
Less: net income attributable to non-controlling interests
          180       (48 )     132  
 
                       
Net income (loss) attributable to NorthStar Real Estate Income Trust, Inc. common stockholders
  $     $ 1,294,272     $ (347,372 )   $ 946,900  
 
                       
 
                               
Total assets as of September 30, 2010
  $     $ 32,533,381     $ 26,787,958     $ 59,321,339  
 
                       
                                 
    Real Estate     Real Estate              
Nine Months Ended September 30, 2011   Debt     Securities     Unallocated(1)     Total  
 
                               
Revenues
                               
Interest income
  $ 722,995     $ 1,179,271     $     $ 1,902,266  
 
                       
Total revenues
    722,995       1,179,271             1,902,266  
Expenses
                               
Interest expense
          674,978             674,978  
Advisory fees — related party
    292,149             164,763       456,912  
Auditing and professional fees
                144,254       144,254  
General and administrative expenses
    4,641       3,442       576,791       584,874  
 
                       
Total expenses
    296,790       678,420       885,808       1,861,018  
Income (loss) from operations
    426,205       500,851       (885,808 )     41,248  
Unrealized gains (losses) on investments and other
          302,793             302,793  
 
                       
Consolidated net income (loss)
    426,205       803,644       (885,808 )     344,041  
Less: net income attributable to non-controlling interests
    43       82       (90 )     35  
 
                       
Net income (loss) attributable to NorthStar Real Estate Income Trust, Inc. common stockholders
  $ 426,162     $ 803,562     $ (885,718 )   $ 344,006  
 
                       
 
                               
Total assets as of September 30, 2011
  $ 34,830,500     $ 34,710,897     $ 40,514,773     $ 110,056,170  
 
                       
 
     
(1)  
Unallocated includes corporate level general and administrative expenses.

 

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NORTHSTAR REAL ESTATE INCOME TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
                                 
    Real Estate     Real Estate              
Nine Months Ended September 30, 2010   Debt     Securities     Unallocated(1)     Total  
 
                               
Revenues
                               
Interest income
  $     $ 1,118,356     $     $ 1,118,356  
 
                       
Total revenues
          1,118,356             1,118,356  
Expenses
                               
Interest expense
          572,504             572,504  
Advisory fees — related party
                37,011       37,011  
Auditing and professional fees
                190,650       190,650  
General and administrative expenses
          55,682       494,503       550,185  
 
                       
Total expenses
          628,186       722,164       1,350,350  
Income (loss) from operations
          490,170       (722,164 )     (231,994 )
Realized gain on investments and other
          199,604             199,604  
Unrealized gains (losses) on investments and other
          2,213,850             2,213,850  
 
                       
Consolidated net income (loss)
          2,903,624       (722,164 )     2,181,460  
Less: net income attributable to non-controlling interests
          560       (139 )     421  
 
                       
Net income (loss) attributable to NorthStar Real Estate Income Trust, Inc. common stockholders
  $     $ 2,903,064     $ (722,025 )   $ 2,181,039  
 
                       
 
                               
Total assets as of September 30, 2010
  $     $ 32,533,381     $ 26,787,958     $ 59,321,339  
 
                       
 
     
(1)  
Unallocated includes corporate level general and administrative expenses.
12. Subsequent Events
Offering Proceeds
For the period from October 1, 2011 to November 8, 2011, the Company sold 2,187,424 common shares pursuant to its Offering, including DRP shares, generating gross proceeds of $21,828,541.
Distributions
On November 8, 2011, the Company’s board of directors approved a daily cash distribution of $0.002191781 per share of common stock for each of the three months ended March 31, 2012. The distributions will be paid in cumulative amounts to the stockholders of record entitled to receive such distributions on February 1, 2012, March 1, 2012 and April 2, 2012.
Sponsor Purchase of Common Stock
The Sponsor has committed to purchase up to $10 million of shares of the Company’s common stock during the two-year period following commencement of the Company’s Offering under certain circumstances to provide additional funds to support distributions to stockholders. On November 8, 2011, the Company and the Sponsor entered into a Second Amended and Restated Distribution Support Agreement, pursuant to which the Sponsor’s purchase commitment is based upon modified funds from operations (“MFFO”) effective for the three months ended September 30, 2011. On November 8, 2011, the Company’s board of directors approved the sale of 71,569 shares of the Company’s common stock, $0.01 par value per share, to NRFC Sub-REIT Corp., a subsidiary of the Sponsor, at a price of $9.00 per share. In connection with this commitment and including the Sponsor’s purchase of shares approved on November 8, 2011, the Sponsor has purchased 253,202 shares for $2.3 million.
Advisory Agreement
On November 8, 2011, the Company and the Sponsor entered into Amendment No. 2 to the Advisory Agreement which provides procedures for allocating investment opportunities between the Company, our Sponsor and affiliates of our Sponsor. If, after consideration of the relevant factors, our Sponsor determines that an investment is equally suitable for the Company, our Sponsor, or another affiliate of our Sponsor, the investment will be allocated among each of the entities, including us, on a rotating basis. Currently, investment opportunities are only allocated to the Company and our Sponsor.

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included in Item 1 of this report. References to “we,” “us,” or “our” refer to NorthStar Real Estate Income Trust, Inc. and its subsidiaries unless context specifically requires otherwise.
Forward-Looking Statements
Certain items in this report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments, financing needs, future market opportunities, financial condition and disclosure in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “seek,” “anticipate,” “estimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. Forward-looking statements are not guarantees of performance and are based on certain assumptions, discuss future expectations, describe plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual effect of plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from those forward looking statements. We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.
Factors that could have a material adverse effect on our operations and future prospects are described in our reports filed with the Securities and Exchange Commission, or SEC, including in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010. The factors set forth in the Risk Factors section and elsewhere in our filings with the SEC could cause our actual results to differ significantly from those contained in any forward-looking statement contained in this report.
Introduction
We are an externally managed commercial real estate finance company that was formed in January 2009 to originate, invest in and manage a diversified portfolio of commercial real estate debt, commercial real estate securities and select commercial real estate equity investments. We commenced our operations in October 2010. We conduct substantially all of our operations and make investments through our operating partnership, of which we are the sole general partner. NS Real Estate Income Trust Advisor, LLC is our external manager, or our Advisor, and is an affiliate of our sponsor, NorthStar Realty Finance Corp., or our Sponsor. Through our operating partnership we seek to originate, acquire and asset manage the following:
   
commercial real estate debt, including first mortgage loans, subordinate mortgage and mezzanine loans and participations in such loans.
   
commercial real estate securities, including primarily commercial mortgage-backed securities (“CMBS”), and may include unsecured REIT debt, collateralized debt obligations and other securities.
   
select commercial real estate equity investments.
We believe that these businesses are complementary to each other due to the overlapping sources of investment opportunities and common reliance on real estate fundamentals.

 

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We elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, commencing with our taxable year ended December 31, 2010. If we qualify as a REIT for federal income tax purposes, we generally will not be subject to federal income tax to the extent we distribute qualifying dividends to our stockholders. If we fail to qualify as a REIT in any taxable year after electing REIT status, we will be subject to federal income tax on our taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for four years following the year in which our qualification is denied. Such an event could materially and adversely affect our net income and cash available for distribution. However, we believe that we are organized and operate in a manner that will enable us to qualify for treatment as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2010, and we intend to continue to operate so as to remain qualified as a REIT for federal income tax purposes thereafter. Further, we intend to operate our business so our Advisor is not required to register as an investment advisor under the Investment Advisors Act of 1940, as amended.
We earn interest income from real estate debt investments and our real estate securities.
Profitability and Performance Metrics
We calculate Funds from Operations (“FFO”) and Modified Funds from Operations (“MFFO”) (see “Non-GAAP Financial Measures—Funds from Operations and Modified Funds from Operations” for a description of these metrics) to evaluate the profitability and performance of our business.
Outlook and Recent Trends
Our strategy in the current market conditions is a cautious but optimistic approach to investing. During 2011, the U.S. economy has continued to recover at a slow pace with a potential risk of sliding back into another recession, due to various factors beyond our control, including high unemployment, a weak residential housing market and the high levels of sovereign debt, which resulted in the recent U.S. credit rating downgrade by Standard & Poor’s and European economic uncertainty. Despite the current difficult economic conditions, we believe the current environment for commercial real estate lending and securities investment will allow us to implement our business plan and generate attractive risk-adjusted returns on our invested capital that will support our distributions.
The current market conditions combined with our Advisor’s platform provides opportunities to: (i) originate loans with attractive current returns and strong structural features directly with borrowers, thereby taking advantage of the changing market conditions in order to seek attractive risk-return dynamics for our stockholders; and (ii) purchase commercial real estate debt and commercial real estate securities from third parties, in many instances at discounts to their face amount (or principal amount), due to the lack of market liquidity and seller deleveraging.
We believe that the near and intermediate-term market for originations and acquisitions of commercial real estate debt, commercial real estate securities and select commercial real estate equity investments is one of the most compelling from a risk-return perspective that the Company or our Advisor has experienced in recent years. We believe our strategy presents a favorable alternative to pure “equity-oriented” investment strategies by offering attractive risk-adjusted returns and a higher potential for capital preservation should the real estate capital market shift to a less favorable environment. Given that the U.S. economy is recovering at a slow pace with some potential risk of sliding back into another recession, we favor an investment strategy weighted towards targeting debt or securities assets which maximize current income with the added features of subordinate capital and downside structural protection.
Many investors who acquired real estate assets prior to the recent economic recession are now having to devote substantial effort to managing their investments and may not have the resources or capital available to take advantage of current market opportunities. Companies such as ours, with no legacy asset issues, should have a competitive advantage in the market. For example, our current originations and acquisitions of commercial real estate debt, commercial real estate securities and select commercial real estate equity investments reflect valuations that have already adjusted to post-recession pricing.

 

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We believe that the following conditions, which are by-products of the recent extended credit market dislocation and the current, slow economic recovery, should create a favorable investment environment for us:
   
The post-recession market for investing in commercial real estate offers an opportunity to participate in what we believe are favorable real estate asset valuations.
   
The scarcity of capital available in the new-issue CMBS market or related securitized debt market (such as collateralized debt obligations, or CDOs) reduces a major source of debt capital for commercial property owners.
   
Contraction in the banking system and the high losses experienced by commercial banks has greatly diminished their capacity to provide commercial real estate debt capital and credit to property owners.
   
The increasing number of maturing commercial real estate loans over the next five years should be much greater than the market’s capacity to provide refinancing capital.
   
Insurance companies and government sponsored lending programs like Freddie Mac and Fannie Mae have increased market share through the downturn, but still cannot come close to fully satisfying demand for commercial real estate debt capital and the government sponsored agencies are coming under significant scrutiny with many calling for their reduced role in the future.
   
Capital markets disruption compounded by scrutiny on credit rating agencies offer attractive investing opportunities in legacy CMBS.
   
The restarting of the CMBS market, which is commonly referred to as CMBS 2.0 (generally seeking to finance only the highest-quality assets based on conservative underwriting) makes new issue CMBS investing appealing.
Due to the market conditions described above and our Advisor’s expertise and industry relationships, we continue to see a robust pipeline of investment opportunities that have credit qualities and yield profiles that are consistent with our underwriting standards and that we believe offer the opportunity to meet or exceed our targeted returns. While we remain optimistic that we will continue to be able to generate and capitalize on an attractive pipeline, there is no assurance that will be the case.
Our Target Assets
We intend to invest in both fixed and floating-rate debt and securities. Our fixed-rate assets have set interest rates that do not fluctuate over time and we receive consistent payments from these assets. Our floating-rate assets generally have interest rates based on a spread to one-month London Interbank Offered Rate, or LIBOR, a floating-rate index based on rates that banks charge each other to borrow. One-month LIBOR as of September 30, 2011 was 0.24%, well below its 2.01% average over the past five years. One-month LIBOR resets every 30 days and the total interest rate paid to us by our borrowers on our floating-rate assets that are tied to LIBOR will generally fluctuate as LIBOR rises and falls. Given the current one-month LIBOR rate is at historically low levels, in order to generate minimum interest rates that are consistent with our targeted returns many of our LIBOR-based assets have a fixed minimum LIBOR rate, or “floor.” The interest rate paid on our floating-rate assets with floors will not increase until the actual one-month LIBOR rate surpasses the fixed floor rate. Our allocation of fixed and floating-rate assets may vary significantly over time.
Returns on real estate securities are sensitive to interest rate volatility. For example, if interest rates increase, the value of our fixed-rate real estate securities may tend to decrease. On the other hand, if interest rates were to decrease, the value of our fixed-rate real estate securities may tend to increase.
Our Financing Strategy
We may employ leverage as a part of our investment strategy. Although we have a maximum leverage level for our portfolio, we do not have a targeted debt-to-equity ratio, as we believe the appropriate leverage for the particular assets we finance depends on the specific credit characteristics of those assets. We utilize leverage for the sole purpose of financing our assets and we do not employ leverage to speculate on changes in interest rates. When we employ leverage we will generally seek to match fund our assets with respect to interest rate and maturity in order to reduce the impact of interest rate fluctuation and risk of refinancing our liabilities prior to the maturity of our assets.

 

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In the first half of 2011, liquidity was beginning to return to the commercial real estate finance markets and corporate capital started to become available to the stronger sponsors. Wall Street and commercial banks began to more actively provide credit to real estate lenders to originate or purchase new real estate loans. A proxy of the easing of credit and restarting of the capital markets for commercial real estate debt is the approximately $22 billion in multi-borrower CMBS transactions that were completed during the first nine months of 2011. Many industry experts are predicting $25 to $30 billion total CMBS issuance in 2011 even though actual issuance could fall below expectations due to more recent volatile market conditions.
Our Risk Management Strategy
Our Advisor uses many methods to actively manage our asset base to preserve our income and capital. Frequent dialogue with borrowers and inspections of our collateral are an effective process for identifying issues early and prior to missed debt service and other payments. Some of our loans may require borrowers to replenish cash reserves for items such as taxes, insurance and future debt service costs. Late replenishments of cash reserves also may be an early indicator there could be a problem with the borrower or collateral property.
Our Advisor conducts comprehensive credit reviews that include day-to-day oversight by the portfolio management team, weekly management meetings and a quarterly credit review process. These processes are designed to enable management to evaluate and proactively manage asset-specific credit issues and identify credit trends on a portfolio-wide basis. Nevertheless, we cannot be certain that our Advisor’s review will identify all issues within our portfolio due to, among other things, adverse economic conditions or events adversely affecting specific assets; therefore, potential future losses may also stem from assets that are not identified by these credit reviews. During the credit reviews, assets may be put on non-performing status and identified for possible impairment based upon several factors, including missed or late contractual payments, significant declines in collateral performance, and other data which may indicate a potential issue in our ability to recover our capital from the investment.
Each of our assets, while primarily backed by commercial real estate collateral, is unique and requires customized asset management strategies for dealing with potential credit situations. The complexity of each situation depends on many factors, including the number of collateral properties, the type of property, macro and local market conditions impacting the demand, cash flow and value of the collateral, and the financial condition of our borrowers and their willingness to support our collateral properties. Our Advisor has an experienced asset management team that monitors those factors on our behalf.
Critical Accounting Policies
Refer to the section of our Annual Report on Form 10-K for the year ended December 31, 2010 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting policies” for a full discussion of our critical accounting policies.

 

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Results of Operations
The following discussion is based upon the consolidated financial statements of the Company for the three and nine months ended September 30, 2011 and the historical carryover financial statements of NorthStar Income Opportunity REIT I, Inc., or NSIO REIT, the Accounting Acquirer, for the three and nine months ended September 30, 2010.
Comparison of the Three Months Ended September 30, 2011 to the Three Months Ended September 30, 2010
                                 
    Three Months Ended September 30,     Increase (decrease)  
    2011     2010     Amount     %  
 
   
Revenues
                               
Interest income
  $ 849,522     $ 413,107     $ 436,415       105.6 %
 
                       
Total revenues
    849,522       413,107       436,415       105.6 %
Expenses
                               
Interest expense
    227,480       227,383       97       0.0 %
Advisory fees — related party
    178,296       13,938       164,358       1179.2 %
Auditing and professional fees
    54,789       60,227       (5,438 )     (9.0 %)
General and administrative expenses
    97,455       274,130       (176,675 )     (64.4 %)
 
                       
Total expenses
    558,020       575,678       (17,658 )     (3.1 %)
Income (loss) from operations
    291,502       (162,571 )     454,073       (279.3 %)
Unrealized gains (losses) on investments and other
    (278,519 )     1,109,603       (1,388,122 )     (125.1 %)
 
                       
Consolidated net income
    12,983       947,032       (934,049 )     (98.6 %)
Less: net income attributable to non-controlling interests
          132       (132 )     (100.0 %)
 
                       
Net income attributable to NorthStar Real Estate Income Trust, Inc. common stockholders
  $ 12,983     $ 946,900     $ (933,917 )     (98.6 %)
 
                       
Revenues
Interest Income
Interest income increased $436,415, primarily attributable to interest income on three first mortgage loans that the Company originated in 2011.
Expenses
Interest Expense
Interest expense remained flat over the prior period as the Company did not utilize any new financings.
Advisory Fees — Related Party
The increase in advisory fees — related party was primarily attributable to acquisition fees in the third quarter of 2011 for the origination of a first mortgage loan and an increase in asset management fees due to increased capital raising and investment activity.
Auditing and Professional Fees
Auditing and professional fees decreased $5,438, primarily attributable to higher professional fees incurred in the third quarter 2010 related to the merger of NSIO REIT and the Company.

 

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General and Administrative Expenses
General and administrative expenses include director fees, organization and other costs associated with operating the Company. The decrease was primarily attributable to the allocation of organization and other costs incurred in the third quarter 2010 in connection with the merger.
Unrealized Gains (Losses) on Investments and Other
The decrease in unrealized gains (losses) on investments and other is primarily related to the change in fair value on two real estate securities for which the fair value option was elected.
Comparison of the Nine Months Ended September 30, 2011 to the Nine Months Ended September 30, 2010
                                 
    Nine Months Ended September 30,     Increase (decrease)  
    2011     2010     Amount     %  
 
   
Revenues
                               
Interest income
  $ 1,902,266     $ 1,118,356     $ 783,910       70.1 %
 
                       
Total revenues
    1,902,266       1,118,356       783,910       70.1 %
Expenses
                               
Interest expense
    674,978       572,504       102,474       17.9 %
Advisory fees — related party
    456,912       37,011       419,901       1134.5 %
Auditing and professional fees
    144,254       190,650       (46,396 )     (24.3 %)
General and administrative expenses
    584,874       550,185       34,689       6.3 %
 
                       
Total expenses
    1,861,018       1,350,350       510,668       37.8 %
Income (loss) from operations
    41,248       (231,994 )     273,242       (117.8 %)
Realized gain on investments and other
          199,604       (199,604 )     (100.0 %)
Unrealized gains (losses) on investments and other
    302,793       2,213,850       (1,911,057 )     (86.3 %)
 
                       
Consolidated net income
    344,041       2,181,460       (1,837,419 )     (84.2 %)
Less: net income attributable to non-controlling interests
    35       421       (386 )     (91.7 %)
 
                       
Net income attributable to NorthStar Real Estate Income Trust, Inc. common stockholders
  $ 344,006     $ 2,181,039     $ (1,837,033 )     (84.2 %)
 
                       
Revenues
Interest Income
Interest income increased $783,910, primarily attributable to the origination of three first mortgage loans and the acquisition of a real estate security in 2011. In 2011, the Company also benefitted from owning two of its real estate securities acquired in 2010 for the entire period. The increase was partially offset by the sale of a real estate security on June 30, 2010.
Expenses
Interest Expense
Interest expense increased $102,474, primarily related to a full period of interest expense in 2011 related to borrowings used to finance two real estate securities acquired in January 2010 and February 2010.

 

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Advisory Fees — Related Party
The increase in advisory fees — related party was primarily attributable to acquisition fees for the origination of three first mortgage loans in 2011 and an increase in asset management fees due to increased capital raising and investment activity.
Auditing and Professional Fees
The decrease in auditing and professional fees was primarily attributable to one-time professional fees incurred during the second quarter of 2010 in connection with the merger of NSIO REIT and the Company.
General and Administrative Expenses
General and administrative expenses include director fees, organization and other costs associated with operating the Company. The increase was primarily attributable to increases in director and officer insurance, equity-based compensation expense and servicer fees, partially offset by a decrease in organization and other costs and a one-time structure fee incurred in 2010 related to the TALF borrowings.
Realized Gain on Investments and Other
We had no realized gain on investments and other for the nine months ended September 30, 2011. Realized gain on investments and other for 2010 was the result of the sale of one real estate security on June 30, 2010.
Unrealized Gains (Losses) on Investments and Other
The decrease in unrealized gains (losses) on investments and other is primarily related to the change in fair value on two real estate securities for which the fair value option was elected.
Liquidity and Capital Resources
We are dependent upon the net proceeds from our continuous, public offering to conduct our operations. We will obtain the capital required to originate and acquire commercial real estate debt investments, commercial real estate securities and select commercial real estate equity investments and conduct our operations from the proceeds of our Offering and any future offerings we may conduct, from secured or unsecured financings from banks and other lenders and from any undistributed funds from our operations. For the nine months ended September 30, 2011, we sold 6,082,467 shares generating gross proceeds of $60,516,953. As of September 30, 2011, we held $40,588,178 of unrestricted cash available for investments.
If we are unable to continue to raise funds in the Offering, we will be unable to make new investments resulting in less diversification in terms of the type, number and size of investments we make and the value of an investment in us will fluctuate with the performance of the specific assets we acquire. Further, we have certain fixed operating expenses, including certain expenses as a publicly-offered REIT, regardless of whether we are able to continue to raise funds in the Offering. Our inability to continue to raise funds would increase our fixed operating expenses as a percentage of gross income, reducing our net income and limiting our ability to make distributions.
Once we have fully invested the proceeds of our Offering, we expect that our financing will not exceed 50% of the greater of the cost or fair value of our investments, although it may exceed this level during our offering stage. Our charter limits us from incurring borrowings that would exceed 75% of our tangible assets. We cannot exceed this limit unless any excess in borrowing over such level is approved by our stockholders. As of September 30, 2011, our leverage was 45.0%, which is well below the maximum allowed by our charter.
In addition to making investments in accordance with our investment objectives, we expect to use our capital resources to make certain payments to our Advisor and NorthStar Realty Securities, LLC, or the Dealer Manager. During our organization and offering stage, these payments will include payments to the Dealer Manager for selling commissions and the dealer manager fee, and payments to the Dealer Manager and our Advisor for reimbursement of certain organization and offering expenses. However, our Advisor has agreed to reimburse us to the extent that selling commissions, the dealer manager fee and other organization and offering expenses incurred by us exceed 15% of our gross offering proceeds from the primary offering. During our acquisition and development stage, we expect to make payments to our Advisor in connection with the selection and origination or acquisition of investments, the management of our assets and costs incurred by our Advisor in providing services to us. The advisory agreement has a one-year term but may be renewed for an unlimited number of successive one-year periods upon the mutual consent of our Advisor and our board of directors.

 

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We elected to be taxed as a REIT and to operate as a REIT commencing with our taxable year ended December 31, 2010. To maintain our qualification as a REIT, we will be required to make aggregate annual distributions to our stockholders of at least 90% of our REIT taxable income (computed without regard to the dividends paid deduction and excluding net capital gain). Our board of directors may authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant. Provided we have sufficient available cash flow, we intend to authorize and declare daily distributions and pay distributions on a monthly basis. We have not established a minimum distribution level.
Cash Flows
The following discussion is based upon the consolidated financial statements of the Company for the nine months ended September 30, 2011 and the historical carryover financial statements of NSIO REIT for the nine months ended September 30, 2010.
Net cash provided by operating activities was $6,086 and $339,877 for the three and nine months ended September 30, 2011, respectively, and included net interest income generated from our investments and fees on originated first mortgage loans offset by fees paid to our Advisor for the acquisition and management of our investments. Net cash (used in) operating activities was $280,551 for the nine months ended September 30, 2010 and included net interest income generated from our investments offset by professional fees paid in connection with the merger with NSIO REIT.
Net cash (used in) investing activities was $32,077,400 for the nine months ended September 30, 2011 and included the origination of three first mortgage loans and the acquisition of a real estate security. Net cash (used in) investing activities was $27,763,765 for the nine months ended September 30, 2010 and included the acquisition of two real estate securities offset by the sale of one real estate security.
Net cash provided by financing activities was $51,920,869 for the nine months ended September 30, 2011 and included the net proceeds from the issuance of common stock through our primary offering and DRP offset by distributions paid on our common stock and a common stock share repurchase. Net cash provided by financing activities was $55,335,463 for the nine months ended September 30, 2010 and included the net proceeds from the issuance of common stock through our primary offering and DRP and borrowings incurred under two TALF agreements offset by distributions paid on our common stock.
Contractual Obligations
As of September 30, 2011, we had the following contractual obligations:
                                         
    Payments Due by Period  
            Less than                     More than  
    Total     1 year     2-3 years     4-5 years     5 years  
Contractual Obligations:
                                       
Borrowings
  $ 24,061,212     $     $     $ 24,061,212     $  
 
                             
Total contractual obligations
  $ 24,061,212     $     $     $ 24,061,212     $  
 
                             
Recent Developments
Offering Proceeds
For the period from October 1, 2011 to November 8, 2011, the Company sold 2,187,424 common shares pursuant to its Offering, including DRP shares, generating gross proceeds of $21,828,541.
Distributions
On November 8, 2011, our board of directors approved a daily cash distribution of $0.002191781 per share of common stock for each of the three months ended March 31, 2012. The distribution will be paid in cumulative amounts to the stockholders of record entitled to receive such distribution February 1, 2012, March 1, 2012 and April 2, 2012.

 

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Sponsor Purchase of Common Stock
The Sponsor has committed to purchase up to $10 million of shares of the Company’s common stock during the two-year period following commencement of the Company’s Offering under certain circumstances to provide additional funds to support distributions to stockholders. On November 8, 2011, the Company and the Sponsor entered into a Second Amended and Restated Distribution Support Agreement, pursuant to which the Sponsor’s purchase commitment is based upon MFFO effective for the three months ended September 30, 2011. On November 8, 2011, the Company’s board of directors approved the sale of 71,569 shares of the Company’s common stock, $0.01 par value per share, to NRFC Sub-REIT Corp., a subsidiary of the Sponsor, at a price of $9.00 per share. In connection with this commitment and including the Sponsor purchase of shares approved on November 8, 2011, the Sponsor has purchased 253,202 shares for $2.3 million.
Off Balance Sheet Arrangements
We have no off balance sheet arrangements that are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Non-GAAP Financial Measures
Funds from Operations and Modified Funds from Operations
Management believes that FFO and MFFO, both of which are non-GAAP measures, are additional appropriate measures of the operating performance of a REIT and of our company in particular. We compute FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts, or NAREIT, as net income or loss (computed in accordance with generally accepted accounting principles (“U.S. GAAP”)), excluding gains or losses from sales of depreciable properties, the cumulative effect of changes in accounting principles, real estate-related depreciation and amortization, and after adjustments for unconsolidated/uncombined partnerships and joint ventures. FFO, as defined by NAREIT, is a computation made by analysts and investors to measure a real estate company’s cash flow generated by operations.
We believe MFFO provides a clear and transparent representation of sustainable cash flow from operations. We compute MFFO in accordance with the definition established by the Investment Program Association, or IPA. Our computation of MFFO may not be comparable to other REIT’s that do not calculate MFFO using the current IPA definition. MFFO excludes from FFO the following items:
   
acquisition fees and expenses;
   
straight-line rent and amortization of above or below intangible lease assets and liabilities;
   
amortization of discounts and premiums on debt investments;
   
non-recurring impairment of real estate-related investments;
   
realized gains (losses) from the early extinguishment of debt;
   
realized gains (losses) on the extinguishment or sales of hedges, foreign exchange, securities and other derivative holdings except where the trading of such instruments is a fundamental attribute of our business;
   
unrealized gains (losses) from fair value adjustments on real estate securities, including commercial mortgage-backed securities and other securities, interest rate swaps and other derivatives not deemed hedges and foreign exchange holdings;
   
unrealized gains (losses) from the consolidation from, or deconsolidation to, equity accounting;

 

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adjustments related to contingent purchase price obligations; and
   
adjustments for consolidated and unconsolidated partnerships and joint ventures calculated to reflect MFFO on the same basis as above.
We believe that MFFO is helpful to management and investors in assessing our future operating performance and the sustainability of our distributions, especially when our acquisition and offering stage is complete, because it eliminates from net income acquisition fees and expenses that are incurred as part of our investment activities and non-cash fair value adjustments on our real estate securities.
Neither FFO nor MFFO is equivalent to net income or cash generated from operating activities determined in accordance with U.S. GAAP. Furthermore, FFO and MFFO do not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments or uncertainties. Neither FFO nor MFFO should be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flow from operating activities as a measure of our liquidity.
Set forth below is a reconciliation of FFO and MFFO to net income attributable to NorthStar Real Estate Income Trust, Inc. common stockholders:
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2011     2010     2011     2010  
 
   
Funds from Operations:
                               
Net income attributable to NorthStar Real Estate
                               
Income Trust, Inc. common stockholders
  $ 12,983     $ 946,900     $ 344,006     $ 2,181,039  
 
                       
Funds from Operations
  $ 12,983     $ 946,900     $ 344,006     $ 2,181,039  
 
                       
 
                               
Modified Funds from Operations:
                               
Funds from Operations
  $ 12,983     $ 946,900     $ 344,006     $ 2,181,039  
Acquisition fees and expenses
    93,778             292,149        
Amortization of premiums, discounts and fees on investments
    5,520       1,460       64,454       12,147  
Unrealized (gains) losses from fair value adjustments
    278,519       (1,109,603 )     (302,793 )     (2,213,850 )
 
                       
Modified Funds from Operations
  $ 390,800     $ (161,243 )   $ 397,816     $ (20,664 )
 
                       
Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
We may be exposed to the effects of interest rate changes as a result of borrowings used to maintain liquidity and to fund the acquisition, expansion and refinancing of our real estate investment portfolio and operations. Our profitability and the value of our investment portfolio may be adversely affected during any period as a result of interest rate changes. Our interest rate risk management objectives are to limit the impact of interest rate changes on income and cash flows and to lower overall borrowing costs. We may utilize a variety of financial instruments, including interest rate caps, floors and swap agreements, in order to limit the effects of changes in interest rates on our operations. When we use these types of derivatives to hedge the risk of interest-earning assets or interest-bearing liabilities, we may be subject to certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of our common stock and that the losses may exceed the amount we invested in the instruments. We will not enter into derivative or interest rate transactions for speculative purposes.
Interest Rate Risk
Changes in interest rates affect our net interest income, which is the difference between the income earned on our assets and the interest expense incurred in connection with our borrowings.

 

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Our debt and security investments bear interest at either a floating or fixed-rate. The interest rates on our floating-rate assets typically float at a fixed spread over an index such as LIBOR, and typically reprice every 30 days based on LIBOR in effect at the time. Currently, all of our real estate debt investments have a fixed minimum LIBOR rate. Given the frequent and periodic repricing of our floating-rate assets, changes in benchmark interest rates are unlikely to materially affect the value of our floating-rate portfolio. Changes in short-term rates will, however, affect income from our investments.
Changes in interest rates could affect the value of our fixed-rate real estate debt and security investments. For example, increasing interest rates would result in a higher required yield on investments, which would decrease the value on existing fixed-rate assets in order to adjust their yields to current market levels.
Credit Spread Risk
The value of our fixed and floating-rate investments also change with market credit spreads. This means that when market-demanded risk premiums, or credit spreads, increase, the value of our fixed and floating-rate assets decrease and vice versa. The fixed-rate securities are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasury of like maturity. This means that their value is dependent on the yield demanded on such assets by the market, based on their credit relative to U.S. Treasuries. The floating-rate debt investments are valued based on a market credit spread over LIBOR. Excessive supply of these investments combined with reduced demand will generally cause the market to require a higher yield on these investments, resulting in the use of a higher or “wider” spread over the benchmark rate (usually the applicable U.S. Treasury yield) to value these assets. Under these conditions, the value of our portfolio should decrease. Conversely, if the spread used to value these assets were to decrease or “tighten,” the value of these assets should increase.
Credit Risk
Credit risk in our real estate debt and security investments relates to each individual’s borrower’s ability to make required interest and principal payments on scheduled due dates. We seek to manage credit risk through a comprehensive credit analysis prior to making an investment, actively monitoring our asset portfolio and the underlying credit quality of our holdings and subordination and diversification of our portfolio. Our analysis is based on a broad range of real estate, financial, economic and borrower-related factors which we believe are critical to the evaluation of credit risk inherent in a transaction.
Item 4.  
Controls and Procedures
Disclosure Controls and Procedures
The management of the Company established and maintains disclosure controls and procedures that are designed to ensure that material information relating to the Company and its subsidiaries required to be disclosed in the reports that are filed or submitted under the 1934 Act are recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
As of the end of the period covered by this report, the Company’s management conducted an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.

 

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PART II. OTHER INFORMATION
Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds Use of Proceeds from Registered Securities
On July 19, 2010, our registration statement on Form S-11 (File No. 333-157688), covering our Offering of up to 110,526,315 shares of common stock, of which 10,526,315 shares of common stock would be offered pursuant to our DRP, was declared effective under the Securities Act. We commenced our Offering on the same date and retained the Dealer Manager, an affiliate of ours, to serve as the dealer manager of the Offering. We are offering up to 100,000,000 shares of common stock at an aggregate offering price of up to $1.0 billion, or $10.00 per share, with discounts available to certain categories of purchasers, and 10,526,315 shares of common stock pursuant to our DRP at an aggregate offering price of $100 million, or $9.50 per share.
As of September 30, 2011, we sold the following securities in our Offering:
   
6,332,934 shares, equal to $63,013,263 of aggregate gross offering proceeds; and
   
87,446 shares, equal to $830,739 of aggregate gross offering proceeds, pursuant to the DRP.
In the aggregate, as of September 30, 2011, we sold 6,420,380 shares resulting in gross proceeds of $63,844,002.
For the nine months ended September 30, 2011, we repurchased 14,748 shares for a total of $147,480, or $10.00 per share.
As of September 30, 2011, we incurred the following costs in connection with the issuance and distribution of the registered securities:
         
Type of Cost   Amount  
 
       
Offering costs to related parties
  $ 6,698,025  
From the commencement of the Offering through September 30, 2011, the net offering proceeds to us from the primary offering component of the Offering, after deducting the total expenses incurred described above, were $56,315,238. From the commencement of the Offering through September 30, 2011, we used $29,357,400 to originate real estate debt investments, $2,720,000 to purchase a real estate security and $292,149 was paid to our Advisor as acquisition fees in connection with the loan originations.

 

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Item 6.  
Exhibits
(a) Exhibits
         
Exhibit    
Number   Description
  3.1    
Second Articles of Amendment and Restatement of NorthStar Real Estate Income Trust, Inc. (filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on August 26, 2010 and incorporated herein by reference)
       
 
  3.2    
Bylaws of NorthStar Real Estate Income Trust, Inc. (filed as Exhibit 3.2 to the Company’s Registration Statement on Form S-11 (File No. 333-157688) and incorporated herein by reference)
       
 
  4.1    
Form of Subscription Agreement (filed as Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 and incorporated herein by reference)
       
 
  4.2    
Amended and Restated Distribution Reinvestment Plan (filed as Exhibit 4.2 to Post-Effective Amendment No. 2 to the Company’s Registration Statement on Form S-11 (File No. 333-157688) and incorporated herein by reference)
       
 
  10.1    
Advisory Agreement dated as of March 17, 2010 by and among NorthStar Real Estate Income Trust, Inc., NorthStar Real Estate Income Trust Operating Partnership, LP, NS Real Estate Income Trust Advisor, LLC and NorthStar Realty Finance Corp (filed as Exhibit 10.2 to Pre-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11 (File No. 333-157688) and incorporated herein by reference)
       
 
  10.2    
Amendment No. 1 to Advisory Agreement, dated February 24, 2011, by and among NorthStar Real Estate Income Trust, Inc., NorthStar Real Estate Income Trust Operating Partnership, LP, NS Real Estate Income Trust Advisor, LLC and NorthStar Realty Finance Corp (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 2, 2011 and incorporated herein by reference)
       
 
  10.3    
Amended and Restated Distribution Support Agreement dated as of August 11, 2011, by and between NorthStar Real Estate Income Trust, Inc. and NorthStar Realty Finance Corp (filed as Exhibit 10.7 to Post-Effective Amendment No. 5 to the Company’s Registration Statement on Form S-11 (File No. 333-157688) and incorporated herein by reference)
       
 
  31.1 *  
Certification by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  31.2 *  
Certification by the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1 *  
Certification by the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  32.2 *  
Certification by the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  **101.INS    
The following materials from the NorthStar Real Estate Income Trust, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at September 30, 2011 (unaudited) and December 31, 2010; (ii) Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2011 and 2010; (iii) Consolidated Statements of Stockholders’ Equity as of September 30, 2011 (unaudited) and December 31, 2010; (iv) Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2011 and 2010; (v) Consolidated Statements of Cash Flows (unaudited) for the three and nine months ended September 30, 2011 and 2010; and (vi) Notes to Consolidated Financial Statements (unaudited)
     
*  
Filed herewith
 
**  
Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

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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.
         
  NORTHSTAR REAL ESTATE INCOME TRUST, INC.
 
 
Date: November 10, 2011  By:   /s/ David T. Hamamoto    
    David T. Hamamoto   
    Chief Executive Officer   
     
  By:   /s/ Debra A. HESS    
    Debra A. Hess   
    Chief Financial Officer   

 

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