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EXCEL - IDEA: XBRL DOCUMENT - Summit Healthcare REIT, Inc | Financial_Report.xls |
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EX-10.1 - EX-10.1 - Summit Healthcare REIT, Inc | a60111aexv10w1.htm |
EX-10.2 - EX-10.2 - Summit Healthcare REIT, Inc | a60111aexv10w2.htm |
EX-31.1 - EX-31.1 - Summit Healthcare REIT, Inc | a60111aexv31w1.htm |
EX-31.2 - EX-31.2 - Summit Healthcare REIT, Inc | a60111aexv31w2.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2011
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 000-52566
CORNERSTONE CORE PROPERTIES REIT, INC.
(Exact name of registrant as specified in its charter)
MARYLAND (State or other jurisdiction of incorporation or organization) |
73-1721791 (I.R.S. Employer Identification No.) |
|
1920 MAIN STREET, SUITE 400, IRVINE, CA (Address of principal executive offices) |
92614 (Zip Code) |
949-852-1007
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the issuer (1) filed all reports required to be filed by section 13
or 15(d) of the 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.
þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (Sec.232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, a smaller reporting company. See definition of accelerated filer and large
accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act).
o Yes þ No
As of
November 11, 2011, we had 23,027,235 shares issued and outstanding.
PART I FINANCIAL INFORMATION
FORM 10-Q
Cornerstone Core Properties REIT, Inc.
TABLE OF CONTENTS
FORM 10-Q
Cornerstone Core Properties REIT, Inc.
TABLE OF CONTENTS
Table of Contents
CORNERSTONE CORE PROPERTIES REIT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
ASSETS |
||||||||
Cash and cash equivalents |
$ | 363,000 | $ | 2,014,000 | ||||
Investments in real estate: |
||||||||
Land |
11,733,000 | 18,073,000 | ||||||
Buildings and improvements, net |
33,667,000 | 51,921,000 | ||||||
Intangible lease assets, net |
98,000 | 179,000 | ||||||
Properties held for sale, net |
24,365,000 | 53,088,000 | ||||||
69,863,000 | 123,261,000 | |||||||
Notes receivable, net |
2,200,000 | 4,000,000 | ||||||
Note receivable from related party |
| 8,000,000 | ||||||
Non-real estate assets associated with properties held for sale |
365,000 | 424,000 | ||||||
Deferred costs and deposits |
28,000 | 32,000 | ||||||
Deferred financing costs, net |
297,000 | 271,000 | ||||||
Tenant and other receivables, net |
433,000 | 446,000 | ||||||
Other assets, net |
314,000 | 549,000 | ||||||
Assets held in variable interest entities: |
||||||||
Cash and cash equivalents |
76,000 | | ||||||
Investments in real estate |
9,810,000 | | ||||||
Accounts receivable, inventory and other assets |
196,000 | | ||||||
Total assets held in variable interest entities |
10,082,000 | | ||||||
Total assets |
$ | 83,945,000 | $ | 138,997,000 | ||||
LIABILITIES AND EQUITY |
||||||||
Liabilities: |
||||||||
Notes payable |
$ | 23,802,000 | $ | 26,604,000 | ||||
Accounts payable and accrued liabilities |
942,000 | 646,000 | ||||||
Payable to related parties |
3,000 | | ||||||
Prepaid rent, security deposits and deferred revenue |
369,000 | 661,000 | ||||||
Intangible lease liabilities, net |
54,000 | 89,000 | ||||||
Distributions payable |
468,000 | 157,000 | ||||||
Liabilities associated with properties held for sale |
3,839,000 | 9,870,000 | ||||||
Liabilities held in variable interest entities: |
||||||||
Note payable |
1,332,000 | | ||||||
Loan payable |
127,000 | | ||||||
Accounts payable and accrued liabilities |
435,000 | | ||||||
Interest payable |
99,000 | | ||||||
Total liabilities held in variable interest entities |
1,993,000 | | ||||||
Total liabilities |
$ | 31,470,000 | $ | 38,027,000 | ||||
Commitments and contingencies (Note 14) |
||||||||
Equity: |
||||||||
Stockholders equity: |
||||||||
Preferred stock, $0.001 par value; 10,000,000 shares
authorized; no shares were issued or outstanding at September
30, 2011 and December 31, 2010 |
| | ||||||
Common stock, $0.001 par value; 290,000,000 shares authorized;
23,027,235 and 23,074,381 shares issued and outstanding at
September 30, 2011 and December 31, 2010, respectively |
23,000 | 23,000 | ||||||
Additional paid-in capital |
116,229,000 | 117,520,000 | ||||||
Accumulated deficit |
(63,481,000 | ) | (16,690,000 | ) | ||||
Total stockholders equity |
52,771,000 | 100,853,000 | ||||||
Noncontrolling interest |
(296,000 | ) | 117,000 | |||||
Total equity |
52,475,000 | 100,970,000 | ||||||
Total liabilities and equity |
$ | 83,945,000 | $ | 138,997,000 | ||||
3
Table of Contents
CORNERSTONE CORE PROPERTIES REIT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Revenues: |
||||||||||||||||
Rental revenues |
$ | 849,000 | $ | 923,000 | $ | 2,640,000 | $ | 2,966,000 | ||||||||
Resident services and fee income |
639,000 | | 639,000 | | ||||||||||||
Tenant reimbursements and other
income |
204,000 | 251,000 | 669,000 | 773,000 | ||||||||||||
Interest income from notes
receivable |
102,000 | 336,000 | 366,000 | 1,124,000 | ||||||||||||
1,794,000 | 1,510,000 | 4,314,000 | 4,863,000 | |||||||||||||
Expenses: |
||||||||||||||||
Property operating and maintenance |
1,076,000 | 488,000 | 1,895,000 | 1,316,000 | ||||||||||||
General and administrative |
713,000 | 521,000 | 2,083,000 | 1,572,000 | ||||||||||||
Asset management fees and expenses |
403,000 | 413,000 | 1,230,000 | 1,241,000 | ||||||||||||
Real estate acquisition costs |
| 30,000 | | 58,000 | ||||||||||||
Depreciation and amortization |
494,000 | 542,000 | 1,567,000 | 1,600,000 | ||||||||||||
Impairment of note receivable |
| | 1,650,000 | | ||||||||||||
Impairment of real estate |
425,000 | | 23,644,000 | | ||||||||||||
3,111,000 | 1,994,000 | 32,069,000 | 5,787,000 | |||||||||||||
Operating loss |
(1,317,000 | ) | (484,000 | ) | (27,755,000 | ) | (924,000 | ) | ||||||||
Interest income |
| 1,000 | | 4,000 | ||||||||||||
Interest expense |
(452,000 | ) | (305,000 | ) | (1,063,000 | ) | (837,000 | ) | ||||||||
Loss from continuing operations |
(1,769,000 | ) | (788,000 | ) | (28,818,000 | ) | (1,757,000 | ) | ||||||||
Discontinued operations: |
||||||||||||||||
Income (loss) from discontinued
operations |
285,000 | 219,000 | (18,377,000 | ) | 1,315,000 | |||||||||||
Net loss |
(1,484,000 | ) | (569,000 | ) | (47,195,000 | ) | (442,000 | ) | ||||||||
Loss attributable to noncontrolling
interests |
352,000 | | 404,000 | | ||||||||||||
Net loss attributable to common
stockholders |
$ | (1,132,000 | ) | $ | (569,000 | ) | $ | (46,791,000 | ) | $ | (442,000 | ) | ||||
Earnings per common share: |
||||||||||||||||
Basic and diluted net loss from
continuing operations per common
share |
$ | (0.07 | ) | $ | (0.03 | ) | $ | (1.22 | ) | $ | (0.08 | ) | ||||
Basic and diluted net income (loss)
from discontinued operations per
common share |
$ | 0.01 | $ | 0.01 | $ | (0.78 | ) | $ | 0.06 | |||||||
Weighted average number of common
shares |
23,860,105 | 22,880,212 | 23,635,914 | 22,917,097 | ||||||||||||
Dividends declared per common share |
$ | | $ | 0.12 | $ | 0.04 | $ | 0.36 |
4
Table of Contents
CORNERSTONE
CORE PROPERTIES REIT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
For the Nine Months Ended September 30, 2011 and 2010
(Unaudited)
For the Nine Months Ended September 30, 2011 and 2010
(Unaudited)
Common | Additional | Total | ||||||||||||||||||||||||||
Number of | Stock Par | Paid-In | Accumulated | Stockholders | Noncontrolling | |||||||||||||||||||||||
Shares | Value | Capital | Deficit | Equity | Interests | Total Equity | ||||||||||||||||||||||
Balance December
31,
2010 |
23,074,381 | $ | 23,000 | $ | 117,520,000 | $ | (16,690,000 | ) | $ | 100,853,000 | $ | 117,000 | $ | 100,970,000 | ||||||||||||||
Issuance of common
stock |
| | | | | | | |||||||||||||||||||||
Redeemed shares |
(47,146 | ) | | (369,000 | ) | | (369,000 | ) | | (369,000 | ) | |||||||||||||||||
Offering costs |
| | | | | | | |||||||||||||||||||||
Dividends declared |
| | (922,000 | ) | | (922,000 | ) | (9,000 | ) | (931,000 | ) | |||||||||||||||||
Net loss |
| | | (46,791,000 | ) | (46,791,000 | ) | (404,000 | ) | (47,195,000 | ) | |||||||||||||||||
Balance
September 30, 2011 |
23,027,235 | $ | 23,000 | $ | 116,229,000 | $ | (63,481,000 | ) | $ | 52,771,000 | $ | (296,000 | ) | $ | 52,475,000 | |||||||||||||
Common | Additional | Total | ||||||||||||||||||||||||||
Number of | Stock Par | Paid-In | Accumulated | Stockholders | Noncontrolling | |||||||||||||||||||||||
Shares | Value | Capital | Deficit | Equity | Interests | Total Equity | ||||||||||||||||||||||
Balance December
31, 2009 |
23,114,201 | $ | 24,000 | $ | 128,559,000 | $ | (13,559,000 | ) | $ | 115,024,000 | $ | 131,000 | $ | 115,155,000 | ||||||||||||||
Issuance of common
stock |
730,318 | 1,000 | 5,609,000 | | 5,610,000 | | 5,610,000 | |||||||||||||||||||||
Redeemed shares |
(848,113 | ) | | (6,501,000 | ) | | (6,501,000 | ) | | (6,501,000 | ) | |||||||||||||||||
Offering costs |
| | (470,000 | ) | | (470,000 | ) | | (470,000 | ) | ||||||||||||||||||
Dividends declared |
| | (8,206,000 | ) | | (8,206,000 | ) | (9,000 | ) | (8,215,000 | ) | |||||||||||||||||
Net loss |
| | | (442,000 | ) | (442,000 | ) | | (442,000 | ) | ||||||||||||||||||
Balance
September 30, 2010 |
22,996,406 | $ | 25,000 | $ | 118,991,000 | $ | (14,001,000 | ) | $ | 105,015,000 | $ | 122,000 | $ | 105,137,000 | ||||||||||||||
5
Table of Contents
CORNERSTONE
CORE PROPERTIES REIT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Unaudited)
Nine Months Ended September 30, | ||||||||
2011 | 2010 | |||||||
Cash flows from operating activities: |
||||||||
Net loss |
$ | (47,195,000 | ) | $ | (442,000 | ) | ||
Adjustments
to reconcile net loss to net cash (used in) provided by operating activities: |
||||||||
Amortization of deferred financing costs |
357,000 | 216,000 | ||||||
Depreciation and amortization |
1,906,000 | 2,574,000 | ||||||
Straight-line rent and acquired (below) above market leases amortization, net |
(34,000 | ) | 29,000 | |||||
Impairment of note receivable |
1,650,000 | | ||||||
Impairment of real estate |
42,977,000 | | ||||||
Provision for bad debt |
(2,000 | ) | (44,000 | ) | ||||
Change in operating assets and liabilities: |
||||||||
Tenant and other receivables |
62,000 | 30,000 | ||||||
Prepaid and other assets |
179,000 | 209,000 | ||||||
Accounts payable and accrued liabilities |
325,000 | 565,000 | ||||||
Payable to related parties |
(6,000 | ) | (376,000 | ) | ||||
Prepaid rent, security deposits and deferred revenue |
(280,000 | ) | (194,000 | ) | ||||
Net cash
(used in) provided by operating activities |
(61,000 | ) | 2,567,000 | |||||
Cash flows from investing activities: |
||||||||
Real estate acquisitions |
| (1,315,000 | ) | |||||
Real estate improvements |
(509,000 | ) | (58,000 | ) | ||||
Acquired
cash of VIE |
236,000 | | ||||||
Proceeds
from sale of investment in real estate |
9,130,000 | | ||||||
Escrow deposits |
| (250,000 | ) | |||||
Notes receivable proceeds (disbursements) |
150,000 | (750,000 | ) | |||||
Notes receivable from related parties (See Note 8) |
(318,000 | ) | (1,089,000 | ) | ||||
Net cash provided by (used in) investing activities |
8,689,000 | (3,462,000 | ) | |||||
Cash flows from financing activities: |
||||||||
Issuance of common stock |
| 1,151,000 | ||||||
Redeemed shares |
(369,000 | ) | (6,501,000 | ) | ||||
Repayment of notes payable |
(8,873,000 | ) | (344,000 | ) | ||||
Offering costs |
(12,000 | ) | (460,000 | ) | ||||
Distributions paid to stockholders |
(611,000 | ) | (3,781,000 | ) | ||||
Distributions paid to noncontrolling interest |
(9,000 | ) | (9,000 | ) | ||||
Deferred financing costs |
(329,000 | ) | (131,000 | ) | ||||
Net cash used in financing activities |
(10,203,000 | ) | (10,075,000 | ) | ||||
Net decrease in cash and cash equivalents |
(1,575,000 | ) | (10,970,000 | ) | ||||
Cash and cash equivalents beginning of period |
2,014,000 | 18,673,000 | ||||||
Cash and cash equivalents end of period (including cash of VIE) |
$ | 439,000 | $ | 7,703,000 | ||||
Supplemental disclosure of cash flow information: |
||||||||
Cash paid for interest |
$ | 760,000 | $ | 684,000 | ||||
Supplemental disclosure of non-cash financing and investing activities: |
||||||||
Accrual for distribution declared |
$ | 468,000 | $ | 906,000 | ||||
Accrued leasing commissions payable |
$ | 18,000 | | |||||
Deferred loan origination fees |
$ | 54,000 | | |||||
Accrued real estate improvements |
$ | 43,000 | $ | 74,000 | ||||
Distributions reinvested |
$ | | $ | 4,459,000 | ||||
Payable to related party, net |
$ | 3,000 | $ | 8,000 | ||||
Elimination of note receivable from related party through consolidation of
variable interest entity (See Note 9) |
||||||||
Assets acquired |
$ | 10,069,000 | $ | | ||||
Liabilities assumed |
$ | 1,806,000 | $ | | ||||
Elimination of note receivable |
$ | 8,263,000 | $ | |
6
Table of Contents
CORNERSTONE CORE PROPERTIES REIT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
SEPTEMBER 30, 2011
UNAUDITED
1. Organization
Cornerstone Core Properties REIT, Inc., a Maryland Corporation, was formed on October 22, 2004
under the General Corporation Law of Maryland for the purpose of engaging in the business of
investing in and owning commercial real estate. As used in this report, the Company, we, us
and our refer to Cornerstone Core Properties REIT, Inc. and its consolidated subsidiaries except
where the context otherwise requires. Subject to certain restrictions and limitations, our business
is managed pursuant to an advisory agreement by an affiliate, Cornerstone Realty Advisors, LLC, a
Delaware limited liability company that was formed on November 30, 2004 (the Advisor).
Cornerstone Operating Partnership, L.P., a Delaware limited partnership (the Operating
Partnership) was formed on November 30, 2004. At September 30, 2011, we owned a 99.88% general
partner interest in the Operating Partnership while the Advisor owned a 0.12% limited partnership
interest. We anticipate that we will conduct all or a portion of our operations through the
Operating Partnership. Our financial statements and the financial statements of the Operating
Partnership are consolidated in the accompanying condensed consolidated financial statements. These
financial statements include consolidation of a variable interest entity (see Note 9). All
intercompany accounts and transactions have been eliminated in consolidation.
2. Public Offerings
On January 6, 2006, we commenced a public offering of a minimum of 125,000 shares and a maximum of
55,400,000 shares of our common stock, consisting of 44,400,000 shares for sale to the public (the
Primary Offering) and 11,000,000 shares for sale pursuant to our distribution reinvestment plan.
We stopped making offers under our initial public offering on June 1, 2009 upon raising gross
offering proceeds of approximately $172.7 million from the sale of approximately 21.7 million
shares, including shares sold under the distribution reinvestment plan. On June 10, 2009, the U.S.
Securities Exchange Commission (SEC) declared our follow-on offering effective and we commenced a
follow-on offering of up to 77,350,000 shares of our common stock, consisting of 56,250,000 shares
for sale to the public (the Follow-On Offering) and 21,100,000 shares for sale pursuant to our
dividend reinvestment plan. The Primary Offering and Follow-On Offering are collectively referred
to as the Offerings. We retained Pacific Cornerstone Capital, Inc. (PCC), an affiliate of our
Advisor, to serve as the dealer manager for the Offerings. PCC was responsible for marketing our
shares being offered pursuant to the Offerings.
On November 23, 2010 we informed our investors of several decisions made by the board of directors
for the health of our REIT. Effective November 23, 2010, we stopped making and accepting offers to
purchase shares of our stock while our board of directors evaluates strategic alternatives to
maximize value. The board of directors continues to evaluate such alternatives and has engaged
consultants to assist in identifying such alternatives.
As of September 30, 2011, approximately 20.9 million shares of our common stock had been sold in
our Offerings for aggregate gross proceeds of approximately $167.1 million. This excludes shares
issued under our distribution reinvestment plan.
7
Table of Contents
3. Summary of Significant Accounting Policies
The preparation of our condensed consolidated financial statements requires us to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We
base these estimates on various assumptions that we believe to be reasonable under the
circumstances, and these estimates form the basis for our judgments concerning the carrying values
of assets and liabilities that are not readily apparent from other sources. We periodically
evaluate these estimates and judgments based on available information and experience. Actual
results could differ from our estimates under different assumptions and conditions. If actual
results significantly differ from our estimates, our financial condition and results of operations
could be materially impacted. For more information regarding our critical accounting policies and
estimates please refer to Summary of Significant Accounting Policies contained in our Annual
Report on Form 10-K for the year ended December 31, 2010. There have been no material changes to
the critical accounting policies previously disclosed in that report.
Interim Financial Information
The accompanying interim condensed consolidated financial statements have been prepared by our
management in accordance with accounting principles generally accepted in the United States of
America (GAAP) and in conjunction with the rules and regulations of the SEC. Certain information
and footnote disclosures required for annual financial statements have been condensed or excluded
pursuant to SEC rules and regulations. Accordingly, the interim condensed consolidated financial
statements do not include all of the information and footnotes required by GAAP for complete
financial statements. The accompanying financial information reflects all adjustments which are, in
the opinion of our management, of a normal recurring nature and necessary for a fair presentation
of our financial position, results of operations and cash flows for the interim periods. Interim
results of operations are not necessarily indicative of the results to be expected for the full
year. The accompanying condensed consolidated financial statements should be read in conjunction
with the audited consolidated financial statements and the notes thereto included in the 2010
Annual Report on Form 10-K as filed with the SEC. Operating results for the three and nine months
ended September 30, 2011 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2011.
Fair Value of Financial Instruments
Financial Accounting Standards Board Accounting Standards Codification (ASC) 825-10, Financial
Instruments, requires the disclosure of fair value information about financial instruments whether
or not recognized on the face of the balance sheet, for which it is practical to estimate that
value.
Fair value represents the estimate of the proceeds to be received, or paid in the case of a
liability, in a current transaction between willing parties. ASC 820, Fair Value Measurement (ASC
820) establishes a fair value hierarchy to categorize the inputs used in valuation techniques to
measure fair value. Inputs are either observable or unobservable in the marketplace. Observable
inputs are based on market data from independent sources and unobservable inputs reflect the
reporting entitys assumptions about market participant assumptions used to value an asset or
liability.
Financial assets and liabilities recorded at fair value on the condensed consolidated balance
sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1. Quoted prices in active markets for identical instruments.
Level 2. Observable inputs other than Level 1 prices, such as quoted prices for similar assets or
liabilities; quoted prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of the assets or
liabilities.
Level 3. Unobservable inputs that are supported by little or no market activity and that are
significant to the fair value of the assets or liabilities.
8
Table of Contents
Assets and liabilities measured at fair value are classified according to the lowest level input
that is significant to their valuation. A financial instrument that has a significant unobservable
input along with significant observable inputs may still be classified as a level 3 instrument.
We generally determine or calculate the fair value of financial instruments using quoted market
prices in active markets when such information is available or use appropriate present value or
other valuation techniques, such as discounted cash flow analyses, incorporating available market
discount rate information for similar types of instruments and our estimates for non-performance
and liquidity risk. These techniques are significantly affected by the assumptions used, including
the discount rate, credit spreads, and estimates of future cash flow.
Our condensed consolidated balance sheets include the following financial instruments: cash and
cash equivalents, notes receivable, note receivable from related party, tenant and other
receivables, other assets, deferred costs and deposits, deferred financing costs, accounts payable
and accrued liabilities, payable to related parties, prepaid rent, security deposits and deferred
revenue, distributions payable and notes payable. With the exception of notes receivable, note
receivable from related party and notes payable discussed below, we consider the carrying values to
approximate fair value for such financial instruments because of the short period of time between
origination of the instruments and their expected payment.
The fair value of notes payable is estimated using lending rates available to us for financial
instruments with similar terms and maturities. As of September 30, 2011 and December 31, 2010, the
fair value of notes payable was $27.3 million and $35.9 million, compared to the carrying value of
$27.0 million and $35.9 million, respectively. The carrying values noted above include notes
classified as liabilities associated with properties held for sale totaling $3.2 million and $9.3
million as of September 30, 2011 and December 31, 2010, respectively.
As of September 30, 2011 and December 31, 2010, the fair value of notes receivable was $2.1 million
and $3.9 million, compared to the carrying value of $2.2 million and $4.0 million, respectively.
The fair value of notes receivable is estimated using current rates at which management believes
similar loans would be made. During the quarter ended June 30, 2011, we determined the note
receivable was impaired and therefore adjusted its carrying value to estimated fair value based on
our assessment of the borrowers business prospects (See Note 7).
At December 31, 2010, the fair value of the note receivable from related party was $8.0 million,
consistent with its carrying value, estimated using current rates at which management believes
similar loans would be made with similar terms and maturities. On September 30, 2011, we
consolidated the related party with which we entered this transaction as we determined that we were
the primary beneficiary of the entity at that date (see Note 9).
As a result of our ongoing analysis for potential impairment of our investments in real estate,
including properties classified as held for sale, we were required to adjust the carrying value of
certain assets to their estimated fair values as of September 30, 2011 (see Note 4). The following
table summarizes the assets measured at fair value on a nonrecurring basis during the third quarter
of 2011:
Level 1 | Level 2 | Level 3 | ||||||||||||||
Assets at | Assets at | Assets at | ||||||||||||||
Fair Value | Fair Value | Fair Value | Total | |||||||||||||
Investments in real estate |
$ | | $ | | $ | 846,000 | $ | 846,000 | ||||||||
Property held for sale |
$ | | $ | 893,000 | $ | | $ | 893,000 |
The following table summarizes the assets measured at fair value on a nonrecurring basis during the
nine months ended September 30, 2011:
Level 1 | Level 2 | Level 3 | ||||||||||||||
Assets at | Assets at | Assets at | ||||||||||||||
Fair Value | Fair Value | Fair Value | Total | |||||||||||||
Investments in real estate |
$ | | $ | | $ | 42,816,000 | $ | 42,816,000 | ||||||||
Properties held for sale |
$ | | $ | 893,000 | $ | 23,472,000 | $ | 24,365,000 | ||||||||
Note receivable |
$ | | $ | | $ | 2,200,000 | $ | 2,200,000 |
The investments in real estate are deemed to be Level 3 assets as their fair value measurements
rely primarily on our estimates of market based inputs and our assumptions about the use of the assets, as
observable inputs are not available. We estimate the fair value of real estate using unobservable
data such as net operating income and estimated capitalization and discount rates. We also consider
local and national
industry market data including comparable sales, and at times engage an external real estate
appraiser to assist us in our estimation of fair value.
The property held for sale measured at fair value during the third quarter of 2011 is deemed to be
a Level 2 asset as we have received a formal offer for the property. We do not believe that this
asset is a Level 1 asset as the provisions in the purchase and sale agreement allowing the
potential buyer to opt out of the purchase have not yet lapsed. The properties held for sale that
were measured at fair value and deemed to be Level 3 assets were valued based primarily on
company-specific inputs and our assumptions about the use of the assets, as observable inputs are
not available. We estimate the fair value of real estate using unobservable data such as net
operating income and estimated capitalization and discount rates. We also consider local and
national industry market data including comparable sales, and at times engage an external real
estate appraiser to assist us in our estimation of fair value.
The note receivable was valued using our estimation of market-based inputs, such as an appropriate
discount rate based on the risk profile and duration of the note, to an income approach valuation
model.
At September 30, 2011 and December 31, 2010, we do not have any significant financial assets or
financial liabilities that are measured at fair value on a recurring basis in our consolidated
financial statements.
Variable Interest Entities
The Company analyzes its contractual and/or other interests to determine whether such interests
constitute an interest in a variable interest entity (VIE) in accordance with ASC 810,
Consolidation (ASC 810), and, if so, whether the Company is the primary beneficiary. If the
Company is determined to be the primary beneficiary of a VIE, it must consolidate the VIE. A VIE is
an entity with insufficient equity investment or in which the equity investors lack some of the
characteristics of a controlling financial interest. In determining whether it is the primary
beneficiary, the Company considers, among other things, whether it has the power to direct the
activities of the VIE that most significantly impact the entitys economic performance, including,
but not limited to, determining or limiting the scope or purpose of the VIE, selling or
transferring property owned or controlled by the VIE, or arranging financing for the VIE. The
Company also considers whether it has the obligation to absorb losses of the VIE or the right to
receive benefits from the VIE (see Note 9).
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Real Estate Assets Held for Sale
The Company evaluates the held for sale classification of its owned real estate each quarter.
Assets that are classified as held for sale are recorded at the lower of their carrying amount or
fair value less cost to sell. Assets are classified as held for sale once management commits to a
plan to sell the properties and has initiated an active program to market them for sale. The
results of operations of these real estate properties are reflected as discontinued operations in
all periods presented. During the second quarter of 2011, management committed to a plan to sell
the Mack Deer Valley, Pinnacle Park Business Center, and 2111 South Industrial Park properties to
third parties and as such we have classified the properties as held for sale. These properties have
not been sold as of September 30, 2011 (see Note 4).
Recent Accounting Pronouncements
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to
Achieve Common Fair Value Measurement and Disclosure Requirements in
U.S. GAAP and IFRSs (ASU 2011-04). The amendment provides a uniform framework for fair value measurements and related
disclosures between GAAP and International Financial Reporting Standards (IFRS). Additional
disclosure requirements in the update include: (1) for Level 3 fair value measurements,
quantitative information about unobservable inputs used, a description of the valuation processes
used by the entity, and a qualitative discussion about the sensitivity of the measurements to
changes in the unobservable inputs; (2) for an entitys use of a nonfinancial asset that is
different from the assets highest and best use, the reason for the difference; (3) for financial
instruments not measured at fair value but for which disclosure of fair value is required, the fair
value hierarchy level in which the fair value measurements were determined; and (4) the disclosure
of all transfers between Level 1 and Level 2 of the fair value hierarchy. ASU 2011-04 will be
effective for interim and annual periods beginning on or after December 15, 2011, which for us will
be our 2012 first quarter. We are currently evaluating the impact ASU 2011-04 will have on our
financial statements.
In April 2011, the FASB issued Accounting Standards Update No. 2011-02, A Creditors Determination
of Whether a Restructuring Is a Troubled Debt Restructuring (ASU 2011-02). The amendments in this
update clarify, among other things, the guidance on a creditors evaluation of whether it has
granted a concession and whether a debtor is experiencing financial difficulties. The Companys
adoption of ASU 2011-02 on July 1, 2011 did not have a significant impact on its consolidated
financial position or results of operations.
4. Investments in Real Estate
Property Portfolio
As of September 30, 2011, our portfolio, including properties held for sale, consists of twelve
properties which were approximately 67.5% leased. The following table provides summary information
regarding our properties.
September | ||||||||||||||||||||||||
Date | Square | Purchase | 30, 2011 | |||||||||||||||||||||
Property(1) | Location | Purchased | Footage | Price | Debt | % Leased | ||||||||||||||||||
2111 South Industrial Park |
North Tempe, AZ | June 1, 2006 | 26,800 | $ | 1,975,000 | $ | | 82.1 | % | |||||||||||||||
Shoemaker Industrial Buildings |
Santa Fe Springs, CA | June 30, 2006 | 18,921 | 2,400,000 | | 100.0 | % | |||||||||||||||||
20100 Western Avenue |
Torrance, CA | December 1, 2006 | 116,433 | 19,650,000 | 1,786,000 | 29.0 | % | |||||||||||||||||
Mack Deer Valley |
Phoenix, AZ | January 21, 2007 | 180,985 | 23,150,000 | 1,469,000 | 68.3 | % | |||||||||||||||||
Marathon Center |
Tampa Bay, FL | April 2, 2007 | 52,020 | 4,450,000 | | 26.1 | % | |||||||||||||||||
Pinnacle Park Business Center |
Phoenix, AZ | October 2, 2007 | 159,661 | 20,050,000 | 1,730,000 | 63.8 | % | |||||||||||||||||
Orlando Small Bay Portfolio
Carter Commerce Center |
Winter Garden, FL | November 15, 2007 | 49,125 | 42.0 | % | |||||||||||||||||||
Goldenrod Commerce Center |
Orlando, FL | November 15, 2007 | 78,646 | 88.6 | % | |||||||||||||||||||
Hanging Moss Commerce Center |
Orlando, FL | November 15, 2007 | 94,200 | 93.4 | % | |||||||||||||||||||
Monroe South Commerce Center |
Sanford, FL | November 15, 2007 | 172,500 | 63.7 | % | |||||||||||||||||||
Orlando Small Bay Portfolio |
394,471 | 37,128,000 | 15,300,000 | |||||||||||||||||||||
Monroe North Commerce Center |
Sanford, FL | April 17, 2008 | 181,348 | 14,275,000 | 6,715,000 | 86.5 | % | |||||||||||||||||
1830 Santa Fe |
Santa Ana, CA | August 5, 2010 | 12,200 | 1,315,000 | | 100.0 | % | |||||||||||||||||
1,142,839 | $ | 124,393,000 | $ | 27,000,000 | 67.5 | % | ||||||||||||||||||
(1) | The table excludes Sherburne Commons, a variable interest entity for which we became the primary beneficiary and therefore began consolidating their financial results as of June 30, 2011. Sherburne Commons is the only property in our senior housing reportable segment (See Notes 8 and 9). |
As of September 30, 2011, adjusted cost and accumulated depreciation and amortization related
to investments in real estate and related intangible lease assets were as follows:
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Acquired | Acquired | |||||||||||||||||||
Buildings and | Above-Market | In-Place Lease | Below-Market | |||||||||||||||||
Land | Improvements | Leases | Value | Leases | ||||||||||||||||
Investments in real estate |
$ | 11,733,000 | $ | 34,176,000 | $ | 1,401,000 | $ | 1,181,000 | $ | (620,000 | ) | |||||||||
Less: accumulated
depreciation and
amortization |
| (509,000 | ) | (1,361,000 | ) | (1,123,000 | ) | 566,000 | ||||||||||||
Net investments in real
estate and related lease
intangibles from
continuing operations |
11,733,000 | 33,667,000 | 40,000 | 58,000 | (54,000 | ) | ||||||||||||||
Net investments in real
estate and related lease
intangibles held for sale |
7,866,000 | 16,282,000 | 65,000 | 152,000 | (28,000 | ) | ||||||||||||||
$ | 19,599,000 | $ | 49,949,000 | $ | 105,000 | $ | 210,000 | $ | (82,000 | ) | ||||||||||
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As of December 31, 2010, cost and accumulated depreciation and amortization related to real
estate and related intangible lease assets were as follows:
Acquired | Acquired | |||||||||||||||||||
Buildings and | Above-Market | In-Place Lease | Below-Market | |||||||||||||||||
Land | Improvements | Leases | Value | Leases | ||||||||||||||||
Investments in real estate |
$ | 18,073,000 | $ | 57,847,000 | $ | 1,401,000 | $ | 1,181,000 | $ | (620,000 | ) | |||||||||
Less: accumulated
depreciation and
amortization |
| (5,926,000 | ) | (1,334,000 | ) | (1,069,000 | ) | 531,000 | ||||||||||||
Net investments in real
estate and related lease
intangibles from
continuing operations |
18,073,000 | 51,921,000 | 67,000 | 112,000 | (89,000 | ) | ||||||||||||||
Net investments in real
estate and related lease
intangibles held for sale |
20,607,000 | 32,198,000 | 84,000 | 199,000 | (39,000 | ) | ||||||||||||||
$ | 38,680,000 | $ | 84,119,000 | $ | 151,000 | $ | 311,000 | $ | (128,000 | ) | ||||||||||
Depreciation
expense associated with buildings and improvements, including
properties held for sale, for the three months ended
September 30, 2011 and 2010 was $0.3 million and $0.7 million, respectively. Depreciation expense
associated with buildings and improvements for the nine months ended September 30, 2011 and 2010
was $1.7 million and $2.2 million, respectively. We are required to make subjective assessments as
to the useful lives of our depreciable assets. In making such assessments, we consider the assets
expected period of future economic benefit to estimate the appropriate useful lives.
Net
amortization expense associated with the intangible lease assets and
liabilities, including those associated with properties held for sale, for the three
months ended September 30, 2011 and 2010 was $9,000 and $76,000, respectively. Net amortization
expense associated with the intangible lease assets and liabilities for the nine months ended
September 30, 2011 and 2010 was $0.1 million and $0.2 million, respectively. Estimated net amortization
expense for October 1, 2011 through December 31, 2011 and each of the subsequent years is as
follows:
Amortization of Intangible | ||||
Lease Assets | ||||
October 1, 2011 to December 31, 2011 |
$ | 78,000 | ||
2012 |
$ | 82,000 | ||
2013 |
$ | 51,000 | ||
2014 |
$ | 12,000 | ||
2015 |
$ | 10,000 |
The estimated useful lives for intangible lease assets range from approximately one month to four
years. As of September 30, 2011, the weighted-average amortization period for in-place leases,
acquired above market leases and acquired below market leases were 2.0 years, 1.6 years and 1.5
years, respectively.
Impairments
In accordance with ASC 360, Property, Plant, and Equipment (ASC 360), we conduct a comprehensive
review of our real estate assets for impairment. ASC 360 requires that asset values be analyzed
whenever events or changes in circumstances indicate that the carrying value of a property may not
be fully recoverable.
Indicators of potential impairment include the following:
| Change in strategy resulting in a decreased holding period; |
| Decreased occupancy levels; |
| Deterioration of the rental market as evidenced by rent decreases over numerous quarters; |
| Properties adjacent to or located in the same submarket as those with recent impairment issues; |
| Significant decrease in market price; and/or |
| Tenant financial problems. |
The intended use of an asset, either held for sale or held for the long term, can significantly
impact how impairment is measured. If an asset is intended to be held for the long term, the
impairment analysis is based on a two-step test.
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The first test measures estimated expected future cash flows over the holding period, including a
residual value (undiscounted and without interest charges), against the carrying value of the
property. If the asset fails that test, the asset carrying value is compared to the estimated fair
value from a market participant standpoint, with the excess of the assets carrying value over the
estimated fair value recognized as an impairment charge to earnings.
In the second quarter of 2011, we reviewed the impairment indicators as described above. At that
time, our board of directors was evaluating strategic alternatives to maximize shareholder value
and therefore we believed that our properties could potentially have shorter holding periods than
previously planned in past reporting periods when estimating whether the carrying value of the
properties was recoverable. The use of shorter hold periods reduced our future (undiscounted) cash
flows attributable to the properties. Consequently, we were required to adjust certain properties
to their estimated fair values resulting in an impairment charge of $23.2 million, which is
classified as impairment of real estate on our condensed consolidated statements of operations for
the nine months ended September 30, 2011. If our holding period assumptions change, additional
properties could require additional testing and could result in additional impairment charges in
future periods.
In the third quarter of 2011, we noted an increase in uncollected
rent payments at the 1830 Sante Fe property. The corresponding
reduction in our undiscounted cash flow forecasts caused us to fail
step 1 of our impairment test. Accordingly, we recorded an impairment of $0.4 million related to this
property.
The fair value of the properties was derived using an income approach primarily utilizing Level 3
inputs. This approach estimates fair value based on expected future cash flows and requires us to
estimate, among other things, (1) future market rental income amounts subsequent to the expiration
of current lease agreements, (2) property operating expenses, (3) risk-adjusted rate of return and
capitalization rates, (4) the number of months it is expected to take to re-lease the property and
(5) the number of years the property is expected to be held for investment. A change in any one or
more of these factors could materially impact whether a property is impaired as of any given
valuation date. When available, current market information, such as comparative sales prices, was
used to determine capitalization, discount, and rental growth rates. In cases where market
information was not readily available, the inputs were based on our understanding of market
conditions and the experience of our management team.
The following table illustrates, by property, the impairment charge recorded to impairment of real
estate during the nine months ended September 30, 2011:
Impairment | ||||
Property | Charge | |||
20100 Western Avenue |
$ | 6,905,000 | ||
Carter Commerce Center |
1,471,000 | |||
Goldenrod Commerce Center |
3,403,000 | |||
Hanging Moss Commerce Center |
2,544,000 | |||
Monroe North Commerce Center |
4,530,000 | |||
Monroe South Commerce Center |
4,366,000 | |||
Santa Fe |
425,000 | |||
$ | 23,644,000 | |||
Real Estate Held for Sale
In the second quarter of 2011, we reclassified the 15172 Goldenwest Circle property (Goldenwest),
which was sold on June 14, 2011, and the Mack Deer Valley, the Pinnacle Park Business Center, and
the 2111 South Industrial Park properties, which we expect to sell in the fourth quarter of 2011,
to properties held for sale. Additionally, the financial results for the properties classified as
properties held for sale have been reclassified to discontinued operations for all periods
presented (see Note 15).
When assets are classified as held for sale, they are recorded at the lower of carrying value or
the estimated fair value of the asset, net of estimated selling costs. Accordingly, we recorded an
impairment charge of $19.2 million for the Goldenwest, Mack Deer Valley, Pinnacle Park, and 2111
South Industrial properties upon their transfer into real estate held for sale in the second
quarter of 2011 (see Note 15). In the third quarter of 2011, we recorded an additional impairment
of $0.1 million for the 2111 South Industrial Park property.
On
November 23, 2011, the previously cancelled purchase and sale
agreement executed on August 31, 2011 between us and Columbia
Industrial Properties Midwest, LLC, in connection with the sale of
the Mack Deer Valley and Pinnacle Park
properties, was reinstated. The Company sold these two properties on
November 28, 2011, and will recognize the related loss of
approximately $0.3 million in the fourth quarter, reflecting a change
in facts and circumstances related to the value of the assets
subsequent to September 30, 2011.
On October
26, 2011, we entered into a purchase and sale agreement in connection
with the sale of the 2111 South Industrial Park property for proceeds
of $0.9 million. The sale is expected to close on or before December
21, 2011.
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The following table illustrates, by property, the impairment charge recorded in discontinued
operations in the nine months ended September 30, 2011:
Impairment | ||||
Property | Charge | |||
Mack Deer Valley |
$ | 9,674,000 | ||
Pinnacle Park Business Center |
7,279,000 | |||
2111 South Industrial Park |
250,000 | |||
Goldenwest |
2,129,000 | |||
$ | 19,332,000 | |||
Leasing Commissions
Leasing commissions are stated at cost and amortized on a straight-line basis over the related
lease term. As of September 30, 2011 and December 31, 2010, we recorded approximately $0.6 million
and $0.5 million in leasing commissions, respectively. Amortization expense for the three months
ended September 30, 2011 and 2010 was approximately $28,000 and
$0.1 million, respectively. Amortization
expense for the nine months ended September 30, 2011 and 2010
was approximately $92,000 and
$0.2 million, respectively.
5. Allowance for Doubtful Accounts
Our allowance for doubtful accounts was $0.2 million and $0.4 million as of September 30, 2011 and
December 31, 2010, respectively.
6. Concentration of Risk
Financial instruments that potentially subject us to a concentration of credit risk are primarily
cash investments, notes receivable and the note receivable from related party. Refer to Notes 7 and 8
with regard to credit risk evaluation of notes receivable and note receivable from related
party. Cash is generally invested in investment-grade short-term instruments. On July 21, 2010,
President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act
that implements significant changes to the regulation of the financial services industry, including
provisions that made permanent the $250,000 limit for federal deposit insurance and increased the
cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000, and
provided unlimited federal deposit insurance until January 1, 2013, for non-interest bearing demand
transaction accounts at all insured depository institutions. As of September 30, 2011, none of our
depository accounts are in excess of the federal deposit insurance nor SIPC- insured limits.
Therefore we do not have credit risks related to these depository accounts.
As of September 30, 2011, we owned three properties in the state of California, three properties in
the state of Arizona and six properties in the state of Florida. Accordingly, there is a geographic
concentration of risk subject to fluctuations in each states economy.
7. Notes Receivable
Pursuant to agreements originally entered into in May 2008, and amended in March 2009 and May 2010,
we committed to loan up to $8.75 million at a rate of 10% per annum to two real estate operating
companies, Servant Investments, LLC and Servant Healthcare Investments, LLC (collectively,
Servant). The commitment was fully funded in December 2010, and the loans mature on May 19, 2013.
At the time the loans were made, Servant was a party to an alliance with the managing member of our
Advisor.
On a quarterly basis, we evaluate the collectability of our notes receivable. Our evaluation of
collectability involves judgment, estimates, and a review of the underlying collateral and
borrowers business models and future cash flows from operations. During the quarter ended
September 30, 2009, we concluded that the collectability of the Servant Investments, LLC (Servant
Investments) note could not be reasonably assured and therefore, we recorded a reserve of $4.75
million against the note balance. As of September 30, 2011 and December 31, 2010, the Servant
Investments note receivable had a net balance of $0. It is our policy to recognize interest income
on the reserved loan on a cash basis. For the three months ended September 30, 2011 and 2010,
interest income related to the
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Servant Investments note receivable was $0 and $80,000, respectively. For the nine months ended
September 30, 2011 and 2010, interest income from the note was $0 and $0.4 million, respectively.
During the quarter ended June 30, 2011, after evaluating the expected effects of changes in the
borrowers business prospects, including the uncertainty surrounding Servants realization of the
fees pursuant to the subadvisory agreement, we concluded that it was probable that the Company
would be unable to collect all amounts due according to the terms of the Servant Healthcare, LLC
(Servant Healthcare) note and consequently, we recorded a note receivable impairment of $1.65
million against the balance of that note. Although the extent to
which we will collect the amount due under the Servant Health care
note remains uncertain, we do not have information that indicates
that a further write-down of the note is warranted at this time. We
are continuing to monitor the collectibility of the note and explore
repayment alternatives with the Servant entities.
The following table reconciles the notes receivable balance from January 1, 2011 to September 30,
2011 and January 1, 2010 to September 30, 2010:
2011 | 2010 | |||||||
Beginning Balance |
$ | 4,000,000 | $ | 2,875,000 | ||||
Additions: |
||||||||
Additions to note receivable |
| 750,000 | ||||||
Deductions: |
||||||||
Note receivable repayments |
(150,000 | ) | | |||||
Note receivable impairments |
(1,650,000 | ) | | |||||
Ending Balance |
$ | 2,200,000 | $ | 3,625,000 | ||||
As of September 30, 2011 and December 31, 2010, the note receivable had a balance of $2.2
million and $4.0 million respectively. For the three months ended September 30, 2011 and 2010,
interest income related to the note receivable was $98,000 and $88,000, respectively. For the nine
months ended September 30, 2011 and 2010, interest income from the note was $0.3 million and $0.2
million, respectively.
8. Note Receivable from Related Party
On December 14, 2009, we made a participating first mortgage loan commitment of $8.0 million to
Nantucket Acquisition LLC (Nantucket Acquisition), a Delaware limited liability company owned and
managed by Cornerstone Ventures Inc., an affiliate of our Advisor. The loan was made in connection
with Nantucket Acquisitions purchase of a 60-unit senior living community, Sherburne Commons
Residences, LLC (Sherburne Commons), located on the island of Nantucket, MA. The loan matures on
January 1, 2015, with no option to extend and bears interest at a fixed rate of 8.0% for the term
of the loan. Interest is payable monthly with the principal balance due at maturity. Under the
terms of the loan, we are entitled to receive additional interest in the form of a 40%
participation in the appreciation in value of the property, which is calculated based on the net
sales proceeds if the property is sold, or the propertys appraised value, less ordinary
disposition costs, if the property has not been sold by the time the loan matures. Prepayment of
the loan is not permitted without our consent and the loan is not assumable.
Leasing activity at Sherburne Commons has been lower than originally anticipated and to preserve
cash flow for operating requirements, the borrower suspended interest payments to us beginning in
the first quarter of 2011. Consequently, we began recognizing interest income on a cash basis
commencing in the first quarter of 2011. In the second quarter of 2011, the loan balance was
increased by $0.3 million to provide funds to meet Sherburne Commons operating shortfalls. It is
anticipated that additional disbursements may be required while we
continue to increase occupancy and evaluate other alternatives to
maximize the value of the property, including the potential for
additional development, joint ventures or the disposition of the
property.
For the three months ended September 30, 2011 and 2010, interest income recognized on the note was
$0 and $0.2 million, respectively. For the nine months ended September 30, 2011 and 2010, interest
income recognized from the note was approximately $55,000 and $0.5 million, respectively.
On a quarterly basis, we evaluate the collectability of our notes receivable from related parties.
Our evaluation of collectability involves judgment, estimates, and a review of the underlying
collateral and borrowers business models and future cash flows. For the three months ended
September 30, 2011 and 2010, we did not record any impairment on the note receivable from related
party.
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The following table reconciles the note receivable from related party from January 1, 2011 to
September 30, 2011 and January 1, 2010 to September 30, 2010:
2011 | 2010 | |||||||
Beginning Balance |
$ | 8,000,000 | $ | 6,911,000 | ||||
Additions: |
||||||||
Additions to note receivable from related parties |
318,000 | 1,089,000 | ||||||
Deductions: |
||||||||
Repayments of note receivable from related parties |
| | ||||||
Ending Balance |
$ | 8,318,000 | $ | 8,000,000 | ||||
Nantucket Acquisition is considered a variable interest entity because the equity owners of
Nantucket Acquisition do not have sufficient equity at risk, and our mortgage loan commitment was
determined to be a variable interest. Due to the suspension of interest payments by the borrower,
we issued a notice of default to the borrower on June 30, 2011 and determined that we are the
primary beneficiary of the VIE due to our enhanced ability to direct the activities of the VIE. The
primary beneficiary of a VIE is required to consolidate the operations of the VIE. Consequently, we
have consolidated the operations of the VIE as of June 30, 2011 and, accordingly, eliminated the
note receivable from related party balance in consolidation (see Note 9).
9. Consolidation of Variable Interest Entity
GAAP requires the consolidation of variable interest entities (VIE) in which an enterprise has a
controlling financial interest. A controlling financial interest has both of the following
characteristics: (i) the power to direct the activities of a VIE that most significantly impact the
VIEs economic performance and (ii) the obligation to absorb losses of the VIE that could
potentially be significant to the VIE or the right to receive benefits from the VIE that could
potentially be significant to the VIE.
In compliance with ASC 810, Consolidation, we continuously analyze and reconsider our initial
determination of VIE status to determine whether we are the primary beneficiary by considering,
among other things, whether we have the power to direct the activities of the VIE that most
significantly impact its economic performance. Such activities would include, among other things,
determining or limiting the scope or purpose of the VIE, selling or transferring property owned or
controlled by the VIE, or arranging financing for the VIE. We also consider whether we have the
obligation to absorb losses of the VIE or the right to receive benefits from the VIE.
As of September 30, 2011, we had a variable interest in one VIE in the form of a note receivable
from Nantucket Acquisition in the amount of $8.3 million (see Note 8).
As a result of our issuing a notice of default with respect to the note, we determined that we were
the primary beneficiary of the VIE, and therefore consolidated the operations of the VIE beginning
June 30, 2011. Assets of the VIE may only be used to settle obligations of the VIE and creditors of
the VIE have no recourse to the general credit of the Company. As of June 30, 2011, our evaluation
of the value of the assets and liabilities of Sherburne Commons was preliminary. During the quarter
ended September 30, 2011, the evaluation was finalized. The following table illustrates our final
fair value allocation of the assets and liabilities of Sherburne Commons consolidated in our
condensed consolidated balance sheets as of June 30, 2011:
Cash and cash equivalents |
$ | 236,000 | ||
Buildings and improvements |
5,658,000 | |||
Site improvements |
610,000 | |||
Furniture and fixtures |
390,000 | |||
Below-market ground lease |
3,180,000 | |||
In-place leases |
90,000 | |||
Below-market leases |
(290,000 | ) | ||
Accounts receivable and other assets |
195,000 | |||
Accounts payable and accrued liabilities |
(289,000 | ) | ||
Interest payable |
(57,000 | ) | ||
Loan payable |
(128,000 | ) | ||
Note payable |
(1,332,000 | ) | ||
Total net assets |
$ | 8,263,000 | ||
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The following unaudited pro forma information for the three and nine months ended September
30, 2011 and 2010 has been prepared to reflect the incremental effect on the Company had the
operations of Sherburne Commons been consolidated on January 1, 2010.
Three months | Three months | |||||||
Ended | Ended | |||||||
September 30, 2011 | September 30, 2010 | |||||||
Revenues |
$ | 1,794,000 | $ | 1,871,000 | ||||
Net loss |
$ | (1,447,000 | ) | $ | (1,283,000 | ) | ||
Basic and diluted net loss per common share attributable to common stockholders |
$ | (0.06 | ) | $ | (0.06 | ) |
Nine months | Nine months | |||||||
Ended | Ended | |||||||
September 30, 2011 | September 30, 2010 | |||||||
Revenues |
$ | 5,081,000 | $ | 5,766,000 | ||||
Net loss |
$ | (48,180,000 | ) | $ | (2,147,000 | ) | ||
Basic and diluted net loss per common share attributable to common stockholders |
$ | (2.04 | ) | $ | (0.09 | ) |
No adjustments for non-recurring charges were made in the pro-forma information presented
above. For Sherburne Commons, we recorded revenues of $0.6 million and expenses of $0.8 million in
our condensed consolidated statements of operations for the three and nine months ended September
30, 2011.
10. Payable to Related Parties
Payable to related parties at September 30, 2011 consists of expense reimbursements payable to the
Advisor.
11. Equity
Common Stock
Our articles of incorporation authorize 290,000,000 shares of common stock with a par value of
$0.001 and 10,000,000 shares of preferred stock with a par value of $0.001. As of September 30,
2011 and December 31, 2010, we had cumulatively issued 20.9 million shares of common stock for a
total of $167.1 million of gross proceeds, exclusive of shares issued under our distribution
reinvestment plan. On November 23, 2010, we stopped making and accepting offers to purchase shares
of our stock (see Note 1).
Distributions
We have adopted a distribution reinvestment plan that allows our stockholders to have their
distributions invested in additional shares of our common stock. We have registered 21,100,000
shares of our common stock for sale pursuant to the distribution reinvestment plan. The purchase
price per share is 95% of the price paid by the purchaser for our common stock, but not less than
$7.60 per share. As of September 30, 2011 and December 31, 2010, approximately 2.3 million shares
had been issued under the distribution reinvestment plan. On November 23, 2010, our board of
directors adopted a resolution to suspend the distribution reinvestment plan indefinitely effective
December 14, 2010. As a result, distributions were paid entirely in cash during the period between
December 14, 2010 and March 31, 2011. Commencing with the April 2011 distributions, the board
elected to pay distributions on a quarterly basis. However, due to cash constraints, the board has
elected to defer the second quarter 2011 distribution payment until the Companys cash position
improves.
We cannot provide any assurance as to if or when we will resume our distribution reinvestment plan.
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The following are the distributions declared during the nine months ended September 30, 2011 and
2010:
Cash flows Provided by (used in) |
||||||||||||||||
Distribution Declared (2) | operating | |||||||||||||||
Period | Cash | Reinvested | Total | activities | ||||||||||||
First quarter 2010 (1) |
$ | 1,221,000 | $ | 1,490,000 | $ | 2,711,000 | $ | 1,103,000 | ||||||||
Second
quarter 2010 (1) |
$ | 1,256,000 | $ | 1,468,000 | $ | 2,724,000 | $ | 461,000 | ||||||||
Third quarter 2010 |
$ | 1,323,000 | $ | 1,448,000 | $ | 2,771,000 | $ | 1,003,000 | ||||||||
First quarter 2011 |
$ | 454,000 | $ | | $ | 454,000 | $ | 481,000 | ||||||||
Second quarter 2011 |
$ | 468,000 | $ | | $ | 468,000 | $ | (219,000 | ) | |||||||
Third quarter 2011 |
$ | | $ | | $ | | $ | (323,000 | ) |
(1) | Distributions declared primarily represented a return of capital for tax purposes. | |
(2) | In order to meet the requirements for being treated as a REIT under the Internal Revenue Code, we must pay distributions to our shareholders each taxable year equal to at least 90% of our net ordinary taxable income. Some of our distributions have been paid from sources other than operating cash flow, such as offering proceeds. |
The declaration of distributions is at the discretion of our board of directors and our board will
determine the amount of distributions on a regular basis. The amount of distributions will depend
on our funds from operations, financial condition, capital requirements, annual distribution
requirements under the REIT provisions of the Internal Revenue Code and other factors our board of
directors deems relevant. On November 23, 2010, our board of directors resolved to lower our
distributions to an annualized rate of $0.08 per share (1% based on a share price of $8.00). No
distributions have been declared for periods after June 30, 2011. The rate and frequency of
distributions is subject to the discretion of our board of directors and may change from time to
time based on our operating results and cash flow.
From our inception in October 2004 through September 30, 2011, we declared aggregate distributions
of $32.8 million. Our cumulative net loss and cumulative cash flows from operations during the same
period were $63.5 million and $6.3 million, respectively.
Stock Repurchase Program
On November 23, 2010, our board of directors concluded that we did not have sufficient funds
available to us to continue funding share repurchases. Accordingly, our board of directors
suspended repurchases under the program effective December 31, 2010. In January 2011, repurchases
due to the death of a shareholder that were requested in 2010, prior to the suspension of the stock
repurchase program were funded. We can make no assurance as to when and on what terms redemptions
will resume. Our board has the authority to resume, suspend again, or terminate the share
redemption program at any time upon 30 days written notice to our stockholders. Our board of
directors may modify our stock repurchase program so that we can redeem stock using the proceeds
from the sale of our real estate investments or other sources.
During the nine months ended September 30, 2011, we redeemed shares pursuant to our stock
repurchase program as follows:
Period | Total Number of Shares Redeemed | Average Price Paid per Share | ||||||
January |
47,146 | $ | 7.82 | |||||
February |
| $ | | |||||
March |
| $ | | |||||
April |
| $ | | |||||
May |
| $ | | |||||
June |
| $ | | |||||
July |
| $ | | |||||
August |
| $ | | |||||
September |
| $ | | |||||
47,146 | ||||||||
We have received requests to redeem 61,123 shares during this period, however, due to the
current suspension of the stock repurchase program we were not able to fulfill any of these
requests.
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During the nine months ended September 30, 2010, we redeemed shares pursuant to our stock
repurchase program as follows:
Period | Total Number of Shares Redeemed | Average Price Paid per Share | ||||||
January |
249,146 | $ | 7.46 | |||||
February |
100,999 | $ | 7.63 | |||||
March |
159,479 | $ | 7.76 | |||||
April |
161,356 | $ | 7.82 | |||||
May |
123,562 | $ | 7.64 | |||||
June |
39,821 | $ | 7.98 | |||||
July |
13,750 | $ | 8.00 | |||||
August |
| $ | | |||||
September |
| $ | | |||||
848,113 | ||||||||
Employee and Director Incentive Stock Plan
We have adopted an Employee and Director Incentive Stock Plan (the Plan) which provides for the
grant of awards to directors, full-time employees, and other eligible participants that provide
services to us. We have no employees, and we do not intend to grant awards under the Plan to
persons who are not directors. Awards granted under the Plan may consist of nonqualified stock
options, incentive stock options, restricted stock, share appreciation rights, and distribution
equivalent rights. The term of the Plan is 10 years. The total number of shares of common stock
reserved for issuance under the Plan is equal to 10% of our outstanding shares of stock at any
time.
Effective January 1, 2006, we adopted the provisions of, FASB ASC 718-10, Compensation Stock
Compensation, which requires the measurement and recognition of compensation expense for all
share-based payment awards to employees and directors based on estimated fair values. On August 6,
2008 and August 8, 2007, we granted our non-employee directors nonqualified stock options to
purchase an aggregate of 20,000 and 20,000 shares of common stock, respectively, at an exercise
price of $8.00 per share. Of these options, 15,000 lapsed on November 8, 2008 due to the
resignation of one director from the board of directors on August 6, 2008. Outstanding stock
options became immediately exercisable in full on the grant date, will expire ten years after their
grant date, and have no intrinsic value as of September 30, 2011. For the three and nine months
ended September 30, 2011 and 2010, we did not incur any non-cash compensation expenses. No stock
options were exercised or canceled during the three and nine months ended September 30, 2011 and
2010. In connection with the registration of the shares in our follow-on offering, we have
suspended the issuance of options to our independent directors under the Plan, and we do not expect
to issue additional options to our independent directors until we cease offering shares pursuant to
our offering.
12. Related Party Transactions
Our company has no employees. Our Advisor is primarily responsible for managing our business
affairs and carrying out the directives of our board of directors. We have an advisory agreement
with the Advisor and a dealer manager agreement with PCC which entitle the Advisor and PCC to
specified fees upon the provision of certain services with regard to our Offerings and investment
of funds in real estate projects, among other services, as well as reimbursement for organizational
and offering costs incurred by the Advisor and PCC on our behalf and reimbursement of certain costs
and expenses incurred by the Advisor in providing services to us.
Advisory Agreement
Under the terms of the advisory agreement, the Advisor will use commercially reasonable efforts to
present to us investment opportunities to provide a continuing and suitable investment program
consistent with the investment policies and objectives adopted by our board of directors. The
advisory agreement calls for the Advisor to provide for our day-to-day management and to retain
property managers and leasing agents, subject to the authority of our board of directors, and to
perform other duties.
The fees and expense reimbursements payable to the Advisor under the advisory agreement are
described below. As discussed below, we amended the advisory agreement on August 31, 2011 to reduce
the asset management fee payable by us to our Advisor beginning on October 1, 2011.
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Organizational and Offering Costs. Organizational and offering costs of our offerings are
being paid by the Advisor on our behalf and will be reimbursed to the Advisor from the proceeds of
our offerings. Organizational and offering costs consist of all expenses (other than sales
commissions and the dealer manager fee) to be paid by us in connection with our offerings,
including our legal, accounting, printing, mailing and filing fees, charges of our escrow holder
and other accountable offering expenses, including, but not limited to, (i) amounts to reimburse
the Advisor for all marketing-related costs and expenses such as salaries and direct expenses of
employees of the Advisor and its affiliates in connection with registering and marketing our
shares; (ii) technology costs associated with the offering of our shares; (iii) the costs of
conducting our training and education meetings; (iv) the costs of attending retail seminars
conducted by participating broker-dealers; and (v) payment or reimbursement of bona fide due
diligence expenses. In no event will we have any obligation to reimburse the Advisor for
organizational and offering costs totaling in excess of 3.5% of the gross proceeds from our initial
public offering and follow-on offering. At times during our offering stage, before the maximum
amount of gross proceeds has been raised, the amount of organization and offering expenses that we
incur, or that our Advisor and its affiliates incur on our behalf, may exceed 3.5% of the gross
offering proceeds then raised. In no event will we have any obligation to reimburse the Advisor for
organizational and offering costs totaling in excess of 3.5% of the gross proceeds from our public
offerings at the conclusion of our offerings.
As of September 30, 2011 and December 31, 2010, the Advisor and its affiliates had incurred on our
behalf organizational and offering costs totaling approximately $5.6 million, including
approximately $0.1 million of organizational costs that was expensed and approximately $5.5 million
of offering costs which reduced net proceeds of our offerings. Of this amount, $4.4 million reduced
the net proceeds of our initial public offering and $1.1 million reduced the net proceeds of our
follow-on offering.
Acquisition Fees and Expenses. The advisory agreement requires us to pay the Advisor
acquisition fees in an amount equal to 2.0% of the gross proceeds from our offerings. We have paid
the acquisition fees upon receipt of the gross proceeds from our initial and follow-on offerings
(excluding gross proceeds related to sales pursuant to our distribution reinvestment plan).
However, if the advisory agreement is terminated or not renewed, the Advisor must return
acquisition fees not yet allocated to one of our investments. In addition, we are required to
reimburse the Advisor for direct costs the Advisor incurs and amounts the Advisor pays to third
parties in connection with the selection and acquisition of a property, whether or not ultimately
acquired. For the three months ended September 30, 2011 and 2010, the Advisor earned $0 and $1,200
of acquisition fees, respectively, which are included in real estate acquisition costs on our
condensed consolidated statement of operations. For the nine months ended September 30, 2011 and
2010, the Advisor earned $0 and $23,000 of acquisition fees, respectively, which are included in
real estate acquisition costs on our condensed consolidated statement of operations.
Management Fees. Prior to October 1, 2011, the advisory agreement required us to pay the
Advisor a monthly asset management fee of one-twelfth of 1.0% of the Average Invested Assets (as
defined in the advisory agreement). For the three months ended September 30, 2011 and 2010, the
Advisor earned $0.4 million and $0.4 million, respectively of asset management fees, which were
expensed and included in asset management fees in our condensed consolidated statement of
operations. For the nine months ended September 30, 2011 and 2010, the Advisor earned $1.2 million
and $1.1 million, respectively of asset management fees, which were expensed and included in asset
management fees in our condensed consolidated statement of operations. On August 31, 2011, we
amended the advisory agreement to provide that, beginning on October 1, 2011, the asset management
fee payable by us to our Advisor shall be reduced to a monthly rate of one-twelfth of 0.75% of our
Average Invested Assets, as defined above.
In addition, we reimburse the Advisor for the direct and indirect costs and expenses incurred by
the Advisor in providing asset management services to us, including personnel and related
employment costs related to providing asset management services on our behalf. These fees and
expenses are in addition to management fees that we pay to third party property managers. For the
three months ended September 30, 2011 and 2010, the Advisor reimbursed $44,000 and $45,000,
respectively, of such direct and indirect costs and expenses on our behalf, which are included in
asset management fees and expenses in our condensed consolidated statement of operations. For the
nine months ended September 30, 2011 and 2010, the Advisor earned $129,000 and $124,000,
respectively, of such direct and indirect costs and expenses on our behalf, which are included in
asset management fees and expenses in our condensed consolidated statement of operations.
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Operating Expenses. The advisory agreement provides for reimbursement of the Advisors
direct and indirect costs of providing administrative and management services to us. For the three
months ended September 30, 2011 and 2010, $0.2 million and $0.3 million of such costs were
reimbursed and are included in general and administrative expenses in our condensed consolidated
statement of operations, respectively. For the nine months ended September 30, 2011 and 2010, $0.7
million and $0.8 million of such costs, respectively, were reimbursed and are included in general
and administrative expenses in our condensed consolidated statement of operations.
Pursuant to provisions contained in our charter and in our amended and restated advisory agreement with our Advisor, our
board of directors has the ongoing responsibility of limiting our total operating expenses for the trailing four
consecutive quarters to amounts that do not exceed the greater of 2% of our average invested assets or 25% of our net
income, calculated in the manner set forth in our charter, unless a majority of the directors (including a majority of the
independent directors) has made a finding that, based on unusual and non-recurring factors that they deem sufficient, a higher
level of expenses is justified (the 2%/25% Test). In the event that a majority of the directors (including a majority of the
independent directors) does not determine that such excess expenses are justified, our Advisor must reimburse to us the amount
of the excess expenses paid or incurred (the Excess Amount).
As previously disclosed, for the periods ended March 31, 2011 and June 30, 2011 our board of directors conditioned
its findings that Excess Amounts for such periods were justified upon the Advisor agreeing to carry over such Excess
Amounts and include them in total operating expenses in subsequent periods, with any waiver of such amounts being dependent
on our Advisors satisfactory progress with respect to executing the strategic alternative to be chosen by the independent
directors. Accordingly, for the five-fiscal-quarter period ended June 30, 2011, our total operating expenses exceeded the
greater of 2% of our average invested assets and 25% of our net income. We incurred operating expenses of
approximately $5.0 million and incurred an Excess Amount of approximately $1.3 million during the five quarters
ended June 30, 2011, which has been carried over and included in the total operating expenses for the current period
for the purpose of the 2%/25% Test.
For the six-fiscal-quarter period ended September 30, 2011, our total operating expenses again exceeded the greater
of 2% of our average invested assets and 25% of our net income. We incurred operating expenses of approximately $6.1 million
and incurred an Excess Amount of approximately $1.7 million during the six quarters ended September 30, 2011. Our board of
directors (including a majority of our independent directors) has determined that this Excess Amount is justified as unusual
because of our small size (for a public reporting company) and non-recurring because of (i) the Advisors current progress
toward developing strategic alternatives for consideration by the independent directors, and (ii) the recent amendment to the
advisory agreement to reduce asset management fees payable to the Advisor. However, notwithstanding such justification, and as a
condition to such justification, the Advisor has again agreed that the Excess Amount the six-fiscal-quarter period ended
September 30, 2011 shall be carried over and included in total operating expenses in subsequent periods, with any
waiver dependent on our Advisors satisfactory progress with respect to executing the strategic alternative to be
chosen by the independent directors.
Property Management Fees. The advisory agreement provides that if we retain our Advisor or
an affiliate to manage and lease some of our properties, we will pay a market-based property
management fee or property leasing fee, which may include reimbursement of our Advisors or
affiliates personnel costs and other costs of managing the properties. For the three months ended
September 30, 2011 and 2010, the Advisor earned $2,000 and $8,000, respectively, of such property
management fees. For the nine months ended September 30, 2011 and 2010, the Advisor earned $13,000
and $20,000, respectively, of such property management fees. These costs are included in property
operations and maintenance expenses in our condensed consolidated statements of operations.
Disposition
Fee. Prior to the second amendment to the Amended and Restated
Advisory Agreement executed on November 11, 2011, the advisory agreement provided that if the Advisor or its affiliates
provide a substantial amount of the services (as determined by a majority of our directors,
including a majority of our independent directors) in connection with the sale of one or more
properties, we will pay the Advisor or such affiliate a disposition fee up to 3% of the sales price
of such property or properties upon closing. This disposition fee may be paid in addition to real
estate commissions paid to non-affiliates, provided that the total real estate commissions
(including such disposition fee) paid to all persons by us for each property shall not exceed an
amount equal to the lesser of (i) 6% of the aggregate contract sales price of each property or (ii)
the competitive real estate commission for each property. We will pay the disposition fees for a
property at the time the property is sold. For the three and nine months ended September 30, 2011,
the Advisor earned $94,000 of disposition fees. We did not incur any
such fees in 2010. Subsequent to November 11, 2011, the disposition
fee was changed from up to 3% of the sales price of properties sold
to up to 1% of the sales price of properties sold if the Advisor or
its affiliates provide a substantial amount of the services (as
determined by a majority of our directors, including a majority of
our independent directors).
Subordinated Participation Provisions. The Advisor is entitled to receive a subordinated
participation upon the sale of our properties, listing of our common stock or termination of the
Advisor, as follows:
| After stockholders have received cumulative distributions equal to $8.00 per share (less any returns of capital) plus cumulative, non-compounded annual returns on net invested capital, the Advisor will be paid a subordinated participation in net sales proceeds ranging from a low of 5% of net sales proceeds provided investors have earned annualized returns of 6% to a high of 15% of net sales proceeds if investors have earned annualized returns of 10% or more. |
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| Upon termination of the advisory agreement, the Advisor will receive the subordinated performance fee due upon termination. This fee ranges from a low of 5% of the amount by which the sum of the appraised value of our assets minus our liabilities on the date the advisory agreement is terminated plus total distributions (other than stock distributions) paid prior to termination of the advisory agreement exceeds the amount of invested capital plus annualized returns of 6%, to a high of 15% of the amount by which the sum of the appraised value of our assets minus our liabilities plus all prior distributions (other than stock distributions) exceeds the amount of invested capital plus annualized returns of 10% or more. |
| In the event we list our stock for trading, the Advisor will receive a subordinated incentive listing fee instead of a subordinated participation in net sales proceeds. This fee ranges from a low of 5% of the amount by which the market value of our common stock plus all prior distributions (other than stock distributions) exceeds the amount of invested capital plus annualized returns of 6%, to a high of 15% of the amount by which the sum of the market value of our common stock plus all prior distributions (other than stock distributions) exceeds the amount of invested capital plus annualized returns of 10% or more. |
Dealer Manager Agreement
PCC, as dealer manager, is entitled to receive sales commissions of up to 7% of gross proceeds from
sales of our initial and follow-on offerings. PCC, as dealer manager, is also entitled to receive a
dealer manager fee equal to up to 3% of gross proceeds from sales of our primary or follow-on
offerings. The dealer manager is also entitled to receive a reimbursement of bona fide due
diligence expenses up to 0.5% of the gross proceeds from sales of our primary and follow-on
offerings. The advisory agreement requires the Advisor to reimburse us to the extent that offering
expenses including sales commissions, dealer manager fees and organization and offering expenses
(but excluding acquisition fees and acquisition expenses discussed above) are in excess of 13.5% of
gross proceeds from our offerings. For the three months ended September 30, 2011 and 2010, our
dealer manager earned sales commissions and dealer manager fees of $0 and $6,000, respectively. For
the nine months ended September 30, 2011 and 2010, our dealer manager earned sales commissions and
dealer manager fees of approximately $0 and $0.1 million, respectively. Dealer manager fees and
sales commissions paid to PCC are a cost of capital raised and, as such, are included as a
reduction of additional paid-in capital in the accompanying condensed consolidated balance sheets.
13. Notes Payable
We have total debt obligations of $27.0 million, including $3.2 million classified as liabilities
associated with real estate held for sale, that will mature in
December 2011, February 2012, and November 2014. We
are pursuing options for restructuring these debts and other repayment alternatives, including
asset sales, sourcing additional equity capital and obtaining new financing that will reposition
the assets. However, there can be no assurance that we will be successful in executing such debt
restructuring or repayment options. If we are unable to obtain alternative financing or sell
properties in order to repay the debt, this could result in the lenders foreclosing on properties.
Based on the various options available to us and ongoing discussions with our lenders, management
believes that we will be able to meet or successfully restructure our debt obligations.
In connection with our notes payable, we incurred financing costs totaling $0.7 million and $2.0
million, as of September 30, 2011 and December 31, 2010, respectively. These financing costs have
been capitalized and are being amortized over the life of the agreements. For the three months
ended September 30, 2011 and 2010, $0.2 million and $0.1 million, respectively, of deferred
financing costs were amortized and included in interest expense in the condensed consolidated
statements of operations. For the nine months ended September 30, 2011 and 2010, $0.4 million and
$0.2 million, respectively, of deferred financing costs were amortized and included in interest
expense in the condensed consolidated statements of operations.
HSH Nordbank AG
We have amended our credit agreement with HSH Nordbank AG, New York Branch (HSH Nordbank) in a
series of amendments extending the credit facility maturity date from September 20, 2010 to
December 16, 2011. As a part of these amendments, we made a principal reduction payment and paid
extension fees.
The July 2011 amendment to this credit agreement extended the maturity date from September 30, 2011
to December 16, 2011 and increased the margin spread over LIBOR from a range of 350 to 375 basis
points to a fixed 375 basis points from June 1, 2011 to September 30, 2011 and to 400 basis points
from October 1, 2011 to the
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maturity date. Additionally, this amendment eliminated our requirement
to make principal reduction payments of $0.3 million in July, August, and September 2011,
respectively. We may not draw additional funds under this credit
agreement. In connection with this extension and the sale of the Goldenwest property (See Note 15),
we made a principal payment of approximately $7.8 million.
As of September 30, 2011 and December 31, 2010, the outstanding principal amount of our obligations
under the credit agreement was approximately $5.0 million and $13.1 million, respectively. The
weighted average interest rate as of September 30, 2011 and December 31, 2010 was 3.79% and 2.11%,
respectively. The facility contains various covenants including financial covenants with respect to
consolidated interest and fixed charge coverage and secured debt to secured asset value. As of
September 30, 2011, we were not in compliance with the financial
covenant pertaining to the maintenance of minimum occupancy levels. This loan was repaid in
its entirety on November 28, 2011.
Wells Fargo Bank, National Association
On November 13, 2007, we entered into a loan agreement with Wells Fargo Bank, National Association
(Wells Fargo Bank), successor by merger to Wachovia Bank, N.A to facilitate the acquisition of
properties during our offering period. Through a series of amendments, we have extended the
maturity date from November 13, 2010 to February 13, 2012.
In connection with our most recent amendment on August 12, 2011, the 2111 South Industrial Park and
Shoemaker Industrial buildings were added to the loan collateral, and we made a principal payment
of $0.5 million. The terms of the amended loan provide for two one-year extensions, subject to
meeting certain loan-to-value and debt service coverage ratios and require monthly principal
payments. Interest on the amended loan increased to 300 basis points over the one-month LIBOR with
a 150 basis point LIBOR floor.
As of September 30, 2011 and December 31, 2010, we had net borrowings of $15.3 million and $15.9
million under the loan agreement, respectively. The weighted average interest rate as of September
30, 2011 and December 31, 2010 was 1.92% and 1.66%, respectively. This loan agreement contains
various reporting covenants including providing periodic balance sheets, statements of income and
expenses of borrower and each guarantor, statements of income and expenses and changes in financial
position of each secured property and cash flow statements of borrower and each guarantor. As of
September 30, 2011, we were in compliance with all financial covenants.
Transamerica Life Insurance Company
In connection with our acquisition of Monroe North Commerce Center, on April 17, 2008, we entered
into an assumption and amendment of note, mortgage and other loan documents (the Loan Assumption
Agreement) with Transamerica Life Insurance Company (Transamerica). Pursuant to the Loan
Assumption Agreement, we assumed the outstanding principal balance of approximately $7.4 million on
the Transamerica secured mortgage loan. The loan matures on November 1, 2014 and bears interest at
a fixed rate of 5.89% per annum. As of September 30, 2011 and December 31, 2010, we had an
outstanding balance of $6.7 million and $6.9 million, respectively, under this loan agreement. This
Loan Assumption Agreement contains various reporting covenants including an annual income
statement, rent roll, operating budget and a narrative summary of leasing prospects for vacant
spaces. As of September 30, 2011, we were in compliance with all these reporting covenants. The
monthly payment on this loan is approximately $50,370. During each of the three months ended
September 30, 2011 and 2010, we incurred $0.1 million of interest expense related to this loan
agreement. During each of the nine months ended September 30, 2011 and 2010, we incurred $0.3
million of interest expense related to this loan agreement.
The principal payments due on the Monroe North Commerce Center mortgage loan for October 1, 2011 to
December 31, 2011 and each of the subsequent years are as follows:
Year | Principal amount | |||
October 1, 2011 to December 31, 2011 |
$ | 35,000 | ||
2012 |
$ | 217,000 | ||
2013 |
$ | 230,000 | ||
2014 |
$ | 6,234,000 |
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14. Commitments and Contingencies
We monitor our properties for the presence of hazardous or toxic substances. While there can be no
assurance that a material environmental liability does not exist, we are not currently aware of any
environmental liability with respect to the properties that would have a material effect on our
condensed consolidated financial condition, results of operations and cash flows. Further, we are
not aware of any environmental liability or any unasserted claim or assessment with respect to an
environmental liability that we believe would require additional disclosure or the recording of a
loss contingency.
Our commitments and contingencies include the usual obligations of real estate owners and operators
in the normal course of business. In the opinion of management, these matters are not expected to
have a material impact on our condensed consolidated financial condition, results of operations and
cash flows. We are also subject to contingent losses related to the notes receivable and note
receivable from related party. For further details see Notes 7 and 8. We are not presently subject
to any material litigation nor, to our knowledge, any material litigation threatened against us
which if determined unfavorably to us would have a material effect on our condensed
consolidated financial condition, results of operations and cash flows.
15. Discontinued Operations
Divestitures
In accordance with FASB ASC 360-10, Property, Plant & Equipment, we report results of operations
from real estate assets that meet the definition of a component of an entity that have been sold,
or meet the criteria to be classified as held for sale, as discontinued operations.
On June 14, 2011, our wholly-owned subsidiary sold the Goldenwest property to Westminster
Redevelopment Agency, a non-related party, for a purchase price of approximately $9.4 million.
Goldenwest is a 102,200 square foot industrial building situated on 5.4 acres of land in
Westminster, CA. Approximately $7.8 million in proceeds from the sale were used to pay down a
portion of the HSH Nordbank credit facility. The operations of Goldenwest, including an impairment
charge of $2.1 million recorded in the second quarter of 2011, are presented as loss from
discontinued operations on our condensed consolidated statement of operations. Prior year results
of operations have been reclassified to discontinued operations.
Real Estate Held for Sale
In the second quarter of 2011, our board of directors authorized us to actively market the Mack
Deer Valley, Pinnacle Park Business Center, and 2111 South Industrial Park properties for sale.
The 2111 South Industrial Park property is currently in escrow and
the sale is expected to close on or before December 21, 2011. The
Pinnacle Park Business Center and Mack Deer Valley properties were
sold on November 28, 2011 for proceeds of $23.9 million. The assets and liabilities of properties for which we have initiated plans to sell, but
have not yet sold as of September 30, 2011, have been classified as real estate held for sale and
liabilities associated with real estate held for sale on the accompanying condensed consolidated
balance sheets. As of September 30, 2011, this represents the assets and liabilities of the three
properties noted above. The results of operations for the above properties have been presented in
discontinued operations on the accompanying condensed consolidated statements of operations for all
periods presented.
The following is a summary of the components of income / (loss) from discontinued operations for
the three and nine months ended September 30, 2011 and 2010:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Rental revenues, tenant reimbursements and other income |
$ | 677,000 | $ | 967,000 | $ | 2,427,000 | $ | 3,245,000 | ||||||||
Operating expenses, real estate taxes, and interest expense |
239,000 | 367,000 | 996,000 | 956,000 | ||||||||||||
Depreciation and amortization |
| 381,000 | 476,000 | 974,000 | ||||||||||||
Impairment of real estate |
153,000 | | 19,332,000 | | ||||||||||||
Income (loss) from discontinued operations |
$ | 285,000 | $ | 219,000 | $ | (18,377,000 | ) | $ | 1,315,000 | |||||||
FASB ASC 360-10 requires that assets classified as held for sale be carried at the lesser of
their carrying amount or fair value less selling costs. Consequently, we recorded an impairment
charge of $19.2 million, classified as income (loss) from discontinued operations, in the second
quarter of 2011 to reduce the carrying value of those properties.
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The fair value of these
properties was derived using an income approach utilizing our internal estimate of market-based leasing projections for each
property and discount and capitalization rates derived from market surveys (see Note 4).
In the third quarter of 2011, we recorded an impairment charge of $0.1 million, classified as
income (loss) from discontinued operations, to adjust the 2111 South Industrial Park property to
its estimated fair value, net of estimated selling costs. The fair value of this property was
derived from a recent offer received on the property.
The following table presents balance sheet information for the properties classified as held for
sale on September 30, 2011. No properties were classified as held for sale as of December 31, 2010.
September 30, | ||||
2011 | ||||
Investments in real estate: |
||||
Land |
$ | 7,865,000 | ||
Buildings and improvements, net |
16,283,000 | |||
Intangible lease assets, net |
217,000 | |||
Real estate held for sale, net |
$ | 24,365,000 | ||
Other assets: |
||||
Tenant and other receivables, net |
$ | 259,000 | ||
Other assets |
6,000 | |||
Leasing commissions, net |
100,000 | |||
Non-real estate assets associated with real estate held for sale |
$ | 365,000 | ||
Total assets |
$ | 24,731,000 | ||
Liabilities: |
||||
Accounts payable and accrued liabilities |
$ | 49,000 | ||
Real estate taxes payable |
369,000 | |||
Tenant security deposits |
195,000 | |||
Intangible lease liabilities, net |
27,000 | |||
Loan payable |
3,199,000 | |||
Liabilities associated with properties held for sale |
$ | 3,839,000 | ||
16. Segment Reporting
Prior to the third quarter of 2011, we operated in one reportable segment: industrial. As of
September 30, 2011, we operated in two reportable business segments for management and internal
financial reporting purposes: industrial and senior housing. These operating segments are the
segments for which separate financial information is available and for which operating results are
evaluated regularly by the chief operating decision maker in deciding how to allocate resources and
in assessing performance. Our senior housing segment consists solely of the operations of the
Sherburne Commons property, a senior-living facility owned by Nantucket Acquisition LLC and a VIE
that we consolidated on June 30, 2011 as a result of our becoming the primary beneficiary of
the entity (see Note 9). Our industrial segment consists of 12 multi-tenant industrial properties,
including the properties held for sale, offering a combination of warehouse and office space
adaptable to a broad range of tenants and uses typically catering to local and regional businesses.
We evaluate performance of the combined properties in each segment based on net operating income.
Net operating income is defined as total revenue less property operating and maintenance expenses.
There were no intersegment transactions in the third quarter of 2011 as we record interest income
from the Sherburne Commons note on a cash basis (see Note 8). We believe net operating income is
useful to investors in understanding the value of income producing real estate property. We use net
operating income to evaluate the operating performance of our real estate investments and to make
decisions concerning the operations of each property. Net income is the GAAP measure that is most
directly comparable to net operating income; however, net operating income should not be considered
an alternative to net income as the primary indicator of operating performance as it excludes
certain items such as interest income from notes receivable, depreciation and amortization, asset
management fees and expenses, real estate acquisition costs, interest expense and general and
administrative expenses. Additionally, net operating income, as we define it, may not be comparable
to net operating income as defined by other REITs or companies.
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The following tables reconcile the segment activity to consolidated net income for the three and
nine months ended September 30, 2011. We operated in a single reportable segment in 2010:
Three Months Ended September 30, 2011 | ||||||||||||
Senior | ||||||||||||
Industrial | Housing | Consolidated | ||||||||||
Rental revenues |
$ | 849,000 | $ | | $ | 849,000 | ||||||
Resident services and fee income |
| 639,000 | 639,000 | |||||||||
Tenant reimbursements and other
income |
204,000 | | 204,000 | |||||||||
1,053,000 | 639,000 | 1,692,000 | ||||||||||
Property operating and maintenance
expenses |
428,000 | 648,000 | 1,076,000 | |||||||||
Net operating income (loss) |
$ | 625,000 | $ | (9,000 | ) | $ | 616,000 | |||||
General and administrative expenses |
713,000 | |||||||||||
Asset management fees and expenses |
403,000 | |||||||||||
Real estate acquisition costs |
| |||||||||||
Depreciation and amortization |
494,000 | |||||||||||
Impairment of real estate |
425,000 | |||||||||||
Interest (income) on notes receivable (1) |
(102,000 | ) | ||||||||||
Interest expense |
452,000 | |||||||||||
Income from discontinued operations |
(285,000 | ) | ||||||||||
Net loss |
$ | (1,484,000 | ) | |||||||||
Noncontrolling interests share of loss |
352,000 | |||||||||||
Net loss applicable to common shares |
$ | (1,132,000 | ) | |||||||||
(1) | Interest income on notes receivable is not allocated to a reportable segment |
Nine Months Ended September 30, 2011 | ||||||||||||
Senior | ||||||||||||
Industrial | Housing | Consolidated | ||||||||||
Rental revenues |
$ | 2,640,000 | $ | | $ | 2,640,000 | ||||||
Resident services and fee income |
| 639,000 | 639,000 | |||||||||
Tenant reimbursements and other income |
669,000 | | 669,000 | |||||||||
$ | 3,309,000 | $ | 639,000 | $ | 3,948,000 | |||||||
Property operating and maintenance
expenses |
1,247,000 | 648,000 | 1,895,000 | |||||||||
Net operating income (loss) |
$ | 2,062,000 | $ | (9,000 | ) | $ | 2,053,000 | |||||
General and administrative expenses |
2,083,000 | |||||||||||
Asset management fees and expenses |
1,230,000 | |||||||||||
Real estate acquisition costs |
| |||||||||||
Depreciation and amortization |
1,567,000 | |||||||||||
Impairment of notes receivable |
1,650,000 | |||||||||||
Impairment of real estate |
23,644,000 | |||||||||||
Interest (income) on notes receivable (1) |
(366,000 | ) | ||||||||||
Interest expense |
1,063,000 | |||||||||||
Loss from discontinued operations |
18,377,000 | |||||||||||
Net loss |
$ | (47,195,000 | ) | |||||||||
Noncontrolling interests share of loss |
404,000 | |||||||||||
Net loss applicable to common shares |
$ | (46,791,000 | ) | |||||||||
(1) | Interest income on notes receivable is not allocated to a reportable segment |
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The following table reconciles the segment activity to consolidated financial position as of
September 30, 2011. As we had only one reportable segment in 2010, that period is excluded from the
table.
September 30, 2011 | ||||
Assets: |
||||
Investments in real estate: |
||||
Industrial |
$ | 69,863,000 | ||
Senior housing |
9,810,000 | |||
Total reportable segments |
$ | 79,673,000 | ||
Reconciliation to consolidated assets: |
||||
Cash and cash equivalents |
439,000 | |||
Tenant and other receivables, net |
449,000 | |||
Note receivables, net |
2,200,000 | |||
Deferred financing costs, net |
297,000 | |||
Non-real estate assets held for sale, net |
365,000 | |||
Other assets |
522,000 | |||
Total assets |
$ | 83,945,000 | ||
17. Subsequent Events
Other than
the purchase and sale agreement entered into for the sale of the 2111 South Industrial
Park property and the sale of the Mack Deer Valley and Pinnacle Park Business
Center properties (discussed in Notes 4 and 15), and the amendment to the
Amended and Restated Advisory Agreement (discussed in Note 12), no significant events have occurred subsequent to our balance
sheet date that require further disclosure or adjustment to our balances.
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
The following Managements Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with our financial statements and notes thereto contained
elsewhere in this report.
This section contains forward-looking statements, including estimates, projections, statements
relating to our business plans, objectives and expected operating results, and the assumptions upon
which those statements are based. These forward-looking statements generally are identified by the
words believes, project, expects, anticipates, estimates, intends, strategy, plan,
may, will, would, will be, will continue, will likely result, and similar expressions.
Forward-looking statements are based on current expectations and assumptions that are subject to
risks and uncertainties which may cause actual results to differ materially from the
forward-looking statements. Forward-looking statements that were true at the time made may
ultimately prove to be incorrect or false. We undertake no obligation to update or revise publicly
any forward-looking statements, whether as a result of new information, future events or otherwise.
All forward-looking statements should be read in light of the risks identified in Part II, Item 1A
herein and Part I, Item 1A of our annual report on Form 10-K for the year ended December 31, 2010
filed with the U.S. Securities and Exchange Commission (the SEC).
Overview
We were incorporated on October 22, 2004 for the purpose of engaging in the business of investing
in and owning commercial real estate. On January 6, 2006, we commenced an initial public offering
of up to 55,400,000 shares of our common stock, consisting of 44,400,000 shares for sale pursuant
to a primary offering and 11,000,000 shares for sale pursuant to our distribution reinvestment
plan. We stopped making offers under our initial public offering on June 1, 2009 upon raising gross
offering proceeds of approximately $172.7 million from the sale of approximately 21.7 million
shares, including shares sold under the distribution reinvestment plan. On June 10, 2009, we
commenced a follow-on offering of up 77,350,000 shares of our common stock, consisting of
56,250,000 shares for sale pursuant to a primary offering and 21,100,000 shares for sale pursuant
to our dividend reinvestment plan.
On November 23, 2010, management informed investors of several decisions made by our board of
directors:
| Effective November 23, 2010, we discontinued making or accepting offers to purchase shares of stock in our public offering while our board of directors evaluates strategic alternatives to maximize value. |
| Effective December 14, 2010, we suspended our distribution reinvestment plan. As a result, all distributions paid after that date will be in cash until further notice. |
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| Effective December 1, 2010, our board of directors resolved to reduce distributions on our common stock to a current annualized rate of $0.08 per share (1% based on a share price of $8.00), from the prior annualized rate of $0.48 per share (6% based on a share price of $8.00), in order to preserve capital that may be needed for capital improvements, debt repayment or other corporate purposes. |
| Our board of directors approved an amendment to our stock repurchase program to suspend redemptions under the program, effective December 31, 2010. |
Further, in June 2011, the board decided, based on the financial position of the Company, to
suspend the declaration of further distributions and to defer the payment of the second quarter
2011 distribution.
Our board of directors continues to evaluate strategic alternatives to reposition the company and
preserve and increase shareholders value. Specifically, we are pursuing options for restructuring
and repaying our debt, including asset sales, sourcing additional equity capital and obtaining new
financing that will reposition the assets.
We used the net proceeds from our initial public offering to invest primarily in investment real
estate including multi-tenant industrial real estate located in major metropolitan markets in the
United States. If we resume our follow-on offering, we intend to use the net proceeds from our
follow-on offering to acquire additional real estate investments and pay down temporary acquisition
financing on our existing assets.
As of September 30, 2011, we had raised approximately $167.1 million of gross proceeds from the
sale of approximately 20.9 million shares of our common stock in our initial public offering and
follow-on offering and had acquired thirteen properties, one of which was subsequently sold.
Our revenues, which are comprised largely of rental income, include rents reported on a
straight-line basis over the initial term of the lease. Our growth depends, in part, on our ability
to increase rental income and other earned income from leases by increasing rental rates and
occupancy levels and control operating and other expenses. Our operations are impacted by property
specific, market specific, general economic and other conditions.
Market Outlook Real Estate and Real Estate Finance Markets
Beginning in 2010, and continuing during 2011, significant and widespread concerns about credit
risk and access to capital experienced during 2009 began to subside. However, uncertainties created
by a sluggish U.S. economy and global economic problems have depressed real estate demand.
Increased trade volume in 2010 spurred some increase in leasing activity in select west coast
industrial markets. However, if economic uncertainty persists, we may continue to experience
significant vacancies and expect to be required to reduce rental rates on occupied space.
Despite recent positive economic indicators, both the national and most global economies have
experienced continued volatility throughout 2010 and the first nine months of 2011. These
conditions, combined with stagnant business activity and low consumer confidence, have resulted in
a challenging operating environment in 2011.
As a result of the decline in general economic conditions, the U.S. commercial real estate industry
has also experienced deteriorating fundamentals across all major property types and most geographic
markets. These market conditions have and will likely continue to have a significant impact on our
real estate investments. In addition, these market conditions have impacted multi-tenants
industrial property tenants and businesses, which makes it
more difficult for them to meet current lease obligations and places pressure on them to negotiate
favorable lease terms upon renewal in order for their businesses to remain viable. Increases in
rental concessions given to retain tenants and maintain our occupancy level, which is vital to the
continued success of our portfolio, has resulted in lower current cash flows from operations.
Projected future declines in rental rates, slower or potentially negative net absorption of leased
space and expectations of future rental concessions, including free rent to retain tenants who are
up for renewal or to sign new tenants, would result in additional decreases in cash flows from
operations.
With respect to our senior housing segment, the above economic conditions have seriously depressed
single family home sales, limiting potential residents ability to move to senior housing and the
lower sales prices of residential properties have reduced the funds seniors have available to fund
their future living and care needs.
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Until market conditions are more stable, we expect to continue to limit capital expenditures,
focusing on those capital expenditures that preserve value or generate rental revenue. However, if
we experience an increase in vacancies, we may incur costs to re-lease properties and pay leasing
commissions.
Critical Accounting Policies
There have been no material changes to our critical accounting policies as previously disclosed in
our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the SEC except
as discussed in Note 3 to our financial statements contained in this report.
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Results of Operations
As of September 30, 2011, we operated in two reportable business segments for management and
internal financial reporting purposes: industrial and senior housing. Our industrial segment
consists of operations of 12 multi-tenant industrial properties, which offer a combination of
warehouse and office space adaptable to a broad range of tenants and uses catering to local and
regional businesses. Our senior housing segment consists solely of the operations of Sherburne
Commons, a senior living facility owned by Nantucket Acquisition, LLC, a VIE that we consolidated
on June 30, 2011 as a result of our becoming the primary beneficiary of the entity. Prior to June
30, 2011, we operated only in the industrial segment as the financial results of Sherburne Commons
were not consolidated in our condensed consolidated financial statements.
Three Months Ended September 30, 2011 and 2010
Three Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2011 | 2010 | $ Change | % Change | |||||||||||||
Net operating income, as defined (1) |
||||||||||||||||
Industrial |
$ | 1,053,000 | $ | 1,174,000 | $ | (121,000 | ) | (10 | %) | |||||||
Senior Housing |
639,000 | | 639,000 | | ||||||||||||
Total portfolio net operating income |
$ | 1,692,000 | $ | 1,174,000 | $ | 518,000 | 44 | % | ||||||||
Reconciliation to net loss: |
||||||||||||||||
Net operating income, as defined (1) |
$ | 616,000 | $ | 686,000 | $ | (70,000 | ) | (10 | %) | |||||||
Unallocated expenses (income): |
||||||||||||||||
General and administrative expenses |
713,000 | 521,000 | 192,000 | 37 | % | |||||||||||
Asset management fees and expenses |
403,000 | 413,000 | (10,000 | ) | (2 | %) | ||||||||||
Real estate acquisitions costs and earn out costs |
| 30,000 | (30,000 | ) | (100 | %) | ||||||||||
Depreciation and amortization |
494,000 | 542,000 | (48,000 | ) | (9 | %) | ||||||||||
Impairment of real estate |
425,000 | | 425,000 | | ||||||||||||
Interest (income) on notes receivable |
(102,000 | ) | (337,000 | ) | (235,000 | ) | (70 | %) | ||||||||
Interest expense |
452,000 | 305,000 | 147,000 | 48 | % | |||||||||||
Net loss from continuing operations |
(1,769,000 | ) | (788,000 | ) | (981,000 | ) | 124 | % | ||||||||
Income from discontinued operations |
285,000 | 219,000 | 66,000 | 30 | % | |||||||||||
Net loss |
(1,484,000 | ) | (569,000 | ) | (915,000 | ) | 161 | % | ||||||||
Net loss attributable to noncontrolling interests |
(352,000 | ) | | (352,000 | ) | | ||||||||||
Net loss attributable to common stockholders |
$ | (1,132,000 | ) | $ | (569,000 | ) | $ | (563,000 | ) | 99 | % | |||||
(1) | Net operating income, a non-GAAP supplemental measure, is defined as total revenue less property operating and maintenance expenses. We use net operating income to evaluate the operating performance of our real estate investments and to make decisions concerning the operation of the property. We believe that net operating income is useful to investors in understanding the value of income-producing real estate. Net income is the GAAP measure that is most directly comparable to net operating income; however, net operating income should not be considered as an alternative to net income as the primary indicator of operating performance as it excludes certain items such as interest income on notes receivable, depreciation and amortization, interest expense and corporate general and administrative expenses. Additionally, net operating income as we define it may not be comparable to net operating income as defined by other REITs or companies. |
Industrial
Total revenue for the industrial segment includes rental revenue and tenant reimbursements and
other income. Total revenue for the three months ended September 30, 2011 decreased to $1.1 million
from $1.2 million for the three months ended September 30, 2010. The decrease is primarily due to
lower occupancy rates, lower lease rental rates and longer lease up periods for vacant units as a
result of the current economic environment partially offset by termination payments from former
tenants. Property operating and maintenance expenses include utilities, repairs and maintenance and
other property operating costs. These costs decreased to $0.4 million for the three months ended
September 30, 2011 from $0.5 million for the three months ended September 30, 2010 primarily due to
a lower bad debt expense and lower property tax assessments resulting from successful property tax
appeals. Net operating income for the three months ended September 30, 2011 decreased to $0.6
million from $0.7 million for the three months ended September 30, 2010.
Three Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2011 | 2010 | $ Change | % Change | |||||||||||||
Industrial Net operating income |
||||||||||||||||
Total revenues: |
||||||||||||||||
Rental revenue |
$ | 849,000 | $ | 923,000 | $ | (74,000 | ) | (8 | %) | |||||||
Tenant reimbursement and other income |
204,000 | 251,000 | (47,000 | ) | (19 | %) | ||||||||||
1,053,000 | 1,174,000 | (121,000 | ) | (10 | %) | |||||||||||
Less: |
||||||||||||||||
Property operating and maintenance expenses |
428,000 | 488,000 | (60,000 | ) | (12 | %) | ||||||||||
Total portfolio net operating income |
$ | 625,000 | $ | 686,000 | $ | (61,000 | ) | (9 | %) | |||||||
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Senior Housing
At June 30, 2011, we began consolidating Nantucket Acquisition and its subsidiary, Sherburne
Commons, a senior housing facility. Since the operating results of Sherburne Commons are not
included in our condensed consolidated financial statements in prior periods, our operating results
from 2011 to 2010 are not directly comparable. Total revenue for the senior housing segment
includes resident services and fee income. Property operating and maintenance expenses include
labor, food, utilities, marketing management and other property operating costs.
Three Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2011 | 2010 | $ Change | % Change | |||||||||||||
Senior Housing Net operating income |
||||||||||||||||
Total revenues |
||||||||||||||||
Resident services and fee income |
$ | 639,000 | $ | | $ | 639,000 | 100 | % | ||||||||
Less: |
||||||||||||||||
Property operating and maintenance expenses |
648,000 | | 648,000 | ) | 100 | % | ||||||||||
Total portfolio net operating loss |
$ | (9,000 | ) | $ | | $ | (9,000 | ) | 100 | % | ||||||
Unallocated (Expenses) Income
General and administrative expense was $0.7 million for the three months ended September 30, 2011
and $0.5 million for the three months ended September 30, 2010, respectively. The increase was
primarily due to increases in insurance expense, consulting fees, and audit and tax fees, partially
offset by lower legal and advisory expense reimbursements.
Asset management fees were comparable at $0.4 million for the three months ended September 30, 2011
and the three months ended September 30, 2010.
Real estate acquisition costs decreased to $0 for the three months ended September 30, 2011 from
$30,000 for the three months ended September 30, 2010. The decrease is a result of suspending our
public offering in November 2010 and the acquisition of the 1830 Santa Fe property in the third
quarter of 2010. Acquisition fees are incurred based on proceeds raised in our public offering.
Depreciation
and amortization expense was comparable at $0.5 million for the three months ended
September 30, 2011 and the three months ended September 30, 2010.
Impairment of real estate increased to $0.4 million for the three months ended September 30, 2011
from $0 in the three months ended September 30, 2010 as a result of the continued negative impact
of economic conditions on our real estate investments.
Interest income, which is primarily from notes receivable decreased to $0.1 million for the three
months ended September 30, 2011 from $0.3 million for the three months ended September 30, 2010.
The decrease is due to non-payment of interest on a note receivable from Servant Investments and
the note receivable from Nantucket Acquisition.
Interest
expense increased to $0.5 million for the three months ended September 30, 2011 from $0.3
million for the three months ended September 30, 2010, due primarily to financing costs incurred as
a result of amending and extending the HSH Nordbank credit agreement and the Wells Fargo Bank loan
agreement combined with higher interest rates on both facilities.
During the second quarter of 2011, we determined that the potential sale of the Mack Deer Valley,
Pinnacle Park, and 2111 South Industrial Park properties to a third party was probable and
therefore classified the properties as held for sale in accordance with ASC 360-10, Property, Plant
and Equipment. The results of operations for these properties, as well as those of the 15172
Goldenwest Circle property, were reclassified to discontinued operations for all periods presented.
For the three months ended September 30, 2011, income from discontinued operations was comparable
to the three months ended September 30, 2010. Although operating revenue, net of operating expenses
was lower in the 2011 period, this decrease was partially offset by the effect of discontinuing
depreciation and amortization in accordance with ASC 360-10.
Nine months ended September 30, 2011 and 2010
Nine Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2011 | 2010 | $ Change | % Change | |||||||||||||
Net operating income, as defined (1) |
||||||||||||||||
Industrial |
$ | 3,309,000 | $ | 3,739,000 | $ | (430,000 | ) | (12 | %) | |||||||
Senior Housing |
639,000 | | 639,000 | | ||||||||||||
Total portfolio net operating income |
$ | 3,948,000 | $ | 3,739,000 | $ | 209,000 | 6 | % | ||||||||
Reconciliation to net loss: |
||||||||||||||||
Net operating income, as defined (1) |
$ | 2,053,000 | $ | 2,423,000 | $ | (370,000 | ) | (15 | %) | |||||||
Unallocated (expenses) income: |
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Nine Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2011 | 2010 | $ Change | % Change | |||||||||||||
General and administrative expenses |
2,083,000 | 1,572,000 | 511,000 | 33 | % | |||||||||||
Asset management fees and expenses |
1,230,000 | 1,241,000 | (11,000 | ) | (1 | %) | ||||||||||
Real estate acquisitions costs |
| 58,000 | (58,000 | ) | (100 | %) | ||||||||||
Depreciation and amortization |
1,567,000 | 1,600,000 | (33,000 | ) | (2 | %) | ||||||||||
Impairment of notes receivable |
1,650,000 | | 1,650,000 | | ||||||||||||
Impairment of real estate |
23,644,000 | | 23,644,000 | | ||||||||||||
Interest (income) on notes receivable |
(366,000 | ) | (1,124,000 | ) | (758,000 | ) | (67 | %) | ||||||||
Interest
expense, net |
1,063,000 | 833,000 | 230,000 | 27 | % | |||||||||||
Net loss from continuing operations |
(28,818,000 | ) | (1,757,000 | ) | (27,061,000 | ) | 1,540 | % | ||||||||
(Loss) Income from discontinued operations |
(18,377,000 | ) | 1,315,000 | (19,692,000 | ) | (1,497 | %) | |||||||||
Net loss |
(47,195,000 | ) | (442,000 | ) | (46,753,000 | ) | 10,577 | % | ||||||||
Net loss attributable to noncontrolling interests |
(404,000 | ) | | 404,000 | | |||||||||||
Net loss attributable to common stockholders |
$ | (46,791,000 | ) | $ | (442,000 | ) | $ | (46,349,000 | ) | 10,486 | % | |||||
Industrial
Nine Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2011 | 2010 | $ Change | % Change | |||||||||||||
Industrial Net operating income |
||||||||||||||||
Total revenues: |
||||||||||||||||
Rental revenue |
$ | 2,640,000 | $ | 2,966,000 | $ | (326,000 | ) | (11 | %) | |||||||
Tenant reimbursement and other income |
669,000 | 773,000 | (104,000 | ) | (13 | %) | ||||||||||
3,309,000 | 3,739,000 | (430,000 | ) | (11 | %) | |||||||||||
Less: |
||||||||||||||||
Property operating and maintenance expenses |
1,247,000 | 1,316,000 | (69,000 | ) | (5 | %) | ||||||||||
Total portfolio net operating income |
$ | 2,062,000 | $ | 2,423,000 | $ | (361,000 | ) | (15 | %) | |||||||
Rental revenues and tenant reimbursements decreased to $3.3 million for the nine months ended
September 30, 2011 from $3.7 million for the nine months ended September 30, 2010. The decrease is
primarily due to lower occupancy rates, lower lease rental rates and longer lease-up periods for
vacant units as a result of the current economic environment partially offset by termination
payments from former tenants.
Property operating and maintenance expense decreased to $1.2 million for the nine months ended
September 30, 2011 from $1.3 million for the nine months ended September 30, 2010. This was
primarily due to lower property tax assessments resulting from successful property tax appeals.
Senior Housing
At June 30, 2011, we began consolidating Nantucket Acquisition and its subsidiary, Sherburne
Commons, a senior housing facility. As a result, we have two reportable segments for periods
subsequent to June 30, 2011. As the operating results of Sherburne commons are not included in our
prior period condensed consolidated financial statements, our operating results from 2011 to 2010
are not directly comparable.
Total revenue for the senior housing segment includes resident services and fee income. Property
operating and maintenance expenses include labor, food, utilities, marketing management and other
property operating costs.
Nine Months Ended | ||||||||||||||||
September 30, | ||||||||||||||||
2011 | 2010 | $ Change | % Change | |||||||||||||
Senior Housing Net operating income |
||||||||||||||||
Total revenues |
||||||||||||||||
Resident services and fee income |
$ | 639,000 | $ | | $ | 639,000 | | |||||||||
Less: |
||||||||||||||||
Property operating and maintenance expenses |
648,000 | | 648,000 | ) | | |||||||||||
Total portfolio net operating loss |
$ | (9,000 | ) | $ | | $ | (9,000 | ) | 100 | % | ||||||
Unallocated Expenses
General and administrative expense was $2.1 million for the nine months ended September 30, 2011
and $1.6 million for the nine months ended September 30, 2010, respectively. The increase was
primarily due to increases in consulting fees, legal fees, and insurance expense.
Asset management fees of $1.2 million were comparable for the nine months ended September 30, 2011
and the nine months ended September 30, 2010.
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Real estate acquisition costs decreased to $0 for the nine months ended September 30, 2011,
compared to $58,000 for the nine months ended September 30, 2010. The decrease is primarily due to
the suspension of our public offering in November 2010 and the acquisition of the 1830 Santa Fe
property in the third quarter of 2010. Acquisition fees are incurred based on proceeds raised in
our public offering.
Depreciation
and amortization expense of $1.6 million for the nine months ended September 30, 2011,
was comparable with the nine month period ended September 30, 2010.
Impairment of note receivable increased to $1.7 million for the nine months ended September 30,
2011 from $0 for the nine months ended September 30, 2010. This increase is attributed to the
Servant Healthcare LLC note receivable that was determined to be impaired due to events arising in
the second quarter of 2011.
Impairment of real estate increased to $23.6 million for the nine months ended September 30, 2011
primarily as a result of the impairment charge taken in the second quarter of 2011. The impairment
evaluation considered high vacancy levels, reduced rental rates and significant lease concessions
combined with the current market outlook and the assumption of shorter hold periods for our
properties. The change in the holding period assumption was in response to the evaluation of
strategic alternatives that our board of directors has undertaken with the objective of maximizing
shareholder value. Alternatives under consideration include, without limitation, the sale of
additional properties to repay debt as it becomes due.
Interest income, which is primarily from notes receivable decreased to $0.4 million for the nine
months ended September 30, 2011 from $1.1 million for the nine months ended September 30, 2010. The
decrease is due to non-payment of interest on the loan receivable from Servant Investments LLC and
the non-payment of interest on the note receivable from Nantucket Acquisition, LLC.
Interest expense increased to $1.1 million for the nine months ended September 30, 2011 from $0.8
million for the nine months ended September 30, 2010. The increase is primarily due to financing
costs incurred as a result of amending and extending the HSH Nordbank credit agreement and the
Wells Fargo Bank loan agreement combined with higher interest rates.
During the second quarter of 2011, we determined that the potential sale of the Mack Deer Valley,
Pinnacle Park, and 2111 South Industrial Park properties to a third party was probable and
therefore classified the properties as held for sale in accordance with ASC 360-10, Property, Plant
and Equipment and the results of operations for these properties, as well as that of the 15172
Goldenwest Circle property, were reclassified to discontinued operations for all periods presented.
For the nine months ended September 30, 2011, loss from discontinued operations was $18.4 million,
compared to income of $1.3 million for the comparable 2010 period. The 2011 loss from discontinued
operations was primarily due impairment charges on the Mack Deer Valley, Pinnacle Park, 2111 South
Industrial Park and the 15172 Goldenwest Circle properties totaling
$19.2 million June 2011. These
losses were partially offset by income from the operation of these properties. The income from
discontinued operations in 2010 was the result of the operating results of the held for sale
properties being reclassified to discontinued operations for the 2010 period.
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Liquidity and Capital Resources
On November 23, 2010, our board of directors made
a decision to stop making or accepting offers to
purchase shares of our stock in our follow-on offering while evaluating strategic alternatives to
maximize value and preserve the capital of our stockholders. During this time, we expect the
primary sources of cash to be rental revenues, property sales, tenant reimbursements and interest income. In
addition, we may obtain cash through the refinancing of debt and / or the sale of additional
properties. We expect our primary uses of cash to be for the repayment of principal on notes
payable, payment of tenant improvements and leasing commissions, advances to our VIE, operating expenses,
interest expense on outstanding indebtedness, and cash
distributions.
Operating expenses are expected to exceed operating revenue over
the next twelve months. We plan to fund this shortfall from the net
proceeds of property sales or refinancing.
Our board of directors is currently evaluating strategic alternatives for our follow-on offering,
but we do not expect our follow-on offering to be a material source of capital until such
evaluation is completed. As of September 30, 2011, we had approximately $0.4 million in cash and
cash equivalents on hand.
Credit Facilities
As of
September 30, 2011, we had total debt obligations of $27.0 million that mature in December 2011, February 2012 and May
2014. Of this amount, $5.0 million was outstanding on a credit facility with HSH Nordbank, including
$3.2 million associated with the properties held for sale, and $15.3 million is outstanding on a
credit facility with Wells Fargo Bank.
In July 2011, we amended our credit facility with HSH Nordbank to extend the maturity date of the
loan to December 16, 2011. As part of the amendment, HSH Nordbank eliminated principal payments
scheduled to be made in the third quarter of 2011 and the requirement to maintain a minimum amount
of cash or cash equivalents. As of September 30, 2011, we were not in compliance with the financial
covenant pertaining to the maintenance of minimum occupancy levels under the HSH Nordbank credit facility. This credit
facility was repaid in its entirely on November 28,
2011 with proceeds from the sale of the Pinnacle Park and Mack Deer Valley properties
discussed in Notes 4 and 15.
In August 2011, we amended our Wells Fargo Bank loan to extend the maturity date to February 13,
2012. The amendment provides for two additional one-year extensions, subject to the satisfaction of
certain conditions imposed by the lender. In connection with this amendment, the 2111 South
Industrial Park and Shoemaker Industrial Buildings were added to the loan collateral, and we made a
principal payment of $500,000. Interest on the amended loan increased to 300 basis points over
one-month LIBOR with a 150 basis point LIBOR floor. All other terms of the promissory note remain
in full force and effect.
Short Term Liquidity Requirements
In addition to the capital requirements for
recurring capital expenditures, tenant improvements and
leasing commissions, we may have to incur expenditures for operating deficits, VIE advances and renovation of our properties, such as
increasing the size of the properties by developing additional rentable square feet and or making
the space more appealing to potential industrial tenants. We sold two properties in the of fourth quarter of 2011 and
currently have one property listed
for sale and we are exploring opportunities to refinance existing debt. We expect to fund our
liquidity requirements from a combination of the net proceeds from property sales or refinancing
proceeds.
We are pursuing options for restructuring and repaying our debts including asset sales and
obtaining new financing that will reposition the assets.
We are also exploring options to monetize a portion or all of our interest in our VIE.
However,
there can be no assurance that we will be successful in executing such restructuring or repayment
to allow us to meet our debt obligations during the twelve months ending September 30, 2012. If we
are unable to obtain alternative financing or sell properties in order to repay the debt, this
could result in the lenders foreclosing on properties. Based on the various options available to us
and ongoing discussions with its lenders, management believes that we will be able to meet or
successfully restructure our debt obligations.
Distributions
Effective December 1, 2010, our board of directors resolved to reduce distributions on our common
stock to a current annualized rate of $0.08 per share (1% based on a share price of $8.00).
Distributions at this rate were declared for the first and second quarters of 2011. Payment of the
second quarter distribution has been deferred due to cash flow considerations and no distributions
have been declared for periods after June 30, 2011. The rate and
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frequency of distributions is subject to the discretion of our board of directors and may
change from time to time based on our operating results and cash flow.
Organization and offering costs
As of September 30, 2011, our Advisor and its affiliates had incurred on our behalf cumulative
organizational and offering costs totaling approximately $5.6 million, including approximately $0.1
million of organizational costs that was expensed and approximately $5.5 million of offering costs
which reduce net proceeds of our offerings. Of this amount, $4.4 million reduced the net proceeds
of our initial public offering and $1.1 million reduced the net proceeds of our follow-on offering.
In no event will we have any obligation to reimburse the Advisor for these costs totaling in
excess of 3.5% of the gross proceeds from our initial public offering and our follow-on public
offering at the conclusion of the offerings. As of September 30, 2011, we had reimbursed to our
Advisor a total of $4.5 million for our initial public offering and $1.1 million for our follow-on
offering.
At times during our offering stage, the amount of organization and offering expenses that we incur,
or that the Advisor and its affiliates incur on our behalf, may exceed 3.5% of the gross offering
proceeds then raised, but our Advisor has agreed to reimburse us to the extent that our
organization and offering expenses exceed this 3.5% limitation at the conclusion of our offerings.
In addition, the Advisor will pay all of our organization and offering expenses that, when combined
with the sales commissions and dealer manager fees that we incur exceed 13.5% of the gross proceeds
from our public offerings. We suspended sales under our follow-on offering on November 23, 2010
while our board of directors evaluates strategic alternatives to maximize stockholder value. The
follow-on offering remained suspended.
We will not rely on advances from the Advisor to acquire properties but the Advisor and its
affiliates may loan funds to special purpose entities that may acquire properties on our behalf
pending our raising sufficient proceeds from our public offerings to purchase the properties from
the special purpose entity.
We will endeavor to repay any temporary acquisition debt financing by raising additional equity or
selling properties so that we will own our properties with no permanent financing. Financial
markets have recently experienced unusual volatility and uncertainty. Liquidity has tightened in
all financial markets, including the debt and equity markets. Our ability to repay or refinance
debt maturities could be adversely affected by an inability to secure financing at reasonable
terms, if at all.
Other than the conditions discussed above and market conditions discussed under the caption Market
OutlookReal Estate and Real Estate Finance Markets, we are not aware of any material trends or
uncertainties, favorable or unfavorable, affecting real estate generally, which we anticipate may
have a material impact on either capital resources or the revenues or income to be derived from the
operation of real estate properties.
Funds from Operations and Modified Funds from Operations
Funds from operations (FFO) is a non-GAAP financial measure that is widely recognized as a
measure of REIT operating performance. We compute FFO in accordance with the definition outlined by
the National Association of Real Estate Investment Trusts (NAREIT). NAREIT defines FFO as net
income (loss), computed in accordance with GAAP, excluding extraordinary items, as defined by the
accounting principles generally accepted in the United States of America (GAAP), and gains (or
losses) from sales of property, plus depreciation and amortization on real estate assets, and after
adjustments for unconsolidated partnerships, joint ventures, noncontrolling interests and
subsidiaries. Our FFO may not be comparable to FFO reported by other REITs that do not define the
term in accordance with the current NAREIT definition or that interpret the current NAREIT
definition differently than we do. We believe that FFO is helpful to investors and our management
as a measure of operating performance because it excludes depreciation and amortization, gains and
losses from property dispositions, and extraordinary items, and as a result, when compared year to
year, reflects the impact on operations from trends in occupancy rates, rental rates, operating
costs, development activities, general and administrative expenses, and interest costs, which is
not immediately apparent from net income. Historical cost accounting for real estate assets in
accordance with GAAP implicitly assumes that the value of real estate diminishes predictably over
time. Since real estate values have historically risen or fallen with market conditions, many
industry investors and analysts have considered the presentation of operating results for real
estate companies that use historical cost accounting alone to be insufficient.
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As a result, our
management believes that the use of FFO, together with the required GAAP presentations, provide a
more complete understanding of our performance. Factors that impact FFO include start-up costs,
fixed costs, delays in buying assets, lower yields on cash held in accounts pending investment,
income from portfolio properties and other portfolio assets, interest rates on acquisition
financing and operating expenses. FFO should not be considered as an alternative to net income
(loss), as an indication of our performance, nor is it indicative of funds available to fund our
cash needs, including our ability to make distributions.
Changes in the accounting and reporting rules under GAAP have prompted a significant increase in
the amount of non-cash and non-operating items included in FFO, as defined. Therefore, we use
modified funds from operations (MFFO), which excludes from FFO acquisition expenses, amortization
of above or below market rent, and non-cash amounts related to straight line rent, impairments of
real estate assets and impairments of notes receivable to further evaluate our operating
performance. We compute MFFO in accordance with the definition suggested by the Investment Program
Association (the IPA), the trade association for direct investment programs (including non-listed
REITs). However, certain adjustments included in the IPAs definition are not applicable to us and
are therefore not included in the foregoing definition.
We believe that MFFO is a helpful measure of operating performance because it excludes costs that
management considers more reflective of investing activities or non-operating changes. Accordingly,
we believe that MFFO can be a useful metric to assist management, investors and analysts in
assessing the sustainability of our operating performance. As explained below, managements
evaluation of our operating performance excludes the items considered in the calculation based on
the following considerations:
| Real estate acquisition expenses. In evaluating investments in real estate, including both business combinations and investments accounted for under the equity method of accounting, managements investment models and analysis differentiate costs to acquire the investment from the operations derived from the investment. These acquisition costs have been funded from the proceeds of our initial public offering and other financing sources and not from operations. We believe by excluding expensed acquisition costs, MFFO provides useful supplemental information that is comparable for each type of our real estate investments and is consistent with managements analysis of the investing and operating performance of our properties. Real estate acquisition expenses include those paid to our Advisor and to third parties. | ||
| Adjustments for amortization of above or below market rent. Similar to depreciation and amortization of other real estate related assets that are excluded from FFO, GAAP implicitly assumes that the value of lease assets diminishes predictably over time and that these charges be recognized currently in revenue. Since real estate values and market lease rates in the aggregate have historically risen or fallen with market conditions, management believes that by excluding these charges, MFFO provides useful supplemental information on the operating performance of our real estate. | ||
| Adjustments for straight line rents. Under GAAP, rental income recognition can be significantly different than underlying contract terms. By adjusting for these items, MFFO provides useful supplemental information on the economic impact of our lease terms and presents results in a manner more consistent with managements analysis of our operating performance. | ||
| Impairment charges. Impairment charges relate to a fair value adjustment, which is based on the impact of current market fluctuations and underlying assessments of general market conditions and the specific performance of the holding, which may not be directly attributable to our current operating performance. As these losses relate to underlying long-term assets and liabilities, where we are not speculating or trading assets, management believes MFFO provides useful supplemental information by focusing on the changes in our core operating fundamentals rather than changes that may reflect anticipated losses. In particular, because GAAP impairment charges are not allowed to be reversed if the underlying fair values improve or because the timing of impairment charges may lag the onset of certain operating consequences, we believe MFFO provides useful supplemental information related to the sustainability of rental rates, occupancy and other core operating fundamentals. |
FFO or MFFO should not be considered as an alternative to net income (loss), as an indication of
our liquidity, nor is it indicative of funds available to fund our cash needs, including our
ability to make distributions. Both FFO and
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MFFO should be reviewed along with other GAAP
measurements. Our FFO and MFFO as presented may not be comparable to amounts calculated by other
REITs.
We believe that MFFO is helpful as a measure of operating performance because it excludes costs
that management considers more reflective of investing activities or non-operating changes.
Our calculations of FFO and MFFO for the three months and nine months ended September 30, 2011 and
2010 are presented below:
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net loss |
$ | (1,132,000 | ) | $ | (569,000 | ) | $ | (46,791,000 | ) | $ | (442,000 | ) | ||||
Adjustments: |
||||||||||||||||
Noncontrolling interests share in earnings |
(352,000 | ) | | (404,000 | ) | | ||||||||||
Depreciation and amortization of real estate
assets |
494,000 | 924,000 | 2,043,000 | 2,574,000 | ||||||||||||
Funds from operations (FFO) (1) |
$ | (990,000 | ) | $ | 355,000 | $ | (45,152,000 | ) | $ | 2,132,000 | ||||||
Adjustments: |
||||||||||||||||
Real estate acquisition costs |
| 30,000 | | 58,000 | ||||||||||||
Reverse amortization of above/below market rent |
(6,000 | ) | 6,000 | | 33,000 | |||||||||||
Straight line rent |
(31,000 | ) | 191,000 | (34,000 | ) | (5,000 | ) | |||||||||
Deferred financing costs |
156,000 | 111,000 | 357,000 | 215,000 | ||||||||||||
Impairment of note receivable |
| | 1,650,000 | | ||||||||||||
Impairment of real estate assets |
578,000 | | 42,976,000 | | ||||||||||||
Modified funds from operations (MFFO) (1) |
$ | (293,000 | ) | $ | 693,000 | $ | (203,000 | ) | $ | 2,433,000 | ||||||
Weighted average common shares
outstanding |
23,860,105 | 22,880,212 | 23,635,914 | 22,917,097 | ||||||||||||
FFO per weighted average shares (1) |
$ | (0.04 | ) | $ | 0.02 | $ | (1.91 | ) | $ | 0.09 | ||||||
MFFO per weighted average shares (1) |
$ | (0.01 | ) | $ | 0.03 | $ | (0.00 | ) | $ | 0.11 |
(1) | Because we raised capital in our public offering during the periods covered in this table, and made equity investments in 2010, the results presented for the periods in this table are not directly comparable and should not be considered an indication of our historical operating performance. |
The following are the distributions declared during the three months ended September 30, 2011
and 2010:
Cash flows provided by | ||||||||||||||||
(used in) | ||||||||||||||||
Distribution Declared (2) | Operating | |||||||||||||||
Period | Cash | Reinvested | Total | Activities | ||||||||||||
First quarter 2010 |
$ | 1,221,000 | $ | 1,490,000 | $ | 2,711,000 | $ | 1,103,000 | ||||||||
Second quarter 2010 (1) |
$ | 1,256,000 | $ | 1,468,000 | $ | 2,724,000 | $ | 461,000 | ||||||||
Third quarter 2010 |
$ | 1,323,000 | $ | 1,448,000 | $ | 2,771,000 | $ | 1,003,000 | ||||||||
First quarter 2011 |
$ | 454,000 | $ | | $ | 454,000 | $ | 481,000 | ||||||||
Second quarter 2011 |
$ | 468,000 | $ | | $ | 468,000 | $ | (219,000 | ) | |||||||
Third quarter 2011 |
$ | | $ | | $ | | $ | (323,000 | ) |
(1) | Distributions declared primarily represented a return of capital for tax purposes. | |
(2) | In order to meet the requirements for being treated as a REIT under the Internal Revenue Code, we must pay distributions to our shareholders each taxable year equal to at least 90% of our net ordinary taxable income. Some of our distributions have been paid from sources other than operating cash flow, such as offering proceeds and debt proceeds. |
From our inception in October 2004 through September 30, 2011, we declared aggregate
distributions of $32.8 million. Our cumulative net loss and cumulative cash flows from operations
during the same period were $63.5 million and $6.3 million, respectively.
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Contractual Obligations
Refer to
Item 7, Managements Discussion and Analysis of Financial
Condition and Results of Operations, in our Annual Report on Form 10-K for information regarding our contractual obligations.
Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
Market risk includes risks that arise from changes in interest rates, foreign currency exchange
rates, commodity prices, equity prices and other market changes that affect market sensitive
instruments. We are 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. We invest our
cash and cash equivalents in government backed securities and FDIC insured savings account which,
by its nature, are subject to interest rate fluctuations. However, we believe that the primary
market risk to which we will be exposed is interest rate risk related to our credit facilities.
We borrow funds and make investments at a combination of fixed and variable rates. Interest rate
fluctuations will generally not affect our future earnings or cash flows on our fixed rate debt or
fixed rate loans receivable unless such instruments mature or are otherwise terminated. Conversely,
movements in interest rates on variable rate debt would change our future earnings and cash flows,
but not significantly affect the fair value of those instruments. However, changes in required risk
premiums would result in changes in the fair value of floating rate instruments.
As of September 30, 2011, we had borrowed approximately $20.3 million under our variable rate
credit facility and loan agreement. An increase or decrease in the variable interest rate on the
facilities constitutes a market risk as a change in rates would increase or decrease interest
incurred and therefore cash flows available for distribution to shareholders. Based on the debt
outstanding as of September 30, 2011, a 1% increase or decrease in interest rates would result in
an increase or decrease in interest expense of approximately $203,000 per year.
In addition to changes in interest rates, the value of our real estate is subject to fluctuations
based on changes in the real estate capital markets, market rental rates for office space, local,
regional and national economic conditions and changes in the creditworthiness of tenants. All of
these factors may also affect our ability to refinance our debt if necessary.
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Item 4. | Controls and Procedures |
We maintain disclosure controls and procedures that are designed to ensure that information
required to be disclosed in our Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms, and that such information
is accumulated and communicated to our senior management, including our Chief Executive Officer
(Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), as
appropriate, to allow timely decisions regarding required disclosure. Our Chief Executive Officer
(Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer) have
evaluated the effectiveness of our disclosure controls and procedures and have concluded that the
disclosure controls and procedures were effective as of the end of the period covered by this
report.
Under the supervision and with the participation of our management, including our Chief Executive
Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), we
evaluated our disclosure controls and procedures, as such term is defined under Rule 13a-15(e)
promulgated under the Securities and Exchange Act of 1934. In designing and evaluating the
disclosure controls and procedures, management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management is required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
There have been no changes in our internal control over financial reporting during our most recent
fiscal quarter that have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
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PART
II OTHER INFORMATION
Item 1A. | Risk Factors |
The following risk factors supplement the risks disclosed in our annual report on Form 10-K for the
fiscal year ended December 31, 2010.
We have, and may in the future, pay distributions from sources other than cash provided from
operations.
Until our investments in real estate generate operating cash flow sufficient to fully fund
distributions to our stockholders, we intend to pay a substantial portion of our distributions from
the proceeds of our offerings or from borrowings in anticipation of future cash flow. To the extent
that we use offering proceeds to fund distributions to stockholders, the amount of cash available
for investment in properties will be reduced. The distributions paid for the four quarters ended
September 30, 2011 were $3.4 million. Of this amount, $1.0 million was reinvested through our
dividend reinvestment plan and $2.4 million was paid in cash to stockholders. For the four quarters
ended September 30, 2011 cash flow from operations and FFO were $0.3 million and a loss of $47.0
million, respectively. Accordingly, for the four quarters ended September 30, 2011, total
distributions exceeded cash flow from operations and FFO for the same period. During the four
quarters ended September 30, 2011, total distributions paid in cash exceeded cash flow from
operations and FFO for the same period. We used offering proceeds to pay cash distributions in
excess of cash flow from operations during the fourth quarters ended September 30, 2011.
Any adverse changes in the financial health of our Advisor or its affiliates or our relationship
with them could hinder our operating performance and the return on your investment. The dealer
manager of our currently suspended public offering has recently experienced significant personnel
reductions. As a result, we do not expect that we will be able to recommence our public offering
unless and until we are able to engage a new dealer manager. We may have difficulty finding a
qualified dealer manager and/or advisor, and any successor dealer manager or advisor may not be as
well suited to manage us or our offering. These potential changes could result in a significant
disruption of our business and may adversely affect the value of your investment in us.
We are dependent on our Advisor to manage our operations and our portfolio of real estate assets.
Our Advisor depends upon the fees and other compensation that it receives from us in connection
with the purchase, management and sale of our properties to conduct its operations. To date, the
fees we pay to our Advisor have been inadequate to cover its operating expenses. To cover its
operational shortfalls, our Advisor has relied on cash raised in private offerings of its sole
member. If our Advisor is unable to secure additional capital, it may become unable to meet its
obligations and we might be required to find alternative service providers, which could result in a
significant disruption of our business and may adversely affect the value of your investment in us.
We may have difficulty finding a new qualified dealer manager, and any change in the dealer manager
will require our public offering to remain suspended until regulatory approvals are obtained. Such
a suspension could last months, and we cannot assure you that the necessary regulatory approvals
would be obtained. In addition, any new dealer manager we engage may fail to raise significant
capital. If we fail to raise significant capital, our portfolio will be less diversified and the
value of your investment in us will vary more greatly with changes in the value of any one asset.
Moreover, our general and administrative expenses will be greater in proportion to our assets,
which will adversely affect your returns.
We have limited liquidity and we may be required to pursue certain measures in order to maintain or
enhance our liquidity.
Liquidity is essential to our business and our ability to operate and to fund our existing
obligations. A primary source of liquidity for us has been the issuance of common stock in our
public offerings. However, our follow-on public offering has been suspended since November 23, 2010
while our board of directors evaluates strategic alternatives to maximize value for our
stockholders. As a result, we are dependent on external debt financing to fund our ongoing
operations. Our access to debt financing depends on the willingness of third parties to provide us
with corporate or asset level debt. It also depends on conditions in the capital markets
generally. Companies in the real estate industry have at times historically experienced limited
availability of capital, and new capital sources may not
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be available on acceptable terms, if at
all. We cannot be certain that sufficient funding will be available to us in the future on terms
that are acceptable to us, if at all. If we cannot obtain sufficient funding on acceptable terms,
or at all, we will not be able to operate and/or grow our business, which would likely have a
negative impact on the value of our common stock and our ability to make distributions to our
stockholders. In such an instance, a lack of sufficient liquidity would have a material adverse
impact on our operations, cash flow, financial condition and our ability to continue as a going
concern. We may be required to pursue certain measures in order to maintain or enhance our
liquidity, including seeking the extension or replacement of our debt facilities, potentially
selling assets at unfavorable prices and/or reducing our operating expenses. We cannot assure you
that we will be successful in measures to improve our liquidity. For information about our
available sources of funds, see Managements Discussion and Analysis of Financial Condition and
Results of Operations Liquidity and Capital Resources and the notes to the Consolidated
Financial Statements in this Quarterly Report on Form 10-Q.
Our stockholders have limited control over changes in our policies and operations, which increases
the uncertainty and risks our stockholders face.
Our board of directors determines our major policies, including our policies regarding investment,
financing, growth, debt capitalization, REIT qualification and distributions. Our board of
directors is currently engaged in a process of evaluating strategic alternatives to maximize value
for our stockholders. As a result of this process, or otherwise, our board of directors may
determine that it is in the best interest of the company to amend or revise certain of our major
policies. Our board of directors may amend or revise these policies without a vote of the
stockholders. Under Maryland General Corporation Law and our charter, our stockholders have a right
to vote only on limited matters. Our boards broad discretion in setting policies and our
stockholders inability to exert control over those policies increases the uncertainty and risks
our stockholders face.
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
(a) We did not sell any equity securities that were not registered under the Securities Act of 1933
during the period covered by this Form 10-Q.
(b) Not applicable.
(c) During the three months ended September 30, 2011, we redeemed no shares pursuant to our stock
repurchase program, which was suspended effective December 31, 2010.
On November 23, 2010, our board of directors concluded that we would not have sufficient funds
available to us to fund any redemptions during 2011. Accordingly, our board of directors approved
an amendment to our stock repurchase program to suspend redemptions under the program effective
December 31, 2010. We can make no assurance as to when and on what terms redemptions will resume.
The share redemption program may be amended, resumed, suspended again, or terminated at any time
based in part on our cash and debt position. Our board has the authority to terminate the program
at any time upon 30 days written notice to our stockholders.
During the nine months ended September 30, 2011, we received requests to have an aggregate of
shares redeemed pursuant to our stock repurchase program, however, due to the current
suspension of the stock repurchase program we were not able to fulfill any of these requests.
Item 5. Other Information
Amendment of Amended and Restated Advisory Agreement
In connection with its efforts to limit the Companys overall operating expenses, our board of
directors has required Cornerstone Realty Advisors, LLC (our Advisor), to reduce the disposition
fees that we may be required to pay to our Advisor upon the sale of one or more of our properties.
Under our advisory agreement, as amended, if our Advisor or one of its affiliates provides a
substantial amount of the services (as determined by a majority of our directors, including a
majority of the independent directors) in connection with the sale of one or more of our
properties, then we are required to pay our Advisor or such affiliate a disposition fee. On
November 11, 2011, we executed an amendment to our advisory agreement to reduce this disposition
fee from the prior rate of 3.0% of the sales price of the property or properties sold to a new rate
of 1.0% of the sales price of the property or properties sold. The other terms of the advisory
agreement, as amended, are unaffected by this amendment and remain in effect.
On November 17, 2011, the purchase and sale agreement between us and
Buchanan Street Partners, L.P., in connection
with the sale of the Pinnacle Park Business Center and Mack Deer
Valley properties, was cancelled.
On November 23, 2011, the previously cancelled purchase and sale agreement executed on August 31, 2011
between us and Columbia Industrial Properties Midwest, LLC in Connection with the sale of these properties
was reinstated. The sale of the properties was completed on November 28, 2011 for proceeds of $23.9 million.
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Item 6. | Exhibits |
Exhibit | Description | |
3.1
|
Articles of Amendment and Restatement of Articles of Incorporation (incorporated by reference to Exhibit 3.2 to the Registrants Annual Report on Form 10-K for the year ended December 31, 2005) | |
3.2
|
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.3 to Post-Effective Amendment No. 1 to the Registration Statement on Form S-11 (No. 333-121238) filed on December 23, 2005) | |
4.1
|
Form of Subscription Agreement (incorporated by reference to Appendix A to the prospectus dated April 16, 2010) | |
4.2
|
Statement regarding restrictions on transferability of shares of common stock (to appear on stock certificate or to be sent upon request and without charge to stockholders issued shares without certificates) (incorporated by reference to Exhibit 4.2 to the Registration Statement on Form S-11 (No. 333-121238) filed on December 14, 2004) | |
4.3
|
Distribution Reinvestment Plan (incorporated by reference to Appendix B to the prospectus dated April 16, 2010) | |
10.1
|
Amendment No. 1 to the Amended and Restated Advisory Agreement dated as of August 31, 2011. | |
10.2
|
Amendment No. 2 to the Amended and Restated Advisory Agreement dated as of November 11, 2011. | |
10.3
|
Amendment No. 10 to Credit Agreement with HSH Nordbank AG, New York Branch dated as of July 20, 2011, incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on July 25, 2011. | |
10.4
|
Assumption and Modification Agreement related to the Wells Fargo loan dated August 12, 2011, incorporated by reference to Exhibit 10.2 to the Companys Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011. | |
10.5
|
Purchase and Sale Agreement made as of August 31, 2011, by and between COP-Deer Valley, LLC, COP-Pinnacle Peak, LLC, and Columbia Industrial Properties Midwest, LLC, incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on September 7, 2011. | |
10.6
|
Purchase and Sale Agreement dated August 31, 2011 by and between the Company and J3 Harmon, L.L.C., incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on September 7, 2011. | |
10.7
|
Purchase and Sale Agreement made as of October 26, 2011, by and between COP- South Industrial, LLC and Damar Holdings, LLC, incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on October 31, 2011. | |
10.8
|
Purchase and Sale Agreement made as of November 10, 2011, by and between COP- Deer Valley, LLC and COP- Pinnacle Peak, LLC and Buchanan Street Partners, L.P., incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on November 16, 2011. | |
31.1
|
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2
|
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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Exhibit | Description | |
32
|
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
101.1
|
The following information from the Companys quarterly report on Form 10-Q for the quarter ended September 30, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Cash Flows |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this quarterly report to be signed on its behalf by the
undersigned, thereunto duly authorized this 1st day of December, 2011.
CORNERSTONE CORE PROPERTIES REIT, INC. |
||||
By: | /s/ Terry G. Roussel | |||
Terry G. Roussel | ||||
Chief Executive Officer (Principal Executive Officer) |
||||
By: | /s/ Sharon C. Kaiser | |||
Sharon C. Kaiser | ||||
Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
45