UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _________ to __________

 

Commission file number: 333-178651

 

UNITED REALTY TRUST INCORPORATED

 (Exact name of registrant as specified in its charter)

 

Maryland		45-3770595
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
60 Broad Street, 34th Floor, New York, NY		10004
(Address of principal executive offices)		(Zip Code)

 

(212) 388-6800

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No

 

Indicate by check mark whether the registrant submitted electronically and posted on its corporate Web Site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☒ (Do not check if a smaller reporting company)	Smaller reporting company ☐

 

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

 

As of October 31, 2014 the registrant had 1,250,679 shares of common stock, $0.01 par value per share, outstanding.

 

 

TABLE OF CONTENTS

 

				Page
Part I. Financial Information				2
	Item 1.	Financial Statements		2
		Consolidated Balance Sheets as of September 30, 2014 (Unaudited) and December 31, 2013		2
		Consolidated Statements of Operations and Comprehensive Loss (Unaudited) for the three and nine months ended September 30, 2014 and 2013		3
		Consolidated Statement of Equity (Unaudited) for the nine months ended September 30, 2014		4
		Consolidated Statements of Cash Flow (Unaudited) for the nine months ended September 30, 2014 and 2013		5
		Notes to Consolidated Financial Statements		6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		26
	Item 4.	Controls and Procedures		26
Part II. Other Information				27
	Item 1.	Legal Proceedings		27
	Item 1A.	Risk Factors		27
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		33
	Item 3.	Defaults Upon Senior Securities		35
	Item 4.	Mine Safety Disclosures		35
	Item 5.	Other Information		35
	Item 6.	Exhibits		35

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

UNITED REALTY TRUST INCORPORATED

 CONSOLIDATED BALANCE SHEETS

 

		September 30, 2014 (Unaudited)				December 31, 2013
ASSETS
Real estate investments:
Land		$	7,686,548			$	4,870,933
Building and improvements			26,584,676				16,426,448
			34,271,224				21,297,381
Less: accumulated depreciation			1,072,615				462,871
			33,198,609				20,834,510
Mortgage note receivable			1,500,000				1,500,000
Real estate investments, net			34,698,609				22,334,510
Cash and cash equivalents			287,473				520,449
Restricted cash			1,146,365				609,259
Prepaid expenses			179,632				227,042
Deferred offering costs			2,917,720				—
Deposit on real estate			50,000				100,000
Due from affiliates			888,137				15,759
Tenant and other receivables, net			177,669				280,983
Deferred rent receivable			25,923				—
Other assets			54,651				65,343
Acquired lease intangible asset, net of accumulated amortization			3,073,619				2,150,515
Deferred charges, net of accumulated amortization			2,342,168				1,638,487
Total assets		$	45,841,966			$	27,942,347
LIABILITIES AND EQUITY
Liabilities
Mortgage notes payable		$	25,973,568			$	15,855,304
Preferred loans payable			3,752,000				—
Acquired lease intangibles liability, net of accumulated amortization			932,214				787,554
Tenant security deposits			82,281				21,508
Dividends and distributions payable			73,768				43,679
Deferred income			255,354				—
Accounts payable and accrued expenses			600,213				283,265
Total Liabilities			31,669,398				16,991,310
Commitments and contingencies			—				—
Equity:
Preferred stock, $0.01 par value 50,000,000 shares authorized; 500,000 shares issued and outstanding			50,000				50,000
Common stock, $0.01 par value 200,000,000 shares authorized; 1,192,879 and 673,727 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively			11,929				6,737
Additional paid-in-capital			10,993,410				6,110,988
Accumulated deficit			(5,336,566	)			(3,685,931	)
Total United Realty Trust Incorporated stockholders’ equity			5,718,773				2,481,794
Noncontrolling interests:
Noncontrolling interests in consolidated joint ventures			8,435,027				8,435,027
Limited partners’ interest in Operating Partnership			18,768				34,216
Total Noncontrolling interests			8,453,795				8,469,243
Total equity			14,172,568				10,951,037
Total liabilities and equity		$	45,841,966			$	27,942,347

 

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

 

 

UNITED REALTY TRUST INCORPORATED

 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)

 

		Three Months Ended								Nine Months Ended
		September 30, 2014				September 30, 2013				September 30, 2014				September 30, 2013
Revenues
Base rents		$	1,037,399			$	715,252			$	2,623,024			$	1,402,408
Recoveries from tenants			210,849				82,000				483,532				161,932
Other			—				—				1,692				—
Total revenue			1,248,248				797,252				3,108,248				1,564,340
Operating expenses
Property operating			254,306				105,532				580,758				184,121
Property taxes			118,028				85,329				313,397				169,410
General & administrative expenses			122,466				125,739				316,122				912,336
Depreciation and amortization			431,286				200,737				1,043,706				386,397
Acquisition transaction costs			6,825				106,850				456,353				1,494,607
Total operating expenses			932,911				624,187				2,710,336				3,146,871
Operating income (loss)			315,337				173,065				397,912				(1,582,531	)
Non-operating expenses
Interest income			—				—				—				36
Interest expense			(480,146	)			(194,920	)			(994,644	)			(384,177	)
Amortization of deferred financing costs			(38,437	)			(25,241	)			(96,803	)			(48,708	)
Net loss			(203,246	)			(47,096	)			(693,535	)			(2,015,380	)
Noncontrolling interests:
Net income attributable to noncontrolling interests			(141,488	)			(138,185	)			(426,190	)			(273,669	)
Net loss and comprehensive loss attributable to United Realty Trust Incorporated		$	(344,734	)		$	(185,281	)		$	(1,119,725	)		$	(2,289,049	)
Net loss per common share:
Basic and diluted		$	(0.31	)		$	(0.34	)		$	(1.25	)		$	(4.99	)
Weighted average number of common shares outstanding
Basic and diluted			1,102,493				547,586				895,652				458,284
Distributions per share		$	0.19			$	0.19			$	0.58			$	0.58

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements

 

 

UNITED REALTY TRUST INCORPORATED

 CONSOLIDATED STATEMENT OF EQUITY

For the Nine Months Ended September 30, 2014

 (Unaudited)

 

		Preferred Stock								Common Stock								Additional paid-in				Retained earnings (Accumulated				Noncontrolling				Total
		Shares				Amount				Shares				Par Value				capital				deficit)				interests				Equity
Balance at December 31, 2013			500,000			$	50,000				673,727			$	6,737			$	6,110,988			$	(3,685,931	)		$	8,469,243			$	10,951,037
Proceeds from the sale of common stock			—				—				491,536				4,916				5,128,450				—				—				5,133,366
Distributions paid to noncontrolling interests			—				—				—				—				—				—				(426,190	)			(426,190	)
Amortization of restricted stock			—				—				—				—				36,000				—				—				36,000
Shares issued under the stock incentive plan			—				—				24,226				242				225,708				—				—				225,950
Registration expenditures			—				—				—				—				(561,099	)			—				—				(561,099	)
Distributions declared			—				—				—				—				—				(530,910	)			—				(530,910	)
Issuance of shares under distribution reinvestment program			—				—				22,593				226				227,723				—				—				227,949
Redemption of common stock											(19,203	)			(192	)			(189,808	)											(190,000	)
Net loss			—				—				—				—				—				(1,119,725	)			426,190				(693,535	)
Reallocation adjustment of limited partners interest																			15,448								(15,448	)			—
Balance at September 30, 2014			500,000			$	50,000				1,192,879			$	11,929			$	10,993,410			$	(5,336,566	)		$	8,453,795			$	14,172,568

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements

 

 

UNITED REALTY TRUST INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOW

 (unaudited)

 

		For the Nine Months Ended
		September 30, 2014				September 30, 2013
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss		$	(693,535	)		$	(2,015,380	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Depreciation and amortization			1,043,706				386,397
Amortization of deferred financing costs			96,803				48,708
Amortization of above/(below)-market rent			36,591				(7,811	)
Amortization of restricted stock			36,000				95,850
Deferred rents receivable			(25,923	)
Change in operating assets and liabilities
Restricted cash - operating			(305,813	)			(289,178	)
Prepaid expenses			47,410				(140,180	)
Security deposits			—				21,473
Tenant and other receivables			103,314				(262,187	)
Due to/from affiliates			(644,413	)			(1,060,061	)
Deferred income			255,354				80,402
Accounts payable			316,036				102,142
Net cash provided by (used in) operating activities			265,530				(3,039,825	)
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of real estate			(14,535,000	)			(16,650,000	)
Improvements to real estate			—				(6,950	)
Restricted cash - investing			(170,520	)			(86,360	)
Deposit on real estate			50,000				—
Net cash flows used in investing activities			(14,655,520	)			(16,743,310	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the sale of common stock			5,133,366				3,352,635
Registration expenditures			(561,099	)			(335,776	)
Redemption of common stock			(190,000	)			—
Proceeds from mortgage notes payable			10,300,000				16,000,000
Principal repayments on mortgage			(181,736	)			(85,002	)
Proceeds from preferred loans payable			3,800,000				—
Principal repayment of preferred loans payable			(48,000	)			—
Deferred financing and other costs			(477,632	)			(529,920	)
Deferred offering costs			(2,917,720	)			—
Contributions from noncontrolling interest			—				585,027
Distribution paid to noncontrolling interest			(426,190	)			(273,669	)
Distributions paid to common stockholders			(273,975	)			(131,028	)
Net cash provided by financing activities			14,157,014				18,582,267
Net decrease in cash and cash equivalents			(232,976	)			(1,200,868	)
Cash and cash equivalents at beginning of period			520,449				1,246,264
Cash and cash equivalents at end of period		$	287,473			$	45,396
Supplemental disclosure of cash activities:
Cash paid for interest		$	944,134			$	380,099
Supplemental disclosure of non-cash activities:
Purchase accounting allocations:
Acquired lease intangible asset		$	2,490,807			$	1,812,800
Acquired lease intangible liability			154,125				(291,625	)
Non-controlling interest			—				7,950,000
Investment in mortgage notes receivable			—				(1,150,000	)

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements

 

 

UNITED REALTY TRUST INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

 

1.	Organization

 

United Realty Trust Incorporated (“we,” “us,” “our,” or the “Company”) was formed on November 8, 2011 as a Maryland corporation and qualified as a real estate investment trust (“REIT”) for U.S. federal income tax purposes beginning with the taxable year ended December 31, 2013. Substantially all of the Company’s business is conducted through United Realty Capital Operating Partnership, L.P. (the “Operating Partnership,” or “OP”), a Delaware limited partnership formed on November 8, 2011. The Company is the general partner of the Operating Partnership and holds both general and limited partnership interests in the Operating Partnership. As the Company completes the settlement for the purchase orders for shares of the Company’s common stock, par value $0.01 per share (“Common Shares”) in its continuous public offering, it will transfer substantially all of the net proceeds of the offering to the Operating Partnership in exchange for OP Units (as defined below).

 

At September 30, 2014, the Company owned a 99.2% economic interest, or 1,192,879 units, in the Operating Partnership. At September 30, 2014, the non-controlling limited partners in the Operating Partnership held a 0.8% interest, or 9,273 units, represented by Operating Partnership Units (“OP Units”). The carrying amount of such interest is adjusted at the end of each reporting period to an amount equal to the limited partners’ ownership percentage of the Operating Partnership’s net equity. The aggregate 1,202,152 OP Units outstanding at September 30, 2014 are economically equivalent to the Company’s Common Shares.

 

The Company was organized to invest in a diversified portfolio of income-producing commercial real estate properties and other real estate-related assets. On November 25, 2011, United Realty Advisor Holdings LLC, a Delaware limited liability company (the “Sponsor”) purchased 500,000 shares of preferred stock for $50,000.

 

The Company is offering to the public 100,000,000 Common Shares in its primary offering and 20,000,000 Common Shares pursuant to its distribution reinvestment program (“DRIP”). The Company may reallocate the Common Shares offered between the primary offering and the DRIP. The Company expects to sell the Common Shares offered in the primary offering until August 15, 2015.

 

The Company intends to invest primarily in interests in real estate located in the United States, with a primary focus on the eastern United States and in markets that the Company believes are likely to benefit from favorable demographic changes, or that the Company believes are poised for strong economic growth. The Company may invest in interests in a wide variety of commercial property types, including office, industrial, retail and hospitality properties, single-tenant properties, multifamily properties, age-restricted residences, and in other real estate-related assets. The Company may acquire assets directly or through joint ventures, by making an equity investment in a project or by making a mezzanine or bridge loan with a right to acquire equity in the project. The Company also may buy debt secured by an asset with a view toward acquiring the asset through foreclosure. The Company also may originate or invest in mortgages, bridge or mezzanine loans and tenant-in-common interests, or entities that make investments similar to the foregoing. Further, the Company may invest in real estate-related securities, including securities issued by other real estate companies.

 

The Company’s advisor is United Realty Advisors LP (the “Advisor”), a Delaware limited partnership formed on July 1, 2011. The Advisor conducts the Company’s operations and manages the portfolio of real estate investments. As of September 30, 2014, the Company owned a 69.2 % interest in a joint venture that owns a residential property located at 2520 Tilden Avenue in Brooklyn, New York (“Tilden House”), a 14.6% interest in a joint venture that owns a residential property known as 14 Highland Ave., Yonkers, New York (“14 Highland”), and a medical building located at 945 82^nd Parkway, Myrtle Beach, SC (“Parkway”). In addition, as of September 30, 2014, the Company owned a 76.7% interest in a joint venture that owns a mortgage note secured by properties located at 58 and 70 Parker Avenue, in Poughkeepsie, NY.

 

2.	Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation and Principles of Consolidation

 

The accompanying consolidated financial statements are prepared on an accrual basis in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the disclosures required by GAAP for complete financial statement disclosures. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Results of operations for the three and nine month period ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2013.

 

The consolidated financial statements include the accounts of the Company and those of its subsidiaries, which are wholly owned or controlled by the Company. Entities which the Company does not control through its voting interest and entities which are variable interest entities (“VIEs”), but where it is not the primary beneficiary, are accounted for under the equity method. All significant intercompany balances and transactions have been eliminated.

 

 

The Company follows the Financial Accounting Standards Board (“FASB”) guidance for determining whether an entity is a VIE and requires the performance of a qualitative rather than a quantitative analysis to determine the primary beneficiary of a VIE. Under this guidance, an entity would be required to consolidate a VIE if it has (i) the power to direct the activities that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could be significant to the VIE. A non-controlling interest in a consolidated subsidiary is defined as the portion of the equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. Non-controlling interests are required to be presented as a separate component of equity in the consolidated balance sheet. This guidance modifies the presentation of net income by requiring earnings and other comprehensive income to be attributed to controlling and non-controlling interests.

 

The Company assesses the accounting treatment for each joint venture. This assessment includes a review of each joint venture or limited liability company agreement to determine which party has what rights and whether those rights are protective or participating. For all VIEs, the Company reviews such agreements in order to determine which party has the power to direct the activities that most significantly impact the entity’s economic performance. In situations where the Company or its partner approves, among other things, the annual budget, receives a detailed monthly reporting package from the Company, meets on a quarterly basis to review the results of the joint venture, reviews and approves the joint venture’s tax return before filing, and approves all leases that cover more than a nominal amount of space relative to the total rentable space at each property, the Company does not consolidate the joint venture as it considers these to be substantive participation rights that result in shared power of the activities that most significantly impact the performance of the joint venture. At September 30, 2014, the Company deemed its investment in 14 Highland to be a VIE since it has an economic interest greater than its voting proportion, and the Company participates in the management activities that significantly impact the performance of the joint venture. Included in real estate investments on the Company’s consolidated balance sheets as of September 30, 2014 and December 31, 2013 is approximately $2.0 million related to the Company’s consolidated VIEs. Included in mortgage notes payable on the Company’s consolidated balance sheet as of September 30, 2014 and December 31, 2013 is approximately $1.5 million related to the Company’s consolidated VIEs.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the disclosure of contingent assets and liabilities, the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the periods covered by the financial statements. Actual results could differ from these estimates.

 

Reclassification

 

Certain prior period amounts have been reclassified to conform to the current period’s presentation of amortization of deferred finance costs.

 

Fair Value Measurements

 

The Company measures the fair value of financial instruments based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, a fair value hierarchy distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions. In accordance with the fair value hierarchy, Level 1 assets/liabilities are valued based on quoted prices for identical instruments in active markets, Level 2 assets/liabilities are valued based on quoted prices in active markets for similar instruments, on quoted prices in less active or inactive markets, or on other “observable” market inputs and Level 3 assets/liabilities are valued based significantly on “unobservable” market inputs.

 

Financial Instruments Not Measured at Fair Value

 

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, prepaid expenses, deferred offering costs, deposit on real estate, tenant and other receivables, due from affiliates, other assets, accounts payable and accrued expenses, deferred income, dividends and distributions payable, and tenant security deposits approximate their fair values based on their short-term maturity. The Company has determined that the carrying value of mortgage notes payable and preferred loans payable approximate their fair value based on prevailing market rates for loans of similar risk and maturities.

 

Real Estate Investments

 

All costs related to the improvement or replacement of real estate properties are capitalized. Additions, renovations and improvements that enhance and/or extend the useful life of a property are also capitalized. Expenditures for ordinary maintenance, repairs and improvements that do not materially prolong the normal useful life of an asset are charged to operations as incurred. The Company expenses transaction costs associated with business combinations in the period incurred.

 

 

Upon the acquisition of real estate properties, the fair value of the real estate purchased is allocated to the acquired tangible assets (consisting of land, building and improvements), and acquired intangible assets and liabilities (consisting of above-market and below-market leases and acquired in-place leases). Acquired lease intangible assets include above-market leases and acquired in-place leases in the accompanying consolidated balance sheet. The fair value of the tangible assets of an acquired property is determined by valuing the property as if it were vacant, which value is then allocated to land, building and improvements based on management’s determination of the relative fair values of these assets. In valuing an acquired property’s intangibles, factors considered by management include an estimate of carrying costs during the expected lease-up periods, and estimates of lost rental revenue during the expected lease-up periods based on its evaluation of current market demand. Management also estimates costs to execute similar leases, including leasing commissions, tenant improvements, legal and other related costs. Leasing commissions, legal and other related costs (“lease origination costs”) are classified as deferred charges in the accompanying consolidated balance sheets.

 

The value of in-place leases is measured by the excess of (i) the purchase price paid for a property after adjusting existing in-place leases to market rental rates, over (ii) the estimated fair value of the property as if vacant. Above-market and below-market lease values are recorded based on the present value (using a discount rate which reflects the risks associated with the leases acquired) of the difference between the contractual amounts to be received and management’s estimate of market lease rates, measured over the terms of the respective leases that management deemed appropriate at the time of acquisition. Such valuations include a consideration of the non-cancellable terms of the respective leases as well as any applicable renewal periods. The fair values associated with below-market rental renewal options are determined based on the Company’s experience and the relevant facts and circumstances that existed at the time of the acquisitions. The value of the above-market and below-market leases associated with the original lease term is amortized to rental income and recorded as either an increase (in the case of below market leases) or decrease (in the case of above market leases), over the terms of the respective leases and option periods. The values of in-place leases are amortized to expense over the remaining non-cancellable terms of the respective leases. If a lease were to be terminated prior to its stated expiration, all unamortized amounts relating to that lease would be recognized in operations at that time. The Company may record a bargain purchase gain if it determines that the purchase price for the acquired assets was less than the fair value. The Company will record a liability in situations where any part of the cash consideration is deferred. The amounts payable in the future are discounted to their present value. The liability is subsequently re-measured to fair value with changes in fair value recognized in the consolidated statements of operations. If, up to one year from the acquisition date, information regarding fair value of assets acquired and liabilities assumed is received and estimates are refined, appropriate property adjustments are made to the purchase price allocation on a retrospective basis.

 

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to aggregate future net cash flows (undiscounted and without interest) expected to be generated by the asset. If such assets are considered impaired, the impairment to be recognized is measured by the amount by which the carrying amounts of the assets exceed the fair value. Management does not believe that the value of any of the Company’s real estate investments was impaired at September 30, 2014.

 

Restricted Cash

 

The terms of the Company’s mortgage notes payable require the Company to deposit certain replacement and other reserves with its lenders. Such “restricted cash” is generally available only for property-level requirements for which the reserves have been established and is not available to fund other property-level or Company-level obligations.

 

Segment Reporting

 

The Company operates in one industry segment, ownership of real estate properties. The Company does not distinguish in property operations for purposes of measuring performance. The Company reassesses its conclusion that it has one reportable operating segment at least annually.

 

Revenue Recognition

 

The Company recognizes minimum rent, including rental abatements and contractual fixed increases attributable to operating leases on a straight-line basis over the term of the related lease and includes amounts expected to be received in later years in deferred rent receivable. The Company records property operating expense reimbursements due from tenants for common area maintenance, real estate taxes and other recoverable costs in the period the related expenses are incurred. The Company makes certain assumptions and judgments in estimating the reimbursements at the end of each reporting period. The Company does not expect the actual results to differ from the estimated reimbursement.

 

The Company makes estimates of the collectability of its tenant receivables related to base rents, expense reimbursements and other revenue or income. The Company specifically analyzes accounts receivable and historical bad debts, customer creditworthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. In addition, with respect to tenants in bankruptcy, the Company will make estimates of the expected recovery of pre-petition and post-petition claims in assessing the estimated collectability of the related receivable. In some cases, the ultimate resolution of these claims can exceed one year. These estimates have a direct impact on its net income because a higher bad debt reserve results in less net income. The provision for doubtful accounts at both September 30, 2014 and December 31, 2013 was approximately $608,000.

 

 

Interest income from loans receivable is recognized based on the contractual terms of the debt instrument utilizing the effective interest method. Under the effective interest method, interest income is recognized at a constant yield based on the increasing or decreasing carrying value of the loans. The total interest income for each period is the carrying value of the loans at the start of the period multiplied by the effective interest rate.

 

Depreciation and Amortization

 

The Company uses the straight-line method for depreciation and amortization. Buildings and building improvements are depreciated over the estimated useful lives which the Company estimates to be 27 to 40 years. Land improvements are depreciated over the estimated useful life of 15 years. Tenant improvements are amortized over the shorter of the life of the related leases or their useful life. Furniture and fixtures are depreciated over the estimated useful lives that range from 5 to 7 years.

 

Deferred Charges

 

Deferred charges consist principally of leasing commissions and acquired lease origination costs (which are amortized ratably over the life of the tenant leases) and financing fees (which are amortized over the term of the related debt obligation). As of September 30, 2014 and December 31, 2013 deferred charges consisted of the following:

 

		September 30, 2014				December 31, 2013
Leasing commissions-acquired leases		$	1,731,102			$	1,289,812
Legal-acquired lease			27,767				6,016
Deferred financing costs			1,007,552				529,920
Total			2,766,421				1,825,748
Less accumulated amortization(1)			424,253				187,261
Deferred charges, net of accumulated amortization		$	2,342,168			$	1,638,487

 

(1)	Includes accumulated amortization of deferred financing costs of $171,925 as of September 30, 2014 and $75,122 as of December 31, 2013, respectively.

 

Organization and Offering Expenses

 

Organization and offering expenses include all costs and expenses to be paid by the Company in connection with the formation of the Company and an offering, including the Company’s legal, accounting, printing, mailing and filing fees, charges of the escrow agent, reimbursements to the dealer manager and participating broker-dealers for due diligence expenses set forth in detailed and itemized invoices, amounts to reimburse the Advisor for its portion of the salaries of the employees of its affiliates who provide services to the Advisor, and other costs in connection with administrative oversight of such offering and the marketing process, such as preparing supplemental sales materials, holding educational conferences and attending retail seminars conducted by the dealer manager or participating broker-dealers.

 

The Advisor will advance the Company’s organization and offering expenses to the extent the Company does not have the funds to pay such expenses. The Company will reimburse the Advisor for organization and offering expenses up to 2% of the total offering price paid by investors (including proceeds from the sale of Common Shares, plus applicable selling commissions and dealer manager fees paid by purchasers of Common Shares). On December 28, 2012, the Company broke escrow, at which time organization and offering expenses advanced by the Advisor became a liability to the Company, subject to the 2% limitation noted above. Between November 25, 2011 and September 30, 2014, the Company paid $3,166,064 of offering costs of which $248,344 was recorded to additional paid-in capital and $2,917,720 was recorded to deferred offering costs in the accompanying consolidated balance sheets. The Company will reclassify amounts from deferred offering costs to additional paid-in capital based on 2% of the total offering price paid by investors. Amounts paid by the Company in excess of the 2% limitation at the end of the offering will be reimbursed by the Advisor. As of September 30, 2014, the Advisor had incurred an additional $10.7 million of organization and offering expenses, of which $231,813 was billed and paid to the Advisor at September 30, 2014.

 

Offering costs incurred by the Company, the Advisor and their affiliates on behalf of the Company have been deferred and will be paid from the proceeds of the continuous public offering and will be treated as a reduction of equity.

 

Income Taxes

 

The Company is taxed as a REIT under Section 856(c) of the Code. As a REIT, the Company is not subject to Federal income tax on that portion of its taxable income or capital gain which is distributed to its stockholders. To maintain its qualification as a REIT, the Company must distribute at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with GAAP) to its stockholders, determined without regard to deductions for dividends paid and excluding any net capital gain and meet certain other requirements. If the Company fails to qualify as a REIT in any taxable year, it will be subject to Federal income tax on its taxable income at regular corporate rates. The Company may also be subject to certain state, local and franchise taxes. Under certain circumstances, Federal income and excise taxes may be due on the Company’s undistributed taxable income.

 

 

Stock-Based Compensation

 

The Company has adopted a Stock Incentive Plan (the “Plan”) for its independent directors, officers and employees, employees of the Advisor and other affiliates and consultants. Compensation cost for stock options is recognized ratably over the vesting period of the award. Our policy is to grant options with exercise price equal to the offering price of our common stock on the grant date. Awards of stock or restricted stock are expensed as compensation over the benefit period based on the fair value of the stock on the grant date.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company places its cash and cash equivalents in excess of insured amounts with high quality financial institutions.

 

Basic and Diluted Earnings (Loss) per Common Share

 

The Company calculates basic earnings (loss) per Common Share by dividing net income (loss) attributable to United Realty Trust Incorporated by the weighted average number of Common Shares outstanding during each period. Diluted earnings (loss) per Common Share includes the effects of potentially issuable Common Shares, but only if dilutive. There were no dilutive Common Shares as of September 30, 2014 and 2013.

 

Accounting Standard Updates

 

In April 2014, the FASB issued guidance which amends the requirements for reporting discontinued operations. Under the amended guidance, a disposal of an individual property or group of properties (i.e., when a property or properties are sold or meet the criteria to be classified as “held for sale”) is required to be reported in “discontinued operations” only if the disposal represents a strategic shift that has, or will have, a major effect on the Company’s operations and financial results. The amended guidance also requires additional disclosures about both discontinued operations and the disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements. The guidance is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2014. The adoption of the guidance is not expected to have a material impact on the Company’s financial condition or results of operations.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This update is effective for interim and annual reporting periods, beginning after December 15, 2016. The Company is currently in the process of evaluating the impact the adoption of this ASU will have on our consolidated financial statements.

 

In August 2014, the FASB issued guidance which requires management to evaluate whether there are conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern, and to provide disclosures when it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. The guidance is effective for annual periods ending after December 15, 2016, with early adoption being permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

 

3.	Acquisitions

 

In September 2014, the Company, through the OP, became contractually bound to close on an agreement of sale previously entered into between United Realty Partners, LLC, an affiliate of the Sponsor, and FRS Carnegie Plaza, L.L.C.. Under this agreement, the OP will acquire the fee simple interest in a commercial property with 90,070 rentable square feet located at 7 Carnegie Plaza in Cherry Hill, NJ. The purchase price is $9.3 million, exclusive of brokerage commissions and closing costs. The transaction, which is expected to close in the fourth quarter of 2014, is subject to customary closing conditions.

 

On May 21, 2014, the Company acquired the fee simple interest in Parkway, a 44,323 rentable square foot commercial property, for $14.5 million, excluding closing costs. The property was 100% leased at closing.

 

Closing costs were approximately $669,700, prepaid expenses and escrows were approximately $196,000 and fees paid to the Advisor were approximately $248,000. Closing costs included $362,000 in supplemental transaction-based advisory fees for financing and equity placement paid to United Realty Partners, LLC (“URP”), an entity controlled and indirectly owned by the Company’s chief executive officer and secretary. We funded the acquisition as follows: (i) $10.3 million with a new first mortgage loan secured by the property; (ii) cash from our OP of approximately $3.2 million; and (iii) a $2.1 million preferred loan from a third party. The 10-year preferred loan yields a preferred return of 15% per annum, compounded monthly (increasing to 24% per annum upon the occurrence of certain events of default) and requires monthly distributions to the preferred lender. The property-holding entity must redeem the preferred loan by June 6, 2024, and has the right to do so at any time upon 30 days prior written notice. Additionally, the lender of the preferred loan may require the OP to redeem the preferred loan at any time after April 21, 2015 upon 30 days prior written notice. The cash from the OP included $1.7 million in proceeds from the OP’s issuance to two third parties of an aggregate of 17 class MB units (the “MB Units”) of limited partnership interest. The OP issued 12 MB Units to one of the two investors in consideration for a capital contribution of $1.2 million. Such 12 MB Units must be redeemed by the Company in November 2014 for $1.32 million. The OP issued five MB Units to the other investor in consideration for a capital contribution of $500,000. Such five MB Units entitle the holder thereof to an annualized preferred return of 10% on the amount of the capital contribution, and must be redeemed by the Company in May 2015.

 

 

Regarding the acquisition of Parkway, the fair values of in-place leases and other intangibles have been allocated to intangible assets and liability accounts. Such allocations are preliminary and may be adjusted as final information becomes available. The Company assessed the fair value of the lease intangibles based on estimated cash flow projections that utilize appropriate discount rates and available market information. Such inputs are Level 3 in the fair value hierarchy.

 

The financial information set forth below summarizes our preliminary purchase price allocations for the property acquired during the nine months ended September 30, 2014 (in thousands).

 

		September 30, 2014
ASSETS
Land		$	2,815
Building and improvements			9,383
Acquired in-place lease costs			2,440
Above market lease value			51
Assets acquired			14,689
Below market lease value			154
Liabilities assumed			154
Purchase price allocation		$	14,535

 

Pro Forma Financial Information

 

The pro forma financial information set forth below is based upon the Company’s historical consolidated statements of operations for the three months ended September 30, 2013 and the nine months ended September 30, 2014 and 2013, adjusted to give effect to the property transaction as if it had closed on January 1, 2013.

 

The pro forma financial information is presented for informational purposes only and may not be indicative of what actual results of operations would have been had the transaction occurred on January 1, 2013, nor does it purport to represent the results of future operations (in thousands).

 

		Three Months Ended				Nine Months Ended
		September 30, 2013				September 30, 2014				September 30, 2013
Statement of operations:
Revenue		$	1,180			$	3,708			$	2,715
Property operating and other expenses			(1,297	)			(3,704	)			(4,266	)
Depreciation and amortization			(199	)			(1,158	)			(1,130	)
Net loss attributable to United Realty Trust Incorporated		$	(316	)		$	(1,154	)		$	(2,681	)

 

4.	Mortgage Notes Payable

 

On March 29, 2013, the Tilden House JV obtained a first mortgage loan (the “Doral Loan”) from Doral Bank in an amount equal to $14.5 million to provide the acquisition funding for Tilden House. The Doral Loan has an initial five-year term ending on April 30, 2018 and provides the JV with the option to extend the maturity date to April 30, 2023. The Doral Loan bears interest at a per annum fixed rate of 5.0% and is secured by a mortgage on Tilden House. During the extended term, the interest rate will be reset based on a rate of 250 basis points spread over the 5 year Federal Home Loan Bank on New York Advanced Rate, with a minimum floor rate to be not less than the initial interest rate.

 

On August 2, 2013, the 14 Highland JV obtained a first mortgage loan (the “Carver Loan”) from Carver Bank in an amount equal to $1.5 million to provide the acquisition funding for 14 Highland. The Carver Loan has an initial five-year term ending on September 5, 2018 and provides the 14 Highland JV with the option to extend the maturity date to September 5, 2023. The Carver Loan bears interest at a per annum fixed rate of 4.25% and is secured by a mortgage on 14 Highland. During the extended term, the interest rate will be a fixed rate equal to the greater of: (i) 4.50% per annum; or (ii) the Wall Street Journal’s Prime Rate in effect within three (3) business days prior to September 5, 2018, plus 2.00% per annum.

 

 

On May 21, 2014, the Company closed on a first mortgage loan (the “Starwood Loan”) from Starwood Mortgage Capital, LLC in an amount equal to $10.3 million, to provide the acquisition funding for Parkway. The Starwood Loan bears interest at 4.788% with a maturity date of June 6, 2024. We are required to make initial monthly interest-only payments for 24 months following the closing of the loan and thereafter payments of principal and interest over a 30-year amortization period. The Starwood Loan is secured by a mortgage on the property, is guaranteed by URTI, and may be accelerated only in the event of a default. We may prepay all or any portion of the principal amount without a prepayment penalty under a defeasance clause in the loan.

 

The principal maturity of mortgage notes payable during the next five years and thereafter is as follows (in thousands):

 

		Principal Repayments					Scheduled Amortization			Total
2014		$	—			$	$ 63		$	63
2015			—				266			266
2016			—				366			366
2017			—				452			452
2018			14,676				254			14,930
Thereafter			8,860				1,036			9,896
		$	23,536			$	2,437		$	25,973

 

5.	Capitalization

 

Under the Company’s charter, the Company has the authority to issue 200,000,000 Common Shares and 50,000,000 shares of preferred stock. All shares of such stock have a par value of $0.01 per share. On November 17, 2011, the Sponsor purchased 18,182 Common Shares for total cash consideration of $200,000 to provide the Company’s initial capitalization. On November 25, 2011, for $50,000, the Sponsor purchased 500,000 shares of preferred stock, subsequently exchanged for 500,000 sponsor preferred shares (“Sponsor Preferred Shares”), which are convertible into Common Shares upon the terms and subject to the conditions set forth in the Company’s charter, and which have a preference upon the Company’s liquidation, dissolution or winding up as described below. Upon the Company’s liquidation, dissolution or winding up, the Sponsor will receive a preference in the amount of 15% of any excess of the net sales proceeds from the sale of all the assets in connection with such liquidation, dissolution or winding up over the amount of Invested Capital, as defined in the Company’s charter, plus a cumulative non-compounded pre-tax annual return to holders of Common Shares of 7% on Invested Capital. The Company’s board of directors is authorized to amend its charter from time to time, without the approval of the stockholders, to increase or decrease the aggregate number of authorized shares of capital stock or the number of shares of any class or series that the Company has authority to issue. As of September 30, 2014, there were 1,192,879 Common Shares outstanding.

 

6.	Stock Incentive Plan

 

The Plan, as outlined in the prospectus, provides for the grant of equity incentive awards to the Company’s independent directors, officers and employees, employees of the Advisor and other affiliates and consultants. The aggregate number of Common Shares that may be issued or used for reference purposes or with respect to which awards may be granted under the Plan shall not exceed the lesser of five percent (5%) of Common Shares outstanding on a fully diluted basis at any time and 5,000,000 Common Shares, which may be either authorized and unissued Common Shares or Common Shares held in or acquired for the treasury of the Company or both. The vesting period of stock-based awards will be determined by the Company’s compensation committee. During the nine months ended September 30, 2014 the Company granted 24,226 Common Shares under the Plan all of which were fully vested as of September 30, 2014. Of the 24,226 Common Shares granted, 22,825 were granted to employees of an affiliate of the Company and to an independent consultant for services provided to the Company. These Common Shares were recorded as a reduction to a receivable from an affiliated entity. The remaining 1,401 Common Shares granted were expensed in the period in which they vested resulting in compensation expense of $8,500 and $15,400 during the three and nine months ended September 30, 2014, respectively. During the quarter ended June 30, 2013, the Company granted 6,300 Common Shares under the Plan, all of which were fully vested as of June 30, 2013. During the three and nine months ended September 30, 2014 and 2013, the Company expensed none, $36,000, $18,000 and $36,000, respectively, related to the 2013 grant. As of September 30, 2014, the cost associated with this restricted stock compensation related to outstanding non-vested restricted stock grants awarded in 2013 was fully amortized.

 

7.	Related Party Arrangements

 

The Company has executed an advisory agreement with the Advisor and a property management agreement with URA Property Management LLC (the “Property Manager”), an affiliate of the Sponsor. Effective September 20, 2013 the Company executed a dealer manager agreement with Cabot Lodge Securities, LLC (the “Dealer Manager”), a Delaware limited liability company and member of the Financial Industry Regulatory Authority, Inc. (“FINRA”) that does business as United Realty Securities and that is indirectly owned by the Sponsor. Prior to September 20, 2013 the Company had a dealer manager agreement with an unaffiliated party which had a soliciting dealer agreement with Cabot Lodge Securities. These agreements entitle the Advisor, the Dealer Manager, and the Property Manager to specified fees upon the provision of certain services with regard to the offering and the investment of funds in real estate properties and real estate-related investments, among other services, as well as reimbursement of organization and offering expenses incurred by the Advisor and the Dealer Manager on behalf of the Company (as discussed in Note 2) and certain costs incurred by the Advisor in providing services to the Company. The Company has engaged and may engage from time to time, URP, an entity controlled and indirectly owned by the Company’s chief executive officer and secretary, to provide brokerage services, services in connection with the origination or refinancing of debt, or advice in connection with joint venture opportunities and equity financing opportunities for the Company’s properties.

 

 

Pursuant to the terms of these agreements, summarized below are the related-party costs incurred by the Company for the three and nine months ended September 30, 2014 and any related amounts payable as of September 30, 2014 and December 31, 2013.

 

		Incurred								Payable as of
		Nine Months Ended				Nine Months Ended
		September 30, 2014				September 30, 2013				September 30, 2014				December 31, 2013
Expensed
Reimbursable general and administrative expenses		$	—			$	902,384			$	—			$	—
Reimbursable property operating expenses and acquisition fee			—				293,095				—				—
Supplemental transaction-based advisory fees			259,000				229,175				—				—
Acquisition fees			145,700				300,675				—				—
Property Management fees			132,976				37,492				—				—
Oversight Fees			2,176				449				—				—
Asset Management fees			182,210				91,154				—				—
Additional Paid-in Capital
Reimbursable other offering costs			—				30,451				—				—
Capitalized
Financing coordination fee			206,000				160,000				—				—

 

8.	Distributions

 

The Operating Partnership’s limited partnership agreement generally provides that the Operating Partnership will distribute cash available for distribution to the partners of the Operating Partnership in proportion to each such partner’s holding of GP Units and/or OP Units, as such terms are defined in the Operating Partnership’s limited partnership agreement at the times and in the amounts as determined by the Company, as the general partner. During the nine months ended September 30, 2014, the Company has distributed $273,975 in cash and $225,934 in Common Shares through the DRIP.

 

9.	Economic Dependency

 

The Company is dependent on the Advisor or its affiliates for certain services that are essential to the Company, including the sale of the Common Shares, asset acquisition, management and disposition decisions and other general and administrative responsibilities. If the Advisor and its affiliates are unable to provide such services, the Company would be required to find alternative service providers.

 

10.	Subsequent Events

 

The Company reviewed all activity from October 1, 2014 to the date the financial statements were issued and determined that there have not been any events that have occurred that would require adjustments to disclosures in the consolidated financial statements.

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is intended to provide the reader with information that will assist in understanding our financial statements and the reasons for changes in key components of our financial statements from period to period. MD&A also provides the reader with our perspective on our financial position and liquidity, as well as certain other factors that may affect our future results. Our MD&A should be read in conjunction with our accompanying financial statements and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to United Realty Trust Incorporated, a Maryland corporation, and, as required by context, United Realty Capital Operating Partnership, L.P., a Delaware limited partnership (the “Operating Partnership” or the “OP”).

 

Forward-Looking Statements

 

Certain statements included in this Quarterly Report on Form 10-Q (this “Quarterly Report”) that are not historical facts (including any statements concerning investment objectives, other plans and objectives of management for future operations or economic performance, or assumptions or forecasts related thereto) are forward-looking statements. These statements are only predictions. We caution that forward-looking statements are not guarantees. Actual events of our investments and results of operations could differ materially from those expressed or implied in any forward-looking statements. Forward-looking statements are typically identified by the use of terms such as “may,” “should,” “expect,” “could,” “intend,” “plan,” “anticipate,” “estimate,” “believe,” “continue,” “predict,” “potential” or the negative of such terms and other comparable terminology.

 

The forward-looking statements included in this Quarterly Report are based upon our current expectations, plans, estimates, assumptions and beliefs, which involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:

 

	•	the fact that we have limited operating history and, as of September 30, 2014, our assets totaled approximately $45.8 million;
	•	our ability to raise capital in our continuous initial public offering (“IPO”);
	•	our ability to deploy effectively the proceeds we raise in our offering of shares of common stock, par value $0.01 per share (“Common Shares”);
	•	changes in economic conditions generally and the real estate market specifically;
	•	legislative or regulatory changes (including changes to the laws governing the taxation of real estate investment trusts (“REITs”));
	•	the availability of credit;
	•	interest rates; and
	•	changes to generally accepted accounting principles in the United States (“GAAP”).

 

Any of the assumptions underlying the forward-looking statements included herein could be inaccurate, and undue reliance should not be placed on any forward-looking statements included herein. All forward-looking statements are made as of the date this Quarterly Report is filed with the Securities and Exchange Commission (the “SEC”), and the risk that actual results will differ materially from the expectations expressed herein will increase with the passage of time. Except as otherwise required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements made herein, whether as a result of new information, future events, changed circumstances or any other reason.

 

All forward-looking statements included herein should be read in light of the factors identified in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2013, as updated in this Quarterly Report.

 

Overview

 

We were formed in November 2011 for the purpose of investing primarily in a diversified portfolio of income-producing real estate properties and other real estate-related assets. We elected to qualify as a REIT commencing January 1, 2013. We conduct substantially all of our investment activities and own all of our assets through the OP, of which we are the sole general partner and a limited partner. United Realty Advisors LP, a Delaware limited partnership (our “Advisor”) manages our day-to-day operations and our portfolio of properties and real estate-related assets.

 

On August 15, 2012, our Registration Statement was declared effective by the SEC. The Registration Statement covers our initial public offering of up to 120,000,000 Common Shares, consisting of up to 100,000,000 Common Shares in our primary offering on a “best efforts” basis and up to 20,000,000 Common Shares pursuant to our distribution reinvestment program (our “DRIP”).

 

 

On December 28, 2012, we received and accepted aggregate subscriptions in excess of the minimum of 200,000 Common Shares, broke escrow and issued Common Shares to our initial investors, who were admitted as stockholders. As of September 30, 2014 we had sold 1,192,879 Common Shares for gross offering proceeds of approximately $12.6 million and net offering proceeds of $11.5 million.

 

As of September 30, 2014, we owned a 69.2 % interest in a joint venture that owns a residential property located at 2520 Tilden Avenue in Brooklyn, New York (“Tilden House”), a 14.6% interest in a joint venture that owns a residential property known as 14 Highland Ave., Yonkers, New York (“14 Highland”), and a medical building located at 945 82^nd Parkway, Myrtle Beach, SC (“Parkway”). In addition, as of September 30, 2014, we owned a 76.7% interest in a joint venture that owns a mortgage note secured by properties located at 58 and 70 Parker Avenue, in Poughkeepsie, NY.

 

Funds from Operations and Modified Funds from Operations

 

Due to certain unique operating characteristics of real estate companies, as discussed below, the National Association of Real Estate Investment Trusts (“NAREIT”), an industry trade group, has promulgated a measure known as funds from operations (“FFO”), which we believe to be an appropriate supplemental measure to reflect the operating performance of a REIT. The use of FFO is recommended by the REIT industry as a supplemental performance measure. FFO is not equivalent to our net income or loss as determined under GAAP.

 

We define FFO, a non-GAAP measure, consistent with the standards established by the White Paper on FFO approved by the Board of Governors of NAREIT, as revised in February 2004 (the “White Paper”). The White Paper defines FFO as net income or loss computed in accordance with GAAP, excluding gains or losses from sales of property and asset impairment write-downs, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO. Our FFO calculation complies with NAREIT’s policy described above.

 

The historical accounting convention used for real estate assets requires straight-line depreciation of buildings and improvements, which implies that the value of real estate assets diminishes predictably over time, especially if such assets are not adequately maintained or repaired and renovated as required by relevant circumstances and/or as requested or required by lessees for operational purposes in order to maintain the value disclosed. We believe that, since real estate values historically rise and fall with market conditions, including inflation, interest rates, the business cycle, unemployment and consumer spending, presentations of operating results for a REIT using historical accounting for depreciation may be less informative. Additionally, we believe it is appropriate to disregard impairment charges, as this is a fair value adjustment that is largely based on market fluctuations and assessments regarding general market conditions which can change over time. An asset will only be evaluated for impairment if certain impairment indicators exist and if the carrying, or book, value exceeds the total estimated undiscounted future cash flows (including net rental and lease revenues, net proceeds on the sale of the property, and any other ancillary cash flows at a property or group level under GAAP) from such asset. Determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property, and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of FFO as described above, because impairments are based on estimated undiscounted future cash flows and the relatively limited term of our operations, it could be difficult to recover any impairment charges.

 

Historical accounting for real estate involves the use of GAAP. Any other method of accounting for real estate such as the fair value method cannot be construed to be any more accurate or relevant than the comparable methodologies of real estate valuation found in GAAP. Nevertheless, we believe that the use of FFO, which excludes the impact of real estate related depreciation and amortization and impairments, provides a more complete understanding of our performance to investors and to management, and when compared year over year, reflects the impact on our operations from trends in occupancy rates, rental rates, operating costs, general and administrative expenses, and interest costs, which may not be immediately apparent from net income. However, FFO and modified funds from operations (“MFFO”), as described below, should not be construed to be more relevant or accurate than the current GAAP methodology in calculating net income or in its applicability in evaluating our operating performance. The method utilized to evaluate the value and performance of real estate under GAAP should be construed as a more relevant measure of operational performance and considered more prominently than the non-GAAP FFO and MFFO measures and the adjustments to GAAP in calculating FFO and MFFO.

 

 

There have been changes in the accounting and reporting promulgations under GAAP that were put into effect in 2009 subsequent to the establishment of NAREIT’s definition of FFO, such as the change to expense as incurred rather than capitalize and depreciate acquisition fees and expenses. Management believes these fees and expenses do not affect our overall long-term operating performance. Publicly registered, non-listed REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation, but have a limited and defined acquisition period. Thus, we will not continuously purchase assets. Due to the above factors and other unique features of publicly registered, non- listed REITs, the Investment Program Association (“IPA”), an industry trade group, has standardized a measure known as MFFO, which the IPA has recommended as a supplemental measure for publicly registered non-listed REITs and which we believe to be another appropriate supplemental measure to reflect the operating performance of a non-listed REIT having the characteristics described above. MFFO is not equivalent to our net income or loss as determined under GAAP, and MFFO may not be a useful measure of the impact of long-term operating performance on value if we purchase a significant amount of new assets. We believe that, because MFFO excludes costs that we consider more reflective of investing activities and other non-operating items included in FFO and also excludes acquisition fees and expenses that affect our operations only in periods in which properties are acquired, MFFO can provide, on a going forward basis, an indication of the sustainability (that is, the capacity to continue to be maintained) of our operating performance after the period in which we are acquiring our properties and once our portfolio is stabilized. By providing MFFO, we believe we are presenting useful information that assists investors and analysts to better assess the sustainability of our operating performance after our portfolio has been stabilized. We also believe that MFFO is a recognized measure of sustainable operating performance by the non-listed REIT industry. Further, we believe MFFO is useful in comparing the sustainability of our operating performance after our IPO and acquisitions are completed with the sustainability of the operating performance of other real estate companies that are not as involved in acquisition activities. MFFO should only be used to assess the sustainability of our operating performance after our portfolio has been stabilized because it excludes acquisition costs that have a negative effect on our operating performance during the periods in which properties are acquired.

 

We define MFFO, a non-GAAP measure, consistent with the IPA’s Guideline 2010-01, Supplemental Performance Measure for Publicly Registered, Non-Listed REITs: Modified Funds from Operations (“Practice Guideline”) issued by the IPA in November 2010. The Practice Guideline defines MFFO as FFO further adjusted for the following items, as applicable, included in the determination of GAAP net income: acquisition fees and expenses; amounts relating to deferred rent receivables and amortization of above and below market leases and liabilities (which are adjusted in order to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments); accretion of discounts and amortization of premiums on debt investments; mark-to-market adjustments included in net income; gains or losses included in net income from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. The accretion of discounts and amortization of premiums on debt investments, gains and losses on hedges, foreign exchange, derivatives or securities holdings, unrealized gains and losses resulting from consolidations, as well as other listed cash flow adjustments are adjustments made to net income in calculating the cash flows provided by operating activities and, in some cases, reflect gains or losses which are unrealized and may not ultimately be realized.

 

Our MFFO calculation complies with the IPA’s Practice Guideline described above. In calculating MFFO, we exclude acquisition related expenses, amortization of above and below market leases, fair value adjustments of derivative financial instruments, deferred rent receivables and the adjustments of such items related to non-controlling interests. Under GAAP, acquisition fees and expenses are characterized as operating expenses in determining operating net income. These expenses are paid in cash by us, and therefore such funds will not be available to distribute to investors. All paid and accrued acquisition fees and expenses negatively impact our operating performance during the period in which properties are acquired and negatively impact the returns earned on an investment in our Common Shares, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of other properties are generated to cover the purchase price of the property, these fees and expenses and other costs related to such property. Therefore, MFFO may not be an accurate indicator of our operating performance, especially during periods in which properties are being acquired. MFFO that excludes such costs and expenses would only be comparable to that of non-listed REITs that have completed their acquisition activities and have similar operating characteristics as us. Further, under GAAP, certain contemplated non-cash fair value and other non-cash adjustments are considered operating non-cash adjustments to net income in determining cash flow from operating activities. In addition, we view fair value adjustments of derivatives as items which are unrealized and may not ultimately be realized. We view both gains and losses from dispositions of assets and fair value adjustments of derivatives as items which are not reflective of ongoing operations and are therefore typically adjusted for when assessing operating performance. While we are responsible for managing interest rate, hedge and foreign exchange risk, we may retain an outside consultant to review all our hedging agreements. Inasmuch as interest rate hedges are not a fundamental part of our operations, we believe it is appropriate to exclude such gains and losses in calculating MFFO, as such gains and losses are not reflective of ongoing operations. The purchase of properties, and the corresponding expenses associated with that process, has been a key operational feature of our business plan to generate operational income and cash flows in order to make distributions to investors. There may be inadequate proceeds from the sale of Common Shares in our IPO to pay and reimburse, as applicable, the Advisor for acquisition fees and expenses, and therefore such fees and expenses may need to be paid from either additional debt, operational earnings or cash flows, net proceeds from the sale of properties or from ancillary cash flows.

 

Our management uses MFFO and the adjustments used to calculate it in order to evaluate our performance against other non- listed REITs with similar acquisition periods and targeted exit strategies. As noted above, MFFO may not be a useful measure of the impact of long-term operating performance on value if we do not continue to acquire and operate properties. We believe that our use of MFFO and the adjustments used to calculate it allow us to present our performance in a manner that reflects certain characteristics that are unique to non-listed REITs, such as a limited and defined acquisition period. By excluding expensed acquisition costs, the use of MFFO provides information consistent with management’s analysis of the operating performance of the properties. Additionally, fair value adjustments, which are based on the impact of current market fluctuations and underlying assessments of general market conditions, but can also result from operational factors such as rental and occupancy rates, may not be directly related or attributable to our current operating performance. By excluding such changes that may reflect anticipated and unrealized gains or losses, we believe MFFO provides useful supplemental information.

 

 

Presentation of this information is intended to provide useful information to investors as they compare the operating performance of different REITs, although it should be noted that not all REITs calculate FFO and MFFO the same way. Accordingly, comparisons with other REITs may not be meaningful. Furthermore, FFO and MFFO are not necessarily indicative of cash flow available to fund cash needs and should not be considered as an alternative to net income (loss) or income (loss) from continuing operations as an indication of our performance, as an alternative to cash flows from operations as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make distributions to our stockholders. FFO and MFFO should be reviewed in conjunction with GAAP measurements as an indication of our performance. MFFO has limitations as a performance measure while an offering is ongoing (unless and until we calculate net asset value) where the price of a Common Share is a stated value and there is no net asset value determination. MFFO is useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the acquisition stage is complete and net asset value is disclosed. FFO and MFFO are not useful measures in evaluating net asset value because impairments are taken into account in determining net asset value but not in determining FFO or MFFO.

 

Neither the SEC, NAREIT nor any other regulatory body has passed judgment on the acceptability of the adjustments that we use to calculate FFO or MFFO. In the future, the SEC, NAREIT or another regulatory body may decide to standardize the allowable adjustments across the non-listed REIT industry and we would have to adjust our calculation and characterization of FFO or MFFO.

 

 

The table below provides a reconciliation of net loss applicable to stockholders in accordance with GAAP to FFO and MFFO for the three and nine months ended September 30, 2014 and the three months ended September 30, 2013. We determined the reporting of FFO and MFFO for the nine months ended September 30, 2013 will not be useful since we did not own any real estate assets during most of the first quarter of 2013.

 

		For the Three Months Ended September 30, 2014				For the Three Months Ended September 30, 2013				For the Nine Months Ended September 30, 2014
Net loss for period		$	(344,734	)		$	(185,281	)		$	(1,119,725	)
Plus: Real property depreciation			206,751				152,143				528,968
Amortization of tenant improvements and allowances			47,209				6,958				91,469
Amortization of deferred leasing costs			177,326				41,636				423,270
FFO		$	86,552			$	15,456			$	(76,018	)
Add: Acquisition transaction costs (1)			6,825				106,850				456,353
Add: Amortization of Above/below-market rent and straight line rent receivable (2)			(8,038	)			(3,906	)			10,668
MFFO		$	85,339			$	118,400			$	391,003
Net cash provided by (used in):
Operating activities		$	(382,598	)		$	231,416			$	265,530
Investing activities		$	(116,888	)		$	(1,958,766	)		$	(14,655,520	)
Financing activities		$	559,778			$	1,758,083			$	14,157,014

 

(1)	In evaluating investments in real estate, management differentiates the costs incurred to acquire the investment from the on-going operational revenue and costs of the investment. Such information would only be comparable for non-listed REITs that have completed their acquisition activity and have similar operating characteristics. By excluding expensed acquisition costs, management believes MFFO provides useful supplemental information for comparison of each type of real estate investment and is consistent with management’s analysis and evaluation of the investing and operating performance of our properties. Acquisition fees and expenses include payments to our Advisor or third parties. Acquisition fees and expenses under GAAP are considered operating expenses and are included in the determination of net income and income from continuing operations, both of which are performance measures under GAAP. All paid and accrued acquisition fees and expenses will have negative effects on returns to investors, the potential for future distributions, and cash flows generated by us, unless earnings from operations or net sales proceeds from the disposition of properties are generated to cover the purchase price of the property.
(2)	Under GAAP, certain intangibles are accounted for at cost and reviewed at least annually for impairment. Some intangibles are assumed to diminish predictably in value over time and amortized, similar to depreciation and amortization of other real estate related assets that are excluded from FFO. However, because real estate values and market lease rates historically rise or fall with market conditions, management believes that by excluding charges relating to amortization of these intangibles, MFFO provides useful supplemental information on the performance of the real estate portfolio.

 

 

Results of Operations

 

Comparison of the three months ended September 30, 2014 to the three months ended September 30, 2013

 

As of September 30, 2014, we owned interests in three properties and one mortgage note receivable. At September 30, 2013, we owned two properties which we acquired in March and August 2013, respectively.

 

		Three Months Ended
		September 30, 2014				September 30, 2013				Change
Revenues
Base rents		$	1,037,399			$	715,252			$	322,147
Recoveries from tenants			210,849				82,000				128,849
Total revenue			1,248,248				797,252				450,996
Operating expenses
Property operating			254,306				105,532				148,774
Property taxes			118,028				85,329				32,699
General & administrative expenses			122,466				125,739				(3,273	)
Depreciation and amortization			431,286				200,737				230,549
Acquisition transaction costs			6,825				106,850				(100,025	)
Total operating expenses			932,911				624,187				308,724
Operating income			315,337				173,065				142,272
Non-operating expenses
Interest income			—				—				—
Interest expense			(480,146	)			(194,920	)			(259,985	)
Amortization of deferred financing costs			(38,437	)			(25,243	)			(38,437	)
Net loss		$	(203,246	)		$	(47,096	)		$	(156,150	)

 

Rental Revenue

 

Rental revenue increased approximately $451,000 for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase in rental revenue was driven primarily increases in base rent and recoveries from tenants due to our acquisition of Parkway in May 2014.

 

Property Operating Expenses and Property Taxes

 

Property operating expenses and property taxes increased approximately $149,000 and $33,000, respectively, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. Property operating expenses consist primarily of asset management fees paid to our advisor, property insurance and utilities. The increase in these expenses was driven primarily by our acquisition of Parkway in May 2014.

 

General and Administrative Expenses

 

General and administrative expenses for the three months ended September 30, 2014 amounted to approximately $122,000 compared to approximately $126,000 during the three months ended September 30, 2013. General and administrative expenses consist primarily of professional fees, director fees and insurance costs.

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense increased approximately $231,000 for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The purchase price of acquired properties is allocated to tangible and identifiable intangible assets and depreciated or amortized over the estimated useful lives. Depreciation and amortization expense is driven by the timing of real estate acquisitions. The increase in these expenses was driven primarily by our acquisition of Parkway in May 2014.

 

Acquisition Transaction Costs

 

Acquisition transaction costs for the three months ended September 30, 2014 amounted to approximately $6,825 which were incurred in connection with a potential acquisition.

 

 

Interest Expense

 

Interest expense increased approximately $260,000 for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. This increase is driven primarily by the financing costs associated with the acquisition of Parkway.

 

Comparison of the nine months ended September 30, 2014 to the nine months ended September 30, 2013

 

As of September 30, 2014, we owned interests in three properties and one mortgage note receivable. We acquired these interests in March 2013, August 2013 and May 2014. Accordingly, our results of operations for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 reflect significant increases in most categories relating to property operations.

 

		Nine Months Ended
		September 30, 2014				September 30, 2013				Change
Revenues
Base rents		$	2,623,024			$	1,402,408			$	1,220,616
Recoveries from tenants			483,532				161,932				321,600
Other			1,692				—				1,692
Total revenue			3,108,248				1,564,340				1,543,908
Operating expenses
Property operating			580,758				184,121				396,637
Property taxes			313,397				169,410				143,987
General & administrative expenses			316,122				912,336				(596,214	)
Depreciation and amortization			1,043,706				386,397				657,309
Acquisition transaction costs			456,353				1,494,607				(1,038,254	)
Total operating expenses			2,710,336				3,146,871				(436,535	)
Operating income (loss)			397,912				(1,582,531	)			1,980,443
Non-operating expenses
Interest income			—				36				(36	)
Interest expense			(994,644	)			(384,177	)			(610,467	)
Amortization of deferred financing costs			(96,803	)			(48,708	)			(48,095	)
Net loss		$	(693,535	)		$	(2,015,380	)		$	1,321,845

 

Rental Revenue

 

Rental revenue increased approximately $1.5 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase in rental revenue was driven primarily by increases in base rent and recoveries from tenants due to the timing of our property acquisitions as noted above.

 

Property Operating Expenses and Property Taxes

 

Property operating expenses and property taxes increased approximately $397,000 and $144,000, respectively, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. Property operating expenses consist primarily of asset management fees paid to our advisor, property insurance and utilities. The increase in these expenses was driven primarily by the timing of our property acquisitions as noted above.

 

General and Administrative Expenses

 

General and administrative expenses for the nine months ended September 30, 2014 amounted to approximately $316,000 compared to approximately $912,000 during the nine months ended September 30, 2013. General and administrative expenses consist primarily of professional fees, director fees and insurance costs. The significant decrease in general and administrative expenses was the result of a change in policy effective April 1, 2013 in which salaries of certain advisor employees were no longer allocated to us.

 

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense increased approximately $657,000 for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The purchase price of acquired properties is allocated to tangible and identifiable intangible assets and depreciated or amortized over the estimated useful lives. Depreciation and amortization expense is driven by the timing of real estate acquisitions. We acquired properties, or interests in properties, in March 2013, August 2013 and May 2014.

 

Acquisition Transaction Costs

 

Acquisition transaction costs for the nine months ended September 30, 2014 amounted to approximately $456,000 resulting from the acquisition of Parkway in May 2014 compared to approximately $1.5 million resulting from the acquisition of properties and real estate related investments in 2013.

 

Interest Expense

 

Interest expense increased approximately $610,000 for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. This increase is driven primarily by the financing costs associated with the closing of acquisitions in 2013 and 2014.

 

Deferred Organization and Offering Expenses

 

Our Advisor will advance our organization and offering expenses to the extent we do not have the funds to pay such expenses. Organization and offering expenses advanced by our Advisor became liabilities to us when our primary offering broke escrow on December 28, 2012. We will reimburse our Advisor up to 2% of the total offering price paid by investors (which includes proceeds to us from the sale of Common Shares, plus applicable selling commissions and dealer manager fee) for organization and offering expenses. Between November 25, 2011 and September 30, 2014, we paid $3,166,064 of offering costs of which $248,344 was recorded to additional paid-in capital and $2,917,720 was recorded to deferred offering costs in the consolidated balance sheet. We will reclassify amounts from deferred offering costs to additional paid in capital based on 2% of the total offering price paid by investors. Amounts that we paid in excess of the 2% limitation at the end of the offering will be reimbursed by the Advisor. As of September 30, 2014, our Advisor had incurred approximately $10.7 million of organization and offering expenses of which $231,813 has been billed to and paid by us.

 

Liquidity and Capital Resources

 

We are dependent upon the net proceeds from our IPO to conduct our proposed operations. We will obtain the capital required to purchase properties and other investments and conduct our operations from the proceeds of our IPO and any future offerings we may conduct, from secured or unsecured financings from banks and other lenders and from any undistributed funds from our operations.

 

If we are unable to raise substantially more funds in our IPO than the minimum offering amount, we will make fewer investments resulting in less diversification in terms of the type, number and size of investments we make and the value of an investment in us will fluctuate with the performance of the specific assets we acquire. Further, we will have certain fixed operating expenses, including certain expenses as a publicly offered REIT, regardless of whether we are able to raise substantial funds in our IPO. Our inability to raise substantial funds would increase our fixed operating expenses as a percentage of gross income, reducing our net income and limiting our ability to make distributions. We do not expect to establish a permanent reserve from our offering proceeds for maintenance and repairs of real properties, as we expect the majority of leases for the properties we acquire will provide for tenant reimbursement of operating expenses. However, to the extent that we have insufficient funds for such purposes, we may establish reserves from offering proceeds, out of cash flow from operations or net cash proceeds from the sale of properties. In addition, the terms of our mortgage loans payable require us to deposit certain replacement and other reserves with the lender.

 

In addition to making investments in accordance with our investment objectives, we expect to use our capital resources to make certain payments to our Advisor and our dealer manager. During our organization and offering stage, these payments will include payments to the dealer manager for selling commissions and dealer manager fee. During this stage, we also will make payments to our Advisor for reimbursement of certain other organization and offering expenses. However, we will not reimburse our Advisor (except in limited circumstances) for other organization and offering expenses to the extent that our total payments for other organization and offering expenses would exceed 2% of the total offering price paid by investors in our IPO. During our acquisition and development stage, we expect to make payments to our Advisor in connection with the selection and origination or purchase of investments and the management of our assets and to reimburse certain costs incurred by our Advisor in providing services to us. The advisory agreement has a one-year term but may be renewed for an unlimited number of successive one-year periods upon the mutual consent of our Advisor and our independent directors.

 

 

We expect to repay the 12 MB Units, with an aggregate outstanding balance inclusive of accrued interest totaling $1.3 million, out of offering proceeds at maturity in November 2014. We expect to repay our other near term debt obligations out of offering proceeds on their maturity dates.

 

Net Cash Flows

 

Operating Activities

 

Net cash flows provided by operating activities amounted to approximately $277,353 during the nine months ended September 30, 2014. This was driven primarily by the additional real estate properties acquired in August 2013 and May 2014.

 

Investing Activities

 

Net cash flows used for investing activities amounted to approximately $14.7 million during the nine months ended September 30, 2014. This use was primarily for the acquisition of Parkway.

 

Financing Activities

 

Net cash flows provided by financing activities amounted to approximately $14.1 million for the nine months ended September 30, 2014. During the nine months ended September 30, 2014, we received approximately $4.4 million from the sale of our Common Shares, net of registration expenditures and redemptions. We incurred approximately $2.9 million in deferred offering costs. We made distributions of approximately $286,000 and $426,000 to common stockholders and non-controlling interest, respectively. We closed on approximately $14.1 million of additional financing in connection with the acquisition of Parkway and incurred approximately $478,000 in deferred financing costs. In addition, we paid approximately $230,000 in principal repayments on our outstanding mortgages and preferred loans payable.

 

Acquisitions

 

Our Advisor expects to continue to evaluate potential acquisitions of real estate and real estate-related assets and to engage in negotiations with sellers and borrowers on our behalf. Investors should be aware that after a purchase contract that contains specific terms is executed, the property will not be purchased until the successful completion of due diligence and negotiation of final binding agreements. During this period, we may decide to temporarily invest any unused proceeds from offerings of Common Shares in certain investments that could yield lower returns than the properties. These lower returns may affect our ability to make distributions.

 

Distributions

 

To maintain our qualification as a REIT, we generally are required to make aggregate annual distributions to our stockholders of at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with GAAP) determined without regard to the deduction for dividends paid and excluding any net capital gain. We expect that our board of directors will authorize distributions in excess of those required for us to maintain REIT status depending on our financial condition and such other factors as our board of directors deems relevant. We expect to continue paying distributions monthly unless our results of operations, our general financial condition, general economic conditions or other factors make it imprudent to do so. The timing and amount of distributions will be determined by our board and will be influenced in part by its intention to comply with REIT requirements of the Internal Revenue Code of 1986, as amended (the “Code”). We have not established a minimum distribution level and our charter does not require that we make distributions to our stockholders.

 

On December 28, 2012, our board of directors declared daily distributions on our Common Shares at a daily rate of $0.00210958904 per Common Share. The distributions began to accrue as of daily record dates beginning on January 1, 2013, and are aggregated and paid monthly, on payment dates determined by us, to stockholders who hold Common Shares as of such daily record dates. We expect to continue paying distributions monthly unless our results of operations, our general financial condition, general economic conditions or other factors make it imprudent to do so. The timing and amount of distributions will be determined by our board and will be influenced in part by its intention to comply with REIT requirements of the Code.

 

We expect to have little, if any, funds from operations available for distribution until we make substantial investments. Further, because we may receive income from interest or rents at various times during our fiscal year and because we may need funds from operations during a particular period to fund capital expenditures and other expenses, we expect that at least during the early stages of our development and from time to time during our operational stage, our board will authorize and we will declare distributions in anticipation of funds that we expect to receive during a later period and we will pay these distributions in advance of our actual receipt of these funds. In these instances, we expect to look to proceeds from our IPO or from the issuance of securities in the future, or to third-party borrowings, to fund our distributions. We also may fund such distributions from advances from our Sponsor or from any waiver of fees by our Advisor.

 

 

Our board has the authority under our organizational documents, to the extent permitted by Maryland law, to authorize the payment of distributions from any source without limits, including proceeds from our IPO or the proceeds from the issuance of securities in the future, and we expect that, at least in the early stages of our existence, we will use the proceeds of our IPO to pay distributions.

 

As a REIT, we generally will not be subject to U.S. federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year after the taxable year in which we initially elect to be taxed as a REIT, we will be subject to U.S. federal income tax on our taxable income at regular corporate rates and will not be permitted to qualify for treatment as a REIT for U.S. federal income tax purposes for four years following the year in which qualification is denied. Failing to qualify as a REIT could materially and adversely affect our net income. The following table shows the sources for the payment of distributions to common stockholders for the periods presented:

 

		Three months ended
		March 31, 2014								June 30, 2014								September 30, 2014
Distributions:						Percentage of Distributions								Percentage of Distributions								Percentage of Distributions
Distributions paid in cash		$	79,557				61.0	%		$	90,195				54.2	%		$	104,223				51.3	%
Distributions reinvested			50,916				39.0				76,157				45.8				98,861				48.7
Total distributions		$	130,473				100.0	%		$	166,352				100.0	%		$	203,085				100.0	%
Source of distribution coverage:
Cash flows provided by operations		$	79,557				61.0	%		$	52,061				31.3	%		$	—				—	%
Common Shares issued under the DRIP			50,916				39.0				76,157				45.8				98,861				48.7
Proceeds from issuance of Common Shares			—				—				38,134				22.9				104,223				51.3
Total sources of distributions		$	130,473				100.0	%		$	166,352				100.0	%		$	203,085				100.0	%
Cash flows provided by (used in) operations (GAAP basis)		$	596,065							$	52,061							$	(382,598	)
Net loss attributable to stockholders (in accordance with GAAP)		$	(152,078	)						$	(622,913	)						$	(344,734	)

 

 

		Nine months ended
		September 30, 2014
Distributions:						Percentage of Distributions
Distributions paid in cash		$	273,975				54.8	%
Distributions reinvested			225,934				45.2
Total distributions		$	499,910				100.0	%
Source of distribution coverage:
Cash flows provided by operations		$	131,618				26.3	%
Common Shares issued under the DRIP			225,934				45.2
Proceeds from issuance of Common Shares			142,357				28.5
Total sources of distributions		$	499,910				100.0	%
Cash flows provided by operations (GAAP basis)		$	265,530
Net loss attributable to stockholders (in accordance with GAAP)		$	(1,119,725	)

 

Leverage Policies

 

We may borrow to finance acquisitions of new properties or other real estate-related loans and securities; to originate new loans; to pay for capital improvements, repairs or tenant build-outs to properties; to pay distributions; or to provide working capital. Careful use of debt will help us to achieve our diversification goals because we will have more funds available for investment. Our investment strategy is to utilize primarily secured and possibly unsecured debt to finance our investment portfolio; however, we may elect to forego the use of debt on some of or all our future real estate acquisitions. We may elect to secure financing subsequent to the acquisition date on future real estate properties and initially acquire investments without debt financing. To the extent that we do not finance our properties and other investments, our ability to acquire additional properties and real estate-related investments will be restricted.

 

We currently have approximately $26.0 million of mortgage notes payable. Once we have fully invested the proceeds of our IPO, assuming we sell the maximum amount, we expect that our portfolio-wide loan-to-value ratio (calculated after the close of our IPO) will be approximately 65%. For purposes of calculating our 65% target leverage, we will determine the loan-to-value ratio on our portfolio based on the greater of the aggregate cost and the fair market value of our investments and other assets. There is no limitation on the amount we may borrow for the purchase of any single asset. Our charter allows us to incur leverage up to 300% of our total “net assets” (as defined by our charter) as of the date of any borrowing, which is generally expected to be approximately 75% of the cost of our investments. We may only exceed this 300% limit with the approval of a majority of our independent directors.

 

During the early stages of our IPO, our independent directors may be more likely to approve debt in excess of this limit. In all events, we expect that our secured and unsecured borrowings will be reasonable in relation to the net value of our assets and will be reviewed by our board of directors at least quarterly.

 

The form of our indebtedness may be long-term or short-term, secured or unsecured, fixed or floating rate or in the form of a revolving credit facility or repurchase agreements or warehouse lines of credit. Our Advisor will seek to obtain financing on our behalf on the most favorable terms available.

 

Except with respect to the borrowing limits contained in our charter, we may reevaluate and change our debt policy in the future without a stockholder vote. Factors that we would consider when reevaluating or changing our debt policy include: then-current economic conditions, the relative cost and availability of debt and equity capital, any investment opportunities, the ability of our properties and other investments to generate sufficient cash flow to cover debt service requirements and other similar factors. Further, we may increase or decrease our ratio of debt to book value in connection with any change of our borrowing policies.

 

 

We will not borrow from our Advisor or its affiliates to purchase properties or make other investments unless a majority of our directors, including a majority of the independent directors not otherwise interested in the transaction, approves the transaction after determining that it is fair, competitive and commercially reasonable and no less favorable to us than comparable loans between unaffiliated parties. In order to arrive at such a determination, our directors will examine data regarding comparable loans between unaffiliated parties in consultation with counsel and independent financial advisors, investment bankers or mortgage brokers.

 

Other Obligations

 

In an effort to provide our stockholders with a limited amount of liquidity in respect of their investment in Common Shares, we have adopted a share repurchase program whereby on a daily basis, stockholders who have held their Common Shares for at least one year may request that we repurchase all or any portion (but generally at least 25%) of their Common Shares. Prior to the NAV pricing start date, as defined in the Registration Statement, stockholders who have held their Common Shares for at least one year may have their Common Shares repurchased (a) in the case of hardship, as defined below, at the total offering price paid or (b) in the discretion of the Advisor, at a price of 92% of the total offering price paid, but in neither event at a price greater than the offering price per Common Share under the DRIP. Following the NAV pricing start date, the repurchase price per Common Share on any business day will be 95% of our NAV per Common Share for that day, calculated after the close of business on the repurchase request day, without giving effect to any share purchases or repurchases to be effected on such day; provided, however, that while the primary offering is ongoing, in no event will the repurchase price following the NAV pricing start date exceed the then-current offering price under the primary offering. We define “hardship” to mean: (a) the death of a stockholder; (b) the bankruptcy of a stockholder; (c) a mandatory distribution under a stockholder’s IRA; or (d) another involuntary exigent circumstance, as approved by our board. Prior to the NAV pricing start date, we will limit the Common Shares repurchased during any calendar quarter to 1.25% of the weighted average number of Common Shares outstanding during the previous calendar quarter, or approximately 5% of the weighted average number of Common Shares outstanding in any 12-month period. Following the NAV pricing start date, we will limit Common Shares repurchased during any calendar quarter to 5% of NAV as of the last day of the previous calendar quarter or as of the NAV pricing start date if it occurred during the then-current quarter, or approximately 20% of NAV in any 12-month period. Our board of directors has the right to modify, suspend or terminate the share repurchase program for any reason.

 

Off-Balance Sheet Arrangements

 

We did not have any off-balance sheet arrangements as of September 30, 2014.

 

Contractual Obligations

 

The following table presents the principal and interest amounts of our long-term debt maturing each year, including amortization of principal based on debt outstanding at September 30, 2014 (in thousands):

 

Contractual obligations:		2014				2015				2016				2017				2018				Thereafter				Total
Mortgage Notes Payables		$	63			$	266			$	366			$	452			$	14,930			$	9,896			$	25,973
Mortgage Interest Expense			323				1,263				1,250				1,225				743				2,483				7,287
Total		$	386			$	1,529			$	1,616			$	1,677			$	15,673			$	12,379			$	33,260

 

Inflation

 

We may be adversely impacted by inflation on our residential leases at 14 Highland, which currently do not contain indexed escalation provisions. However, the leases for Tilden House and Parkway contain base rent escalations based on CPI. We anticipate that in the future, if we enter into triple net leases, the tenant will be obligated to pay all property-level operating expenses, which may include maintenance costs, real estate taxes and insurance. This may reduce our exposure to increases in costs and operating expenses resulting from inflation.

 

 

Critical Accounting Policies

 

Our accounting policies have been established to conform with GAAP and in conjunction with the rules and regulations of the SEC. We consider these policies critical because they involve significant management judgments and assumptions, require estimates about matters that are inherently uncertain and are important for understanding and evaluating our reported financial results. These judgments affect the reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Additionally, other companies may utilize different estimates that may impact the comparability of our results of operations to those of companies in similar businesses. A discussion of the accounting policies that management considers critical in that they involve significant management judgments, assumptions and estimates is included in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC. In addition, refer to Note 2 of our consolidated financial statements for a discussion of additional accounting policies.

 

Recent Accounting Pronouncements

 

See Note 2 to the accompanying consolidated financial statements.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

 

The market risk associated with financial instruments and derivative financial instruments is the risk of loss from adverse changes in market prices or interest rates. Our long-term debt, which consists of secured financings, bears interest at fixed rates. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. From time to time, we may enter into interest rate hedge contracts such as swaps, collars, and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We would not hold or issue these derivative contracts for trading or speculative purposes. We do not have any foreign operations and thus we are not exposed to foreign currency fluctuations.

 

As of September 30, 2014, our debt consisted of fixed-rate secured mortgage loans payable, with a carrying value of $26.0 million, which approximated the fair value at September 30, 2014. Changes in market interest rates on our fixed-rate debt impact the fair value of the loans, but have no impact on interest incurred or cash flow. For instance, if interest rates increase 100 basis points and our fixed-rate debt balance remains constant, we expect the fair value of our obligation to decrease, the same way the price of a bond declines as interest rates rise. The sensitivity analysis related to our fixed–rate debt assumes an immediate 100 basis point move in interest rates from their September 30, 2014 levels, with all other variables held constant. A 100 basis point increase in market interest rates would result in a decrease in the fair value of our fixed-rate debt by $1.4 million. A 100 basis point decrease in market interest rates would result in an increase in the fair value of our fixed-rate debt by $1.2 million. These amounts were determined by considering the impact of hypothetical interest rates changes on our borrowing costs, and assuming no other changes in our capital structure.

 

As the information presented above includes only those exposures that existed as of September 30, 2014, it does not consider exposures or positions arising after that date. The information represented herein has limited predictive value. Future actual realized gains or losses with respect to interest rate fluctuations will depend on cumulative exposures, hedging strategies employed and the magnitude of the fluctuations.

 

Item 4.

Controls and Procedures.

 

Disclosure Controls and Procedures

 

Our disclosure controls and procedures include our controls and other procedures designed to provide reasonable assurance that information required to be disclosed in this and other reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the required time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosures. It should be noted that no system of controls can provide complete assurance of achieving a company’s objectives and that future events may impact the effectiveness of a system of controls.

 

Our chief executive officer and chief financial officer, together with other members of our management, after conducting an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act), concluded that our disclosure controls and procedures were effective as of September 30, 2014 at a reasonable level of assurance, as required by paragraph (b) of Rule 13a-15 and Rule 15d-15 under the Exchange Act.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II — OTHER INFORMATION

 

Item 1.

Legal Proceedings.

 

As of September 30, 2014, neither the Company nor the Operating Partnership was involved in any material litigation nor, to management’s knowledge, was any material litigation threatened against us or our portfolio other than routine litigation arising in the ordinary course of business or litigation that is adequately covered by insurance.

 

Item 1A.

Risk Factors.

 

There have been no material changes from the risk factors disclosed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2013, except for the items described below.

 

The risk factors substantially similar to the following are restated in their entirety as follows:

 

Distributions paid from sources other than our cash flows from operations, particularly from proceeds of our initial public offering, or IPO, will result in us having fewer funds available for the acquisition of properties and other real estate-related investments and may dilute our stockholders’ interests in us, which may adversely affect our ability to fund future distributions with cash flows from operations and may adversely affect our stockholders’ overall return.

 

Our cash flows provided by operations of $265,530 for the nine months ended September 30, 2014 was a shortfall of $234,380 to our distributions paid of $499,910 (inclusive of $225,934 of Common Shares issued under our DRIP) during such period. Our cash flows used in operations of ($3,210,347) for the 12 months ended December 31, 2013 was a shortfall of $3,543,683 to our distributions paid of $333,336 (inclusive of $199,093 of Common Shares issued under our DRIP) during such period. We paid these shortfalls from proceeds from the issuance of Common Shares, including under our DRIP.

 

Using offering proceeds to pay distributions, especially if the distributions are not reinvested through our DRIP, reduces cash available for investment in assets or other purposes, and reduces our stockholders’ equity per Common Share. We may continue to use net offering proceeds to fund distributions.

 

We may not generate sufficient cash flows from operations to pay distributions. If we have not generated sufficient cash flows from our operations and other sources, such as from borrowings, the sale of additional securities, advances from our Advisor, and our Advisor’s deferral, suspension or waiver of its fees and expense reimbursements, to fund distributions, we may use the proceeds from our IPO. Moreover, our board of directors may change our distribution policy, in its sole discretion, at any time. Distributions made from offering proceeds are a return of capital to stockholders, from which we will have already paid offering expenses in connection with our IPO. We have not established any limit on the amount of proceeds from our IPO that may be used to fund distributions, except that, in accordance with our organizational documents and Maryland law, we may not make distributions that would: (a) cause us to be unable to pay our debts as they become due in the usual course of business; (b) cause our total assets to be less than the sum of our total liabilities plus senior liquidation preferences, if any; or (c) jeopardize our ability to qualify as a REIT.

 

Funding distributions from borrowings could restrict the amount we can borrow for investments, which may affect our profitability. Funding distributions with the sale of assets or the proceeds of our IPO may affect our ability to generate additional operating cash flows. Funding distributions from the sale of additional securities could dilute each stockholder’s interest in us if we sell shares of our common stock or securities that are convertible or exercisable into shares of our common stock to third-party investors. Payment of distributions from the mentioned sources could restrict our ability to generate sufficient cash flows from operations, affect our profitability or affect the distributions payable to stockholders upon a liquidity event, any or all of which may have an adverse effect on an investment in our shares.

 

Investors who invest in us at the beginning of our IPO may realize a lower rate of return than later investors because earlier investors may receive a relatively larger proportion of distributions from sources other than operating cash flow.

 

There can be no assurances as to when we will begin to generate sufficient cash flow to fully fund the payment of distributions. As a result, investors who invest in us before we generate significant cash flow may realize a lower rate of return than later investors. We expect to have little cash flow from operations available for distribution until we make substantial investments. In addition, to the extent our investments are in development or redevelopment projects or in properties that have significant capital requirements, our ability to make distributions may be negatively impacted, especially during our early periods of operation. Therefore, until such time as we have sufficient cash flow from operations to fully fund the payment of distributions therefrom, some of or all our distributions will be paid from other sources, such as from the proceeds of our IPO, cash advances to us by our advisor, cash resulting from a waiver of asset management fees, and borrowings, including borrowings secured by our assets, in anticipation of future operating cash flow.

 

 

Investors who invest in us before the NAV pricing start date may be diluted if the NAV pricing start date occurs before the end of our primary offering and our NAV per Common Share falls below the price such investors paid. If, during our primary offering, our daily NAV falls significantly below our offering price, investors may be deterred from purchasing Common Shares.

 

Commencing on the NAV pricing start date, the offering price per Common Share in our primary offering and under our DRIP and the share repurchase program will vary from day to day based on our NAV per Common Share on each business day. Investors who invest in us before the NAV pricing start date may be diluted if the NAV pricing start date occurs before the end of our primary offering and our NAV per Common Share falls below the price such investors paid, because other stockholders may purchase shares in our primary offering and under our DRIP at the lower price of NAV per Common Share. If, during our primary offering, our daily NAV falls significantly below our offering price, investors may be deterred from purchasing Common Shares. If we do not raise significant additional funds in our IPO, it is likely that we will not be able to achieve optimal diversification and that our profitability will fluctuate with the performance of individual assets. We are not limited in the number or size of our investments or the percentage of net proceeds we may dedicate to a single investment. Your investment in our Common Shares will be subject to greater risk to the extent that we lack a diversified portfolio of investments. In addition, to the extent we are not able to raise additional funds, our fixed operating expenses, as a percentage of gross income, would be higher, and our financial condition and ability to pay distributions could be adversely affected.

 

The investment objectives of the prior programs of the principal of our sponsor, and the investments for his own account, were markedly different from our own, so the performance of such prior investments are not indicative of the returns, if any, we may achieve.

 

Our primary investment objectives are to achieve stable cash distributions, preservation of capital, diversification, growth, and future liquidity, through a dual strategy involving acquisitions of stabilized, cash-flowing properties and of opportunistic properties. The section of our prospectus titled “Prior Performance Summary” and the tables included in Appendix A therein, which we have filed with the SEC, disclose the prior performance of affiliates of our sponsor, but the investment objectives of the programs and other investments disclosed were markedly different from our own. For example, the primary investment objectives of some of Mr. Frydman’s prior investments were capital appreciation with a secondary objective of income, which differ from our investment objectives of stable cash distributions, preservation of capital contributions, portfolio diversification, growth in the value of our assets upon their sale and the potential for future liquidity. Because the investment objectives of such prior programs and other investments diverged so widely from ours, the results of those programs and other investments are not indicative of the returns, if any, we may achieve.

 

Commencing on the NAV pricing start date, the purchase of Common Shares in our IPO and the repurchase of our Common Shares under our share repurchase program will be at a price equal to our NAV per Common Share, which will be calculated based upon subjective judgments, assumptions and opinions about future events, and may not be accurate. As a result, our daily NAV per Common Share may not reflect the amount that you might receive for your Common Shares in a market transaction, and you will not know the NAV per Common Share at the time of purchase.

 

Commencing on the NAV pricing start date, we will base the purchase price of Common Shares and the repurchase price for Common Shares under our share repurchase program on our NAV per Common Share. NAV will be calculated by estimating the market value of our assets and liabilities, many of which may be illiquid. An independent valuer will perform valuations of our real estate portfolio and provide the board with the metrics to be used in calculating our daily NAV, all of which the board of directors will approve. The valuation may not be precise because the valuation methodologies used to value a real estate portfolio involve subjective judgments, assumptions and opinions about future events. Any resulting disparity may benefit the stockholders whose Common Shares are or are not being repurchased under our share repurchase program, those purchasing or not purchasing Common Shares or those participating or not participating in our DRIP. Investors will not know the NAV per Common Share at which they will purchase Common Shares at the time they submit a purchase order following the NAV pricing start date. See the section of our prospectus titled “Valuation Policies” for more details about how our NAV will be calculated.

 

It may be difficult to accurately reflect material events that may impact our daily NAV between valuations and, accordingly, commencing on the NAV pricing start date, we may be selling Common Shares and repurchasing Common Shares under our share repurchase program at too high or too low a price.

 

Commencing on the NAV pricing start date, our independent valuer will estimate at least annually the market value of our principal assets and liabilities, and also provide the metrics to be used in the subsequent calculation of NAV, and we will rely on those estimates to determine the daily NAV per Common Share. As a result, the published NAV per Common Share may not fully reflect changes in value that may have occurred since the prior valuation. Furthermore, it may be difficult to reflect changing market conditions or material events that may impact the value of our portfolio between valuations, or to obtain timely complete information regarding any such events. Therefore, the NAV per Common Share published after the announcement of an extraordinary event may differ significantly from our actual NAV until such time as sufficient information is available and analyzed, the financial impact is fully evaluated, and the appropriate adjustment to be made to NAV, on a going forward basis, is determined by our advisor and our independent valuer. Any resulting disparity may benefit the stockholders whose Common Shares are or are not being repurchased, those purchasing or not purchasing Common Shares or those who do or do not elect to participate in our DRIP.

 

 

Because we rely on affiliates of United Realty for the provision of advisory, property management and dealer manager services, if United Realty is unable to meet its obligations, we may be required to find alternative providers of these services, which could result in a significant and costly disruption of our business.

 

United Realty, through one or more of its subsidiaries, owns and controls our advisor, URP, United Realty Securities and our property manager. The operations of our advisor, URP, United Realty Securities and our property manager rely substantially on United Realty. United Realty is dependent on its principal, who in turn depends on fee income from his sponsored real estate programs. Real estate market disruptions could adversely affect the amount of such fee income. If the principal of our sponsor becomes unable to meet his obligations as they become due, he might liquidate United Realty, and we might be required to find alternative service providers, which could result in a significant disruption of our business and would likely adversely affect the value of your investment in us.

 

Market disruptions could adversely impact aspects of our operating results and operating condition.

 

Market disruptions, including recessions, reduced consumer spending, sovereign downgrades and lack of credit, could reduce demand for hotel space and remove support for rents and property values. The value of our properties may decline if any such market conditions were to emerge.

 

Our business could be affected by future market and economic challenges experienced by the U.S. economy. These conditions could materially affect the value and performance of our properties, and could affect our ability to pay distributions, the availability or the terms of financing that we have or may anticipate utilizing, and our ability to make principal and interest payments on, or refinance, any outstanding debt when due. Any such challenging economic conditions also could impact the ability of certain of our tenants to enter into new leasing transactions or satisfy rental payments under existing leases. Specifically, market disruptions could have any of the following adverse consequences:

 

	•	the financial condition of tenants occupying the properties we acquire could be adversely affected, which could result in us having to increase concessions, reduce rental rates or make capital improvements beyond those contemplated at the time we acquired the properties in order to maintain occupancy levels or to negotiate for reduced space needs, which could result in a decrease in our occupancy levels;
	•	significant job losses could occur, which could decrease demand for office space, multifamily communities and hospitality properties and result in lower occupancy levels, which could result in decreased revenues for properties that we acquire, which could diminish the value of such properties that depend, in part, upon the cash flow generated by such properties;
	•	there could be an increase in the number of bankruptcies or insolvency proceedings of tenants and lease guarantors, which could delay our efforts to collect rent and any past due balances under the relevant leases and ultimately could preclude collection of these sums;
	•	credit spreads for major sources of capital could widen if investors demanded higher risk premiums, resulting in lenders increasing the cost for debt financing;
	•	our ability to borrow on terms and conditions that we found acceptable, or at all, could be limited, which could result in our investment operations generating lower overall economic returns and a reduced level of cash flow, which could potentially impact our ability to make distributions to our stockholders, reduce our ability to pursue acquisition opportunities if any, and increase our interest expense;
	•	there could be a reduction in the amount of capital available to finance real estate, which, in turn, could lead to a decline in real estate values generally, slow real estate transaction activity, reduce the loan-to-value ratio upon which lenders are willing to lend, and make sourcing or refinancing our debt more difficult;
	•	the value of certain properties we may acquire could decrease below the amounts we paid for them, which could limit our ability to dispose of assets at attractive prices or to obtain debt financing secured by our properties and could reduce the availability of unsecured loans;

 

 

	•	to the extent that we may use or purchase derivative financial instruments, one or more counterparties to such derivative financial instruments could default on their obligations to us, or could fail, increasing the risk that we may not realize the benefits of those instruments; and
	•	the value and liquidity of our short-term investments could be reduced as a result of dislocations in the markets for our short-term investments and increased volatility in market rates for such investments or other factors.

 

 

Valuations and appraisals of our properties and valuations of our investments in real estate-related assets are estimates of fair value and may not necessarily correspond to realizable value, which could adversely affect the value of your investment.

 

Commencing on the NAV pricing start date, in order to calculate our daily NAV, our properties will initially be valued at cost, which we expect to represent fair value. After this initial valuation, valuations of properties will be conducted in accordance with our valuation guidelines and will be based partially on appraisals performed by our independent valuer. Similarly, our real estate-related asset investments will initially be valued at cost, and thereafter will be valued at least annually, or in the case of liquid securities, daily, as applicable, at fair value as determined by our advisor. See the section of our prospectus titled “Valuation Policies.” The valuation methodologies used to value our properties will involve subjective judgments concerning factors such as comparable sales, rental and operating expense data, capitalization or discount rate, and projections of future rent and expenses. Appraisals and valuations will be only estimates, and ultimate realization depends on conditions beyond our advisor’s control. Further, valuations do not necessarily represent the price at which we would be able to sell an asset, because such prices would be negotiated. We will not retroactively adjust the valuation of such assets, the price of our Common Shares in our primary offering or under our DRIP, the price we paid to repurchase Common Shares or NAV-based fees we paid to our advisor. Because commencing on the NAV pricing start date the price of Common Shares in our primary offering or under our DRIP and the price at which your Common Shares may be repurchased by us pursuant to our share repurchase plan are based on our estimated NAV per Common Share, you may pay more than realizable value or receive less than realizable value for your investment.

 

Commencing on the NAV pricing start date, in calculating our daily NAV, our advisor will base its calculations in part on independent appraisals of our properties, the accuracy of which our advisor will not independently verify.

 

In calculating our daily NAV, our advisor will include valuations of individual properties and the metrics which will be used to calculate our daily NAV that were obtained from our independent valuer. We will not independently verify the appraised value of our properties or the metrics used to arrive at those valuations. As a result, the appraised value of a particular property may be greater or less than its potential realizable value, which would cause our estimated NAV to be greater or less than the potential realizable NAV.

 

Commencing on the NAV pricing start date, our NAV per Common Share may suddenly change if the appraised values of our properties materially change or the actual operating results differ from what we originally budgeted for that month.

 

Appraisals of our properties used to calculate our daily NAV will probably not be spread evenly throughout the calendar year. Each of our properties will be appraised at least annually, and appraisals will be scheduled over the course of a year so that approximately 25% of all properties are appraised each quarter. We anticipate that such appraisals will be conducted near the end of the calendar quarter in which they occur. Therefore, when these appraisals are reflected in our NAV calculation, there may be a sudden change in our NAV per Common Share. In addition, actual operating results for a given month may differ from our original estimate, which may affect our NAV per Common Share. We will base our calculation of estimated income and expenses on a monthly budget. As soon as practicable after the end of each month, we will adjust the estimated income and expenses to reflect the income and expenses actually earned and incurred. We will not retroactively adjust the daily NAV per Common Share for the previous month. Therefore, because the actual results from operations may be better or worse than what we previously budgeted for a particular month, the adjustment to reflect actual operating results may cause our NAV per Common Share to change, and such change will occur on the day the adjustment is made.

 

 

Commencing on the NAV pricing start date, the NAV per Common Share that we publish may not necessarily reflect changes in our NAV and in the value of your Common Shares or the impact of extraordinary events that we cannot immediately quantify.

 

We may experience events affecting our investments that may have a material impact on our NAV. For example, if a material lease is unexpectedly terminated or renewed, or a property experiences an unanticipated structural or environmental event, the value of a property may materially change. Furthermore, if we cannot immediately quantify the financial impact of any extraordinary events, our NAV per Common Share as published on any given day will not reflect such events. As a result, the NAV per Common Share published after the announcement of a material event may differ significantly from our actual NAV per Common Share until we are able to quantify the financial impact of such event and our NAV is appropriately adjusted on a going forward basis. The resulting potential disparity may benefit repurchasing or non-repurchasing stockholders whose Common Shares are or are not being repurchased, stockholders electing to purchase or not to purchase, or stockholders electing or not electing to participate in our DRIP, in each case at the expense of the other, depending on whether NAV is overstated or understated.

 

Potential changes in U.S. accounting standards regarding operating leases may make the leasing of our properties less attractive to our potential tenants, which could reduce overall demand for our leasing services.

 

Under current authoritative accounting guidance for leases, a lease is classified by a tenant as a capital lease if the significant risks and rewards of ownership are considered to reside with the tenant. Under capital lease accounting for a tenant, both the leased asset and liability are reflected on its balance sheet. If the lease does not meet any of the criteria for a capital lease, the lease is considered an operating lease by the tenant, and the obligation does not appear on the tenant’s balance sheet; rather, the contractual future minimum payment obligations are only disclosed in the footnotes thereto. Thus, entering into an operating lease can appear to enhance a tenant’s balance sheet in comparison to direct ownership. The Financial Accounting Standards Board, or FASB, and the International Accounting Standards Board have proposed an accounting model that would significantly change lease accounting. The proposals have gone through several rounds of public comment and are not yet final. Changes to the accounting guidance could affect both our accounting for leases as well as that of our current and potential tenants. These changes may affect how the real estate leasing business is conducted. For example, if the accounting standards regarding the financial statement classification of operating leases are revised, then companies may be less willing to enter into leases in general or desire to enter into leases with shorter terms because the apparent benefits to their balance sheets could be reduced or eliminated. This in turn could cause a delay in investing our offering proceeds and make it more difficult for us to enter into leases on terms we find favorable.

 

We have incurred mortgage indebtedness, which, along with any other borrowings we may incur the future, may increase our business risks.

 

We have acquired and anticipate that we will continue to acquire real properties and other real estate-related investments either by assuming existing indebtedness or borrowing new funds. In addition, we may incur or increase our mortgage debt by obtaining loans secured by some of or all our real properties to obtain funds to acquire additional properties and other investments and for payment of distributions to stockholders. We also may borrow funds for payment of distributions to stockholders, in particular if necessary to satisfy the requirement that we distribute annually to stockholders at least 90% of our REIT taxable income, or otherwise as is necessary or advisable to assure that we maintain our qualification as a REIT and minimize U.S. federal income and excise tax.

 

There is no limitation on the amount we may invest in any single property or other asset or on the amount we can borrow for the purchase of any individual property or other investment. Under our charter, the maximum amount of our indebtedness shall not exceed 300% of our “net assets” (as defined by our charter) as of the date of any borrowing; however, we may exceed that limit if approved by a majority of our independent directors.

 

In addition to our charter limitation, our board of directors has adopted a policy to generally limit our aggregate borrowings to approximately 65% of the greater of the aggregate cost and the fair market value of our assets unless substantial justification exists that borrowing a greater amount is in our best interests. Our policy limitation, however, does not apply to individual real estate assets and only will apply once we have ceased raising capital under our IPO or any subsequent offering and invested substantially all of our capital. As a result, we expect to borrow more than 65% of the aggregate cost and the fair market value of each real estate asset we acquire to the extent our board of directors determines that borrowing these amounts is prudent. For these purposes, the value of our assets is based on methodologies and policies determined by our board of directors that may include, but do not require, independent appraisals.

 

If there is a shortfall in cash flow available to service our mortgage debt, then the amount available for distributions to stockholders may be affected. In addition, incurring mortgage debt increases the risk of loss because (a) loss in investment value is generally borne entirely by the borrower until such time as the investment value declines below the principal balance of the associated debt, and (b) defaults on indebtedness secured by a property may result in foreclosure actions initiated by lenders and our loss of the property securing the loan that is in default. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds from the foreclosure. We may give full or partial guarantees to lenders of mortgage debt to the entities that own our properties. When we give a guaranty on behalf of an entity that owns one of our properties, we will be responsible to the lender for satisfaction of the debt if it is not paid by such entity. If any mortgages contain cross-collateralization or cross-default provisions, there is a risk that more than one real property may be affected by a default. If any of our properties is foreclosed upon due to a default, our ability to make distributions to our stockholders will be adversely affected. In addition, because our goal (which may not be achieved) is to be in a position to liquidate our assets within six to nine years after the termination of our IPO, our approach to investing in properties utilizing leverage in order to accomplish our investment objectives over this period of time may present more risks to investors than comparable real estate programs that have a longer intended duration and that do not utilize borrowing to the same degree.

 

 

Our failure to remain qualified as a REIT would subject us to U.S. federal income tax and potentially state and local tax, and would adversely affect our operations and the market price of our Common Shares.

 

We elected to be taxed as a REIT commencing with our taxable year ending December 31, 2013 and intend to operate in a manner that would allow us to continue to qualify as a REIT. We may terminate our REIT qualification if our board of directors determines that not qualifying as a REIT is in our best interests, or inadvertently. Our qualification as a REIT depends upon our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. The REIT qualification requirements are extremely complex and interpretation of the U.S. federal income tax laws governing qualification as a REIT is limited. Our ability to satisfy the asset tests depends on our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income or quarterly asset requirements also depends on our ability to successfully manage the composition of our income and assets on an ongoing basis. Accordingly, if certain of our operations were to be recharacterized by the Internal Revenue Service, or IRS, such recharacterization would jeopardize our ability to satisfy all the requirements for qualification as a REIT. Furthermore, future legislative, judicial or administrative changes to the U.S. federal income tax laws could be applied retroactively, which could result in our disqualification as a REIT.

 

If we fail to qualify as a REIT for any taxable year, and we do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax on our taxable income at corporate rates. In addition, we would generally be disqualified from treatment as a REIT for the four taxable years following the year of losing our REIT qualification. Losing our REIT qualification would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability. In addition, distributions to stockholders would no longer qualify for the dividends paid deduction, and we would no longer be required to make distributions. If this occurs, we might be required to borrow funds or liquidate some investments in order to pay the applicable tax.

 

The ability of our board of directors to revoke our REIT qualification without stockholder approval may subject us to U.S. federal income tax and reduce distributions to our stockholders.

 

Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. We elected to be taxed as a REIT commencing with our taxable year ended December 31, 2013. We also may terminate our REIT election if we determine that qualifying as a REIT is no longer in our best interests. If we cease to be a REIT, we would become subject to U.S. federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on our total return to our stockholders and on the value of our Common Shares.

 

If the fiduciary of an employee pension benefit plan subject to the ERISA (such as a profit-sharing, Section 401(k) or pension plan) or any other retirement plan or account fails to meet the fiduciary and other standards under ERISA or the Code as a result of an investment in our Common Shares, the fiduciary could be subject to criminal and civil penalties.

 

There are special considerations that apply to employee benefit plans subject to ERISA (such as profit-sharing, Section 401(k) or pension plans) and other retirement plans or accounts subject to Section 4975 of the Code (such as an IRA) that are investing in our Common Shares. Fiduciaries investing the assets of such a plan or account in our Common Shares should satisfy themselves that:

 

	•	the investment is consistent with their fiduciary obligations under ERISA and the Code;
	•	the investment is made in accordance with the documents and instruments governing the plan or IRA, including the plan’s or account’s investment policy;
	•	the investment satisfies the prudence and diversification requirements of Sections 404(a)(1)(B) and 404(a)(1)(C) of ERISA and other applicable provisions of ERISA and the Code;

 

 

	•	the investment will not impair the liquidity of the plan or IRA;
	•	the investment will not produce an unacceptable amount of UBTI for the plan or IRA;
	•	the value of the assets of the plan can be established annually in accordance with ERISA requirements and applicable provisions of the plan or IRA; and
	•	the investment will not constitute a non-exempt prohibited transaction under Section 406 of ERISA or Section 4975 of the Code.

 

With respect to the annual valuation requirements described above, we expect to provide an estimated value for our Common Shares annually. Until the NAV pricing start date, we expect to use the offering price of a Common Share in our IPO, which is $10.45, as the per share estimated value. Commencing on the NAV pricing start date, we will provide a daily NAV per Common Share. The estimated value is not likely to reflect the proceeds you would receive upon our liquidation or upon the sale of your Common Shares. Accordingly, we can make no assurances that such estimated value will satisfy the applicable annual valuation requirements under ERISA and the Code. The Department of Labor or the IRS may determine that a plan fiduciary or an IRA custodian is required to take further steps to determine the value of our Common Shares. In the absence of an appropriate determination of value, a plan fiduciary or an IRA custodian may be subject to damages, penalties or other sanctions.

 

Failure to satisfy the fiduciary standards of conduct and other applicable requirements of ERISA and the Code may result in the imposition of civil and criminal penalties and could subject the fiduciary to remedies. In addition, if an investment in our Common Shares constitutes a non-exempt prohibited transaction under ERISA or the Code, the fiduciary or IRA owner who authorized or directed the investment may be subject to the imposition of excise taxes with respect to the amount invested. In the case of a non-exempt prohibited transaction involving an IRA owner, the IRA may be disqualified and all the assets of the IRA may be deemed distributed and subject to tax.

 

Prospective investors with investment discretion over the assets of an IRA, employee benefit plan or other retirement plan or arrangement that is covered by ERISA or Section 4975 of the Code should carefully review the information in the section of our prospectus titled “ERISA Considerations.” Any such prospective investors are required to consult their own legal and tax advisors on these matters.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

 

On May 21, 2014, in connection with our acquisition of the fee simple interest in Parkway, in consideration for $1.7 million, our OP issued to two investors not affiliated with us or our advisor, and each an “accredited investor,” as that term is defined in Regulation D promulgated under the Securities Act of 1933, as amended (the “Securities Act”), 17 class MB units of limited partnership interest (the “MB Units”). Our OP issued 12 MB Units to one of the two investors in consideration for a capital contribution of $1.2 million. Such 12 MB Units entitle the holder thereof to an annualized preferred return of 20% on the amount of the capital contribution, and must be redeemed by us in November 2014 for $1.32 million. Our OP issued five MB Units to the other investor in consideration for a capital contribution of $500,000. Such five MB Units entitle the holder thereof to an annualized preferred return of 10% on the amount of the capital contribution, and must be redeemed by us in May 2015. The MB Units were offered and sold in a private placement pursuant to an exemption from the registration requirements under Section 4(a)(2) of the Securities Act and Rule 506(b) of Regulation D promulgated thereunder. The MB Units have not been registered under the Securities Act and may not be offered or sold in the United States in the absence of an effective registration statement or exemption from the registration requirements.

 

On August 15, 2012, we commenced our IPO on a “best efforts” basis of up to 100.0 million Common Shares. The IPO is being conducted by United Realty Securities, our dealer manager, a division of Cabot Lodge Securities, LLC, a Delaware limited liability company and a member of FINRA, that is indirectly owned by our Sponsor. We are offering the Common Shares at a price of $10.45 per Common Share, subject to certain volume and other discounts, pursuant to the Registration Statement on Form S-11 (Reg. No. 333-178651) filed with the SEC under the Securities Act (the “Registration Statement”). The Registration Statement also covers up to 20.0 million shares available pursuant to our DRIP, under which our stockholders may elect to have their distributions reinvested in additional Common Shares at the greater of $10.00 per Common Share and 95% of the fair market value per Common Share. Commencing on the NAV pricing start date, the offering price per Common Share in our primary offering and under our DRIP will be equal to our NAV per Common Share. The total dollar amount of securities registered on the Registration Statement is $1.245 billion.

 

As of September 30, 2014, we had 1,192,879 Common Shares outstanding. As of September 30, 2014, we had received net offering proceeds of approximately $11.5 million from the sale of Common Shares, including pursuant to our DRIP.

 

 

The following table reflects the offering costs associated with the issuance of Common Shares.

 

		Nine Months Ended
		September 30, 2014
Selling commissions and dealer manager fees		$	510,366
Other offering costs			50,732
Total offering costs		$	561,098

 

The dealer manager reallowed the selling commissions and a portion of the dealer manager fees to participating broker-dealers. The following table details the selling commissions incurred and reallowed related to the sale of Common Shares.

 

		Nine Months Ended
		September 30, 2014
Total commissions incurred from the dealer manager		$	510,366
Less:
Commissions to participating broker-dealers			(356,366	)
Reallowance to participating broker-dealers			—
Net to the dealer manager		$	154,000

 

As of September 30, 2014, we have incurred $1.5 million of cumulative offering costs in connection with the issuance and distribution of Common Shares. Net offering proceeds of $11.5 million exceeded cumulative offering costs by $10.0 million as of September 30, 2014.

 

Cumulative offering costs include $1.1 million incurred from our dealer manager for dealer manager fees and commissions and $0.4 million from our Advisor.

 

We expect to use substantially all the net proceeds from our IPO to invest primarily in interests in real estate located in the United States, with a primary focus on the eastern United States and in markets that we believe are likely to benefit from favorable demographic changes, or that we believe are poised for strong economic growth. As of September 30, 2014, we have used the net proceeds from our IPO to fund a portion of the purchase of four real estate-related investments with an aggregate purchase price of $40.3 million.

 

Share Repurchase Program

 

The table below outlines the Common Shares we repurchased pursuant to our share repurchase program during the three months ended September 30, 2014. Our share repurchase program was adopted on August 15, 2012.

 

														Maximum Number
										Total Number of				(or Approximate Dollar
										Common Shares				Value) of Common
										Repurchased as				Shares that May
		Total Number of				Average Price				Part of Publicly				Yet Be Purchased
		Common Shares				Paid per Common				Announced Plans or				Under the Plans
		Repurchased				Share				Programs				or Programs
July 2014			2,601.45			$	9.89				2,601.45			(1)
August 2014			7,601.46				—				7,601.46			(1)
September 2014			—				—				—			(1)
			10,202.91			$	9.89				10,202.91			(1)

 

(1)	A description of the maximum number of Common Shares that may be repurchased under our share repurchase program is included under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Other Obligations.”

 

During the nine months ended September 30, 2014, we received four requests to repurchase an aggregate of 50,429 Common Shares pursuant to our share repurchase program. As of September 30, 2014, we had funded repurchase requests with respect to 19,203 Common Shares at an average price per share of $9.89, and repurchase requests for 31,226 Common Shares were voluntarily withdrawn by the requesting shareholders. As of September 30, 2014, we had not approved any additional repurchase requests. We fund Common Share repurchases from cash flows from operations. As of the date of this filing and subsequent to September 30, 2014, we received no additional requests to repurchase Common Shares.

 

 

Item 3.

Defaults Upon Senior Securities.

 

None.

 

Item 4.

Mine Safety Disclosures.

 

Not applicable.

 

Item 5.

Other Information.

 

None.

 

Item 6.

Exhibits.

 

The exhibits filed in response to Item 601 of Regulation S-K listed on the Exhibit Index (following the signatures section of this Quarterly Report) are included herewith.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	United Realty Trust Incorporated
Date: November 7, 2014	By:	/s/ Jacob Frydman
		Jacob Frydman
		Chief Executive Officer, Secretary and
		Chairman of the Board of Directors
		(Principal Executive Officer)
Date: November 7, 2014	By:	/s/ Steven Kahn
		Chief Financial Officer and Treasurer
		(Principal Financial Officer and
		Principal Accounting Officer)

 

 

EXHIBIT INDEX

 

The following exhibits are included in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 (and are numbered in accordance with Item 601 of Regulation S-K).

 

Exhibit No.		Description
10.1*		Agreement of Sale by and between FRS Carnegie Plaza, L.L.C. and United Realty Partners, LLC dated July 23, 2014.
10.2*		First Amendment to Agreement of Sale between United Realty Partners, LLC and FRS Carnegie Plaza, L.L.C. dated August 20, 2014.
10.3*		Side Letter between United Realty Partners, LLC and FRS Carnegie Plaza, L.L.C. dated September 5, 2014.
10.4*		Side Letter between United Realty Partners, LLC and FRS Carnegie Plaza, L.L.C. dated September 11, 2014.
10.5*		Assignment and Assumption of Agreement of Sale between United Realty Partners LLC and 7 Carnegie Plaza Fee LLC.
31.1*		Certification of the Principal Executive Officer of the Company pursuant to Securities Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of the Principal Financial Officer of the Company pursuant to Securities Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32*		Written statements of the Principal Executive Officer and Principal Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101*		XBRL (eXtensible Business Reporting Language). The following materials from the United Realty Trust Incorporated Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2014, formatted in XBRL: (i) the Consolidated Balance Sheets (unaudited), (ii) the Consolidated Statements of Operations and Comprehensive Loss (unaudited), (iii) the Consolidated Statement of Equity (unaudited), (iv) the Consolidated Statements of Cash Flow (unaudited) and (v) the Notes to the Consolidated Financial Statements (unaudited). As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purpose of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

 

 

* Filed herewith

 

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