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MacKenzie Realty Capital, Inc. (the “Company”) was incorporated under the general corporation laws of the State of Maryland on January 25, 2012, and has been active in matters relating to its operation as a non-diversified, closed-end investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (“1940 Act”). The Company is authorized to issue 100,000,000 shares, of which (i) 80,000,000 are designated as Common Stock, with a $0.0001 par value per share; and (ii) 20,000,000 are designated as Preferred Stock, with a $0.0001 par value per share.

The Company filed a registration statement on June 1, 2012 and several pre- and post-effective amendments with the Securities and Exchange Commission (“SEC”) to register the initial public offering of 5,000,000 shares of the Company’s common stock. The initial registration statement was declared effective by the SEC on August 2, 2013, and the offering commenced shortly thereafter. The Company filed post-effective amendments No. 3 and 4 on May 14, 2014 and August 6, 2014, respectively, for purpose of updating the initial registration statement. The Company commenced its operations on February 28, 2013.  The Company intends to operate so as to qualify to be taxed as a real estate investment trust (“REIT”) as defined under Subchapter M of the Internal Revenue Code of 1986 (the “Code”). The Company’s fiscal year-end is June 30.

On February 28, 2013, the Company acquired, under an exchange agreement (the “Contribution Agreement”), a portfolio of investments and cash (the “Legacy Portfolio”) from eight private funds which are collectively referred to as “Legacy Funds,” which are managed by MacKenzie. The assets acquired from the Legacy Funds had a collective fair value of approximately $6.9 million ($6.4 million in investments and $500 thousand in cash) as of February 28, 2013. As consideration for the Company’s acquisition of the Legacy Portfolio, the Company issued 692,217 shares of the Company’s common stock to the Legacy Funds. In addition, in 2012 prior to the acquisition of the Legacy Portfolio, each of the Legacy Funds and MP Value Fund 8, LLC, a private investment fund managed by MacKenzie,  purchased 4,000 shares of the Company’s common stock at $10 per share in order to provide the Company with funds to complete this exchange and prepare its initial public offering.

As of September 30, 2014, cumulative contributions of approximately $12.0 million (inclusive of the $6.9 million initial Legacy Funds capital investment), representing 1,196,284.50 shares, have been received.

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Organization and Deferred Offering Costs:  Organization costs include, among other things, the cost of legal services pertaining to the organization and incorporation of the business, incorporation fees and audit fees relating to the initial registration statement and the initial statement of assets and liabilities. These costs are expensed as incurred. Deferred offering costs include, among other things, legal fees and other costs pertaining to the preparation of the registration statements and pre- and post-effective amendments. These offering costs have been deferred and expensed over a twelve month period beginning on August 2, 2013 (the effective date of the Company’s registration statement filed with the SEC).

As provided in the Investment Advisory Agreement, the organization and offering costs incurred and paid by the Company in excess of $550,000 are reimbursed by the Adviser. Accordingly, the Company incurred and paid the non-reimbursable organization costs of $125,175 and offering costs of $424,825 totaling $550,000 during the period from January 25, 2012 (inception) through June 30, 2013. All organization and offering costs incurred by the Company subsequent to June 30, 2013 are reimbursed by the Adviser as disclosed in Note 5. The non-reimbursable organization costs of $125,175 were expensed as incurred during the period from January 25, 2012 (inception) through June 30, 2013. The non-reimbursable offering costs of $424,825 were deferred and expensed over a twelve month period beginning on August 2, 2013 (the effective date of the Company’s registration statement filed with the SEC). Amortization of the deferred offering cost for the three months ended September 30, 2014 and 2013, were $35,402 and $70,804, respectively. As of September 30, 2014, the deferred offering costs have been fully amortized.

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Subsequent Events:  Subsequent events are events or transactions that occur after the date of the statements of assets and liabilities but before the date the financial statements are available to be issued. Subsequent events that provide additional evidence about conditions that existed at the date of the statement of assets and liabilities are considered in the preparation of the financial statements presented herein. Subsequent events that occur after the date of the statement of assets and liabilities that do not provide evidence about the conditions that existed as of the date of the statement of net assets are considered for disclosure based upon their significance in relation to the Company’s financial statements taken as a whole.

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Valuation of Investments: The Company’s financial statements include investments that are measured at their estimated fair values in accordance with GAAP. A fair value measurement represents the price at which an orderly transaction would occur between willing market participants at the measurement date. The Company develops fair values for investments based on available inputs which could include pricing that is observed in the marketplace.

Examples of market information that the Company attempts to obtain include the following:

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Recently quoted trading prices for the same or similar securities;

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Recent purchase prices paid for the same or similar securities;

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Recent sale prices received for the same or similar securities;

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Relevant reports issued by industry analysts and publications; and

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Other relevant observable and unobservable inputs, including liquidity discounts.

After considering all available indications of the appropriate rate of return that market participants would require, the Company considers the reasonableness of the range indicated by the results to determine an estimate that, in its opinion, is most representative of fair value.

The real estate securities in which the Fund invests are, due to the absence of an efficient market, generally illiquid. Establishing fair values for illiquid investments is inherently subjective and is often dependent upon significant estimates and modeling assumptions. If either the volume and/or level of trading activity for an investment has significantly changed from normal market conditions, or price quotations or observable inputs are not associated with orderly transactions, the market inputs used might not be relevant. For example, recently quoted trading prices might not be relevant if a ready market does not exist for the quantity of investments that the Company may wish to sell.

In circumstances where relevant market inputs cannot be obtained, increased analysis and management judgment are required to estimate fair value. This generally requires the Company to establish the use of internal assumptions about future cash flows, including the cash flows of underlying real property, and appropriate risk-adjusted discount rates. Regardless of the valuation inputs used, the objective of fair value measurement is unchanged from what it would be if markets were operating at normal activity levels and/or transactions were orderly; that is, to determine the current exit price.

 

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The Company is under no compulsion to dispose of its investments, and expects to hold them for a substantial period of time. Therefore, estimated values as determined above may not reflect amounts that could be realized upon actual sale at a future date.

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For the year ended June 30, 2014, changes in unrealized gain included in earnings relating to level III investments still held at June 30, 2014 was $290,795.

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(1)

Based on weighted average number of shares of common stock outstanding for the period.

(2)

Average net assets were derived from the beginning and ending period-end net assets.

(3)

Total return is calculated based upon the change in value of the net assets. An individual shareholder’s return may vary from this return based on the time of capital transactions.

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$0.13 per share is attributed to sales commissions and dealer manager fees.

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Not annualized for the three months ended September 30, 2014.

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

Statements by MacKenzie Realty Capital, Inc. (the “Fund,” ”we,” or “us”) contained herein, other than historical facts, may constitute “forward-looking statements.”  These statements may relate to, among other things, future events or our future performance or financial condition.  In some cases, you can identify forward-looking statements by terminology such as “may,” “might,” “believe,” “will,” “provided,” “anticipate,” “future,” ”could,” “growth,” “plan,” “intend,” “expect,” “should,” “would,” “if,” “seek,” “possible,” “potential,” “likely” or the negative of such terms or comparable terminology.  These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any anticipated results, levels of activity, performance or achievements expressed or implied by such forward-looking statements, including an economic downturn could impair our portfolio companies’ ability to continue to operate, which could lead to the loss of some or all of our investments in such portfolio companies; a contraction of available credit and/or an inability to access the equity markets could impair our lending and investment activities; and interest rate volatility could adversely affect our results, particularly if we elect to use leverage as a part of our investment strategy.  For a discussion of factors that could cause our actual results to differ from forward-looking statements contained herein, please see the discussion under the heading “Risk Factors” in our Registration Statement filed on Form N-2.

We may experience fluctuations in our operating results due to a number of factors, including the return on our equity investments, the interest rates payable on our debt investments, the default rates on such investments, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions.  As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.

Overview

We have elected to be regulated as a business development company (“BDC”) and we are classified as a non-diversified closed-end management investment company under the Investment Company Act of 1940, as amended (the “1940 Act”).   We also intend to elect to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”) as soon as we are able to so qualify, which we believe will be during the tax year ending December 31, 2014. After we have qualified to be a REIT, we will not be subject to federal income taxes on amounts that we distribute to the stockholders, provided that, on an annual basis, we distribute at least 90% of our REIT taxable income to the stockholders and meet certain other conditions. To the extent that we satisfy the annual distribution requirement but distribute less than 100% of our taxable income, we will be subject to an excise tax on our undistributed taxable income. As of September 30, 2014, the REIT election has not yet been made; as such, our net increase in net assets resulting from operations is currently taxed at regular corporate tax rates for both federal and state income tax purposes.

We were formed to continue and expand the business of the portfolio of assets we acquired from eight private funds, which we refer to as our “Legacy Funds,” and which are managed by an affiliate of our investment adviser. The portfolio had a fair value, as determined by our Board of Directors, of approximately $6.92 million on February 28, 2013, including approximately $6.45 million of debt and equity investments issued by 47 portfolio companies (the “Legacy Portfolio”). As consideration for our acquisition of that portfolio, 692,217 shares of our common stock (“Shares”) were issued to the Legacy Funds.   We intend to invest primarily in debt and equity real estate-related securities with the receipt of proceeds from our initial public offering which we are continuing at this time (the “IPO”).

 

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Portfolio Investment Composition

The following table summarizes the composition of our investments at cost and fair value as of September 30, 2014 and June 30, 2014:

Net Asset Value

Our net asset value (“NAV”) as of September 30, 2014, was $9.59 per Share, compared to $9.81 per Share at June 30, 2014, a $0.22 per Share decrease of approximately 2.2%. The net decrease was primarily due to decreases resulting from (i) net investment loss of $0.18 per Share (which includes the amortization of deferred offering cost of $0.03 per Share), (ii) income tax provision of $0.20 per Share, (iii) dividend to stockholders of $0.24 per Share and (iv) issuance of Shares (net of selling commissions and dealer manager fees) below NAV per Share, resulting in decrease of $0.30 per Share. The decreases in NAV were offset by increases resulting from (i) net realized gain on sale of investments of $0.12 per Share and (ii) net unrealized gains on investments of $0.58 per Share.

Investment Plan

We commenced our operations on February 28, 2013 with the acquisition of the Legacy Portfolio.  Our investments are generally expected to range in size from $10 thousand to $3 million, similar to the investments in the Legacy Portfolio. However, we may make larger investments from time to time on an opportunistic basis. We intend to focus primarily on real estate-related securities.  We will purchase most of our securities (i) directly from existing security holders, (ii) through established securities markets, and (iii) in the case of unregistered, privately offered securities, directly from issuers.  We will invest primarily in debt and equity securities issued by U.S. companies that primarily own commercial real estate that are either illiquid or not listed on any exchange.

Distributions from Investments

We intend to generate revenues in the form of capital gains and dividends on dividend-paying equity securities or other equity interests that we acquire, in addition to interest on any debt investments that we hold.  Further, we may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance and possibly consulting fees and performance-based fees. Any such fees will be generated in connection with our investments and recognized as earned.

 

Revenues

 

We plan to generate revenue primarily from dividends and/or capital gains from our investments. Further, we may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance and possibly consulting fees and performance-based fees. Any such fees will be generated in connection with our investments and recognized as earned.

 

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Capital Resources

We filed a Registration Statement on Form N-2 (“Registration Statement”) with the Securities and Exchange Commission (“SEC”) to register the sale of 5,000,000 Shares, which was declared effective by the SEC on August 2, 2013, under which we seek to raise up to $50,000,000 in our IPO. On May 14, 2014 and August 6, 2014 we filed post-effective amendments No. 3 and 4, respectively, for the purpose of updating the Registration Statement, which was declared effective by the SEC on August 7, 2014.  The initial sales of our common stock occurred in January 2014 and, for the three months ended September 30, 2014, we sold 302,302 Shares at $10 per Share with gross proceeds of $3,023,020, and issued 174.83 Shares under our dividend reinvestment plan (“DRIP”) at $9 per Share with gross proceeds of $1,573.50. We do not have any plans to issue any preferred equity. We plan to fund future investments with the net proceeds raised in the IPO and any future offerings of securities and cash flows from operations, including earnings on investments in the Legacy Portfolio and future investments, as well as interest earned from the temporary investment of cash in U.S. government securities and other high-quality debt investments that mature in one year or less. We may also fund a portion of our investments through borrowings from banks and issuances of senior securities; however, we do not have any current plans to borrow money.  We are currently selling our Shares on a continuous basis at a price of $10 which may be below NAV per Share from time to time, as approved by our stockholders.

Our aggregate borrowings (if any), secured and unsecured, are expected to be reasonable in relation to our net assets and will be reviewed by the Board of Directors, at least quarterly.  The maximum amount of such borrowing is limited by the 1940 Act.

Our primary use of funds is investing in portfolio companies, cash dividends to holders of our common stock (primarily from investment income and realized capital gains), payments to any lenders or senior security holders, and the payment of operating expenses.  If we sell all Shares registered in the IPO, we expect to have cash resources of approximately $43.5 million.

Cash Flows:

For the three months ended September 30, 2014, we experienced a net decrease in cash of $249,306. During this period, we generated $2,245,960 of cash from our financing activities and used $2,495,266 of cash in operating activities. Net cash outflow from operating activities was primarily due to investments of $3,156,122 offset by cash inflow of $790,480 and $20,781 from sales of investments and return of capital from our investments, respectively.  Cash inflow from financing activities resulted from the sale of 302,476.83 Shares with gross receipts of $3,024,594, offset by the payment of selling commissions and fees of $392,992, stockholder dividends of $255,442 and a decrease in capital pending acceptance of $130,200.

 

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We have entered into two contracts under which we have material future commitments, the Advisory Agreement, under which the Adviser serves as our investment adviser, and the Administration Agreement, under which MacKenzie furnishes us with certain non-investment management services and administrative services necessary to conduct our day-to-day operations. Each of these agreements is terminable by either party upon proper notice. Payments under the Advisory Agreement in future periods (after the up-front payment of the portfolio structuring fee during the IPO) will be (i) a percentage of the value of our Managed Funds; and (ii) incentive fees based on our income and our performance above specified hurdles (except in the year of liquidation).  Payments under the Administration Agreement will occur on an ongoing basis as expenses are incurred on our behalf by MacKenzie.  However if MacKenzie withdraws as our administrator, it will be liable for any expenses we incur as a result of such withdrawal.

Borrowings

 

The financial statements included in this report are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions.  Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require management’s most difficult, complex or subjective judgments.

We determine the NAV of our investment portfolio each quarter (and as of each bi-monthly closing when our IPO continues) by subtracting our total liabilities from the fair value of our gross assets.  We conduct the valuation of our assets and determine our NAV consistent with GAAP and the 1940 Act, and report our NAV in our periodic reports filed with the SEC under the Securities Exchange Act of 1934 (“1934 Act”).

 

We report our investments at fair value and in order to determine the fair value of investments, we follow the provisions of ASC 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements.

 

Securities for which market quotations are readily available on an exchange are valued at such price as of the closing price on the day closest to the valuation date. Where a security is traded but in limited volume, we may instead utilize the weighted average closing price of the security over the prior 10 trading days. We may also use published secondary market trading information for securities that do not trade on a national exchange in order to value assets. When doing so, we determine whether the trading price obtained is sufficient according to GAAP to determine the fair value of the security. If determined adequate, we use the trading price obtained.

 

Securities for which reliable market data are not readily available or for which the pricing source does not provide a valuation or methodology or provides a valuation or methodology that, in the judgment of the Adviser or our Board of Directors, does not represent fair value, which we expect will represent a substantial majority of the investments in our portfolio, will each be valued as follows: (i) each portfolio company or investment is initially valued by the investment professionals responsible for the portfolio investment; (ii) preliminary valuation conclusions are documented and discussed with our senior management; and (iii) the Board of Directors will discuss valuations and determine the fair value of each investment in our portfolio in good faith based on the input of the Adviser and, where appropriate and necessary, the respective third-party valuation firms.

 

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The recommendation of fair value is generally based on the following factors, as relevant:

 

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the nature and realizable value of any collateral;

 

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the portfolio company’s ability to make payments;

 

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the portfolio company’s earnings and discounted cash flow;

 

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the markets in which the issuer does business; and

 

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comparisons to publicly traded securities.

 

Securities for which market data are not readily available or for which a pricing source is not sufficient may include the following:

 

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private placements and restricted securities that do not have an active trading market;

 

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securities whose trading has been suspended or for which market quotes are no longer available;

 

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debt securities that have recently gone into default and for which there is no current market;

 

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securities whose prices are stale;

 

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securities affected by significant events; and

 

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securities that the Adviser believes were priced incorrectly.

 

Determination of fair value involves subjective judgments and estimates. Accordingly, the notes to our financial statements express the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on our financial statements.

 

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

 

Distributions to Stockholders

We began distributing dividends to our stockholders on May 9, 2014, for the first calendar quarter 2014, and to the extent that we have income from operations available, we intend to distribute quarterly dividends to our stockholders.  Our quarterly dividends, if any, will be determined by our Board of Directors after a quarterly review and distributed pro-rata to holders of our Shares. Any dividends to our stockholders will be declared out of assets legally available for distribution.  In no event are we permitted to borrow money to make distributions if the amount of such distribution would exceed our annual accrued and received revenues, less operating costs.

 

We are currently taxed at regular corporate tax rates for both federal and state income tax purposes; however, we expect to elect to be taxed as a REIT under the Code when we become eligible to make that election. If we elect to be treated as a REIT, we will be required to make distributions, other than capital gain distributions, to our stockholders each year in the amount of at least 90% of our REIT taxable income.  We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, to the extent that we issue senior securities, we will be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings.

 

Our current intention is to make any distributions in additional Shares under our DRIP to stockholders who have elected to participate in our DRIP unless participation in the DRIP is restricted by a state securities regulator.

 

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Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

Our portfolio, as well as our future investments, will primarily consist of equity and debt securities issued by smaller U.S. companies that primarily own commercial real estate that are either illiquid or not listed on any exchange, and our investments in these securities are considered speculative in nature. Our investments do and will often include securities that are subject to legal or contractual restrictions on resale that adversely affect the liquidity and marketability of such securities. As a result, we are subject to risk of loss which may prevent our stockholders from achieving price appreciation, dividend distributions and a return of their capital.

At September 30, 2014, financial instruments that subjected us to concentrations of market risk consisted principally of equity investments, which represented 73% of our total assets as of that date.  As discussed in Note 3 to our financials statement (“Investments”), these investments primarily consist of securities in companies with no readily determinable market values and as such are valued in accordance with our fair value policies and procedures. Our investment strategy represents a high degree of business and financial risk due to the fact that portfolio company investments are generally illiquid and in small and middle market companies. We may make short-term investments in cash equivalents, U.S. government securities and other high-quality investments that mature in one year or less, pending investments in portfolio companies made according to our principal investment strategy.

Item 4. CONTROLS AND PROCEDURES

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the 1934 Act) as of the end of the period covered by this report as required by paragraph (b) of Rule 13a-15 or 15d-15 of the 1934 Act.  Based upon such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective and provided reasonable assurance that information required to be disclosed by us in the reports we file or submit under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

There have been no changes in our internal control over financial reporting (identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 of the 1934 Act) during the fiscal quarter ended September 30, 2014, 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

 

None.

 

Item 1A.    RISK FACTORS