Attached files
| file | filename |
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| EXCEL - IDEA: XBRL DOCUMENT - LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II INC | Financial_Report.xls |
| EX-32.1 - EXHIBIT 32.1 - LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II INC | v404987_ex32-1.htm |
| EX-21.1 - EXHIBIT 21.1 - LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II INC | v404987_ex21-1.htm |
| EX-31.2 - EXHIBIT 31.2 - LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II INC | v404987_ex31-2.htm |
| EX-32.2 - EXHIBIT 32.2 - LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II INC | v404987_ex32-2.htm |
| EX-31.1 - EXHIBIT 31.1 - LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II INC | v404987_ex31-1.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ý Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For The Fiscal Year Ended December 31, 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 000-54047
LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC.
(Exact Name of Registrant as Specified in Its Charter)
| Maryland | 83-0511223 |
| (State or other jurisdiction | (I.R.S. Employer Identification No.) |
| of incorporation or organization) |
| 1985 Cedar Bridge Avenue, Suite 1, Lakewood, NJ | 08701 |
| (Address of principal executive offices) | (Zip code) |
Registrant's telephone number, including area code: 732-367-0129
Securities registered under Section 12(b) of the Exchange Act:
| Title of Each Class | Name of Each Exchange on Which Registered | |
| None | None |
Securities registered under Section 12(g) of the Exchange Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No ý
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 ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
As of June 30, 2014, the aggregate market value of the common shares held by non-affiliates of the registrant was $110.8 million. While there is no established market for the Registrant’s common shares, the Registrant has sold its common shares pursuant to a Form S-11 Registration Statement under the Securities Act of 1933 at a price of $10.00 per common share. As of March 23, 2015, there were approximately 18.7 million shares of common stock held by non-affiliates of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
None.
LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC.
Table of Contents
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Special Note Regarding Forward-Looking Statements
This annual report on Form 10-K, together with other statements and information publicly disseminated by Lightstone Value Plus Real Estate Investment Trust II, Inc. (the “Lightstone REIT II”) contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Exchange Act”), and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and include this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors, which are, in some cases, beyond our control and which could materially affect actual results, performances or achievements. Factors which may cause actual results to differ materially from current expectations include, but are not limited to, (i) general economic and local real estate conditions, (ii) the inability of major tenants to continue paying their rent obligations due to bankruptcy, insolvency or general downturn in their business, (iii) financing risks, such as the inability to obtain equity, debt, or other sources of financing on favorable terms, (iv) changes in governmental laws and regulations, (v) the level and volatility of interest rates and foreign currency exchange rates, (vi) the availability of suitable acquisition opportunities and (vii) increases in operating costs. Accordingly, there is no assurance that our expectations will be realized.
All forward-looking statements should be read in light of the factors identified herein at Part 1, Item 1A as well as in the “Risk Factors” section of the Registration Statement on Form S-11 (File No. 333-151532) of the Lightstone REIT II filed with the Securities and Exchange Commission (the “SEC”), as the same may be amended and supplemented from time to time.
General Description of Business
The Lightstone REIT II is a Maryland corporation, formed on April 28, 2008, which has qualified as a real estate investment trust (“REIT”) for U.S. federal income tax purposes since its taxable year ending December 31, 2009. The Lightstone REIT II was formed primarily for the purpose of engaging in the business of investing in and owning commercial and residential real estate properties located principally in North America, as well as other real estate-related investments.
The Lightstone REIT II is structured as an umbrella partnership REIT (“UPREIT”), and substantially all of its current and future business is and will be conducted through Lightstone Value Plus REIT II LP (the “Operating Partnership”), a Delaware limited partnership formed on April 30, 2008.
The Lightstone REIT II and the Operating Partnership and its subsidiaries are collectively referred to as the “Company” and the use of “we,” “our,” “us” or similar pronouns in this annual report refers to the Lightstone REIT II, its Operating Partnership or the Company as required by the context in which such pronoun is used.
Offering and Structure
Our Sponsor, David Lichtenstein (“Lichtenstein”), who does business through The Lightstone Group (the “Sponsor”) and majority owns the limited liability company of that name, is one of the largest private residential and commercial real estate owners and operators in the United States today, with a diversified portfolio of over 100 properties containing approximately 10,135 multifamily units, 1.3 million square feet of office space, 1.6 million square feet of industrial space, 24 hotels, and 3.3 million square feet of retail space. The residential, office, industrial and retail properties are located in 20 states. Based in New York, and supported by regional offices in New Jersey, Maryland and Illinois, our Sponsor employs approximately 425 staff and professionals. Our Sponsor has extensive experience in the areas of investment selection, underwriting, due diligence, portfolio management, asset management, property management, leasing, disposition, finance, accounting and investor relations.
Our advisor is Lightstone Value Plus REIT II LLC (the “Advisor”), which is wholly owned by our Sponsor. Our Advisor, together with our Board of Directors, is and will continue to be primarily responsible for making investment decisions and managing our day-to-day operations. Through his ownership and control of The Lightstone Group, Mr. Lichtenstein is the indirect owner of our Advisor and the indirect owner and manager of Lightstone SLP II LLC, the associate general partner of our Operating Partnership. Mr. Lichtenstein also acts as our Chairman and Chief Executive Officer. As a result, he controls both the general partner and associate general partner of our Operating Partnership and is the majority decision-maker of our Operating Partnership.
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We do not have and will not have any employees that are not also employed by our Sponsor or its affiliates. We depend substantially on our Advisor, which generally has responsibility for our day-to-day operations. Under the terms of the advisory agreement, the Advisor also undertakes to use its commercially reasonable best efforts to present to us investment opportunities consistent with our investment policies and objectives as adopted by our Board of Directors.
We have two affiliated property managers (our “Property Managers”), which may manage the properties we acquire. We also use other unaffiliated third-party property managers, principally for the management of our hospitality properties. Our Property Managers are Paragon Retail Property Management LLC (“Paragon”) and Beacon Property Management LLC (“Beacon”), both of which are majority owned and controlled by our Sponsor. Paragonmanages, leases, develops and redevelops all the factory outlet malls and certain retail properties controlled by our Sponsor. Beacon is a significant manager in the multi-family residential housing sector and oversees the management of approximately 10,000 multifamily units.
On April 24, 2009, we commenced an initial public offering (the “Offering”) to sell a maximum of 51.0 million shares of common stock at a price of $10 per share and 6.5 million shares of common stock available pursuant to our distribution reinvestment program (the “DRIP”). We also have 255,000 shares reserved for issuance under our employee and director incentive restricted share plan. Our Registration Statement on Form S-11 (the “Registration Statement”) was declared effective under the Securities Act of 1933 on February 17, 2009, and on April 24, 2009, we began offering shares of our common stock for sale to the public.
The Offering, which terminated on August 15, 2012, raised aggregate gross proceeds of approximately $49.8 million from the sale of approximately 5.0 million shares of common stock. After allowing for the payment of approximately $5.2 million in selling commissions and dealer manager fees and $4.5 million in organization and other offering expenses, the Offering generated aggregate net proceeds of approximately $40.1 million. In addition, through August 15, 2012 (the termination date of the Offering), the Company had issued approximately 0.3 million shares of common stock under its DRIP, representing approximately $2.9 million of additional proceeds.
The Company’s registration statement on Form S-11 (the “Follow-On Offering”), pursuant to which it offered to sell up to 30,000,000 shares of its common stock for $10.00 per share, subject to certain volume discounts (the “Primary Offering”) (exclusive of 2,500,000 shares available pursuant to its DRIP at an initial purchase price of $9.50 per share and 255,000 shares reserved for issuance under its Employee and Director Incentive Restricted Share Plan) was declared effective by SEC under the Securities Act of 1933 on September 27, 2012. The Follow-On Offering, which terminated on September 27, 2014, raised aggregate gross proceeds of approximately $127.5 million from the sale of approximately 12.9 million shares of common stock. After allowing for the payment of approximately $11.0 million in selling commissions and dealer manager fees and $4.0 million in organization and other offering expenses, the Follow-On Offering generated aggregate net proceeds of approximately $112.5 million.
The Company’s DRIP Registration Statement on Form S-3D was filed and became effective under the Securities Act of 1933 on September 26, 2014. As of December 31, 2014, 5.9 million shares remain available for issuance under our DRIP. On January 19, 2015, the Board of Directors suspended the Company’s DRIP effective April 15, 2015. For so long as the DRIP remains suspended, all future distributions will be in the form of cash.
Effective September 27, 2012, Orchard Securities, LLC (“Orchard Securities”) became the Dealer Manager of the Company’s Follow-On Offering. Orchard Securities also opened a branch office that does business as “Lightstone Capital Markets” and focuses primarily on distributing interests in programs sponsored by our Sponsor. Prior to September 27, 2012, ICON Securities Corp. (“ICON Securities”) served as the dealer manager for the Company’s offering.
All further references to the Dealer Manager will be deemed to refer to ICON Securities or Orchard Securities during the respective period of time that each was serving in such capacity.
As of December 31, 2014, the Advisor owned 20,000 shares of common stock which were issued on May 20, 2008 for $200,000, or $10.00 per share. In addition, as of September 30, 2009, the Company had reached the minimum offering under its Offering by receiving subscriptions of its common shares, representing gross offering proceeds of approximately $6.5 million, and effective October 1, 2009 investors were admitted as stockholders and the Operating Partnership commenced operations. Through the termination of the Follow-On Offering (September 27, 2014), cumulative gross offering proceeds of $177.3 million were released to the Company. The Company invested the proceeds received from the Offering, the Follow-On Offering and the Advisor in the Operating Partnership, and as a result, held a 99% general partnership interest as of December 31, 2014 in the Operating Partnership’s common units.
The Company’s shares of common stock are not currently listed on a national securities exchange. The Company may seek to list its shares of common stock for trading on a national securities exchange only if a majority of its independent directors believe listing would be in the best interest of its stockholders. The Company does not intend to list its shares at this time. The Company does not anticipate that there would be any market for its shares of common stock until they are listed for trading. In the event the Company does not obtain listing prior to the tenth anniversary of the completion or termination of its Offering, its charter requires that the Board of Directors must either (i) seek stockholder approval of an extension or amendment of this listing deadline; or (ii) seek stockholder approval to adopt a plan of liquidation of the corporation.
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Noncontrolling Interest – Partners of Operating Partnership
On May 20, 2008, the Advisor contributed $2,000 to the Operating Partnership in exchange for 200 limited partner common units in the Operating Partnership. The limited partner has the right to convert Operating Partnership common units into cash or, at our option, an equal number of our shares of our common stock, as allowed by the limited partnership agreement.
Lightstone SLP II LLC, which is wholly owned by our Sponsor, committed to purchase subordinated profits interests in our Operating Partnership (“Subordinated Profits Interests”) at a cost of $100,000 per unit for each $1.0 million in subscriptions up to ten percent of the proceeds from the primary shares under the Offering and Follow-On Offering on a semi-annual basis beginning with the quarter ended June 30, 2010. Lightstone SLP II LLC may elect to purchase the Subordinated Profits Interests with either cash or an interest in real property of equivalent value. Any proceeds received from the cash sale of the Subordinated Profits Interests will be used to offset payments made by the Company from offering proceeds to pay the dealer manager fees, selling commissions and organization and other offering expenses.
From our inception through December 31, 2014, our Sponsor contributed cash of approximately $12.9 million and elected to contribute equity interests totaling 48.6% in Brownmill, LLC (“Brownmill”), which were valued at $4.8 million, in exchange for 177.0 Subordinated Profits Interests with an aggregate value of $17.7 million. See “Sponsor’s Contribution of Equity Interests in Brownmill” below for additional information. Our Sponsor may continue to elect to contribute interests in real property in lieu of cash in exchange for Subordinated Profits Interests in order to fulfill its semi-annual commitment.
Operations - Operating Partnership Activity
Our Operating Partnership commenced its operations on October 1, 2009. Since then we have and will continue to seek to acquire and operate commercial, residential, and hospitality properties, principally in North America through our Operating Partnership. Our commercial holdings will consist of retail (primarily multi-tenanted shopping centers), lodging, industrial and office properties. All such properties may be acquired and operated by us alone or jointly with another party. In addition, we may invest up to 20% of our net assets in collateralized debt obligations, commercial mortgage-backed securities (“CMBS”) and mortgage and mezzanine loans secured, directly or indirectly, by the same types of properties which it may acquire directly.
The following summarizes our completed acquisitions for the year ended December 31, 2014:
| · | On April 1, 2014 we acquired a Holiday Inn Express Hotel & Suites (the “Holiday Inn — Opelika”) located in Opelika, Alabama; |
| · | On April 8, 2014 we acquired an Aloft Hotel (the “Aloft — Tucson”) located in Tucson, Arizona; |
| · | On October 2, 2014 we acquired a Hampton Inn Hotel (the “Hampton Inn — Fort Myers Beach”) located in Fort Myers Beach, Florida; and |
| · | On December 17, 2014, we acquired a portfolio comprised of two hotels and a land parcel located in Philadelphia, Pennsylvania, the Aloft Philadelphia Airport (the “Aloft - Philadelphia”) and the Four Points by Sheraton Philadelphia Airport (the “Four Points by Sheraton - Philadelphia”, and collectively, the “Philadelphia Airport Hotel Portfolio”) |
The following summarizes our completed acquisitions and investments from our inception through December 31, 2013:
| · | During 2009, we acquired a 32.42% Class D Member Interest in HG CMBS Finance, LLC (“HGF”), a real estate limited liability company that primarily invested in CMBS, which were sold by HGF during 2010; |
| · | We have an aggregate 48.6% equity interest in Brownmill, LLC (“Brownmill”), which includes two retail properties known as the Browntown Shopping Center and the Millburn Mall, located in Old Bridge, New Jersey and Vauxhall, New Jersey, respectively, which was acquired on June 30, 2010 (with respect to a 26.25% equity interest), December 29, 2010 (with respect to a 8.163% equity interest), December 28, 2011 (with respect to a 5.587% equity interest), June 6, 2012 (with respect to a 5.102% equity interest) and October 1, 2012 (with respect to an 3.4776% equity interest); |
| · | On January 19, 2011, we acquired a 95.0% ownership interest in a TownePlace Suites hotel (the “TownePlace Suites – Metairie”) located in Harahan, Louisiana; |
| · | On March 21, 2011, we acquired a 20.0% ownership interest in LVP CP Boston Holdings, LLC (the “CP Boston Joint Venture”), a joint venture which owns a hotel and water park located in Danvers, Massachusetts, which we subsequently disposed of on February 20, 2012 with an effective date of January 1, 2012; |
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| · | On April 12, 2011, we acquired a 10.0% ownership interest in LVP Rego Park, LLC(the “Rego Park Joint Venture”), a joint venture which owned a second mortgage loan secured by a residential apartment complex located in Queens, New York, which was paid in full on June 27, 2013; |
| · | On July 13, 2012 we acquired a SpringHill Suites by Marriott hotel (the “SpringHill Suites – Peabody”) located in Peabody, Massachusetts; |
| · | On December 31, 2012, we acquired an aggregate 87.7% ownership interest in a Fairfield Inn hotel (the “Fairfield Inn – East Rutherford”) located in East Rutherford, New Jersey as a result of the restructuring of our mortgage loan receivable secured by the Fairfield Inn – East Rutherford , which was previously acquired on June 29, 2010; and |
| · | On June 18, 2013, we acquired a 95.0% ownership interest in a portfolio comprised of two TownePlace Suites hotels (collectively, the “Arkansas Hotel Portfolio”) located in Little Rock (the “TownePlace Suites – Little Rock”) and Johnson/Springdale, Arkansas (the “TownePlace Suites – Fayetteville”), respectively. |
Related Parties
Our Advisor and Property Managers are each related parties. Each of these entities have or will receive compensation and fees for services related to our offerings (which were completed on September 27, 2014) and will continue to receive compensation and fees and services for the investment and management of our assets. These entities will receive fees during the offering, acquisition, operational and liquidation stages. The compensation levels during the offering, acquisition and operational stages are based on percentages of the offering proceeds sold, the cost of acquired properties and the annual revenue earned from such properties, and other such fees outlined in each of the respective agreements.
Primary Business Objectives and Strategies
Our primary objective is to achieve capital appreciation with a secondary objective of income without subjecting principal to undue risk. We intend to achieve this goal primarily through investments in real estate properties. We intend to use substantially all of the net proceeds from our offerings to acquire and operate a diversified portfolio of real estate investments.
If we have not provided some form of liquidity for our stockholders or if our Company is not liquidated, generally within seven to ten years after the proceeds from the Primary Offering are fully invested, we will cease reinvesting our capital and sell the properties and other assets, either on a portfolio basis or individually, or engage in another transaction approved by our Board of Directors (market conditions permitting) unless the directors, including a majority of the independent directors, determine that, in light of our expected life at any given time, it is deemed to be in the best interest of the stockholders to reinvest proceeds from property sales or refinancings. Alternatively, we may merge with, or otherwise be acquired by, an unaffiliated entity, our Sponsor or affiliates of our Sponsor.
Acquisition and Investment Policies
We have acquired and intend to continue to acquire residential and commercial properties as well as other real estate-related investments principally in North America. Our acquisitions may include both portfolios and individual properties. Unlike other REITs, which typically specialize in one sector of the real estate market, we invest and intend to continue to invest in both residential and commercial properties as well as other real estate-related investments to create a diverse portfolio of property types and take advantage of our Sponsor’s expertise in acquiring larger properties and portfolios of both residential and commercial properties. We generally intend to hold each property for seven to ten years.
We are not limited in the number, size or geographical location of any real estate assets. The number and mix of assets we acquire depends, in part, upon real estate and market conditions and other circumstances existing at the time we acquire our assets and, in part, on the net proceeds raised in our public offerings. We may expand our focus to include properties located outside the United States. If we invest in properties outside of the United States, we intend to focus on properties which we believe to have similar characteristics as those properties in which we have previous investment and management expertise. We do not anticipate that these international investments would comprise more than 10% of our portfolio. Investment in areas outside of the United States may be subject to risks different than those impacting properties in the United States.
We have made and/or expect that we will make the following types of real estate investments:
| • | Fee interests in market-rate, multifamily properties located either in or near major metropolitan areas. We will attempt to identify those sub-markets with job growth opportunities and demand demographics which support potential long-term value appreciation for multifamily properties. |
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| • | Fee interests in power shopping centers and malls located in highly trafficked retail corridors, in selected high-barrier to entry markets and sub-markets. “Power” shopping centers are large retail complexes that are generally unenclosed and located in suburban areas that typically contain one or more large brand name retailers rather than a department store anchor tenant. We will attempt to identify those sub-markets with constraints on the amount of additional property supply, which will make future competition less likely. |
| • | Fee interests in improved, multi-tenanted, industrial properties and properties that contain industrial and office space (“industrial flex”) located near major transportation arteries and distribution corridors with limited management responsibilities. |
| • | Fee interests in improved, multi-tenanted, office properties located near major transportation arteries in urban and suburban areas. |
| • | Fee interests in lodging properties located near major transportation arteries in urban and suburban areas. |
| • | Preferred equity interests in entities that own the property types listed above. |
| • | Mezzanine loans secured by the pledges of equity interests in entities that own the property types listed above. |
| • | Commercial mortgage-backed securities secured by mortgages on real property. |
| • | Collateralized debt obligations. |
| • | Investments in equity securities issued by public or private real estate companies. |
In addition, we further diversify and intend to continue to diversify our portfolio by investing up to 20% of our net assets in collateralized debt obligations, commercial mortgage-backed securities and mortgage and mezzanine loans secured, directly or indirectly, by the same types of properties which we may acquire directly. We may also acquire majority or minority interests in other entities (or business units of such entities) with investment objectives similar to ours or with management, investment or development capabilities that our Board of Directors deems desirable or advantageous to acquire.
Financing Strategy and Policies
We have and intend to continue to utilize leverage to make our investments. The number of different investments we will acquire will be affected by numerous factors, including the amount of funds available to us. When interest rates on mortgage loans are high or financing is otherwise unavailable on terms that are satisfactory to us, we may purchase certain investments for cash with the intention of obtaining a mortgage loan for a portion of the purchase price at a later time. There is no limitation on the amount we may invest in any single investment or on the amount we can borrow for the purchase of any investment.
Our charter restricts the aggregate amount we may borrow, both secured and unsecured, to 300% of net assets in the absence of a satisfactory showing that a higher level is appropriate, the approval of the Board of Directors and disclosure to the stockholders. In addition, our charter limits our aggregate long-term permanent borrowings (having a maturity greater than two years) to 75% of the aggregate fair market value of all investments unless any excess borrowing is approved by a majority of our independent directors and is disclosed to our stockholders. Our charter also prohibits us from making or investing in mortgage loans, including construction loans, on any one property if the aggregate amount of all mortgage loans outstanding on the property, including our loans, would exceed 85% of the property’s appraised value.
We may finance our investment acquisitions through a variety of means, including but not limited to single property mortgages, as well as, mortgages cross-collateralized by a pool of property and through exchange of an interest in the property for limited partnership units of the Operating Partnership. Generally, though not exclusively, we intend to seek to finance our investments with debt which will be on a non-recourse basis. However, we may, secure recourse financing or provide a guarantee to lenders, if we believe this may result in more favorable terms.
Distribution Objectives
U.S. federal income tax law requires that a REIT distribute annually at least 90% of its REIT taxable income (which does not equal net income, as calculated in accordance with generally accepted accounting principles in the United States, or GAAP) determined without regard to the deduction for dividends paid and excluding any net capital gain. In order to continue to qualify for REIT status, we may be required to make distributions in excess of cash available.
Distributions will be at the discretion of our Board of Directors. We commenced quarterly distributions beginning with the fourth quarter of 2009 and we have generally used cash proceeds from the sale of shares of our common stock to fund such distributions. We may continue to fund such distributions with cash proceeds from the sale of shares of our common stock or borrowings if we do not generate sufficient cash flow from our operations to fund distributions. Our ability to pay regular distributions and the size of these distributions will depend upon a variety of factors. For example, our borrowing policy permits us to incur short-term indebtedness, having a maturity of two years or less, and we may have to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. We cannot assure that regular distributions will continue to be made or that we will maintain any particular level of distributions that we have established or may establish.
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We are an accrual basis taxpayer, and as such our REIT taxable income could be higher than the cash available to us. We may therefore borrow to make distributions, which could reduce the cash available to us, in order to distribute 90% of our REIT taxable income as a condition to our election to be taxed as a REIT. These distributions made with borrowed funds may constitute a return of capital to stockholders. “Return of capital” refers to distributions to investors in excess of net income. To the extent that distributions to stockholders exceed earnings and profits, such amounts constitute a return of capital for U.S. federal income tax purposes, although such distributions might not reduce stockholders’ aggregate invested capital. Because our earnings and profits are reduced for depreciation and other non-cash items, it is likely that a portion of each distribution will constitute a tax-deferred return of capital for U.S. federal income tax purposes.
On March 30, 2009, our Board of Directors declared the Annualized Distribution Rate for each quarterly period commencing 30 days subsequent to achieving the minimum offering of 500,000 shares of common stock. The distribution is calculated based on stockholders of record each day during the applicable period at a rate of $0.00178082191 per share per day, and equals a daily amount that, if paid each day for a 365-day period, would equal a 6.5% annualized rate based on the share price of $10.00.
At the beginning of October 2009, we achieved our minimum offering of 500,000 shares of common stock and on November 3, 2009, our Board of Directors declared our first quarterly distribution at an annualized distribution rate (the “Annualized Distribution Rate”) for the three-month period ending December 31, 2009. Subsequently, our Board of Directors has declared regular quarterly distributions at the Annualized Distribution Rate.
Total distributions declared during the years ended December 31, 2014, 2013 and 2012 were $8.2 million, $4.1 million and $3.3 million, respectively.
On March 27, 2015, our Board of Directors declared the quarterly distribution for the three-month period ended March 31, 2015 in the amount of $0.00178082191 per share per day payable to stockholders of record on the close of business each day during the quarter, which will be paid on April 15, 2015.
DRIP and Share Repurchase Programs
Our DRIP provides our stockholders with an opportunity to purchase additional shares of our common stock at a discount by reinvesting distributions.
On January 19, 2015, the Board of Directors suspended the Company’s DRIP effective April 15, 2015. For so long as the DRIP remains suspended, all future distributions will be in the form of cash.
Our share repurchase program may provide our stockholders with limited, interim liquidity by enabling them to sell their shares of common stock back to us, subject to restrictions. From our inception through December 31, 2009, we did not receive any requests to redeem shares of our common stock under our share repurchase program. For the years ended December 31, 2014, 2013 and 2012, we redeemed 72,318, 74,927and 50,784 shares of common stock, respectively, pursuant to our share repurchase program. During the year ended December 31, 2014, we redeemed 100% of the redemption requests at an average price per share of common stock of $9.34. We funded share redemptions for the periods noted above from the cumulative proceeds of the sale of shares of common shares pursuant to our DRIP and from our operating funds.
However, our Board of Directors reserves the right to terminate either program for any reason without cause by providing written notice of termination of the DRIP to all participants or written notice of termination of the share repurchase program to all stockholders.
Tax Status
We elected to be taxed as a REIT in conjunction with the filing of our 2009 U.S. federal income tax return. If we remain qualified as a REIT, we generally will not be subject to U.S. federal income tax on our net taxable income that we distribute currently to our stockholders. To maintain our REIT qualification under the Internal Revenue Code of 1986, as amended, (the “Code”), we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders at least 90% of our REIT taxable income (which does not equal net income, as calculated in accordance with generally accepted accounting principles in the United States of America (“GAAP”), determined without regard to the deduction for dividends paid and excluding any net capital gain. If we fail to remain qualified for taxation as a REIT in any subsequent year and do not qualify for certain statutory relief provisions, our income for that year will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.
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As of December 31, 2014 and 2013, we had no material uncertain income tax positions. The tax years subsequent to and including 2010 remain open to examination by the major taxing jurisdictions to which we are subject. Additionally, even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on our undistributed income.
To maintain our qualification as a REIT, we engage in certain activities through taxable REIT subsidiaries (“TRSs”). As such, we are subject to U.S. federal and state income and franchise taxes from these activities.
Competition
The retail, lodging, office, industrial and residential real estate markets are highly competitive. We will compete in all of our markets with other owners and operators of retail, lodging, office, industrial and residential real estate. The continued development of new retail, lodging, office, industrial and residential properties has intensified the competition among owners and operators of these types of real estate in many market areas in which we intend to operate. We compete based on a number of factors that include location, rental rates, security, suitability of the property’s design to prospective tenants’ needs and the manner in which the property is operated and marketed. The number of competing properties in a particular market could have a material effect on our occupancy levels, rental rates and on the operating expenses of certain of our properties.
In addition, we will compete with other entities engaged in real estate investment activities to locate suitable properties to acquire and to locate tenants and purchasers for our properties. These competitors include other REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, lenders, governmental bodies and other entities. There are also other REITs with asset acquisition objectives similar to ours and others that may be organized in the future. Some of these competitors, including larger REITs, have substantially greater marketing and financial resources than we will have and generally may be able to accept more risk than we can prudently manage, including risks with respect to the creditworthiness of tenants. In addition, these same entities seek financing through similar channels to those sought by us. Therefore, we will compete for institutional investors in a market where funds for real estate investment may decrease.
Competition from these and other third party real estate investors may limit the number of suitable investment opportunities available to us. It may also result in higher prices, lower yields and a narrower spread of yields over our borrowing costs, making it more difficult for us to acquire new investments on attractive terms. In addition, competition for desirable investments could delay the investment of proceeds from our Follow-On Offering in desirable assets, which may in turn reduce our earnings per share and negatively affect our ability to commence or maintain distributions to stockholders.
We believe that our senior management’s experience, coupled with our financing, professionalism, diversity of properties and reputation in the industry will enable us to compete with the other real estate investment companies.
Because we are organized as an UPREIT, we believe we are well positioned within the industries in which we intend to operate to offer existing owners the opportunity to contribute those properties to our Lightstone REIT II in tax-deferred transactions using our Operating Partnership units as transactional currency. As a result, we believe we have a competitive advantage over most of our competitors that are structured as traditional REITs and non-REITs in pursuing acquisitions with tax-sensitive sellers.
Environmental
As an owner of real estate, we will be subject to various environmental laws of U.S. federal, state and local governments. Compliance with existing laws has not had a material adverse effect on our financial condition or results of operations, and management does not believe it will have such an impact in the future. However, we cannot predict the impact of unforeseen environmental contingencies or new or changed laws or regulations on properties in which we hold an interest, or on properties that may be acquired directly or indirectly in the future.
Employees
We do not have employees. We entered into an advisory agreement with our advisor on February 17, 2009, pursuant to which our Advisor supervises and manages our day-to-day operations and selects our real estate and real estate related investments, subject to oversight by our Board of Directors. We have paid and will continue to pay our Advisor fees for services related to the investment and management of our assets, and we have reimbursed and will continue to reimburse our Advisor for certain expenses incurred on our behalf.
Economic Dependence
We are dependent upon the net proceeds received from our public offerings to conduct our proposed activities. The capital required to acquire real estate and real estate related investments will be obtained from the proceeds from our public offerings and from any indebtedness that we may incur in connection with the acquisition of any real estate and real estate related investments thereafter.
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Available Information
We electronically file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports, and proxy statements, with the SEC. Stockholders may obtain copies of our filings with the SEC, free of charge, from the website maintained by the SEC at http://www.sec.gov, or at the SEC's Public Reference Room at 100 F. Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our office is located at 1985 Cedar Bridge Avenue, Lakewood, NJ 08701. Our telephone number is (732) 367-0129. Our website is www.lightstonecapitalmarkets.com.
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Set forth below are the risk factors that we believe are material to our investors. This section contains forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements on page 3. If any of the risk events described below actually occurs, our business, financial condition or results of operations could be adversely affected.
Risks Related to the Common Stock
Our common stock is not currently listed on an exchange or trading market and is illiquid. There is currently no public trading market for the shares.
Our common stock has not been listed on a stock exchange. Accordingly, we do not expect a public trading market for our shares to develop. We may never list the shares for trading on a national stock exchange or include the shares for quotation on a national market system. The absence of an active public market for our shares could impair your ability to sell our stock at a profit or at all. Therefore, our shares should be purchased as a long term investment only.
Distributions to stockholders may be reduced or not made at all.
The amount of cash available for distributions will be affected by many factors, such as our ability to buy properties as offering proceeds become available, the operating performance of the properties we acquire and many other variables. We may not be able to pay or maintain distributions or increase distributions over time. Therefore, we cannot determine what amount of cash will be available for distributions. Some of the following factors, which we believe are the material factors that can affect our ability to make distributions, are beyond our control, and a change in any one factor could adversely affect our ability to pay future distributions:
| · | Some of the properties we may acquire may be adversely affected by the recent adverse market conditions that affected real property. If our properties are adversely affected by the recent adverse market conditions, our cash flows from operations will decrease and we will have less cash available for distributions. |
| · | Cash available for distributions may be reduced if we are required to make capital improvements to properties. |
| · | Cash available to make distributions may decrease if the assets we acquire have lower cash flows than expected. |
| · | A period of time may pass between the sale of the common stock through our Follow-On Offering and our purchase of real properties. During that time, we may invest in lower yielding short term instruments, which could result in a lower yield on your investment. |
| · | In connection with future property acquisitions, we may issue additional shares of common stock and/or Operating Partnership units or interests in the entities that own our properties. We cannot predict the number of shares of common stock, units or interests that we may issue, or the effect that these additional shares might have on cash available for distributions to you. If we issue additional shares, that issuance could reduce the cash available for distributions to you. |
| · | We make distributions to our stockholders to comply with the distribution requirements of the Code, and to eliminate, or at least minimize, exposure to U.S. federal income taxes and the nondeductible REIT excise tax. Differences in timing between the receipt of income and the payment of expenses, and the effect of required debt payments, could require us to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the U.S. federal income tax benefits associated with qualifying as a REIT. |
Distributions paid from sources other than our cash flow from operations will cause us to have less funds available for the acquisition of properties and real estate-related investments and may dilute your interest in us, which may adversely affect your overall return.
We have in the past, and may in the future, pay distributions to stockholders from sources other than from our cash flow from operations. For the year ended December 31, 2014 our cash flow from operations of approximately $4.4 million was a shortfall of approximately $3.8 million, or 46%, of our distributions of approximately $8.2 million declared during such period, for the year ended December 31, 2013 our cash flow from operations of approximately $2.7 million was a shortfall of approximately $1.4 million, or 34%, of our distributions of approximately $4.1 million declared during such period, and for the year ended December 31, 2012, our cash flow from operations of approximately $1.7 million was a shortfall of approximately $1.6 million, or 48%, of our distributions of approximately $3.3 million declared during such period. If we fund distributions from sources other than cash flow from operations, we will have less funds available for acquiring properties or real estate-related investments. Our inability to acquire additional properties or real estate-related investments may have a negative effect on our ability to generate sufficient cash flow from operations to pay distributions. As a result, the return you realize on your investment may be reduced. Additionally, we may fund our distributions from borrowings, the sale of assets, or the sale of additional securities if we do not generate sufficient cash flow from operations to pay distributions. 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 may affect our ability to generate cash flows. Funding distributions from the sale of additional securities could dilute your interest in us. Payment of distributions from these sources would restrict our ability to generate sufficient cash flow from operations or would affect the distributions payable to you upon a liquidity event, which may have an adverse effect on your investment.
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Our Board of Directors may amend or terminate our DRIP.
The directors, including a majority of independent directors, may by majority vote amend or terminate the DRIP upon 30 days notice to participants. If our Board of Directors terminates our DRIP, you will not be able to reinvest your distributions to purchase our shares at a lower price, which may have a material effect on your investment.
You may not be able to receive liquidity on your investment through our share repurchase program.
Limitations on participation in our share repurchase program, and the ability of our Board of Directors to modify or terminate the plan, may restrict your ability to participate in and receive liquidity on your investment through this program.
Your percentage of ownership may become diluted if we issue new shares of stock.
Stockholders have no rights to buy additional shares of stock in the event we issue new shares of stock. We may issue common stock, convertible debt or preferred stock pursuant to a subsequent public offering or a private placement, or to sellers of properties we directly or indirectly acquire instead of, or in addition to, cash consideration. In addition, we may also issue shares under our Employee and Director Incentive Restricted Share Plan. Investors purchasing common stock in our Offering who do not participate in any future stock issues will experience dilution in the percentage of the issued and outstanding stock they own.
Our charter permits our Board of Directors to issue stock with terms that may subordinate the rights of common stockholders.
Our charter permits our Board of Directors to issue up to 110.0 million shares of stock, including 100.0 million shares of common stock and 10.0 million shares of preferred stock. In addition, our Board of Directors, without any action by our stockholders, may amend our charter from time to time to increase or decrease the aggregate number of shares or the number of shares of any class or series of stock that we have authority to issue. Our Board of Directors may classify or reclassify any unissued common stock or preferred stock into other classes or series of stock and establish the preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications and terms or conditions of redemption of any such stock. Thus, if also approved by a majority of our independent directors not otherwise interested in the transaction, our Board of Directors could authorize the issuance of preferred stock with terms and conditions that could have a priority as to distributions and amounts payable upon liquidation over the rights of the holders of our common stock. Preferred stock could also have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our common stock.
Our operations could be restricted if we become subject to the Investment Company Act of 1940.
We are not registered, and do not intend to register ourselves or any of our subsidiaries, as an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”). If we or any of our subsidiaries become obligated to register as an investment company, the registered entity would have to comply with a variety of substantive requirements under the Investment Company Act imposing, among other things:
| · | limitations on capital structure; |
| · | restrictions on specified investments; |
| · | prohibitions on transactions with affiliates; and |
| · | compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly change our operations. |
Under Section 3(a)(1)(A) of the Investment Company Act, a company is deemed to be an “investment company” if it is, or holds itself out as being, engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities. Under Section 3(a)(1)(C) of the Investment Company Act, a Company is deemed to be an “investment company” if it is engaged, or proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire “investment securities” having a value exceeding 40% of the value of its total assets (exclusive of government securities and cash items) on an unconsolidated basis, which we refer to as the “40% test.”
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Under Section 3(c)(5)(C), the SEC staff generally requires a company to maintain at least 55% of its assets directly in qualifying assets and at least 80% of its assets in qualifying assets and in a broader category of real estate related assets to qualify for this exception. Mortgage-related securities may or may not constitute such qualifying assets, depending on the characteristics of the mortgage-related securities, including the rights that the entity has with respect to the underlying loans. Our ownership of mortgage-related securities, therefore, is limited by provisions of the Investment Company Act and SEC staff interpretations.
The method we use to classify our assets for purposes of the Investment Company Act will be based in large measure upon no-action positions taken by the SEC staff in the past. These no-action positions were issued in accordance with factual situations that may be substantially different from the factual situations we may face, and a number of these no-action positions were issued more than twenty years ago. No assurance can be given that the SEC staff will concur with our classification of our assets. In addition, the SEC staff may, in the future, issue further guidance that may require us to re-classify our assets for purposes of qualifying for an exclusion from regulation under the Investment Company Act. If we are required to re-classify our assets, we may no longer be in compliance with the exclusion from the definition of an “investment company” provided by Section 3(c)(5)(C) of the Investment Company Act.
A change in the value of any of our assets could cause us or one or more of our wholly or majority-owned subsidiaries to fall within the definition of “investment company” and negatively affect our ability to maintain our exemption from regulation under the Investment Company Act. To avoid being required to register Lightstone REIT II or any of its subsidiaries as an investment company under the Investment Company Act, we may be unable to sell assets we would otherwise want to sell and may need to sell assets we would otherwise wish to retain. In addition, we may have to acquire additional income- or loss-generating assets that we might not otherwise have acquired or may have to forgo opportunities to acquire interests in companies that we would otherwise want to acquire and would be important to our investment strategy.
If we were required to register Lightstone REIT II as an investment company but failed to do so, we would be prohibited from engaging in our business and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of us and liquidate our business.
The Subordinated Profits Interests will entitle Lightstone SLP II LLC, which is wholly owned by The Lightstone Group, our Sponsor, to certain payments and distributions that will significantly reduce the distributions available to you after a 7% return.
Lightstone SLP II LLC will receive returns on its Subordinated Profits Interests that are subordinated to stockholders’ 7% return on their net investment. Distributions to stockholders will be reduced after they have received this 7% return because of the payments and distributions to Lightstone SLP II LLC in connection with its Subordinated Profits Interests which were issued as proceeds were raised in our offerings. In addition, if the advisory agreement is terminated we may repay Lightstone SLP II LLC for its investment in the Subordinated Profit Interests in connection with our offerings, which will result in a smaller pool of assets available for distribution to you.
We intend to disclose modified funds from operations, or MFFO, a non-GAAP financial measure, in future communications with investors, including documents filed with the SEC; however, MFFO is not equivalent to our net income or loss as determined under GAAP, and you should consider GAAP measures to be more relevant to our operating performance.
We will use internally, and intend to disclose to investors, MFFO, a non-GAAP financial measure. MFFO is not equivalent to our net income or loss as determined under GAAP, and you should consider GAAP measures to be more relevant to our operating performance. MFFO differs from GAAP net income by excluding gains or losses from sales of property and asset impairment write-downs, adding back depreciation and amortization, adjusting for unconsolidated partnerships and joint ventures, and further excluding 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.
Because of the manner in which MFFO differs from GAAP net income or loss, it may not be an accurate indicator of our operating performance, especially during periods in which properties are being acquired. Furthermore, MFFO is not necessarily indicative of cash flow available to fund cash needs and should not be considered 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. Neither the SEC nor any other regulatory body has passed judgment on the acceptability of the adjustments that we use to calculate funds from operations, or FFO, or MFFO. Also, because not all companies calculate MFFO the same way, comparisons with other companies may not be meaningful.”
Conflicts of Interest
There are conflicts of interest between our Advisor, our Property Managers their affiliates and us.
David Lichtenstein, our Sponsor, is the founder of The Lightstone Group, LLC which he majority owns and does business in his individual capacity under that name. Through The Lightstone Group, Mr. Lichtenstein controls and indirectly owns a majority of our Advisor, our Property Managers, and their affiliates, except for us. Our Advisor does not advise any entity other than us. However, employees of our Advisor are also employed by Lightstone Value Plus REIT LLC, the Advisor to Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone I”), Lightstone Value Plus REIT III LLC, the Advisor to Lightstone Value Plus Real Estate Investment Trust III, Inc. (“Lightstone III”) and Lightstone Real Estate Income LLC, the Advisor to Lightstone Real Estate Income Trust Inc. (“Lightstone IV” and collectively, the “Sponsor’s Other Public Programs”), all non-traded REIT with similar investment objectives to ours. Mr. Lichtenstein is one of our directors and The Lightstone Group (or an affiliated entity controlled by Mr. Lichtenstein) employs each of our officers. As a result, our operation and management may be influenced or affected by conflicts of interest arising out of our relationship with our affiliates.
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There is competition for the time and services of the personnel of our Advisor and its affiliates.
Our Sponsor and its affiliates may compete with us for the time and services of the personnel of our Advisor and its other affiliates in connection with our operation and the management of our assets. Specifically, employees of our Sponsor, the Advisor and our Property Managers will face conflicts of interest relating to time management and the allocation of resources and investment opportunities.
We do not have employees.
We and our Advisor will rely on the employees of the Sponsor and its affiliates to manage and operate our business. The Sponsor is not restricted from acquiring, developing, operating, managing, leasing or selling real estate through entities other than us and will continue to be actively involved in operations and activities other than our operations and activities. The Sponsor currently controls and/or operates other entities that own properties in many of the markets in which we may seek to invest. The Sponsor spends a material amount of time managing these properties and other assets unrelated to our business. Our business may suffer as a result because we lack the ability to manage it without the time and attention of our Sponsor’s employees.
Our Sponsor and its affiliates are general partners and Sponsors of other real estate programs having investment objectives and legal and financial obligations similar to ours. Because the Sponsor and its affiliates have interests in other real estate programs and also engage in other business activities, they may have conflicts of interest in allocating their time and resources among our business and these other activities. Our officers and directors, as well as those of the Advisor, may own equity interests in entities affiliated with our Sponsor from which we may buy properties. These individuals may make substantial profits in connection with such transactions, which could result in conflicts of interest. Likewise, such individuals could make substantial profits as the result of investment opportunities allocated to entities affiliated with the Sponsor other than us. As a result of these interests, they could pursue transactions that may not be in our best interest. Also, if our Sponsor suffers financial or operational problems as the result of any of its activities, whether or not related to our business, the ability of our Sponsor and its affiliates, our Advisor and Property Manager to operate our business could be adversely impacted.
Certain of our affiliates who provide services to us may be engaged in competitive activities.
Our Advisor, Property Managers and their respective affiliates may, in the future, be engaged in other activities that could result in potential conflicts of interest with the services that they will provide to us. In addition, the Sponsor may compete with us for both the acquisition and/or refinancing of properties of a type suitable for our investment following the final closing of our offering, and after 75% of the total gross proceeds from our offering of the shares offered for sale pursuant to our offering have been invested or committed for investment in real properties.
Our Sponsor’s Other Public Programs may be engaged in competitive activities.
Our Advisor, Property Managers and their respective affiliates through activities of our Sponsor’s Other Public Programs may be engaged in other activities that could result in potential conflicts of interest with the services that they will provide to us, including Lightstone I may compete with us for both the acquisition and/or refinancing of properties of a type suitable for our investment.
If we invest in joint ventures, the objectives of our partners may conflict with our objectives.
In accordance with one of our acquisition strategies, we may make investments in joint ventures or other partnership arrangements between us and affiliates of our Sponsor or with unaffiliated third parties. Investments in joint ventures which own real properties may involve risks otherwise not present when we purchase real properties directly. For example, our co-venturer may file for bankruptcy protection, may have economic or business interests or goals which are inconsistent with our interests or goals, or may take actions contrary to our instructions, requests, policies or objectives. Among other things, actions by a co-venturer might subject real properties owned by the joint venture to liabilities greater than those contemplated by the terms of the joint venture or other adverse consequences.
These diverging interests could result in, among other things, exposing us to liabilities of the joint venture in excess of our proportionate share of these liabilities. The partition rights of each owner in a jointly owned property could reduce the value of each portion of the divided property. Moreover, there is an additional risk that the co-venturers may not be able to agree on matters relating to the property they jointly own. In addition, the fiduciary obligation that our Sponsor or our Board of Directors may owe to our partner in an affiliated transaction may make it more difficult for us to enforce our rights.
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We may purchase real properties from persons with whom affiliates of our Advisor have prior business relationships.
If we purchase properties from third parties who have sold, or may sell, properties to our Advisors or its affiliates, our Advisor will experience a conflict between our current interests and its interest in preserving any ongoing business relationship with these sellers.
Property management services are being provided by affiliated parties.
Our Property Managers are controlled by our Sponsor, and are thus subject to an inherent conflict of interest. In addition, our Advisor may face a conflict of interest when determining whether we should dispose of any property we own that is managed by one of our Property Managers because the Property Managers may lose fees associated with the management of the property. Specifically, because the Property Managers will receive significant fees for managing our properties, our Advisor may face a conflict of interest when determining whether we should sell properties under circumstances where the Property Managers would no longer manage the property after the transaction. As a result of this conflict of interest, we may not dispose of properties when it would be in our best interests to do so.
Our Advisor and its affiliates receive fees and other compensation based upon our investments.
Some compensation is payable to our Advisor whether or not there is cash available to make distributions to our stockholders. To the extent this occurs, our Advisor and its affiliates benefit from us retaining ownership of our assets and leveraging our assets, while our stockholders may be better served by sale or disposition or not leveraging the assets. In addition, the Advisor’s ability to receive fees and reimbursements depends on our continued investment in real properties. Therefore, the interest of the Advisor and its affiliates in receiving fees may conflict with the interest of our stockholders in earning income on their investment in our common stock. Because asset management fees payable to our Advisor are based on total assets under management, including assets purchased using debt; our Advisor may have an incentive to incur a high level of leverage in order to increase the total amount of assets under management.
Our Sponsor may face conflicts of interest in connection with the management of our day-to-day operations and in the enforcement of agreements between our Sponsor and its affiliates.
The Property Managers and the Advisor will manage our day-to-day operations and properties pursuant to management agreements and an advisory agreement. With the exception of those agreements that we entered into with third party property managers, these agreements were not negotiated at arm’s length and certain fees payable by us under such agreements are paid regardless of our performance. Our Sponsor and its affiliates may be in a conflict of interest position as to matters relating to these agreements. Examples include the computation of fees and reimbursements under such agreements, the enforcement and/or termination of the agreements and the priority of payments to third parties as opposed to amounts paid to our Sponsor’s affiliates. These fees may be higher than fees charged by third parties in an arm’s length transaction as a result of these conflicts.
Title insurance services are being provided by an affiliated party. From time to time, we purchase title insurance from an agent in which our Sponsor owns a fifty percent limited partnership interest. Because this title insurance agent receives significant fees for providing title insurance, our Advisor may face a conflict of interest when considering the terms of purchasing title insurance from this agent. However, prior to our purchase of any title insurance, an independent title consultant with more than 25 years of experience in the title insurance industry reviews the transaction, and performs market research and competitive analysis on our behalf. This process results in terms similar to those that would be negotiated at an arm’s-length basis.
We may compete with other entities affiliated with our Sponsor for tenants.
The Sponsor and its affiliates, as well as our Sponsor’s Other Public Programs are not prohibited from engaging, directly or indirectly, in any other business or from possessing interests in any other business venture or ventures, including businesses and ventures involved in the acquisition, development, ownership, management, leasing or sale of real estate projects. The Sponsor, its affiliates or the Sponsor’s Other Public Programs may own and/or manage properties in most if not all geographical areas in which we expect to acquire real estate assets. Therefore, our properties may compete for tenants with other properties owned and/or managed by the Sponsor and its affiliates. The Sponsor may face conflicts of interest when evaluating tenant opportunities for our properties and other properties owned and/or managed by the Sponsor, its affiliates or the Sponsor’s Other Public Programs and these conflicts of interest may have a negative impact on our ability to attract and retain tenants.
We have the same legal counsel as our Sponsor and its affiliates.
Proskauer Rose LLP acts as legal counsel to us and also represents our Sponsor and various affiliates including our Advisor, and our Sponsor’s Other Public Programs. The interests of our Sponsor and its affiliates, including our Advisor, may become adverse to ours in the future. Under legal ethics rules, Proskauer Rose LLP may be precluded from representing us due to any conflict of interest between us and our Sponsor and its affiliates, including our Advisor.
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Members of our Board of Directors are also on the Board of Directors of Our Sponsor’s Other Public Programs.
Certain of our directors are also directors of our Sponsor’s Other Public Programs. Accordingly, each of our directors owes fiduciary duties to our Sponsor’s Other Public Programs and their respective stockholders. The duties of our directors to our Sponsor’s Other Public Programs may influence the judgment of our Board of Directors when considering issues that may affect us. For example, we are permitted to enter into a joint venture or preferred equity investment with Lour Sponsor’s Other Public Programs for the acquisition of property or real estate-related investments. Decisions of our Board of Directors regarding the terms of those transactions may be influenced by our directors’ duties to our Sponsor’s Other Public Programs and their respective stockholders.
Risks Related to our Organization, Structure and Management
Anti-takeover provisions may have the effect of preventing a change of control.
Because of the way we are organized, we would be a difficult takeover target. Certain provisions in our charter, bylaws, Operating Partnership agreement, advisory agreement and Maryland law may have the effect of discouraging a third party from making an acquisition proposal and could thereby depress the price of our stock and inhibit a management change.
There are ownership limits and restrictions on transferability and ownership in our charter.
In order for us to qualify as a REIT, no more than 50% of the outstanding shares of our stock may be beneficially owned, directly or indirectly, by five or fewer individuals at any time during the last half of each taxable year. To make sure that we will not fail to qualify as a REIT under this test, our charter provides that, subject to some exceptions, no person may beneficially own (i) more than 9.8% in value of our aggregate outstanding stock or (ii) more than 9.8% in value or in the number of outstanding shares or any class or series of our stock, including our common stock. Our Board of Directors may exempt a person from the 9.8% ownership limit upon the receipt of certain representation and undertakings required by our charter and such other conditions as the Board of Directors may direct. However, our Board of Directors may not grant an exemption from the 9.8% ownership limit to any proposed transferee if it would result in our being “closely held” within the meaning of the Code or otherwise failing to qualify as a REIT.
This restriction may:
| · | Have the effect of delaying, deferring or preventing a change in control of us, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of our common stock; or |
| · | Compel a stockholder who had acquired more than 9.8% of our stock to dispose of the additional shares and, as a result to forfeit the benefits of owning the additional shares. |
Our charter permits our Board of Directors to issue preferred stock with terms that may discourage a third party from acquiring us. Our charter authorizes us to issue additional authorized but unissued shares of common stock or preferred stock. In addition, our Board of Directors may classify or reclassify any unissued shares of common stock or preferred stock into other classes or series of stock and may set the preferences, conversion or other rights, voting powers, restrictions and limitations as to dividends or other distributions, qualifications and terms and conditions of redemption of the classified or reclassified shares. Our Board of Directors could establish a series of preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for the common stock or otherwise be in the best interest of our stockholders.
If our Advisor loses or is unable to obtain key personnel, our ability to implement our investment strategies could be hindered, which could adversely affect our ability to make distributions and the value of your investment.
Our success depends to a significant degree upon the contributions of certain of our executive officers and other key personnel of our Advisor. In particular, we depend on the skills and expertise of David Lichtenstein, who, subject to the oversight of our Board of Directors, directs our investment strategies. Neither we nor our Advisor has employment agreements with any of our or its key personnel, including Mr. Lichtenstein, and we cannot guarantee that all, or any particular one, will remain affiliated with us or our Advisor. If any of our key personnel were to cease their affiliation with our Advisor, our operating results could suffer.
Further, we do not intend to separately maintain key person life insurance that would provide us with proceeds in the event of the death or disability of Mr. Lichtenstein or any of our key personnel. We believe our future success depends upon our Advisor’s ability to hire and retain highly skilled managerial, operational and marketing personnel. Competition for such personnel is intense, and we cannot assure you that our Advisor will be successful in attracting and retaining such skilled personnel. If our Advisor loses or is unable to obtain the services of key personnel, our ability to implement our investment strategies could be delayed or hindered, and the value of your investment could decline.
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The Operating Partnership agreement contains provisions that may discourage a third party from acquiring us.
A limited partner in Lightstone Value Plus REIT II LP, a Delaware limited partnership and our Operating Partnership, has the option to exchange his or her limited partnership units for cash or, at our option, shares of our common stock. Those exchange rights are generally not exercisable until the limited partner has held those limited partnership units for more than one year. However, if we or the Operating Partnership propose to engage in any merger, consolidation or other combination with or into another person or a sale of all or substantially all of our assets, or a liquidation, or any reclassification, recapitalization or change of common and preferred stock into which a limited partnership common unit may be exchanged, each holder of a limited partnership unit will have the right to exchange the partnership unit into cash or, at our option, shares of common stock, prior to the stockholder vote on the transaction. As a result, limited partnership unit holders who timely exchange their units prior to the record date for the stockholder vote on any transaction will be entitled to vote their shares of common stock with respect to the transaction. The additional shares that might be outstanding as a result of these exchanges of limited partnership units may deter an acquisition proposal.
Maryland law may discourage a third party from acquiring us.
Certain provisions of Maryland law restrict mergers and other business combinations and provide that holders of control shares of a Maryland corporation acquired in a control share acquisition may have limited voting rights. The business combination statute could have the effect of discouraging offers from third parties to acquire us and increasing the difficulty of successfully completing this type of offer. The control share statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer. Our bylaws contain a provision exempting from the control share acquisition statute any acquisition by any person of shares of our stock, however, this provision may be amended or eliminated at any time in the future.
Management and Policy Changes
Our rights and the rights of our stockholders to take action against the directors and the Advisor are limited.
Maryland law provides that a director has no liability in that capacity if he or she performs his duties in good faith, in a manner he or she reasonably believes to be in the best interests of the corporation and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Subject to the restrictions discussed below, our charter, in the case of our directors and officers, and our charter and the advisory agreement, in the case of the Advisor, require us generally to indemnify our directors and officers and the Advisor for actions taken on our behalf, determined in good faith and in our best interest and without negligence or misconduct or, in the case of independent directors, without gross negligence or willful misconduct. We may, with the approval of our Board of Directors, provide indemnification to any of our employees or agents. As a result, we and the stockholders may have more limited rights against our directors, officers, employees and agents, and the Advisor than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by our directors, officers, employees and agents or the Advisor in some cases.
Stockholders have limited control over changes in our investment objectives and strategies.
Our Board of Directors determines our investment objectives, financing, growth, debt capitalization, REIT qualification and distributions. Subject to the investment objectives and limitations set forth in our charter, our Board of Directors may amend or revise these and other objectives and strategies. Stockholders will have limited control over changes in our objectives and strategies.
If we internalize our external management functions, your interest in us could be diluted, and we could incur other significant costs associated with being self-managed.
Our strategy may involve becoming “self-managed” by internalizing our management functions, particularly if we seek to list our shares on an exchange as a way of providing our stockholders with a liquidity event. The method by which we could internalize these functions could take many forms. We may hire our own group of executives and other employees or we may elect to negotiate to acquire our advisor’s and Property Managers’ assets and personnel. At this time, we cannot be sure of the form or amount of consideration or other terms relating to any such acquisition. Such consideration could take many forms, including cash payments, promissory notes and shares of our stock. An internalization transaction could result in significant payments to affiliates of our advisor irrespective of whether you enjoyed satisfactory returns on your investment. The payment of such consideration could result in dilution of your interests as a stockholder and could reduce the net income per Common Share and MFFO per Common Share attributable to your investment. We will not be required to seek a stockholder vote to become self-managed.
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In addition, our direct expenses would include general and administrative costs, including legal, accounting and other expenses related to corporate governance and SEC reporting and compliance. If stockholders or other interested parties file a lawsuit related to, or challenging, an internalization transaction, we could incur high litigation costs that would adversely affect the value of your shares. We also would incur the compensation and benefits costs of our officers and other employees and consultants that are now paid by our advisor or its affiliates. In addition, we may issue restricted shares under our Employee and Director Incentive Restricted Share Plan, which awards would decrease net income and MFFO and may further dilute your investment. We cannot reasonably estimate the amount of fees to our advisor and its affiliates we would save and the costs we would incur if we became self-managed. If the expenses we assume as a result of an internalization are higher than the expenses we avoid paying to our advisor and its affiliates, our net income per Common Share and FFO per Common Share would be lower as a result of the internalization than it otherwise would have been, potentially decreasing the amount of funds available to distribute to our stockholders and the value of our shares.
As currently organized, we do not directly employ any employees. If we elect to internalize our operations, we would employ personnel and would be subject to potential liabilities commonly faced by employers, such as workers disability and compensation claims, potential labor disputes and other employee-related liabilities and grievances. Nothing in our charter prohibits us from entering into the transaction described above.
Additionally, there is no assurance that internalizing our management functions will prove to be beneficial to us and our stockholders. We could have difficulty integrating our management functions as a stand-alone entity. Certain personnel of our advisor and its affiliates perform property management, asset management and general and administrative functions, including accounting and financial reporting, for multiple entities. We could fail to properly identify the appropriate mix of personnel and capital needs to operate as a stand-alone entity. An inability to manage an internalization transaction effectively could thus result in our incurring excess costs or suffering deficiencies in our disclosure controls and procedures or our internal control over financial reporting. Such deficiencies could cause us to incur additional costs, and our management’s attention could be diverted from most effectively managing our portfolio of investments.”
Certain of our affiliates will receive substantial fees prior to the payment of distributions to our stockholders.
We will pay or cause to be paid substantial compensation to our, Advisor, Property Managers and affiliates and their employees. In general, this compensation will not be dependent on our success or profitability. These payments are payable before the payment of distributions to our stockholders and none of these payments are subordinated to a specified return to our stockholders. Also, although our Property Managers, affiliates of our Sponsor, will receive compensation under management agreements prior to the payment of distributions to our stockholders. In addition, other affiliates of our Sponsor may from time to time provide services to us if approved by the disinterested directors. It is possible that we could obtain such goods and services from unrelated persons at a lesser price.
Limitations on Liability and Indemnification
The liability of directors and officers is limited.
Subject to any additional limitations set forth in our charter, our directors and officers will not be liable to us or our stockholders for monetary damages unless the director or officer actually received an improper benefit or profit in money, property or services, or is adjudged to be liable to us or our stockholders based on a finding that his or her action, or failure to act, was the result of active and deliberate dishonesty and was material to the cause of action adjudicated in the proceeding.
Our directors are also required to act in good faith in a manner believed by them to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. A director who performs his or her duties in accordance with the foregoing standards should not be liable to us or any other person for failure to discharge his obligations as a director. We are permitted to purchase and maintain insurance or provide similar protection on behalf of any directors, officers, employees and agents, including our Advisor and its affiliates, against any liability asserted which was incurred in any such capacity with us or arising out of such status, except as limited by our charter. This may result in us having to expend significant funds, which will reduce the available cash for distribution to our stockholders.
We may indemnify our directors, officers and agents against loss.
Under our charter, we will, under specified conditions, indemnify and pay or reimburse reasonable expenses to our directors, officers, employees and other agents, including our Advisor and its affiliates, against all liabilities incurred in connection with their serving in such capacities, subject to the limitations set forth in our charter. Our Advisor and its affiliates may be indemnified and held harmless from liability only if it has been determined in good faith that its actions were in our best interests and it has acted in a manner not constituting negligence or misconduct. We may also enter into any contract for indemnity and advancement of expenses in this regard. This may result in us having to expend significant funds, which will reduce the available cash for distribution to our stockholders.
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Risks Associated with Our Properties and the Market
Real Estate Investment Risks
Our cash flows from real estate investments may become insufficient to pay our operating expenses and to cover the distributions we have paid and/or declared.
We intend to rely primarily on our cash flow from our investments to pay our operating expenses and, once the proceeds of our Follow-On offering are fully invested, to make distributions to our stockholders. The cash flow from equity investments in commercial and residential properties depends on the amount of revenue generated and expenses incurred in operating the properties. If the properties we invest in fail to generate revenue that is sufficient to meet operating expenses, debt service, and capital expenditures, our income and ability to make distributions to stockholders will be adversely affected. We cannot assure you that we will be able to maintain sufficient cash flows to fund operating expenses and debt service payments and distributions at any particular level, if at all. The sufficiency of cash flow to fund future distributions will depend on the performance of our real property investments.
Economic conditions may adversely affect our income.
A commercial or residential property’s income and value may be adversely affected by national and regional economic conditions, local real estate conditions such as an oversupply of properties or a reduction in demand for properties, availability of “for sale” properties, competition from other similar properties, our ability to provide adequate maintenance, insurance and management services, increased operating costs (including real estate taxes), the attractiveness and location of the property and changes in market rental rates. A rise in energy costs could result in higher operating costs, which may affect our results from operations. Our income will be adversely affected if a significant number of tenants are unable to pay rent or if our properties cannot be rented on favorable terms. Additionally, if tenants of properties that we lease on a triple-net basis fail to pay required tax, utility and other impositions, we could be required to pay those costs, which would adversely affect funds available for future acquisitions or cash available for distributions. Our performance is linked to economic conditions in the regions where our properties will be located and in the market for residential, office, retail and industrial space generally. Therefore, to the extent that there are adverse economic conditions in those regions, and in these markets generally, that impact the applicable market rents, such conditions could result in a reduction of our income and cash available for distributions and thus affect the amount of distributions we can make to you.
The profitability of our acquisitions is uncertain.
Acquisition of properties entails risks that investments will fail to perform in accordance with expectations. In undertaking these acquisitions, we will incur certain risks, including the expenditure of funds on, and the devotion of management’s time to, transactions that may not come to fruition. Additional risks inherent in acquisitions include risks that the properties will not achieve anticipated occupancy levels and that estimates of the costs of improvements to bring an acquired property up to standards established for the market position intended for that property may prove inaccurate.
Real estate investments are illiquid.
Because real estate investments are relatively illiquid, our ability to vary our portfolio promptly in response to economic or other conditions will be limited. In addition, certain significant expenditures, such as debt service, real estate taxes, and operating and maintenance costs generally are not reduced in circumstances resulting in a reduction in income from the investment. The foregoing and any other factor or event that would impede our ability to respond to adverse changes in the performance of our investments could have an adverse effect on our financial condition and results of operations.
Rising expenses could reduce cash flow and funds available for future acquisitions.
Our properties will be subject to increases in tax rates, utility costs, operating expenses, insurance costs, repairs and maintenance, administrative and other expenses. While some of our properties may be leased on a triple-net-lease basis or require the tenants to pay a portion of the expenses, renewals of leases or future leases may not be negotiated on that basis, in which event we will have to pay those costs. If we are unable to lease properties on a triple-net-lease basis or on a basis requiring the tenants to pay all or some of the expenses, we would be required to pay those costs, which could adversely affect funds available for future acquisitions or cash available for distributions.
We will depend on tenants who lease from us on a triple-net basis to pay the appropriate portion of expenses.
If the tenants who lease from us on a triple-net basis fail to pay required tax, utility and other impositions, we could be required to pay those costs for properties we invest in, which would adversely affect funds available for future acquisitions or cash available for distributions. If we lease properties on a triple-net basis, we run the risk of tenant default or downgrade in the tenant’s credit, which could lead to default and foreclosure on the underlying property.
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If we purchase assets at a time when the commercial and residential real estate market is experiencing substantial influxes of capital investment and competition for properties, the real estate we purchase may not appreciate or may decrease in value.
The commercial and residential real estate markets may experience substantial influxes of capital from investors. This substantial flow of capital, combined with significant competition for real estate, may result in inflated purchase prices for such assets. To the extent we purchase real estate in such an environment, we are subject to the risk that if the real estate market ceases to attract the same level of capital investment in the future as it is currently attracting, or if the number of companies seeking to acquire such assets decreases, our returns will be lower and the value of our assets may not appreciate or may decrease significantly below the amount we paid for such assets.
The bankruptcy or insolvency of a major commercial tenant would adversely impact us.
Any or all of our commercial tenants, or a guarantor of a commercial tenant’s lease obligations, could be subject to a bankruptcy proceeding. The bankruptcy or insolvency of a significant commercial tenant or a number of smaller commercial tenants would have an adverse impact on our income and our ability to pay distributions because a tenant or lease guarantor bankruptcy could delay efforts to collect past due balances under the relevant leases, and could ultimately preclude full collection of these sums. Such an event could cause a decrease or cessation of rental payments, which would mean a reduction in our cash flow and the amount available for distributions to stockholders.
Generally, under bankruptcy law, a tenant has the option of continuing or terminating any unexpired lease. In the event of a bankruptcy, we cannot assure you that the tenant or its trustee will continue our lease. If a given lease, or guaranty of a lease, is not assumed, our cash flow and the amounts available for distributions to you may be adversely affected. If the tenant continues its current lease, the tenant must cure all defaults under the lease and provide adequate assurance of its future performance under the lease. If the tenant terminates the lease, we will lose future rent under the lease and our claim for past due amounts owing under the lease will be treated as a general unsecured claim and may be subject to certain limitations. General unsecured claims are the last claims paid in a bankruptcy and therefore this claim could be paid only in the event funds were available, and then only in the same percentage as that realized on other unsecured claims.
The terms of new leases may adversely impact our income.
Even if the tenants of the properties we invest in do renew their leases, or we relet the units to new tenants, the terms of renewal or reletting may be less favorable than current lease terms. If the lease rates upon renewal or reletting are significantly lower than expected rates, then our results of operations and financial condition will be adversely affected. As noted above, certain significant expenditures associated with each equity investment in real estate (such as mortgage payments, real estate taxes and maintenance costs) are generally not reduced when circumstances result in a reduction in rental income.
We depend on commercial tenants for our revenue and therefore our revenue may depend on the success and economic viability of our commercial tenants. Our reliance on single or significant commercial tenants in certain buildings may decrease our ability to lease vacated space.
Our financial results will depend in part on leasing space in the properties we acquire to tenants on economically favorable terms. A default by a commercial tenant, the failure of a guarantor to fulfill its obligations or other premature termination of a lease, or a commercial tenant’s election not to extend a lease upon its expiration could have an adverse effect on our income, general financial condition and ability to pay distributions. Therefore, our financial success depends on the success of the businesses operated by the commercial tenants of our properties.
Lease payment defaults by commercial tenants would most likely cause us to reduce the amount of distributions to stockholders. In the event of a tenant default, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-letting our property. A default by a significant commercial tenant or a substantial number of commercial tenants at any one time on lease payments to us would cause us to lose the revenue associated with such lease(s) and cause us to have to find an alternative source of revenue to meet mortgage payments and prevent a foreclosure if the property is subject to a mortgage. Therefore, lease payment defaults by tenants could cause us to reduce the amount of distributions to stockholders.
Even if the tenants of our properties do renew their leases or we relet the units to new tenants, the terms of renewal or reletting may be less favorable than current lease terms. If the lease rates upon renewal or reletting are significantly lower than expected rates, then our results of operations and financial condition will be adversely affected. Commercial tenants may have the right to terminate their leases upon the occurrence of certain customary events of default and, in other circumstances, may not renew their leases or, because of market conditions, may be able to renew their leases on terms that are less favorable to us than the terms of the current leases. If a lease is terminated, we cannot assure you that we will be able to lease the property for the rent previously received or sell the property without incurring a loss. Therefore, the weakening of the financial condition of a significant commercial tenant or a number of smaller commercial tenants and vacancies caused by defaults of tenants or the expiration of leases may adversely affect our operations.
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A property that incurs a vacancy could be difficult to re-lease.
A property may incur a vacancy either by the continued default of a tenant under its lease or the expiration of one of our leases. If we terminate any lease following a default by a lessee, we will have to re-lease the affected property in order to maintain our qualification as a REIT. If a tenant vacates a property, we may be unable either to re-lease the property for the rent due under the prior lease or to re-lease the property without incurring additional expenditures relating to the property. In addition, we could experience delays in enforcing our rights against, and collecting rents (and, in some cases, real estate taxes and insurance costs) due from a defaulting tenant. Any delay we experience in re-leasing a property or difficulty in re-leasing at acceptable rates may reduce cash available to make distributions to our stockholders.
In many cases, tenant leases contain provisions giving the tenant the exclusive right to sell particular types of merchandise or provide specific types of services within the particular retail center, or limit the ability of other tenants to sell such merchandise or provide such services. When re-leasing space after a vacancy is necessary, these provisions may limit the number and types of prospective tenants for the vacant space.
We also may have to incur substantial expenditures in connection with any re-leasing. A number of our properties may be specifically suited to the particular needs of our tenants. Therefore, we may have difficulty obtaining a new tenant for any vacant space we have in our properties, particularly if the floor plan of the vacant space limits the types of businesses that can use the space without major renovation. If the vacancy continues for a long period of time, we may suffer reduced revenues resulting in less cash to be distributed to stockholders. As noted above, certain significant expenditures associated with each equity investment (such as mortgage payments, real estate taxes and maintenance costs) are generally not reduced when circumstances cause a reduction in income from the investment. The failure to re-lease or to re-lease on satisfactory terms could result in a reduction of our income, funds from operations and cash available for distributions and thus affect the amount of distributions to you. In addition, the resale value of the property could be diminished because the market value of a particular property will depend principally upon the value of the leases of such property.
We may be unable to sell a property if or when we decide to do so.
We may give some commercial tenants the right, but not the obligation, to purchase their properties from us beginning a specified number of years after the date of the lease. Some of our leases also generally provide the tenant with a right of first refusal on any proposed sale provisions. These policies may lessen the ability of the Advisor and our Board of Directors to freely control the sale of the property.
Although we may grant a lessee a right of first offer or option to purchase a property, there is no assurance that the lessee will exercise that right or that the price offered by the lessee in the case of a right of first offer will be adequate. In connection with the acquisition of a property, we may agree on restrictions that prohibit the sale of that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. Even absent such restrictions, the real estate market is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control. We may not be able to sell any property for the price or on the terms set by us, and prices or other terms offered by a prospective purchaser may not be acceptable to us. We cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. We may be required to expend funds to correct defects or to make improvements before a property can be sold. We may not have funds available to correct such defects or to make such improvements.
We may not make a profit if we sell a property.
The prices that we can obtain when we determine to sell a property will depend on many factors that are presently unknown, including the operating history, tax treatment of real estate investments, demographic trends in the area and available financing. There is a risk that we will not realize any significant appreciation on our investment in a property. Accordingly, your ability to recover all or any portion of your investment under such circumstances will depend on the amount of funds so realized and claims to be satisfied there from.
We may incur liabilities in connection with properties we acquire.
Our anticipated acquisition activities are subject to many risks. We may acquire properties or entities that are subject to liabilities or that have problems relating to environmental condition, state of title, physical condition or compliance with zoning laws, building codes, or other legal requirements. In each case, our acquisition may be without any recourse, or with only limited recourse, with respect to unknown liabilities or conditions. As a result, if any liability were asserted against us relating to those properties or entities, or if any adverse condition existed with respect to the properties or entities, we might have to pay substantial sums to settle or cure it, which could adversely affect our cash flow and operating results. We will attempt to obtain appropriate representations and indemnities from the sellers of the properties or entities we acquire, although it is possible that the sellers may not have the resources to satisfy their indemnification obligations if a liability arises. Unknown liabilities to third parties with respect to properties or entities acquired might include:
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| · | liabilities for clean-up of undisclosed environmental contamination; |
| · | claims by tenants, vendors or other persons dealing with the former owners of the properties; |
| · | liabilities incurred in the ordinary course of business; and |
| · | claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties. |
Competition with third parties in acquiring and operating properties may reduce our profitability and the return on your investment.
We compete with many other entities engaged in real estate investment activities, many of which have greater resources than we do. Specifically, there are numerous commercial developers, real estate companies, REITs and U.S. institutional and foreign investors that operate in the markets in which we may operate, that will compete with us in acquiring residential, office, retail, lodging, industrial and other properties that will be seeking investments and tenants for these properties. Many of these entities have significant financial and other resources, including operating experience, allowing them to compete effectively with us. Competitors with substantially greater financial resources than us may generally be able to accept more risk than we can prudently manage, including risks with respect to the creditworthiness of entities in which investments may be made or risks attendant to a geographic concentration of investments. In addition, those competitors that are not REITs may be at an advantage to the extent they can utilize working capital to finance projects, while we will be required by the annual distribution provisions under the Code to distribute significant amounts of cash from operations to our stockholders. Demand from third parties for properties that meet our investment objectives could result in an increase in the price of such properties. If we pay higher prices for properties, our profitability may be reduced and you may experience a lower return on your investment. In addition, our properties may be located in close proximity to other properties that will compete against our properties for tenants. These competing properties may be better located and/or appointed than the properties that we will acquire, giving these properties a competitive advantage over our properties, and we may, in the future, face additional competition from properties not yet constructed or even planned. This competition could adversely affect our business. The number of competitive properties could have a material effect on our ability to rent space at our properties and the amount of rents charged. We could be adversely affected if additional competitive properties are built in locations competitive with our properties, causing increased competition for residential renters, retail customer traffic and creditworthy commercial tenants. In addition, our ability to charge premium rental rates to tenants may be negatively impacted. This increased competition may increase our costs of acquisitions or lower the occupancies and the rent we may charge tenants. This could result in decreased cash flow from tenants and may require us to make capital improvements to properties which we would not have otherwise made, thus affecting cash available for distributions to you.
We may not have control over costs arising from rehabilitation of properties.
We may elect to acquire properties which may require rehabilitation. In particular, we may acquire affordable properties that we will rehabilitate and convert to market rate properties. Consequently, we intend to retain independent general contractors to perform the actual physical rehabilitation work and will be subject to risks in connection with a contractor’s ability to control rehabilitation costs, the timing of completion of rehabilitation, and a contractor’s ability to build in conformity with plans and specifications.
We may incur losses as a result of defaults by the purchasers of properties we sell in certain circumstances.
Under certain circumstances, we may sell our properties by providing financing to purchasers. When we provide financing to purchasers, we will bear the risk of default by the purchaser and will be subject to remedies provided by law. There are no limitations or restrictions on our ability to take purchase money obligations. We may incur losses as a result of such defaults, which may adversely affect our available cash and our ability to make distributions to stockholders.
We may experience energy shortages and allocations.
There may be shortages or increased costs of fuel, natural gas, water, electric power or allocations thereof by suppliers or governmental regulatory bodies in the areas where we purchase properties, in which event the operation of our properties may be adversely affected. Increased costs of fuel may reduce discretionary spending on luxury retail items, which may adversely affect our retail tenants if we purchase retail properties. Our revenues will be dependent upon payment of rent by retailers, which may be particularly vulnerable to uncertainty in the local economy and rising costs of energy for their customers. Such adverse economic conditions could affect the ability of our tenants to pay rent, which could have a material adverse effect on our operating results and financial condition, as well as our ability to pay distributions to you.
We have limited experience with international investments.
Neither we nor our Sponsor, The Lightstone Group, or any of its affiliates has any substantial experience investing in properties or other real estate-related assets located outside the United States. We may acquire real estate assets located outside the United States and may make or purchase mortgage or mezzanine loans made by a buyer located outside of the United States or secured by property located outside of the United States. We may not have the expertise necessary to maximize the return on our international investments.
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Your investment may be subject to additional risks if we make international investments.
We may purchase real estate assets located outside the United States and may make or purchase mortgage or mezzanine loans or joint venture interests in mortgage or mezzanine loans made by a borrower located outside the United States or secured by property located outside the United States. Any international investments may be affected by factors peculiar to the laws of the jurisdiction in which the borrower or the property is located. These laws may expose us to risks that are different from and in addition to those commonly found in the United States. Foreign investments could be subject to the following risks:
| · | governmental laws, rules and policies, including laws relating to the foreign ownership of real property or mortgages and laws relating to the ability of foreign persons or corporations to remove profits earned from activities within the country to the person’s or corporation’s country of origin; |
| · | variations in currency exchange rates or exchange controls or other currency restrictions and fluctuations in exchange ratios related to foreign currency; |
| · | adverse market conditions caused by inflation or other changes in national or local economic conditions; |
| · | changes in relative interest rates; |
| · | changes in the availability, cost and terms of mortgage funds resulting from varying national economic policies; |
| · | changes in real estate and other tax rates, the tax treatment of transaction structures and other changes in operating expenses in a particular country where we have an investment; |
| · | lack of uniform accounting standards (including availability of information in accordance with GAAP); |
| · | changes in land use and zoning laws; |
| · | more stringent environmental laws or changes in these laws; |
| · | changes in the social stability or other political, economic or diplomatic developments in or affecting a country where we have an investment; |
| · | legal and logistical barriers to enforcing our contractual rights; and |
| · | expropriation, confiscatory taxation and nationalization of our assets located in the markets where we operate. |
Any of these risks could have an adverse effect on our business, results of operations and ability to pay distributions to our stockholders.
We may acquire properties with lockout provisions which may prohibit us from selling a property, or may require us to maintain specified debt levels for a period of years on some properties.
We may acquire properties in exchange for Operating Partnership units and agree to restrictions on sales or refinancing, called “lockout” provisions that are intended to preserve favorable tax treatment for the owners of such properties who sell them to us. Lockout provisions may restrict sales or refinancings for a certain period in order to comply with the applicable government regulations. Lockout provisions could materially restrict us from selling or otherwise disposing of or refinancing properties. This would affect our ability to turn our investments into cash and thus affect cash available to return capital to stockholders. Lockout provisions could impair our ability to take actions during the lockout period that would otherwise be in the best interests of our stockholders and, therefore, might have an adverse impact on the value of the shares, relative to the value that would result if the lockout provisions did not exist. In particular, lockout provisions could preclude us from participating in major transactions that could result in a disposition of our assets or a change in control even though that disposition or change in control might be in the best interests of our stockholders.
Changes in applicable laws may adversely affect the income and value of our properties.
The income and value of a property may be affected by such factors as environmental, rent control and other laws and regulations, changes in applicable general and real estate tax laws (including the possibility of changes in U.S. federal income tax laws or the lengthening of the depreciation period for real estate) and interest rates, the availability of financing, acts of nature (such as hurricanes and floods) and other factors beyond our control.
Retail Industry Risks
Retail conditions may adversely affect our income.
A retail property’s revenues and value may be adversely affected by a number of factors, many of which apply to real estate investment generally, but which also include trends in the retail industry and perceptions by retailers or shoppers of the safety, convenience and attractiveness of the retail property. In addition, to the extent that the investing public has a negative perception of the retail sector, the value of our common stock may be negatively impacted.
Some of our leases may provide for base rent plus contractual base rent increases. A number of our retail leases may also include a percentage rent clause for additional rent above the base amount based upon a specified percentage of the sales our tenants generate. Generally, retailers face declining revenues during downturns in the economy. As a result, the portion of our revenue which we may derive from percentage rent leases could decline upon a general economic downturn.
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Our revenue will be impacted by the success and economic viability of our anchor retail tenants. Our reliance on single or significant tenants in certain buildings may decrease our ability to lease vacated space.
In the retail sector, any tenant occupying a large portion of the gross leasable area of a retail center, a tenant of any of the triple-net single-user retail properties outside the primary geographical area of investment, commonly referred to as an anchor tenant, or a tenant that is our anchor tenant at more than one retail center, may become insolvent, may suffer a downturn in business, or may decide not to renew its lease. Any of these events would result in a reduction or cessation in rental payments to us and would adversely affect our financial condition. A lease termination by an anchor tenant could result in lease terminations or reductions in rent by other tenants whose leases permit cancellation or rent reduction if another tenant’s lease is terminated. We may own properties where the tenants may have rights to terminate their leases if certain other tenants are no longer open for business. These “co-tenancy” provisions may also exist in some leases where we own a portion of a retail property and one or more of the anchor tenants leases space in that portion of the center not owned or controlled by us. If such tenants were to vacate their space, tenants with co-tenancy provisions would have the right to terminate their leases with us or seek a rent reduction from us. In such event, we may be unable to re-lease the vacated space. Similarly, the leases of some anchor tenants may permit the anchor tenant to transfer its lease to another retailer. The transfer to a new anchor tenant could cause customer traffic in the retail center to decrease and thereby reduce the income generated by that retail center. A lease transfer to a new anchor tenant could also allow other tenants to make reduced rental payments or to terminate their leases at the retail center. In the event that we are unable to re-lease the vacated space to a new anchor tenant, we may incur additional expenses in order to re-model the space to be able to re-lease the space to more than one tenant.
Competition with other retail channels may reduce our profitability and the return on your investment.
Retail tenants will face potentially changing consumer preferences and increasing competition from other forms of retailing, such as discount shopping centers, outlet centers, upscale neighborhood strip centers, catalogues and other forms of direct marketing, discount shopping clubs, internet and telemarketing. Other retail centers within the market area of properties we invest in will compete with our properties for customers, affecting their tenants’ cash flows and thus affecting their ability to pay rent. In addition, tenants’ rent payments may be based on the amount of sales revenue that they generate. If these tenants experience competition, the amount of their rent may decrease and our cash flow will decrease.
Residential Industry Risks
The short-term nature of our residential leases may adversely impact our income.
Because substantially all of our residential leases will be for apartments, they will generally be for terms of no more than one or two years. If our residents decide not to renew their leases upon expiration, we may not be able to relet their units. If we are unable to promptly renew the leases or relet the units then our results of operations and financial condition will be adversely affected. Certain significant expenditures associated with each equity investment in real estate (such as mortgage payments, real estate taxes and maintenance costs) are generally not reduced when circumstances result in a reduction in rental income.
An economic downturn could adversely affect the residential industry and may affect operations for the residential properties that we acquire.
As a result of the effects of an economic downturn, including increased unemployment rates, the residential industry may experience a significant decline in business caused by a reduction in overall renters. The current economic downturn and increase in unemployment rates may have an adverse affect on our operations if the tenants occupying the residential and office properties we acquire cease making rent payments to us or if there a change in spending patterns resulting in reduced traffic at the retail properties we acquire. Moreover, low residential mortgage interest rates could accompany an economic downturn and encourage potential renters to purchase residences rather than lease them. The residential properties we acquire may experience declines in occupancy rate due to any such decline in residential mortgage interest rates.
Lodging Industry Risks
We may be subject to the risks common to the lodging industry.
Our hotels will be subject to all of the risks common to the hotel industry and subject to market conditions that affect all hotel properties. These risks could adversely affect hotel occupancy and the rates that can be charged for hotel rooms as well as hotel operating expenses, and generally include:
| · | increases in supply of hotel rooms that exceed increases in demand; |
| · | increases in energy costs and other travel expenses that reduce business and leisure travel; |
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| · | reduced business and leisure travel due to continued geo-political uncertainty, including terrorism; |
| · | adverse effects of declines in general and local economic activity; |
| · | adverse effects of a downturn in the hotel industry; and |
| · | risks generally associated with the ownership of hotels and real estate, as discussed below. |
We do not have control over the market and business conditions that affect the value of our lodging properties, and adverse changes with respect to such conditions could have an adverse effect on our results of operations, financial condition and cash flows. Hotel properties, including extended stay hotels, are subject to varying degrees of risk generally common to the ownership of hotels, many of which are beyond our control, including the following:
| · | increased competition from other existing hotels in our markets; |
| · | new hotels entering our markets, which may adversely affect the occupancy levels and average daily rates of our lodging properties; |
| · | declines in business and leisure travel; |
| · | increases in energy costs, increased threat of terrorism; terrorist events, airline strikes or other factors that may affect travel patterns and reduce the number of business and leisure travelers; |
| · | increases in operating costs due to inflation and other factors that may not be offset by increased room rates; |
| · | changes in, and the related costs of compliance with, governmental laws and regulations, fiscal policies and zoning ordinances; and |
| · | adverse effects of international, national, regional and local economic and market conditions. |
Adverse changes in any or all of these factors could have an adverse effect on our results of operations, financial condition and cash flows, thereby adversely impacting our ability to service debt and to make distributions to our stockholders.
Third-party management of lodging properties can adversely affect our properties.
If we invest in lodging properties, such properties will be operated by a third-party management company and could be adversely affected if that third-party management company, or its affiliated brands, experiences negative publicity or other adverse developments, such as financial disagreements between the third party manager and the owner, disagreements about marketing between the third party manager and the owner and the third party manager’s brand falling out of favor.
As a REIT, we cannot directly operate our lodging properties.
We cannot and will not directly operate our lodging properties and, as a result, our results of operations, financial position, ability to service debt and ability to make distributions to stockholders are dependent on the ability of our third-party management companies and our tenants to operate our hotel properties successfully. In order for us to satisfy certain REIT qualification rules, we cannot directly operate any lodging properties we may acquire or actively participate in the decisions affecting their daily operations. Instead, through a TRS, we must enter into management agreements with a third-party management company, or we must lease our lodging properties to third-party tenants on a triple-net lease basis. We cannot and will not control this third-party management company or the tenants who operate and are responsible for maintenance and other day-to-day management of our lodging properties, including, but not limited to, the implementation of significant operating decisions. Thus, even if we believe our lodging properties are being operated inefficiently or in a manner that does not result in satisfactory operating results, we may not be able to require the third-party management company or the tenants to change their method of operation of our lodging properties. Our results of operations, financial position, cash flows and our ability to service debt and to make distributions to stockholders are, therefore, dependent on the ability of our third-party management company and tenants to operate our lodging properties successfully.
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We will rely on a third-party hotel management company to establish and maintain adequate internal controls over financial reporting at our lodging properties. In doing this, the property manager should have policies and procedures in place which allows them to effectively monitor and report to us the operating results of our lodging properties which ultimately are included in our consolidated financial statements. Because the operations of our lodging properties ultimately become a component of our consolidated financial statements, we evaluate the effectiveness of the internal controls over financial reporting at all of our properties, including our lodging properties, in connection with the certifications we provide in our quarterly and annual reports on Form 10-Q and Form 10-K, respectively, pursuant to the Sarbanes-Oxley Act of 2002. However, we will not control the design or implementation of or changes to internal controls at any of our lodging properties. Thus, even if we believe that our lodging properties are being operated without effective internal controls, we may not be able to require the third-party management company to change its internal control structure. This could require us to implement extensive and possibly inefficient controls at a parent level in an attempt to mitigate such deficiencies. If such controls are not effective, the accuracy of the results of our operations that we report could be affected. Accordingly, our ability to conclude that, as a company, our internal controls are effective is significantly dependent upon the effectiveness of internal controls that our third-party management company will implement at our lodging properties. It is possible that we could have a significant deficiency or material weakness as a result of the ineffectiveness of the internal controls at one or more of our lodging properties.
If we replace a third-party management company or tenant, we may be required by the terms of the relevant management agreement or lease to pay substantial termination fees, and we may experience significant disruptions at the affected lodging properties. If we experience such disruptions, it may adversely affect our results of operations, financial condition and our cash flows, including our ability to service debt and to make distributions to our stockholders.
Our use of the TRS structure will increase our expenses.
A TRS structure will subject us to the risk of increased lodging operating expenses. The performance of our TRS lessees will be based on the operations of our lodging properties. Our operating risks will include not only changes in hotel revenues and changes to our TRS lessees’ ability to pay the rent due to us under the leases, but also increased hotel operating expenses, including, but not limited to, the following cost elements:
| · | wage and benefit costs; |
| · | repair and maintenance expenses; |
| · | energy costs; |
| · | property taxes; |
| · | insurance costs; and |
| · | other operating expenses. |
Any increases in one or more these operating expenses could have a significant adverse impact on our results of operations, cash flows and financial position.
Failure to maintain franchise licenses could decrease our revenues.
Our inability or that of our third-party management companies or our third-party tenants to maintain franchise licenses could decrease our revenues. Maintenance of franchise licenses for our lodging properties is subject to maintaining our franchisor’s operating standards and other terms and conditions. Franchisors periodically inspect lodging properties to ensure that we, our third-party tenants or our third-party management company maintain their standards. Failure by us or one of our third-party tenants or our third-party management company to maintain these standards or comply with other terms and conditions of the applicable franchise agreement could result in a franchise license being canceled. If a franchise license terminates due to our failure to make required improvements or to otherwise comply with its terms, we may also be liable to the franchisor for a termination fee. As a condition to the maintenance of a franchise license, our franchisor could also require us to make capital expenditures, even if we do not believe the capital improvements are necessary, desirable, or likely to result in an acceptable return on our investment. We may risk losing a franchise license if we do not make franchisor-required capital expenditures.
If our franchisor terminates the franchise license, we may try either to obtain a suitable replacement franchise or to operate the lodging property without a franchise license. The loss of a franchise license could materially and adversely affect the operations or the underlying value of the lodging property because of the loss associated with the brand recognition and/or the marketing support and centralized reservation systems provided by the franchisor. A loss of a franchise license for one or more lodging properties could materially and adversely affect our results of operations, financial condition and our cash flows, including our ability to service debt and make distributions to our stockholders.
There are risks associated with employing hotel employees.
We will generally be subject to risks associated with the employment of hotel employees. Any lodging properties we acquire will be leased to a wholly-owned TRS entity and be subject to management agreements with a third-party manager to operate the properties that we do not lease to a third party under a net lease. Hotel operating revenues and expenses for these properties will be included in our consolidated results of operations. As a result, although we do not directly employ or manage the labor force at our lodging properties, we are subject to many of the costs and risks generally associated with the hotel labor force. Our third-party manager will be responsible for hiring and maintaining the labor force at each of our lodging properties and for establishing and maintaining the appropriate processes and controls over such activities. From time to time, the operations of our lodging properties may be disrupted through strikes, public demonstrations or other labor actions and related publicity. We may also incur increased legal costs and indirect labor costs as a result of the aforementioned disruptions, or contract disputes or other events. Our third-party manager may be targeted by union actions or adversely impacted by the disruption caused by organizing activities. Significant adverse disruptions caused by union activities and/or increased costs affiliated with such activities could materially and adversely affect our results of operations, financial condition and our cash flows, including our ability to service debt and make distributions to our stockholders.
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The travel and hotel industries may be affected by economic slowdowns, terrorist attacks and other world events.
If there is less travelling due to an economic slowdown, increased unemployment rates or a rise in fuel prices, the lodging properties we may acquire may be adversely affected. As a result of terrorist attacks around the world, the war in Afghanistan and the effects of the recent economic recession, the lodging industry experienced a significant decline in business caused by a reduction in both business and leisure travel. We cannot presently determine the impact that future events such as military or police activities in the U.S. or foreign countries, future terrorist activities or threats of such activities, natural disasters or health epidemics could have on our business. Our business and lodging properties may continue to be affected by such events, including our hotel occupancy levels and average daily rates, and, as a result, our revenues may decrease or not increase to levels we expect. In addition, other terrorist attacks, natural disasters, health epidemics, acts of war, prolonged U.S. involvement in military activity could have additional adverse effects on the economy in general, and the travel and lodging industry in particular. These factors could have a material adverse effect on our results of operations, financial condition, and cash flows, thereby impacting our ability to service debt and ability to make distributions to our stockholders.
The hotel industry is very competitive.
The hotel industry is intensely competitive, and, as a result, if our third-party management company and our third-party tenants are unable to compete successfully or if our competitors’ marketing strategies are more effective, our results of operations, financial condition, and cash flows including our ability to service debt and to make distributions to our stockholders, may be adversely affected. Our lodging properties compete with other existing and new hotels in their geographic markets.
Since we do not operate our lodging properties, our revenues depend on the ability of our third-party management company and our-third party tenants to compete successfully with other hotels in their respective markets. Some of our competitors have substantially greater marketing and financial resources than we do. If our third-party management company and our third-party tenants are unable to compete successfully or if our competitors’ marketing strategies are effective, our results of operations, financial condition, ability to service debt and ability to make distributions to our stockholders may be adversely affected.
The hotel industry is seasonal which can adversely affect our hotel properties.
The hotel industry is seasonal in nature, and, as a result, our lodging properties may be adversely affected. The seasonality of the hotel industry can be expected to cause quarterly fluctuations in our revenues. In addition, our quarterly earnings may be adversely affected by factors outside our control, such as extreme or unexpectedly mild weather conditions or natural disasters, terrorist attacks or alerts, outbreaks of contagious diseases, airline strikes, economic factors and other considerations affecting travel. To the extent that cash flows from operations are insufficient during any quarter, due to temporary or seasonal fluctuations in revenues, we may attempt to borrow in order to make distributions to our stockholders or be required to reduce other expenditures or distributions to stockholders.
The expanding use of internet travel websites by customers can adversely affect our profitability.
The increasing use of internet travel intermediaries by consumers may cause fluctuations in operating performance during the year and otherwise adversely affect our profitability and cash flows. Our third party hotel management company will rely upon Internet travel intermediaries to generate demand for our lodging properties. As Internet bookings increase, these intermediaries may be able to obtain higher commissions, reduced room rates or other significant contract concessions from our third-party management company. Moreover, some of these Internet travel intermediaries are attempting to offer hotel rooms as a commodity, by increasing the importance of price and general indicators of quality (such as “three-star downtown hotel”) at the expense of brand identification. Consumers may eventually develop brand loyalties to their reservations system rather than to our third-party management company and/or our brands, which could have an adverse effect on our business because we will rely heavily on brand identification. If the amount of sales made through Internet intermediaries increases significantly and our third-party management company and our third-party tenants fail to appropriately price room inventory in a manner that maximizes the opportunity for enhanced profit margins, room revenues may flatten or decrease and our profitability may be adversely affected.
Industrial Industry Risks
Potential liability as the result of, and the cost of compliance with, environmental matters is greater if we invest in industrial properties or lease our properties to tenants that engage in industrial activities.
Under various U.S. federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the cost of removal or remediation of hazardous or toxic substances on such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances.
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We may invest in properties historically used for industrial, manufacturing and commercial purposes. Some of these properties are more likely to contain, or may have contained, underground storage tanks for the storage of petroleum products and other hazardous or toxic substances. All of these operations create a potential for the release of petroleum products or other hazardous or toxic substances.
Leasing properties to tenants that engage in industrial, manufacturing, and commercial activities will cause us to be subject to increased risk of liabilities under environmental laws and regulations. The presence of hazardous or toxic substances, or the failure to properly remediate these substances, may adversely affect our ability to sell, rent or pledge such property as collateral for future borrowings.
Industrial properties are subject to fluctuations in manufacturing activity in the United States.
To the extent we acquire industrial properties, such properties may be adversely affected if manufacturing activity decreases in the United States. Trade agreements with foreign countries have given employers the option to utilize less expensive non-US manufacturing workers. The outsourcing of manufacturing functions could lower the demand for our industrial properties. Moreover, an increase in the cost of raw materials or decrease in the demand for housing could cause a slowdown in manufacturing activity, such as furniture, textiles, machinery and chemical products, and our profitability may be adversely affected.
Office Industry Risks
The loss of anchor tenants for our office properties could adversely affect our profitability.
We may acquire office properties and, as with our retail properties, we are subject to the risk that tenants may be unable to make their lease payments or may decline to extend a lease upon its expiration. A lease termination by a tenant that occupies a large area of space in one of our office properties (commonly referred to as an anchor tenant) could impact leases of other tenants. Other tenants may be entitled to modify the terms of their existing leases in the event of a lease termination by an anchor tenant or the closure of the business of an anchor tenant that leaves its space vacant, even if the anchor tenant continues to pay rent. Any such modifications or conditions could be unfavorable to us as the property owner and could decrease rents or expense recoveries. In the event of default by an anchor tenant, we may experience delays and costs in enforcing our rights as landlord to recover amounts due to us under the terms of our agreements with those parties.
Declines in overall activity in our markets may adversely affect the performance of our office properties.
Rental income from office properties fluctuates with general market and economic conditions. Our office properties may be adversely affected during periods of diminished economic growth and a decline in white-collar employment. We may experience a decrease in occupancy and rental rates accompanied by increases in the cost of re-leasing space (including for tenant improvements) and in uncollectible receivables. Early lease terminations may significantly contribute to a decline in occupancy of our office properties and may adversely affect our profitability. While lease termination fees increase current period income, future rental income may be diminished because, during periods in which market rents decline, it is unlikely that we will collect from replacement tenants the full contracted amount which had been payable under the terminated leases.
Risks Related to Real Estate-Related Investments
Risks Associated with Investments in Mezzanine and Mortgage Loans
Our Advisor does not have substantial experience investing in mezzanine and mortgage loans, which could result in losses to us.
Neither our Advisor nor any of its affiliates have substantial experience investing in mezzanine or mortgage loans. If we make or acquire such loans, or participations in them, we may not have the necessary expertise to maximize the return on our investment in these types of loans.
The risk of default on mezzanine and mortgage loans is caused by many factors beyond our control, and our ability to recover our investment in foreclosure may be limited.
The default risk on mezzanine and mortgage loans is caused by factors beyond our control, including local and other economic conditions affecting real estate values, interest rate changes, rezoning and failure by the borrower to maintain the property. We do not know whether the values of the property securing the loans will remain at the levels existing on the dates of origination of the loans. If the values of the underlying properties drop, our risk will increase because of the lower value of the security associated with such loans.
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In the event that there are defaults under these loans, we may not be able to quickly repossess and sell the properties securing such loans. An action to foreclose on a property securing a loan is regulated by state statutes and regulations and is subject to many delays and expenses typical of any foreclosure action. In the event of default by a mortgagor, these restrictions, among other things, may impede our ability to foreclose on or sell the mortgaged property or to obtain proceeds sufficient to repay all amounts due to us on the loan, which could reduce the value of our investment in the defaulted loan.
The mezzanine loans in which we may invest involve greater risks of loss than senior loans secured by income-producing real properties.
We may invest in mezzanine loans that take the form of subordinated loans secured by second mortgages on the underlying real property or loans secured by a pledge of the ownership interests of either the entity owning the real property or the entity that owns the interest in the entity owning the real property. These types of investments involve a higher degree of risk than long-term senior mortgage lending secured by income producing real property because the investment may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of the entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt. As a result, we may not recover some or all of our investment.
Our mortgage or mezzanine loans will be subject to interest rate fluctuations, which could reduce our returns as compared to market interest rates and reduce the value of the loans in the event we sell them.
If we invest in fixed-rate, long-term mortgage or mezzanine loans and interest rates rise, the loans could yield a return lower than then-current market rates. If interest rates decrease, we will be adversely affected to the extent that mortgage or mezzanine loans are prepaid, because we may not be able to make new loans at the previously higher interest rate. If we invest in variable-rate loans and interest rates decrease, our revenues will also decrease. Fluctuations in interest rates adverse to our loans could adversely affect our returns on such loans.
The liquidation of our assets may be delayed as a result of our investment in mortgage or mezzanine loans, which could delay distributions to our stockholders.
The mezzanine and mortgage loans we may purchase will be illiquid investments due to their short life, their unsuitability for securitization and the greater difficulty of recoupment in the event of a borrower’s default. If we enter into mortgage or mezzanine loans with terms that expire after the date we intend to have sold all of our properties, any intended liquidation of us may be delayed beyond the time of the sale of all of our properties until all mortgage or mezzanine loans expire or are sold.
Risks Related to Investments in Real Estate-Related Securities
We may invest in various types of real estate-related securities.
We may invest in real estate-related securities, including securities issued by other real estate companies, commercial mortgage-backed securities (“CMBS ”) or collateralized debt obligations (“ CDOs ”). We may also invest in real estate-related securities of both publicly traded and private real estate companies. Neither we nor our Advisor may have the expertise necessary to maximize the return on our investment in real estate-related securities. If our Advisor determines that it is advantageous to us to make the types of investments in which our Advisor or its affiliates do not have experience, our Advisor intends to employ persons, engage consultants or partner with third parties that have, in our Advisor’s opinion, the relevant expertise necessary to assist our Advisor in evaluating, making and administering such investments.
Investments in real estate-related securities will be subject to specific risks relating to the particular issuer of the securities and may be subject to the general risks of investing in subordinated real estate securities, which may result in losses to us.
Our investments in real estate-related securities will involve special risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer. Issuers of real estate-related securities generally invest in real estate or real estate-related assets and are subject to the inherent risks associated with real estate-related investments including risks relating to rising interest rates.
Real estate-related securities are often unsecured and also may be subordinated to other obligations of the issuer. As a result, investments in real estate-related securities are subject to risks of (1) limited liquidity in the secondary trading market in the case of unlisted or thinly traded securities, (2) substantial market price volatility resulting from changes in prevailing interest rates in the case of traded equity securities, (3) subordination to the prior claims of banks and other senior lenders to the issuer, (4) the operation of mandatory sinking fund or call/redemption provisions during periods of declining interest rates that could cause the issuer to reinvest redemption proceeds in lower yielding assets, (5) the possibility that earnings of the issuer may be insufficient to meet its debt service and distribution obligations and (6) the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic slowdown or downturn. These risks may adversely affect the value of outstanding real estate-related securities and the ability of the issuers thereof to repay principal and interest or make distribution payments.
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The mortgage loans in which we invest and the commercial mortgage loans underlying the CMBS in which we may invest will be subject to delinquency, foreclosure and loss, which could result in losses to us.
Commercial mortgage loans are secured by multifamily or other types of commercial property, and are subject to risks of delinquency and foreclosure and risks of loss that are greater than similar risks associated with loans made on the security of single family residential property. The ability of a borrower to repay a loan secured by a property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Net operating income of an income producing property can be affected by, among other things: tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that increase operating expense or limit rents that may be charged, any need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property, changes in national, regional or local economic conditions and/or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, real estate tax rates and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest and civil disturbances.
In the event of any default under a mortgage loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan, which could have a material adverse effect on our cash flow from operations and limit amounts available for distribution to our stockholders. In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law. Foreclosure of a mortgage loan can be an expensive and lengthy process which could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan.
The CMBS and CDOs in which we may invest are subject to several types of risks.
CMBS are bonds which evidence interests in, or are secured by, a single commercial mortgage loan or a pool of commercial mortgage loans. CDOs backed by commercial real estate assets, such as CMBS, commercial mortgage loans, B-notes, or mezzanine paper. Accordingly, the CMBS and CDOs we may invest in are subject to all the risks of the underlying mortgage loans.
In a rising interest rate environment, the value of CMBS and CDOs may be adversely affected when payments on underlying mortgages do not occur as anticipated, resulting in the extension of the security’s effective maturity and the related increase in interest rate sensitivity of a longer-term instrument. The value of CMBS and CDOs may also change due to shifts in the market’s perception of issuers and regulatory or tax changes adversely affecting the mortgage securities markets as a whole. In addition, CMBS and CDOs are subject to the credit risk associated with the performance of the underlying mortgage properties. In certain instances, third party guarantees or other forms of credit support can reduce the credit risk.
CMBS and CDOs are also subject to several risks created through the securitization process. Subordinate CMBS and CDOs are paid interest only to the extent that there are funds available to make payments. To the extent the collateral pool includes a large percentage of delinquent loans, there is a risk that interest payment on subordinate CMBS and CDOs will not be fully paid. Subordinate securities of CMBS and CDOs are also subject to greater credit risk than those CMBS and CDOs that are more highly rated.
If we use leverage in connection with our investment in CMBS or CDOs, the risk of loss associated with this type of investment will increase.
We may use leverage in connection with our investment in CMBS or CDOs. The use of leverage may substantially increase the risk of loss. There can be no assurance that leveraged financing will be available to us on favorable terms or that, among other factors, the terms of such financing will parallel the maturities of the underlying securities acquired. Therefore, such financing may mature prior to the maturity of the CMBS or CDOs acquired by us. If alternative financing is not available, we may have to liquidate assets at unfavorable prices to pay off such financing. We may utilize repurchase agreements as a component of our financing strategy. Repurchase agreements economically resemble short-term, variable-rate financing and usually require the maintenance of specific loan-to-collateral value ratios. If the market value of the CMBS or CDOs subject to a repurchase agreement decline, we may be required to provide additional collateral or make cash payments to maintain the loan to collateral value ratio. If we are unable to provide such collateral or cash repayments, we may lose our economic interest in the underlying securities.
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Investments in real estate-related preferred equity securities involve a greater risk of loss than traditional debt financing.
We may invest in real estate-related preferred equity securities, which may involve a higher degree of risk than traditional debt financing due to several factors, including that such investments are subordinate to traditional loans and are not secured by property underlying the investment. If the issuer defaults on our investment, we would only be able to take action against the entity in which we have an interest, not the property owned by such entity underlying our investment. As a result, we may not recover some or all of our investment, which could result in losses to us.
Market conditions and the risk of further market deterioration may cause a decrease in the value of our real estate securities.
The U.S. credit markets and the sub-prime residential mortgage market have experienced severe dislocations and liquidity disruptions from 2008 - 2011. Sub-prime mortgage loans experienced increased rates of delinquency, foreclosure and loss. These and other related events had a significant impact on the capital markets associated not only with sub-prime mortgage-backed securities and asset-backed securities and CDOs, but also with the U.S. credit and financial markets as a whole.
We may invest in any real estate securities, including CMBS and CDOs, that contain assets that could be classified as sub-prime residential mortgages. The values of many of these securities are sensitive to the volatility of the credit markets, and many of these securities may be adversely affected by future developments. In addition, to the extent there is turmoil in the credit markets, it has the potential to materially affect both the value of our real estate related securities investments and/or the availability or the terms of financing that we may anticipate utilizing in order to leverage our real estate related securities investments.
The market volatility also made the valuation of these securities more difficult, particularly the CMBS and CDO assets. Management’s estimate of the value of these investments will incorporate a combination of independent pricing of agency and third-party dealer valuations, as well as comparable sales transactions. However, the methodologies that we will use in valuing individual investments are generally based on a variety of estimates and assumptions specific to the particular investments, and actual results related to the investments therefore often vary materially from such assumptions or estimates.
Because there is significant uncertainty in the valuation of, or in the stability of the value of, certain of these securities holdings, the fair values of such investments as reflected in our results of operations may not reflect the prices that we would obtain if such investments were actually sold. Furthermore, due to market events, many of these investments are subject to rapid changes in value caused by sudden developments which could have a material adverse effect on the value of these investments.
A portion of our real estate securities investments may be illiquid and we may not be able to adjust our portfolio in response to changes in economic and other conditions.
Certain of the real estate securities that we may purchase in the future in connection with privately negotiated transactions may not be registered under the relevant securities laws, resulting in a prohibition against their sale, transfer, pledge or other disposition except in a transaction exempt from the registration requirements of those laws. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited.
Interest rate and related risks may cause the value of our real estate securities investments to be reduced.
Interest rate risk is the risk that fixed income securities will decline in value because of changes in market interest rates. Generally, when interest rates rise, the market value of such securities will decline, and vice versa. Our investment in such securities means that the net asset value and market price of the common shares may tend to decline if interest rates rise.
During periods of rising interest rates, the average life of certain types of securities may be extended because of slower than expected principal payments. This may lock in a below-market interest rate, increase the security’s duration and reduce the value of the security. This is known as extension risk. During periods of declining interest rates, an issuer may be able to exercise an option to prepay principal earlier than scheduled, which is generally known as call or prepayment risk. If this occurs, we may be forced to reinvest in lower yielding securities. This is known as reinvestment risk. An issuer may redeem an obligation if the issuer can refinance the debt at a lower cost due to declining interest rates or an improvement in the credit standing of the issuer. These risks may reduce the value of our real estate securities investments.
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Real Estate Financing Risks
General Financing Risks
We have incurred mortgage indebtedness and other borrowings, which may increase our business risks.
We have incurred mortgage indebtedness and other borrowings, and may acquire properties subject to existing financing. In addition, we may increase our mortgage debt by obtaining loans secured by selected or all of the real properties to obtain funds to acquire additional real properties. We may also borrow funds if necessary to satisfy the requirement that we annually distribute to stockholders 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, or otherwise as is necessary or advisable to assure that we maintain our qualification as a REIT for U.S. federal income tax purposes.
We incur mortgage debt on a particular real property if we believe the property’s projected cash flow is sufficient to service the mortgage debt. However, if there is a shortfall in cash flow, requiring us to use cash from other sources to make the mortgage payments on the property, then the amount available for distributions to stockholders may be affected. In addition, incurring mortgage debt increases the risk of loss since defaults on indebtedness secured by properties may result in foreclosure actions initiated by lenders and our loss of the property securing the loan which 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. We may, in some circumstances, give a guaranty on behalf of an entity that owns one of our properties. In these cases, 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.
Our mortgage debt which contains clauses providing for prepayment penalties. If a lender invokes these penalties upon the sale of a property or the prepayment of a mortgage on a property, the cost to us to sell the property could increase substantially, and may even be prohibitive. This could lead to a reduction in our income, which would reduce cash available for distribution to stockholders and may prevent us from borrowing more money. Moreover, if we enter into financing arrangements involving balloon payment obligations, such financing arrangements will involve greater risks than financing arrangements whose principal amount is amortized over the term of the loan. At the time the balloon payment is due, we may not be able to refinance the balloon payment on terms as favorable as the original loan or sell the property at a price sufficient to make the balloon payment.
If we have insufficient working capital reserves, we will
have to obtain financing from other sources.
If our working capital reserves are insufficient to meet our cash needs, we may have to obtain financing to fund our cash requirements. Sufficient financing may not be available or, if available, may not be available on economically feasible terms or on terms acceptable to us. If mortgage debt is unavailable at reasonable rates, we will not be able to place financing on the properties, which could reduce the number of properties we can acquire and the amount of distributions per share. If we place mortgage debt on the properties, we run the risk of being unable to refinance the properties when the loans come due, or of being unable to refinance on favorable terms. If interest rates are higher when the properties are refinanced, our income could be reduced, which would reduce cash available for distribution to stockholders and may prevent us from borrowing more money. Additional borrowing for working capital purposes will increase our interest expense, and therefore our financial condition and our ability to pay distributions may be adversely affected.
We may not have funding or capital resources for future improvements.
When a commercial tenant at one of our properties does not renew its lease or otherwise vacates its space in one of our buildings, it is likely that, in order to attract one or more new tenants, we will be required to expend substantial funds for leasing costs, tenant improvements and tenant refurbishments to the vacated space. We will incur certain fixed operating costs during the time the space is vacant as well as leasing commissions and related costs to re-lease the vacated space. We may also have similar future capital needs in order to renovate or refurbish any of our properties for other reasons.
Also, in the event we need to secure funding sources in the future but are unable to secure such sources or are unable to secure funding on terms we feel are acceptable, we may be required to defer capital improvements or refurbishment to a property. This may cause such property to suffer from a greater risk of obsolescence or a decline in value and/or produce decreased cash flow as the result of our inability to attract tenants to the property. If this happens, we may not be able to maintain projected rental rates for affected properties, and our results of operations may be negatively impacted. Or, we may be required to secure funding on unfavorable terms.
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We may be adversely affected by limitations in our charter on the aggregate amount we may borrow.
Our charter provides that the aggregate amount of borrowing, both secured and unsecured, may not exceed 300% of net assets in the absence of a satisfactory showing that a higher level is appropriate, the approval of our Board of Directors and disclosure to stockholders. Net assets means our total assets, other than intangibles, at cost before deducting depreciation, reserves for bad debt or other non-cash reserves, less our total liabilities, calculated at least quarterly on a basis consistently applied. Any excess in borrowing over such 300% of net assets level must be approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report to stockholders, along with justification for such excess.
That limitation could have adverse business consequences such as:
| · | limiting our ability to purchase additional properties; |
| · | causing us to lose our REIT status if additional borrowing was necessary to pay the required minimum amount of cash distributions to our stockholders to maintain our status as a REIT; |
| · | causing operational problems if there are cash flow shortfalls for working capital purposes; and |
| · | resulting in the loss of a property if, for example, financing was necessary to repay a default on a mortgage. |
Our debt financing for acquisitions will frequently be determined from appraised values in lieu of acquisition cost. As appraisal values are typically greater than acquisition cost for the type of value assets we seek to acquire, our debt can be expected to exceed certain leverage limitations of the Lightstone REIT II. Our Board of Directors, including all of its independent directors, will approve any leverage exceptions as required by the Lightstone REIT II’s Articles of Incorporation.
Any excess borrowing over the 300% level will be disclosed to stockholders in our next quarterly report, along with justification for such excess.
Lenders may require us to enter into restrictive covenants relating to our operations.
In connection with obtaining financing, a bank or other lender could impose restrictions on us affecting our ability to incur additional debt and our distribution and operating policies. Loan documents we enter into may contain negative covenants limiting our ability to, among other things, further mortgage our properties, discontinue insurance coverage or replace Lightstone Value Plus REIT II LLC as our Advisor. In addition, prepayment penalties imposed by banks or other lenders could affect our ability to sell properties when we want.
If lenders are not willing to make loans to our Sponsor because of recent defaults on some of the Sponsor’s properties, lenders may be less inclined to make loans to us and we may not be able to obtain financing for our acquisitions.
In recent years U.S. and international markets experienced increased levels of volatility due to a combination of factors, including decreasing values of residential and commercial real estate, limited access to credit, and the collapse or near collapse of certain financial institutions, higher energy costs, decreased consumer spending and a national and global recession. Certain of our Sponsor’s program and non-program properties were adversely affected by these market conditions and their impact on the real estate market. For example, increased unemployment and the resulting decrease in business travel had adversely affected the occupancy rates and revenues per room at our Sponsor’s lodging properties. After an analysis of these factors and other factors, taking into account the increased costs of borrowing, the dislocation in the credit markets and that certain properties are not generating sufficient cash flow to cover their fixed costs, the Sponsor elected to stop making payments on the non-recourse debt obligations for certain program and non-program properties. As a result, lenders may be less willing to make loans to our Sponsor or its affiliates. If lenders are unwilling to make loans to us, we may be unable to purchase certain properties or may be required to defer capital improvements or refurbishments to our properties. Additionally, sellers of real property may be less inclined to enter into negotiations with us if they believe that we may be unable to obtain financing. The inability to purchase certain properties may increase the time it takes for us to generate funds from operations. Additionally, the inability to improve our properties may cause such property to suffer from a greater risk of obsolescence or a decline in value, which could result in a decrease in our cash flow from the inability to attract tenants.
Financing Risks on the Property Level
Some of our mortgage loans may have “due on sale” provisions.
We may obtain financing with “due-on-sale” and/or “due-on-encumbrance” clauses. Due-on-sale clauses in mortgages allow a mortgage lender to demand full repayment of the mortgage loan if the borrower sells the mortgaged property. Similarly, due-on-encumbrance clauses allow a mortgage lender to demand full repayment if the borrower uses the real estate securing the mortgage loan as security for another loan. These clauses may cause the maturity date of such mortgage loans to be accelerated and such financing to become due. In such event, we may be required to sell our properties on an all-cash basis, to acquire new financing in connection with the sale, or to provide seller financing. It is not our intent to provide seller financing, although it may be necessary or advisable for us to do so in order to facilitate the sale of a property. It is unknown whether the holders of mortgages encumbering our properties will require such acceleration or whether other mortgage financing will be available. Such factors will depend on the mortgage market and on financial and economic conditions existing at the time of such sale or refinancing.
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Lenders may be able to recover against our other properties under our mortgage loans.
We may seek recourse financing to finance properties, in which event, in addition to the property securing the loan, the lender may look to our other assets for satisfaction of the debt. Thus, should we be unable to repay a recourse loan with the proceeds from the sale or other disposition of the property securing the loan, the lender could look to one or more of our other properties for repayment. Also, in order to facilitate the sale of a property, we may allow the buyer to purchase the property subject to an existing loan whereby we remain responsible for the debt.
Our presently outstanding mortgage loans charge variable interest, as may any mortgage loans we incur in the future.
Our presently outstanding mortgage loans will be subject to fluctuating interest rates based on Libor. Future increases in Libor would result in increases in debt service on these loans and thus reduce funds available for acquisitions of properties and distributions to the stockholders.
In addition, we may incur mortgage loans in the future that charge variable interest based on index rates such as the prime rate or Libor, and these loans would subject us to similar risks.
Insurance Risks
We may suffer losses that are not covered by insurance.
If we suffer losses that are not covered by insurance or that are in excess of insurance coverage, we could lose invested capital and anticipated profits. Material losses may occur in excess of insurance proceeds with respect to any property as insurance proceeds may not provide sufficient resources to fund the losses. In addition, there are types of losses, generally of a catastrophic nature, such as losses due to wars, earthquakes, floods, hurricanes, pollution, environmental matters, mold and terrorism which are either uninsurable or not economically insurable, or may be insured subject to limitations, such as large deductibles or co-payments.
Insurance companies have recently begun to exclude acts of terrorism from standard coverage. Terrorism insurance is currently available at an increased premium, and it is possible that the premium will increase in the future or that terrorism coverage will become unavailable. Mortgage lenders in some cases have begun to insist that specific coverage against terrorism be purchased by commercial owners as a condition for providing loans. We intend to obtain terrorism insurance if required by our lenders, but the terrorism insurance that we obtain may not be sufficient to cover loss for damages to our properties as a result of terrorist attacks. In addition, we may not be able to obtain insurance against the risk of terrorism because it may not be available or may not be available on terms that are economically feasible. In such instances, we may be required to provide other financial support, either through financial assurances or self-insurance, to cover potential losses. We cannot assure you that we will have adequate coverage for such losses. If such an event occurred to, or caused the destruction of, one or more of our properties, we could lose both our invested capital and anticipated profits from such property. In addition, certain losses resulting from these types of events are uninsurable and others may not be covered by our terrorism insurance. Terrorism insurance may not be available at a reasonable price or at all.
In addition, many insurance carriers are excluding asbestos-related claims from standard policies, pricing asbestos endorsements at prohibitively high rates or adding significant restrictions to this coverage. Because of our inability to obtain specialized coverage at rates that correspond to the perceived level of risk, we may not obtain insurance for acts of terrorism or asbestos-related claims. We will continue to evaluate the availability and cost of additional insurance coverage from the insurance market. If we decide in the future to purchase insurance for terrorism or asbestos, the cost could have a negative impact on our results of operations. If an uninsured loss or a loss in excess of insured limits occurs on a property, we could lose our capital invested in the property, as well as the anticipated future revenues from the property and, in the case of debt that is recourse to us, would remain obligated for any mortgage debt or other financial obligations related to the property. Any loss of this nature would adversely affect us. Although we intend to adequately insure our properties, we cannot assure that we will successfully do so.
Compliance with Laws
The costs of compliance with environmental laws and regulations may adversely affect our income and the cash available for any distributions.
All real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. These laws and regulations generally govern wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation and disposal of solid and hazardous materials, and the remediation of contamination associated with disposals. Some of these laws and regulations may impose joint and several liability on tenants, owners or operators for the costs of investigation or remediation of contaminated properties, regardless of fault or the legality of the original disposal. Under various federal, state and local laws, ordinances and regulations, a current or previous owner, developer or operator of real estate may be liable for the costs of removal or remediation of hazardous or toxic substances at, on, under or in its property. The costs of removal or remediation could be substantial. In addition, the presence of these substances, or the failure to properly remediate these substances, may adversely affect our ability to sell or rent such property or to use the property as collateral for future borrowing.
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Environmental laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of hazardous or toxic materials. Even if more than one person may have been responsible for the contamination, each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred. In addition, third parties may sue the owner or operator of a site for damages and costs resulting from environmental contamination arising from that site. The presence of hazardous or toxic materials, or the failure to address conditions relating to their presence properly, may adversely affect the ability to rent or sell the property or to borrow using the property as collateral. Persons who dispose of or arrange for the disposal or treatment of hazardous or toxic materials may also be liable for the costs of removal or remediation of such materials, or for related natural resource damages, at or from an off-site disposal or treatment facility, whether or not the facility is or ever was owned or operated by those persons. In addition, environmental laws today can impose liability on a previous owner or operator of a property that owned or operated the property at a time when hazardous or toxic substances were disposed on, or released from, the property. A conveyance of the property, therefore, does not relieve the owner or operator from liability.
There may be potential liability associated with lead-based paint arising from lawsuits alleging personal injury and related claims. Typically, the existence of lead paint is more of a concern in residential units than in commercial properties. Although a structure built prior to 1978 may contain lead-based paint and may present a potential for exposure to lead, structures built after 1978 are not likely to contain lead-based paint.
Properties’ values may also be affected by their proximity to electric transmission lines. Electric transmission lines are one of many sources of electro-magnetic fields (“EMFs”) to which people may be exposed. Research completed regarding potential health concerns associated with exposure to EMFs has produced inconclusive results. Notwithstanding the lack of conclusive scientific evidence, some states now regulate the strength of electric and magnetic fields emanating from electric transmission lines, and other states have required transmission facilities to measure for levels of EMFs. On occasion, lawsuits have been filed (primarily against electric utilities) that allege personal injuries from exposure to transmission lines and EMFs, as well as from fear of adverse health effects due to such exposure. This fear of adverse health effects from transmission lines has been considered both when property values have been determined to obtain financing and in condemnation proceedings. We may not, in certain circumstances, search for electric transmission lines near our properties, but are aware of the potential exposure to damage claims by persons exposed to EMFs.
Recently, indoor air quality issues, including mold, have been highlighted in the media and the industry is seeing mold claims from lessees rising. To date, we have not incurred any material costs or liabilities relating to claims of mold exposure or abating mold conditions. However, due to the recent increase in mold claims and given that the law relating to mold is unsettled and subject to change, we could incur losses from claims relating to the presence of, or exposure to, mold or other microbial organisms, particularly if we are unable to maintain adequate insurance to cover such losses. We may also incur unexpected expenses relating to the abatement of mold on properties that we may acquire.
Limited quantities of asbestos-containing materials are present in various building materials such as floor coverings, ceiling texture material, acoustical tiles and decorative treatment. Environmental laws govern the presence, maintenance and removal of asbestos. These laws could be used to impose liability for release of, and exposure to, hazardous substances, including asbestos-containing materials, into the air. Such laws require that owners or operators of buildings containing asbestos (1) properly manage and maintain the asbestos, (2) notify and train those who may come into contact with asbestos and (3) undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building. Such laws may impose fines and penalties on building owners or operators who fail to comply with these requirements. These laws may allow third parties to seek recovery from owners or operators of real properties for personal injury associated with exposure to asbestos fibers. As the owner of our properties, we may be potentially liable for any such costs.
We cannot assure you that properties which we acquire in the future will not have any material environmental conditions, liabilities or compliance concerns. Accordingly, we have no way of determining at this time the magnitude of any potential liability to which we may be subject arising out of environmental conditions or violations with respect to the properties we own.
The costs of compliance with laws and regulations relating to our lodging and residential properties may adversely affect our income and the cash available for any distributions.
Various laws, ordinances, and regulations affect multi-family residential properties, including regulations relating to recreational facilities, such as activity centers and other common areas. In addition, rent control laws may be applicable to any of our residential properties.
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Some of these laws and regulations have been amended so as to require compliance with new or more stringent standards as of future dates. Compliance with new or more stringent laws or regulations, stricter interpretation of existing laws or the future discovery of environmental contamination may require material expenditures by us. Future laws, ordinances or regulations may impose material environmental liabilities, and the current environmental condition of our properties might be affected by the operations of the tenants, by the existing condition of the land, by operations in the vicinity of the properties, such as the presence of underground storage tanks, or by the activities of unrelated third parties.
These laws typically allow liens to be placed on the affected property. In addition, there are various local, state and federal fire, health, life-safety and similar regulations which we may be required to comply with, and which may subject us to liability in the form of fines or damages for noncompliance.
Any newly acquired or developed lodging or multi-family residential properties must comply with Title II of the Americans with Disabilities Act (the “ADA”) to the extent that such properties are “public accommodations” and/or “commercial facilities” as defined by the ADA. Compliance with the ADA requires removal of structural barriers to handicapped access in certain public areas of the properties where such removal is “readily achievable.” Our properties may not comply in all material respects with all present requirements under the ADA and applicable state laws. When acquiring properties, we may not succeed in placing the burden on the seller to ensure compliance with the ADA. Noncompliance with the ADA could result in the imposition of injunctive relief, monetary penalties or, in some cases, an award of damages to private litigants. The cost of defending against any claims of liability under the ADA or the payment of any fines or damages could adversely affect our financial condition and affect cash available to return capital and the amount of distributions to you.
The Fair Housing Act (the “FHA”) requires, as part of the Fair Housing Amendments Act of 1988, apartment communities first occupied after March 13, 1990 to be accessible to the handicapped. Noncompliance with the FHA could result in the imposition of fines or an award of damages to private litigants. The cost of defending against any claims of liability under the FHA or the payment of any fines or damages could adversely affect our financial condition.
Changes in applicable laws and regulations may adversely affect the income from and value of our properties.
The income from and value of a property may be affected by such factors as environmental, rent control and other laws and regulations and changes in applicable general and real estate tax laws (including the possibility of changes in the U.S. federal income tax laws or the lengthening of the depreciation period for real estate). For example, the properties we will acquire will be subject to real and personal property taxes that may increase as property tax rates change and as the properties are assessed or reassessed by taxing authorities. We anticipate that most of our leases will generally provide that the property taxes, or increases therein, are charged to the lessees as an expense related to the properties that they occupy. As the owner of the properties, however, we are ultimately responsible for payment of the taxes to the government. If property taxes increase, our tenants may be unable to make the required tax payments, ultimately requiring us to pay the taxes. In addition, we will generally be responsible for property taxes related to any vacant space. If we purchase residential properties, the leases for such properties typically will not allow us to pass through real estate taxes and other taxes to residents of such properties. Consequently, any tax increases may adversely affect our results of operations at such properties.
Failure to comply with applicable laws and regulations where we invest could result in fines, suspension of personnel of our Advisor, or other sanctions. Compliance with new laws or regulations or stricter interpretation of existing laws may require us to incur material expenditures, which could reduce the available cash flow for distributions to our stockholders. Additionally, future laws, ordinances or regulations may impose material environmental liability, which may have a material adverse effect on our results of operations.
Risks Related to General Economic Conditions
Adverse economic conditions may negatively affect our returns and profitability.
The timing, length and severity of any economic slowdown that the nation may experience, including the current economic slowdown, cannot be predicted with certainty. Since we may liquidate within seven to ten years after the proceeds from the Follow-On Offering are fully invested, there is a risk that depressed economic conditions at that time could cause cash flow and appreciation upon the sale of our properties, if any, to be insufficient to allow sufficient cash remaining after payment of our expenses for a significant return on stockholders’ investment.
The instability of the U.S. economy may reduce the number of suitable investment opportunities available to us and may slow the pace at which those investments are made. In addition, armed hostilities and acts of terrorism may directly impact our properties. These developments may subject us to increased risks and, depending on their magnitude, could have a material adverse effect on our business and stockholders’ investment.
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State of debt markets could limit our ability to obtain financing which may have a material adverse impact on our earnings and financial condition.
The commercial real estate debt markets recently experienced volatility as a result of certain factors including the tightening of underwriting standards by lenders and credit rating agencies and the significant inventory of unsold CMBS in the market. Credit spreads for major sources of capital widened significantly as investors demanded a higher risk premium. This resulted in lenders increasing the cost for debt financing. Should the overall cost of borrowings increase, either by increases in the index rates or by increases in lender spreads, we will need to factor such increases into the economics of our acquisitions. This may result in our acquisitions generating lower overall economic returns and potentially reducing cash flow available for distribution.
The recent dislocations in the debt markets reduced the amount of capital available to finance real estate, which, in turn, (a) will no longer allow real estate investors to rely on capitalization rate compression to generate returns and (b) has slowed real estate transaction activity, all of which may reasonably be expected to have a material impact, favorable or unfavorable, on revenues or income from the acquisition and operations of real properties and mortgage loans. Investors will need to focus on market-specific growth dynamics, operating performance, asset management and the long-term quality of the underlying real estate.
In addition, the state of the debt markets could have an impact on the overall amount of capital investing in real estate which may result in price or value decreases of real estate assets.
U.S. Federal Income Tax Risks
Our failure to qualify or 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 stock.
We believe that we have qualified to be taxed as a REIT commencing with our taxable year ending December 31, 2009, and intend to operate in a manner that would allow us to continue to qualify as a REIT. However, we may terminate our REIT qualification, if our Board of Directors determines that not qualifying as a REIT is in the best interests of our stockholders, 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. We intend to structure our activities in a manner designed to satisfy all the requirements for qualification as a REIT. However, the REIT qualification requirements are extremely complex and interpretation of the U.S. federal income tax laws governing qualification as a REIT is limited. Furthermore, any opinion of counsel, including tax counsel, as to our eligibility to qualify or remain qualified as a REIT is not binding on the IRS and is not a guarantee that we will qualify, or continue to qualify as a REIT. Accordingly, we cannot be certain that we will be successful in operating so we can qualify or remain qualified as a REIT. 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 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.
Even if we qualify as a REIT, in certain circumstances, may incur tax liabilities that would reduce our cash available for distribution to you.
Even if we qualify and maintain our status as a REIT, we may be subject to U.S. federal, state and local income taxes. For example, net income from the sale of properties that are “dealer” properties sold by a REIT (a “prohibited transaction” under the Code) will be subject to a 100% tax. We may not make sufficient distributions to avoid excise taxes applicable to REITs. We also may decide to retain net capital gain we earn from the sale or other disposition of our property and pay U.S. federal income tax directly on such income. In that event, our stockholders would be treated as if they earned that income and paid the tax on it directly. However, stockholders that are tax-exempt, such as charities or qualified pension plans, would have no benefit from their deemed payment of such tax liability unless they file U.S. federal income tax returns and thereon seek a refund of such tax. We also will be subject to corporate tax on any undistributed REIT taxable income. We also may be subject to state and local taxes on our income or property, including franchise, payroll and transfer taxes, either directly or at the level of our Operating Partnership or at the level of the other companies through which we indirectly own our assets, such as our TRSs, which are subject to full U.S. federal, state, local and foreign corporate-level income taxes. Any taxes we pay directly or indirectly will reduce our cash available for distribution to you.
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To qualify as a REIT we must meet annual distribution requirements, which may force us to forgo otherwise attractive opportunities or borrow funds during unfavorable market conditions. This could delay or hinder our ability to meet our investment objectives and reduce your overall return.
In order to qualify and maintain our status as a REIT, we must annually distribute to our stockholders at least 90% of our REIT taxable income, determined without regard to the deduction for distributions paid and excluding net capital gain. We will be subject to U.S. federal income tax on our undistributed REIT taxable income and net capital gain and to a 4% nondeductible excise tax on any amount by which distributions we pay with respect to any calendar year are less than the sum of (a) 85% of our ordinary income, (b) 95% of our capital gain net income and (c) 100% of our undistributed income from prior years. These requirements could cause us to distribute amounts that otherwise would be spent on investments in real estate assets and it is possible that we might be required to borrow funds, possibly at unfavorable rates, or sell assets to fund these distributions. Although we intend to make distributions sufficient to meet the annual distribution requirements and to avoid U.S. federal income and excise taxes on our earnings while we qualify as a REIT, it is possible that we might not always be able to do so.
Certain of our business activities are potentially subject to the prohibited transaction tax, which could reduce the return on your investment.
For so long as we qualify as a REIT, our ability to dispose of property during the first few years following acquisition may be restricted to a substantial extent as a result of our REIT qualification. Under applicable provisions of the Code regarding prohibited transactions by REITs, while we qualify as a REIT, we will be subject to a 100% penalty tax on any gain recognized on the sale or other disposition of any property (other than foreclosure property) that we own, directly or through any subsidiary entity, including our Operating Partnership, but generally excluding our TRSs, that is deemed to be inventory or property held primarily for sale to customers in the ordinary course of a trade or business. Whether property is inventory or otherwise held primarily for sale to customers in the ordinary course of a trade or business depends on the particular facts and circumstances surrounding each property. While we qualify as a REIT, we avoid the 100% prohibited transaction tax by (1) conducting activities that may otherwise be considered prohibited transactions through a TRS (but such TRS will incur corporate rate income taxes with respect to any income or gain recognized by it), (2) conducting our operations in such a manner so that no sale or other disposition of an asset we own, directly or through any subsidiary, will be treated as a prohibited transaction or (3) structuring certain dispositions of our properties to comply with the requirements of the prohibited transaction safe harbor available under the Code for properties that, among other requirements have been held for at least two years. Despite our present intention no assurance can be given that any particular property we own, directly or through any subsidiary entity, including our Operating Partnership, but generally excluding our TRSs, will not be treated as inventory or property held primarily for sale to customers in the ordinary course of a trade or business.
Our TRSs are subject to corporate-level taxes and our dealings with our TRSs may be subject to 100% excise tax.
A REIT may own up to 100% of the stock of one or more TRS. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 20% of the value of a REIT’s assets may consist of stock or securities of one or more TRS.
A TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT, including gross income from operations pursuant to management contracts. We must operate our “qualified lodging facilities” through one or more TRS that lease such properties from us. We may use our TRSs generally for other activities as well, such as to hold properties for sale in the ordinary course of business or to hold assets or conduct activities that we cannot conduct directly as a REIT. A TRS will be subject to applicable U.S. federal, state, local and foreign income tax on its taxable income. In addition, the rules which are applicable to us as a REIT also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis.
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If our leases to our TRSs are not respected as true leases for U.S. federal income tax purposes, we would fail to qualify as a REIT.
To qualify as a REIT, we must satisfy two gross income tests, under which specified percentages of our gross income must be derived from certain sources, such as “rents from real property.” In order for such rent to qualify as “rents from real property” for purposes of the REIT gross income tests, the leases must be respected as true leases for U.S. federal income tax purposes and not be treated as service contracts, joint ventures or some other type of arrangement. If our leases are not respected as true leases for U.S. federal income tax purposes, we would fail to qualify as a REIT.
If our Operating Partnership failed to qualify as a partnership or is not otherwise disregarded for U.S. federal income tax purposes, we would cease to qualify as a REIT.
We intend to maintain the status of the Operating Partnership as a partnership or a disregarded entity for U.S. federal income tax purposes. However, if the IRS were to successfully challenge the status of the Operating Partnership as a partnership or disregarded entity for such purposes, it would be taxable as a corporation. In such event, this would reduce the amount of distributions that the Operating Partnership could make to us. This also would result in our failing to qualify as a REIT, and becoming subject to a corporate level tax on our income. This substantially would reduce our cash available to pay distributions and the yield on your investment. In addition, if any of the partnerships or limited liability companies through which the Operating Partnership owns its properties, in whole or in part, loses its characterization as a partnership and is otherwise not disregarded for U.S. federal income tax purposes, it would be subject to taxation as a corporation, thereby reducing distributions to the Operating Partnership. Such a recharacterization of an underlying property owner could also threaten our ability to maintain our REIT qualification.
If our “qualified lodging facilities” are not properly leased to a TRS or the managers of such “qualified lodging facilities” do not qualify as “eligible independent contractors,” we could fail to qualify as a REIT.
In general, we cannot operate any lodging facilities and can only indirectly participate in the operation of “qualified lodging facilities” on an after-tax basis through leases of such properties to our TRSs. A “qualified lodging facility” is a hotel, motel, or other establishment in which more than one-half of the dwelling units are used on a transient basis at which or in connection with which wagering activities are not conducted. Rent paid by a lessee that is a “related party tenant” of ours will not be qualifying income for purposes of the two gross income tests applicable to REITs. A TRS that leases lodging facilities from us will not be treated as a “related party tenant” with respect to our lodging facilities that are managed by an independent management company, so long as the independent management company qualifies as an “eligible independent contractor.”
Each of the management companies that enters into a management contract with our TRSs must qualify as an “eligible independent contractor” under the REIT rules in order for the rent paid to us by our TRSs to be qualifying income for purposes of the REIT gross income tests. An “eligible independent contractor” is an independent contractor that, at the time such contractor enters into a management or other agreement with a TRS to operate a “qualified lodging facility,” is actively engaged in the trade or business of operating “qualified lodging facilities” for any person not related, as defined in the Code, to us or the TRS. Among other requirements, in order to qualify as an independent contractor a manager must not own, directly or applying attribution provisions of the Code, more than 35% of our outstanding shares of stock (by value), and no person or group of persons can own more than 35% of our outstanding shares and 35% of the ownership interests of the manager (taking into account only owners of more than 5% of our shares and, with respect to ownership interest in such managers that are publicly traded, only holders of more than 5% of such ownership interests). The ownership attribution rules that apply for purposes of the 35% thresholds are complex. Although we intend to monitor ownership of our stock by our managers and their owners, there can be no assurance that these ownership levels will not be exceeded.
Our investments in certain debt instruments may cause us to recognize “phantom income” for U.S. federal income tax purposes even though no cash payments have been received on the debt instruments, and certain modifications of such debt by us could cause the modified debt to not qualify as a good REIT asset, thereby jeopardizing our REIT qualification.
Our taxable income may substantially exceed our net income as determined based on GAAP, or differences in timing between the recognition of taxable income and the actual receipt of cash may occur. For example, we may acquire assets, including debt securities requiring us to accrue original issue discount, or OID, or recognize market discount income, that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets referred to as “phantom income.” In addition, if a borrower with respect to a particular debt instrument encounters financial difficulty rendering it unable to pay stated interest as due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income with the effect that we will recognize income but will not have a corresponding amount of cash available for distribution to our stockholders.
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As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to (a) sell assets in adverse market conditions, (b) borrow on unfavorable terms, (c) distribute amounts that would otherwise be used for future acquisitions or used to repay debt, or (d) make a taxable distribution of our shares of common stock as part of a distribution in which stockholders may elect to receive shares of common stock or (subject to a limit measured as a percentage of the total distribution) cash, in order to comply with the REIT distribution requirements.
Moreover, we may acquire distressed debt investments that require subsequent modification by agreement with the borrower. If the amendments to the outstanding debt are “significant modifications” under the applicable Treasury Regulations, the modified debt may be considered to have been reissued to us in a debt-for-debt taxable exchange with the borrower. This deemed reissuance may prevent the modified debt from qualifying as a good REIT asset if the underlying security has declined in value and would cause us to recognize income to the extent the principal amount of the modified debt exceeds our adjusted tax basis in the unmodified debt.
The failure of a mezzanine loan to qualify as a real estate asset would adversely affect our ability to qualify as a REIT.
In general, in order for a loan to be treated as a qualifying real estate asset producing qualifying income for purposes of the REIT asset and income tests, the loan must be secured by real property. We may acquire mezzanine loans that are not directly secured by real property but instead secured by equity interests in a partnership or limited liability company that directly or indirectly owns real property. In Revenue Procedure 2003-65, the IRS provided a safe harbor pursuant to which a mezzanine loan that is not secured by real estate would, if it meets each of the requirements contained in the Revenue Procedure, be treated by the IRS as a qualifying real estate asset. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law and in many cases it may not be possible for us to meet all the requirements of the safe harbor. We cannot provide assurance that any mezzanine loan in which we invest would be treated as a qualifying asset producing qualifying income for REIT qualification purposes. If any such loan fails either the REIT income or asset tests, we may be disqualified as a REIT.
We may choose to make distributions in our own stock, in which case you may be required to pay income taxes in excess of the cash dividends you receive.
In connection with our qualification as a REIT, we are required to distribute annually to our stockholders 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 net capital gain. In order to satisfy this requirement, we may make distributions that are payable in cash and/or shares of our common stock (which could account for up to 80% of the aggregate amount of such distributions) at the election of each stockholder. Taxable stockholders receiving such distributions will be required to include the full amount of such distributions as ordinary dividend income to the extent of our current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. As a result, U.S. stockholders may be required to pay U.S. federal income taxes with respect to such distributions in excess of the cash portion of the distribution received. Accordingly, U.S. stockholders receiving a distribution of our shares may be required to sell shares received in such distribution or may be required to sell other stock or assets owned by them, at a time that may be disadvantageous, in order to satisfy any tax imposed on such distribution. If a U.S. stockholder sells the stock that it receives as part of the distribution in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the distribution, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such distribution, including in respect of all or a portion of such distribution that is payable in stock, by withholding or disposing of part of the shares included in such distribution and using the proceeds of such disposition to satisfy the withholding tax imposed. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividend income, such sale may put downward pressure on the price of our common stock.
Various tax aspects of such a taxable cash/stock distribution are uncertain and have not yet been addressed by the IRS. No assurance can be given that the IRS will not impose requirements in the future with respect to taxable cash/stock distributions, including on a retroactive basis, or assert that the requirements for such taxable cash/stock distributions have not been met.
Our stockholders may have tax liability on distributions that they elect to reinvest in common stock, but they would not receive the cash from such distributions to pay such tax liability.
If our stockholders participate in our DRIP, they will be deemed to have received, and for U.S. federal income tax purposes will be taxed on, the amount reinvested in shares of our common stock to the extent the amount reinvested was not a tax-free return of capital. In addition, our stockholders will be treated for tax purposes as having received an additional distribution to the extent the shares are purchased at a discount to fair market value. As a result, unless a stockholder is a tax-exempt entity, it may have to use funds from other sources to pay its tax liability on the value of the shares of common stock received.
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Dividends payable by REITs generally do not qualify for the reduced tax rates available for some dividends.
Currently, the maximum tax rate applicable to qualified dividend income payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, generally are not eligible for the reduced rates. Although this does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common stock.
If we were considered to actually or constructively pay a “preferential dividend” to certain of our stockholders, our status as a REIT could be adversely affected.
In order to qualify as a REIT, we must annually
distribute to our stockholders at least 90% of our REIT taxable income, determined without regard to the deduction for dividends
paid and excluding net capital gain. In order for distributions to be counted as satisfying the annual distribution requirements
for REITs, and to provide us with a REIT-level tax deduction, the distributions must not be “preferential dividends.”
A dividend is not a preferential dividend if the distribution is pro rata among all outstanding shares of stock within a particular
class, and in accordance with the preferences among different classes of stock as set forth in our organizational documents. Currently,
there is uncertainty as to the IRS’s position regarding whether certain arrangements that REITs have with their stockholders
could give rise to the inadvertent payment of a preferential dividend (e.g., the pricing methodology for stock purchased under
a distribution reinvestment program inadvertently causing a greater than 5% discount on the price of such stock purchased). There
is no de minimis exception with respect to preferential dividends; therefore, if the IRS were to take the position that we inadvertently
paid a preferential dividend, we may be deemed to have failed the 90% distribution test, and our status as a REIT could be terminated
for the year in which such determination is made if we were unable to cure such failure. While we believe that our operations have
been structured in such a manner that we will not be treated as inadvertently paying preferential dividends, we can provide no
assurance to this effect.
Complying with REIT requirements may limit our ability to hedge our liabilities effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code may limit our ability to hedge our liabilities. Any income from a hedging transaction we enter into to manage risk of interest rate changes, price changes or currency fluctuations with respect to borrowings made or to be made to acquire or carry real estate assets, if properly identified under applicable Treasury Regulations, does not constitute “gross income” for purposes of the 75% or 95% gross income tests. To the extent that we enter into other types of hedging transactions, the income from those transactions will likely be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we may need to limit our use of advantageous hedging techniques or implement those hedges through a taxable REIT subsidiary. This could increase the cost of our hedging activities because our taxable REIT subsidiaries would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in a taxable REIT subsidiary generally will not provide any tax benefit, except for being carried forward against future taxable income of such taxable REIT subsidiary.
Complying with REIT requirements may force us to forgo and/or liquidate otherwise attractive investment opportunities.
To qualify as a REIT, we must ensure that we meet the REIT gross income tests annually and that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified REIT real estate assets, including certain mortgage loans and certain kinds of mortgage-related securities. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by securities of one or more TRS. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate assets from our portfolio or not make otherwise attractive investments in order to maintain our qualification as a REIT. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
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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. While we have elected to be taxed as a REIT, we may terminate our REIT election if we determine that qualifying as a REIT is no longer in the best interests of our stockholders. 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 market price of our common stock.
We may be subject to adverse legislative or regulatory tax changes that could increase our tax liability, reduce our operating flexibility and reduce the price of our common stock.
In recent years, numerous legislative, judicial and administrative changes have been made in the provisions of U.S. federal income tax laws applicable to investments similar to an investment in shares of our common stock. Additional changes to the tax laws are likely to continue to occur, and we cannot assure you that any such changes will not adversely affect the taxation of a stockholder. Any such changes could have an adverse effect on an investment in our shares or on the market value or the resale potential of our assets. You are urged to consult with your tax advisor with respect to the impact of recent legislation on your investment in our shares and the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in our shares. You also should note that our counsel’s tax opinion is based upon existing law, applicable as of the date of its opinion, all of which will be subject to change, either prospectively or retroactively.
Although REITs generally receive better tax treatment than entities taxed as regular corporations, it is possible that future legislation would result in a REIT having fewer tax advantages, and it could become more advantageous for a company that invests in real estate to elect to be treated for U.S. federal income tax purposes as a corporation. As a result, our charter provides our Board of Directors with the power, under certain circumstances, to revoke or otherwise terminate our REIT election and cause us to be taxed as a regular corporation, without the vote of our stockholders. Our Board of Directors has fiduciary duties to us and our stockholders and could only cause such changes in our tax treatment if it determines in good faith that such changes are in the best interest of our stockholders.
Non-U.S. stockholders will be subject to U.S. federal withholding tax and may be subject to U.S. federal income tax on distributions received from us and upon the disposition of our shares.
Subject to certain exceptions, distributions received from us will be treated as dividends of ordinary income to the extent of our current or accumulated earnings and profits. Such dividends ordinarily will be subject to U.S. withholding tax at a 30% rate, or such lower rate as may be specified by an applicable income tax treaty, unless the distributions are treated as “effectively connected” with the conduct by the non-U.S. stockholder of a U.S. trade or business. Capital gain distributions attributable to sales or exchanges of U.S. real property generally will be taxed to a non-U.S. stockholder as if such gain were effectively connected with a U.S. trade or business. However, a capital gain dividend will not be treated as effectively connected income if (a) the distribution is received with respect to a class of stock that is regularly traded on an established securities market located in the United States and (b) the non-U.S. stockholder does not own more than 5% of the class of our stock at any time during the one-year period ending on the date the distribution is received. We do not anticipate that our shares will be “regularly traded” on an established securities market for the foreseeable future, and therefore, this exception is not expected to apply.
Gain recognized by a non-U.S. stockholder upon the sale or exchange of our common stock generally will not be subject to U.S. federal income taxation unless such stock constitutes a “U.S. real property interest” within the meaning of the Foreign Investment in Real Property Tax Act of 1980, or FIRPTA. Our common stock will not constitute a “U.S. real property interest” so long as we are a “domestically-controlled qualified investment entity.” A domestically-controlled qualified investment entity includes a REIT if at all times during a specified testing period, less than 50% in value of such REIT’s stock is held directly or indirectly by non-U.S. stockholders. We believe, but cannot assure you, that we will be a domestically-controlled qualified investment entity.
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Even if we do not qualify as a domestically-controlled qualified investment entity at the time a non-U.S. stockholder sells or exchanges our common stock, gain arising from such a sale or exchange would not be subject to U.S. taxation under FIRPTA as a sale of a U.S. real property interest if (a) our common stock is “regularly traded,” as defined by applicable Treasury regulations, on an established securities market, and (b) such non-U.S. stockholder owned, actually and constructively, 5% or less of our common stock at any time during the five-year period ending on the date of the sale. However, it is not anticipated that our common stock will be “regularly traded” on an established market. We encourage you to consult your tax advisor to determine the tax consequences applicable to you if you are a non-U.S. stockholder.
Potential characterization of distributions or gain on sale may be treated as unrelated business taxable income to tax-exempt investors.
If (a) we are a “pension-held REIT,” (b) a tax-exempt stockholder has incurred (or deemed to have incurred) debt to purchase or hold our common stock, or (c) a holder of common stock is a certain type of tax-exempt stockholder, dividends on, and gains recognized on the sale of, common stock by such tax-exempt stockholder may be subject to U.S. federal income tax as unrelated business taxable income under the Code.
Employee Benefit Plan Risks
An investment in our common stock may not satisfy the requirements of ERISA or other applicable laws.
When considering an investment in our common stock, an individual with investment discretion over assets of any pension plan, profit-sharing plan, retirement plan, individual retirement account “IRA” or other employee benefit plan covered by the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) or other applicable laws should consider whether the investment satisfies the requirements of Section 404 of ERISA or other applicable laws. In particular, attention should be paid to the diversification requirements of Section 404(a)(1)(C) of ERISA in light of all the facts and circumstances, including the portion of the plan’s portfolio of which the investment will be a part. All plan investors should also consider whether the investment is prudent and meets plan liquidity requirements as there may be only a limited market in which to sell or otherwise dispose of our common stock, and whether the investment is permissible under the plan’s governing instrument. We have not, and will not, evaluate whether an investment in our common stock is suitable for any particular plan. Rather, we will accept entities as stockholders if an entity otherwise meets the suitability standards.
The annual statement of value that send to stockholders subject to ERISA and stockholders is only an estimate and may not reflect the actual value of our shares. The annual statement of value reports the estimated value of each common share as of the close of our fiscal year. Because this is only an estimate, we may subsequently revise any annual valuation that is provided. It is possible that:
| · | a value included in the annual statement may not actually be realized by us or by our stockholders upon liquidation; |
| · | stockholders may not realize that value if they were to attempt to sell their common stock; or |
| · | an annual statement of value might not comply with any reporting and disclosure or annual valuation requirements under ERISA or other applicable law. We will stop providing annual statements of value if the common stock becomes listed for trading on a national stock exchange or included for quotation on a national market system. |
ITEM 1B. UNRESOLVED STAFF COMMENTS:
None applicable.
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| Location | Year Built | Leasable Square Feet | Percentage
Occupied as of December 31, 2014 | Annualized
Revenues based on rents as of December 31, 2014 | Annualized
Revenues per square foot as of December 31, 2014 | |||||||||||||||
| Unconsolidated Affiliated Real Estate Entities: | ||||||||||||||||||||
| Retail | ||||||||||||||||||||
| Brownmill LLC (2 retail properties) | Old Bridge and Vauxhall, New Jersey | 1962 | 155,928 | 85 | % | $2.7 million | $ | 17.37 | ||||||||||||
Consolidated Properties:
| Hospitality | Year to Date | Percentage Occupied for the Year Ended | Revenue per Available Room
for the Year | Average Daily Rate For the
Year Ended | ||||||||||||||||
| Location | Year Built | Available Rooms | December 31, 2014 | Ended December 31, 2014 | December 31, 2014 | |||||||||||||||
| TownePlace Suites - Metairie | Harahan, Louisiana | 2000 | 45,260 | 71 | % | $ | 76 | $ | 107 | |||||||||||
| SpringHill Suites - Peabody | Peabody, Massachusetts | 2002 | 59,860 | 70 | % | $ | 80 | $ | 114 | |||||||||||
| Fairfield Inn - East Rutherford | East Rutherford, New Jersey | 1990 | 51,465 | 79 | % | $ | 95 | $ | 120 | |||||||||||
| TownePlace Suites - Fayetteville | Johnson/Springdale, Arkansas | 2009 | 33,580 | 63 | % | $ | 54 | $ | 86 | |||||||||||
| TownePlace Suites - Little Rock | Little Rock, Arkansas | 2009 | 33,580 | 63 | % | $ | 50 | $ | 80 | |||||||||||
| Holiday Inn - Opelika (1) | Opelika, Alabama | 2009 | 23,925 | 76 | % | $ | 83 | $ | 109 | |||||||||||
| Aloft - Tucson (2) | Tucson, Arizona | 1971 | 41,272 | 69 | % | $ | 74 | $ | 108 | |||||||||||
| Hampton Inn – Fort Myers Beach (3) | Fort Myers Beach, Florida | 2001 | 10,920 | 75 | % | $ | 67 | $ | 90 | |||||||||||
| Aloft - Philadelphia (4) | Philadelphia, Pennsylvania | 2008 | 2,040 | 49 | % | $ | 46 | $ | 95 | |||||||||||
| Four Points by Sheraton - Philadelphia (5) | Philadelphia, Pennsylvania | 1985 | 2,655 | 48 | % | $ | 41 | $ | 87 | |||||||||||
(1) The Holiday Inn - Opelika was acquired on April 1, 2014
(2) The Aloft - Tucson was acquired on April 8, 2014
(3) The Hampton Inn – Fort Myers Beach was acquired on October 2, 2014
(4) The Aloft - Philadelphia was acquired on December 17, 2014
(5) The Four Points by Sheraton - Philadelphiawas acquired on December 17, 2014
Annualized revenue is defined as the minimum monthly payments due as of December 31, 2014 annualized, excluding periodic contractual fixed increases and rents calculated based on a percentage of tenants' sales. The annualized base rent disclosed in the table above includes all concessions, abatements and reimbursements of rent to tenants.
From time to time in the ordinary course of business, we may become subject to legal proceedings, claims or disputes.
On July 13, 2011, JF Capital Advisors, filed a lawsuit against The Lightstone Group, LLC, the Company, and Lightstone Value Plus Real Estate Investment Trust, Inc. in the Supreme Court of the State of New York seeking payment for services alleged to have been rendered, and to be rendered prospectively, under theories of unjust enrichment and breach of contract. The plaintiff had a limited business arrangement with The Lightstone Group, LLC; that arrangement has been terminated. We filed a motion to dismiss the action and, on January 31, 2012, the Supreme Court dismissed the complaint in its entirety, but granted the plaintiff leave to replead two limited causes of action.
The plaintiff filed an amended complaint on May 18, 2012, bringing limited claims under theories of unjust enrichment and quantum meruit. On November 21, 2012, the court dismissed this second complaint in part, leaving only $164 (plus interest) in potential damages. The plaintiff appealed this decision and Lightstone cross-appealed arguing that the case should have been dismissed in full. The appeals court denied plaintiff’s motion and granted defendants’ motion, as a result of which all claims were dismissed on March 25, 2014. The plaintiff filed a motion requesting the right to re-appeal to the Court of Appeals, which was granted on August 1, 2014. Lightstone continues to believe these claims to be without merit and will defend the case vigorously.
While any proceeding or litigation has an element of uncertainty, management currently believes that the likelihood of an unfavorable outcome with respect to the aforementioned legal proceedings is remote. No provision for loss has been recorded in connection therewith.
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As of the date hereof, the Company is not a party to any material pending legal proceedings of which the outcome is probable or reasonably possible to have a material adverse effect on its results of operations or financial condition, which would require accrual or disclosure of the contingency and possible range of loss. Additionally, the Company has not recorded any loss contingencies related to legal proceedings in which the potential loss is deemed to be remote.
ITEM 4. Mine Safety Disclosures
Not applicable.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES:
As of March 23, 2015, we had approximately 18.7 million shares of common stock outstanding, held by a total of 5,378 stockholders. The number of stockholders is based on the records of DST Systems Inc., which serves as our registrar and transfer agent.
The Company’s shares of common stock are not currently listed on a national securities exchange. The Company may seek to list its shares of common stock for trading on a national securities exchange only if a majority of its independent directors believe listing would be in the best interest of its stockholders. The Company does not intend to list its shares of common stock at this time. The Company does not anticipate that there would be any market for its shares of common stock until they are listed for trading. Accordingly, it is not possible to determine the market value of the shares of common stock. In the event the Company does not obtain listing prior to the tenth anniversary of the completion or termination of its Primary Offering, its charter requires that the Board of Directors must either (i) seek stockholder approval of an extension or amendment of this listing deadline; or (ii) seek stockholder approval to adopt a plan of liquidation of the Company.
Share Repurchase Program
Our share repurchase program may provide eligible stockholders with limited, interim liquidity by enabling them to sell shares of common stock back to us, subject to restrictions and applicable law. A selling stockholder must be unaffiliated with us, and must have beneficially held the shares of common stock for at least one year prior to offering the shares of common stock for sale to us through the share repurchase program. Subject to the limitations described in the Registration Statement, we will also redeem shares of common stock upon the request of the estate, heir or beneficiary of a deceased stockholder.
The prices at which stockholders who have held shares of common stock for the required one-year period may sell shares of common stock back to us are as follows:
| · | during the 18 months following the termination of the Follow-On Offering (September 27, 2014), the lesser of (i) $9.50 per share of common stock or (ii) the purchase price per share of common stock if purchased from the dealer manager at a reduced price; and |
| · | after 18 months following the termination of the Follow-On Offering, the lesser of (i) $10.00 per share of common stock or (ii) the purchase price per share of common stock if purchased from the dealer manager at a reduced price. |
On December 21, 2012, our Board of Directors declared that in the case of the death of the stockholder, the purchase price per share is the lesser of the actual amount paid by the stockholder to acquire the shares or $10.00 per share.
Redemption of shares, when requested, will be made quarterly. Subject to funds being available, we will limit the number of shares repurchased during any 12-month period to two percent of the weighted average number of shares outstanding during the prior calendar year. Funding for the share repurchase program will come exclusively from operating funds, if any, as the Board of Directors, at its sole discretion, may reserve for this purpose.
Our Board of Directors, at its sole discretion, may choose to terminate the share repurchase program after the end of the offering period, change the price per share of common stock under the share repurchase program, or reduce the number of shares purchased under the program, if it determines that the funds allocated to the share repurchase program are needed for other purposes, such as the acquisition, maintenance or repair of properties, or for use in making a declared distribution. A determination by our Board of Directors to eliminate or reduce the share repurchase program will require the unanimous affirmative vote of the independent directors.
In order for Financial Industry Regulatory Authority, Inc. (“FINRA”) members and their associated persons to have participated in the offering and sale of our shares of common stock or to participate in any future offering of our shares of common stock, we are required pursuant to FINRA rules to disclose in each annual report distributed to our stockholders a per share estimated value of the shares of common stock, the method by which it was developed and the date of the data used to develop the estimated value. In addition, our Advisor must prepare annual statements of estimated share values to assist fiduciaries of retirement plans subject to the annual reporting requirements of ERISA in the preparation of their reports relating to an investment in shares of our common stock. For these purposes, the estimated value of the shares of our common stock shall be deemed to be $10.00 per share as of December 31, 2014.
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The value for stockholders is only an estimate and may not reflect the actual value of our shares. The value is based on the Company’s Follow-On Offering, pursuant to which it offered to sell up to 30,000,000 shares of its common stock for $10.00 per share that terminated on September 27, 2014. The Company intends to determine and disclose the estimated net asset value per share of its common stock within 18 months of the termination of the Follow-On Offering.
Distributions
U.S. federal income tax law requires that a REIT distribute annually at least 90% of its 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. In order to continue to qualify for REIT status, we may be required to make distributions in excess of cash available.
Distributions will be at the discretion of our Board of Directors. We commenced quarterly distributions beginning with the fourth quarter of 2009 and we have generally used cash proceeds from the sale of shares of our common stock to fund such distributions. We may continue to fund such distributions with cash proceeds from the sale of shares of our common stock or borrowings if we do not generate sufficient cash flow from our operations to fund distributions. Our ability to pay regular distributions and the size of these distributions will depend upon a variety of factors. For example, our borrowing policy permits us to incur short-term indebtedness, having a maturity of two years or less, and we may have to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. We cannot assure that regular distributions will continue to be made or that we will maintain any particular level of distributions that we have established or may establish.
We are an accrual basis taxpayer, and as such our REIT taxable income could be higher than the cash available to us. We may therefore borrow to make distributions, which could reduce the cash available to us, in order to distribute 90% of our REIT taxable income as a condition to our election to be taxed as a REIT. These distributions made with borrowed funds may constitute a return of capital to stockholders. “Return of capital” refers to distributions to investors in excess of net income. To the extent that distributions to stockholders exceed earnings and profits, such amounts constitute a return of capital for U.S. federal income tax purposes, although such distributions might not reduce stockholders’ aggregate invested capital. Because our earnings and profits are reduced for depreciation and other non-cash items, it is likely that a portion of each distribution will constitute a tax-deferred return of capital for U.S. federal income tax purposes.
Distributions Declared by our Board of Directors and Source of Distributions
On March 30, 2009, our Board of Directors declared the Annualized Distribution Rate for each quarterly period commencing 30 days subsequent to achieving the minimum offering of 500,000 shares of common stock. The distribution is calculated based on stockholders of record each day during the applicable period at a rate of $0.00178082191 per share per day, and equals a daily amount that, if paid each day for a 365-day period, would equal a 6.5% annualized rate based on the share price of $10.00.
At the beginning of October 2009, we achieved our minimum offering of 500,000 shares of common stock and on November 3, 2009, our Board of Directors declared our first quarterly distribution at an annualized distribution rate (the “Annualized Distribution Rate”) for the three-month period ending December 31, 2009. Subsequently, our Board of Directors has declared regular quarterly distributions at the Annualized Distribution Rate.
Total distributions declared during the years ended December 31, 2014, 2013 and 2012 and were $8.2 million, $4.1 million, and $3.3 million, respectively.
The following tables provide a summary of the quarterly distributions declared during the periods indicated (dollar and share amounts are presented in thousands):
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| Year Ended December 31, 2014 | Three Months Ended December 31, 2014 | Three Months Ended September 30, 2014 | Three Months Ended June 30, 2014 | Three Months Ended March 31, 2014 | ||||||||||||||||||||||||||||||||||||
| Distribution period: | Percentage of Distributions | Q4 2014 | Percentage of Distributions | Q3 2014 | Percentage of Distributions | Q2 2014 | Percentage of Distributions | Q1 2014 | Percentage of Distributions | |||||||||||||||||||||||||||||||
| Date distribution declared | November 14, 2014 | August 8, 2014 | May 14, 2014 | March 28, 2014 | ||||||||||||||||||||||||||||||||||||
| Date distribution paid | January 15, 2015 | October 15, 2014 | July 15, 2014 | April 15, 2014 | ||||||||||||||||||||||||||||||||||||
| Distributions paid | $ | 3,792 | $ | 1,307 | $ | 1,036 | $ | 785 | $ | 664 | ||||||||||||||||||||||||||||||
| Distributions reinvested | $ | 4,402 | 1,721 | 1,205 | 817 | 659 | ||||||||||||||||||||||||||||||||||
| Total Distributions | $ | 8,194 | $ | 3,028 | $ | 2,241 | $ | 1,602 | $ | 1,323 | ||||||||||||||||||||||||||||||
| Source of distributions: | ||||||||||||||||||||||||||||||||||||||||
| Cash flows provided by operations | $ | 3,792 | 46 | % | $ | - | 0 | % | $ | 1,036 | 46 | % | $ | 785 | 49 | % | $ | 250 | 19 | % | ||||||||||||||||||||
| Offering proceeds | $ | - | 0 | % | 1,307 | 43 | % | - | 0 | % | - | 0 | % | 414 | 31 | % | ||||||||||||||||||||||||
| Proceeds from issuance of common stock through DRIP | $ | 4,402 | 54 | % | 1,721 | 57 | % | 1,205 | 54 | % | 817 | 51 | % | 659 | 50 | % | ||||||||||||||||||||||||
| Total Sources | $ | 8,194 | 100 | % | $ | 3,028 | 100 | % | $ | 2,241 | 100 | % | $ | 1,602 | 100 | % | $ | 1,323 | 100 | % | ||||||||||||||||||||
| Cash flows provided by/(used in) operations (GAAP basis) | $ | 4,351 | $ | (1 | ) | $ | 2,014 | $ | 2,088 | $ | 250 | |||||||||||||||||||||||||||||
| Number of shares (in thousands) of common stock issued pursuant to the Company's DRIP | 463 | 181 | 127 | 86 | 69 | |||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2013 | Three Months Ended December 31, 2013 | Three Months Ended September 30, 2013 | Three Months Ended June 30, 2013 | Three Months Ended March 31, 2013 | ||||||||||||||||||||||||||||||||||||
| Distribution period: | Percentage
of Distributions | Q4 2013 | Percentage
of Distributions | Q3 2013 | Percentage
of Distributions | Q2 2013 | Percentage
of Distributions | Q1 2013 | Percentage
of Distributions | |||||||||||||||||||||||||||||||
| Date distribution declared | November 14, 2013 | August 12, 2013 | May 14, 2013 | March 22, 2013 | ||||||||||||||||||||||||||||||||||||
| Date distribution paid | January 15, 2014 | October 15, 2013 | July 15, 2013 | April 15, 2013 | ||||||||||||||||||||||||||||||||||||
| Distributions paid | $ | 2,083 | $ | 595 | $ | 545 | $ | 488 | $ | 455 | ||||||||||||||||||||||||||||||
| Distributions reinvested | 1,967 | 577 | 507 | 464 | 419 | |||||||||||||||||||||||||||||||||||
| Total Distributions | $ | 4,050 | $ | 1,172 | $ | 1,052 | $ | 952 | $ | 874 | ||||||||||||||||||||||||||||||
| Source of distributions: | ||||||||||||||||||||||||||||||||||||||||
| Cash flows provided by operations | $ | 2,083 | 51 | % | $ | 452 | 39 | % | $ | 545 | 52 | % | $ | 488 | 51 | % | $ | 455 | 52 | % | ||||||||||||||||||||
| Offering proceeds | - | 0 | % | 143 | 12 | % | - | 0 | % | - | 0 | % | - | 0 | % | |||||||||||||||||||||||||
| Proceeds from issuance of common stock through DRIP | 1,967 | 49 | % | 577 | 49 | % | 507 | 48 | % | 464 | 49 | % | 419 | 48 | % | |||||||||||||||||||||||||
| Total Sources | $ | 4,050 | 100 | % | $ | 1,172 | 100 | % | $ | 1,052 | 100 | % | $ | 952 | 100 | % | $ | 874 | 100 | % | ||||||||||||||||||||
| Cash flows provided by/(used in) operations (GAAP basis) | $ | 2,746 | $ | 452 | $ | 953 | $ | 736 | $ | 605 | ||||||||||||||||||||||||||||||
| Number of shares (in thousands) of common stock issued pursuant to the Company's DRIP | 207 | 61 | 53 | 49 | 44 | |||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2012 | Three Months Ended December 31, 2012 | Three Months Ended September 30, 2012 | Three Months Ended June 30, 2012 | Three Months Ended March 31, 2012 | ||||||||||||||||||||||||||||||||||||
| Distribution period: | Percentage
of Distributions | Q4 2012 | Percentage
of Distributions | Q3 2012 | Percentage
of Distributions | Q2 2012 | Percentage
of Distributions | Q1 2012 | Percentage
of Distributions | |||||||||||||||||||||||||||||||
| Date distribution declared | November 9, 2012 | August 10, 2012 | May 14, 2012 | March 30, 2012 | ||||||||||||||||||||||||||||||||||||
| Date distribution paid | January 15, 2013 | October 15, 2012 | July 13, 2012 | April 13, 2012 | ||||||||||||||||||||||||||||||||||||
| Distributions paid | $ | 1,752 | $ | 459 | $ | 453 | $ | 433 | $ | 407 | ||||||||||||||||||||||||||||||
| Distributions reinvested | 1,516 | 401 | 393 | 372 | 350 | |||||||||||||||||||||||||||||||||||
| Total Distributions | $ | 3,268 | $ | 860 | $ | 846 | $ | 805 | $ | 757 | ||||||||||||||||||||||||||||||
| Source of distributions: | ||||||||||||||||||||||||||||||||||||||||
| Cash flows provided by operations | $ | 1,706 | 52 | % | $ | 459 | 53 | % | $ | 268 | 32 | % | $ | 200 | 25 | % | $ | 385 | 51 | % | ||||||||||||||||||||
| Offering proceeds | 46 | 1 | % | - | 0 | % | 185 | 22 | % | 233 | 29 | % | 22 | 3 | % | |||||||||||||||||||||||||
| Proceeds from issuance of common stock through DRIP | 1,516 | 47 | % | 401 | 47 | % | 393 | 46 | % | 372 | 46 | % | 350 | 46 | % | |||||||||||||||||||||||||
| Total Sources | $ | 3,268 | 100 | % | $ | 860 | 100 | % | $ | 846 | 100 | % | $ | 805 | 100 | % | $ | 757 | 100 | % | ||||||||||||||||||||
| Cash flows provided by/(used in) operations (GAAP basis) | $ | 1,706 | $ | 853 | $ | 268 | $ | 200 | $ | 385 | ||||||||||||||||||||||||||||||
| Number of shares (in thousands) of common stock issued pursuant to the Company's DRIP | 158 | 42 | 41 | 39 | 36 | |||||||||||||||||||||||||||||||||||
On March 27, 2015, our Board of Directors declared the quarterly distributions for the three-month period ended March 31, 2015 in the amount of $0.00178082191 per share per day payable to stockholders of record on the close of business each day during the quarter, which will be paid on April 15, 2015.
Our stockholders have the option to elect the receipt of shares of common stock in lieu of cash under our DRIP. On January 19, 2015, the Board of Directors suspended the Company’s DRIP effective April 15, 2015. For so long as the DRIP remains suspended, all future distributions will be in the form of cash.
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Recent Sales of Unregistered Securities
The description of the sale of Subordinated Profits Interests set forth under “- Use of Public Offering Proceeds” is incorporated herein by reference.
Use of Public Offering Proceeds
On April 24, 2009, we commenced an initial public offering (the “Offering”) to sell a maximum of 51.0 million shares of common stock at a price of $10 per share and 6.5 million shares of common stock available pursuant to our DRIP. We also have 255,000 shares reserved for issuance under our employee and director incentive restricted share plan. Our Registration Statement was declared effective under the Securities Act of 1933 on February 17, 2009, and on April 24, 2009, we began offering our shares of common stock for sale to the public.
The Offering, which terminated on August 15, 2012, raised aggregate gross proceeds of approximately $49.8 million from the sale of approximately 5.0 million shares of common stock. After allowing for the payment of approximately $5.2 million in selling commissions and dealer manager fees and $4.5 million in organization and other offering expenses, the Offering generated aggregate net proceeds of approximately $40.1 million. In addition, through August 15, 2012 (the termination date of the Offering), the Company had issued approximately 0.3 million shares of common stock under its DRIP, representing approximately $2.9 million of additional proceeds.
The Follow-On Offering, pursuant to which it was offering to sell up to 30,000,000 shares of its common stock for $10.00 per share, subject to certain volume discounts (exclusive of 2,500,000 shares available pursuant to its DRIP at an initial purchase price of $9.50 per share and 255,000 shares reserved for issuance under its Employee and Director Incentive Restricted Share Plan) was declared effective by SEC under the Securities Act of 1933 on September 27, 2012. The Follow-On Offering, which terminated on September 27, 2014, raised aggregate gross proceeds of approximately $127.5 million from the sale of approximately 12.9 million shares of common stock. After allowing for the payment of approximately $11.0 million in selling commissions and dealer manager fees and $4.0 million in organization and other offering expenses, the Follow-On Offering generated aggregate net proceeds of approximately $112.5 million.
As of December 31, 2014, the Advisor owned 20,000 shares of common stock which were issued on May 20, 2008 for $200,000 or $10.00 per share. In addition, as of September 30, 2009, the Company had reached the minimum offering under its Offering by receiving subscriptions of its common shares, representing gross offering proceeds of approximately $6.5 million, and effective October 1, 2009 investors were admitted as stockholders and the Operating Partnership commenced operations. Through December 31, 2014, cumulative gross offering proceeds of $177.3 million were released to the Company. The Company invested the proceeds received from the Offering, the Follow-On Offering and the Advisor in the Operating Partnership, and as a result, held a 99% general partnership interest as of December 31, 2014 in the Operating Partnership’s common units.
Lightstone SLP II LLC, which is wholly owned by our Sponsor, committed to purchase Subordinated Profits Interests at a cost of $100,000 per unit for each $1.0 million in subscriptions up to ten percent of the proceeds from the primary shares under the Offering and Follow-On Offering on a semi-annual basis beginning with the quarter ended June 30, 2010. Lightstone SLP II LLC may elect to purchase the Subordinated Profits Interests with either cash or an interest in real property of equivalent value. Any proceeds received from the cash sale of the Subordinated Profits Interests will be used to offset payments made by the Company from offering proceeds to pay the dealer manager fees, selling commissions and organization and other offering expenses.
From our inception through December 31, 2014, our Sponsor contributed cash of approximately $12.9 million and elected to contribute equity interests totaling 48.6% in Brownmill, which were valued at $4.8 million, in exchange for 177.0 Subordinated Profits Interests with an aggregate value of $17.7 million. See “Sponsor’s Contribution of Equity Interests in Brownmill” below for additional information. Our Sponsor may continue to elect to contribute interests in real property in lieu of cash in exchange for Subordinated Profits Interests in order to fulfill its semi-annual commitment.
We will utilize a portion of our public offering proceeds towards funding the dealer manager fees, selling commissions and organization and other offering costs.
Below is a summary of the expenses we have incurred in connection with the issuance and distribution of the registered securities since inception:
| (Dollars in Thousands) | ||||
| Type of Expense Amount | ||||
| Underwriting discounts and commissions | $ | 16,257 | ||
| Other expenses incurred to be paid non-affiliates | 8,506 | |||
| Total offering expenses incurred from inception through December 31, 2014 | $ | 24,763 | ||
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Cumulatively through December 31, 2014, we have used the net offering proceeds of $152.5 million, after deduction of offering expenses paid since inception of $24.8 million, as follows:
| (Dollars in thousands) | ||||
| Purchase of investment properties, net of mortgage financings | $ | 85,712 | ||
| Purchase of investments in unconsolidated affiliated entities | 4,514 | |||
| Purchase of marketable securities, net of margin loan | 12,114 | |||
| Cash and cash equivalents, as adjusted | 46,603 | |||
| Cash distributions not funded by operations | 2,265 | |||
| Funding of restricted escrows | 853 | |||
| Other uses (primarily timing of payables) | 449 | |||
| Total uses | $ | 152,510 | ||
As of March 23, 2015, we have sold approximately 18.7 million shares of common stock at an aggregate of price of approximately $185.0 million, these include, approximately 1.1 million shares of common stock at an aggregate price of approximately $10.0 million under our DRIP.
ITEM 6. SELECTED FINANCIAL DATA:
The following selected consolidated and combined financial data are qualified by reference to and should be read in conjunction with our consolidated financial statements and Notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.
| As of and for the Years Ended December 31, | ||||||||||||||||||||
| (In Thousands, Except Per Share Amounts) | 2014 | 2013 | 2012 | 2011 | 2010 | |||||||||||||||
| Operating Data: | ||||||||||||||||||||
| Revenues | $ | 23,566 | $ | 13,058 | $ | 5,942 | $ | 2,978 | $ | - | ||||||||||
| Bargain purchase gain | $ | 2,790 | $ | 1,263 | $ | 7,857 | $ | - | $ | - | ||||||||||
| Net income/(loss) | $ | 4,540 | $ | 1,370 | $ | 9,764 | $ | 430 | $ | (780 | ) | |||||||||
| Less: net income attributable to noncontrolling interests | (68 | ) | (40 | ) | (555 | ) | (28 | ) | - | |||||||||||
| Net income/(loss) applicable to Company's common shares | $ | 4,472 | $ | 1,330 | $ | 9,209 | $ | 402 | $ | (780 | ) | |||||||||
| Basic and diluted earnings/(loss) per Company's common shares | $ | 0.35 | $ | 0.21 | $ | 1.84 | $ | 0.10 | $ | (0.31 | ) | |||||||||
| Dividends declared on Company's common shares | $ | 8,194 | $ | 4,050 | $ | 3,268 | $ | 2,587 | $ | 1,632 | ||||||||||
| Weighted average common shares outstanding-basic and diluted | 12,608 | 6,235 | 5,016 | 3,978 | 2,540 | |||||||||||||||
| Balance Sheet Data: | ||||||||||||||||||||
| Total assets | $ | 207,693 | $ | 95,826 | $ | 64,734 | $ | 38,072 | $ | 29,535 | ||||||||||
| Long-term obligations | $ | 23,761 | $ | 24,260 | $ | 11,157 | $ | - | $ | - | ||||||||||
| Company's Stockholder's Equity | $ | 153,184 | $ | 59,424 | $ | 42,873 | $ | 28,547 | $ | 24,919 | ||||||||||
| Other financial data: | ||||||||||||||||||||
| Funds from operations (FFO) attributable to Company's common shares (1) | $ | 5,611 | $ | 2,479 | $ | 2,317 | $ | 1,279 | $ | (391 | ) | |||||||||
| 1. | For more information about FFO and MFFO, including a reconciliation to our GAAP net income/(loss) for each period reported, please see Management’s Discussion and Analysis of Financial Condition and Results of Operations - “Funds from Operations and Modified Funds from Operations.” |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
You should read the following discussion and analysis together with our consolidated financial statements and notes thereto included in this Annual Report on Form 10-K. The following information contains forward-looking statements, which are subject to risks and uncertainties. Should one or more of these risks or uncertainties materialize, actual results may differ materially from those expressed or implied by the forward-looking statements. Please see “Special Note Regarding Forward-Looking Statements” above for a description of these risks and uncertainties. Dollar amounts are presented in thousands, except per share data and where indicated in millions.
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Overview
Lightstone Value Plus Real Estate Investment Trust II, Inc. (the “Lightstone REIT II” or “Company”) intends to continue to acquire and operate commercial, residential and hospitality properties, principally in North America. Principally through the Lightstone Value Plus REIT II, LP, (the “Operating Partnership”), our acquisitions may include both portfolios and individual properties. We expect that our commercial holdings will consist of retail (primarily multi-tenanted shopping centers), lodging, industrial and office properties and that our residential properties located either in or near major metropolitan areas.
Capital required for the purchase of real estate and real estate related investments will be obtained from the public offering of shares of our common stock, and from any indebtedness that we may incur in connection with the acquisition of any real estate and real estate related investments thereafter. A Registration Statement on Form S-11 covering our public offering (the “Offering”) was declared effective under the Securities Act of 1933 on February 17, 2009. The Offering commenced on April 24, 2009 and terminated on August 15, 2012, raised aggregate gross proceeds of approximately $49.8 million from the sale of approximately 5.0 million shares of common stock. After allowing for the payment of approximately $5.2 million in selling commissions and dealer manager fees and $4.5 million in organization and other offering expenses, the Offering generated aggregate net proceeds of approximately $40.1 million. In addition, through August 15, 2012 (the termination date of the Offering), the Company had issued approximately 0.3 million shares of common stock under its DRIP, representing approximately $2.9 million of additional proceeds.
The Company’s registration statement on Form S-11 (the “Follow-On Offering”), pursuant to which it was offering to sell up to 30,000,000 shares of its common stock for $10.00 per share, subject to certain volume discounts (exclusive of 2,500,000 shares available pursuant to its DRIP at an initial purchase price of $9.50 per share and 255,000 shares reserved for issuance under its Employee and Director Incentive Restricted Share Plan) was declared effective by SEC under the Securities Act of 1933 on September 27, 2012. The Follow-On Offering, which terminated on September 27, 2014, raised aggregate gross proceeds of approximately $127.5 million from the sale of approximately 12.9 million shares of common stock. After allowing for the payment of approximately $11.0 million in selling commissions and dealer manager fees and $4.0 million in organization and other offering expenses, the Follow-On Offering generated aggregate net proceeds of approximately $112.5 million.
We do not have employees. We entered into an advisory agreement dated February 17, 2009 with Lightstone Value Plus REIT II LLC, a Delaware limited liability company, which we refer to as the “Advisor,” pursuant to which the Advisor supervises and manages our day-to-day operations and selects our real estate and real estate related investments, subject to oversight by our Board of Directors. We pay the Advisor fees for services related to the investment and management of our assets, and we will reimburse the Advisor for certain expenses incurred on our behalf.
To maintain our qualification as a REIT, we engage in certain activities through a wholly-owned taxable REIT subsidiary (“TRS”). As such, we are subject to U.S. federal and state income and franchise taxes from these activities.
Acquisitions and Investment Strategy
We have made and intend to continue to make direct or indirect real estate investments that will satisfy our primary investment objectives of preserving capital, paying regular cash distributions and achieving appreciation of our assets over the long term. The ability of our Advisor to identify and execute investment opportunities at a pace consistent with the capital raised through our public offerings will directly impact our financial performance.
We will continue to seek to acquire and operate commercial, residential, and hospitality properties, principally in North America. Our commercial holdings will consist of retail (primarily multi-tenanted shopping centers), lodging, industrial and office properties. We may acquire and operate all such properties alone or jointly with another party. In addition, we may invest up to 20% of its net assets in collateralized debt obligations, commercial mortgage-backed securities (“CMBS”) and mortgage and mezzanine loans secured, directly or indirectly, by the same types of properties which we may acquire directly.
The following summarizes our completed acquisitions for the year ended December 31, 2014:
| · | On April 1, 2014 we acquired a Holiday Inn Express Hotel & Suites (the “Holiday Inn — Opelika”) located in Opelika, Alabama; |
| · | On April 8, 2014 we acquired an Aloft Hotel (the “Aloft — Tucson”) located in Tucson, Arizona; |
| · | On October 2, 2014 we acquired a Hampton Inn Hotel (the “Hampton Inn — Fort Myers Beach”) located in Fort Myers Beach, Florida; and |
| · | On December 17, 2014, we acquired a portfolio comprised of two hotels and a land parcel located in Philadelphia, Pennsylvania, the Aloft Philadelphia Airport (the “Aloft - Philadelphia”) and the Four Points by Sheraton Philadelphia Airport (the “Four Points by Sheraton - Philadelphia”, and collectively, the “Philadelphia Airport Hotel Portfolio”) |
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The following summarizes our completed acquisitions and investments from our inception through December 31, 2013:
| · | During 2009, we acquired a 32.42% Class D Member Interest in HG CMBS Finance, LLC (“HGF”), a real estate limited liability company that primarily invested in CMBS, which were sold by HGF during 2010; |
| · | We have an aggregate 48.6% equity interest in Brownmill, LLC (“Brownmill”), which includes two retail properties known as the Browntown Shopping Center and the Millburn Mall, located in Old Bridge, New Jersey and Vauxhall, New Jersey, respectively, which was acquired on June 30, 2010 (with respect to a 26.25% equity interest), December 29, 2010 (with respect to a 8.163% equity interest), December 28, 2011 (with respect to a 5.587% equity interest), June 6, 2012 (with respect to a 5.102% equity interest) and October 1, 2012 (with respect to an 3.4776% equity interest); |
| · | On January 19, 2011, we acquired a 95.0% ownership interest in a TownePlace Suites hotel (the “TownePlace Suites – Metairie”) located in Harahan, Louisiana; |
| · | On March 21, 2011, we acquired a 20.0% ownership interest in LVP CP Boston Holdings, LLC (the “CP Boston Joint Venture”), a joint venture which owns a hotel and water park located in Danvers, Massachusetts, which we subsequently disposed of on February 20, 2012 with an effective date of January 1, 2012; |
| · | On April 12, 2011, we acquired a 10.0% ownership interest in LVP Rego Park, LLC(the “Rego Park Joint Venture”), a joint venture which owned a second mortgage loan secured by a residential apartment complex located in Queens, New York, which was paid in full on June 27, 2013; |
| · | On July 13, 2012 we acquired a SpringHill Suites by Marriott hotel (the “SpringHill Suites – Peabody”) located in Peabody, Massachusetts; |
| · | On December 31, 2012, we acquired an aggregate 87.7% ownership interest in a Fairfield Inn hotel (the “Fairfield Inn – East Rutherford”) located in East Rutherford, New Jersey as a result of the restructuring of our mortgage loan receivable secured by the Fairfield Inn – East Rutherford , which was previously acquired on June 29, 2010; and |
| · | On June 18, 2013, we acquired a 95.0% ownership interest in a portfolio comprised of two TownePlace Suites hotels (collectively, the “Arkansas Hotel Portfolio”) located in Little Rock (the “TownePlace Suites – Little Rock”) and Johnson/Springdale, Arkansas (the “TownePlace Suites – Fayetteville”), respectively. |
Current Environment
Our operating results as well as our investment opportunities are impacted by the health of the North American economies. Our business and financial performance may be adversely affected by current and future economic conditions, such as availability of credit, financial markets volatility, and recession.
U.S. and international markets are currently experiencing increased levels of volatility due to a combination of many factors, including depressed home prices, limited access to credit markets, higher fuel prices, less consumer spending and fears of a national and global recession. The effects of the current market dislocation may persist as financial institutions continue to take the necessary steps to restructure their business and capital structures. As a result, this economic downturn has reduced demand for space and removed support for rents and property values. Since we cannot predict when the real estate markets may recover, the value of our properties may decline if current market conditions persist or worsen.
Our business may be affected by market and economic challenges experienced by the U.S. and global economies. These conditions may materially affect the value and performance of our properties, and may 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.
We are not aware of any other material trends or uncertainties, favorable or unfavorable, other than national economic conditions affecting real estate generally, that may be reasonably anticipated to have a material impact on either capital resources or the revenues or income to be derived from the acquisition and operation of real estate and real estate related investments, other than those referred to in this Form 10-K.
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Critical Accounting Estimates and Policies
General.
Our consolidated financial statements included in this annual report include our accounts and the Operating Partnership (over which we exercise financial and operating control). All inter-company balances and transactions have been eliminated in consolidation.
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of our financial statements requires us to make estimates and judgments about the effects of matters or future events that are inherently uncertain. These estimates and judgments may affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
On an ongoing basis, we evaluate our estimates, including contingencies and litigation. We base these estimates on historical experience and on various other assumptions that we believe to be reasonable in the circumstances. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
To assist in understanding our results of operations and financial position, we have identified our critical accounting policies and discussed them below. These accounting policies are most important to the portrayal of our results and financial position, either because of the significance of the financial statement items to which they relate or because they require management's most difficult, subjective or complex judgments.
Revenue Recognition and Valuation of Related Receivables.
Our revenue, which will be comprised largely of rental income, will include rents that tenants pay in accordance with the terms of their respective leases reported on a straight-line basis over the initial term of the lease. Since our leases may provide for rental increases at specified intervals, straight-line basis accounting requires us to record as an asset, and include in revenue, unbilled rent that we only receive if the tenant makes all rent payments required through the expiration of the initial term of the lease. Accordingly, we will determine, in our judgment, to what extent the unbilled rent receivable applicable to each specific tenant is collectible. We review unbilled rent receivables on a quarterly basis and take into consideration the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates and economic conditions in the area in which the property is located. In the event that the collection of unbilled rent with respect to any given tenant is in doubt, we will record an increase in our allowance for doubtful accounts or will record a direct write-off of the specific rent receivable, which will have an adverse effect on our net income for the year in which the allowance is increased or the direct write-off is recorded and decrease our total assets and stockholders’ equity. Revenues from the operations of the hotels are recognized when the services are provided.
In addition, we will defer the recognition of contingent rental income, such as percentage rents, until the specific target which triggers the contingent rental income is achieved. Cost recoveries from tenants will be included in tenant reimbursement income in the period the related costs are incurred.
Investments in Real Estate.
We record investments in real estate at cost and capitalize improvements and replacements when they extend the useful life or improve the efficiency of the asset. We expense costs of repairs and maintenance as incurred. We compute depreciation using the straight-line method over the estimated useful lives of our real estate assets, which is approximately 39 years for buildings and improvements, 5 to 10 years for equipment and fixtures and the shorter of the useful life or the remaining lease term for tenant improvements and leasehold interests.
We make subjective assessments as to the useful lives of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income because, if we were to shorten the expected useful lives of our investments in real estate, we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.
When circumstances such as adverse market conditions indicate a possible impairment of the value of a property, we review the recoverability of the property’s carrying value. The review of recoverability is based on our estimate of the future undiscounted cash flows, excluding interest charges, expected to result from the property’s use and eventual disposition. Our forecast of these cash flows considers factors such as expected future operating income, market and other applicable trends and residual value, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a property, we will record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the property.
We make subjective assessments as to whether there are impairments in the values of our investments in real estate. We evaluate our ability to collect both interest and principal related to any real estate related investments in which we invest. If circumstances indicate that such investment is impaired, we reduce the carrying value of the investment to its net realizable value. Such reduction in value is reflected as a charge to operations in the period in which the determination is made.
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Real Estate Purchase Price Allocation.
When we make an investment in real estate, the fair value of the real estate acquired is allocated to the acquired tangible assets, consisting of land, building and tenant improvements, identified intangible assets and liabilities, consisting of the value of above-market and below-market leases for acquired in-place leases and the value of tenant relationships, and certain liabilities such as assumed debt and contingent liabilities, based in each case on their fair values. Purchase accounting is applied to assets and liabilities related to real estate entities acquired based upon the percentage of interest acquired. Fees incurred related to acquisitions are expensed as incurred within general and administrative costs within the consolidated statements of operations. Transaction costs such as professional fees, commissions, acquisition fees and closing costs incurred related to our investment in unconsolidated real estate entities, accounted for under the equity method of accounting, are capitalized as part of the cost of the investment.
Upon acquisition of real estate operating properties, we estimate the fair value of acquired tangible assets and identified intangible assets and liabilities, assumed debt and contingent liabilities at the date of acquisition, based upon an evaluation of information and estimates available at that date. Based on these estimates, we allocate the initial purchase price to the applicable assets, liabilities and noncontrolling interest, if any. As final information regarding fair value of the assets acquired and liabilities assumed and noncontrolling interest is received and estimates are refined, appropriate adjustments are made to the purchase price allocation. The allocations are finalized within twelve months of the acquisition date.
We allocate the purchase price of an acquired property to tangible assets based on the estimated fair values of those tangible assets assuming the building was vacant. We record above-market and below-market in-place lease values for acquired properties based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (1) the contractual amounts to be paid pursuant to the in-place leases and (2) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. We amortize capitalized above-market lease values as a reduction of rental income over the remaining non-cancelable terms of the respective leases. We amortize any capitalized below-market lease values as an increase to rental income over the initial term and any fixed-rate renewal periods in the respective leases.
We measure the aggregate value of other intangible assets acquired based on the difference between (1) the property valued with existing in-place leases adjusted to market rental rates and (2) the property valued as if vacant. The fair value of in-place leases includes direct costs associated with obtaining a new tenant, opportunity costs associated with lost rentals which are avoided by acquiring an in-place lease, and tenant relationships. Direct costs associated with obtaining a new tenant include commissions, tenant improvements, and other direct costs and are estimated based upon independent appraisals and management’s consideration of current market costs to execute similar leases. These direct costs are included in intangible lease assets in the accompanying consolidated balance sheet and are amortized over the remaining terms of the respective lease. The value of customer relationship intangibles are amortized to expense over the initial term in the respective leases, but in no event is the amortization period for intangible assets in excess of the remaining depreciable life of the building. Should a tenant terminate its lease, the unamortized portion of the in-place lease value and customer relationship intangibles is charged to expense.
Investments in Unconsolidated Entities.
We evaluate investments in other entities for consolidation. We consider the percentage interest in the joint venture, evaluation of control and whether a variable interest entity exists when determining if the investment qualifies for consolidation.
Under the equity method, the investment is recorded initially at cost, and subsequently adjusted for equity in net income (loss) and cash contributions and distributions. The net income or loss of each investor is allocated in accordance with the provisions of the applicable operating agreements of the entities. The allocation provisions in these agreements may differ from the ownership interest held by each investor. Differences between the carrying amount of our investment in the respective joint venture and our share of the underlying equity of such unconsolidated entities are amortized over the respective lives of the underlying assets as applicable. These items are reported as a single line item in the consolidated statements of operations as income or loss from investments in unconsolidated affiliated entities. Under the cost method of accounting, the investment is recorded initially at cost, and subsequently adjusted for cash contributions and distributions resulting from any capital events. Dividends earned from the underlying entities are recorded as interest income.
On a quarterly basis, we assess whether the value of our investments in unconsolidated entities has been impaired. An investment is impaired only if management’s estimate of the fair value of the investment is less than the carrying value of the investment, and such decline in value is deemed to be other than temporary. The ultimate realization of our investment in partially owned entities is dependent on a number of factors including the performance of that entity and market conditions. If we determine that a decline in the value of a partially owned entity is other than temporary, we record an impairment charge.
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Accounting for Derivative Financial Investments and Hedging Activities.
We may enter into derivative financial instrument transactions in order to mitigate interest rate risk on a related financial instrument. We may designate these derivative financial instruments as hedges and apply hedge accounting. We will record all derivative instruments at fair value on the consolidated balance sheet.
Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, will be considered cash flow hedges. We will formally document all relationships between hedging instruments and hedged items, as well as our risk- management objective and strategy for undertaking each hedge transaction. We will periodically review the effectiveness of each hedging transaction, which involves estimating future cash flows. Cash flow hedges will be accounted for by recording the fair value of the derivative instrument on the consolidated balance sheet as either an asset or liability, with a corresponding amount recorded in other comprehensive income (loss) within stockholders’ equity. Amounts will be reclassified from other comprehensive income (loss) to the consolidated statement of operations in the period or periods the hedged forecasted transaction affects earnings. Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, will be considered fair value hedges. The effective portion of the derivatives gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.
Accounting for Organization and Other Offering Costs.
Selling commissions and dealer manager fees paid to the Dealer Manager, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs, and professional fees, are accounted for as a reduction against additional paid-in capital. Any organization costs are expensed to general and administrative costs.
Inflation
We will be exposed to inflation risk as income from long-term leases is expected to be the primary source of our cash flows from operations. Our long-term leases are expected to contain provisions to mitigate the adverse impact of inflation on our operating results. Such provisions will include clauses entitling us to receive scheduled base rent increases and base rent increases based upon the consumer price index. In addition, our leases are expected to require tenants to pay a negotiated share of operating expenses, including maintenance, real estate taxes, insurance and utilities, thereby reducing our exposure to increases in cost and operating expenses resulting from inflation.
Treatment of Management Compensation, Expense Reimbursements and Operating Partnership Participation Interest
Management of our operations is outsourced to our Advisor and certain other affiliates of our Sponsor. Fees related to each of these services are accounted for based on the nature of such service and the relevant accounting literature. Fees for services performed that represent our period costs are expensed as incurred. Such fees include acquisition fees associated with the purchase of interests in real estate entities; asset management fees paid to our Advisor and property management fees paid to our Property Managers. These fees are expensed or capitalized to the basis of acquired assets, as appropriate.
Our Property Managers may also perform fee-based construction management services for both our development and redevelopment activities and tenant construction projects. These fees will be considered incremental to the construction effort and will be capitalized to the associated real estate project as incurred. Costs incurred for tenant construction will be depreciated over the shorter of their useful life or the term of the related lease. Costs related to development and redevelopment activities will be depreciated over the estimated useful life of the associated project.
Leasing activity at our properties has also been outsourced to our Property Managers. Any corresponding leasing fees we pay will be capitalized and amortized over the life of the related lease.
Expense reimbursements made to both our Advisor and Property Managers will be expensed or capitalized to the basis of acquired assets, as appropriate.
Lightstone SLP II, LLC, which is wholly owned by our Sponsor, committed to purchase subordinated profits interests (“Subordinated Profits Interests”) in our Operating Partnership at a cost of $0.1 million per unit. Lightstone SLP II, LLC may elect to purchase the Subordinated Profits Interests with either cash or an interest in real property of equivalent value. These Subordinated Profits Interests, the purchase price of which will be repaid only after stockholders receive a stated preferred return and their net investment, will entitle Lightstone SLP II, LLC to a portion of any regular distributions made by our Operating Partnership. Such distributions will always be subordinated until stockholders receive a stated preferred return. The cash proceeds, if any, received from the sale of the Subordinated Profits Interests will be used to offset payments made by us from offering proceeds to pay the dealer manager fees, selling commissions and organization and other offering costs. Through December 31, 2014, Lightstone SLP II, LLC had purchased 177 units of Subordinated Profits Interests by contributing $12.9 million and an aggregate 48.6% equity interest it owned in Brownmill (see Note 4 of the Notes to Consolidated Financial Statements).
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Income Taxes
We elected to be taxed as a REIT in conjunction with the filing of our 2009 U.S. federal income tax return. If we remain qualified as a REIT, we generally will not be subject to U.S. federal income tax on our net taxable income that we distribute currently to our stockholders. To maintain our REIT qualification under the Internal Revenue Code of 1986, as amended, or the Code, we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders 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. If we fail to remain qualified for taxation as a REIT in any subsequent year and do not qualify for certain statutory relief provisions, our income for that year will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.
As of December 31, 2014 and 2013, we had no material uncertain income tax positions. The tax years subsequent to and including 2011 remain open to examination by the major taxing jurisdictions to which we are subject. Additionally, even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on our undistributed income.
To maintain our qualification as a REIT, we engage in certain activities through taxable REIT subsidiaries (“TRSs”). As such, we are subject to U.S. federal and state income and franchise taxes from these activities.
Results of Operations
The Company’s primary financial measure for evaluating its properties is net operating income (“NOI”). NOI represents revenues less property operating expenses, real estate taxes and general and administrative expenses. The Company believes that NOI is helpful to investors as a supplemental measure of the operating performance of a real estate company because it is a direct measure of the actual operating results of the Company’s properties.
For the year ended December 31, 2014, the Company’s consolidated results of operations included the operating results from (i) the TownePlace Suites - Metairie, (ii) the SpringHill Suites - Peabody, (iii) the Fairfield Inn – East Rutherford, (iv) the TownePlace Suites – Fayetteville and the TownePlace Suites – Little Rock (collectively, the “Arkansas Hotel Portfolio”), (v) the Holiday Inn - Opelika from the date it was acquired (April 1, 2014), (vi) the Aloft – Tucson from the date it was acquired (April 8, 2014), (vii) the Hampton Inn — Fort Myers Beach from the date it was acquired (October 2, 2014) and (viii) the Aloft - Philadelphia and the Four Points by Sheraton - Philadelphia (collectively, the “Philadelphia Airport Hotel Portfolio”) from the date they were acquired (December 17, 2014).
For the year ended December 31, 2013, the Company’s consolidated results of operations included the operating results from (i) the TownePlace Suites - Metairie, (ii) the SpringHill Suites - Peabody, (iii) the Fairfield Inn – East Rutherford and (iv) the TownePlace Suites – Fayetteville and the TownePlace Suites – Little Rock (collectively, the “Arkansas Hotel Portfolio”) from the date they were acquired (June 18, 2013).
See Note 3 of the Notes to Consolidated Financial Statements for additional information on our acquisitions.
Comparison of the year ended December 31, 2014 vs. December 31, 2013
Consolidated
Rental revenue
Rental revenue increased by $10.5 million to $23.6 million during the year ended December 31, 2014 compared to $13.1 million for the same period in 2013. The increase is primarily attributable to the acquisitions of the Arkansas Hotel Portfolio, the Holiday Inn – Opelika, the Aloft – Tucson and the Hampton Inn — Fort Myers Beach as well as higher revenue at several of our hotels which underwent brand-required property improvement plans during 2013 and 2014.
Property operating expenses
Property operating expenses increased by $6.2 million to $14.7 million during the year ended December 31, 2014 compared to $8.5 million for the same period in 2013. The increase is primarily attributable to the acquisitions of the Arkansas Hotel Portfolio, the Holiday Inn – Opelika, the Aloft – Tucson and the Hampton Inn — Fort Myers Beach.
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Real estate taxes
Real estate taxes increased by $0.3 million to $0.9 million during the year ended December 31, 2014 compared to $0.6 million for the same period in 2013. The increase is primarily attributable to the acquisitions of the Arkansas Hotel Portfolio, the Holiday Inn – Opelika, the Aloft – Tucson and the Hampton Inn — Fort Myers Beach, offset slightly by a refund in the 2014 period.
General and administrative expense
General and administrative expense increased by $1.3 million to $2.9 million during the year ended December 31, 2014 compared to $1.6 million for the same period in 2013. The increase is primarily attributable to the acquisitions of the Arkansas Hotel Portfolio, the Holiday Inn – Opelika, the Aloft – Tucson and the Hampton Inn — Fort Myers Beach.
Depreciation and amortization
Depreciation and amortization expense increased by $1.6 million to $3.4 million during the year ended December 31, 2014 compared to $1.8 million for the same period in 2013. The increase is primarily attributable to the acquisitions of the Arkansas Hotel Portfolio, the Holiday Inn – Opelika, the Aloft – Tucson and the Hampton Inn — Fort Myers Beach as well as brand-required property improvement plans which several of our hotels underwent during 2013 and 2014.
Interest and dividend income
Interest and dividend income increased by $0.5 million to $1.4 million during the year ended December 31, 2014 compared to $0.9 million for the same period in 2013. The 2014 amount consisted primarily of dividend income earned on our investments in marketable securities. The 2013 amount includes (i) $0.3 million of interest on notes receivables and (ii) $0.6 million of dividend income earned on our investments in marketable securities. The increase can be attributed to an increase in marketable securities of approximately $10.0 million offset by the decrease in interest on notes receivable that were paid in full in 2013.
Bargain purchase gain
On December 17, 2014, we completed the acquisition of the Philadelphia Airport Hotel Portfolio. In connection with the acquisition, we recognized a bargain purchase gain of $2.8 million in our consolidated statements of operations for the year ended December 31, 2014. On June 18, 2013, we completed the acquisition of the Arkansas Hotel Portfolio. In connection with the acquisition, we recognized a bargain purchase gain of $1.3 million in our consolidated statements of operations for the year ended December 31, 2013. These gains represent the amount by which the estimated fair value of the assets acquired exceeded our aggregate cost.
Earnings from investments in unconsolidated affiliated entities
Our loss from investments in unconsolidated affiliated entities during the year ended December 31, 2014 was $111 compared to $14 for the same period in 2013. Our earnings from investments in unconsolidated affiliated entities are attributable to our investments in (i) Brownmill and (ii) LVP Rego Park LLC. We account or accounted for our ownership interests in these unconsolidated affiliated entities under the equity method of accounting. See Note 4 of the Notes to Consolidated Financial Statements for additional information.
Interest expense
Interest expense was $1.3 million during the year ended December 31, 2014 compared to $1.0 million for the same period in 2013. Interest expense during the 2014 period consisted of $1.2 million related to our mortgage indebtedness and approximately $0.1 million related to our margin loan. Interest expense during the 2013 period consists primarily of $0.9 million related to our mortgage indebtedness and approximately $0.1 million related to our margin loan and note payable affiliate. The increase is primarily attributable to the timing of our new mortgage financings during the 2013 period.
Noncontrolling interests
The income allocated to noncontrolling interests relates to (i) the interest in our Operating Partnership held by our Sponsor and (ii) membership interests held by others in LVP Metairie JV LLC, LVP East Rutherford LLC, LVP TPS Little Rock Holdings LLC and LVP TPS Fayetteville Holdings LLC.
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Comparison of the year ended December 31, 2013 vs. December 31, 2012
Consolidated
Rental revenue
Rental revenue increased by $7.2 million to $13.1 million during the year ended December 31, 2013 compared to $5.9 million for the same period in 2012. The increase is primarily attributable to the timing of our acquisitions, principally the SpringHill Suites – Peabody, the Fairfield Inn – East Rutherford and the Arkansas Hotel Portfolio, during the 2012 and 2013 periods.
Property operating expenses
Property operating expenses increased by $5.2 million to $8.5 million during the year ended December 31, 2013 compared to $3.3 million for the same period in 2012. The increase is primarily attributable to the timing of our acquisitions, principally the SpringHill Suites – Peabody, the Fairfield Inn – East Rutherford and the Arkansas Hotel Portfolio, during the 2012 and 2013 periods.
Real estate taxes
Real estate taxes increased by $0.4 million to $0.6 million during the year ended December 31, 2013 compared to $0.2 million for the same period in 2012. The increase is primarily attributable to the timing of our acquisitions, principally the SpringHill Suites – Peabody, the Fairfield Inn – East Rutherford and the Arkansas Hotel Portfolio, during the 2012 and 2013 periods.
General and administrative expenses
General and administrative expenses decreased by $0.4 million to $1.6 million during the year ended December 31, 2013 compared to $2.0 million for the same period in 2012. The decrease reflects lower asset management fees in the 2013 period as result of the Sponsor’s waiver of such fees during the year ended December 31, 2013 (see Note 11 of the Notes to Consolidated Financial Statements for additional information).
Depreciation and amortization
Depreciation and amortization expense increased by $1.2 million to $1.8 million during the year ended December 31, 2013 compared to $0.6 million for the same period in 2012. The increase is primarily attributable to the timing of acquisitions, principally the SpringHill Suites – Peabody, the Fairfield Inn – East Rutherford and the Arkansas Hotel Portfolio, during the 2012 and 2013 periods.
Interest and dividend income
Interest and dividend income decreased by $0.8 million to $0.9 million during the year ended December 31, 2013 compared to $1.7 million for the same period in 2012. The 2013 amount includes (i) $0.3 million of interest on notes receivables and (ii) $0.6 million of dividend income earned on our investments in marketable securities. The 2012 amount consisted of (i) $0.2 million of interest on the note receivable from affiliate we received in connection with the disposition of our 20.0% joint venture ownership interest in the CP Boston Joint Venture effective January 1, 2012, (ii) $0.7 million of dividend income earned on our investments in marketable securities, (iii) $0.8 million of interest income on our mortgage loan receivable and (iv) $14 of interest on our cash and cash equivalents.
Bargain purchase gain
On June 18, 2013, we completed the acquisition of the Arkansas Hotel Portfolio. In connection with the acquisition, we recognized a bargain purchase gain of $1.3 million in our consolidated statements of operations. During the year ended December 31, 2012, we completed the acquisitions of the Springhill Suites - Peabody and the Fairfield Inn – East Rutherford. In connection with these acquisitions, we recognized a bargain purchase gain of $7.9 million in our consolidated statements of operations during the year ended December 31, 2012. These gains represent the amount by which the estimated fair value of the net assets acquired exceeded our aggregate cost.
Gain on disposition of unconsolidated affiliated entity
On February 20, 2012, we completed the disposition of our 20.0% joint venture ownership interest in the CP Boston Joint Venture with an effective date of January, 1, 2012, to subsidiaries of Lightstone Value Plus Real Estate Investment, Inc. (“Lightstone REIT I”), our Sponsor’s other public program, which now owns 100.0% of the CP Boston Joint Venture. In connection with the disposition, we recognized a gain on disposition of investment in unconsolidated affiliated entity of $0.7 million in our consolidated statements of operations during the nine months ended September 30, 2012.
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(Loss)/income from investments in unconsolidated affiliated entities
Our loss from investments in unconsolidated affiliated entities during the year ended December 31, 2013 was $14 compared to income of $0.2 million for the same period in 2012. Our earnings from investments in unconsolidated affiliated entities are attributable to our ownership interests in certain unconsolidated affiliated entities, which we account or accounted for under the equity method of accounting commencing with their respective date of acquisition through their respective date of disposition, if applicable. See Note 4 of the Notes to Consolidated Financial Statements for additional information.
Interest expense
Interest expense increased $0.5 million to $1.0 million during the year ended December 31, 2013 compared to $0.5 million for the same period in 2012. Interest expense during the 2013 period consists primarily of $0.9 million related to our mortgage indebtedness and approximately $0.1 million related to our margin loan and note payable affiliate. Interest expense during the 2012 period consisted of $0.5 million and $34 related to our mortgage indebtedness and our margin loan, respectively. The increase is primarily attributable to the timing of our new mortgage financings during the 2012 and 2013 periods. See Note 6 of the Notes to the Consolidated Financial Statements for additional information.
Noncontrolling interests
The income or loss allocated to noncontrolling interests relates to (i) the interest in our Operating Partnership held by our Sponsor and (ii) membership interests held by others in the TownePlace Suites – Metairie, the Fairfield Inn – East Rutherford, the TownePlace Suites – Little Rock and the TownePlace Suites – Fayetteville.
Financial Condition, Liquidity and Capital Resources
Overview:
For the year ended December 31, 2014, our primary source of funds were (i) $104.6 million of proceeds from the sale of shares of common stock under our Follow-On Offering, (ii) $11.3 million of contributions from noncontrolling interests, (iii) $9.7 million of proceeds from the sale of marketable securities and (iv) $3.9 million of proceeds from our margin loan. The primary source of capital required to fund our future purchases of real estate and/or real estate related investments will principally come from the remaining proceeds related to our public offering of shares of our common stock, the sale of marketable securities and from any indebtedness that we may incur in connection with the acquisition and operations of any real estate investments thereafter.
We have and intend to continue to utilize leverage either in connection with acquiring our properties or subsequent to their acquisition. The number of different properties we will acquire will be affected by numerous factors, including, the amount of funds available to us. When interest rates on mortgage loans are high or financing is otherwise unavailable on terms that are satisfactory to us, we may purchase certain properties for cash with the intention of obtaining a mortgage loan for a portion of the purchase price at a later time.
Our future sources of funds will primarily consist of (i) cash flows from our operations, (ii) proceeds from our borrowings, (iii) the sale of marketable securities and (iv) the release of funds held in restricted escrows. We currently believe that these cash resources will be sufficient to satisfy our cash requirements for the foreseeable future, and we do not anticipate a need to raise funds from other than these sources within the next twelve months.
We currently have mortgage indebtedness totaling $23.8 million and a margin loan of $5.8 million. We have and intend to continue to limit our aggregate long-term permanent borrowings to 75% of the aggregate fair market value of all properties unless any excess borrowing is approved by a majority of the independent directors and is disclosed to our stockholders. Market conditions will dictate our overall leverage limit; as such our aggregate long-term permanent borrowings may be less than 75% of aggregate fair market value of all properties. We may also incur short-term indebtedness, having a maturity of two years or less.
Our charter provides that the aggregate amount of our borrowing, both secured and unsecured, may not exceed 300% of net assets in the absence of a satisfactory showing that a higher level is appropriate, the approval of our Board of Directors and disclosure to stockholders. Net assets means our total assets, other than intangibles, at cost before deducting depreciation or other non-cash reserves less our total liabilities, calculated at least quarterly on a basis consistently applied. Any excess in borrowing over such 300% of net assets level must be approved by a majority of our independent directors and disclosed to our stockholders in our next quarterly report to stockholders, along with justification for such excess. Market conditions will dictate our overall leverage limit; as such our aggregate borrowings may be less than 300% of net assets. As of December 31, 2014, our total borrowings aggregated $29.6 million which represented 17% of our net assets.
Our future borrowings may consist of single-property mortgages as well as mortgages cross-collateralized by a pool of properties. Such mortgages may be put in place either at the time we acquire a property or subsequent to our purchasing a property for cash. In addition, we may acquire properties that are subject to existing indebtedness where we choose to assume the existing mortgages. Generally, though not exclusively, we intend to seek to encumber our properties with non-recourse debt. This means that a lender’s rights on default will generally be limited to foreclosing on the property. However, we may, at our discretion, secure recourse financing or provide a guarantee to lenders if we believe this may result in more favorable terms. When we give a guaranty for a property owning entity, we will be responsible to the lender for the satisfaction of the indebtedness if it is not paid by the property owning entity.
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In general the type of future financing executed by us to a large extent will be dictated by the nature of the investment and current market conditions. For long-term real estate investments, it is our intent to finance future acquisitions using long-term fixed rate debt. However there may be certain types of investments and market circumstances which may result in variable rate debt being the more appropriate choice of financing. To the extent floating rate debt is used to finance the purchase of real estate, management will evaluate a number of protections against significant increases in interest rates, including the purchase of interest rate caps instruments.
We may also obtain lines of credit to be used to acquire properties. If obtained, these lines of credit will be at prevailing market terms and will be repaid from offering proceeds, proceeds from the sale or refinancing of properties, working capital and/or permanent financing. Our Sponsor and/or its affiliates may guarantee our lines of credit although they are not obligated to do so. We may draw upon lines of credit to acquire properties pending our receipt of proceeds from our public offerings. We expect that such properties may be purchased by our Sponsor’s affiliates on our behalf, in our name, in order to minimize the imposition of a transfer tax upon a transfer of such properties to us.
Additionally, in order to leverage our investments in marketable securities and seek a higher rate of return, we borrowed using a margin loan collateralized by the securities held with the financial institution that provided the margin loan. This loan is due on demand and will be paid upon the liquidation of securities.
In addition to making investments in accordance with our investment objectives, we have used and expect to continue use our capital resources to make certain payments to our Advisor, our Dealer Manager, and our Property Manager during the various phases of our organization and operation. During our organizational and offering stage, these payments include payments to our Dealer Manager for selling commissions and the dealer manager fee, and payments to our Advisor for the reimbursement of organization and other offering costs.
Selling commissions and dealer manager fees are paid to the Dealer Manager, pursuant to various agreements, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs, and professional fees are accounted for as a reduction against additional paid-in capital as costs are incurred. Any organizational costs are accounted for as general and administrative costs. The following table represents the selling commissions and dealer manager fees and other offering costs for the periods indicated:
| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Selling commissions and dealer manager fees | $ | 8,934 | $ | 2,023 | $ | 715 | ||||||
| Other offering costs | $ | 611 | $ | 1,937 | $ | 1,495 | ||||||
Since commencement of our Offering through the termination of the Follow-On Offering (September 27, 2014), we have incurred approximately $16.3 million in selling commissions and dealer manager fees and $8.5 million of other offering costs.
During the acquisition and development stage, payments may include asset acquisition fees and asset management fees, and the reimbursement of acquisition related expenses to our Advisor. During the operational stage, we will pay our Property Managers and/or other third party property managers a property management fee and our Advisor an asset management fee. We will also reimburse our Advisor and its affiliates for actual expenses it incurs for administrative and other services provided to us. Additionally, our Operating Partnership may be required to make distributions to Lightstone SLP II LLC, an affiliate of the Advisor.
The following table represents the fees incurred associated with the payments to our advisor and its affiliates:
| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Acquisition fees | $ | 547 | $ | 102 | $ | 85 | ||||||
| Asset management fees | - | 114 | 346 | |||||||||
| Development fees | 140 | 78 | - | |||||||||
| Total | $ | 687 | $ | 294 | $ | 431 | ||||||
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Pursuant to an Advisory Agreement, our Advisor is entitled to receive an asset management fee equal to 0.95% of our average invested assets, as defined. The asset management fee is payable quarterly and based on balances as of the end of each month in the quarterly period. Commencing with the quarter ended June 30, 2013, the Advisor has elected to waive or reduce its quarterly asset management fee to the extent our non-GAAP measure modified funds from operations available, or MFFO, as defined by the Investment Program Association, or IPA, for the preceding twelve months period ending on the last day of the current quarter is less than the distributions declared with respect to the same twelve month period. As a result, asset management fees of $ 0.8 million and $0.4 million were waived by the Advisor during the years ended December 31, 2014 and 2013, respectively.
During the years ended December 31, 2014, 2013 and 2012, we did not incur any fees associated with payments to our Property Managers.
Other Related Party Transactions
From time to time, we purchase title insurance from an agent in which our Sponsor owns a 50% limited partnership interest. Because this title insurance agent receives significant fees for providing title insurance, our Advisor may face a conflict of interest when considering the terms of purchasing title insurance from this agent. However, before we purchase any title insurance, an independent title consultant with more than 25 years of experience in the title insurance industry reviews the transaction, and performs market research and competitive analysis on our behalf. This process results in terms similar to those that would be negotiated at an arm’s length basis. During the years ended December 31, 2014, 2013 and 2012, we paid approximately $44, $106 and $32 in fees to this title insurance agent, respectively.
Summary of Cash Flows. The following summary discussion of our cash flows is based on the consolidated statements of cash flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below:
| Year Ended December 31, 2014 | Year Ended December 31, 2013 | Year Ended December 31, 2012 | ||||||||||
| Cash flows provided by operating activities | $ | 4,351 | $ | 2,746 | $ | 1,706 | ||||||
| Cash flows used in investing activities | (69,172 | ) | (13,177 | ) | (11,541 | ) | ||||||
| Cash flows provided by financing activities | 105,803 | 28,799 | 12,873 | |||||||||
| Net change in cash and cash equivalents | 40,982 | 18,368 | 3,038 | |||||||||
| Cash and cash equivalents, beginning of the year | 26,520 | 8,152 | 5,114 | |||||||||
| Cash and cash equivalents, end of the year | $ | 67,502 | $ | 26,520 | $ | 8,152 | ||||||
Our principal sources of cash flow were derived from net offering proceeds received, contributions from noncontrolling interests, proceeds from the sale of marketable securities and proceeds from new borrowings. In the future, we expect to continue to acquire properties which should provide a relatively consistent stream of cash flow to provide us with resources to fund our operating expenses, scheduled debt service and any quarterly distributions authorized by our Board of Directors.
Our principal demands for liquidity currently are acquisition and development activities and scheduled debt service on our mortgage payable. The principal sources of funding for our operations are operating cash flows and cash available from the issuance of equity securities.
Operating activities
The net cash provided by operating activities of approximately $4.4 million during the 2014 period primarily related to our income of $4.5 million and non-cash items of $0.9 million offset by changes in assets and liabilities of $1.0 million.
Investing activities
The net cash used by investing activities of approximately $69.1 million during the 2014 period primarily reflects (i) $60.6 million of capital expenditures and (ii) $19.8 million purchases of marketable securities offset by $1.3 million released from restricted escrows and $9.7 million from the sale of marketable securities.
Financing activities
The net cash provided by financing activities of approximately $105.8 million during the 2014 period primarily consists of (i) proceeds from the issuance of our common stock of $104.6 million, (ii) net proceeds from our margin loan of $3.9 million and (iii) contributions of $11.3 million from certain noncontrolling interests partially offset by (i) the payment of selling commissions, dealer manager fees and other offering costs of $9.6 million, (ii) distributions to common stockholders of $3.1 million, (iii) payments on our mortgages payable of $0.5 million and (iv) redemptions and cancellations of shares of common stock of $0.7 million
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We believe that these cash resources will be sufficient to satisfy our cash requirements for the foreseeable future, and we do not anticipate a need to raise funds from other than these sources within the next twelve months.
DRIP and Share Repurchase Programs
Our DRIP provides our stockholders with an opportunity to purchase additional shares of our common stock at a discount by reinvesting distributions.
On January 19, 2015, the Board of Directors suspended the Company’s DRIP effective April 15, 2015. For so long as the DRIP remains suspended, all future distributions will be in the form of cash.
Our share repurchase program may provide our stockholders with limited, interim liquidity by enabling them to sell their shares of common stock back to us, subject to restrictions. From our inception through December 31, 2009, we did not receive any requests to redeem shares of our common stock under our share repurchase program. For the years ended December 31, 2014, 2013 and 2012, we redeemed 72,318, 74,927and 50,784 shares of common stock, respectively, pursuant to our share repurchase program. During the year ended December 31, 2014, we redeemed 100% of the redemption requests at an average price per share of common stock of $9.34. We funded share redemptions for the periods noted above from the cumulative proceeds of the sale of shares of common shares pursuant to our DRIP and from our operating funds.
Our Board of Directors reserves the right to terminate either program for any reason without cause by providing written notice of termination of the DRIP to all participants or written notice of termination of the share repurchase program to all stockholders.
Contractual Obligations
Contractual Obligations
The following is a summary of our estimated contractual obligations outstanding over the next five years and thereafter as of December 31, 2014.
| Contractual Obligations | 2015 | 2016 | 2017 | 2018 | 2019 | Thereafter | Total | |||||||||||||||||||||
| Principal maturities | $ | 524 | $ | 548 | $ | 580 | $ | 22,109 | $ | - | $ | - | $ | 23,761 | ||||||||||||||
| Interest payments | 1,178 | 1,154 | 1,123 | 732 | - | - | 4,187 | |||||||||||||||||||||
| Total | $ | 1,702 | $ | 1,702 | $ | 1,703 | $ | 22,841 | $ | - | $ | - | $ | 27,948 | ||||||||||||||
In addition to the mortgage payable described above, we have a margin loan that was made available to us from a financial institution that holds custody of certain of our marketable securities. The margin loan is collateralized by the marketable securities in our account. The amounts available to us under the margin loan are at the discretion of the financial institution and not limited to the amount of collateral in our account. The amount outstanding under this margin loan was $5.8 million as of December 31, 2014 and is due on demand. The margin loan bears interest at Libor plus 0.85% (1.00% as of December 31, 2014).
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, Inc. (“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.
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The historical accounting convention used for real estate assets requires 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 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. Investors should note, however, that 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, investors are cautioned that due to the fact that 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 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.
Changes in the accounting and reporting promulgations under GAAP (for acquisition fees and expenses from a capitalization/depreciation model to an expensed-as-incurred model) that were put into effect in 2009 and other changes to GAAP accounting for real estate subsequent to the establishment of NAREIT’s definition of FFO have prompted an increase in cash-settled expenses, specifically acquisition fees and expenses for all industries as items that are expensed under GAAP, that are typically accounted for as operating 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. While other start up entities may also experience significant acquisition activity during their initial years, we believe that non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after the acquisition activity ceases. We will use the proceeds raised in our Follow On Offering to acquire properties, and we intend to begin the process of achieving a liquidity event (i.e., listing of our common stock on a national exchange, a merger or sale of the company or another similar transaction) within seven to ten years after the proceeds from the Primary Offering are fully invested. Thus, we will not continuously purchase assets and will have a limited life. 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 modified funds from operations, (“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 do not continue to operate with a limited life and targeted exit strategy, as currently intended. 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 in place. 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 Follow-On Offering has been completed and our properties have been acquired. 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 Follow-On Offering and acquisitions are completed with the sustainability of the operating performance of other real estate companies that are not as involved in acquisition activities. Investors are cautioned that MFFO should only be used to assess the sustainability of our operating performance after our Follow-On Offering has been completed and properties have been acquired, as it excludes acquisition costs that have a negative effect on our operating performance during the periods in which properties are acquired.
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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 (the “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, unrealized 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. While we are responsible for managing interest rate, hedge and foreign exchange risk, we do 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.
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 noncontrolling 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 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 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. The purchase of properties, and the corresponding expenses associated with that process, is a key operational feature of our business plan to generate operational income and cash flows in order to make distributions to investors. Acquisition fees and expenses will not be reimbursed by the advisor if there are no further proceeds from the sale of shares in our offering, and therefore such fees and expenses will 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 which have limited lives with short and defined acquisition periods and targeted exit strategies shortly thereafter. 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 operate in this manner. 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 their limited life, limited and defined acquisition period and targeted exit strategy, and hence that the use of such measures is useful to investors. For example, acquisition costs are funded from the proceeds of our Follow-On Offering and other financing sources and not from operations. 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 in an offering such as ours where the price of a share of common stock is a stated value and there is no net asset value determination during the offering stage and for a period thereafter. MFFO is useful in assisting management and investors in assessing the sustainability of operating performance in future operating periods, and in particular, after the offering and acquisition stages are 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.
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The below table illustrates the items deducted from or added to net income in the calculation of FFO and MFFO during the periods presented. The table discloses MFFO in the IPA recommended format and MFFO without the straight-line rent adjustment which management also uses as a performance measure. Items are presented net of non-controlling interest portions where applicable.
| For the Years Ended | ||||||||||||
| December 31, 2014 | December 31, 2013 | December 31, 2012 | ||||||||||
| Net income | $ | 4,540 | $ | 1,370 | $ | 9,764 | ||||||
| FFO adjustments: | ||||||||||||
| Depreciation and amortization of real estate assets | 3,446 | 1,822 | 558 | |||||||||
| Gain on disposition of unconsolidated affiliated entity | - | - | (741 | ) | ||||||||
| Adjustments to equity in earnings from unconsolidated entities, net unconsolidated entities, net | 620 | 667 | 667 | |||||||||
| Bargain purchase gain | (2,790 | ) | (1,263 | ) | (7,857 | ) | ||||||
| FFO | 5,816 | 2,596 | 2,391 | |||||||||
| MFFO adjustments: | ||||||||||||
| Other adjustments: | ||||||||||||
| Acquisition and other transaction related costs expensed(1) | 1,769 | 635 | 804 | |||||||||
| Gain on sale of unconsolidated real unconsolidated entities, net estate entity | - | - | - | |||||||||
| Adjustments to equity in earnings from unconsolidated entities, net unconsolidated entities, net | 65 | (59 | ) | (250 | ) | |||||||
| Amortization of above or below market leases and liabilities(2) | - | - | - | |||||||||
| Accretion of discounts and amortizatio of premiums on debt investments | - | - | - | |||||||||
| Mark-to-market adjustments(3) | - | - | - | |||||||||
| Non-recurring (loss)/gain from extinguishment/sale of debt, derivatives or securities holdings(4) | (112 | ) | 144 | - | ||||||||
| MFFO | 7,538 | 3,316 | 2,945 | |||||||||
| Straight-line rent(5) | - | - | - | |||||||||
| MFFO - IPA recommended format(6) | $ | 7,538 | $ | 3,316 | $ | 2,945 | ||||||
| Net income | $ | 4,540 | $ | 1,370 | $ | 9,764 | ||||||
| Less: income attributable to noncontrolling interests | (68 | ) | (40 | ) | (555 | ) | ||||||
| Net income applicable to company's common shares | $ | 4,472 | $ | 1,330 | $ | 9,209 | ||||||
| Net income per common share, basic and diluted | $ | 0.35 | $ | 0.21 | $ | 1.84 | ||||||
| FFO | $ | 5,816 | $ | 2,596 | $ | 2,391 | ||||||
| Less: FFO attributable to noncontrolling interests | (205 | ) | (117 | ) | (74 | ) | ||||||
| FFO attributable to company's common shares | $ | 5,611 | $ | 2,479 | $ | 2,317 | ||||||
| FFO per common share, basic and diluted | $ | 0.45 | $ | 0.40 | $ | 0.46 | ||||||
| MFFO - IPA recommended format | $ | 7,538 | $ | 3,316 | $ | 2,945 | ||||||
| Less: MFFO attributable to noncontrolling interests | (209 | ) | (86 | ) | (76 | ) | ||||||
| MFFO attributable to company's common shares | $ | 7,329 | $ | 3,230 | $ | 2,869 | ||||||
| Weighted average number of common shares outstanding, basic and diluted | 12,608 | 6,235 | 5,016 | |||||||||
| (1) | The purchase of properties, and the corresponding expenses associated with that process, is a key operational feature of our business plan to generate operational income and cash flows in order to make distributions to investors. In evaluating investments in real estate, management differentiates the costs to acquire the investment from the operations derived from the investment. Such information would be comparable only for non-listed REITs that have completed their acquisition activity and have other similar operating characteristics. By excluding expensed acquisition costs, management believes MFFO provides useful supplemental information that is comparable for each type of real estate investment and is consistent with management’s analysis 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 as expenses included in the determination of net income and income from continuing operations, both of which are performance measures under GAAP. Such fees and expenses are paid in cash, and therefore such funds will not be available to distribute to investors. Such fees and expenses negatively impact our operating performance during the period in which properties are being acquired. Therefore, MFFO may not be an accurate indicator of our operating performance, especially during periods in which properties are being acquired. 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, these fees and expenses and other costs related to the property. Acquisition fees and expenses will not be paid or reimbursed, as applicable, to our advisor even if there are no further proceeds from the sale of shares in our Follow On Offering, and therefore such fees and expenses would 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. |
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| (2) | Under GAAP, certain intangibles are accounted for at cost and reviewed at least annually for impairment, and certain 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. |
| (3) | Management believes that adjusting for mark-to-market adjustments is appropriate because they are items that may not be reflective of ongoing operations and reflect unrealized impacts on value based only on then current market conditions, although they may be based upon current operational issues related to an individual property or industry or general market conditions. Mark-to-market adjustments are made for items such as ineffective derivative instruments, certain marketable securities and any other items that GAAP requires we make a mark-to-market adjustment for. The need to reflect mark-to-market adjustments is a continuous process and is analyzed on a quarterly and/or annual basis in accordance with GAAP. |
| (4) | Management believes that adjusting for gains or losses related to extinguishment/sale of debt, derivatives or securities holdings is appropriate because they are items that may not be reflective of ongoing operations. By excluding these items, management believes that MFFO provides supplemental information related to sustainable operations that will be more comparable between other reporting periods. |
| (5) | Under GAAP, rental receipts are allocated to periods using various methodologies. This may result in income recognition that is significantly different than underlying contract terms. By adjusting for these items (to reflect such payments from a GAAP accrual basis to a cash basis of disclosing the rent and lease payments), MFFO provides useful supplemental information on the realized economic impact of lease terms and debt investments, providing insight on the contractual cash flows of such lease terms and debt investments, and aligns results with management’s analysis of operating performance. |
The table below presents our cumulative distributions declared and cumulative FFO:
| For the period April, 28, 2008 | ||||
| (date of inception) through | ||||
| December 31, 2014 | ||||
| FFO | $ | 11,047 | ||
| Distributions | $ | 19,887 | ||
For the year ended December 31, 2014, we paid distributions of $6.3 million, including $3.1 million of distributions paid in cash and $3.2 million of distributions reinvested through our DRIP. FFO for the year ended December 31, 2014 was $5.6 million and cash flow from operations was $4.4 million. For the year ended December 31, 2013, we paid distributions of $3.7 million, including $1.9 million of distributions paid in cash and $1.8 million of distributions reinvested through our DRIP. FFO for the year ended December 31, 2013 was $2.5 million and cash flow from operations was $2.7 million. See the reconciliation of FFO to net income above.
On January 19, 2015, the Board of Directors suspended the Company’s DRIP effective April 15, 2015. For so long as the DRIP remains suspended, all future distributions will be in the form of cash.
New Accounting Pronouncements
See Note 2 to the Notes to Consolidated Financial Statements for further information of certain accounting standards that have been adopted during 2014 and certain accounting standards that we have not yet been required to implement and may be applicable to our future operations.
Subsequent Events
See Note 14 of the Notes to Consolidated Financial Statements for further information related to subsequent events during the period from January 1, 2015 through March 31, 2015.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK:
Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. The primary market risk to which we are currently and expect to continue to be exposed is interest rate risk.
We are currently and expect to continue to be exposed to the effects of interest rate changes primarily as a result of borrowings used to maintain liquidity and fund the expansion and refinancing of our real estate investment portfolio and operations. Our interest rate risk management objectives have been and will continue to be to limit the impact of interest rate changes on our earnings, prepayment penalties and cash flows and to lower our overall borrowing costs while taking into account variable interest rate risk. To achieve our objectives, we may borrow at fixed rates or variable rates. We may also enter into derivative financial instruments such as interest rate swaps and caps in order to mitigate our interest rate risk on a related financial instrument. We will not enter into derivative or interest rate transactions for speculative purposes. As of December 31, 2014, we did not have any derivative agreements outstanding.
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As of December 31, 2014, we held marketable equity securities with a fair value of $18.2 million, which are available for sale for general investment return purposes. We regularly review the market prices of our investments for impairment purposes. As of December 31, 2014, a hypothetical adverse 10.0% movement in market values would result in a hypothetical loss in fair value of approximately $1.8 million.
The following table shows our estimated principal maturities during the next five years and thereafter as of December 31, 2014:
| 2015 | 2016 | 2017 | 2018 | 2019 | Thereafter | Total | ||||||||||||||||||||||
| Principal maturities | $ | 524 | $ | 548 | $ | 580 | $ | 22,109 | $ | - | $ | - | $ | 23,761 | ||||||||||||||
The carrying amounts of cash and cash equivalents, restricted escrows and deposits, prepaid expenses and other assets, accounts payable and other accrued expenses, margin loan, due to sponsor, and distributions payable approximated their fair values as of December 31, 2014 because of the short maturity of these instruments. The estimated fair value of our mortgages payable is as follows:
| As of December 31, 2014 | As of December 31, 2013 | |||||||||||||||
| (Dollars in thousands) | Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | ||||||||||||
| Mortgages payable | $ | 23,761 | $ | 23,548 | $ | 24,260 | $ | 23,898 | ||||||||
The fair value of our mortgages payable was determined by discounting the future contractual interest and principal payments by market interest rates.
In addition to changes in interest rates, the value of our real estate will be subject to fluctuations based on changes in the real estate capital markets, market rental rates for office space, local, regional and national economic conditions and changes in the creditworthiness of tenants which may affect our ability to obtain or refinance debt in the future. As of December 31, 2014, we had no off-balance sheet arrangements.
We cannot predict the effect of adverse changes in interest rates on our debt and, therefore, our exposure to market risk, nor can we provide any assurance that long-term debt will be available at advantageous pricing. Consequently, future results may differ materially from the estimated adverse changes discussed above.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Lightstone Value Plus Real Estate Investment Trust II, Inc. and Subsidiaries
(a Maryland corporation)
Index
Schedules not filed:
All schedules other than the one listed in the Index have been omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Lightstone Value Plus Real Estate Investment Trust II, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Lightstone Value Plus Real Estate Investment Trust II, Inc. and Subsidiaries (the “Company”) as of December 31, 2014 and 2013 and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2014. The financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lightstone Value Plus Real Estate Investment Trust II, Inc. and Subsidiaries as of December 31, 2014 and 2013 and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.
In connection with our audit of the consolidated financial statements referred to above, we also audited Schedule III – Real Estate and Accumulated Depreciation as of December 31, 2014. In our opinion, this financial schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information stated therein.
/s/ EisnerAmper LLP
Iselin, New Jersey
March 31, 2015
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except per share data)
| December 31, 2014 | December 31, 2013 | |||||||
| Assets | ||||||||
| Investment property: | ||||||||
| Land and improvements | $ | 22,726 | $ | 8,942 | ||||
| Building and improvements | 80,392 | 35,567 | ||||||
| Furniture and fixtures | 17,223 | 8,706 | ||||||
| Construction in progress | 449 | 3,542 | ||||||
| Gross investment property | 120,790 | 56,757 | ||||||
| Less accumulated depreciation | (6,111 | ) | (2,670 | ) | ||||
| Net investment property | 114,679 | 54,087 | ||||||
| Investments in unconsolidated affiliated entity | 3,504 | 3,834 | ||||||
| Cash and cash equivalents | 67,502 | 26,520 | ||||||
| Marketable securities, available for sale | 18,180 | 8,134 | ||||||
| Restricted escrows and deposits | 988 | 2,294 | ||||||
| Prepaid expenses and other assets | 2,840 | 957 | ||||||
| Total Assets | $ | 207,693 | $ | 95,826 | ||||
| Liabilities and Stockholders' Equity | ||||||||
| Accounts payable and other accrued expenses | $ | 2,868 | $ | 1,356 | ||||
| Margin loan | 5,815 | 1,906 | ||||||
| Mortgages payable | 23,761 | 24,260 | ||||||
| Due to sponsor | 199 | 107 | ||||||
| Distributions payable | 3,028 | 1,172 | ||||||
| Total liabilities | 35,671 | 28,801 | ||||||
| Commitments and contingencies (Note 12) | ||||||||
| Stockholders' Equity: | ||||||||
| Company's stockholders' equity: | ||||||||
| Preferred shares, $0.01 par value, 10,000 shares authorized, none issued and outstanding | - | - | ||||||
| Common stock, $0.01 par value; 100,000 shares authorized, 18,493 and 7,643 shares issued and outstanding in 2014 and 2013, respectively | 185 | 76 | ||||||
| Additional paid-in-capital | 158,330 | 60,755 | ||||||
| Subscription receivable | (80 | ) | (25 | ) | ||||
| Accumulated other comprehensive income | 252 | 399 | ||||||
| Accumulated deficit | (5,503 | ) | (1,781 | ) | ||||
| Total Company stockholders' equity | 153,184 | 59,424 | ||||||
| Noncontrolling interests | 18,838 | 7,601 | ||||||
| Total Stockholders' Equity | 172,022 | 67,025 | ||||||
| Total Liabilities and Stockholders' Equity | $ | 207,693 | $ | 95,826 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Rental revenue | $ | 23,566 | $ | 13,058 | $ | 5,942 | ||||||
| Expenses: | ||||||||||||
| Property operating expenses | 14,692 | 8,464 | 3,329 | |||||||||
| Real estate taxes | 857 | 648 | 216 | |||||||||
| General and administrative costs | 2,903 | 1,583 | 1,953 | |||||||||
| Depreciation and amortization | 3,446 | 1,822 | 558 | |||||||||
| Total operating expenses | 21,898 | 12,517 | 6,056 | |||||||||
| Operating income/(loss) | 1,668 | 541 | (114 | ) | ||||||||
| Interest and dividend income | 1,443 | 856 | 1,665 | |||||||||
| Gain on disposition of unconsolidated affiliated entity | - | - | 741 | |||||||||
| Bargain purchase gain | 2,790 | 1,263 | 7,857 | |||||||||
| Interest expense | (1,325 | ) | (1,035 | ) | (535 | ) | ||||||
| Other income/(expense), net | 75 | (241 | ) | (9 | ) | |||||||
| (Loss)/income from investments in unconsolidated affiliated entities | (111 | ) | (14 | ) | 159 | |||||||
| Net income | 4,540 | 1,370 | 9,764 | |||||||||
| Less: net income attributable to noncontrolling interests | (68 | ) | (40 | ) | (555 | ) | ||||||
| Net income applicable to Company's common shares | $ | 4,472 | $ | 1,330 | $ | 9,209 | ||||||
| Net income per Company's common share, basic and diluted | $ | 0.35 | $ | 0.21 | $ | 1.84 | ||||||
| Weighted average number of common shares outstanding, basic and diluted | 12,608 | 6,235 | 5,016 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands, except per share data)
| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Net income | $ | 4,540 | $ | 1,370 | $ | 9,764 | ||||||
| Other comprehensive (loss)/income: | ||||||||||||
| Unrealized (loss)/gain on available for sale securities | (147 | ) | 165 | 2,443 | ||||||||
| Reclassification adjustment for gains included in net income | - | 5 | - | |||||||||
| Other comprehensive (loss)/income | (147 | ) | 170 | 2,443 | ||||||||
| Comprehensive income | 4,393 | 1,540 | 12,207 | |||||||||
| Less: Comprehensive income attributable to noncontrolling interests | (68 | ) | (40 | ) | (555 | ) | ||||||
| Comprehensive income attributable to the Company's common shares | $ | 4,325 | $ | 1,500 | $ | 11,652 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Amounts in thousands)
| Common Shares | ||||||||||||||||||||||||||||||||
| Additional | Accumulated Other | Total | Total | |||||||||||||||||||||||||||||
| Common | Paid-In | Subscription | Comprehensive | Accumulated | Noncontrolling | Stockholders' | ||||||||||||||||||||||||||
| Shares | Amount | Capital | Receivable | Income/(Loss) | Surplus/(Deficit) | Interests | Equity | |||||||||||||||||||||||||
| BALANCE, December 31, 2011 | 4,503 | $ | 45 | $ | 35,822 | $ | (104 | ) | $ | (2,214 | ) | $ | (5,002 | ) | $ | 4,735 | $ | 33,282 | ||||||||||||||
| Net income | - | - | - | - | - | 9,209 | 555 | 9,764 | ||||||||||||||||||||||||
| Other comprehensive income | 2,443 | - | - | 2,443 | ||||||||||||||||||||||||||||
| Distributions declared | - | - | - | - | - | (3,268 | ) | - | (3,268 | ) | ||||||||||||||||||||||
| Distributions paid | - | - | - | - | - | - | (306 | ) | (306 | ) | ||||||||||||||||||||||
| Units issued to noncontrolling interest in exchange for investment in unconsolidated affiliated real estate entity | - | - | - | - | - | - | 911 | 911 | ||||||||||||||||||||||||
| Contributions from noncontrolling interests | - | - | - | - | - | - | 103 | 103 | ||||||||||||||||||||||||
| Proceeds from offering | 706 | 7 | 7,041 | 104 | - | - | - | 7,152 | ||||||||||||||||||||||||
| Selling commissions and dealer manager fees | - | - | (715 | ) | - | - | - | - | (715 | ) | ||||||||||||||||||||||
| Other offering costs | - | - | (1,495 | ) | - | - | - | - | (1,495 | ) | ||||||||||||||||||||||
| Redemption and cancellation of shares | (51 | ) | (1 | ) | (457 | ) | - | - | - | - | (458 | ) | ||||||||||||||||||||
| Shares issued from distribution reinvestment program | 153 | 2 | 1,456 | - | - | - | - | 1,458 | ||||||||||||||||||||||||
| BALANCE, December 31, 2012 | 5,311 | $ | 53 | $ | 41,652 | $ | - | $ | 229 | $ | 939 | $ | 5,998 | $ | 48,871 | |||||||||||||||||
| Net income | - | - | - | - | - | 1,330 | 40 | 1,370 | ||||||||||||||||||||||||
| Other comprehensive income | - | - | - | - | 170 | - | - | 170 | ||||||||||||||||||||||||
| Distributions declared | - | - | - | - | - | (4,050 | ) | - | (4,050 | ) | ||||||||||||||||||||||
| Distributions paid to noncontrolling interests | - | - | - | - | - | - | (175 | ) | (175 | ) | ||||||||||||||||||||||
| Contributions from noncontrolling interests | - | - | - | - | - | - | 2,060 | 2,060 | ||||||||||||||||||||||||
| Proceeds from offering | 2,218 | 22 | 21,969 | (25 | ) | - | - | - | 21,966 | |||||||||||||||||||||||
| Selling commissions and dealer manager fees | - | - | (2,023 | ) | - | - | - | - | (2,023 | ) | ||||||||||||||||||||||
| Other offering costs | - | - | (1,937 | ) | - | - | - | - | (1,937 | ) | ||||||||||||||||||||||
| Redemption and cancellation of shares | (75 | ) | (1 | ) | (695 | ) | - | - | - | - | (696 | ) | ||||||||||||||||||||
| Shares issued from distribution reinvestment program | 189 | 2 | 1,789 | - | - | - | - | 1,791 | ||||||||||||||||||||||||
| Notes receivable issued to noncontrolling interests | - | - | - | - | - | - | (322 | ) | (322 | ) | ||||||||||||||||||||||
| BALANCE, December 31, 2013 | 7,643 | $ | 76 | $ | 60,755 | $ | (25 | ) | $ | 399 | $ | (1,781 | ) | $ | 7,601 | $ | 67,025 | |||||||||||||||
| Net income | - | - | - | - | - | 4,472 | 68 | 4,540 | ||||||||||||||||||||||||
| Other comprehensive loss | - | - | - | - | (147 | ) | - | - | (147 | ) | ||||||||||||||||||||||
| Distributions declared | - | - | - | - | - | (8,194 | ) | - | (8,194 | ) | ||||||||||||||||||||||
| Distributions paid to noncontrolling interests | - | - | - | - | - | - | (131 | ) | (131 | ) | ||||||||||||||||||||||
| Contributions from noncontrolling interests | - | - | - | - | - | - | 11,300 | 11,300 | ||||||||||||||||||||||||
| Proceeds from offering | 10,579 | 107 | 104,540 | (55 | ) | - | - | - | 104,592 | |||||||||||||||||||||||
| Selling commissions and dealer manager fees | - | - | (8,934 | ) | - | - | - | - | (8,934 | ) | ||||||||||||||||||||||
| Other offering costs | - | - | (611 | ) | - | - | - | - | (611 | ) | ||||||||||||||||||||||
| Redemption and cancellation of shares | (72 | ) | (1 | ) | (675 | ) | - | - | - | - | (676 | ) | ||||||||||||||||||||
| Shares issued from distribution reinvestment program | 343 | 3 | 3,255 | - | - | - | - | 3,258 | ||||||||||||||||||||||||
| BALANCE, December 31, 2014 | 18,493 | $ | 185 | $ | 158,330 | $ | (80 | ) | $ | 252 | $ | (5,503 | ) | $ | 18,838 | $ | 172,022 | |||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||
| Net income | 4,540 | $ | 1,370 | $ | 9,764 | |||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 3,446 | 1,822 | 558 | |||||||||
| Amortization of deferred financing costs | 72 | 83 | 65 | |||||||||
| Gain on disposition of investment in unconsolidated affiliated entity | - | - | (741 | ) | ||||||||
| Bargain purchase gain | (2,790 | ) | (1,263 | ) | (7,857 | ) | ||||||
| Loss/(income) from investments in unconsolidated affiliated entities | 111 | 14 | (159 | ) | ||||||||
| Other non-cash adjustments | (112 | ) | 145 | - | ||||||||
| Changes in assets and liabilities: | ||||||||||||
| Decrease in restricted escrows | - | 157 | 136 | |||||||||
| (Increase)/decrease in prepaid expenses and other assets | (1,910 | ) | 24 | (429 | ) | |||||||
| Increase in accounts payable and other accrued expenses | 902 | 400 | 330 | |||||||||
| Increase/(decrease) in due to sponsor | 92 | (6 | ) | 39 | ||||||||
| Net cash provided by operating activities | 4,351 | 2,746 | 1,706 | |||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||
| Purchase of investment property, net | (60,615 | ) | (18,158 | ) | (9,808 | ) | ||||||
| Purchase of marketable securities, net of margin loan | (19,774 | ) | - | - | ||||||||
| Proceeds from sale of marektable securities | 9,692 | 190 | - | |||||||||
| Purchase of restricted escrow | - | - | (835 | ) | ||||||||
| Proceeds from disposition of investment in unconsolidated affiliated entity | - | - | 560 | |||||||||
| Collections on note receivable from affiliate | - | 2,340 | 60 | |||||||||
| Release/(funding) of restricted escrows | 1,306 | 348 | (1,807 | ) | ||||||||
| Distributions from unconsolidated affiliated entities | 219 | 2,103 | 289 | |||||||||
| Net cash used in investing activities | (69,172 | ) | (13,177 | ) | (11,541 | ) | ||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||
| Proceeds from mortgage financings | - | 24,420 | 11,273 | |||||||||
| Payment on mortgages payable | (499 | ) | (11,317 | ) | (116 | ) | ||||||
| Payment of loan fees and expenses | - | (359 | ) | (242 | ) | |||||||
| Proceeds/(payment) on margin loans, net | 3,909 | (810 | ) | (624 | ) | |||||||
| Proceeds from issuance of common stock | 104,592 | 21,966 | 7,152 | |||||||||
| Payment of commissions and offering costs | (9,612 | ) | (4,021 | ) | (2,242 | ) | ||||||
| Redemption and cancellation of common shares | (676 | ) | (696 | ) | (458 | ) | ||||||
| Notes receivable from affiliates | - | (322 | ) | - | ||||||||
| Contribution from noncontrolling interests | 11,300 | 2,060 | 103 | |||||||||
| Distributions to noncontrolling interests | (131 | ) | (175 | ) | (306 | ) | ||||||
| Distributions to common stockholders | (3,080 | ) | (1,947 | ) | (1,667 | ) | ||||||
| Net cash provided by financing activities | 105,803 | 28,799 | 12,873 | |||||||||
| Net change in cash and cash equivalents | 40,982 | 18,368 | 3,038 | |||||||||
| Cash and cash equivalents, beginning of year | 26,520 | 8,152 | 5,114 | |||||||||
| Cash and cash equivalents, end of year | $ | 67,502 | $ | 26,520 | $ | 8,152 | ||||||
See Note 1 for supplemental cash flow information.
The accompanying notes are an integral part of these consolidated financial statements.
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LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2014, 2013 and 2012
(Dollar amounts in thousands, except per share/unit data and where indicated in millions)
1. Organization
Lightstone Value Plus Real Estate Investment Trust II, Inc. (the “Lightstone REIT II”) is a Maryland corporation formed on April 28, 2008, which has qualified as a real estate investment trust (“REIT”) for U.S. federal income tax purposes since its taxable year ending December 31, 2009. The Lightstone REIT II was formed primarily for the purpose of engaging in the business of investing in and owning commercial and residential real estate properties, as well as other real estate-related investments, located principally in North America.
The Lightstone REIT II is structured as an umbrella partnership REIT, or UPREIT, and substantially all of its current and future business is and will be conducted through Lightstone Value Plus REIT II LP (the “Operating Partnership”), a Delaware limited partnership formed on April 30, 2008.
The Lightstone REIT II and the Operating Partnership and its subsidiaries are collectively referred to as the ‘‘Company’’ and the use of ‘‘we,’’ ‘‘our,’’ ‘‘us’’ or similar pronouns refers to the Lightstone REIT II, its Operating Partnership or the Company as required by the context in which such pronoun is used.
Offering and Structure
Our sponsor David Lichtenstein (“Lichtenstein”), who does business as the Lightstone Group (the “Sponsor”) and majority owns the limited liability company of that name with a diversified portfolio of over 100 properties containing approximately 10,135 multifamily units, 1.3 million square feet of office space, 1.6 million square feet of industrial space, 24 hotels and 3.3 million square feet of retail space. The residential, office, industrial and retail properties are located in 20 states. Based in New York, and supported by regional offices in New Jersey, Maryland and Illinois, our sponsor employs approximately 425 staff and professionals.
Our advisor is Lightstone Value Plus REIT II LLC (the “Advisor”), which is wholly owned by our Sponsor. Our Advisor, together with our Board of Directors, is and will continue to be primarily responsible for making investment decisions and managing our day-to-day operations. Through his ownership and control of The Lightstone Group, Mr. Lichtenstein is the indirect owner of our Advisor and the indirect owner and manager of Lightstone SLP II LLC, the associate general partner of our Operating Partnership. Mr. Lichtenstein also acts as our Chairman and Chief Executive Officer. As a result, he controls both the general partner and associate general partner of our Operating Partnership and is the decision-maker of our Operating Partnership.
We do not have and will not have any employees that are not also employed by our Sponsor or its affiliates. We depend substantially on our Advisor, which generally has responsibility for our day-to-day operations. Under the terms of the advisory agreement, the Advisor also undertakes to use its commercially reasonable best efforts to present to us investment opportunities consistent with our investment policies and objectives as adopted by our Board of Directors.
We have two affiliated property managers (our “Property Managers”), which may manage the properties we acquire. We also use other unaffiliated third-party property managers, principally for the management of our hospitality properties. Our Property Managers are Paragon Retail Property Management LLC (“Paragon”) and Beacon Property Management LLC (“Beacon”), all of which are majority owned and controlled by our Sponsor. Paragon develops and redevelops all the factory outlet malls and certain retail properties controlled by our Sponsor. Beacon is a significant manager in the multi-family residential housing sector and oversees the management of approximately 10,000 multifamily units.
On April 24, 2009, we commenced an initial public offering (the “Offering”) to sell a maximum of 51.0 million shares of common stock at a price of $10 per share (the “Primary Offering”) and 6.5 million shares of common stock available pursuant to our distribution reinvestment program (the “DRIP”). We also have 75,000 shares reserved for issuance under our stock option plan and 255,000 shares reserved for issuance under our employee and director incentive restricted share plan. Our Registration Statement on Form S-11 (the “Registration Statement”) was declared effective under the Securities Act of 1933 on February 17, 2009, and on April 24, 2009, we began offering our shares of common stock for sale to the public.
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The Offering, which terminated on August 15, 2012, raised aggregate gross proceeds of approximately $49.8 million from the sale of approximately 5.0 million shares of common stock. After allowing for the payment of approximately $5.2 million in selling commissions and dealer manager fees and $4.5 million in organization and other offering expenses, the Offering generated aggregate net proceeds of approximately $40.1 million. In addition, through August 15, 2012 (the termination date of the Offering), the Company had issued approximately 0.3 million shares of common stock under its DRIP, representing approximately $2.9 million of additional proceeds.
The Company’s registration statement on Form S-11 (the “Follow-On Offering”), pursuant to which it offered to sell up to 30,000,000 shares of its common stock for $10.00 per share, subject to certain volume discounts (exclusive of 2,500,000 shares available pursuant to its DRIP at an initial purchase price of $9.50 per share and 255,000 shares reserved for issuance under its Employee and Director Incentive Restricted Share Plan) was declared effective by SEC under the Securities Act of 1933 on September 27, 2012. The Follow-On Offering, which terminated on September 27, 2014, raised aggregate gross proceeds of approximately $127.5 million from the sale of approximately 12.9 million shares of common stock. After allowing for the payment of approximately $11.0 million in selling commissions and dealer manager fees and $4.0 million in organization and other offering expenses, the Follow-On Offering generated aggregate net proceeds of approximately $112.5 million.
The Company’s DRIP Registration Statement on Form S-3D was filed and became effective under the Securities Act of 1933 on September 26, 2014. As of December 31, 2014, 5.9 million shares remained available for issuance under the DRIP. On January 19, 2015, the Board of Directors suspended the Company’s DRIP effective April 15, 2015. For so long as the DRIP remains suspended, all future distributions will be in the form of cash.
Effective September 27, 2012, Orchard Securities, LLC (“Orchard Securities”) became the Dealer Manager of the Company’s Follow-On Offering. Prior to September 27, 2012, ICON Securities Corp. (“ICON Securities”) served as the dealer manager for the Company’s Offering.
All further references to the Dealer Manager will be deemed to refer to either ICON Securities or Orchard Securities during the respective period of time that each was serving in such capacity.
As of December 31, 2014, the Advisor owned 20,000 shares of common stock which were issued on May 20, 2008 for $200, or $10.00 per share. In addition, as of September 30, 2009, the Company had reached the minimum offering under its Offering by receiving subscriptions of its common shares, representing gross offering proceeds of approximately $6.5 million, and effective October 1, 2009 investors were admitted as stockholders and the Operating Partnership commenced operations. Through the termination of the Follow-On Offering (September 27, 2014), cumulative gross offering proceeds of $177.3 million were released to the Company. The Company invested the proceeds received from the Offering, the Follow-On Offering and the Advisor in the Operating Partnership, and as a result, held a 99% general partnership interest as of December 31, 2014 in the Operating Partnership’s common units.
The Company’s shares of common stock are not currently listed on a national securities exchange. The Company may seek to list its shares of common stock for trading on a national securities exchange only if a majority of its independent directors believe listing would be in the best interest of its stockholders. The Company does not intend to list its shares at this time. The Company does not anticipate that there would be any market for its shares of common stock until they are listed for trading. In the event the Company does not obtain listing prior to the tenth anniversary of the completion or termination of its Offering, its charter requires that the Board of Directors must either (i) seek stockholder approval of an extension or amendment of this listing deadline; or (ii) seek stockholder approval to adopt a plan of liquidation of the corporation.
Noncontrolling Interest – Partners of Operating Partnership
The noncontrolling interests consist of (i) parties of the Company that hold units in the Operating Partnership and (ii) certain interests in LVP Metairie JV LLC, LVP East Rutherford LLC, LVP TPS Little Rock Holdings LLC and LVP TPS Fayetteville Holdings LLC which are not owned by the Company.
On May 20, 2008, the Advisor contributed $2 to the Operating Partnership in exchange for 200 limited partner common units in the Operating Partnership. The limited partner has the right to convert Operating Partnership common units into cash or, at our option, an equal number of shares of our common stock, as allowed by the limited partnership agreement.
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Lightstone SLP II LLC, which is wholly owned by our Sponsor, committed to purchase subordinated profits interests in our Operating Partnership (“Subordinated Profits Interests”) at a cost of $100,000 per unit for each $1.0 million in subscriptions up to ten percent of the proceeds from the primary shares under the Offering and Follow-On Offering on a semi-annual basis beginning with the quarter ended June 30, 2010. Lightstone SLP II LLC may elect to purchase the Subordinated Profits Interests with either cash or an interest in real property of equivalent value. Any proceeds received from the cash sale of the Subordinated Profits Interests will be used to offset payments made by the Company from offering proceeds to pay the dealer manager fees, selling commissions and organization and other offering expenses.
From our inception through December 31, 2014, our Sponsor contributed cash of approximately $12.9 million and equity interests totaling 48.6% in Brownmill, LLC (“Brownmill”), which were valued at $4.8 million, in exchange for 177.0 Subordinated Profits Interests with an aggregate value of $17.7 million. See “Sponsor’s Contribution of Equity Interests in Brownmill” below for additional information. Our Sponsor may continue to elect to contribute interests in real property in lieu of cash in exchange for Subordinated Profits Interests in order to fulfill its semi-annual commitment.
Operations - Operating Partnership Activity
Our Operating Partnership commenced its operations on October 1, 2009. Since then we have and will continue to seek to acquire and operate commercial, residential, and hospitality properties, principally in North America through our Operating Partnership. Our commercial holdings will consist of retail (primarily multi-tenanted shopping centers), lodging, industrial and office properties. All such properties may be acquired and operated by us alone or jointly with another party. In addition, we may invest up to 20% of our net assets in collateralized debt obligations, commercial mortgage-backed securities (“CMBS”) and mortgage and mezzanine loans secured, directly or indirectly, by the same types of properties which it may acquire directly.
Related Parties
Our Advisor, Property Managers and Dealer Manager are each related parties. Each of these entities have or will receive compensation and fees for services related to the Offering and will continue to receive compensation and fees and services for the investment and management of our assets. These entities will receive fees during the Offering, acquisition, operational and liquidation stages. The compensation levels during the Offering, acquisition and operational stages are based on percentages of the Offering proceeds sold, the cost of acquired properties and the annual revenue earned from such properties, and other such fees outlined in each of the respective agreements. See Note 11 for additional information.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Lightstone REIT II and the Operating Partnership and its subsidiaries (over which Lightstone REIT exercises financial and operating control). As of December 31, 2014, the Company had a 99% general partnership interest in the Operating Partnership. All inter-company balances and transactions have been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during a reporting period. The most significant assumptions and estimates relate to the valuation of real estate and investments in other real estate entities, depreciable lives of long-lived assets and revenue recognition. Application of these assumptions requires the exercise of judgment as to future uncertainties and, as a result, actual results could differ from these estimates.
Investments in other real estate entities where the Company has the ability to exercise significant influence, but does not exercise financial and operating control, and is not considered to be the primary beneficiary will be accounted for using the equity method. Investments in other real estate entities where the Company has virtually no influence will be accounted for using the cost method.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. All cash equivalents are held in commercial paper and money market funds.
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| Supplemental disclosure of cash flow information: | Year Ended December 31, | |||||||||||
| 2014 | 2013 | 2011 | ||||||||||
| Cash paid for interest | $ | 1,255 | $ | 939 | $ | 413 | ||||||
| Distributions declared | $ | 8,194 | $ | 4,050 | $ | 3,268 | ||||||
| Noncash commissions and other offering costs in accounts payable and other accrued expenses | $ | 126 | $ | 193 | $ | 254 | ||||||
| Subscription receivable | $ | 55 | $ | 25 | $ | (104 | ) | |||||
| Value of shares issued from distribution reinvestment program | $ | 3,258 | $ | 1,791 | $ | 1,458 | ||||||
| Issuance of units in exchange for investment in unconsolidated affiliated entities | $ | - | $ | - | $ | 911 | ||||||
| Restricted escrow deposits and related liability initially established related to Note receivable received in connection with disposition of investment in unconsolidated affiliated entity | $ | - | $ | - | $ | 2,400 | ||||||
| Satisfaction of promissory note | $ | - | $ | - | $ | 7,029 | ||||||
Marketable Securities
Marketable securities consist of equity securities and corporate bonds that are designated as available-for-sale and are recorded at fair value. Unrealized holding gains or losses will be reported as a component of accumulated other comprehensive income (loss). Realized gains or losses resulting from the sale of these securities will be determined based on the specific identification of the securities sold. An impairment charge will be recognized when the decline in the fair value of a security below the amortized cost basis is determined to be other-than-temporary. The Company will consider various factors in determining whether to recognize an impairment charge, including the duration and severity of any decline in fair value below our amortized cost basis, any adverse changes in the financial condition of the issuers and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. The Board has authorized the Company from time to time to invest the Company’s available cash in marketable securities of real estate related companies. The Board of Directors has approved investments up to 30% of the Company’s total assets to be made at the Company’s discretion, subject to compliance with any REIT or other restrictions.
Revenue Recognition
The Company invests in real estate assets that generate rental income. Minimum rents will be recognized on a straight-line accrual basis, over the terms of the related leases. The capitalized above-market lease values and the capitalized below-market lease values will be amortized as an adjustment to rental income over the initial lease term. Percentage rents, which are based on commercial tenants’ sales, will be recognized once the sales reported by such tenants exceed any applicable breakpoints as specified in the tenants’ leases. Recoveries from commercial tenants for real estate taxes, insurance and other operating expenses, and from residential tenants for utility costs, will be recognized as revenues in the period that the applicable costs are incurred. Revenues from the operations of hotels is recognized when the services are provided.
Accounts Receivable
The Company makes estimates of the uncollectability of its accounts receivable related to base rents, expense reimbursements and other revenues. The Company analyzes accounts receivable and historical bad debt levels, customer credit worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. In addition, tenants in bankruptcy are analyzed and estimates are made in connection with the expected recovery of pre-petition and post-petition claims. The Company’s reported net income or loss is directly affected by management’s estimate of the collectability of accounts receivable.
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Investment in Real Estate
Accounting for Acquisitions
When the Company makes an investment in real estate, the fair value of the real estate acquired is allocated to the acquired tangible assets, consisting of land, building and tenant improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases for acquired in-place leases and the value of tenant relationships, based in each case on their fair values. Purchase accounting is applied to assets and liabilities related to real estate entities acquired based upon the percentage of interest acquired. Fees incurred related to acquisitions are expensed as incurred and recorded in general and administrative costs in the consolidated statements of operation. Transaction costs incurred related to the Company’s investments in unconsolidated affiliated entities, accounted for under the equity method of accounting, are capitalized as part of the cost of the investment.
Upon the acquisition of real estate operating properties, the Company estimates the fair value of acquired tangible assets and identified intangible assets and liabilities and certain liabilities such as assumed debt and contingent liabilities, at the date of acquisition, based on evaluation of information and estimates available at that date. Based on these estimates, the Company allocates the initial purchase price to the applicable assets, liabilities and noncontrolling interests, if any. As final information regarding fair value of the assets acquired, liabilities assumed and noncontrolling interests is received and estimates are refined, appropriate adjustments are be made to the purchase price allocation. The allocations are finalized as soon as all the information necessary is available and in no case later than within twelve months from the acquisition date.
In determining the fair value of the identified intangible assets and liabilities of an acquired property, above-market and below-market in-place lease values are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market lease values and the capitalized below-market lease values are amortized as an adjustment to rental income over the initial non-cancelable lease term and any fixed-rate renewal periods, which are reasonably assured, in the respective leases.
The aggregate value of in-place leases is determined by evaluating various factors, including an estimate of carrying costs during the expected lease-up periods, current market conditions and similar leases. In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses, and estimates of lost rental revenue during the expected lease-up periods based on current market demand. Management also estimates costs to execute similar leases including leasing commissions, legal and other related costs. Optional renewal periods are not considered.
The aggregate value of other acquired intangible assets includes tenant relationships. Factors considered by management in assigning a value to these relationships include: assumptions of probability of lease renewals, investment in tenant improvements, leasing commissions and an approximate time lapse in rental income while a new tenant is located. The value assigned to this intangible asset is amortized over the remaining lease terms.
Carrying Value of Assets
The amounts capitalized as a result of periodic improvements and additions to real estate property, when applicable, and the periods over which the assets are depreciated or amortized, are determined based on the application of accounting standards that may require estimates as to fair value and the allocation of various costs to the individual assets. Differences in the amount attributed to the assets can be significant based upon the assumptions made in calculating these estimates.
Impairment Evaluation
Management evaluates the recoverability of its investments in real estate assets at the lowest identifiable level, the individual property level. Long-lived assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. An impairment loss is recognized only if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value.
The Company evaluates the long-lived assets for potential impairment on a quarterly basis and records an impairment charge when there is an indicator of impairment and the undiscounted projected cash flows are less than the carrying amount for a particular property. The estimated cash flows used for the impairment analysis and the determination of estimated fair value are based on the Company’s plans for the respective assets and the Company’s views of market and economic conditions. The estimates consider matters such as current and historical rental rates, occupancies for the respective properties and comparable properties, and recent sales data for comparable properties. Changes in estimated future cash flows due to changes in the Company’s plans or views of market and economic conditions could result in recognition of impairment losses, which, under the applicable accounting guidance, could be substantial. As of December 31, 2014 and 2013, the Company did not recognize any impairment charges.
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Depreciation and Amortization
Depreciation expense is computed based on the straight-line method over the estimated useful life of the applicable real estate asset. We generally use estimated useful lives of up to thirty-nine years for buildings and improvements and five to ten years for furniture, fixtures and equipment. Expenditures for tenant improvements and construction allowances paid to commercial tenants are capitalized and amortized over the initial term of each lease. Expenditures for ordinary maintenance and repairs are charged to expense as incurred.
Deferred Costs
The Company capitalizes initial direct costs associated with financing and leasing activities. The costs are capitalized upon the execution of the loan or lease and amortized over the initial term of the corresponding loan or lease. Amortization of deferred loan costs begins in the period during which the loan is originated using the effective interest method over the term of the loan. Deferred leasing costs are not amortized to expense until the earlier of the store opening date or the date the tenant’s lease obligation begins.
Investments in Unconsolidated Affiliated Entities
The Company evaluates its investments in other entities for consolidation. The percentage interest in the joint venture, evaluation of control and whether a variable interest entity (“VIE”) exists are all considered in determining if the investment qualifies for consolidation.
The Company accounts for its investments in unconsolidated affiliated entities using the equity or cost method of accounting, as appropriate. Under the equity method, the investment is recorded initially at cost, and subsequently adjusted for equity in net income/(loss) and cash contributions and distributions. The net income/(loss) of each investor is allocated in accordance with the provisions of the applicable operating agreements of the entities. The allocation provisions in these agreements may differ from the ownership interest held by each investor. Differences between the carrying amount of the Company’s investment in the respective joint venture and the Company’s share of the underlying equity of such unconsolidated affiliated entities are amortized over the respective lives of the underlying assets as applicable. These items are reported as a single line item in the consolidated statements of operations as income or loss from investments in unconsolidated affiliated entities. Under the cost method of accounting, the investment is recorded initially at cost, and subsequently adjusted for cash contributions and distributions resulting from any capital events. Dividends earned from the underlying entities are recorded as interest income in the consolidated statements of operations.
On a quarterly basis, the Company assesses whether the value of the investments in unconsolidated affiliated entities has been impaired. An investment is impaired only if management’s estimate of the fair value of the investment is less than the carrying value of the investment, and such decline in value is deemed to be other than temporary. To the extent impairment has occurred, the loss shall be measured as the excess of the carrying amount of the investment over the fair value of the investment. Management’s estimate of value for each investment is based on a number of assumptions that are subject to economic and market uncertainties. As these factors are difficult to predict and are subject to future events that may alter our assumptions, the values estimated by management in the impairment analysis may not be realized. Any decline that is not considered temporary will result in the recording of an impairment charge. Management believes no impairment of its investments in unconsolidated affiliated entities existed as of December 31, 2014 and 2013.
Income Taxes
We elected to be taxed as a REIT in conjunction with the filing of our 2009 U.S. federal income tax return. If we remain qualified as a REIT, we generally will not be subject to U.S. federal income tax on our net taxable income that we distribute currently to our stockholders. To maintain our REIT qualification under the Internal Revenue Code of 1986, as amended, or the Code, we must meet a number of organizational and operational requirements, including a requirement that we annually distribute to our stockholders 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. If we fail to remain qualified for taxation as a REIT in any subsequent year and do not qualify for certain statutory relief provisions, our income for that year will be taxed at regular corporate rates, and we may be precluded from qualifying for treatment as a REIT for the four-year period following our failure to qualify as a REIT. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders.
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The Company engages in certain activities through taxable REIT subsidiaries ("TRSs"). When the Company purchases a hotel it establishes a TRS and enters into an operating lease agreement for the hotel. As such, the Company may be subject to U.S. federal and state income taxes and franchise taxes from these activities.
As of December 31, 2014, the Company had no material uncertain income tax. The tax years subsequent to and including 2010 remain open to examination by the major taxing jurisdictions to which we are subject.
Additionally, even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to some U.S. federal, state and local taxes on our income and property and to U.S. federal income taxes and excise taxes on our undistributed income.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, restricted escrows and deposits, prepaid expenses and other assets, accounts payable and other accrued expenses, margin loan, due to sponsor, and distributions payable approximated their fair values as of December 31, 2014 because of the short maturity of these instruments. The estimated fair value of our mortgages payable is as follows:
| As of December 31, 2014 | As of December 31, 2013 | |||||||||||||||
| (Dollars in thousands) | Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | ||||||||||||
| Mortgages payable | $ | 23,761 | $ | 23,548 | $ | 24,260 | $ | 23,898 | ||||||||
Selling Commission, Dealer Manager Fees and Organization and Other Offering Costs
Selling commissions and dealer manager fees paid to the Dealer Manager, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs, and professional fees are accounted for as a reduction against additional paid-in capital (“APIC”) as costs are incurred. Any organization costs are expensed as general and administrative costs. From the commencement of the Offering through the termination of the Follow-On Offering (September 27, 2014), the Company incurred approximately $16.3 million in selling commissions and dealer manager fees and $8.5 million of other offering costs and recorded approximately $24.8 million of these costs against APIC.
Accounting for Derivative Financial Investments and Hedging Activities.
The Company may enter into derivative financial instrument transactions in order to mitigate interest rate risk on a related financial instrument. The Company may designate these derivative financial instruments as hedges and apply hedge accounting. The Company will record all derivative instruments at fair value on the consolidated balance sheet.
Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, will be considered cash flow hedges. The Company will formally document all relationships between hedging instruments and hedged items, as well as our risk- management objective and strategy for undertaking each hedge transaction. The Company will periodically review the effectiveness of each hedging transaction, which involves estimating future cash flows. Cash flow hedges will be accounted for by recording the fair value of the derivative instrument on the consolidated balance sheet as either an asset or liability, with a corresponding amount recorded in accumulated other comprehensive income (loss) within stockholders’ equity. Amounts will be reclassified from other comprehensive income (loss) to the consolidated statement of operations in the period or periods the hedged forecasted transaction affects earnings. Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, will be considered fair value hedges. The effective portion of the derivatives gain or loss is initially reported as a component of other comprehensive income and subsequently reclassified into earnings when the transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.
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Stock-Based Compensation
The Company has an Employee and Director Incentive Restricted Share Plan. Awards, if any, will be granted at the fair market value on the date of the grant with fair value estimated using the Black-Scholes-Merton option valuation model, which incorporates assumptions surrounding the volatility, dividend yield, the risk-free interest rate, expected life, and the exercise price as compared to the underlying stock price on the grant date. As stock-based compensation expense recognized in the consolidated statements of operations will be based on awards ultimately expected to vest, the amount of expense will be reduced for forfeitures estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures will be estimated based on historical experience. The tax benefits associated with these share-based payments will be classified as financing activities in the consolidated statement of cash flows. The Company has not granted any stock-based incentive awards.
Concentration of Risk
The Company maintains its cash in bank deposit accounts, which, at times, may exceed U.S. federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.
Basic and Diluted Net Earnings per Common Share
The Company had no potentially dilutive securities outstanding during the periods presented. Accordingly, earnings per share is calculated by dividing net income attributable to common shareholders by the weighted-average number of shares of common stock outstanding during the applicable period.
New Accounting Pronouncements
In April 2014, the Financial Accounting Standards Board ("FASB") issued an accounting standards update providing new guidance on the requirements for reporting a discontinued operation. The update changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. This update is effective for fiscal years beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in the financial statements previously issued or available for issuance. The adoption of this standards update affects presentation only and, as such, will not have a material impact on the Company’s consolidated financial statements.
In May 2014, the FASB issued an accounting standards update that completes the joint effort by the FASB and International Accounting Standards Board to improve financial reporting by creating common revenue recognition guidance for GAAP and International Financial Reporting Standards. The update applies to all companies that enter into contracts with customers to transfer goods or services and is effective for us for interim and annual reporting periods beginning after December 15, 2016. Early application is not permitted and companies have the choice to apply the update either retrospectively to each reporting period presented or by recognizing the cumulative effect of applying the update at the date of initial application (January 1, 2017) and not adjusting comparative information. The Company is currently evaluating the requirements and impact of this update on its consolidated financial statements.
Reclassifications
Certain prior period amounts may have been reclassified to conform to the current year presentation.
3. Acquisitions
Holiday Inn - Opelika
On April 1, 2014, the Company completed the acquisition of an 87-room select service hotel located in Opelika, Alabama (the “Holiday Inn — Opelika”), from an unrelated third party. The Holiday Inn — Opelika operates as a “Holiday Inn Express Hotel & Suites” pursuant to a 15-year franchise agreement with the International Hotel Group.
The aggregate purchase price for the Holiday Inn — Opelika was approximately $6.9 million. The acquisition was funded with cash. Additionally, in connection with the acquisition, our advisor received an acquisition fee equal to 0.95% of the contractual purchase price of $6.9 million, or approximately $66.
The acquisition of the Holiday Inn — Opelika was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Holiday Inn — Opelika has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. There was no contingent consideration related to this acquisition. Approximately $1.0 million was allocated to land and improvements, $5.3 million was allocated to building and improvements, and $0.6 million was allocated to furniture and fixtures and other assets.
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The aggregate capitalization rate for the Holiday Inn — Opelika as of the closing of the acquisition was approximately 9.8%. We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income is determined using the projected or budgeted net operating income based upon then-current projections. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
Aloft - Tucson
On April 8, 2014, the Company completed the acquisition of a 154-room select service hotel located in Tucson, Arizona (the “Aloft — Tucson”), from an unrelated third party. The Aloft — Tucson operates as an “Aloft” pursuant to a 20-year franchise agreement with Sheraton LLC, or Starwood.
The aggregate purchase price for the Aloft - Tucson was approximately $19.0 million. The acquisition was funded with cash. Additionally, in connection with the acquisition, our advisor received an acquisition fee equal to 0.95% of the contractual purchase price of $19.0 million, or approximately $181.
The acquisition of the Aloft — Tucson was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Aloft — Tucson has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. There was no contingent consideration related to this acquisition. Approximately $1.9 million was allocated to land and improvements, $14.7 million was allocated to building and improvements, and $2.4 million was allocated to furniture and fixtures and other assets.
The aggregate capitalization rate for the Aloft — Tucson as of the closing of the acquisition was approximately 8.8%. We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income is determined using the projected or budgeted net operating income based upon then-current projections. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
Hampton Inn – Fort Myers Beach
On October 2, 2014, the Company completed the acquisition of a 120-room select service hotel located in Fort Myers, Florida (the “Hampton Inn – Fort Myers Beach”) from an unrelated third party. The Hampton Inn – Fort Myers Beach operates as a “Hampton Inn & Suites” pursuant to a 15-year franchise agreement with Hampton Inn Franchise LLC.
The aggregate purchase price for the Hampton Inn – Fort Myers Beach was approximately $9.4 million. The acquisition was funded with cash. Additionally, in connection with the acquisition, our Advisor received an acquisition fee equal to 0.95% of the contractual purchase price, approximately $0.1 million.
The acquisition of the Hampton Inn – Fort Myers Beach was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Hampton Inn – Fort Myers Beach has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. There was no contingent consideration related to this acquisition. Approximately $3.0 million was allocated to land and improvements, $5.1 million was allocated to building and improvements, and $1.3 million was allocated to furniture and fixtures and other assets.
The aggregate capitalization rate for the Hampton Inn – Fort Myers Beach as of the closing of the acquisition was approximately 8.5%. We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income is determined using the actual net operating income based the twelve month period ended June 2014. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
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Philadelphia Airport Hotel Portfolio
On December 17, 2014, the Company completed the portfolio acquisition of the Aloft Philadelphia Airport (the “Aloft - Philadelphia”), a 136-room select service hotel, the Four Points by Sheraton Philadelphia Airport (the “Four Points by Sheraton - Philadelphia”), a 177-room select service hotel and a land parcel adjacent the Four Points by Sheraton Philadelphia (the “Land Parcel”) (the “Philadelphia Hotel Portfolio”) from an unrelated third party. The Aloft Philadelphia operates as an “Aloft” pursuant to a 20-year franchise agreement with Starwood and the Four Points by Sheraton Philadelphia operates as a “Four Points by Sheraton” pursuant to a 20-year franchise agreement with Starwood.
The aggregate purchase price for the Philadelphia Hotel Portfolio was approximately $22.6 million (including contingent consideration of approximately $0.3 million). The acquisition was funded with cash. Additionally, in connection with the acquisition, our Advisor received an acquisition fee equal to 0.95% of the contractual purchase price, approximately $0.2 million. The fair value of the assets acquired of approximately $25.4 million exceeded the aggregate cost of $22.6 million, resulting in the recognition of a bargain purchase gain of approximately $2.8 million in the consolidated statements of operations during the fourth quarter of 2014. The Company believes it was able to acquire these properties for less than their aggregate fair value because the seller has implemented a strategy to significantly reduce its owned hotel portfolio and increase its focus on its management and franchise business.
The acquisition of the Philadelphia Hotel Portfolio was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Philadelphia Hotel Portfolio has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. Approximately $7.9 million was allocated to land and improvements, $15.5 million was allocated to building and improvements, and $2.0 million was allocated to furniture and fixtures and other assets.
The capitalization rate for the Philadelphia Hotel Portfolio as of the closing of the acquisition was approximately 8.0%. We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income is determined using the projected or budgeted net operating income based upon then-current projections. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
Arkansas Hotel Portfolio
On June 18, 2013, the Company, through LVP TPS Little Rock Holdings LLC and LVP TPS Fayetteville Holdings, LLC, both joint venture subsidiaries of our Operating Partnership, completed the portfolio acquisition of 95% ownership interests in two 92-room limited service hotels (the “Arkansas Hotel Portfolio”), which operate as TownePlace Suites by Marriott, located in Little Rock, which we refer to as the TownePlace Suites – Little Rock, and Johnson/Springdale, Arkansas, which we refer to as the TownePlace Suites - Fayetteville, from certain limited liability companies controlled by the same seller, an unrelated third party. The remaining 5% ownership interests were acquired by TPSLR, LLC for the TownePlace Suites - Little Rock and TPSFN, LLC for the TownePlace Suites - Fayetteville, respectively, both unrelated third parties.
The Arkansas Hotel Portfolio was acquired as part of a transaction in which the third party sellers sold a portfolio of four hotel properties, two of which comprise the Arkansas Hotel Portfolio, and two hotel properties acquired by Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone REIT I”), an affiliated company. The aggregate purchase price paid for the four properties was $29.1 million, of which $10.7 million related to the Arkansas Hotel Portfolio and such amount was determined based on an internal allocation of the purchase price which was approved by the separate boards of directors of the Company and Lightstone REIT I. Additionally, in connection with the acquisition, our advisor received an acquisition fee equal to 0.95% of the contractual purchase price of $10.7 million, or approximately $102. The fair value of the assets acquired of $11.9 million exceeded the aggregate cost of $10.7 million, resulting in the recognition of a bargain purchase gain of approximately $1.2 million in the consolidated statements of operations during the second quarter of 2013. The Company believes it was able to acquire this portfolio for less than its fair value because it was a distressed sale which was required by the mortgage lender.
The acquisition was funded with $3.7 million in cash and a $7.0 million demand note, or the Demand Note, entered into between our Operating Partnership and Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone REIT I”). The Demand Note was due on demand and bore interest at a floating rate of LIBOR plus 4.95%. We paid $3.0 million of the Demand Note’s balance in June 2013 and repaid the remaining $4.0 million on July 30, 2013.
The Company entered into a separate management agreement with a management company controlled by the minority owner of each hotel for the management of the respective hotel. Additionally, the Companyh entered into a 20-year franchise agreement, or the Franchise Agreement, with Marriott, pursuant to which the TownePlace Suites - Fayetteville and the TownePlace Suites - Little Rock Hotel will both continue to operate as a “TownePlace Suites by Marriott,” which commenced on June 18, 2013.
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The acquisition of the Arkansas Hotel Portfolio was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition of the Arkansas Hotel Portfolio has been allocated to the assets acquired based upon their estimated fair values as of the date of the acquisition. There was no contingent consideration related to this acquisition. Approximately $1.5 million was allocated to land and improvements, $8.5 million was allocated to building and improvements, and $1.9 million was allocated to furniture and fixtures and other assets.
The aggregate capitalization rate for the Arkansas Hotel Portfolio as of the closing of the acquisition was approximately 10.6%. We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income is determined using the projected or budgeted net operating income based upon then-current projections. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
SpringHill Suites - Peabody
On July 13, 2012, the Company entered into an Assignment and Assumption of Purchase and Sale Agreement (the “Assignment”) with Lightstone Acquisitions V LLC (the “Assignor”), an affiliate of the Company’s Sponsor. Under the terms of the Assignment, the Company was assigned the rights and assumed the obligations of the Assignor with respects to certain Purchase and Sale Agreement (the “Purchase Agreement”), dated March 12, 2012, made between the Assignor as the Purchaser and Springhill Peabody HH LLC as the Seller, as amended, whereby the Assignor contracted to purchase a six story, 164-suite, limited services hotel located in Peabody, Massachusetts which operates as a SpringHill Suites by Marriott (the “SpringHill Suites - Peabody”) which was constructed and commenced operations in July 2002.
On July 13, 2012, the Company completed the acquisition of the SpringHill Suites - Peabody from the Seller, an unrelated third party. In connection with the acquisition, the Company assumed the existing Management Agreement with Marriott and simultaneously gave the requisite 30-day notice for early termination, which required the payment of a termination fee (the “Termination Fee”) of approximately $1.2 million to Marriott. Contemporaneously, the Company entered into a 20-year franchise agreement (the “Franchise Agreement”) with Marriott, pursuant to which the SpringHill Suites - Peabody continued to operate as a SpringHill Suites by Marriott commencing on August 11, 2012. The Company entered into a new management agreement (the “SSH Peabody Management Agreement”) with an unrelated third party for the management of the SpringHill Suites - Peabody which commenced on August 11, 2012.
The SSH Peabody Management Agreement has an initial term of one-year and automatically renews for additional one-year terms on the anniversary date provided 60-day advance written notice is not provided by either party. The SSH Peabody Management Agreement provides for (i) a basic management fee equal to 3% of total revenues, (ii) a centralized accounting services fee of $3 per month, subject annual increases based on the consumer price index, and (iii) an incentive management fee equal to 15% of the amount by which gross operating profit, as defined, exceeds a prescribed threshold, subject to a cap of 2.0% of total annual revenues.
The aggregate cost for the SpringHill Suites - Peabody was approximately $10.1 million, including the Termination Fee and approximately $0.8 million for a furniture, fixtures and equipment reserve (the “FFE Reserve”) held in escrow by Marriott. In connection with the acquisition, the Company’s incurred closing and other transaction costs of approximately $0.2 million, including an acquisition fee equal to 0.95% of the contractual purchase price less the Termination Fee, or approximately $85, paid to the Company’s advisor. The acquisition was funded in part with cash and proceeds from a $5.3 million mortgage obtained by the Company from the Bank of the Ozarks. The FFE Reserve was subsequently released from escrow by Marriott in October 2012 as a result of the termination of the existing Management Agreement.
The acquisition was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. The fair value of the assets acquired of $13.6 million exceeded the aggregate cost of $10.1 million, resulting in the recognition of a bargain purchase gain of approximately $3.5 million in the consolidated statements of operations during the third quarter of 2012. The Company believes it was able to acquire this property for less than its fair value because it was a distressed sale as the mortgage lender had previously taken ownership via a quitclaim deed. There was no contingent consideration related to this acquisition. Approximately $2.8 million was allocated to land, $9.0 million was allocated to building and improvements and $1.0 million was allocated to furniture and fixtures. Additionally, the FFE Reserve was recorded at its cost of approximately $0.8 million.
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The capitalization rate for the SpringHill Suites - Peabody as of the closing of the acquisition was 10.5%. We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income was determined using the projected or budgeted net operating income of the property based upon then-current projections. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
Restructuring of Mortgage Loan Secured by a Limited Service Hotel Located in East Rutherford, New Jersey (the “Fairfield Inn – East Rutherford”) and Simultaneous Acquisition of the Hotel.
On December 31, 2012, the Company, and LVP East Rutherford, LLC (“LVP East Rutherford”), a newly formed majority-owned subsidiary, entered into a Restructuring Agreement (the “Restructuring Agreement”) with a syndicate of unrelated third-party investors, including Moody National FFI Meadowlands Rollup LLC (collectively, the “Borrowers”) and Moody National FFI Meadowlands MT, LLC (together with the Borrowers, the “Borrower Parties”). The Borrowers were the owners of the Fairfield Inn – East Rutherford, which operates as a Fairfield Inn under a franchise agreement with Marriott International Inc. (“Marriott”) and is managed by an unrelated third party under a management agreement with an initial term that expires in August 2017.
Previously, on June 29, 2010, the Company purchased a fixed-rate, nonrecourse mortgage note (the “Loan”) with an original principal balance of $18.7 million for $7.9 million from an unrelated third-party financial institution. The Loan, which was secured by the Fairfield Inn – East Rutherford, had been in default since February 2009 and the carrying value of the Company’s investment in the Loan was approximately $7.0 million as of December 30, 2012. Additionally, during the year ended December 31, 2011, the Company applied $0.1 million of excess cash received to outstanding principal. During the years ended December 31, 2012 and 2011 the Company recognized approximately $0.8 million and $1.0 of interest income, respectively.
Under the terms of the Restructuring Agreement, the Borrowers contributed the Fairfield Inn – East Rutherford to LVP East Rutherford and the Borrower Parties and the Company received 17.4% and 82.6%, respectively, of the outstanding common units in LVP East Rutherford. Additionally, the Company issued a promissory note (the “Promissory Note”) in the principal amount of $6.3 million to LVP East Rutherford which is secured by the Fairfield Inn – East Rutherford. The Promissory Note has an initial maturity date of January 6, 2021, bears interest at 9.00%, and requires monthly principal and interest payments pursuant to a 30-year amortization schedule through its stated maturity. LVP East Rutherford also has an option to further extend the maturity of the Promissory Note for two additional one-year periods. Upon consummation of the transactions provided for in the Restructuring Agreement, all existing obligations under the Loan were satisfied in full.
On December 31, 2012, the transactions provided for in the Restructuring Agreement were consummated. Simultaneously, the Company purchased an additional 5.1% of the outstanding common units of LVP East Rutherford for $0.1 million from various Borrowers that chose not to participate in the Restructuring Agreement. As a result, the Company holds in the aggregate 87.7% of the outstanding common units of LVP East Rutherford.
Under the terms of the operating agreement of LVP East Rutherford, the Company is the majority holder and manager of, and has the ability to make all major decisions regarding, LVP East Rutherford, unless they relate to certain agreements with affiliated parties or amendments to the operating agreement that may adversely affect a minority interest holder in a disproportionate manner to other members of the same class of stock. LVP East Rutherford has two authorized classes of stock consisting of preferred units, none of which have been issued at this time, and common units. Distributions will be first to the preferred units, if any, and then to the common units in proportion to their ownership interests.
The Fairfield Inn – East Rutherford, which opened in 1997 and was renovated in 2007, has 141 rooms, including 39 king guestrooms, 89 double/double guestrooms, nine double rooms, and four suites. Located at 850 Paterson Plank Road in East Rutherford, NJ, the Fairfield Inn – East Rutherford is in immediate proximity to Teterboro Airport and Meadowlands Sports Complex, seven miles west of New York City and 15 miles from Newark International Airport.
The Company has a relicensing franchise agreement (the “Franchise Agreement”) with Marriott for the Fairfield Inn – East Rutherford which runs through 2025.
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The aggregate cost for the Fairfield Inn – East Rutherford was approximately $7.4 million. The acquisition was accounted for under the purchase method of accounting with the Company treated as the acquiring entity. Accordingly, the consideration paid by the Company to complete the acquisition has been allocated to the assets acquired based upon their fair values as of the date of the acquisition. The fair value of the assets acquired of $11.7 million exceeded the aggregate cost of $7.4 million, resulting in the recognition of a bargain purchase gain of approximately $4.3 million in the consolidated statements of operations during the year ended December 31, 2012. The Company believes it was able to acquire this property for less than its fair value pursuant to a restructuring transaction as the Company had previously purchased the associated mortgage indebtedness, which was in default, from the lender. There was no contingent consideration related to this acquisition.
Approximately $2.5 million was allocated to land, $8.4 million was allocated to building and improvements and $0.8 million was allocated to furniture and fixtures.
The capitalization rate for the Fairfield Inn – East Rutherford as of the closing of the acquisition was 8.0%. We calculate the capitalization rate for a real property by dividing net operating income of the property by the purchase price of the property, excluding costs. For purposes of this calculation, net operating income was determined using the projected or budgeted net operating income of the property based upon then-current projections. Additionally, net operating income is all gross revenues from the property less all operating expenses, including property taxes and management fees but excluding depreciation.
Financial Information
The following table provides the total amount of rental revenue and net income included in the Company’s consolidated statements of operations from the the SpringHill Suites – Peabody, the Fairfield Inn – East Rutherford, the Arkansas Hotel Portfolio, the Holiday Inn – Opelika, the Aloft – Tucson, the Hampton Inn — Ft. Myers and the Philadelphia Airport Hotel Portfolio since their respective dates of acquisition for the periods indicated:
| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Rental revenue | $ | 20,069 | $ | 9,858 | $ | 2,151 | ||||||
| Net income(1)(2)(3) | $ | 3,126 | $ | 503 | $ | 6,933 | ||||||
Note:
| (1) | Includes the $7.9 million bargain purchase gain recorded in the year ended December 31, 2012 in connection with the acquisitions of the SpringHill Suites - Peabody and the Fairfield Inn – East Rutherford. |
| (2) | Includes the approximately $1.3 million bargain purchase gain recorded in the year ended December 31, 2013 in connection with the acquisition of the Arkansas Hotel Portfolio. |
| (3) | Includes the approximately $2.8 million bargain purchase gain recorded in the year ended December 31, 2014 in connection with the acquisition of the Philadelpia Hotel Portfolio. |
The following table provides unaudited pro forma results of operations for the periods indicated, as if the the SpringHill Suites – Peabody, the Fairfield Inn – East Rutherford and the Arkansas Hotel Portfolio, the Holiday Inn – Opelika, the Aloft – Tucson, the Hampton Inn — Fort Myers Beach and the Philadelphia Airport Hotel Portfolio had been acquired at the beginning of the earliest period presented. Such pro forma results are not necessarily indicative of the results that actually would have occurred had these acquisitions been completed on the dates indicated, nor are they indicative of the future operating results of the combined company.
| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Pro forma rental revenue | $ | 38,203 | $ | 32,141 | $ | 30,706 | ||||||
| Pro forma net income/(loss) per Company's common share (4)(5)(6) | $ | 4,326 | $ | 1,219 | $ | 1,589 | ||||||
| Pro forma net income/(loss) per Company's common share, basic and diluted(4)(5)(6) | $ | 0.34 | $ | 0.20 | $ | 0.32 | ||||||
Note:
| (4) | Excludes $7.9 million bargain purchase gain recorded in the year ended December 31, 2012 in connection with the acquisitions of the SpringHill Suites - Peabody and the Fairfield Inn – East Rutherford. |
| (5) | Excludes the approximately $1.3 million bargain purchase gain recorded in the year ended December 31, 2013 in connection with the acquisition of the Arkansas Hotel Portfolio. |
| (6) | Excludes the approximately $2.8 million bargain purchase gain recorded in the year ended December 31, 2014 in connection with the acquisition of the Philadelpia Hotel Portfolio. |
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4. Investments in Unconsolidated Affiliated Entity
The entity listed below is partially owned by the Company. The Company accounts for this investment under the equity method of accounting as the Company exercises significant influence, but does not exercise financial and operating control, and is not considered to be the primary beneficiary of this entity. A summary of the Company’s investment in the unconsolidated affiliated entity is as follows:
| As of | ||||||||||||||||
| Entity | Date of Ownership | Ownership % | December 31, 2014 | December 31, 2013 | ||||||||||||
| Brownmill LLC ("Brownmill") | Various | 48.58 | % | $ | 3,504 | $ | 3,834 | |||||||||
Brownmill
During 2010, 2011 and 2012, the Company entered into five separate contribution agreements with Lightstone Holdings LLC (‘‘LGH’’), a wholly-owned subsidiary of the Company’s Sponsor, pursuant to which LGH contributed to the Company an approximate aggregate 48.6% equity interest (34.4%, 5.6% and 8.6% in 2010, 2011 and 2012, respectively) in Brownmill in order to fulfill the Sponsor’s semi-annual commitment to purchase Subordinated Profits Interests with cash or contributed property. In exchange, the Company issued an aggregate of 48 units (33, 6 and 9 in 2010, 2011 and 2012, respectively) of Subordinated Profits Interests, at $100,000 per unit (at an aggregate total value of $4.8 million, of which $3.3 million, $0.6 million and $0.9 million were in 2010, 2011 and 2012, respectively), to Lightstone SLP II LLC.
The aggregate fair value of the Company’s 48.6% interest in Brownmill, based on estimated fair values as of the effective dates of the applicable contributions, was approximately $15.5 million, of which $4.8 million was in the form of equity and $10.7 million was in the form of mortgage indebtedness.
As a result of these contributions in exchange for Subordinated Profit Interests, as of December 31, 2014, the Company owns a 48.6% membership interest in Brownmill. The Company’s interest in Brownmill is a non-managing interest. An affiliate of the Company’s Sponsor is the majority owner and manager of Brownmill. Profit and cash distributions are allocated in accordance with each investor’s ownership percentage. The Company recorded its investment in Brownmill in accordance with the equity method of accounting. Accordingly, its portion of Brownmill’s total indebtedness is not included in the investment. In connection with the contributions of the ownership interests in Brownmill, the Company did not incur any transactions fees. During the years ended December 31, 2014, 2013 and 2012, Brownmill made distributions of $450, $150 and $300, respectively, to its members, of which the Company’s share was $219, $73 and $135, respectively.
Brownmill owns two retail properties known as Browntown Shopping Center, located in Old Bridge, New Jersey, and Millburn Mall, located in Vauxhaull, New Jersey, which collectively, are referred to as the “Brownmill Properties.”
Brownmill Condensed Financial Information
The Company’s carrying value of its interest in Brownmill differs from its share of member’s equity reported in the condensed balance sheet of Brownmill due to the Company’s basis of its investment in excess of the historical net book value of Brownmill. The Company’s additional basis allocated to depreciable assets is being recognized on a straight-line basis over the lives of the appropriate assets.
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The following table represents the unaudited condensed income statement for Brownmill for the period indicated:
| For the Year Ended December 31, 2014 | For the Year Ended December 31, 2013 | For the Year Ended December 31, 2012 | ||||||||||
| Revenue | $ | 3,600 | $ | 3,551 | $ | 3,682 | ||||||
| Property operating expenses | 1,458 | 1,377 | 1,361 | |||||||||
| Depreciation and amortization | 842 | 840 | 862 | |||||||||
| Operating income | 1,300 | 1,334 | 1,459 | |||||||||
| Interest expense and other, net | (1,094 | ) | (1,151 | ) | (1,179 | ) | ||||||
| Net income | $ | 206 | $ | 183 | $ | 280 | ||||||
| Company's share of net income | $ | 100 | $ | 89 | $ | 122 | ||||||
| Additional depreciation and amortization expense (1) | (211 | ) | (259 | ) | (283 | ) | ||||||
| Company's loss from investment | $ | (111 | ) | $ | (170 | ) | $ | (161 | ) | |||
| 1. | Additional depreciation and amortization expense relates to the amortization of the difference between the cost of the interest in Brownmill and the amount of the underlying equity in net assets of Brownmill. |
The following table represents the unaudited condensed balance sheet for Brownmill:
| As of | As of | |||||||
| December 31, 2014 | December 31, 2013 | |||||||
| Real estate, at cost (net) | $ | 15,493 | $ | 16,039 | ||||
| Cash and restricted cash | 664 | 1,530 | ||||||
| Other assets | 2,096 | 1,363 | ||||||
| Total assets | $ | 18,253 | $ | 18,932 | ||||
| Mortgage payable | $ | 20,217 | $ | 20,700 | ||||
| Other liabilities | 636 | 588 | ||||||
| Members' deficiency | (2,600 | ) | (2,356 | ) | ||||
| Total liabilities and members' deficiency | $ | 18,253 | $ | 18,932 | ||||
Rego Park Joint Venture
During 2013, LVP Rego Park, LLC (the “Rego Park Joint Venture”), a joint venture in which the Company and Lightstone Value Plus Real Estate Investment Trust, Inc. (“Lightstone I”) a real estate investment trust also sponsored by the Company’s sponsor, The Lightstone Group, had 10.0% and 90.0% ownership interests, respectively, made final distributions to its members and, as a result, the Company no longer has any investment in the Rego Park Joint Venture. During the years ended December 31, 2013 and 2012, the Rego Park Joint Venture had net income of approximately $1,722 and $3,198, respectively, of which the Company’s share was approximately $156 and $320, respectively.
5. Marketable Securities and Fair Value Measurements
Marketable Securities:
The following is a summary of the Company’s available for sale securities as of the dates indicated:
| As of December 31, 2014 | ||||||||||||||||
| Adjusted Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
| Equity Securities | $ | 17,928 | $ | 408 | $ | (156 | ) | $ | 18,180 | |||||||
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| As of December 31, 2013 | ||||||||||||||||
| Adjusted Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
| Equity Securities | $ | 7,735 | $ | 399 | $ | $ | 8,134 | |||||||||
The Company has access to a margin loan from a financial institution that holds custody of certain of the Company’s marketable securities. The margin loan is collateralized by the marketable securities in the Company’s account. The amounts available to the Company under the margin loan are at the discretion of the financial institution and not limited to the amount of collateral in its account. The margin loan bears interest at libor plus 0.85% (1.00% at December 31, 2014) and interest expense on the margin loan was $52, $24 and $34 for the years ended December 31, 2014, 2013 and 2012, respectively.
When evaluating the investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell, the investment before recovery of the investment’s amortized cost basis. As of December 31, 2014 and 2013, the Company did not recognize any impairment charges.
Fair Value Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.
The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:
| • | Level 1 – Quoted prices in active markets for identical assets or liabilities. |
| • | Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
| • | Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. |
As of December 31, 2014 all of the Company’s equity securities were classified as Level 1 assets and there were no transfers between the level classifications. The Company did not have any other significant financial assets or liabilities, which would require revised valuations that are recognized at fair value.
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| 6. | Mortgages Payable |
Mortgages payable consisted of the following:
| Loan Amount Outstanding | ||||||||||||||||||||||
| Description | Interest Rate | Weighted Average Interest Rate as of December 31, 2014 | Maturity Date | Amount Due at Maturity | As of December 31, 2014 | As of December 31, 2013 | ||||||||||||||||
| Promissory Note, secured by four properties | 4.94 | % | 4.94 | % | August 2018 | $ | 21,754 | 23,761 | 24,260 | |||||||||||||
| 4.94 | % | $ | 23,761 | $ | 24,260 | |||||||||||||||||
Promissory Note
On July 29, 2013, the Company, through certain subsidiaries, entered into a promissory note (the “Promissory Note”) with Barclays Bank PLC (“Barclays”) for approximately $24.4 million. The Promissory Note has a term of five years with a maturity date of August 6, 2018, bears interest at 4.94%, and requires monthly principal and interest payments of approximately $142 through its stated maturity.
The Promissory Note is cross-collateralized by four hotel properties consisting of the SpringHill Suites - Peabody, the TownePlace Suites - Metairie and the Arkansas Hotel Portfolio.
Principal Maturities
The following table, based on the initial terms of the mortgages, sets forth their aggregate estimated contractual principal maturities, including balloon payments due at maturity, as of December 31, 2014:
| 2015 | 2016 | 2017 | 2018 | 2019 | Thereafter | Total | ||||||||||||||||||||||
| Principal maturities | $ | 524 | $ | 548 | $ | 580 | $ | 22,109 | $ | - | $ | - | $ | 23,761 | ||||||||||||||
Debt Compliance
Pursuant to the Company’s debt agreements, approximately $1.0 million was held in restricted escrow accounts as of December 31, 2014. Such escrows are subject to release in accordance with the applicable debt agreement for the payment of real estate taxes, insurance and capital improvements, as required. Certain of our debt agreements also contain clauses providing for prepayment penalties and require the maintenance of certain ratios, including debt service coverage. The Company is currently in compliance with respect to all of its debt covenants.
7. Selling Commission, Dealer Manager Fees and Other Offering Costs
Selling commissions and dealer manager fees are paid to the Dealer Manager, pursuant to various agreements, and other third-party offering expenses such as registration fees, due diligence fees, marketing costs, and professional fees are accounted for as a reduction against additional paid-in capital (“APIC”) as costs are incurred. Any organizational costs are accounted for as general and administrative costs. The following table represents the selling commissions and dealer manager and other offering costs for the periods indicated:
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| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Selling commissions and dealer manager fees | $ | 8,934 | $ | 2,023 | $ | 715 | ||||||
| Other offering costs | $ | 611 | $ | 1,937 | $ | 1,495 | ||||||
Since commencement of its Offering through the termination of the Follow-On Offering (September 27, 2014), the Company has incurred approximately $16.3 million in selling commissions and dealer manager fees and $8.5 million of other offering costs.
8. Subscription Receivable
The subscription receivable relates to shares issued to the Company’s shareholders for which the proceeds have not yet been received by the Company solely due to a fact of timing of transfers from the escrow agent holding the funds.
9. Stockholder’s Equity
Preferred Shares
Shares of preferred stock may be issued in the future in one or more series as authorized by the Company’s Board of Directors. Prior to the issuance of shares of any series, the Board of Directors is required by the Company’s charter to fix the number of shares to be included in each series and the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications and terms or conditions of redemption for each series. Because the Company’s Board of Directors has the power to establish the preferences, powers and rights of each series of preferred stock, it may provide the holders of any series of preferred stock with preferences, powers and rights, voting or otherwise, senior to the rights of holders of our common stock. The issuance of preferred stock could have the effect of delaying, deferring or preventing a change in control of the Company, including an extraordinary transaction (such as a merger, tender offer or sale of all or substantially all of our assets) that might provide a premium price for holders of the Company’s common stock. To date, the Company had no outstanding preferred shares.
Common Shares
All of the common stock offered by the Company will be duly authorized, fully paid and nonassessable. Subject to the preferential rights of any other class or series of stock and to the provisions of its charter regarding the restriction on the ownership and transfer of shares of our stock, holders of the Company’s common stock will be entitled to receive distributions if authorized by the Board of Directors and to share ratably in the Company’s assets available for distribution to the stockholders in the event of a liquidation, dissolution or winding-up.
Each outstanding share of the Company’s common stock entitles the holder to one vote on all matters submitted to a vote of stockholders, including the election of directors. There is no cumulative voting in the election of directors, which means that the holders of a majority of the outstanding common stock can elect all of the directors then standing for election, and the holders of the remaining common stock will not be able to elect any directors.
Holders of the Company’s common stock have no conversion, sinking fund, redemption or exchange rights, and have no preemptive rights to subscribe for any of its securities. Maryland law provides that a stockholder has appraisal rights in connection with some transactions. However, the Company’s charter provides that the holders of its stock do not have appraisal rights unless a majority of the Board of Directors determines that such rights shall apply. Shares of the Company’s common stock have equal dividend, distribution, liquidation and other rights.
Under its charter, the Company cannot make any material changes to its business form or operations without the approval of stockholders holding at least a majority of the shares of our stock entitled to vote on the matter. These include (1) amendment of its charter, (2) its liquidation or dissolution, (3) its reorganization, and (4) its merger, consolidation or the sale or other disposition of its assets. Share exchanges in which the Company is the acquirer, however, do not require stockholder approval.
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Distributions
U.S. federal income tax law requires that a REIT distribute annually at least 90% of its 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. In order to continue to qualify for REIT status, we may be required to make distributions in excess of cash available.
Distributions will be at the discretion of our Board of Directors. We commenced quarterly distributions beginning with the fourth quarter of 2009 and we have generally used cash proceeds from the sale of shares of our common stock to fund such distributions. We may continue to pay such distributions from the sale of shares of our common stock or borrowings if we do not generated sufficient cash flow from our operations to fund distributions. Our ability to pay regular distributions and the size of these distributions will depend upon a variety of factors. For example, our borrowing policy permits us to incur short-term indebtedness, having a maturity of two years or less, and we may have to borrow funds on a short-term basis to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT. We cannot assure that regular distributions will continue to be made or that we will maintain any particular level of distributions that we have established or may establish.
We are an accrual basis taxpayer, and as such our REIT taxable income could be higher than the cash available to us. We may therefore borrow to make distributions, which could reduce the cash available to us, in order to distribute 90% of our REIT taxable income as a condition to our election to be taxed as a REIT. These distributions made with borrowed funds may constitute a return of capital to stockholders. “Return of capital” refers to distributions to investors in excess of net income. To the extent that distributions to stockholders exceed earnings and profits, such amounts constitute a return of capital for U.S. federal income tax purposes, although such distributions might not reduce stockholders’ aggregate invested capital. Because our earnings and profits are reduced for depreciation and other non-cash items, it is likely that a portion of each distribution will constitute a tax-deferred return of capital for U.S. federal income tax purposes.
On March 30, 2009, our Board of Directors declared the Annualized Distribution Rate for each quarterly period commencing 30 days subsequent to achieving the minimum offering of 500,000 shares of common stock. The distribution is calculated based on stockholders of record each day during the applicable period at a rate of $0.00178082191 per share per day, and equals a daily amount that, if paid each day for a 365-day period, would equal a 6.5% annualized rate based on the share price of $10.00.
At the beginning of October 2009, we achieved our minimum offering of 500,000 shares of common stock and on November 3, 2009, our Board of Directors declared our first quarterly distribution at an annualized distribution rate (the “Annualized Distribution Rate”) for the three-month period ending December 31, 2009. Subsequently, our Board of Directors has declared regular quarterly distributions at the Annualized Distribution Rate
Total distributions declared during the years ended December 31, 2014, 2013 and 2012 were $8.2 million, $4.1 million and $3.3 million, respectively.
On March 27, 2015, the our Board of Directors declared the quarterly distribution for the three-month period ended March 31, 2015 in the amount of $0.00178082191 per share per day payable to stockholders of record on the close of business each day during the quarter, which will be paid on April 15, 2015.
Our stockholders have the option to elect the receipt of shares of common stock in lieu of cash under our DRIP. On January 19, 2015, the Board of Directors suspended the Company’s DRIP effective April 15, 2015. For so long as the DRIP remains suspended, all future distributions will be in the form of cash.
The amount of distributions to be paid to our stockholders in the future will be determined by our Board of Directors and are dependent on a number of factors, including funds available for payment of distributions, our financial condition, capital expenditure requirements and annual distribution requirements needed to maintain our status as a REIT under the Code.
Equity Compensation Plans
The Company’s Employee and Director Incentive Restricted Share Plan provides for grants of awards to its directors, officers and full-time employees (in the event the Company ever has employees), full-time employees of its advisor and its affiliates, full-time employees of entities that provide services to it, directors of its advisor or of entities that provide services to it, certain of its consultants and certain consultants to the advisor and its affiliates or to entities that provide services to it. Such awards shall consist of restricted shares.
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Restricted share awards entitle the recipient to common shares from us under terms that provide for vesting over a specified period of time or upon attainment of pre-established performance objectives. Such awards would typically be forfeited with respect to the unvested shares upon the termination of the recipient’s employment or other relationship with the Company. Restricted shares may not, in general, be sold or otherwise transferred until restrictions are removed and the shares have vested. Holders of restricted shares may receive cash dividends prior to the time that the restrictions on the restricted shares have lapsed. Any dividends payable in common shares shall be subject to the same restrictions as the underlying restricted shares.
On March 30, 2012, our Board of Directors approved the termination of our stock option plan. The stock option plan was terminated by our Board of Directors as a result of a request from a state securities regulator. Prior to its termination, we had adopted a stock option plan under which our independent directors were eligible to receive annual nondiscretionary awards of nonqualified stock options. We had authorized and reserved 75,000 shares of our common stock for issuance under our stock option plan, which shares are no longer reserved for such purpose.
10. Noncontrolling Interests
The noncontrolling interests consist of (i) parties of the Company that hold units in the Operating Partnership and (ii) the interests held by minority owners of certain of our hotels. The units include Subordinated Profits Interests, limited partner units, and Common Units. With respect to the units in the Operating Partnership, the noncontrolling interest in the Company’s consolidated balance sheets as of December 31, 2014 and 2013 include (i) the 200 limited partner units held by the Advisor and (ii) 177 and 64 Subordinated Profits Interests units held by Lightstone SLP II LLC as of December 31, 2014 and 2013, respectively.
Share Description
See Note 1 for a discussion of rights related to the Subordinated Profits Interests. The limited partner and Common Units of the Operating Partnership have similar rights as those of the Company’s stockholders including distribution rights.
Distributions
During the year ended December 31, 2014, 2013 and 2012, the Company paid distributions to noncontrolling interests in LVP Metairie JV LLC of $131, $175 and $306, respectively.
11. Related Party Transactions
The Company has agreements with the Dealer Manager, Advisor and Property Managers to pay certain fees, as follows, in exchange for services performed by these entities and other affiliated entities. The Company’s ability to secure financing and subsequent real estate operations are dependent upon its Advisor, Property Managers and their affiliates to perform such services as provided in these agreements.
| Fees | Amount | |
| Selling Commission | The Dealer Manager was paid up to 7% of the gross offering proceeds before reallowance of commissions earned by participating broker-dealers. From our inception through the termination of the Follow-On Offering (September 27, 2014), approximately $11.2 million of selling commissions were incurred. | |
| Dealer Management Fee |
The Dealer Manager was paid up to 3% of gross offering proceeds before reallowance to participating broker-dealers. From our inception through termination of the Follow-On Offering (September 27, 2014), approximately $5.1 million of dealer management fees were incurred. | |
| Reimbursement of Offering Expenses |
The Company sold Subordinated Profits Interests to Lightstone SLP II LLC for $12.9 million and Lightstone SLP II LLC contributed equity interests totaling 48.6% in Brownmill, which were valued at $4.8 million, in exchange for 177.0 Subordinated Profits Interests with an aggregate value of $17.7 million. The proceeds received from the cash sale of Subordinated Profits Interests were used to pay the dealer manager fees and selling commissions. |
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| Fees | Amount | |
| Acquisition Fee | The Advisor will be paid an acquisition fee equal to 0.95% of the gross contractual purchase price (including any mortgage assumed) of each property purchased. The Advisor will also be reimbursed for expenses that it incurs in connection with the purchase of a property. | |
Property Management –
|
The Property Manager will be paid a monthly management fee of up to 5% of the gross revenues from residential, hospitality and retail properties. The Company may pay the Property Managers a separate fee for the one-time initial rent-up or leasing-up of newly constructed properties in an amount not to exceed the fee customarily charged in arm’s length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of brokers and agents in such area. | |
Property
|
The Property Manager s will be paid monthly property management and leasing fees of up to 4.5% of gross revenues from office and industrial properties. In addition, the Company may pay the Property Managers a separate fee for the one-time initial rent-up or leasing-up of newly constructed properties in an amount not to exceed the fee customarily charged in arm’s length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of brokers and agents in such area. | |
| Asset Management Fee |
The Advisor or its affiliates will be paid an asset management fee of 0.95% of the Company’s average invested assets, as defined, payable quarterly in an amount equal to 0.2375 of 1% of average invested assets as of the last day of the immediately preceding quarter. | |
| Reimbursement of Other expenses |
For any year in which the Company qualifies as a REIT, the Advisor must reimburse the Company for the amounts, if any, by which the total operating expenses, the sum of the advisor asset management fee plus other operating expenses paid during the previous fiscal year exceed the greater of 2% of average invested assets, as defined, for that fiscal year, or, 25% of net income for that fiscal year. Items such as property operating expenses, depreciation and amortization expenses, interest payments, taxes, non-cash expenditures, the special liquidation distribution, the special termination distribution, organization and offering expenses, and acquisition fees and expenses are excluded from the definition of total operating expenses, which otherwise includes the aggregate expense of any kind paid or incurred by the Company. | |
| The Advisor or its affiliates will be reimbursed for expenses that may include costs of goods and services, administrative services and non-supervisory services performed directly for the Company by independent parties. |
Lightstone SLP II, LLC has purchased Subordinated Profits Interests in the Operating Partnership. These Subordinated Profits Interests, the purchase price of which will be repaid only after stockholders receive a stated preferred return and their net investment, may entitle Lightstone SLP II, LLC to a portion of any regular distributions made by the Operating Partnership. There have been no distributions to date. Any future distributions will be paid at a 7% annualized rate of return to Lightstone SLP II, LLC and will always be subordinated until stockholders receive a stated preferred return, as described below.
The Subordinated Profits Interests may also entitle Lightstone SLP II, LLC to a portion of any liquidating distributions made by the Operating Partnership. The value of such distributions will depend upon the net sale proceeds upon the liquidation of the Company and, therefore, cannot be determined at the present time. Liquidating distributions to Lightstone SLP II, LLC will always be subordinated until stockholders receive a distribution equal to their initial investment plus a stated preferred return, as described below:
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| Liquidating Stage Distributions |
Amount of Distribution | |
| 7% Stockholder Return Threshold |
Once stockholders have received liquidation distributions, and a cumulative non-compounded 7% return per year on their initial net investment, Lightstone SLP, LLC will receive available distributions until it has received an amount equal to its initial purchase price of the Subordinated Profits Interests plus a cumulative non-compounded return of 7% per year. | |
| Returns in Excess of 7% | Once stockholders have received liquidation distributions, and a cumulative non-compounded return of 7% per year on their initial net investment, 70% of the aggregate amount of any additional distributions from the Operating Partnership will be payable to the stockholders, and 30% of such amount will be payable to Lightstone SLP II, LLC, until a 12% return is reached. | |
| Returns in Excess of 12% | After stockholders and Lightstone SLP II, LLC have received liquidation distributions, and a cumulative non-compounded return of 12% per year on their initial net investment, 60% of any remaining distributions from the Operating Partnership will be distributable to stockholders, and 40% of such amount will be payable to Lightstone SLP II, LLC. |
| Operating Stage Distributions |
Amount of Distribution | |
| 7% stockholder Return Threshold | Once a cumulative non-compounded return of 7% return on their net investment is realized by stockholders, Lightstone SLP II, LLC is eligible to receive available distributions from the Operating Partnership until it has received an amount equal to a cumulative non-compounded return of 7% per year on the purchase price of the Subordinated Profits Interests. “Net investment” refers to $10 per share, less a pro rata share of any proceeds received from the sale or refinancing of the Company’s assets. | |
| Returns in excess of 7% | Once a cumulative non-compounded return of 7% per year is realized by stockholders on their net investment, 70% of the aggregate amount of any additional distributions from the Operating Partnership will be payable to the stockholders, and 30% of such amount will be payable to Lightstone SLP II, LLC until a 12% return is reached. | |
| Returns in Excess of 12% | After the 12% return threshold is realized by stockholders and Lightstone SLP II, LLC, 60% of any remaining distributions from the Operating Partnership will be distributable to stockholders, and 40% of such amount will be payable to Lightstone SLP II, LLC. |
In addition to certain related party payments made to the Dealer Manager (see Note 7), the Company also has agreements with the Advisor and the Property Managers and their affiliates to perform such services as provided in these agreements.
The following table represents the fees incurred associated with the payments to the Company’s Advisor and Property Manager for the periods:
| For the Years Ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Acquisition fees | $ | 547 | $ | 102 | $ | 85 | ||||||
| Asset management fees | - | 114 | 346 | |||||||||
| Development fees | 140 | 78 | - | |||||||||
| Total | $ | 687 | $ | 294 | $ | 431 | ||||||
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Pursuant to an Advisory Agreement, our Advisor is entitled to receive an asset management fee equal to 0.95% of our average invested assets, as defined. The asset management fee is payable quarterly and based on balances as of the end of each month in the quarterly period. Commencing with the quarter ended June 30, 2013, the Advisor has elected to waive or reduce its quarterly asset management fee to the extent our non-GAAP measure modified funds from operations available, or MFFO, as defined by the Investment Program Association, or IPA, for the preceding twelve months period ending on the last day of the current quarter is less than the distributions declared with respect to the same twelve month period. As a result, asset management fees of $0.8 and $0.4 million were waived by the Advisor during the year ended December 31, 2014 and 2013.
As of December 31, 2014, the Company owns a 48.6% membership interest in Brownmill. Affiliates of the Company’s Sponsor are the majority owners and manager of Brownmill. See Note 4.
Other Related Party Transactions
From time to time, the Company purchases title insurance from an agent in which our Sponsor owns a 50% limited partnership interest. Because this title insurance agent receives significant fees for providing title insurance, our Advisor may face a conflict of interest when considering the terms of purchasing title insurance from this agent. However, prior to the purchase by the Company of any title insurance, an independent title consultant with more than 25 years of experience in the title insurance industry reviews the transaction, and performs market research and competitive analysis on our behalf. This process results in terms similar to those that would be negotiated at an arm’s length basis. During the years ended December 31, 2014, 2013 and 2012, the Company has paid approximately $44, $106 and $32 in fees to this title insurance agent, respectively.
12. Commitments and Contingencies
Legal Proceedings
From time to time in the ordinary course of business, the Company may become subject to legal proceedings, claims or disputes.
On July 13, 2011, JF Capital Advisors, filed a lawsuit against The Lightstone Group, LLC, the Company, and Lightstone Value Plus Real Estate Investment Trust, Inc. in the Supreme Court of the State of New York seeking payment for services alleged to have been rendered, and to be rendered prospectively, under theories of unjust enrichment and breach of contract. The plaintiff had a limited business arrangement with The Lightstone Group, LLC; that arrangement has been terminated. We filed a motion to dismiss the action and, on January 31, 2012, the Supreme Court dismissed the complaint in its entirety, but granted the plaintiff leave to replead two limited causes of action.
The plaintiff filed an amended complaint on May 18, 2012, bringing limited claims under theories of unjust enrichment and quantum meruit. On November 21, 2012, the court dismissed this second complaint in part, leaving only $164 (plus interest) in potential damages. The plaintiff appealed this decision and Lightstone cross-appealed arguing that the case should have been dismissed in full. The appeals court denied plaintiff’s motion and granted defendants’ motion, as a result of which all claims were dismissed on March 25, 2014. The plaintiff filed a motion requesting the right to re-appeal to the Court of Appeals, which was granted on August 1, 2014. Lightstone continues to believe these claims to be without merit and will defend the case vigorously.
While any proceeding or litigation has an element of uncertainty, management currently believes that the likelihood of an unfavorable outcome with respect to the aforementioned legal proceedings is remote. No provision for loss has been recorded in connection therewith.
As of the date hereof, the Company is not a party to any material pending legal proceedings of which the outcome is probable or reasonably possible to have a material adverse effect on its results of operations or financial condition, which would require accrual or disclosure of the contingency and possible range of loss. Additionally, the Company has not recorded any loss contingencies related to legal proceedings in which the potential loss is deemed to be remote.
13. Quarterly Financial Data (Unaudited)
The following table presents selected unaudited quarterly financial data for each quarter during the year ended December 31, 2014 and 2013:
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| 2014 | ||||||||||||||||||||
| Year ended | Quarter ended | Quarter ended | Quarter ended | Quarter ended | ||||||||||||||||
| December 31, | December 31, | September 30, | June 30, | March 31, | ||||||||||||||||
| Total revenue | $ | 23,566 | $ | 7,289 | $ | 6,601 | $ | 6,408 | $ | 3,268 | ||||||||||
| Operating income/(loss) | $ | 1,668 | $ | 88 | $ | 834 | $ | 895 | $ | (149 | ) | |||||||||
| Net income /(loss) (a) | $ | 4,540 | $ | 2,807 | $ | 855 | $ | 845 | $ | 33 | ||||||||||
| Less (income)/loss attributable to noncontrolling interests | (68 | ) | (9 | ) | (23 | ) | (31 | ) | (5 | ) | ||||||||||
| Net income/(loss) applicable to Company's common shares | $ | 4,472 | $ | 2,798 | $ | 832 | $ | 814 | $ | 28 | ||||||||||
| Net income/(loss) per common share, basic and diluted | $ | 0.35 | $ | 0.15 | $ | 0.06 | $ | 0.08 | $ | - | ||||||||||
| a) | Net income for the year ended December 31, 2014 includes a bargain purchase gain of $2.8 million in the 4th quarter of 2014 in connection with the purchase of the Philadelphia Airport Hotel Portfolio. (See Note 3) |
| 2013 | ||||||||||||||||||||
| Year ended | Quarter ended | Quarter ended | Quarter ended | Quarter ended | ||||||||||||||||
| December 31, | December 31, | September 30, | June 30, | March 31, | ||||||||||||||||
| Total revenue | $ | 13,058 | $ | 3,335 | $ | 4,092 | $ | 3,308 | $ | 2,323 | ||||||||||
| Operating income/(loss) | $ | 541 | $ | 26 | $ | 490 | $ | 314 | $ | (289 | ) | |||||||||
| Net income /(loss) (a) | $ | 1,370 | $ | (238 | ) | $ | 202 | $ | 1,535 | $ | (129 | ) | ||||||||
| Less (income)/loss attributable to noncontrolling interests | (40 | ) | 16 | (1 | ) | (66 | ) | 11 | ||||||||||||
| Net income/(loss) applicable to Company's common shares | $ | 1,330 | $ | (222 | ) | $ | 201 | $ | 1,469 | $ | (118 | ) | ||||||||
| Net income/(loss) per common share, basic and diluted | $ | 0.21 | $ | (0.03 | ) | $ | 0.03 | $ | 0.25 | $ | (0.02 | ) | ||||||||
| b) | Net income for the year ended December 31, 2013 includes a bargain purchase gain of $1.2 million in the 2nd quarter of 2013 in connection with the purchase of the Arkansas Hotel Portfolio. (See Note 3) |
14. Subsequent Events
Joint Venture to acquire 11 limited service hotels
On January 19, 2015, the board of directors (the “Board of Directors”) of the Company provided approval for the Company to form a joint venture (the “Joint Venture”) with Lightstone I and for the Joint Venture to acquire Lightstone I’s membership interest in 11 limited service hotels for approximately $122.4 million, plus closing and other third party transaction costs, contingent upon lender approval. As of December 31, 2014, the 11 limited service hotels were encumbered by approximately $67.2 million in debt. The purchase price was determined based on independent third-party appraisals.
On January 29, 2015 the Company through its operating partnership, entered into an agreement to form the Joint Venture with Lightstone I whereby the Company and Lightstone I have 97.5% and 2.5% membership interests in the Joint Venture, respectively. The Company is the managing member. Each member may receive distributions and make future capital contributions based upon its respective ownership percentage, as required.
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On January 29, 2015, the Company, through the Joint Venture, and Lightstone I, through a wholly owned subsidiary of Lightstone Value Plus REIT LP, entered into five separate contribution agreements pursuant to which the Joint Venture agreed to acquire Lightstone I’s membership interest in a portfolio of five limited service hotels (the “Hotel Portfolio”) for approximately $64.6 million, excluding transaction costs. The Hotel Portfolio represents five of the 11 limited service hotels to be acquired previously approved by the Board of Directors. The limited service hotels included in the Hotel Portfolio are as follows:
| · | a 90-room limited service hotel which operates as a Courtyard by Marriott located in Willoughby, Ohio | |
| · | a 102-room limited service hotel which operates as a Fairfield Inn & Suites by Marriott located in West Des Moines, Iowa | |
| · | a 97-suite limited service hotel which operates as a SpringHill Suites by Marriott located in West Des Moines, Iowa | |
| · | a 126-room limited service hotel which operates as a Hampton Inn located in Miami, Florida | |
| · | a 104-room limited service hotel which operates as a Hampton Inn & Suites located in Fort Lauderdale, Florida |
On January 29, 2015, the Company, through two wholly owned subsidiaries, entered into a $60.0 million Revolving Credit Facility with GE Capital Markets, Inc. (“GE Capital”). The Revolving Credit Facility bears interest at Libor plus 4.95% (5.20% as of January 29, 2015) and provides a line of credit over the next three years, with two, one-year options to extend solely at the discretion of GE Capital. The Revolving Credit Facility may be accelerated upon the occurrence of customary events of default. Interest is payable monthly and the entire unpaid principal balance is due upon expiration of the Revolving Credit Facility. Under the terms of the Revolving Credit Facility, the Company may designate properties as collateral that allow the Company to borrow up to a 65.0% loan-to-value ratio of the properties. On January 29, 2015, the Company received the initial loan of $35.0 million under the Revolving Credit Facility which is secured by the Hotel Portfolio plus the Aloft — Tucson and the Holiday Inn — Opelika and $25.0 million remained available under the Revolving Credit Facility.
On February 11, 2015, the Company, through the Joint Venture, completed the acquisition of a 100% membership interest in Courtyard-Parsippany and the acquisition of a 90% membership interest in the Residence Inn - Baton Rouge. In connection with the acquisition of the Courtyard – Parsippany and the Residence Inn - Baton Rouge, the Joint Venture, through subsidiaries, assumed approximately $11.2 million of debt and paid approximately $12.2 million from cash contributed by the Joint Venture members based upon their respective ownership percentages (the Company $11.9 million and Lightstone I $0.3 million.) The Company’s contribution was funded with offering proceeds from the sale of the Company’s common stock. The Company’s advisor has elected to waive the acquisition fee associated with this transaction and did not receive any fees associated with this transaction.
The $7.8 million loan assumed related to Courtyard-Parsippany is secured by the hotel, has maturity date of August 1, 2018, bears interest at Libor plus 3.50% and requires monthly principal and interest payments through its stated maturity. The $3.8 million loan assumed related to Residence Inn - Baton Rouge is secured by the hotel, has a maturity date of November 2018, bears interest at 5.36% and requires monthly principal and interest payments through its stated maturity.
The Company through, the Joint Venture, has acquired membership interests in 7 of the 11 limited service hotels approved for acquisition.
Revolving Promissory Note
On February 4, 2015, the Company provided Lightstone Value Plus Real Estate Investment Trust III, Inc. (“Lightstone III”) with a $10.0 million Revolving Promissory Note (the “Revolving Promissory Note”.) The Revolving Promissory Note has a term of one year, bears interest at a floating rate of three-month Libor plus 6.0% and requires quarterly interest payments through its stated maturity with the entire unpaid balance due upon maturity. The Company received an origination fee of $0.1 million in connection with issuance of the Revolving Promissory Note. Ligthstone III pledged its ownership interest in a 120-room select service hotel located in Des Moines, Iowa, which operates as a Hampton Inn, as collateral for the Revolving Promissory Note.
Distribution Declaration
On March 27, 2015, the Company’s Board of Directors declared the quarterly distribution for the three-month period ended March 31, 2015, in the amount of $0.00178082191 per share per day, and will equal a daily amount that, if paid each day for a 365-day period, would equal a 6.5% annualized rate based on a share price of $10.00. The distribution will be paid in cash on April 15, 2015 to shareholders of record as of March 31, 2015.
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Real Estate and Accumulated Depreciation
December 31, 2014
| Gross amount at which | ||||||||||||||||||||||||||||||||||||||
| Initial Cost (A) | carried at end of period | |||||||||||||||||||||||||||||||||||||
| Encumbrance | Land | Buildings
and Improvements | Net
Costs Capitalized & Impairments Subsequent to Acquisition | Land
and Improvements | Buildings
and Improvements | Total (B) | Accumulated Depreciation (C) | Date Acquired | Depreciable Life (D) | |||||||||||||||||||||||||||||
| TownePlace Suites Hotel | ||||||||||||||||||||||||||||||||||||||
| Harahan, LA | $ | 9,244 | $ | 1,800 | $ | 10,484 | $ | 1,896 | $ | 1,800 | $ | 12,380 | $ | 14,180 | $ | (1,573 | ) | 1 | /19/2011 | (D) | ||||||||||||||||||
| SpringHill Suites Hotel | ||||||||||||||||||||||||||||||||||||||
| Peabody, MA | 7,930 | 2,126 | 10,624 | 2,786 | 2,168 | 13,368 | 15,536 | (1,876 | ) | 7 | /13/2012 | (D) | ||||||||||||||||||||||||||
| Fairfield Inn | ||||||||||||||||||||||||||||||||||||||
| East Rutherford, NJ | - | 2,945 | 8,743 | 5,240 | 2,973 | 13,955 | 16,928 | (1,059 | ) | 12 | /31/2012 | (D) | ||||||||||||||||||||||||||
| TownePlace Suites Hotel | ||||||||||||||||||||||||||||||||||||||
| Johnson, AR | 2,919 | 990 | 4,710 | 549 | 990 | 5,259 | 6,249 | (388 | ) | 6 | /18/2013 | (D) | ||||||||||||||||||||||||||
| TownePlace Suites Hotel | ||||||||||||||||||||||||||||||||||||||
| Little Rock, AR | 3,668 | 1,037 | 5,220 | 908 | 1,046 | 6,119 | 7,165 | (406 | ) | 6 | /18/2013 | (D) | ||||||||||||||||||||||||||
| Holiday Inn Express Hotel | ||||||||||||||||||||||||||||||||||||||
| Opelika, AL | - | 999 | 5,871 | - | 999 | 5,871 | 6,870 | (172 | ) | 4 | /1/2014 | (D) | ||||||||||||||||||||||||||
| Aloft Tucson University Hotel | ||||||||||||||||||||||||||||||||||||||
| Tucson, AZ | - | 1,860 | 17,140 | 24 | 1,860 | 17,164 | 19,024 | (554 | ) | 4 | /8/2014 | (D) | ||||||||||||||||||||||||||
| Hampton Inn Hotel | ||||||||||||||||||||||||||||||||||||||
| Ft. Myers Beach, FL | - | 3,028 | 6,397 | 5 | 3,028 | 6,402 | 9,430 | (83 | ) | 10 | /2/2014 | (D) | ||||||||||||||||||||||||||
| Aloft Philadelphia Airport Hotel | ||||||||||||||||||||||||||||||||||||||
| Philadelphia, PA | - | 2,595 | 11,805 | 8 | 2,595 | 11,813 | 14,408 | - | 12 | /17/2014 | (D) | |||||||||||||||||||||||||||
| Four Points by Sheraton Hotel | ||||||||||||||||||||||||||||||||||||||
| Philadelphia, PA | - | 3,267 | 5,733 | - | 3,267 | 5,733 | 9,000 | - | 12 | /17/2014 | (D) | |||||||||||||||||||||||||||
| Vacant Lot | ||||||||||||||||||||||||||||||||||||||
| Philadelphia, PA | - | 2,000 | - | - | 2,000 | - | 2,000 | - | 12 | /17/2014 | (D) | |||||||||||||||||||||||||||
| Total | $ | 23,761 | $ | 22,647 | $ | 86,727 | $ | 11,416 | $ | 22,726 | $ | 98,064 | $ | 120,790 | $ | (6,111 | ) | |||||||||||||||||||||
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Notes to Schedule III:
(A) The initial cost to the Company represents the original purchase price of the property, including (i) bargain purchase gains recorded in connection with the acquisition and (ii) amounts incurred subsequent to acquisition which were contemplated at the time the property was acquired.
(B) Reconciliation of total real estate owned:
| 2014 | 2013 | 2012 | ||||||||||
| Balance at beginning of year | $ | 56,757 | $ | 37,336 | $ | 12,514 | ||||||
| Acquisitions, at cost | 57,905 | 10,694 | 16,581 | |||||||||
| Acquisitions, bargain purchase gain | 2,790 | 1,263 | 7,857 | |||||||||
| Improvements | 3,338 | 7,464 | 384 | |||||||||
| - | ||||||||||||
| Balance at end of year | $ | 120,790 | $ | 56,757 | $ | 37,336 | ||||||
(C) Reconciliation of accumulated depreciation:
| For the years ended December 31, | ||||||||||||
| 2014 | 2013 | 2012 | ||||||||||
| Balance at beginning of year | $ | 2,670 | 850 | $ | 293 | |||||||
| Depreciation expense | 3,441 | 1,820 | 557 | |||||||||
| Balance at end of year | $ | 6,111 | $ | 2,670 | $ | 850 | ||||||
(D) Depreciation is computed based upon the following estimated lives:
| Buildings and improvements | 15-39 years |
| Tenant improvements and equipment | 5-10 years |
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PART II. CONTINUED:
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:
None.
| Item 9A. | CONTROLS AND PROCEDURES |
Disclosure Controls and Procedures. As of December 31, 2014, we conducted an evaluation under the supervision and with the participation of the Advisor’s management, including our Chairman and Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chairman and Chief Executive Officer and Chief Financial Officer concluded as of December 31, 2014 that our disclosure controls and procedures were adequate and effective.
Management’s Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control system is a process designed by, or under the supervision of, our Chairman and Chief Executive Officer and Chief Financial Officer and effected by our Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles.
Our internal control over financial reporting includes policies and procedures that:
| • | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and disposition of assets; |
| • | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with the authorization of our management and directors; and |
| • | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. |
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, they used the control criteria framework of the Committee of Sponsoring Organizations, or COSO, of the Treadway Commission published in its report entitled Internal Control—Integrated Framework (2013). Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2014.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
| 100 |
None.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE REGISTRANT
Directors
The following table presents certain information
as of March 15, 2015 concerning each of our directors serving in such capacity:
| Principal Occupation and | Year Term of | Served as a | ||||||
| Name | Age | Positions Held | Office Will Expire | Director Since | ||||
| David Lichtenstein | 54 | Chief Executive Officer and Chairman of the Board of Directors | 2015 | 2008 | ||||
| Edwin J. Glickman | 82 | Director | 2015 | 2008 | ||||
| George R. Whittemore | 65 | Director | 2015 | 2008 | ||||
| Dov Gertzulin | 36 | Director | 2015 | 2008 | ||||
| Bruno de Vinck | 69 | Secretary and Director | 2015 | 2008 |
DAVID LICHTENSTEIN is the Chairman of the Board of Directors and Chief Executive Officer. Mr. Lichtenstein founded both American Shelter Corporation and The Lightstone Group. From 1988 to the present, Mr. Lichtenstein has served as Chairman of the Board of Directors and Chief Executive Officer of The Lightstone Group, directing all aspects of the acquisition, financing and management of a diverse portfolio of multi-family, lodging, retail and industrial properties located in 20 states. From 2004 to the present, Mr. Lichtenstein has served as the Chairman of the Board of Directors and Chief Executive Officer of Lightstone I and Lightstone Value Plus REIT LLC, its advisor. Mr. Lichtenstein is also the Chairman of the Board of Directors and Chief Executive Officer Lightstone Value Plus Real Estate Investment Trust III, Inc. and Lightstone Real Estate Income Trust Inc. Mr. Lichtenstein was the president and/or director of certain subsidiaries of Extended Stay that filed for Chapter 11 protection with Extended Stay. Extended Stay and its subsidiaries filed for bankruptcy protection on June 15, 2009 so they could reorganize their debts in the face of looming amortization payments. Extended Stay emerged from bankruptcy on October 8, 2010. Mr. Lichtenstein is no longer affiliated with Extended Stay. Mr. Lichtenstein is also a member of the International Council of Shopping Centers and the National Association of Real Estate Investment Trusts, Inc., or NAREIT, an industry trade group. Mr. Lichtenstein has been selected to serve as a director due to his extensive experience and networking relationships in the real estate industry, along with his experience in acquiring and financing real estate properties.
EDWIN J. GLICKMAN is one of our independent directors and the Chairman of our audit committee. From 2004 to January 2015, Mr. Glickman served as a member of the board of directors of Lightstone I. Mr. Glickman is also an independent director of Lightstone Value Plus Real Estate Investment Trust III, Inc. and Lightstone Real Estate Income Trust Inc. In January 1995, Mr. Glickman co-founded Capital Lease Funding, a leading mortgage lender for properties net leased to investment grade tenants, where he remained as Executive Vice President until May 2003. Mr. Glickman was previously a trustee of publicly traded RPS Realty Trust from October 1980 through May 1996 and Atlantic Realty Trust from May 1996 to March 2006. Mr. Glickman graduated from Dartmouth College. Mr. Glickman has been selected to serve as an independent director due to his extensive experience in mortgage lending and finance.
GEORGE R. WHITTEMORE is one of our independent directors. From July 2006 to the present, Mr. Whittemore has served as a member of the board of directors of Lightstone I and Lightstone Value Plus Real Estate Investment Trust III, Inc. Mr. Whittemore also presently serves as a Director of Village Bank Financial Corporation in Richmond, Virginia and as a Director of Supertel Hospitality, Inc. in Norfolk, Nebraska, both publicly traded companies. Mr. Whittemore previously served as President and Chief Executive Officer of Supertel Hospitality Trust, Inc. from November 2001 until August 2004 and as Senior Vice President and Director of both Anderson & Strudwick, Incorporated, a brokerage firm based in Richmond, Virginia, and Anderson & Strudwick Investment Corporation, from October 1996 until October 2001. Mr. Whittemore has also served as a Director, President and Managing Officer of Pioneer Federal Savings Bank and its parent, Pioneer Financial Corporation, from September 1982 until August 1994, and as President of Mills Value Adviser, Inc., a registered investment advisor. Mr. Whittemore is a graduate of the University of Richmond in Virginia. Mr. Whittemore has been selected to serve as an independent director because of his extensive experience in accounting, banking, finance and real estate.
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DOV GERTZULIN is one of our independent directors. Mr. Gertzulin is the Founder and Managing Member of DG Capital Management, LLC, a New York City based investment adviser founded in February of 2007. Prior to establishing DG Capital, Mr. Gertzulin was a Vice President and Portfolio Manager at Neuberger Berman where he co-managed over $4 billion for high net worth and institutional investors. Mr. Gertzulin joined Neuberger Berman in March of 2002 as a research analyst. Previously, he was a research analyst at JDS Capital Management, which he joined in January of 2000 after beginning his investment career at Neuberger Berman in June of 1998. Mr. Gertzulin earned his MBA from New York University's Stem School of Business in 2006, where he specialized in finance and accounting and was named a Stern Scholar. He earned a BBA from Baruch College in 2001. Mr. Gertzulin is the Chairman of the Investment Committee of the Baruch College Fund with responsibility of overseeing the endowment and is a member of the Executive Committee of the Baruch College Fund Board of Trustees. Mr. Gertzulin has been selected to serve as an independent director due to his extensive experience in investment advisory, finance and accounting.
BRUNO DE VINCK is our Senior Vice President, secretary and a director. Mr. de Vinck was a Senior Vice President with The Lightstone Group through March 2013 and had been employed by the Lightstone Group since April 1994. From 2004 to the present, Mr. de Vinck also has served as Chief Operating Officer, Senior Vice President, Secretary and a member of the board of directors of Lightstone I and Lightstone Value Plus REIT LLC, its advisor. Mr. de Vinck is also a director of the privately held Park Avenue Bank Corp, and he was a director of the privately held Park Avenue Bank that was taken over by the FDIC in March 2010. He was also a director of Prime Group Realty Trust, a publicly registered REIT, from 2005 through 2011. Mr. de Vinck was previously General Manager of JN Management Co. from November 1992 to January 1994, AKS Management Co., Inc. from September 1988 to July 1992 and Heritage Management Co., Inc. from May 1986 to September 1988. In addition, Mr. de Vinck worked as Senior Property Manager at Hekemien & Co. from May 1975 to May 1986, as a Property Manager at Charles H. Greenthal & Co. from July 1972 to June 1975 and in sales and residential development for McDonald & Phillips Real Estate Brokers from May 1970 to June 1972. From July 1982 to July 1984 Mr. de Vinck was the founding President of the Ramsey Homestead Corp., a not-for-profit senior citizen residential health care facility and, from July 1984 until October 2004, was Chairman of its board of directors. Mr. de Vinck studied Architecture at Pratt Institute and then worked for the Bechtel Corporation from February 1966 to May 1970. Mr. de Vinck was also a director of certain subsidiaries of Extended Stay that filed for Chapter 11 protection with Extended Stay. Extended Stay and its subsidiaries filed for bankruptcy protection on June 15, 2009 so they could reorganize their debts in the face of looming amortization payments. Extended Stay emerged from bankruptcy on October 8, 2010. Mr. de Vinck is no longer affiliated with Extended Stay. Mr. de Vinck has been selected to serve as a director because of his extensive experience in the real estate industry.
Executive Officers:
The following table presents certain information as of March 15, 2015 concerning each of our executive officers serving in such capacities:
| Name | Age | Principal Occupation and Positions Held | ||
| David Lichtenstein | 54 | Chief Executive Officer and Chairman of the Board of Directors | ||
| Bruno de Vinck | 69 | Secretary | ||
| Mitchell Hochberg | 61 | President and Chief Operating Officer | ||
| Joseph Teichman | 41 | General Counsel | ||
| Donna Brandin | 58 | Chief Financial Officer and Treasurer |
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David Lichtenstein for biographical information about Mr. Lichtenstein, see ‘‘Management — Directors.”
Bruno de Vinck for biographical information about Mr. de Vinck, see ‘‘Management — Directors.”
MITCHELL HOCHBERG is our President and Chief Operating Officer and also serves as President of Lightstone I and the President and Chief Operating Officer of Lightstone Value Plus Real Estate Investment Trust III, Inc. and Lightstone Real Estate Income Trust Inc. Mr. Hochberg also serves as the President of our sponsor. Prior to joining The Lightstone Group in August 2012, Mr. Hochberg served as principal of Madden Real Estate Ventures, a real estate investment, development and advisory firm specializing in hospitality and residential projects from 2007 to August 2012 when it combined with our sponsor. Mr. Hochberg held the position of President and Chief Operating Officer of Ian Schrager Company, a developer and manager of innovative luxury hotels and residential projects in the United States from early 2006 to early 2007 and prior to that Mr. Hochberg founded Spectrum Communities, a developer of luxury residential neighborhoods in the Northeast in 1985 where for 20 years he served as its President and Chief Executive Officer. Additionally, Mr. Hochberg serves on the board of directors of Orient-Express Hotels Ltd and as Chairman of the board of directors of Orleans Homebuilders, Inc. Mr. Hochberg received his law degree from Columbia University School of Law where he was a Harlan Fiske Stone Scholar and graduated magna cum laude from New York University College of Business and Public Administration with a Bachelor of Science degree in accounting and finance.
JOSEPH E. TEICHMAN is our General Counsel and also serves as General Counsel of Lightstone I, Lightstone Value Plus Real Estate Investment Trust III, Inc. and Lightstone Real Estate Income Trust Inc. Mr. Teichman also serves as Executive Vice President and General Counsel of our sponsor and as General Counsel of our advisor. Prior to joining The Lightstone Group in January 2007, Mr. Teichman practiced law at the law firm of Paul, Weiss, Rifkind, Wharton & Garrison LLP in New York, NY from September 2001 to January 2007. Mr. Teichman earned a J.D. from the University of Pennsylvania Law School and a B.A. from Beth Medrash Govoha, Lakewood, New Jersey. Mr. Teichman is licensed to practice law in New York and New Jersey. Mr. Teichman was also a director of certain subsidiaries of Extended Stay that filed for Chapter 11 protection with Extended Stay. Extended Stay and its subsidiaries filed for bankruptcy protection on June 15, 2009 so they could reorganize their debts in the face of looming amortization payments. Extended Stay emerged from bankruptcy on October 8, 2010. Mr. Teichman is no longer affiliated with Extended Stay.
DONNA BRANDIN is our Chief Financial Officer and Treasurer and also serves as the Chief Financial Officer and Treasurer of Lightstone I, Lightstone Value Plus Real Estate Investment Trust III, Inc. and Lightstone Real Estate Income Trust Inc. Ms. Brandin also serves as the Executive Vice President, Chief Financial Officer and Treasurer of our sponsor and as the Chief Financial Officer and Treasurer of our advisor. Prior to joining The Lightstone Group in April 2008, Ms. Brandin held the position of Executive Vice President and Chief Financial Officer of US Power Generation from September 2007 through November 2007 and before that was the Executive Vice President and Chief Financial Officer of Equity Residential, the largest publicly traded apartment REIT in the country, from August 2004 through September 2007. Prior to joining Equity Residential, Ms. Brandin held the position of Senior Vice President and Treasurer for Cardinal Health from June 2000 through August 2004. Prior to 2000, Ms. Brandin held various executive-level positions at Campbell Soup, Emerson Electric Company and Peabody Holding Company. Ms. Brandin earned a Bachelor of Science at Kutztown University and a Masters in Finance at St. Louis University and is a certified public accountant.
Section 16 (a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires each director, officer and individual beneficially owning more than 10% of our common stock to file initial statements of beneficial ownership (Form 3) and statements of changes in beneficial ownership (Forms 4 and 5) of our common stock with the Securities Exchange Commission ("SEC"). Officers, directors and greater than 10% beneficial owners are required by Securities and Exchange Commission rules to furnish us with copies of all such forms they file. Based solely on a review of the copies of such forms furnished to us during and with respect to the fiscal year ended December 31, 2014, or written representations that no additional forms were required, we believe that all of our officers and directors and persons that beneficially own more than 10% of the outstanding shares of our common stock complied with these filing requirements in 2014.
Information Regarding Audit Committee
Our Board established an audit committee in December 2008. The charter of audit committee is available at www.lightstonecapitalmarkets.com/lightstone-other.html or in print to any shareholder who requests it c/o Lightstone Value Plus Real Estate Investment Trust II, Inc., 1985 Cedar Bridge Avenue, Lakewood, NJ 08701. Our audit committee consists of Messrs. Edwin J. Glickman, George R. Whittemore and Dov Gertzulin each of whom is “independent” within the meaning of the NYSE listing standards. The Board determined that Mr. Glickman is qualified as an audit committee financial experts as defined in Item 401 (h) of Regulation S-K. For more information regarding the relevant professional experience of Messrs. Glickman, Whittemore and Gertzulin see “Directors”.
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Code of Conduct and Ethics
We have adopted a Code of Conduct and Ethics that applies to all of our executive officers and directors, including but not limited to, our principal executive officer and principal financial officer. Our Code of Conduct and Ethics can be found at www.lightstonecapitalmarkets.com/lightstone-other.html
ITEM 11. EXECUTIVE COMPENSATION
Compensation of Executive Officers
Our officers will not receive any cash compensation from us for their services as our officers. We may compensate our officers with restricted shares of our common stock in accordance with our Employee and Director Incentive Restricted Share Plan. Our board of directors (including a majority of our independent directors) will determine if and when any of our officers will receive restricted shares of our common stock. Additionally, our officers are officers of one or more of our affiliates and are compensated by those entities (including our sponsor), in part, for their services rendered to us. From our inception through December 31, 2014, the Company has not compensated the officers.
Compensation of Board of Directors
We pay our independent directors an annual fee of $30,000 and are responsible for reimbursement of their out-of-pocket expenses, as incurred. Pursuant to our Employee and Director Incentive Share Plan, in lieu of receiving his or her annual fee in cash, an independent director is entitled to receive the annual fee in the form of our common shares or a combination of common shares and cash.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Executive Officers:
The following table presents certain information as of March 23, 2015 concerning each of our directors and executive officers serving in such capacities:
| Name and Address of Beneficial Owner | Number of Shares of Common Stock of the Lightstone REIT II Beneficially Owned | Percent of All Common Shares of the Lightstone REIT II | ||||||
| David Lichtenstein (1) | 20,000 | 0.11 | % | |||||
| Edwin J. Glickman | - | - | ||||||
| George R. Whittemore | - | - | ||||||
| Dov Gertzulin | - | - | ||||||
| Bruno de Vinck | - | - | ||||||
| Mitchell Hochberg | - | - | ||||||
| Donna Brandin | - | - | ||||||
| Joseph Teichman | - | - | ||||||
| Our directors and executive officers as a group (8 persons) | 20,000 | 0.11 | % | |||||
| (1) | Includes 20,000 shares owned by our Advisor. Our Advisor is wholly owned by The Lightstone Group, our Sponsor, which is majority owned by David Lichtenstein. The beneficial owner’s business address is 1985 Cedar Bridge Avenue, Lakewood, New Jersey 08701. Lightstone SLP II LLC, which is controlled and wholly owned by our Sponsor, will receive subordinated profits interests of our Operating Partnership in exchange for $30,000,000, assuming 30,000,000 shares are sold pursuant to the Follow-On Offering, which we will use to pay all selling commissions, dealer manager fees and a portion of organization and other offering expenses. |
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EQUITY COMPENSATION PLAN INFORMATION
On March 30, 2012, our board of directors approved the termination of our stock option plan. The stock option plan was terminated by our board of directors as a result of a request from a state securities regulator. Prior to its termination, we had adopted a stock option plan under which our independent directors were eligible to receive annual nondiscretionary awards of nonqualified stock options. We had authorized and reserved 75,000 shares of our common stock for issuance under our stock option plan, which shares are no longer reserved for such purpose. No stock options were issued or outstanding when the plan was terminated.
Employee and Director Incentive Restricted Share Plan
Our Employee and Director Incentive Restricted Share Plan:
| • | furnishes incentives to individuals chosen to receive restricted shares because they are considered capable of improving our operations and increasing profits; | |
| • | encourages selected persons to accept or continue employment with our advisor and its affiliates; and | |
| • | increases the interest of our employees, officers and directors in our welfare through their participation in the growth in the value of our common shares. |
The Employee and Director Incentive Restricted Share Plan provides us with the ability to grant awards of restricted shares to our directors, officers and full-time employees (in the event we ever have employees), full-time employees of our advisor and its affiliates, full-time employees of entities that provide services to us, directors of the advisor or of entities that provide services to us, certain of our consultants and certain consultants to the advisor and its affiliates or to entities that provide services to us. The total number of common shares reserved for issuance under the Employee and Director Incentive Restricted Share Plan is equal to 0.5% of our outstanding shares on a fully diluted basis at any time, not to exceed 255,000 shares.
Restricted share awards entitle the recipient to common shares from us under terms that provide for vesting over a specified period of time or upon attainment of pre-established performance objectives. Such awards would typically be forfeited with respect to the unvested shares upon the termination of the recipient’s employment or other relationship with us. Restricted shares may not, in general, be sold or otherwise transferred until restrictions are removed and the shares have vested. Holders of restricted shares may receive cash dividends prior to the time that the restrictions on the restricted shares have lapsed. Any dividends payable in common shares shall be subject to the same restrictions as the underlying restricted shares.
The guidance under Section 409A of the Code provides that there is no deferral of compensation merely because the value of property (received in connection with the performance of services) is not includible in income by reason of the property being substantially nonvested (as defined in Section 83 of the Code). Accordingly, it is intended that the restricted share grants will not be considered “nonqualified deferral compensation.”
We have not yet granted any awards of restricted shares.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
David Lichtenstein serves as the Chairman of our Board of Directors and our Chief Executive Officer. Our Advisor and Property Managers are indirectly owned and controlled by subsidiaries of our Sponsor, The Lightstone Group, which is majority owned by Mr. Lichtenstein. On February 17, 2009, we entered into agreements with our Advisor and Property Manager to pay certain fees, as described below, in exchange for services performed by these and other affiliated entities. As the indirect owner of those entities, Mr. Lichtenstein benefits from fees and other compensation that they receive pursuant to these agreements.
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Property Managers
We have two affiliated property managers (our “Property Managers”), which may manage the properties we acquire. We also use other unaffiliated third-party property managers, principally for the management of our hospitality properties. Our Property Managers are Paragon Retail Property Management LLC (“Paragon”) and Beacon Property Management LLC (“Beacon”), all of which are majority owned and controlled by our Sponsor. Paragon, which previously operated under the name Prime Retail Property Management, LLC, manages, leases, develops and redevelops all the factory outlet malls and certain retail properties controlled by our Sponsor. Beacon is a significant manager in the multi-family residential housing sector and oversees the management of approximately 10,000 multifamily units.
We have agreed to pay our Property Managers a monthly management fee of up to 5% of the gross revenues from our residential, lodging and retail properties. In addition, for the management and leasing of our office and industrial properties, we will pay, to our Property Managers, property management and leasing fees of up to 4.5% of gross revenues from our office and industrial properties. We may pay our property managers a separate fee for the one-time initial rent-up or leasing-up of newly constructed office and industrial properties in an amount not to exceed the fee customarily charged in arm’s length transactions by others rendering similar services in the same geographic area for similar properties as determined by a survey of brokers and agents in such area.
Notwithstanding the foregoing, our Property Managers may be entitled to receive higher fees in the event our Property Managers demonstrate to the satisfaction of a majority of the directors (including a majority of the independent directors) that a higher competitive fee is justified for the services rendered. Our Property Managers will also be paid a monthly fee for any extra services equal to no more than that which would be payable to an unrelated party providing the services. The actual amounts of these fees are dependent upon results of operations and, therefore, cannot be determined at the present time.
We have not incurred any fees to the Property Managers for the years ended December 31, 2014, 2013 and 2012.
Dealer Manager
We pay the Dealer Manager selling commissions of up to 7% of gross offering proceeds before reallowance of commissions earned by participating broker-dealers. The Dealer Manager expects to reallow 100% of commissions earned for those transactions that involve participating broker-dealers. We also pay to our Dealer Manager a dealer manager fee of up to 3% of gross offering proceeds before reallowance to participating broker-dealers. Our Dealer Manager, in its sole discretion, may reallow a portion of its dealer manager fee of up to 3% of the gross offering proceeds to be paid to such participating broker-dealers. Total fees paid to the dealer manager for the years ended December 31, 2014, 2013 and 2012 were $8.9 million, $2.0 million and $0.7 million, respectively.
Advisor
We will pay our Advisor an acquisition fee equal to 0.95% of the gross contractual purchase price (including any mortgage assumed) of each property purchased and will reimburse our Advisor for expenses that it incurs in connection with the purchase of a property. We anticipate that acquisition expenses will be 0.45% of a property's purchase price, and acquisition fees and expenses are capped at 5% of the gross contract purchase price of a property. However, $11.3 million may be paid as an acquisition fee and for the reimbursement of acquisition expenses if the maximum offering was sold, assuming aggregate long-term permanent leverage of approximately 75%. The Advisor will also be paid an advisor asset management fee of 0.95% of our average invested assets and we will reimburse some expenses of the Advisor. Total fees paid to the Advisor for the years ended December 31, 2014, 2013 and 2012 were $0.5 million, $0.3 million and $0.4 million, respectively.
Commencing with the quarter ended June 30, 2013, the Advisor has elected to waive or reduce its quarterly asset management fee to the extent our non-GAAP measure modified funds from operations available, or MFFO, as defined by the Investment Program Association, or IPA, for the preceding twelve months period ending on the last day of the current quarter is less than the distributions declared with respect to the same twelve month period. As a result, asset management fees of $0.8 million and $0.4 million were waived by the Advisor during the year ended December 31, 2014 and 2013.
Sponsor
Lightstone SLP II LLC, which is wholly owned by our Sponsor, committed to purchase Subordinated Profits Interests at a cost of $100,000 per unit for each $1.0 million in subscriptions up to ten percent of the proceeds from the primary shares under the Offering and Follow-On Offering on a semi-annual basis beginning with the quarter ended June 30, 2010. Lightstone SLP II LLC could have elected to purchase the Subordinated Profits Interests with either cash or an interest in real property of equivalent value. Any proceeds received from the cash sale of the Subordinated Profits Interests will be used to offset payments made by the Company from offering proceeds to pay the dealer manager fees, selling commissions and organization and other offering expenses.
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From our inception through December 31, 2014, our Sponsor contributed cash of approximately $12.9 million and equity interests totaling 48.6% in Brownmill, which were valued at $4.8 million, in exchange for 177.0 Subordinated Profits Interests with an aggregate value of $17.7 million. See Note 4 of the Notes to Consolidated Financial Statements for additional information. Our Sponsor may continue to elect to contribute interests in real property in lieu of cash in exchange for Subordinated Profits Interests in order to fulfill its semi-annual commitment.
As the majority owner of our Sponsor, which owns and controls Lightstone SLP II, LLC, Mr. Lichtenstein is the indirect, beneficial owner of 99% of such Subordinated Profits Interests and will thus receive an indirect benefit from any distributions made in respect thereof.
These Subordinated Profit Interests will entitle Lightstone SLP II, LLC to a portion of any regular and liquidation distributions that we make to stockholders, but only after stockholders have received a stated preferred return. Although the actual amounts are dependent upon results of operations and, therefore, cannot be determined at the present time, distributions to Lightstone SLP II, LLC, as holder of the Subordinated Profits Interests, could be substantial.
From time to time, Lightstone purchases title insurance from an agent in which our Sponsor owns a 50% limited partnership interest. Because this title insurance agent receives significant fees for providing title insurance, our Advisor may face a conflict of interest when considering the terms of purchasing title insurance from this agent. However, prior to the purchase by Lightstone of any title insurance, an independent title consultant with more than 25 years of experience in the title insurance industry reviews the transaction, and performs market research and competitive analysis on our behalf. This process results in terms similar to those that would be negotiated at an arm’s-length basis.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Principal Accounting Firm Fees
The following table presents the aggregate fees billed to us for the years presented by our principal accounting firm:
| Year ended December 31, 2014 | Year ended December 31, 2013 | |||||||
| Audit Fees (a) | 308,550 | 278,575 | ||||||
| Audit-Related Fees (b) | - | - | ||||||
| Tax Fees (c) | 65,000 | 95,000 | ||||||
| Total Fees | $ | 373,550 | $ | 373,575 | ||||
| (a) | Fees for audit services consisted of the audit of the Lightstone REIT II’s annual financial statements and interim reviews, including services normally provided in connection with statutory and regulatory filings and including registration statements and consents. |
| (b) | Fees for audit-related services related to audits of entities that the Company has acquired. |
| (c) | Fees for tax services. |
In considering the nature of the services provided by the independent auditor, the audit committee determined that such services are compatible with the provision of independent audit services. The audit committee discussed these services with the independent auditor and Lightstone REIT II management to determine that they are permitted under the rules and regulations concerning auditor independence promulgated by the Securities and Exchange Commission to implement the related requirements of the Sarbanes-Oxley Act of 2002, as well as the American Institute of Certified Public Accountants.
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AUDIT COMMITTEE REPORT
To the Directors of Lightstone Value Plus Real Estate Investment Trust II, Inc.:
We have reviewed and discussed with management Lightstone Value Plus Real Estate Investment Trust II, Inc.’s audited financial statements as of and for the year ended December 31, 2014.
We have discussed with the independent auditors the matters required to be discussed by Statement on Auditing Standards No. 61, “Communication with Audit Committees,” (Codification of Statements of Auditing Standards, August 2, 2007 AU 380), as amended, as adopted by the Public Company Accounting Oversight Board in Rule 3200T.
We have received and reviewed the written disclosures and the letter from the independent auditors required by Public Company Accounting Oversight Board Rule 3526, Communication with Audit Committees Concerning Independence and have discussed with the auditors the auditors’ independence.
Based on the reviews and discussions referred to above, we recommend to the board of directors that the financial statements referred to above be included in Lightstone Value Plus Real Estate Investment Trust II, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2014.
Audit Committee
George R. Whittemore
Edwin J. Glickman
Dov Gertzulin
INDEPENDENT DIRECTORS’ REPORT
To the Stockholders of Lightstone Value Plus Real Estate Investment Trust II, Inc.:
We have reviewed the Company’s policies and determined that they are in the best interest of the Company’s stockholders. Set forth below is a discussion of the basis for that determination.
General
The Company’s primary objective is to achieve capital appreciation with a secondary objective of income without subjecting principal to undue risk. The Company intends to achieve this goal primarily through investments in real estate properties.
The Company intends to acquire residential and commercial properties. The Company’s acquisitions may include both portfolios and individual properties. The Company expects that its commercial holdings will consist of retail (primarily multi-tenanted shopping centers), lodging (primarily limited service hotels), industrial and office properties.
The following is descriptive of the Company’s investment objectives and policies:
| • | Reflecting a flexible operating style, the Company’s portfolio is likely to be diverse and include properties of different types (such as retail, lodging, office, industrial and residential properties); both passive and active investments; and joint venture transactions. The portfolio is likely to be determined largely by the purchase opportunities that the market offers, whether on an upward or downward trend. This is in contrast to those funds that are more likely to hold investments of a single type, usually as outlined in their charters. |
| • | The Company may invest in properties that are not sold through conventional marketing and auction processes. The Company’s investments may be at a dollar cost level lower than levels that attract those funds that hold investments of a single type. |
| • | The Company may be more likely to make investments that are in need of rehabilitation, redirection, remarketing and/or additional capital investment. |
| • | The Company may place major emphasis on a bargain element in its purchases, and often on the individual circumstances and motivations of the sellers. The Company will search for bargains that become available due to circumstances that occur when real estate cannot support the mortgages securing the property. |
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| • | The Company intends to pursue returns in excess of the returns targeted by real estate investors who target a single type of property investment. |
Financing Policies
The Company intends to utilize leverage to acquire its properties. The number of different properties the Company will acquire will be affected by numerous factors, including, the amount of funds available to us. When interest rates on mortgage loans are high or financing is otherwise unavailable on terms that are satisfactory to the Company, the Company may purchase certain properties for cash with the intention of obtaining a mortgage loan for a portion of the purchase price at a later time. There is no limitation on the amount the Company may invest in any single property or on the amount the Company can borrow for the purchase of any property.
The Company intends to limit its aggregate long-term permanent borrowings to 75% of the aggregate fair market value of all properties unless any excess borrowing is approved by a majority of the independent directors and is disclosed to the Company’s stockholders. The Company may also incur short-term indebtedness, having a maturity of two years or less. By operating on a leveraged basis, the Company will have more funds available for investment in properties. This will allow the Company to make more investments than would otherwise be possible, resulting in a more diversified portfolio. Although the Company’s liability for the repayment of indebtedness is expected to be limited to the value of the property securing the liability and the rents or profits derived therefrom, the Company’s use of leveraging increases the risk of default on the mortgage payments and a resulting foreclosure of a particular property. To the extent that the Company does not obtain mortgage loans on the Company’s properties, the Company’s ability to acquire additional properties will be restricted. The Company will endeavor to obtain financing on the most favorable terms available.
Policy on Sale or Disposition of Properties
The Company’s Board will determine whether a particular property should be sold or otherwise disposed of after considering the relevant factors, including performance or projected performance of the property and market conditions, with a view toward achieving its principal investment objectives.
The Company currently intends to hold its properties for a minimum of seven to ten years prior to selling them. After seven to ten years, the Company’s Board may decide to liquidate the Company, list its shares on a national stock exchange, sell its properties individually or merge or otherwise consolidate the Company with a publicly-traded REIT. Alternatively, the Company may merge with, or otherwise be acquired by, the Sponsor or its affiliates. The Company may, however, sell properties prior to such time and if so, may invest the proceeds from any sale, financing, refinancing or other disposition of its properties into additional properties. Alternatively, the Company may use these proceeds to fund maintenance or repair of existing properties or to increase reserves for such purposes. The Company may choose to reinvest the proceeds from the sale, financing and refinancing of its properties to increase its real estate assets and its net income. Notwithstanding this policy, the Board, in its discretion, may distribute all or part of the proceeds from the sale, financing, refinancing or other disposition of all or any of the Company’s properties to the Company’s stockholders. In determining whether to distribute these proceeds to stockholders, the Board will consider, among other factors, the desirability of properties available for purchase, real estate market conditions, the likelihood of the listing of the Company’s shares on a national securities exchange and compliance with the applicable requirements under federal income tax laws.
When the Company sells a property, it intends to obtain an all-cash sale price. However, the Company may take a purchase money obligation secured by a mortgage on the property as partial payment, and there are no limitations or restrictions on the Company’s ability to take such purchase money obligations. The terms of payment to the Company will be affected by custom in the area in which the property being sold is located and the then prevailing economic conditions. If the Company receives notes and other property instead of cash from sales, these proceeds, other than any interest payable on these proceeds, will not be available for distributions until and to the extent the notes or other property are actually paid, sold, refinanced or otherwise disposed. Therefore, the distribution of the proceeds of a sale to the stockholders may be delayed until that time. In these cases, the Company will receive payments in cash and other property in the year of sale in an amount less than the selling price and subsequent payments will be spread over a number of years.
Independent Directors
George R. Whittemore
Edwin J. Glickman
Dov Gertzulin
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ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES:
LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC.
Annual Report on Form 10-K
For the fiscal year ended December 31, 2014
EXHIBIT INDEX
The following exhibits are included, or incorporated by reference, as part of this Annual Report on Form 10-K (and are numbered in accordance with Item 601 of Regulation S-K:
| EXHIBIT NO. | DESCRIPTION | |
| 1.1(12) | Form of Dealer Manager Agreement by and between Lightstone Value Plus Real Estate Investment Trust II, Inc. and Orchard Securities, LLC. | |
| 1.2(10) | Form of Soliciting Dealer Agreement by and between Orchard Securities, LLC and the Soliciting Dealers. | |
| 3.1(10) | Lightstone Value Plus Real Estate Investment Trust II, Inc. Conformed Articles of Amendment and Restatement. | |
| 3.2(7) | Bylaws of Lightstone Value Plus Real Estate Investment Trust II, Inc. | |
| 4.1(7) | Form of Amended and Restated Agreement of Limited Partnership of Lightstone Value Plus REIT II LP. | |
| 4.4(6) | Third Amended and Restated Agreement dated as of January 30, 2009, by and among Lightstone Value Plus REIT II LP, Lightstone SLP II LLC, and David Lichtenstein. | |
| 4.5(9) | Fourth Amended and Restated Agreement dated August 2, 2012, by and among Lightstone Value Plus REIT II LP, Lightstone SLP II LLC, and David Lichtenstein. | |
| 5.1(10) | Opinion of Venable LLP. | |
| 8.1(10) | Opinion of Proskauer Rose LLP as to tax matters | |
| 10.1 (8) | Form of Advisory Agreement by and between Lightstone Value Plus Real Estate Investment Trust II, Inc. and Lightstone Value Plus REIT II LLC. | |
| 10.2(8) | Form of Management Agreement, by and among Lightstone Value Plus Real Estate Investment Trust II, Inc., Lightstone Value Plus REIT II LP and Paragon Retail Property Management LLC, formerly known as Prime Retail Property Management, LLC. | |
| 10.3(8) | Form of Management Agreement, by and among Lightstone Value Plus Real Estate Investment Trust II, Inc., Lightstone Value Plus REIT II LP and Beacon Property Management, LLC. | |
| 10.4(7) | Form of Employee and Director Incentive Restricted Share Plan. | |
| 10.5(3) | Hotel Management Agreement dated January 19, 2011 between LVP Metairie Holding Corp and Trans Inn Management, Inc. | |
| 10.6(11) | Contribution Agreement dated June 30, 2010 by and among Lightstone Holdings, LLC and Lightstone Value Plus REIT II LP | |
| 10.7(4) | First Amendment to First Amended and Restated Operating Agreement of Brownmill, LLC effective April 1, 2010 by and among Lightstone Holdings, LLC, the DWL 2003 Family Trust, Brownmill Manager Corp. and Lightstone Value Plus REIT II LP. | |
| 10.8(4) | Second Amendment to First Amended and Restated Operating Agreement of Brownmill, LLC effective October 1, 2010 by and among Lightstone Holdings, LLC, the DWL 2003 Family Trust, Brownmill Manager Corp. and Lightstone Value Plus REIT II LP | |
| 10.9(4) | First Amended and Restated Operating Agreement of Brownmill, LLC dated September 27, 2005 by and among Lightstone Holdings, LLC, the DWL 2003 Family Trust and Brownmill Manager Corp. | |
| 10.10(4) | Assignment of Membership Interest dated as of June 30, 2010 made by Lightstone Holdings, LLC to Lightstone Value Plus REIT II LP | |
| 10.11(3) | Limited Liability Company Agreement of LVP Metairie JV, LLC dated January 14, 2011 adopted and entered into by Lightstone Value Plus REIT II, LP, TPS Metairie, LLC and Sherman Family Trust. | |
| 10.12(3) | Limited Liability Company Agreement of LVP CP Boston Holdings, LLC dated March 21, 2011 adopted and entered into by Lightstone Value Plus REIT LP and Lightstone Value Plus REIT II LP. | |
| 10.13(3) | Limited Liability Company Agreement of LVP Metairie, LLC dated January 13, 2011 by and between LVP Metairie JV, LLC and Gail Grossman. | |
| 21(1) | Subsidiaries of the Registrant. | |
| 31.1* | Certification Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 110 |
| 31.2* | Certification Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32.1* | Certification Pursuant to Rule 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2* | Certification Pursuant to Rule 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 financial information from Lightstone Value Plus Real Estate Investment Trust II, Inc. on Form 10-K for the year ended December 31, 2014, filed with the SEC on March 31, 2015, formatted in XBRL includes: (1) Consolidated Balance Sheets, (2) Consolidated Statements of Operations, (3) Consolidated Statements of Comprehensive Income, (4) Consolidated Statements of Stockholders’ Equity, (5) Consolidated Statements of Cash Flows and (6) the Notes to the Consolidated Financial Statement. |
| * | As filed herewith |
| (1) | Previously filed as an exhibit to the Annual Report on Form 10-K that we filed with the Securities and Exchange Commission on March 30, 2012. |
| (2) | Previously filed as an exhibit to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on November 4, 2011. |
| (3) | Previously filed as an exhibit to Post-Effective Amendment No. 1 to Post-Effective Amendment No. 5 to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on April 21, 2011. |
| (4) | Previously filed as an exhibit to Post-Effective Amendment No. 1 to Post-Effective Amendment No. 4 to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on February 11, 2011. |
| (5) | Previously filed as an exhibit to Post-Effective Amendment No. 1 to Post-Effective Amendment No. 3 to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on September 27, 2010. |
| (6) | Previously filed as an exhibit to Amendment No. 5 to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on January 30, 2009. |
| (7) | Previously filed as an exhibit to Amendment No. 3 to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on November 17, 2008. |
| (8) | Previously filed as an exhibit to Amendment No. 1 to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on August 22, 2008. |
| (9) | Previously filed as an exhibit to Amendment No. 3 to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on August 10, 2012. |
| (10) | Previously filed as an exhibit to Amendment No. 5 to the Registration Statement on Form S-11 that we filed with the Securities and Exchange Commission on September 4, 2012. |
| (11) | Previously filed as an exhibit to the Quarterly Report on Form 10-Q that we filed with the Securities and Exchange Commission on August 16, 2010. |
| (12) | Previously filed as an exhibit to the Quarterly Report on Form 10-Q that we filed with the Securities and Exchange Commission on November 16, 2012. |
| 111 |
Pursuant to the requirements of Section 13 or 15(d) 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.
| LIGHTSTONE VALUE PLUS REAL ESTATE INVESTMENT TRUST II, INC. | ||
| Date: March 31, 2015 | By: | s/ David Lichtenstein |
| David Lichtenstein | ||
| Chief Executive Officer and Chairman of the Board of Directors | ||
| (Principal Executive Officer) | ||
Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
| NAME | CAPACITY | DATE | ||
| /s/ David Lichtenstein | Chief Executive Officer and Chairman of the Board | March 31, 2015 | ||
| David Lichtenstein | of Directors (Principal Executive Officer) | |||
| /s/ Donna Brandin | Chief Financial Officer and Treasurer | |||
| Donna Brandin | (Principal Financial Officer and Principal | |||
| Accounting Officer) | March 31, 2015 | |||
| /s/ Bruno de Vinck | Director | March 31, 2015 | ||
| Bruno de Vinck | ||||
| /s/ Edwin J. Glickman | Director | March 31, 2015 | ||
| Edwin J. Glickman | ||||
| /s/ George R. Whittemore | Director | March 31, 2015 | ||
| George R. Whittemore | ||||
| /s/ Dov Gertzulin | Director | March 31, 2015 | ||
| Dov Gertzulin |
| 112 |