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EX-32.1 - EXHIBIT 32.1 - Jernigan Capital, Inc.v465434_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Jernigan Capital, Inc.v465434_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Jernigan Capital, Inc.v465434_ex31-1.htm
EX-10.1 - EXHIBIT 10.1 - Jernigan Capital, Inc.v465434_ex10-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended March 31, 2017

 

OR

 

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

 

For the transition period from                               to                            

 

001-36892

(Commission file number)

 

JERNIGAN CAPITAL, INC.

(Exact name of registrant as specified in its charter)

  

Maryland   47-1978772

State or other jurisdiction

of incorporation or organization

 

(I.R.S. Employer

Identification No.)

 

6410 Poplar Avenue, Suite 650   38119
Memphis, Tennessee   (Zip Code)
(Address of principal executive offices)    

 

(901) 567-9510

Registrant’s telephone number, including area code

 

Indicate by check mark whether the Registrant (1) has filed all reports 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 report(s), and (2) has been subject to such filing requirements for the past 90 days. Yes    x    No    ¨

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of ‘‘large accelerated filer,’’ ‘‘accelerated filer,’’ ‘‘smaller reporting company,’’ and ‘‘emerging growth company’’ in Rule 12b–2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨

Non-accelerated filer  x

(Do not check if a smaller reporting company)

Smaller reporting company ¨
  Emerging growth company x

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x

 

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

 

As of May 8, 2017, Jernigan Capital, Inc. had 10,000,020 shares of common stock outstanding.

 

 

 

 

Table of Contents

 

 

     
     
PART I.  FINANCIAL INFORMATION   3
     
Item 1. Financial Statements   3
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   32
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk   44
     
Item 4. Controls and Procedures   44
     
PART II.  Other information   45
     
Item 1. Legal Proceedings   45
     
Item 1A. Risk Factors   45
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds from Registered Securities   45
     
Item 3. Defaults Upon Senior Securities   45
     
Item 4. Mine Safety Disclosures   45
     
Item 5. Other Information   45
     
Item 6. Exhibits   45

 

2 

 

 

In this quarterly report on Form 10-Q (“report”), unless the context indicates otherwise, references to “Jernigan Capital,” “we,” “the Company,” “our” and “us” refer to the activities of and the assets and liabilities of the business and operations of Jernigan Capital, Inc.; “Operating Company” refers to Jernigan Capital Operating Company, LLC, a Delaware limited liability company; and “our Manager” refers to JCap Advisors, LLC, a Florida limited liability company.

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

JERNIGAN CAPITAL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

   As of 
   March 31, 2017   December 31, 2016 
   (Unaudited)     
Assets:          
Cash and cash equivalents  $28,252   $67,373 
Development property investments at fair value, of which $31.2 million and $33.3 million of funded principal is pledged as collateral against certain of the Company’s senior loan participations as of March 31, 2017 and December 31, 2016, respectively   117,936    95,102 
Operating property loans at fair value, of which $2.8 million of funded principal is pledged as collateral against certain of the Company’s senior loan participations as of March 31, 2017 and December 31, 2016   9,965    9,905 
Investment in and advances to real estate venture   10,812    5,373 
Self-storage real estate owned   7,350    - 
Other loans, at cost   14,826    11,752 
Deferred costs   2,294    2,207 
Prepaid expenses and other assets   809    868 
Fixed assets, net   185    199 
Total assets  $192,429   $192,779 
           
Liabilities:          
Senior loan participations  $19,299   $18,582 
Due to Manager   839    1,008 
Accounts payable, accrued expenses and other liabilities   1,040    697 
Dividends payable   3,695    4,130 
Total liabilities   24,873    24,417 
           
Equity:          
Jernigan Capital, Inc. stockholders’ equity:          
Cumulative preferred stock, $0.01 par value, 100,000,000 shares authorized, 10,000 shares issued and outstanding at March 31, 2017 and December 31, 2016, at liquidation preference of $10.0 million, net of allocated costs   9,446    9,448 
Common stock, $0.01 par value, 500,000,000 shares authorized at March 31, 2017 and December 31, 2016; 8,997,707 and 8,956,354 issued and outstanding at March 31, 2017 and December 31, 2016, respectively   90    90 
Additional paid-in capital   163,772    162,664 
Accumulated deficit   (5,752)   (3,840)
Total equity   167,556    168,362 
Total liabilities and equity  $192,429   $192,779 

 

See accompanying notes to consolidated financial statements.

 

3 

 

 

JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)

 

   Three months ended March 31, 
   2017   2016 
Revenues:          
Interest income from investments  $2,119   $1,143 
Rental and other property related income from real estate owned   63    - 
Other revenues   119    - 
Total revenues   2,301    1,143 
           
Costs and expenses:          
General and administrative expenses   1,578    1,304 
Management fees to Manager   630    414 
Property operating expenses of real estate owned   55    - 
Transaction and other expenses   -    1,952 
Restructuring costs   -    7 
Deferred termination fee to Manager   -    157 
Total costs and expenses   2,263    3,834 
           
Operating income (loss)   38    (2,691)
           
Other income (expense):          
Equity in earnings from unconsolidated real estate venture   422    - 
Change in fair value of investments   1,393    3,791 
Interest expense   (204)   - 
Other interest income   134    22 
Total other income   1,745    3,813 
Net income   1,783    1,122 
Net income attributable to preferred stockholders   (546)   - 
Net income attributable to common stockholders  $1,237   $1,122 
           
Basic earnings per share attributable to common stockholders  $0.14   $0.18 
Diluted earnings per share attributable to common stockholders  $0.14   $0.18 
           
Dividends declared per share of common stock  $0.35   $0.35 

 

See accompanying notes to consolidated financial statements.

 

4 

 

 

JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

(in thousands, except share data)

 

   Preferred Stock   Common Stock   Additional   Accumulated   Total Stockholders'   Non-
Controlling
     
   Shares   Amount   Shares   Amount   Paid-In-Capital   Deficit   Equity   Interests   Total Equity 
Balance at December 31, 2015   -   $-    6,162,500   $62   $110,634   $(9,396)  $101,300   $464   $101,764 
Stock-based compensation   -    -    -    -    175    -    175    -    175 
Deferred termination fee to Manager   -    -    -    -    -    -    -    157    157 
Dividends declared on common stock   -    -    -    -    -    (2,157)   (2,157)   -    (2,157)
Net income   -    -    -    -    -    1,122    1,122    -    1,122 
Balance at March 31, 2016   -   $-    6,162,500   $62   $110,809   $(10,431)  $100,440   $621   $101,061 
                                              
Balance at December 31, 2016   10,000   $9,448    8,956,354   $90   $162,664   $(3,840)  $168,362   $-   $168,362 
Equity offering costs related to issuance of preferred stock   -    (2)   -    -    -    -    (2)   -    (2)
Stock dividend paid on preferred stock   -    -    41,353    -    823    -    823    -    823 
Equity offering costs related to issuance of common stock   -    -    -    -    (7)   -    (7)   -    (7)
Stock-based compensation   -    -    -    -    292    -    292    -    292 
Dividends declared on preferred stock   -    -    -    -    -    (546)   (546)   -    (546)
Dividends declared on common stock   -    -    -    -    -    (3,149)   (3,149)   -    (3,149)
Net income   -    -    -    -    -    1,783    1,783    -    1,783 
Balance at March 31, 2017   10,000   $9,446    8,997,707   $90   $163,772   $(5,752)  $167,556   $-   $167,556 

 

 See accompanying notes to consolidated financial statements.

 

5 

 

 

JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands) 

   Three Months Ended March 31, 
   2017   2016 
Cash flows from operating activities          
Net income  $1,783   $1,122 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Interest capitalized on outstanding loans   (1,476)   (730)
Change in fair market value of investments   (1,393)   (3,791)
Stock-based compensation   292    175 
Equity in earnings from unconsolidated real estate venture   (419)   - 
Return on investment from unconsolidated joint venture   192    - 
Deferred termination fee to Manager   -    157 
Depreciation   38    18 
Amortization of deferred financing costs   2    - 
Accretion of origination fees   (153)   (38)
Origination fees received in cash   1,129    - 
Changes in operating assets and liabilities:          
 Other assets   70    (174)
 Due to Manager   (169)   (24)
 Accounts payable, accrued expenses, and other liabilities   108    1,783 
Net cash provided by (used in) operating activities   4    (1,502)
           
Cash flows from investing activities          
Purchase of fixed assets   -    (1)
Purchase of self-storage real estate owned   (1,270)     
Capital contributions to real estate venture   (1,324)   - 
Advances to real estate venture   (11,564)   - 
Repayment of advances to real estate venture   7,719    - 
Capitalized real estate venture costs   -    (226)
Funding of investment portfolio:          
Development property investments   (33,787)   (10,551)
Operating property loans   -    (165)
 Funding of other loans   (8,152)   (456)
 Repayments of investment portfolio investments   6,860    - 
 Repayment of other loans   5,079    - 
Net cash used in investing activities   (36,439)   (11,399)
           
Cash flows from financing activities          
Senior loan participations   717    - 
Deferred costs   (87)   - 
Costs related to the issuance of common stock   (7)   - 
Costs related to the issuance of preferred stock   (2)     
Dividends paid on preferred stock   (173)   - 
Dividends paid on common stock   (3,134)   (2,157)
Net cash used in financing activities   (2,686)   (2,157)
Net change in cash and cash equivalents   (39,121)   (15,058)
Cash and cash equivalents at the beginning of the period   67,373    43,859 
Cash and cash equivalents at the end of the period  $28,252   $28,801 

 

See accompanying notes to consolidated financial statements. 

 

6 

 

 

JERNIGAN CAPITAL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(in thousands, except share and per share data, percentages and as otherwise indicated)

 

1. ORGANIZATION AND FORMATION OF THE COMPANY

 

Jernigan Capital, Inc. (together with its consolidated subsidiaries, the “Company”) makes debt and equity investments in newly-constructed and existing self-storage facilities. The Company is a Maryland corporation that was organized on October 1, 2014. The Company closed its initial public offering of its common stock (the “IPO”) on April 1, 2015, and has used proceeds of the IPO and other capital sources primarily to fund real estate loans to private developers, owners and operators of self-storage facilities. The Company is structured as an Umbrella Partnership REIT (“UPREIT”) and conducts its investment activities through its operating company, Jernigan Capital Operating Company, LLC (the “Operating Company”). The Company is externally managed by JCAP Advisors, LLC (the “Manager”).

 

The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986 (the “Code”), as amended. As a REIT, the Company generally will not be subject to U.S. federal income taxes on REIT taxable income, determined without regard to the deduction for dividends paid and excluded capital gains, to the extent that it annually distributes all of its REIT taxable income to stockholders and complies with various other requirements for qualification as a REIT set forth in the Code.

 

2. SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying interim consolidated financial statements include all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim periods included therein. Substantially all operations are conducted through the Operating Company and all significant intercompany transactions and balances have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Actual results could differ from those estimates.

 

Variable Interest Entities

 

The Company invests in entities that may qualify as variable interest entities (“VIEs”). A VIE is a legal entity that lacks one or more of the characteristics of a voting interest entity. A VIE is defined as an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The determination of whether an entity is a VIE includes both a qualitative and quantitative analysis. Management bases the qualitative analysis on its review of the design of the entity, its organizational structure including allocation of decision-making authority and relevant financial agreements and the quantitative analysis on the forecasted cash flow of the entity. Management reassesses the initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.

 

A VIE must be consolidated only by its primary beneficiary, which is defined as the party that, along with its affiliates and agents, has both the: (i) power to direct the activities that most significantly impact the VIE’s economic performance and (ii) obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. Management determines whether the Company is the primary beneficiary of a VIE by considering qualitative and quantitative factors, including, but not limited to: which activities most significantly impact the VIE’s economic performance and which party controls such activities; the amount and characteristics of its investment; the obligation or likelihood for the Company or other interests to provide financial support; consideration of the VIE’s purpose and design, including the risks the VIE was designed to create and pass through to its variable interest holders and the similarity with and significance to the Company’s business activities and the other interests. Management reassesses the determination of whether the Company is the primary beneficiary of a VIE each reporting period.

 

Equity Investments

 

Investments in real estate ventures and entities over which the Company exercises significant influence but not control are accounted for using the equity method. In accordance with Accounting Standards Codification (“ASC”) 825, Financial Instruments (“ASC 825-10”), issued by the Financial Accounting Standards Board (“FASB”), the Company has elected the fair value option of accounting for its development property investments, which would otherwise be required to be accounted for under the equity method. The Company also holds an investment in a real estate venture that is accounted for under the equity method of accounting.

 

7 

 

 

Loan Investments and Election of Fair Value Option of Accounting for Certain Loan Investments

 

The Company has elected the fair value option of accounting for all of its investment portfolio loan investments, including those that are required under GAAP to be accounted for under the equity method, in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance including its revenues and value inherent in the Company’s equity participation in development projects. Changes in the fair value of these investments are recorded in change in fair value of investments within other income. All direct loan costs are charged to expense as incurred.

 

Each loan investment, including those recorded at cost and presented on the Consolidated Balance Sheets as other loans, is evaluated for impairment on a periodic basis. For loans carried at fair value, indicators of impairment are reflected in measurement of the loan. For loans that are carried at cost, the Company estimates an allowance for loan loss at each reporting date. In evaluating loan impairment, the Company also periodically evaluates the extent and impact of any credit deterioration associated with the performance and/or value of the underlying collateral property as well as the financial and operating capability of the borrower on a loan by loan basis. The Company also evaluates the financial wherewithal of any loan guarantors as well as the borrower’s competency in managing and operating the property. In addition, the Company considers the overall economic environment, real estate sector and geographic sub-market in which the borrower operates. A loan will be considered impaired when, based on current information and events, it is probable that the loan will not be collected according to the contractual terms of the loan agreement. Factors to be considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. At March 31, 2017 and December 31, 2016, there were no loans that were deemed to be impaired loans. Additionally, for loans recorded at cost, the Company determined that no allowance for loan loss was necessary at March 31, 2017 and December 31, 2016.

 

For investments carried at fair value, fees and costs are expensed as incurred.

 

Loan arrangements under which the Company is entitled to greater than 50% of the residual profits are accounted for as a real estate investment in accordance with ASC 310, Receivables (“ASC 310”), and are included in the Consolidated Balance Sheets as self-storage real estate owned.

 

Fair Value Measurement

 

The Company carries certain financial instruments at fair value because it has elected to apply the fair value option on an instrument by instrument basis under ASC 825-10. The Company’s financial instruments consist of cash, development property investments (which are typically structured as first mortgages and a 49.9% profits interest in the development project), operating property loans (loans secured by operating properties), the investment in real estate venture, other loans, receivables, senior loan participations, and payables.

 

The following table presents the financial instruments measured at fair value on a recurring basis at March 31, 2017:

 

   Fair Value Measurements Using 
   Total   Level 1   Level 2   Level 3 
Development property investments  $117,936   $-   $-   $117,936 
Operating property loans   9,965    -    -    9,965 
Total investments  $127,901   $-   $-   $127,901 

 

The following table presents the financial instruments measured at fair value on a recurring basis at December 31, 2016:

 

   Fair Value Measurements Using 
   Total   Level 1   Level 2   Level 3 
Development property investments  $95,102   $-   $-   $95,102 
Operating property loans   9,905    -    -    9,905 
Total investments  $105,007   $-   $-   $105,007 

 

Estimating fair value requires the use of judgment. The types of judgments involved depend upon the availability of observable market information. Management’s judgments include determining the appropriate valuation model to use, estimating unobservable inputs and applying valuation adjustments. See Note 4, Fair Value of Financial Instruments, for additional disclosure on the valuation methodology and significant assumptions, as well as the election of the fair value option for certain financial instruments.

 

8 

 

 

Self-Storage Real Estate Owned

 

Land is carried at historical cost. Building and improvements are carried at historical cost less accumulated depreciation and impairment losses. The cost reflects the purchase price or development cost of the assets. Ordinary repairs and maintenance are expensed as incurred; major replacements and betterments, which improve or extend the life of the asset, are capitalized and depreciated over their estimated useful lives. The costs of building and improvements are depreciated using the straight-line method based on a useful life of 40 years.

 

We evaluate long-lived assets for impairment when events and circumstances such as declines in occupancy and operating results indicate that there may be an impairment.  The carrying value of these long-lived assets is compared to the undiscounted future net operating cash flows, plus a terminal value, attributable to the assets to determine if the facility’s basis is recoverable.  If an asset’s basis is not considered recoverable, an impairment loss is recorded to the extent the net carrying value of the asset exceeds the fair value.  The impairment loss recognized equals the excess of net carrying value over the related fair value of the asset.

 

Cash and Cash Equivalents

 

Cash, investments in money market accounts, and certificates of deposit with original maturities of three months or less are considered to be cash equivalents. The Company places its cash and cash equivalents primarily with two financial institutions, and the balance at each financial institution exceeds the Federal Deposit Insurance Corporation insurance limit of $250,000 per institution.

 

Other Loans

 

The Company’s other loans balance primarily includes principal balances for certain revolving loan agreements and short-term mortgage loans made by the Company in situations where it was determined that making such loans would benefit the Company’s primary business. These loans are accounted for under the cost method.

 

Fixed Assets

 

Fixed assets are recorded at cost and consist of furniture, office and computer equipment, and software. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets, which range from three to seven years. Fixed assets are generally purchased by the Manager and the cost reimbursed by the Company. Maintenance and repair costs are charged to expense as incurred. Upon sale or retirement, the asset cost and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss is included in income.

 

Revenue Recognition

 

Interest income is recognized as earned on a simple interest basis and is reported in interest income from investments in the Consolidated Statements of Operations. Accrual of interest will be discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. The Company will recognize income on impaired loans when they are placed into non-accrual status on a cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company will not recognize income on such loans. Accrued interest generally is reversed when a loan is placed on non-accrual status.

 

The Company’s loan origination fees are accreted into interest income over the term of the investment using the effective yield method.

 

The operations of the self-storage real estate owned are managed by a third-party self-storage management company. All rental leases are operating leases, and rental income is recognized in accordance with the terms of the leases, which generally are month to month.

 

Debt Issuance Costs

 

Costs related to the sale of senior participations are deferred and are amortized as interest expense over the estimated life of the related senior participation using the straight-line method, which approximates the effective interest method. If a debt instrument is repurchased prior to its original maturity date, the unamortized balance of debt issuance costs are written off to interest expense or, if significant, included in “early extinguishment of debt.” Debt issuance costs are presented in Consolidated Balance Sheets as a deduction from the carrying amount of the principal balance.

 

Transaction and other expenses

 

Transaction and other expenses consist of non-capitalizable advisory fees and other unreimbursed expenses incurred in connection with various financing and investment transactions and are expensed as incurred. The Company did not incur any transaction and other expenses during the three months ended March 31, 2017. During the same period in 2016, the Company incurred $2.0 million of transaction and other expenses.

 

9 

 

 

Offering and Registration Costs

 

Offering and registration costs represent underwriting discounts and commissions, professional fees, fees paid to various regulatory agencies, and other costs incurred in connection with the registration and sale of the Company’s securities. Offering and registration costs incurred in connection with the Company’s common stock offerings are reflected as a reduction of additional paid-in capital.

 

On July 27, 2016, the Company entered into a Stock Purchase Agreement (see Note 10, Stockholders’ Equity) which requires the Company to issue and sell a minimum of $50.0 million of Series A Preferred Stock by July 27, 2018. The Company incurred $2.8 million of preferred stock offering costs in connection with the execution of the Stock Purchase Agreement. Such costs are presented as deferred costs on the Consolidated Balance Sheets until such time as Series A Preferred Stock is issued. A pro rata portion of such deferred costs, based upon the ratio of the amount issued to the $50.0 million minimum issuance of Series A Preferred Stock, is reclassified to cumulative preferred stock upon issuance of the Series A Preferred Stock. Of the $2.8 million of offering costs incurred, $2.2 million is in deferred costs on the Consolidated Balance Sheet at March 31, 2017, and $0.6 million has reduced the cumulative preferred stock balance on the Consolidated Balance Sheet at March 31, 2017.

 

Income Taxes

 

The Company has elected to be taxed as a REIT and to comply with the related provisions of the Code. Accordingly, the Company will generally not be subject to U.S. federal income tax to the extent of its distributions to stockholders and as long as certain asset, income and share ownership tests are met. To qualify as a REIT, the Company must annually distribute at least 90% of its REIT taxable income to its stockholders and meet certain other requirements.

 

Earnings per Share (“EPS”)

 

Basic EPS includes only the weighted average number of common shares outstanding during the period. Diluted EPS includes the weighted average number of common shares and the dilutive effect of restricted stock, accrued stock dividends, and redeemable Operating Company units when such instruments are dilutive.

 

All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are treated as participating in undistributed earnings with common shareholders. Awards of this nature are considered participating securities and the two-class method of computing basic and diluted EPS must be applied.

 

Comprehensive Income

 

For the three months ended March 31, 2017 and 2016, comprehensive income equaled net income; therefore, separate Consolidated Statements of Comprehensive Income are not included in the accompanying consolidated financial statements.

 

Segment Reporting

 

The Company does not evaluate performance on a relationship specific or transactional basis and does not distinguish its principal business or group its operations on a geographical basis for purposes of measuring performance. Accordingly, the Company believes it has a single operating segment for reporting purposes in accordance with GAAP.

 

Recent Accounting Pronouncements

 

In August 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance on the classification of certain cash receipts and payments in the statement of cash flows, including distributions received from equity method investees. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2017, with early adoption being allowed. The Company is currently assessing the impact this new accounting guidance will have on its consolidated financial statements; however, the Company does not expect the new accounting guidance to have a material impact on its consolidated financial statements as the Company is currently presenting distributions received from equity method investees consistent with the presentation required under ASU 2016-05.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2019, with early adoption being allowed as of the fiscal years beginning after December 15, 2018. The Company is currently assessing the impact this new accounting guidance will have on its consolidated financial statements; however, the Company does not expect the new accounting guidance to have a material impact on its consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvement to Employee Share-based Payment Accounting. This ASU simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2016, with early adoption being allowed. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

 

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In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which is the final standard on accounting for leases. The most significant change for lessees is the requirement under the new guidance to recognize right-of-use assets and lease liabilities for all leases not considered short-term leases. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. The amendments in ASU 2016-02 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently assessing the impact this new accounting guidance will have on its consolidated financial statements.

 

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued (or available to be issued when applicable) and, if so, disclose that fact. This ASU is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. The adoption of this guidance did not have a material effect on the Company’s consolidated financial statements and disclosures.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2017. This ASU outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry specific guidance. Several ASUs expanding and clarifying the initial guidance issued in ASU 2014-09 have been released since May 2014. The Company will adopt the ASU effective January 1, 2018 and does not expect the adoption to have a material effect on its consolidated financial statements as the new guidance does not apply to revenue associated with loans or derived from lease contracts; however, the Company is still in the process of evaluating the impact these standards will have on its consolidated financial statements.

 

Consolidated Statements of Cash Flows - Supplemental Disclosures

 

The following table provides supplemental disclosures related to the Consolidated Statements of Cash Flows:

 

   Three months ended March 31, 
   2017   2016 
Supplemental disclosure of cash flow information:          
Interest paid  $153   $- 
           
Supplemental disclosure of non-cash investing and financing activities:          
Stock dividend paid on preferred stock  $823   $- 
Dividends declared on preferred stock   546    - 
Dividends declared on common stock   3,149    2,157 
Contribution of assets to real estate venture   -    7,693 
Reclassification of self-storage real estate owned   6,041    - 

 

3. INVESTMENTS

 

The Company’s self-storage investments at March 31, 2017 consisted of the following:

 

·Development Property Investments - The Company had 22 investments totaling an aggregate committed principal amount of approximately $207.4 million to finance the ground-up construction of or conversion of existing buildings into self-storage facilities. Each development property investment is funded as the developer constructs the project, is secured by a first mortgage on the development project and generally includes a 49.9% interest in the positive cash flows (including the sale and refinancing proceeds after debt repayment) of the project. Loans comprising development property investments are non-recourse with customary carve-outs and subject to completion guaranties, are interest-only with a fixed interest rate of 6.9% per annum and have a term of 72 months.

 

The Company also had two construction loan investments totaling an aggregate committed principal amount of approximately $22.5 million, each of which had an initial term of 18 months that can be extended on a case-by-case basis. Each construction loan is interest-only at a fixed interest rate of 6.9% per annum, has no equity participation and is secured by a first priority mortgage or deed of trust on the project. Each of these construction loans is subject to a purchase and sale agreement between the developer and a third-party purchaser or has a bona fide written offer on the property, containing certain conditions, pursuant to which the financed project is anticipated to be sold and our loan repaid on or about the time a certificate of occupancy is issued for the financed self-storage facility.

 

·Operating property loans - The Company had four term loans totaling $10.0 million of aggregate committed principal amount, the proceeds of which were used by borrowers to finance the acquisition of, refinance existing indebtedness on, or recapitalize operating self-storage facilities. These loans are secured by first mortgages on the projects financed, are interest-only with fixed interest rates ranging from 5.85% to 6.9% per annum, and generally have a term of 72 months.

 

The Company’s development property investments and operating property loans are collectively referred to herein as the Company’s investment portfolio.

 

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As of March 31, 2017, the aggregate committed principal amount of the Company’s investment portfolio was approximately $239.9 million and outstanding principal was $115.3 million, as described in more detail in the table below:

 

Closing Date 

Metropolitan

Statistical Area

("MSA")

 

Total Investment

Commitment

  

Funded

Investment(1)

  

Remaining

Unfunded

Commitment

   Fair Value 
Development property investments:                
Loan investments with a profits interest:                
4/21/2015  Orlando 1 (2) (4)  $5,372   $5,336   $36   $1,325 
6/10/2015  Atlanta 1 (2)   8,132    7,763    369    10,265 
6/19/2015  Tampa (2)   5,369    5,285    84    6,306 
6/26/2015  Atlanta 2 (2)   6,050    5,655    395    8,895 
6/29/2015  Charlotte 1 (2)   7,624    6,978    646    10,213 
7/2/2015  Milwaukee (2)   7,650    6,695    955    8,412 
7/31/2015  New Haven (2)   6,930    5,818    1,112    7,531 
8/10/2015  Pittsburgh (3)   5,266    3,961    1,305    5,006 
8/14/2015  Raleigh   8,792    2,055    6,737    1,955 
9/30/2015  Jacksonville 1 (2)   6,445    5,954    491    8,219 
10/27/2015  Austin (2)   8,658    5,616    3,042    6,748 
9/20/2016  Charlotte 2   12,888    1,875    11,013    1,662 
11/17/2016  Orlando 2 (3)   5,134    2,089    3,045    2,074 
11/17/2016  Jacksonville 2   7,530    1,553    5,977    1,491 
1/4/2017  New York City   16,117    8,765    7,352    8,746 
1/18/2017  Atlanta 3   14,115    3,051    11,064    2,944 
1/31/2017  Atlanta 4   13,678    5,305    8,373    5,234 
2/24/2017  Orlando 3   8,056    604    7,452    526 
2/24/2017  New Orleans   12,549    -    12,549    - 
2/27/2017  Atlanta 5   17,492    4,469    13,023    4,332 
3/1/2017  Fort Lauderdale   9,952    1,710    8,242    1,622 
3/1/2017  Houston   13,630    3,211    10,419    3,102 
      $207,429   $93,748   $113,681   $106,608 
                        
Construction loans:                    
8/5/2015  Sarasota   4,792    4,098    694    4,134 
12/23/2015  Miami   17,733    7,473    10,260    7,194 
      $22,525   $11,571   $10,954   $11,328 
   Subtotal  $229,954   $105,319   $124,635   $117,936 
                        
Operating property loans:                    
6/19/2015  New Orleans   2,800    2,800    -    2,783 
7/7/2015  Newark   3,480    3,480    -    3,464 
10/30/2015  Nashville(5)   1,210    1,210    -    1,211 
12/22/2015  Chicago   2,502    2,500    2    2,507 
   Subtotal  $9,992   $9,990   $2   $9,965 
                        
   Total investments  $239,946   $115,309   $124,637   $127,901 

 

(1)Represents principal balance of loan gross of origination fees.
(2)Facility had received certificate of occupancy as of March 31, 2017. See Note 4, Fair Value of Financial Instruments, for information regarding recognition of entrepreneurial profit.
(3)Facility had achieved at least 40% construction completion but had not received certificate of occupancy as of March 31, 2017. See Note 4, Fair Value of Financial Instruments, for information regarding recognition of entrepreneurial profit.
(4)In February 2017, the Company purchased, for $1.3 million, 50% of the economic rights of the Class A membership units of the limited liability company which owns this development property investment, thus increasing the Company’s profits interest in this investment from 49.9% to 74.9%. As such, the Company’s investment was reclassified as self-storage real estate owned in the March 31, 2017 Consolidated Balance Sheet. See Note 7, Self-storage Real Estate Owned, for additional discussion. The committed and funded investment amounts in this table pertain to the full terms of the development investment, while, the fair value represents only the portion (25.1%) of the principal balance constituting a loan to the Class A member.

(5) This investment was repaid in April 2017.

 

12 

 

 

The following table provides a reconciliation of the funded principal to the fair market value of investments at March 31, 2017:

 

Funded principal  $115,309 
Adjustments:     
Unamortized origination fees   (1,918)
Change in fair value of investments   20,635 
Reclassification of self-storage real estate owned   (6,041)
Other   (84)
Fair value of investments  $127,901 

 

As of December 31, 2016, the aggregate committed principal amount of the Company’s investment portfolio was approximately $141.9 million and outstanding principal was $86.9 million, as described in more detail in the table below:

 

Closing Date 

Metropolitan

Statistical Area

("MSA")

 

Total Investment

Commitment

  

Funded

Investment (1)

  

Remaining

Unfunded

Commitment

   Fair Value 
Development property investments:                
Loan investments with a profits interest:                
4/21/2015  Orlando 1(2)  $5,372   $5,308   $64   $7,302 
6/10/2015  Atlanta 1(2)   8,132    7,694    438    10,404 
6/19/2015  Tampa(2)   5,369    5,285    84    6,279 
6/26/2015  Atlanta 2(2)   6,050    5,620    430    8,900 
6/29/2015  Charlotte 1(2)   7,624    6,842    782    9,853 
7/2/2015  Milwaukee(2)   7,650    5,608    2,042    7,008 
7/31/2015  New Haven(2)   6,930    5,257    1,673    6,730 
8/10/2015  Pittsburgh(3)   5,266    3,497    1,769    4,551 
8/14/2015  Raleigh   8,792    1,460    7,332    1,396 
9/30/2015  Jacksonville 1(2)   6,445    5,852    593    7,962 
10/27/2015  Austin(3)   8,658    4,366    4,292    5,192 
9/20/2016  Charlotte 2   12,888    1,446    11,442    1,298 
11/17/2016  Orlando 2   5,134    1,342    3,792    1,237 
11/17/2016  Jacksonville 2   7,530    624    6,906    551 
      $101,840   $60,201   $41,639   $78,663 
                        
Construction loans:                    
8/5/2015  West Palm Beach (4)   7,500    6,712    788    6,702 
8/5/2015  Sarasota   4,792    3,485    1,307    3,473 
12/23/2015  Miami   17,733    6,517    11,216    6,264 
      $30,025   $16,714   $13,311   $16,439 
   Subtotal  $131,865   $76,915   $54,950   $95,102 
                        
Operating property loans:                   
6/19/2015  New Orleans   2,800    2,800    -    2,768 
7/7/2015  Newark   3,480    3,480    -    3,441 
10/30/2015  Nashville   1,210    1,210    -    1,204 
12/22/2015  Chicago   2,502    2,500    2    2,492 
   Subtotal  $9,992   $9,990   $2   $9,905 
                        
   Total investments  $141,857   $86,905   $54,952   $105,007 

  

(1)Represents principal balance of loan gross of origination fees.
(2)Facility had received certificate of occupancy as of December 31, 2016. See Note 4, Fair Value of Financial Instruments, for information regarding recognition of entrepreneurial profit.
(3)Facility had achieved at least 40% construction completion but had not received certificate of occupancy as of December 31, 2016. See Note 4, Fair Value of Financial Instruments, for information regarding recognition of entrepreneurial profit.
(4)This investment was repaid in January 2017.

 

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The following table provides a reconciliation of the funded principal to the fair market value of investments at December 31, 2016:

  

Funded principal  $86,905 
Adjustments:     
Unamortized origination fees   (1,056)
Change in fair value of investments   19,242 
Other   (84)
Fair value of investments  $105,007 

 

The Company has elected the fair value option of accounting for all of its investment portfolio investments in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance, including its revenues and value inherent in its equity participation in development projects. See Note 4, Fair Value of Financial Instruments, for additional disclosure on the valuation methodology and significant assumptions.

 

On January 26, 2017, the Company received $6.7 million for the payoff of a construction loan in the West Palm Beach, Florida MSA.

 

No loans were in non-accrual status as of March 31, 2017 and December 31, 2016.

 

All of the Company’s development property investments with a profits interest except for the Orlando 1 investment would have been accounted for under the equity method had the Company not elected the fair value option. For the development property investments with a profits interest, the assets and liabilities of the equity method investees approximated $103.3 million and $88.4 million, respectively, at March 31, 2017 and approximated $71.0 million and $60.2 million, respectively, at December 31, 2016. These investees had revenues of approximately $0.4 million and a net operating loss of approximately $0.4 million for the three months ended March 31, 2017. These investees had no significant revenues or expenses for the three months ended March 31, 2016 since the development properties were under construction during this period. For the three months ended March 31, 2017, the total income (interest income and change in fair value) from each of two development property investments with a profits interest exceeded 20% of the Company’s net income. The Company recorded total income for the three months ended March 31, 2017 of $0.4 million from the Milwaukee MSA development property investment with a profits interest and $0.4 million from the Austin MSA development property investment with a profits interest.

 

For five of the Company’s development property investments with a profits interest, an investor has an option to put its interest to the Company upon the event of default of the underlying property loans. The put, if exercised, requires the Company to purchase the member’s interest at the original purchase price plus a yield of 4.5% on such purchase price. The Company concluded that the likelihood of loss is remote and assigned no value to these put provisions at March 31, 2017.

 

4. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The fair value option under ASC 825-10 allows companies to elect to report selected financial assets and liabilities at fair value. The Company has elected the fair value option of accounting for its development property investments and operating property loan investments in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance, including its revenues and value inherent in its equity participation in self-storage development projects.

 

The Company applies ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), which defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosure of fair value measurements. ASC 820 defines fair value as the price that would be received for an investment in a current sale, which assumes an orderly transaction between market participants on the measurement date. ASC 820 requires the Company to assume that the investment is sold in its principal market to market participants or, in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, the Company considers its principal market as the market for the purchase and sale of self-storage properties, which the Company believes would be the most likely market for the Company’s loan investments given the nature of the collateral securing such loans and the types of borrowers. ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with ASC 820, these inputs are summarized in the three broad levels listed below:

 

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Level 1 -Quoted prices for identical assets or liabilities in an active market.
 
Level 2 -Financial assets and liabilities whose values are based on the following: (i) Quoted prices for similar assets or liabilities in active markets; (ii) Quoted prices for identical or similar assets or liabilities in non-active markets; (iii) Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.
  
Level 3 -Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement.

 

The carrying values of cash, other loans, receivables, senior loan participations and payables approximate their fair values due to their short-term nature or due to a variable interest rate. Cash, receivables, and payables are categorized as Level 1 instruments in the measurement of fair value. Other loans and senior loan participations are categorized as Level 2 instruments in the measurement of fair value as the fair values of these investments are determined using a discounted cash flow model with inputs from third-party pricing sources and similar instruments. The table below summarizes the valuation techniques and inputs used to measure the fair value of items categorized in Level 3 of the fair value hierarchy.

 

Instrument   Valuation technique and assumptions   Hierarchy classification
         
Development property investments   Valuations are determined using an Income Approach analysis, using the discounted cash flow method model, capturing the prepayment penalty / call price schedule as applicable.  The valuation models are calibrated to the total investment net drawn amount as of the issuance date.   Level 3
         
Development property investments with a profits interest  (a)   Valuations are determined using an Income Approach analysis, using the discounted cash flow method model, capturing the prepayment penalty / call price schedule as applicable. The valuation models are calibrated to the total investment net drawn amount as of the issuance date factoring in the value of the profits interests.   Level 3
         
    An option-pricing method (OPM) framework is utilized to calculate the value of the profits interests.    
         
Operating property loans   Valuations are determined using an Income Approach analysis, using the discounted cash flow method model, capturing the prepayment penalty / call price schedule as applicable.    Level 3

 

(a) Certain of the Company's development property investments include profits interests.

 

The Company’s development property investments and operating property loan investments are valued using two different valuation techniques. The first valuation technique is an income approach analysis of the debt instrument components of the Company’s investments. The second valuation technique is an option pricing model that is used to determine the fair value of any profits interests associated with an investment. The valuation models are calibrated to the total investment net drawn amount as of the issuance date factoring in the value of the profits interests. At the issuance date of each development property investment, generally the value of the property underlying such investment approximates the sum of the net investment drawn amount plus the developer’s equity investment.

 

For development property investments with a profits interest, at a certain stage of construction, the option pricing method incorporates an adjustment to measure entrepreneurial profit. Entrepreneurial profit is a monetary return above total construction costs that provides compensation for the risk of a development project. Under this method, the value of each property is estimated based on the cost incurred to date, plus an estimated earned entrepreneurial profit.  Total entrepreneurial profit is estimated as the difference between the projected value of a property at stabilization and the total development costs, including land, building improvements, and lease-up costs.  Utilizing information obtained from the market coupled with the Company’s own experience, the Company has estimated that in most cases, approximately one-third of the entrepreneurial profit is earned during the construction period beginning when construction is approximately 40% complete and ending when construction is 100% complete, and approximately two-thirds of the entrepreneurial profit is earned from construction completion through stabilization. For the two properties between 40% and 100% complete at March 31, 2017, the Company has estimated the entrepreneurial profit adjustment to the enterprise value input used in the option pricing model to be equal to one-third of the estimated entrepreneurial profit, allocated on a straight-line basis. Nine properties have reached construction completion at March 31, 2017. For the Company’s development property investments at or around completion of construction, a discounted cash flow model, based on periodically updated estimates of rental rates, occupancy and operating expenses, is the primary method for projecting value of a project. The Company also will consider inputs such as appraisals that differ from the developer’s equity investment, bona fide third-party offers to purchase development projects, sales of development projects, or sales of comparable properties in its markets.

 

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Level 3 Fair Value Measurements

 

The following tables summarize the significant unobservable inputs the Company used to value its investments categorized within Level 3 as of March 31, 2017 and December 31, 2016. These tables are not intended to be all-inclusive, but instead to capture the significant unobservable inputs relevant to the Company’s determination of fair values.

  

As of March 31, 2017
        Unobservable Inputs
Asset Category  

Primary Valuation

Techniques

  Input   Estimated Range  

Weighted

Average

Development property

investments (a)

  Income approach analysis  

Market yields/

discount rate

  7.38 - 9.53%   8.44%
        Exit date   0.18 – 4.92 years   2.33 years
                 

Development property

investments with a

profits interest    (b)

  Option pricing model   Volatility   66.38 – 74.58%   70.76%
        Exit date   1.17 - 4.92 years   2.51 years
        Capitalization rate(c)   5.25 - 5.50%   5.46%
        Discount rate   8.25 - 8.50%   8.46%
                 
Operating property loans   Income approach analysis   Market yields/
discount rate
  5.95 - 7.07%   6.60%
        Exit date(d)   4.25 - 5.41 years   4.82 years

  

(a) The valuation technique for the development property investments with a profits interest does not differ from the development property investments without a profits interest. Therefore, this line item focuses on all development property investments, including those with a profits interest.

(b) The valuation technique for the development property investments with a profits interest does not differ from the development property investments without a profits interest. The development property investments with a profits interest only require incremental valuation techniques to determine the value of the profits interest. Therefore this line only focuses on the profits interest valuation.

 (c) Eleven properties were 40% - 100% complete, thus requiring a capitalization rate to derive entrepreneurial profit. Capitalization rates are estimated based on current data derived from independent sources in the markets in which the Company holds investments.

(d)

The exit dates for the operating property loans are the contractual maturity dates.

 

 

As of December 31, 2016
        Unobservable Inputs
Asset Category  

Primary Valuation

Techniques

  Input   Estimated Range    

Weighted

Average

 

Development property

investments (a)

  Income approach analysis  

Market yields/

discount rate

    7.23 - 9.28%       8.34%  
        Exit date     0.17 - 3.88 years       1.81 years  
                         

Development property

investments with a

profits interest  (b)

  Option pricing model   Volatility     68.72 - 73.46%       73.17%  
        Exit date     1.42 - 3.88 years       2.12 years  
        Capitalization rate(c)     5.25 - 5.50%       5.47%  
        Discount rate     8.25 – 8.50%       8.47%  
                         
Operating property loans   Income approach analysis  

Market yields/

discount rate

    6.09 - 7.20%       6.73%  
        Exit date(d)     4.50 – 5.66 years       5.07 years  

 

16 

 

 

(a)The valuation technique for the development property investments with a profits interest does not differ from the development property investments without a profits interest. Therefore, this line item focuses on all development property investments, including those with a profits interest.
(b)The valuation technique for the development property investments with a profits interest does not differ from the development property investments without a profits interest. The development property investments with a profits interest only require incremental valuation techniques to determine the value of the profits interest. Therefore this line only focuses on the profits interest valuation.
(c)Ten properties were 40% - 100% complete, thus requiring a capitalization rate to derive entrepreneurial profit. Capitalization rates are estimated based on current data derived from independent sources in the markets in which the Company holds investments.
(d)The exit dates for the operating property loans are the contractual maturity dates.

 

The fair value measurements are sensitive to changes in unobservable inputs. A change in those inputs to a different amount might result in a significantly higher or lower fair value measurement. The following provides a discussion of the impact of changes in each of the unobservable inputs on the fair value measurement.

 

Market yields - changes in market yields and discount rates, each in isolation, may change the fair value of certain of the Company’s investments. Generally, an increase in market yields or discount rates may result in a decrease in the fair value of certain of the Company’s investments. The following fluctuations in the market yields/discount rates would have had the following impact on the fair value of our investments:

 

   Increase (decrease) in fair value of investments 
Change in market yields/discount rates (in millions)  March 31, 2017   December 31, 2016 
Up 25 basis points  $(0.6)  $(0.3)
Down 25 basis points, subject to a minimum yield/rate of 10 basis points   0.6    0.3 

 

Capitalization rate - changes in capitalization rate, in isolation and all else equal, may change the fair value of certain of the Company’s development investments containing profits interests. Generally an increase in the capitalization rate assumption may result in a decrease in the fair value of the Company’s investments. The following fluctuations in the capitalization rates would have had the following impact on the fair value of our investments:

 

   Increase (decrease) in fair value of investments 
Change in capitalization rates (in millions)  March 31, 2017   December 31, 2016 
Up 25 basis points  $(2.2)  $(2.1)
Down 25 basis points   2.4    2.3 
           
Up 50 basis points   (4.2)   (3.8)
Down 50 basis points   5.0    4.6 

 

Exit date - changes in exit date, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have profits interests. Generally, an acceleration in the exit date assumption may result in an increase in the fair value of the profits interests in certain of the Company’s investments.

 

Volatility - changes in volatility, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have profits interests. Generally, an increase in volatility may result in an increase in the fair value of the profits interests in certain of the Company’s investments.

 

Operating cash flow projections - changes in the operating cash flow projections of the underlying self-storage facilities, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have profits interests. Generally, an increase in operating cash flow projections may result in an increase in the fair value of the profits interests in certain of the Company’s investments.

 

The Company also evaluates the impact of changes in instrument-specific credit risk in determining the fair value of investments. There were no gains or losses attributable to changes in instrument-specific credit risk in the three months ended March 31, 2017 and 2016.

 

17 

 

 

Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may fluctuate from period to period. Additionally, the fair value of the Company’s investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If the Company was required to liquidate an investment in a forced or liquidation sale, it could realize significantly less than the value at which the Company has recorded it. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned. 

 

The following table presents changes in investments that use Level 3 inputs for the three month period ended March 31, 2017:

 

Balance as of December 31, 2016  $105,007 
Net realized gains   - 
Net unrealized gains   1,393 
Fundings of principal and change in unamortized origination fees   32,926 
Repayments of loans   (6,860)
Payment-in-kind interest   1,476 
Reclassification of self-storage real estate owned   (6,041)
Net transfers in or out of Level 3   - 
Balance at March 31, 2017  $127,901 

 

As of March 31, 2017 and December 31, 2016, the total net unrealized appreciation on the investments that use Level 3 inputs was $20.6 million and $19.2 million, respectively.

 

For the three months ended March 31, 2017 and 2016, substantially all of the change in fair value of investments in the Company’s Consolidated Statements of Operations were attributable to unrealized gains relating to the Company’s Level 3 assets still held as of the respective balance sheet date.

 

Transfers between levels, if any, are recognized at the beginning of the quarter in which the transfers occur.

 

5. INVESTMENT IN REAL ESTATE VENTURE

 

On March 7, 2016, the Company, through its Operating Company, entered into the Limited Liability Company Agreement (the “JV Agreement”) of Storage Lenders LLC, a Delaware limited liability company, to form a real estate venture (the “SL1 Venture”) with HVP III Storage Lenders Investor, LLC (“HVP III”), an investment vehicle managed by Heitman Capital Management LLC (“Heitman”). The SL1 Venture was formed for the purpose of providing capital to developers of self-storage facilities identified and underwritten by the Company. Upon formation, HVP III committed $110.0 million for a 90% interest in the SL1 Venture, and the Company committed $12.2 million for a 10% interest.

 

On March 31, 2016, the Company contributed to the SL1 Venture three of its existing development property investments with a profits interest located in Miami and Fort Lauderdale, Florida that were not yet under construction. These investments had an aggregate committed principal amount of approximately $41.9 million and an aggregate drawn balance of $8.1 million. In exchange, the Company’s initial funding commitment of $12.2 million was reduced by $8.1 million, representing the Company’s initial “Net Invested Capital” balance as defined in the JV Agreement. The Company accounted for this contribution in accordance with ASC 845, Nonmonetary Transactions, and recorded an investment in the SL1 Venture based on the fair value of the contributed development property investments, which is the same as carryover basis. The fair value of the contributed development property investments as of March 31, 2016 was $7.7 million. Pursuant to the JV Agreement, Heitman, in fulfilling its initial $110.0 million commitment, provides capital to the SL1 Venture as cash is required, including funding draws on the three contributed development property investments. During the year ended December 31, 2016, HVP III and the Company agreed to true up the balances in the respective members’ capital accounts to be in accordance with the 90% commitment and 10% commitment made by HVP III and the Company, respectively. Accordingly, during the year ended December 31, 2016, HVP III contributed cash of $7.3 million to the SL1 Venture, and the Company received a $7.3 million cash distribution as a return of its capital.

 

As of March 31, 2017, the SL1 Venture had closed on eight new development property investments with a profits interest with an aggregate commitment amount of approximately $81.4 million, bringing the total aggregate commitment of SL1 Venture’s investments to $123.3 million as of March 31, 2017. Accordingly, HVP III’s total commitment for a 90% interest in the SL1 Venture is $111.0 million, and the Company’s total commitment for a 10% interest in the SL1 Venture is $12.3 million.

 

18 

 

 

Under the JV Agreement, the Company will receive a priority distribution (after debt service and any reserve but before any other distributions) out of operating cash flow and residual distributions based upon 1% of the committed principal amount of loans made by the SL1 Venture, exclusive of the loans contributed to the SL1 Venture by the Company. Operating cash flow of the SL1 Venture (after debt service, reserves and the foregoing priority distributions) will be distributed in accordance with capital commitments. Residual cash flow from capital and other events (after debt service, reserves and priority distributions) will be distributed (i) pro rata in accordance with capital commitments (its “Percentage Interest”) until each member has received a return of all capital contributed; (ii) pro rata in accordance with each member’s Percentage Interest until Heitman has achieved a 14% internal rate of return; (iii) to Heitman in an amount equal to its Percentage Interest less 10% and to the Company in an amount equal to the Company’s Percentage Interest plus 10% until Heitman has achieved a 17% internal rate of return; (iv) to Heitman in an amount equal to its Percentage Interest less 20% and to the Company in an amount equal to the Company’s Percentage Interest plus 20% until Heitman has achieved a 20% internal rate of return; and (v) any excess to Heitman in an amount equal to its Percentage Interest less 30% and to the Company in an amount equal to the Company’s Percentage Interest plus 30%. However, the Company will not be entitled to any such promoted interest prior to the earlier to occur of the third anniversary of the JV Agreement and Heitman receiving distributions to the extent necessary to provide Heitman with a 1.48 multiple on its contributed capital.

 

Since the allocation of cash distributions and liquidating distributions are determined as described in the preceding paragraph, the Company has applied the hypothetical-liquidation-at-book-value (“HLBV”) method to allocate the earnings of SL1 Venture. Under the HLBV approach, the Company’s share of the investee’s earnings or loss is calculated by:

 

·The Company’s capital account at the end of the period assuming that the investee was liquidated or sold at book value, plus

 

·Cash distributions received by the Company during the period, minus

 

·Cash contributions made by the Company during the period, minus

 

·The Company’s capital account at the beginning of the period assuming that the investee were liquidated or sold at book value.

 

SL1 Venture has elected the fair value option of accounting for its development property investments with a profits interest, which are equity method investments of SL1 Venture. The assumptions used to value SL1 Venture’s investments are materially consistent with those used to value the Company’s investments. As of March 31, 2017, SL1 Venture had eleven development property investments with a profits interest as described in more detail in the table below:

 

Closing Date 

Metropolitan

Statistical Area

("MSA")

 

Total Investment

Commitment

  

Funded

Investment(1)

  

Remaining

Unfunded

Commitment

   Fair Value 
5/14/2015  Miami 1 (2)  $13,867   $6,813   $7,054   $7,587 
5/14/2015  Miami 2 (2)   14,849    6,064    8,785    5,930 
9/25/2015  Fort Lauderdale (2)   13,230    4,574    8,656    4,433 
4/15/2016  Washington DC   17,269    8,716    8,553    8,756 
4/29/2016  Atlanta 1   10,223    1,196    9,027    1,109 
7/19/2016  Jacksonville   8,127    3,669    4,458    4,257 
7/21/2016  New Jersey   7,828    789    7,039    712 
8/15/2016  Atlanta 2   8,772    3,025    5,747    3,132 
8/25/2016  Denver   11,032    3,557    7,475    3,448 
9/28/2016  Columbia   9,199    3,461    5,738    3,427 
12/22/2016  Raleigh   8,877    1,081    7,796    1,006 
   Total  $123,273   $42,945   $80,328   $43,797 

 

(1)Represents principal balance of loan gross of origination fees.
(2)These development property investments (having approximately $8.1 million of outstanding principal at contribution) were contributed to the SL1 Venture on March 31, 2016 by the Company.

 

As of March 31, 2017, the SL1 Venture had total assets of $46.7 million and total liabilities of $6.3 million. During the three months ended March 31, 2017, the SL1 Venture had net income of $2.3 million, of which $0.4 million was allocated to the Company and $1.9 million was allocated to HVP III under the HLBV method. At March 31, 2017, $0.2 million of transaction expenses were included in the carrying amount of the Company’s investment in the SL1 Venture. Additionally, the Company may from time to time make advances to the SL1 Venture. At March 31, 2017 and December 31, 2016, the Company had $6.2 million and $2.3 million, respectively, in advances to the SL1 Venture, and the related interest on these advances are classified in equity in earnings from unconsolidated real estate venture in the Consolidated Statements of Operations.

 

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In accordance with the JV Agreement, for each development property investment, the borrower must deliver to the SL1 Venture a completion guarantee whereby the borrower agrees to cover all costs in excess of the agreed-upon budget amount. Additionally, the Company is required to deliver to the SL1 Venture a backstop completion guarantee for each development property investment to guarantee completion in the event the borrower does not satisfy its obligations. The Company concluded that the likelihood of loss is remote and assigned no value to these guarantees as of March 31, 2017.

 

Under the JV Agreement, Heitman and the Company will seek to obtain and, if obtained, will share joint rights of first refusal to acquire self-storage facilities that are the subject of development property investments made by the SL1 Venture. Additionally, so long as the Company, through its operating subsidiary, is a member of the SL1 Venture and the SL1 Venture holds any assets, the Company will not make any investment of debt or equity or otherwise, directly or indirectly, in one or more new joint ventures or similar programs for the purposes of funding or providing development loans or financing, directly or indirectly, for the development, construction or conversion of self-storage facilities, in each case without first offering such opportunity to Heitman to participate on substantially the same terms as those set forth in the JV Agreement, either through the SL1 Venture or a newly formed real estate venture.

 

The JV Agreement permits Heitman to cause the Company to repurchase from Heitman its Developer Equity Interests (as defined in the JV Agreement) in certain limited circumstances. Under the JV Agreement, if a developer causes to be refinanced a self-storage facility with respect to which the SL1 Venture has made a development property investment and such refinancing does not coincide with a sale of the underlying self-storage facility, then at any time after the fourth anniversary of the commencement of the SL1 Venture, Heitman may either put to the Company its share of the Developer Equity Interests in respect of each such development property investment, or sell Heitman’s Developer Equity Interests to a third party. The Company concluded that the likelihood of loss is remote and assigned no value to these puts as of March 31, 2017.

 

The Company is the managing member of the SL1 Venture and will manage and administer (i) the day-to-day business and affairs of the SL1 Venture and any of its acquired properties and (ii) loan servicing and other administration of the approved development property investments. The Company will be paid a monthly expense reimbursement amount by the SL1 Venture in connection with its role as managing member, as set forth in the JV Agreement. Heitman may remove the Company as the managing member of the SL1 Venture if it commits an event of default (as defined in the JV Agreement), if it undergoes a change of control (as defined in the JV Agreement), or if it becomes insolvent.

 

Heitman has the right to approve all “Major Decisions” of the SL1 Venture, as defined in the JV Agreement, including, but not limited to, each investment of capital, the incurrence of any indebtedness, the sale or other disposition of assets of the SL1 Venture, the replacement of the managing member, the acceptance of new members into the SL1 Venture and the liquidation of the SL1 Venture.

 

For four of the SL1 Venture development property investments with a profits interest, an investor has an option to put its interest to the Company upon the event of default of the underlying property loans. The puts, if exercised, require the Company to purchase the member’s interest at the original purchase price plus a yield of 4.5% on such purchase price. The Company concluded that the likelihood of loss is remote and assigned no value to these put provisions at March 31, 2017.

 

6. VARIABLE INTEREST ENTITIES

 

Development Property Investments

 

The Company holds variable interests in its development property investments. The Company has determined that these investees qualify as VIEs because the entities do not have enough equity to finance their activities without additional subordinated financial support. In determining whether the Company is the primary beneficiary of the VIEs, the Company identified the activities that most significantly impact the VIEs’ economic performance. Such activities are (1) managing the construction and operations of the project, (2) selecting the property manager, (3) financing decisions, (4) authorizing capital expenditures and (5) disposition of the property. Although the Company has certain participating and protective rights, it does not have the power to direct the activities that most significantly impact the VIEs’ economic performance and is not the primary beneficiary; therefore, the Company does not consolidate the VIEs.

 

The Company has recorded assets of $117.9 million and $95.1 million at March 31, 2017 and December 31, 2016, respectively, for its variable interest in the VIEs which is included in the development property investments at fair value line item in the Consolidated Balance Sheets. The Company’s maximum exposure to loss as a result of its involvement with the VIEs is as follows:

 

   March 31, 2017   December 31, 2016 
Assets recorded related to VIEs  $117,936   $95,102 
Unfunded loan commitments to VIEs   124,635    54,950 
Maximum exposure to loss  $242,571   $150,052 

 

The Company has a construction completion guaranty from the managing members of the VIEs or individual affiliates/owners of such managing members.

 

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Investment in Real Estate Venture

 

The Company determined that the SL1 Venture qualifies as a VIE because it does not have enough equity to finance its activities without additional subordinated financial support. In determining whether the Company is the primary beneficiary of the entity, the Company identified the activities that most significantly impact the entity’s economic performance. Such activities are (1) approving self-storage development investments and acquiring self-storage properties, (2) managing directly-owned properties, (3) obtaining debt financing, and (4) disposing of investments. Although the Company has certain rights, it does not have the power to direct the activities that most significantly impact the entity’s economic performance and thus is not the primary beneficiary. As such, the Company does not consolidate the entity and accounts for its unconsolidated interest in the SL1 Venture using the equity method of accounting. The Company’s investment in the SL1 Venture is included in the investment in and advances to real estate venture balance in the Consolidated Balance Sheets, and earnings from the SL1 Venture are included in equity in earnings from unconsolidated real estate venture in the Company’s Consolidated Statements of Operations. The Company’s maximum contribution to the SL1 Venture is $12.3 million, and as of March 31, 2017 and December 31, 2016, the Company’s remaining unfunded commitment to the SL1 Venture is $8.1 million and $9.4 million, respectively.

 

7. SELF-STORAGE REAL ESTATE OWNED

 

On February 3, 2017, the Company purchased 50% of the economic rights of the Class A membership units of a limited liability company which owns a development property investment with a profits interest in Orlando, Florida for $1.3 million and increased its profits interest on this development property investment from 49.9% to 74.9%. The Class A member retains all management and voting rights in the limited liability company. Previously, the Company accounted for this investment as an equity method investment. Now that the Company is entitled to greater than 50% of the residual profits from the investment, the Company accounts for this investment as a real estate investment in its consolidated financial statements in accordance with ASC 310.

 

The following table shows the impact of this real estate investment on the Company’s Consolidated Balance Sheet as of March 31, 2017:

 

Cash  $34 
      
Land   1,507 
Building and improvements   5,919 
Accumulated depreciation   (76)
Self-storage real estate owned  $7,350 
      
Accrued liabilities  $92 

 

The following table shows the impact of this real estate investment on the Company’s Consolidated Statement of Operations for the three months ended March 31, 2017:

 

Rental revenues  $63 
      
Property operating expenses   (31)
Depreciation expense   (24)
Property operating expenses of real estate owned  $(55)

 

The Company’s basis in the land and building was recorded at cost (equal to cash paid and accrued interest, plus unrealized gains accrued at the date of reclassification) at February 3, 2017, the date of the Company’s purchase of 50% of the economic rights of the Class A membership units of the limited liability company that owns the development property investment with a profits interest. The allocation to land and building was based on the historical cost of these assets.

 

8. OTHER LOANS, AT COST

 

As of March 31, 2017, the Company had an aggregate balance of $13.1 million related to five bridge loans extended to four limited liability companies that are under common control with borrowers in certain of the Company’s development property investments. These bridge loans are secured by first mortgages on real and personal property, are personally guaranteed, and are interest-only with a fixed interest rate of 6.9% per annum, and mature in three to nine months. The maturities are based upon the estimated time needed to prepare the sites for closing into a development loan. During the three months ended March 31, 2017, the Company received repayments of $4.2 million related to two bridge loans and entered into two new bridge loans with an aggregate commitment of $7.3 million. At December 31, 2016, the Company had executed five bridge loans extended to four limited liability companies that are under common control with borrowers in certain of the Company’s development property investments. These bridge loans were accounted for under the cost method, and fair value approximates cost at March 31, 2017 and December 31, 2016. None of these bridge loans were in non-accrual status as of March 31, 2017 and December 31, 2016. The Company determined that no allowance for loan loss was necessary at March 31, 2017 and December 31, 2016.

 

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The Company also had executed six revolving loan agreements with an aggregate outstanding principal amount of $1.6 million at March 31, 2017. Five of the agreements are with individuals who are owners of limited liability companies, one is with a limited liability company, and all are personally guaranteed. All of the borrowers are either directly or indirectly owners of certain of the Company’s development property investments. Three of the agreements provide for borrowings of up to $0.5 million, one provides for borrowings of up to $0.25 million, one provides for borrowings of up to $0.7 million, and one agreement provides for borrowings of up to $1.0 million (total of $3.5 million) to fund expenses for pursuit costs to contract for and perform diligence on additional self-storage sites. The revolving loans are typically unsecured but cross-defaulted against development loans. One of the revolving loans is guaranteed by a part owner of one of the Company’s development loan investments, and this guaranty is secured by a pledge of the owner’s membership interest in one of the Company’s development loan investments. The loans bear interest at 6.9-7.0% per annum and are due in full in three years. During the three months ended March 31, 2017, the Company received repayments on these revolving loan agreements of $0.8 million. At December 31, 2016, the Company had executed six revolving loan agreements with an aggregate outstanding principal amount of $1.7 million. These loans are accounted for under the cost method, and fair value approximates cost at March 31, 2017 and December 31, 2016. None of these loans are in non-accrual status as of March 31, 2017 and December 31, 2016. The Company determined that no allowance for loan loss was necessary at March 31, 2017 and December 31, 2016.

 

9. SENIOR PARTICIPATIONS

 

On April 29, 2016, the Company sold senior participations (the “Operating Property A Notes”) in two separate operating property loans in the Nashville, Tennessee and New Orleans, Louisiana MSAs, having an aggregate outstanding principal balance of $7.8 million, to a regional commercial bank in exchange for cash consideration of $5.0 million. The sale of Operating Property A Notes was effected pursuant to participation agreements between the bank and the Company (the “Participation Agreements”). On December 14, 2016, the Company received proceeds of $5.2 million for an early payoff on the operating property loan in the Nashville, Tennessee MSA, and the Company repurchased the senior participation on this loan that was included in Operating Property A Notes. The Company paid the regional commercial bank a total of $3.4 million in connection with the repurchase, which included a $0.1 million prepayment penalty that is recorded in interest expense in the Consolidated Statements of Operations. Under the remaining Participation Agreement, the Company will continue to service the underlying loans as long as it is not in default under the Participation Agreement. The bank has the option to “put” the senior participation to the Company in the event the underlying borrower defaults on the underlying loan or if the Company defaults under the Participation Agreement. The Company will pay to the bank interest on the outstanding balance of the Operating Property A Note at the rate of 30-day LIBOR plus 3.85%, or 4.83% at March 31, 2017. The Operating Property A Note matures on April 1, 2019, at which time the Company is obligated to repurchase the Operating Property A Note at the then outstanding principal balances thereof. As part of the Participation Agreement, the Company will maintain a minimum aggregate balance of $0.5 million in depository or money market accounts at the bank, and if such balance is not maintained, the interest rate will increase. The outstanding balance for the remaining Operating Property A Note at March 31, 2017 was $1.8 million.

 

On May 27, 2016, the Company sold a third senior participation in a construction loan on a facility in the Miami, Florida MSA (“the Miami A Note”), having a commitment amount of $17.7 million, to the same commercial bank that purchased the Operating Property A Notes in exchange for a commitment by the bank to provide net proceeds of $10.0 million to fund construction draws under the construction loan (the “Miami A Note Sale”) once the total outstanding principal balance exceeds $7.7 million. The Miami A Note Sale was effected pursuant to a participation agreement between the bank and the Company (the “Miami Participation Agreement”). Under the Miami Participation Agreement, the Company will continue to service the underlying loan as long as it is not in default under the Miami Participation Agreement. The bank has the option to “put” the senior participation to the Company in the event the underlying borrower defaults on the underlying loan or if the Company defaults under the Miami Participation Agreement. The Company will pay to the bank interest on the outstanding balance of the Miami A Note at the rate of 30-day LIBOR plus 3.10%, or 4.08% at March 31, 2017. The Company also paid a loan fee of 100 basis points, or $0.1 million upon closing of the loan. The Miami A Note initially had a maturity date of July 1, 2017. During the three months ended March 31, 2017, the maturity date was extended to January 31, 2018, at which time the Company is obligated to repurchase the Miami A Note at the then outstanding principal balance thereof. No proceeds have been received as of March 31, 2017 from the Miami A Note.

 

On July 26, 2016, the Company sold to a national commercial bank operating in the Company’s markets senior participations in the construction loans of four separate development property investments with a profits interest (the “July 2016 A Notes”) (one in the Orlando, Florida MSA, two in the Atlanta, Georgia MSA, and one in the Tampa, Florida MSA) having an aggregate committed principal balance of approximately $21.8 million and earning interest at a rate of 6.9% per annum, in exchange for a commitment by the bank to provide net proceeds of $14.2 million (the “July 2016 A Note Sales”). Construction has been completed and certificates of occupancy have been issued for these properties. At closing, the bank paid to the Company approximately $12.5 million for senior participations in the construction loans and will fund up to a total of $14.2 million as future draws are made on the construction loans. The Company will pay interest to the bank on its senior participations at the annual rate of 30-day LIBOR plus 3.50%, or 4.48% at March 31, 2017. The July 2016 A Notes mature on August 1, 2019, at which time the Company is obligated to repurchase the July 2016 A Notes at the then outstanding principal balance thereof. As part of the senior participation agreements, the Company will maintain a minimum aggregate balance of $0.5 million in depository or money market accounts at the bank, and if such balance is not maintained, the interest rate will increase. The outstanding balance for the July 2016 A Notes at March 31, 2017 was $13.6 million.

 

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On October 18, 2016, the Company sold to a local Memphis, Tennessee-based community bank a senior participation in the construction loan of one of the Company’s development property investments with a profits interest (the “October 2016 A Note”) in Charlotte, North Carolina having a committed principal balance of approximately $6.8 million and earning interest at a rate of 6.9% per annum, in exchange for a commitment by the bank to provide net proceeds of $4.4 million (the “October 2016 A Note Sale”). Construction has been completed and a certificate of occupancy has been issued for this property. At closing, the bank paid to the Company approximately $3.4 million for the senior participation in the construction loan and will fund up to a total of $4.4 million as future draws are made on the construction loans. The Company will pay interest to the bank on the senior participation at the annual rate of 30-day LIBOR plus 3.50%, or 4.48% at March 31, 2017. The October 2016 A Note matures on September 1, 2021, at which time the Company is obligated to repurchase the October 2016 A Note at the then outstanding principal balance thereof. The outstanding balance for the October 2016 A Note at March 31, 2017 was $3.9 million.

 

The table below details the bank commitments and outstanding balances of our senior participations at March 31, 2017:

 

  

Commitment by

Bank

  

Amount

Borrowed

  

Remaining

Funds

   Interest Rate 

Effective

Interest

Rate at

March

31, 2017

   Maturity Date
Operating Property A Note  $1,820   $1,820   $-   30-day LIBOR + 3.85%   4.83%  April 1, 2019
Miami A Note   10,001    -    10,001   30-day LIBOR + 3.10%   4.08%  January 31, 2018
July 2016 A Notes   14,185    13,577    608   30-day LIBOR + 3.50%   4.48%  August 1, 2019
October 2016 A Note   4,405    3,935    470   30-day LIBOR + 3.50%   4.48%  September 1, 2021
Total  $30,411    19,332   $11,079            
Unamortized fees        (33)                
Net balance       $19,299                 

 

10. STOCKHOLDERS’ EQUITY

 

The Company had 8,997,707 and 8,956,354 shares of common stock issued and outstanding as of March 31, 2017 and December 31, 2016, respectively. The Company had 10,000 shares of Series A Preferred Stock issued and outstanding as of March 31, 2017 and December 31, 2016.

 

Common Stock Offering

 

On December 13, 2016, the Company received $53.5 million in proceeds, net of underwriter’s discount and offering costs, related to the issuance of 2,996,311 shares of common stock.

 

Stock Repurchase Plan

 

On May 20, 2016, the Company’s Board of Directors authorized a share repurchase program for the repurchase of up to $10.0 million of the outstanding shares of common stock of the Company. As of March 31, 2017, the Company had repurchased and retired a total of 213,078 shares of its common stock at an aggregate cost of approximately $3.2 million. As of March 31, 2017, the Company has $6.8 million remaining under the Board’s authorization to repurchase shares of its common stock.

 

Equity Incentive Plan

 

In connection with the IPO, the Company established the 2015 Equity Incentive Plan for the purpose of attracting and retaining directors, executive officers, investment professionals and other key personnel and service providers, including officers and employees of the Manager and other affiliates, and to stimulate their efforts toward the Company’s continued success, long-term growth and profitability. The 2015 Equity Incentive Plan provides for the grant of stock options, share awards (including restricted common stock and restricted stock units), stock appreciation rights, dividend equivalent rights, performance awards, annual incentive cash awards and other equity-based awards, including Long-Term Incentive Plan (“LTIP”) units, which are convertible on a one-for-one basis into Operating Company Units (“OC Units”).  A total of 200,000 shares of common stock were reserved for issuance pursuant to the 2015 Equity Incentive Plan, subject to certain adjustments set forth in the plan. On April 1, 2015, each non-employee director of the Company received an award of 2,500 shares of restricted common stock (total of 10,000 shares) which vest ratably over a three-year period. On June 15, 2015, in connection with the appointment of the Company’s President and Chief Operating Officer (an employee of the Manager), 100,000 shares of restricted common stock were granted, which shares vest ratably over a five-year period. During the year ended December 31, 2015, the Company granted 52,500 shares of restricted common stock to an executive officer (an employee of the Manager) and key employees of the Manager, which shares vest ratably over a three-year period. The Manager provides services to the Company. On May 20, 2016, each non-employee director of the Company received an award of 3,585 shares of common stock (total of 14,340 shares) which immediately vested on the grant date. On May 3, 2017, the Company’s stockholders approved, and the Company adopted, the Amended and Restated 2015 Stock Incentive Plan increasing the number of shares of common stock reserved for issuance under the Plan by 170,000 shares from 200,000 shares to 370,000 shares and extending the term of the Plan until May 2, 2027. On May 3, 2017, three non-employee directors of the Company were each granted an award of 2,138 shares of common stock (total of 6,414 shares), which immediately vested on the grant date. In addition, certain employees of the Manager were granted a cumulative total of 105,000 shares of restricted common stock, which vest ratably over a three-year period.

 

23 

 

 

Restricted Stock Awards

 

The 2015 Equity Incentive Plan permits the issuance of restricted stock awards to employees of the Manager (as the Company has no employees) and non-employee directors. Granted stock awards at March 31, 2017 and December 31, 2016 aggregated 176,840 service-based stock awards, of which 55,172 vested in 2016, 39,999 will vest in 2017, 40,002 will vest in 2018, and 20,000 will vest in 2019 and 2020, respectively. Additionally, 1,667 were forfeited during the year ended December 31, 2016. Non-vested shares are earned over the respective vesting period based on a service condition only. Expenses related to restricted stock awards are charged to compensation expense and are recognized over the respective vesting period (primarily three to five years) of the awards. For restricted stock issued to non-employee directors of the Company, compensation expense is based on the market value of the shares at the grant date. For restricted stock awards issued to employees of the Manager, compensation expense is re-measured at each reporting date until service is complete and the restricted shares become vested based on the then current value of the Company’s common stock.

 

The Company recognized approximately $0.3 million and $0.2 million of stock-based compensation expense for the three months ended March 31, 2017 and 2016, respectively. As of March 31, 2017 and December 31, 2016, the total unrecognized compensation cost related to the Company’s restricted shares was approximately $1.9 million and $2.0 million, respectively, based on the grant date market value for awards issued to non-employee directors of the Company and based on the measurement of awards using the Company’s stock price of $23.04 and $21.05 as of March 31, 2017 and December 31, 2016, respectively, for awards issued to employees of the Manager. This cost is expected to be recognized over the remaining weighted average period of 2.7 years. The Company presents stock-based compensation expense in general and administrative expenses in the Consolidated Statements of Operations.

 

A summary of changes in the Company’s restricted shares for the three months ended March 31, 2017 and 2016 is as follows:

 

  

Three Months Ended

March 31, 2017

  

Three Months Ended

March 31, 2016

 
   Shares  

Weighted

average grant

date fair value

   Shares  

Weighted

average grant

date fair value

 
                 
Nonvested at December 31,   120,001   $20.10    162,500   $20.08 
Granted   -    -    -    - 
Vested   -    -    -    - 
Forfeited   -    -    -    - 
Nonvested at March 31,   120,001   $20.10    162,500   $20.08 

 

Nonvested restricted shares receive dividends which are nonforfeitable.

 

Series A Preferred Stock Private Placement

 

On July 27, 2016 (the “Effective Date”), the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) with accounts managed by NexPoint Advisors, L.P., an affiliate of Highland Capital Management, L.P. (collectively, the “Buyers”) relating to the issuance and sale, from time to time until the second anniversary of the Effective Date (such period, the “Commitment Period”), of up to $100 million in shares of the Company’s newly designated Series A Preferred Stock, par value $0.01 per share (the “Series A Preferred Stock”), at a price of $1,000 per share (the “Liquidation Value”) (subject to a minimum amount of $50 million of Series A Preferred Stock to be issued and sold by the Company on or prior to the expiration of the Commitment Period), which may be increased at the request of the Company up to $125 million. The sale of shares of Series A Preferred Stock pursuant to the Purchase Agreement may occur from time to time, in minimum monthly increments of $5 million, maximum monthly increments of $15 million and maximum increments of $35 million over any rolling three month period, all to be completed during the Commitment Period.

 

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The Series A Preferred Stock will rank senior to the shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, on parity with any class or series of capital stock of the Company expressly designated as ranking on parity with the Series A Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, junior to any class or series of capital stock of the Company expressly designated as ranking senior to the Series A Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company and junior in right of payment to the Company’s existing and future indebtedness.

 

Holders of Series A Preferred Stock are entitled to a cumulative cash distribution (“Cash Distribution”) equal to (A) 7.0% per annum on the Liquidation Value for the period beginning on the respective date of issuance until the sixth anniversary of the Effective Date, payable quarterly in arrears, (B) 8.5% per annum on the Liquidation Value for the period beginning the day after the sixth anniversary of the Effective Date and for each year thereafter as long as the Series A Preferred Stock remains issued and outstanding, payable quarterly in arrears, and (C) an amount in addition to the amounts in (A) and (B) equal to 5.0% per annum on the Liquidation Value upon the occurrence of certain triggering events (a “Cash Premium”). In addition, the holders of the Series A Preferred Stock will be entitled to a cumulative dividend payable in-kind in shares of Common Stock or additional shares of Series A Preferred Stock, at the election of the holders (the “Stock Dividend”), equal in the aggregate to the lesser of (Y) 25% of the incremental increase in the Company’s book value (as adjusted for equity capital issuances, share repurchases and certain non-cash expenses) plus, to the extent the Company owns equity interests in income-producing real property, the incremental increase in net asset value (provided, however, that no interest in the same real estate asset will be double counted) and (Z) an amount that would, together with the Cash Distribution, result in a 14.0% internal rate of return for the holders of the Series A Preferred Stock from the date of issuance of the Series A Preferred Stock, as set forth in the Articles Supplementary classifying the Series A Preferred Stock (the “Articles Supplementary”). Triggering events that will trigger the payment of a Cash Premium with respect to a Cash Distribution include: (i) the occurrence of certain change of control events affecting the Company after the third anniversary of the Effective Date, (ii) the Company’s ceasing to be subject to the reporting requirements of Section 13 or Section 15(d) of the Exchange Act, (iii) the Company’s failure to remain qualified as a real estate investment trust, (iv) an event of default under the Purchase Agreement, (v) the failure by the Company to register for resale shares of Common Stock pursuant to the Registration Rights Agreement (a “Registration Default”), (vi) the Company’s failure to redeem the Series A Preferred Stock as required by the Purchase Agreement, or (vii) the filing of a complaint, a settlement with, or a judgment entered by the Securities and Exchange Commission against the Company or any of its subsidiaries or a director or executive officer of the Company relating to the violation of the securities laws, rules or regulations with respect to the business of the Company. Accrued but unpaid Cash Distributions and Stock Dividends on the Series A Preferred Stock will accumulate and will earn additional Cash Distributions and Stock Dividends as calculated above, compounded quarterly.

 

The holders of Series A Preferred Stock have the right to purchase their pro rata share of any qualified offering of Common Stock, which consists of any offering by the Company of Common Stock except any shares of Common Stock issued (i) in connection with a merger, consolidation, acquisition or similar business combination, (ii) in connection with a joint venture, strategic alliance or similar corporate partnering arrangement, (iii) in connection with any acquisition of assets by the Company, (iv) at market prices pursuant to a registered at-the-market program and/or (v) as part of a compensatory or employment arrangement.

 

As long as shares of Series A Preferred Stock remain outstanding, the Company is required to maintain a ratio of debt to total tangible assets determined under U.S. generally accepted accounting principles of no more than 0.4:1, measured as of the last day of each fiscal quarter. The Company has complied with this covenant as of March 31, 2017.

 

The Series A Preferred Stock may be redeemed at the Company’s option (i) after five years from the Effective Date at a price equal to 105% of the Liquidation Value per share plus the value of all accumulated and unpaid Cash Distributions and Stock Dividends, and (ii) after six years from the Effective Date at a price equal to 100% of the Liquidation Value per share plus the value of all accumulated and unpaid Cash Distributions and Stock Dividends. In the event of certain change of control events affecting the Company prior to the third anniversary of the Effective Date, the Company must redeem all shares of Series A Preferred Stock for a price equal to (a) the Liquidation Value, plus (b) accumulated and unpaid Cash Distributions and Stock Dividends, plus (c) a make-whole premium designed to provide the holders of the Series A Preferred Stock with a return on the redeemed shares equal to a 14.0% internal rate of return through the third anniversary of the Effective Date.

 

Holders of Series A Preferred Stock will be entitled to a separate class vote with respect to (i) any amendments to the Company’s Amended and Restated Articles of Incorporation (the “Charter”), as supplemented by the Articles Supplementary, or bylaws that would alter or change the rights, preferences, privileges or restrictions of the Series A Preferred Stock so as to materially and adversely affect such Series A Preferred Stock and (ii) reclassification or otherwise, any issuances by the Company of securities that are senior to, or equal in priority with, the Series A Preferred Stock.

 

In the event of any liquidation, dissolution or winding up of the Company, the holders of the Series A Preferred Stock shall be entitled to receive an amount equal to the greater of (i) the Liquidation Value, plus all accumulated but unpaid Cash Distributions and Stock Dividends thereon to, but not including, the date of any liquidation, but excluding any Cash Premium and (ii) the amount that would be paid on such date in the event of a redemption following a change of control.

 

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Pursuant to the Purchase Agreement and the Articles Supplementary, the Company increased the size of its Board by one director and elected James Dondero, as representative of the Buyers, to the Board for a term expiring at the Company’s 2017 annual meeting of stockholders (Mr. Dondero has subsequently been reelected to the Board for a term expiring at the Company’s 2018 annual meeting of stockhoders). Thereafter, so long as any shares of the Series A Preferred Stock are outstanding, the holders of the Series A Preferred Stock, voting as a single class, are entitled to nominate and elect one individual to serve on our Board of Directors. If the Company has not paid the full amount of the Cash Distribution or the Stock Dividend on the shares of the Series A Preferred Stock for six or more quarterly dividend periods (whether or not consecutive), the Company will increase the size of the Board by two directors and the holders of the our Series A Preferred Stock are entitled to elect two additional directors to serve on our Board of Directors until the Company pays in full all accumulated and unpaid Cash Distributions and Stock Dividends.

 

Further, at any time that the Series A Preferred Stock remains outstanding, if Dean Jernigan, the Company’s current Chief Executive Officer and Chairman of the Board, voluntarily leaves the position of Chief Executive Officer, and is not serving as the Executive Chairman of the Board (a “Key Man Event”), the holders of the Series A Preferred Stock shall have the right to accept or reject the service of any person as Chief Executive Officer (or such person serving as the principal executive officer) of the Company.

 

The Purchase Agreement requires that the Company and its subsidiaries conduct their business in the ordinary course of business consistent with past practice and use reasonable best efforts to (i) preserve substantially intact the business organization and (ii) avoid becoming subject to the requirements of the Investment Company Act of 1940, as amended. Additionally, the Company and its subsidiaries may not change or alter materially its method of accounting or the manner in which it keeps its accounting books and records unless required by the Securities and Exchange Commission to reflect changes in U.S. generally accepted accounting principles or, in the business judgment of the Board, such change would be in the best interests of the Company or stockholders.

 

Future issuances of shares of Series A Preferred Stock at any one or more closings after the Effective Date are contingent upon the satisfaction of certain conditions at the time of such proposed purchase, including that (i) the representations and warranties of the Purchase Agreement remain true and correct in all material respects and the Company has complied with all covenants and conditions under the Purchase Agreement, the Articles Supplementary, the Registration Rights Agreement and the documents related thereto, (ii) no material adverse effect (as such term is defined in the Purchase Agreement) has occurred, (iii) there is no suspension of trading of the Common Stock on the New York Stock Exchange or such other market or exchange on which the Common Stock is then listed or traded (the “Principal Market”), (iv) a Key Man Event shall not have occurred, as described above, and (v) the Company has delivered certain customary closing deliverables.

 

An event of default under the Purchase Agreement terminates the obligation of the Buyers to acquire shares of Series A Preferred Stock from the Company and also triggers the Cash Premium described above. Such events of default under the Purchase Agreement include (i) a Registration Default, (ii) the suspension of trading or delisting of the Common Stock on the Principal Market, (iii) the failure by the transfer agent of the Company to issue shares of the Series A Preferred Stock to the Buyers (subject to an applicable cure period), (iv) the Company’s breach of a representation or warranty, covenant or other term or condition under the Purchase Agreement, Articles Supplementary, the Registration Rights Agreement or the documents related thereto that has a material adverse effect (subject to an applicable cure period), (v) the failure of the Company to sell $50 million of shares of Series A Preferred Stock on or prior to the tenth business day after the expiration of the Commitment Period, (vi) an event of default under any secured indebtedness of the Company, or (vii) certain bankruptcy proceedings.

 

The holders of the Series A Preferred Stock will have certain customary registration rights with respect to the Common Stock issued as Stock Dividends pursuant to the terms of a Registration Rights Agreement.

 

The issuance and sale of the Series A Preferred Stock, and the issuance of shares of common stock and/or additional shares of Series A Preferred Stock issuable as Stock Dividends, will be exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”) pursuant to Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D thereunder. The Buyers represented to the Company that they are “accredited investors” as defined in Rule 501 of the Securities Act and that the Series A Preferred Stock is being acquired for investment purposes and not with a view to, or for sale in connection with, any distribution thereof, and appropriate legends will be affixed to any certificates evidencing the shares of Series A Preferred Stock or Common Stock issuable pursuant to the Stock Purchase Agreement.

 

As of March 31, 2017, the Company had issued 10,000 restricted shares of the Series A Preferred Stock to the Buyers and received $10.0 million in proceeds pursuant to the terms of the Purchase Agreement. On March 7, 2017, we declared a (i) cash distribution of $17.50 per share of Series A Preferred stock, payable on April 14, 2017, to holders of Series A Preferred stock of record on the close of business on April 1, 2017, and (ii) distributions payable in kind in a number of shares of common stock as determined in accordance with the terms of the designation of the Series A Preferred stock, payable on April 17, 2017, to holders of Series A Preferred Stock of record on the close of business on April 1, 2017.

 

11. EARNINGS PER SHARE

 

Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period.  All outstanding unvested restricted share awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two-class method of computing basic earnings per share. Both the unvested restricted shares and the assumed share-settlement of the stock dividend to holders of the Series A Preferred Stock, and the related impacts to earnings, are considered when calculating earnings per share on a diluted basis with our diluted earnings per share being the more dilutive of the treasury stock or two-class methods.  For the three months ended March 31, 2017 and 2016, the Company’s basic earnings per share is computed using the two-class method, and our diluted earnings per share is computed using the more dilutive of the treasury stock method or two-class method:

 

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   Three months ended March 31, 
   2017   2016 
Weighted average common shares - basic   8,857,030    6,000,000 
Effect of dilutive securities   136,498    162,500 
Weighted average common shares, all classes   8,993,528    6,162,500 
           
Calculation of Earnings per Share - basic          
Net income  $1,783   $1,122 
Less:          
  Net income allocated to preferred stockholders   546    - 
  Net income allocated to unvested restricted shares (1)   17    30 
Net income attributable to common shareholders - two-class method  $1,220   $1,092 
           
Weighted average common shares - basic   8,857,030    6,000,000 
Earnings per share - basic  $0.14   $0.18 
           
Calculation of Earnings per Share - diluted          
Net income  $1,783   $1,122 
Less:          
  Net income allocated to preferred stockholders   546    - 
Net income attributable to common shareholders - two-class method  $1,237   $1,122 
           
Weighted average common shares - diluted   8,993,528    6,162,500 
Earnings per share - diluted  $0.14   $0.18 

 

(1) Unvested restricted shares participate in dividends with common shares on a 1:1 basis and thus are considered participating securities under the two-class method for the three months ended March 31, 2017 and 2016.

  

12. RELATED PARTY TRANSACTIONS

 

Equity Method Investments

 

Certain of the Company’s development property investments are equity method investments for which the Company has elected the fair value option of accounting. The fair value of these equity method investments at March 31, 2017 and December 31, 2016 were $106.6 million and $78.7 million, respectively. The interest income realized and the change in fair value from these equity method investments was $2.8 million and $3.8 million for the three months ended March 31, 2017 and 2016, respectively.

 

The Company’s investment in the real estate venture, the SL1 Venture, has a carrying amount of $10.8 million and $5.4 million at March 31, 2017 and December 31, 2016, respectively, and the earnings from this venture were $0.4 million for the three months ended March 31, 2017. There were no earnings from this venture for the three months ended March 31, 2016.

 

Management Agreement

 

On April 1, 2015, the Company entered into a management agreement with its Manager (the “Management Agreement”). Pursuant to the terms of the Management Agreement, the Manager will be responsible for (a) the Company’s day-to-day operations, (b) determining investment criteria and strategy in conjunction with the Company’s Board of Directors, (c) sourcing, analyzing, originating, underwriting, structuring, and acquiring the Company’s portfolio investments, and (d) performing portfolio management duties. The Manager has an Investment Committee that approves investments in accordance with the Company’s investment guidelines, investment strategy, and financing strategy.

 

On May 23, 2016, the Company entered into an Amended and Restated Management Agreement (the “Amended and Restated Management Agreement”) by and among the Company, the Operating Company and the Manager that amends and restates the original Management Agreement dated April 1, 2015. The Amended and Restated Management Agreement was approved on behalf of the Company and the Operating Company by a unanimous vote of the Nominating and Corporate Governance Committee of the Company’s Board of Directors, which consists solely of independent directors.

 

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The Amended and Restated Management Agreement modifies certain procedures with respect to the future internalization of the Manager (as described in the Amended and Restated Management Agreement, an “Internalization Transaction”). Prior to entry into the Amended and Restated Management Agreement, if no Internalization Transaction had occurred prior to the end of the last renewal term, the Manager would have been entitled to the Termination Fee (as defined in the Amended and Restated Management Agreement) and the Company would not have acquired the assets of the Manager.  The Amended and Restated Management Agreement, however, requires an Internalization Transaction at the end of the last renewal term (if an Internalization Transaction or termination of the Amended and Restated Management Agreement has not occurred prior to that date).  The Internalization Price in such event would equal the Termination Fee amount and the Company would receive the Manager’s assets.  Accordingly, the amount the Manager would receive has not changed, but the Company now would receive the assets of the Manager, which it would not have received prior to the Amended and Restated Management Agreement.

 

Under the Amended and Restated Management Agreement, if an Internalization Transaction has not occurred prior to March 31, 2023, the last day of the last renewal term, then the Manager and the Company shall consummate an Internalization Transaction to be effective as of that date and all assets of the Manager (or, alternatively, all of the equity interests in the Manager) shall be conveyed to and acquired by the Operating Company in exchange for the Internalization Price (as described herein). At such time, all employees of the Manager shall become employees of the Operating Company and the Manager shall discontinue all business activities. Unlike an Internalization Transaction that occurs prior to the end of the final renewal term of the Amended and Restated Management Agreement, an Internalization Transaction that occurs at the end of the final renewal term shall not require a fairness opinion, the approval of a special committee of the Company’s Board of Directors or the approval of the Company’s stockholders.

 

The “Internalization Price” payable in the event of an Internalization Transaction at the end of the last renewal term shall be equal to the Termination Fee and the Board of Directors of the Company has no discretion to change such Internalization Price or the conditions applicable to its payment.

 

The Internalization Price paid to the Manager in any Internalization Transaction will be payable by the Operating Company in the number of units of limited liability company interests (“OC Units”) of the Operating Company equal to the Internalization Price, divided by the volume-weighted average of the closing market price of the common stock of the Company for the ten consecutive trading days immediately preceding the date with respect to which value must be determined. However, if the common stock of the Company is not traded on a national securities exchange at the time of closing of any Internalization Transaction, then the number of OC Units shall be determined by agreement between the Board of Directors of the Company and the Manager or, in the absence of such agreement, the Internalization Price shall be paid in cash.

 

Prior to entry into the Amended and Restated Management Agreement, any Termination Fee would have been payable by the Operating Company in OC Units equal to the Termination Fee divided by the average of the daily market price of the Common Stock for the ten consecutive trading days immediately preceding the date of termination within 90 days after occurrence of the event requiring the payment of the Termination Fee. In accordance with ASC 505-50, Equity - Equity-based Payments to Non-Employees, since the number of OC Units to be issued was dependent upon different possible outcomes, the Company recognized the lowest aggregate amount within the range of outcomes. Accordingly, the Company estimated the deferred termination fee payable and accrued the expense over the term of the Management Agreement. Upon entry into the Amended and Restated Management Agreement, the Company ceased recognizing the deferred termination fee expense and reclassified the Non-Controlling Interests to Additional Paid-In-Capital since the Termination Fee is no longer certain of being paid other than in exchange for either the assets or equity of the Manager. Accordingly, the Company recorded none and $0.2 million of expense for the deferred termination fee for the three months ended March 31, 2017 and 2016, respectively.

 

The initial term of the Management Agreement will be five years, with up to a maximum of three, one-year extensions that end on the applicable anniversary of the completion of the Company’s offering. The Company’s independent directors will review the Manager’s performance annually. Following the initial term, the Management Agreement may be terminated annually upon the affirmative vote of at least two-thirds of the Company’s independent directors based upon: (a) the Manager’s unsatisfactory performance that is materially detrimental to the Company; or (b) the Company’s determination that the management fees payable to the Manager are not fair, subject to the Manager’s right to prevent termination based on unfair fees by accepting a reduction of management fees agreed to by at least two-thirds of the independent directors. The Company will provide its Manager with 180 days’ prior notice of such a termination. Upon such a termination, the Company will pay the Manager a Termination Fee except as provided below.

 

No later than 180 days prior to the end of the initial term of the Management Agreement, the Manager will offer to contribute to the Company’s Operating Company at the end of the initial term all of the assets or equity interests in the Manager at the internalization price and on such terms and conditions included in a written offer provided by the Manager.

 

Upon receipt of the Manager’s initial internalization offer, a special committee consisting solely of the Company’s independent directors may accept the Manager’s proposal or submit a counter offer to the Manager. If the Manager and the special committee are unable to agree, the Manager and the special committee will repeat this process annually during the term of any extension of the Management Agreement. Acquisition of the Manager pursuant to this process requires a fairness opinion from a nationally recognized investment banking firm and stockholder approval, in addition to approval by the special committee. As described above, if an Internalization Transaction has not occurred prior to March 31, 2023, the last day of the last renewal term, then the Manager and the Company shall consummate an Internalization Transaction to be effective as of that date, and such Internalization Transaction shall not require a fairness opinion, the approval of a special committee of the Company’s Board of Directors or the approval of the Company’s stockholders.

 

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If the Management Agreement terminates other than for Cause, voluntary non-renewal by the Manager or the Company being required to register as an investment company under the Investment Company Act of 1940, then the Company shall pay to the Manager, on the date on which such termination is effective, a Termination Fee equal to the greater of (i) three times the sum of the average annual Base Management Fee and Incentive Fee earned by the Manager during the 24-month period prior to such termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination, or (ii) the offer price, which will be based on the lesser of (a) the Manager’s earnings before interest, taxes, depreciation and amortization (adjusted for unusual, extraordinary and non-recurring charges and expenses), or “EBITDA” annualized based on the most recent quarter ended, multiplied by a specific multiple, or EBITDA Multiple, depending on the Company’s achieved total annual return, and (b) the Company’s equity market capitalization multiplied by a specific percentage, or Capitalization Percentage, depending on the Company’s achieved total return (the Internalization Price). Any Termination Fee will be payable by the Operating Company in cash.

 

The Company also may terminate the Amended and Restated Management Agreement at any time, including during the initial term, without the payment of any Termination Fee, with 30 days’ prior written notice from the Board of Directors, for cause. “Cause” is defined as: (i) the Manager’s continued breach of any material provision of the Amended and Restated Management Agreement following a prescribed period; (ii) the occurrence of certain events with respect to the bankruptcy or insolvency of the Manager; (iii) a change of control of the Manager that a majority of the Company’s independent directors determines is materially detrimental to the Company; (iv) the Manager committing fraud against the Company, misappropriating or embezzling the Company’s funds, or acting grossly negligent in the performance of its duties under the Amended and Restated Management Agreement; (v) the dissolution of the Manager; (vi) the Manager fails to provide adequate or appropriate personnel that are reasonably necessary for the Manager to identify investment opportunities for the Company and to manage and develop the Company’s investment portfolio if such default continues uncured for a period of 60 days after written notice thereof, which notice must contain a request that the same be remedied; (vii) the Manager is convicted (including a plea of nolo contendere) of a felony; or (viii) both the current Chief Executive Officer and the current President and Chief Operating Officer are no longer senior executive officers of the Manager or the Company during the term of the Amended and Restated Management Agreement other than by reason of death or disability.

 

The Manager may terminate the Amended and Restated Management Agreement if the Company becomes required to register as an investment company under the 1940 Act, with such termination deemed to occur immediately before such event, in which case the Company would not be required to pay the Manager a Termination Fee. The Manager may also decline to renew the Amended and Restated Management Agreement by providing the Company with 180 days’ written notice, in which case the Company would not be required to pay a Termination Fee.

 

The Amended and Restated Management Agreement provides for the Manager to earn a base management fee and an incentive fee. In addition, the Company will reimburse certain expenses of the Manager, excluding the salaries and cash bonuses of the Manager’s chief executive officer and chief financial officer, a portion of the salary of the president and chief operating officer, and certain other costs as determined by the Manager in accordance with the Amended and Restated Management Agreement. Certain prepaid expenses and fixed assets are also purchased through the Manager and reimbursed by the Company. In the event that the Company terminates the Amended and Restated Management Agreement per the terms of the agreement, other than for cause or the Company being required to register as an investment company, there will be a Termination Fee due to the Manager. Amounts reimbursable to the Manager for expenses are included in general and administrative expenses in the Consolidated Statements of Operations and totaled $0.8 million for the three months ended March 31, 2017 and 2016.

 

Management Fees

 

As of March 31, 2017, the Company did not have any personnel. As a result, the Company is relying on the properties, resources and personnel of the Manager to conduct operations. The Company has agreed to pay the Manager a base management fee in an amount equal to 0.375% of the Company’s stockholders’ equity (a 1.5% annual rate) calculated and payable quarterly in arrears in cash. For purposes of calculating the base management fee, the Company’s stockholder’s equity means: (a) the sum of (i) the net proceeds from all issuances of the Company’s equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus (ii) the Company’s retained earnings at the end of the most recently completed fiscal quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods); less (b) any amount that the Company pays to repurchase the Company’s common stock since inception, provided that if the Company’s retained earnings are in a net deficit position (following any required adjustments set forth below), then retained earnings shall not be included in stockholders’ equity. It also excludes (x) any unrealized gains and losses and other non-cash items that have impacted stockholders’ equity as reported in the Company’s financial statements prepared in accordance with accounting principles generally accepted in the United States, or GAAP, and (y) one-time events pursuant to changes in GAAP (such as a cumulative change to the Company’s operating results as a result of a codification change pursuant to GAAP), and certain non-cash items not otherwise described above (such as depreciation and amortization), in each case after discussions between the Company’s Manager and the Company’s independent directors and approval by a majority of the Company’s independent directors. As a result, the Company’s stockholders’ equity, for purposes of calculating the base management fee, could be greater or less than the amount of stockholders’ equity shown on the Company’s financial statements. The base management fee is payable independent of the performance of the Company’s portfolio. The Manager computes the base management fee within 30 days after the end of the fiscal quarter with respect to which such installment is payable and promptly delivers such calculation to the Company’s Board of Directors. The amount of the installment shown in the calculation is due and payable no later than the date which is five business days after the date of delivery of such computation to the Board of Directors. The calculation generally will be reviewed by the Board of Directors at their regularly scheduled quarterly board meeting. The base management fee was $0.6 million and $0.4 million for the three months ended March 31, 2017 and 2016, respectively. At March 31, 2017 and December 31, 2016, the Company had outstanding fees due to Manager of $0.8 million and $1.0 million, respectively, consisting of the management fees payable and certain general and administrative fees payable.

 

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Incentive Fee

 

The Manager is entitled to an incentive fee with respect to each fiscal quarter (or part thereof that the Amended and Restated Management Agreement is in effect) in arrears in cash. The incentive fee will be an amount, not less than zero, determined pursuant to the following formula:

 

IF = .20 times (A minus (B times .08)) minus C

 

In the foregoing formula:

 

· A equals the Company’s Core Earnings (as defined below) for the previous 12-month period;

 

· B equals (i) the weighted average of the issue price per share of the Company’s common stock of all of its public offerings of common stock, multiplied by (ii) the weighted average number of all shares of common stock outstanding (including (i) any restricted stock units and any restricted shares of common stock in the previous 12-month period and (ii) shares of common stock issuable upon conversion of outstanding OC Units); and

 

· C equals the sum of any incentive fees earned by the Manager with respect to the first three fiscal quarters of such previous 12-month period.

 

Notwithstanding application of the incentive fee formula, no incentive fee shall be paid with respect to any fiscal quarter unless cumulative annual stockholder total return for the four most recently completed fiscal quarters is greater than 8%. Any computed incentive fee earned but not paid because of the foregoing hurdle will accrue until such 8% cumulative annual stockholder total return is achieved. The total return is calculated by adding stock price appreciation (based on the volume-weighted average of the closing price of the Company’s common stock on the NYSE (or other applicable trading market) for the last ten consecutive trading days of the applicable computation period minus the volume-weighted average of the closing market price of the Company’s common stock for the last ten consecutive trading days of the period immediately preceding the applicable computation period) plus dividends per share paid during such computation period, divided by the volume-weighted average of the closing market price of the Company’s common stock for the last ten consecutive trading days of the period immediately preceding the applicable computation period. For purposes of computing the Incentive Fee, “Core Earnings” is defined as net income (loss) determined under GAAP, plus non-cash equity compensation expense, the incentive fee, depreciation and amortization (to the extent that the Company forecloses on any facilities underlying the Company’s target investments), any unrealized losses or other non-cash expense items reflected in GAAP net income (loss), less any unrealized gains reflected in GAAP net income. The amount will be adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between the Manager and the Company’s independent directors and after approval by a majority of the independent directors.

 

The Manager computes each quarterly installment of the incentive fee within 45 days after the end of the fiscal quarter with respect to which such installment is payable and promptly delivers such calculation to the Company’s Board of Directors. The amount of the installment shown in the calculation is due and payable no later than the date which is five business days after the date of delivery of such computation to the Board of Directors. The calculation generally will be reviewed by the Board of Directors at their regularly scheduled quarterly board meeting. The Manager has not earned an incentive fee for the three months ended March 31, 2017 and 2016.

 

13. SUBSEQUENT EVENTS

 

The Company’s management has evaluated subsequent events through the date of issuance of the consolidated financial statements included herein. Other than those disclosed below, there have been no subsequent events that occurred during such period that require disclosure or recognition in the accompanying consolidated financial statements.

 

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Investment Activity

 

Subsequent to March 31, 2017, the Company closed on the following development property investments with a profits interest:

 

Closing Date  MSA  Total Investment
Commitment
 
4/14/2017  Louisville  $8,523 
4/20/2017  Denver 1    11,164 
4/20/2017  Denver 2    9,806 
5/2/2017  Tampa 2   8,091 
5/2/2017  Atlanta 6   12,543 
    Total   $50,127 

 

On April 20, 2017, the Company received $1.2 million for the payoff of an operating property loan in the Nashville, Tennessee MSA.

 

On April 20, 2017, the Company received aggregate repayments of $2.8 million related to two loans recorded at cost in connection with the above-described closings of the Denver 1 and Denver 2 development property investments with a profits interest.

 

On May 2, 2017, the Company received a repayment of $3.0 million related to a loan recorded at cost in connection with the closing of the above-described Atlanta 6 development property investment with a profits interest.

  

Capital Activity

 

On April 5, 2017, the Company entered into an at-the-market continuous equity offering program (“ATM Program”) with an aggregate offering price of up to $50.0 million. Since the inception of the ATM Program, the Company has issued and sold an aggregate of 874,402 shares of common stock at a weighted average price of $22.76 per share under the ATM Program, receiving net proceeds after commissions of $19.6 million. The Company intends to use net proceeds from sales under the ATM Program to fund investments and for general corporate purposes. The timing of any sales will depend on a variety of factors to be determined by the Company.

 

Dividend Declarations

 

On May 3, 2017, the Company’s Board of Directors declared a cash dividend to the holders of the Series A Preferred Stock and a distribution payable in kind in a number of shares of common stock or Series A Preferred Stock as determined in accordance with the election of the holders of the Series A Preferred Stock for the quarter ending June 30, 2017. The dividends are payable on July 15, 2017 (or if not a business day, on the next business day) to holders of Series A Preferred Stock of record on July 1, 2017.

 

On May 3, 2017, the Company’s Board of Directors also declared a cash dividend of $0.35 per share of common stock for the quarter ending June 30, 2017. The dividend is payable on July 14, 2017 to stockholders of record on July 3, 2017.

 

Second Amended and Restated Management Agreement

 

Effective as of April 1, 2017, the Company, the Operating Company and the Manager entered into a Second and Amended Restated Management Agreement to modify the manner in which certain expenses incurred by the Manager are accounted for and paid by the Company. Under the Amended and Restated Management Agreement, the Manager may engage independent contractors that provide investment banking, securities brokerage, mortgage brokerage and other financial, legal and account services as may be required for the Company’s investments, and the Company agrees to reimburse the Manager for costs and expenses incurred in connection with these services. The Second Amended and Restated Management Agreement now provides that expenses incurred by the Manager are reimbursable to the Manager by the Company only to the extent such expenses are not otherwise directly reimbursed by an unaffiliated third party. The amount of expenses to be reimbursed to the Manager by the Company will be reduced dollar-for-dollar by the amount of any such payment or reimbursement.

 

Amended and Restated 2015 Equity Incentive Plan

 

On May 3, 2017, the stockholders of the Company approved the Amended and Restated 2015 Equity Incentive Plan to increase the number of shares of common stock reserved for issuance under the Plan by 170,000 shares from 200,000 shares to 370,000 shares and to extend the term of the Amended and Restated 2015 Equity Incentive Plan to May 2, 2027. On May 3, 2017, three non-employee directors of the Company were each granted an award of 2,138 shares of common stock (total of 6,414 shares), which immediately vested on the grant date. In addition, certain employees of the Manager were granted a cumulative total of 105,000 shares of restricted common stock, which vest ratably over a three-year period.

 

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

 

Note Regarding Forward-Looking Statements

 

We make statements in this Quarterly Report on Form 10-Q that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). These forward-looking statements include, without limitation, statements about our estimates, expectations, predictions and forecasts of our future business plans and financial and operating performance and/or results, as well as statements of management’s goals and objectives and other similar expressions concerning matters that are not historical facts. When we use the words “may,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” or similar expressions or their negatives, as well as statements in future tense, we intend to identify forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, beliefs and expectations, such forward-looking statements are not predictions of future events or guarantees of future performance and our actual financial and operating results could differ materially from those set forth in the forward-looking statements. Some factors that might cause such differences are described in the section entitled “Risk Factors” in this report and in the Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”), which was filed with the Securities and Exchange Commission (“SEC”) on March 8, 2017, which factors include, without limitation, the following:

 

·our ability to successfully source, structure, negotiate and close investments in self-storage facilities;
·changes in our business strategy and the market’s acceptance of our investment terms;
·our ability to fund our outstanding and future investment commitments;
·availability, terms and our rate of deployment of equity and debt capital;
·our manager’s ability to hire and retain qualified personnel;
·changes in the self-storage industry, interest rates or the general economy;
·the degree and nature of our competition;
·volatility in the value of our assets carried at fair market value; and
·general volatility of the capital markets and the market price of our common stock.

 

Given these uncertainties, undue reliance should not be placed on our forward-looking statements. We assume no duty or responsibility to publicly update or revise any forward-looking statement that may be made to reflect future events or circumstances or to reflect the occurrence of unanticipated events. We urge you to review the disclosures concerning risks in the sections entitled “Risk Factors,” “Forward-Looking Statements,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2016 Form 10-K.

 

Overview

 

We are a commercial real estate company incorporated in Maryland that provides capital to private developers, owners and operators of self-storage facilities. Our principal business objective is to deliver attractive, long-term risk-adjusted returns to our stockholders by investing primarily in newly-constructed self-storage facilities, which we refer to as development property investments. We expect to generate attractive long-term returns on development property investments through interest payments (typically at a fixed rate) on our invested capital together with a 49.9% interest in the positive cash flows from operations, sales and/or refinancings of the self-storage facility, which we refer to herein as “Profits Interests.” We have selectively made construction loans, operating property loans, and bridge loans where we have determined that making such loans will benefit our primary business. In addition, in connection with many of our development property investments, we obtain a right of first refusal to acquire the subject property. In the future, we expect to acquire self-storage properties by exercising our rights of first refusal.

 

We account for our development property investments and operating property loans at fair value. Under fair value accounting, each of our development property investments and operating property loans is re-valued each quarter, and any unrealized appreciation and depreciation from those financial instruments is reflected in the carrying values of those investments in our Consolidated Balance Sheets and in our Consolidated Statements of Operations. We believe reflecting our investments at fair value provides our stockholders and others who rely on our financial statements with a more complete and accurate understanding of our financial condition and economic performance, including our revenues and the intrinsic value inherent in our Profits Interests as newly-developed self-storage facilities we finance are occupied, leased-up and become stabilized.

 

As of March 31, 2017, we had 28 on-balance sheet investments, for an aggregate committed principal amount of $239.9 million, including 22 development property investments totaling approximately $207.4 million of aggregate committed principal amount, each of which provides us with a Profits Interest, two construction loans totaling approximately $22.5 million of aggregate committed principal amount and four operating property loans totaling approximately $10.0 million of aggregate committed principal amount. Each of the development property investments is located in a submarket within a major U.S. market with demographics that management believes will support successful lease-up and value creation in the property As of March 31, 2017, we had funded approximately $115.3 million of the aggregate committed principal amount of our closed investments.

 

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We have funded all of our investments to date with the following sources of capital:

 

·net proceeds from our IPO and concurrent private placement, which were consummated on April 1, 2015;
·proceeds from the sale of senior participations, which we also refer to as “A notes”, in certain investments;
·net proceeds from the issuance of our Series A Preferred Stock pursuant to a Stock Purchase Agreement between us and funds managed by Highland Capital Management, L.P. providing for the issuance and sale of up to $125.0 million of Series A Preferred Stock from time to time until July 28, 2018; and
·net proceeds from our follow-on public offering of common stock, which was consummated on December 13, 2016.

 

On March 7, 2016, we, through our Operating Company, entered into the JV Agreement of Storage Lenders LLC to form SL1 Venture with HVP III, an investment vehicle managed by Heitman. The SL1 Venture was formed for the purpose of providing capital to developers of self-storage facilities identified and underwritten by us. Upon formation, HVP III committed $110.0 million for a 90% interest in the SL1 Venture, and we committed $12.2 million for a 10% interest. On March 31, 2016, we contributed to the SL1 Venture three self-storage development investments with an aggregate commitment amount of $41.9 million. As of March 31, 2017, the SL1 Venture had closed on eight additional development property investments with a profits interest with an aggregate commitment amount of approximately $81.4 million, bringing the total aggregate commitment of SL1 Venture’s investments to $123.3 million as of March 31, 2017.

 

The Company is externally managed and advised by the Manager. The Manager is led by our founder and chief executive officer, Dean Jernigan, and our president and chief operating officer, John A. Good. Mr. Jernigan is a 30-year veteran of the self-storage industry, including a combined 16 years as the chief executive officer of Storage USA and CubeSmart, both New York Stock Exchange listed self-storage REITs. During his time at these two companies, Mr. Jernigan oversaw the investment of over $3 billion of capital in the self-storage industry. Mr. Good has over 28 years working with senior management teams and boards of directors of public companies in the REIT and financial services industries on corporate finance, corporate governance, merger and acquisition, tax, executive compensation, joint venture, and strategic planning projects as a nationally recognized corporate and securities lawyer. Prior to joining the Company, he served as lead counsel on over 200 securities offerings, including our IPO, raising in excess of $25 billion over the past 25 years, with more than 125 of those deals being in the REIT industry. We believe the industry experience and depth of relationships of our senior management team and other investment professionals provide us with a significant competitive advantage in sourcing, evaluating, underwriting and servicing self-storage investments.

 

We are a Maryland corporation that was organized on October 1, 2014 that has elected to be taxed as a REIT under the Internal Revenue Code of 1986 (the “Code”). As a REIT, we generally will not be subject to U.S. federal income taxes on our taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gains, to the extent that we annually distribute all of our REIT taxable income to stockholders and comply with certain other requirements for qualification as a REIT set forth in the Code. We are structured as an UPREIT and conduct our investment activities through our Operating Company. We also intend to operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940.

 

Factors Impacting Our Operating Results

 

The results of our operations are affected by a number of factors including, among other things;

 

·the pace at which we are able to deploy capital into development property investments and begin earning interest income, which pace can be dependent on the timing of government issuance of building permits, weather and other factors outside our control;
·the timing of certificates of occupancy of facilities we finance and the pace of lease-up of such facilities;
·availability of capital and whether investments are made on-balance sheet or through off-balance sheet joint ventures:
·changes in the fair value of our assets; and
·the performance of self-storage facilities in which we have invested, either directly or through the SL1 Venture.

 

Our total investment income includes interest income from investments, which also reflects the accretion of origination fees, and is recognized utilizing the interest method based on the contractual rate and the outstanding principal balance of the loans we originate. The objective of the interest method is to arrive at periodic interest income that yields a level rate of return over the loan term. Interest rates may vary according to the type of loan, conditions in the financial markets, creditworthiness of our borrowers, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers. Our income also includes earnings from our investment in the SL1 Venture, which is calculated based on the allocation of earnings as prescribed in the JV Agreement. In addition, our operating results are affected by the valuation of our development property investments and our operating property loans. These investments are marked to fair value each quarter, and increases and decreases in fair value are reflected in the carrying values of the investments in our Consolidated Balance Sheets and as unrealized increases/decreases in fair value in our Consolidated Statements of Operations. In one event we made, and in the future we may make, additional equity investments in self-storage facilities, either for fee simple ownership by our Operating Company or in joint ventures with our developers, institutional or other strategic partners Our operating results include rental income and related operating expenses from owned self-storage facilities. In that regard, in connection with many of our development investments, we have obtained rights of first refusal in connection with potential future sales of self-storage facilities that we finance. Our results for the three months ended March 31, 2017 and 2016 also were impacted by our accounting methods as discussed below.

 

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Changes in Fair Value of Our Assets

 

We have elected the fair value option of accounting for our investment portfolio. We have elected fair value accounting for these financial instruments because we believe such accounting provides stockholders and others who rely on our financial statements with a more complete and accurate understanding of our economic performance, including our revenues and the intrinsic value inherent in the Profits Interests we possess. Under the fair value option, we mark our development property investments and operating property loans to estimated fair value at the end of each accounting period, with corresponding increases or decreases in fair value being reflected in our Consolidated Statements of Operations. There is no active secondary market for our development property investments and operating property loans and no readily available market value; accordingly, our determination of fair value requires judgment and extensive use of estimates. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our development property investments and operating property loans may fluctuate from period to period. Additionally, the fair value of our development property investments and operating property loans may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that we may ultimately realize. Our development property investments and operating property loans are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If we were required to liquidate an investment in a forced or liquidation sale, we could realize significantly less than the value at which we have recorded it. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned.

 

Changes in Market Interest Rates

 

With respect to our business operations, increases in interest rates, in general, may over time cause: the interest expense associated with our borrowings to increase; the value of our loan portfolio to decline; interest rates on any floating rate loans to reset, although on a delayed basis, to higher interest rates; and to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to increase. Conversely, decreases in interest rates, in general, may over time cause: the interest expense associated with our borrowings to decrease; the value of our mortgage loan portfolio to increase; interest rates on any floating rate loans to reset, although on a delayed basis, to lower interest rates; and to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to decrease.

 

Credit Risk

 

We are subject to varying degrees of credit risk in connection with our target investments and other loans. Our Manager seeks to mitigate this risk by seeking to originate or acquire loans of higher quality at appropriate prices given anticipated and unanticipated losses, by utilizing a comprehensive selection, underwriting and due diligence review process, and by proactively monitoring originated or acquired loans. Nevertheless, unanticipated credit losses could occur that could adversely impact our operating results.

 

Market Conditions

 

We believe that present market conditions are favorable for realizing attractive risk-adjusted returns on investments in self-storage facilities owned by private operators. While construction in the self-storage sector remains low compared to historical averages, the sector has experienced increased construction starts recently and the trend is expected to continue upwards. In addition, the number of purchase and sale transactions has been increasing, fueled by investor appetite for self-storage’s cash flow performance. The key demand drivers of the self-storage sector include population mobility and new job creation, both of which are experiencing increases since the recession, as well as population growth. These drivers have created demand for self-storage, which in turn have developers looking to develop and match demand with supply. The main deterrent for developers is the lack of financing available in the sector. Currently, lenders are only willing to lend up to 70% LTV, whereas our substantial industry knowledge enables us to make loans at ratios of approximately 90% LTC.

 

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Recent Developments

 

Investment Activity

 

Subsequent to March 31, 2017, we closed on the following development property investments with a profits interest:

  

Closing Date   MSA  

Total Investment

Commitment

 
4/14/2017   Louisville   $ 8,523  
4/20/2017   Denver 1     11,164  
4/20/2017   Denver 2     9,806  
5/2/2017   Tampa 2     8,091  
5/2/2017   Atlanta 6     12,543  
    Total   $ 50,127  

 

On April 20, 2017, we received $1.2 million for the payoff of an operating property loan in the Nashville, Tennessee MSA.

 

On April 20, 2017, we received aggregate repayments of $2.8 million related to two loans recorded at cost in connection with the closings of the above-described Denver 1 and Denver 2 development property investments with a profits interest.

 

On May 2, 2017, we received a repayment of $3.0 million related to a loan recorded at cost in connection with the closing of the above-described Atlanta 6 development property investment with a profits interest.

 

Capital Activity

 

On April 5, 2017, we commenced an at-the-market continuous equity offering program (the “ATM Program”) through which we may, from time to time, issue and sell shares of our common stock having an aggregate offering price of up to $50.0 million. Since the inception of the ATM Program, we have issued and sold an aggregate of 874,402 shares of common stock at a weighted average price of $22.76 per share under the ATM Program, receiving net proceeds after offering costs and commissions of $19.6 million. We intend to use net proceeds from sales under the ATM Program to fund investments and for general corporate purposes. The timing of any sales will depend on a variety of factors to be determined by management.

 

Dividend Declarations

 

On May 3, 2017, our Board of Directors declared a cash dividend to the holders of the Series A Preferred Stock and a distribution payable in kind in a number of shares of common stock or Series A Preferred Stock as determined in accordance with the election of the holders of the Series A Preferred Stock for the quarter ending June 30, 2017. The dividends are payable on July 15, 2017 (or if not a business day, on the next business day) to holders of Series A Preferred Stock of record on July 1, 2017.

 

On May 3, 2017, our Board of Directors also declared a cash dividend of $0.35 per share of common stock for the quarter ending June 30, 2017. The dividend is payable on July 14, 2017 to stockholders of record on July 3, 2017.

 

Second Amended and Restated Management Agreement

 

Effective as of April 1, 2017, we, along with the Manager, entered into a Second and Amended Restated Management Agreement to modify the manner in which certain expenses incurred by the Manager are accounted for and paid by us. Under the Amended and Restated Management Agreement, the Manager may engage independent contractors that provide investment banking, securities brokerage, mortgage brokerage and other financial, legal and account services as may be required for our investments, and we agree to reimburse the Manager for costs and expenses incurred in connection with these services. The Second Amended and Restated Management Agreement now provides that expenses incurred by the Manager are reimbursable to the Manager by us only to the extent such expenses are not otherwise directly reimbursed by an unaffiliated third party. The amount of expenses to be reimbursed to the Manager by us will be reduced dollar-for-dollar by the amount of any such payment or reimbursement.

 

Amended and Restated 2015 Equity Incentive Plan

 

On May 3, 2017, our stockholders approved the Amended and Restated 2015 Equity Incentive Plan to increase the number of shares of common stock reserved for issuance under the Plan by 170,000 shares from 200,000 shares to 370,000 shares and to extend the term of the Amended and Restated 2015 Equity Incentive Plan to May 2, 2027. On May 3, 2017, three non-employee directors of the Company were each granted an award of 2,138 shares of common stock (total of 6,414 shares), which immediately vested on the grant date. In addition, certain employees of the Manager were granted a cumulative total of 105,000 shares of restricted common stock, which vest ratably over a three-year period.

 

Investment Activity

 

Our self-storage investments at March 31, 2017 consisted of the following:

 

·Development Property Investments - We had 22 investments totaling an aggregate committed principal amount of approximately $207.4 million to finance the ground-up construction of or conversion of existing buildings into self-storage facilities. Each development property investment is funded as the developer constructs the project. Each development property investment is typically comprised of a first mortgage loan and a 49.9% interest in the positive cash flows (including the sale and refinancing proceeds after debt repayment) of the project. The loans are secured by the first mortgages on the projects and in certain cases a first priority security interests in the membership interests of the owners of the projects. Loans comprising development property investments are non-recourse with customary carve-outs and subject to completion guaranties, are interest-only with a fixed interest rate of 6.9% per annum and have a term of 72 months.

 

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We also had two construction loan investments totaling an aggregate committed principal amount of approximately $22.5 million, each of which had an initial term of 18 months that can be extended on a case-by-case basis. Each construction loan is interest-only at a fixed interest rate of 6.9% per annum, has no equity participation and is secured by a first priority mortgage or deed of trust on the project. Each of these construction loans is subject to a purchase and sale agreement between the developer and a third-party purchaser, containing certain conditions, pursuant to which the financed project is anticipated to be sold and our loan repaid on or about the time a certificate of occupancy is issued for the financed self-storage facility.

 

·Operating property loans - We had four term loans totaling $10.0 million of aggregate committed principal amount, the proceeds of which were used by borrowers to finance the acquisition of, refinance existing indebtedness on, or recapitalize operating self-storage facilities. These loans are secured by first mortgages on the projects financed, are interest-only with fixed interest rates ranging from 5.85% to 6.9% per annum, and generally have a term of 72 months.

 

Our development property investments and operating property loans are collectively referred to herein as our investment portfolio.

 

As of March 31, 2017, the aggregate committed principal amount of our investment portfolio is approximately $239.9 million and outstanding principal is $115.3 million, as described in more detail in the table below (dollars in thousands):   

 

Closing Date 

Metropolitan

Statistical Area

("MSA")

 

Total Investment

Commitment

  

Funded

Investment(1)

  

Remaining

Unfunded

Commitment

   Fair Value 
Development property investments:                
Loan investments with a profits interest:                    
4/21/2015  Orlando 1 (2) (4)  $5,372   $5,336   $36   $1,325 
6/10/2015  Atlanta 1 (2)   8,132    7,763    369    10,265 
6/19/2015  Tampa (2)   5,369    5,285    84    6,306 
6/26/2015  Atlanta 2 (2)   6,050    5,655    395    8,895 
6/29/2015  Charlotte 1 (2)   7,624    6,978    646    10,213 
7/2/2015  Milwaukee (2)   7,650    6,695    955    8,412 
7/31/2015  New Haven (2)   6,930    5,818    1,112    7,531 
8/10/2015  Pittsburgh (3)   5,266    3,961    1,305    5,006 
8/14/2015  Raleigh   8,792    2,055    6,737    1,955 
9/30/2015  Jacksonville 1 (2)   6,445    5,954    491    8,219 
10/27/2015  Austin (2)   8,658    5,616    3,042    6,748 
9/20/2016  Charlotte 2   12,888    1,875    11,013    1,662 
11/17/2016  Orlando 2 (3)   5,134    2,089    3,045    2,074 
11/17/2016  Jacksonville 2   7,530    1,553    5,977    1,491 
1/4/2017  New York City   16,117    8,765    7,352    8,746 
1/18/2017  Atlanta 3   14,115    3,051    11,064    2,944 
1/31/2017  Atlanta 4   13,678    5,305    8,373    5,234 
2/24/2017  Orlando 3   8,056    604    7,452    526 
2/24/2017  New Orleans   12,549    -    12,549    - 
2/27/2017  Atlanta 5   17,492    4,469    13,023    4,332 
3/1/2017  Fort Lauderdale   9,952    1,710    8,242    1,622 
3/1/2017  Houston   13,630    3,211    10,419    3,102 
      $207,429   $93,748   $113,681   $106,608 
                        
Construction loans:                    
8/5/2015  Sarasota   4,792    4,098    694    4,134 
12/23/2015  Miami   17,733    7,473    10,260    7,194 
      $22,525   $11,571   $10,954   $11,328 
   Subtotal  $229,954   $105,319   $124,635   $117,936 
                        
Operating property loans:                    
6/19/2015  New Orleans   2,800    2,800    -    2,783 
7/7/2015  Newark   3,480    3,480    -    3,464 
10/30/2015  Nashville(5)   1,210    1,210    -    1,211 
12/22/2015  Chicago   2,502    2,500    2    2,507 
   Subtotal  $9,992   $9,990   $2   $9,965 
                        
   Total investments  $239,946   $115,309   $124,637   $127,901 
                        

 

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  (1) Represents principal balance of loan gross of origination fees.  
  (2) Facility had received certificate of occupancy as of March 31, 2017. See Note 4, Fair Value of Financial Instruments, for information regarding recognition of entrepreneurial profit.
  (3) Facility had achieved at least 40% construction completion but had not received certificate of occupancy as of March 31, 2017. See Note 4, Fair Value of Financial Instruments, for information regarding recognition of entrepreneurial profit.
  (4) In February 2017, we purchased, for $1.3 million, 50% of the economic rights of the Class A membership units of the limited liability company which owns this development property investment, thus increasing our profits interest in this investment from 49.9% to 74.9%. As such, the investment was reclassified as self-storage real estate owned in the March 31, 2017 Consolidated Balance Sheet. See Note 7, Self-Storage Real Estate Owned, for additional discussion. The committed and funded investment amounts in this table pertain to the full terms of the development investment, while, the fair value represents only the portion (25.1%) of the principal balance constituting a loan to the Class A member.
  (5) This investment was repaid in April 2017.

  

As of March 31, 2017, SL1 Venture had 11 development property investments with a profits interest as described in more detail in the table below (dollars in thousands):

 

Closing Date  

Metropolitan

Statistical Area

("MSA")

 

Total Investment

Commitment

   

Funded

Investment(1)

   

Remaining

Unfunded

Commitment

    Fair Value  
5/14/2015   Miami 1 (2)   $ 13,867     $ 6,813     $ 7,054     $ 7,587  
5/14/2015   Miami 2 (2)     14,849       6,064       8,785       5,930  
9/25/2015   Fort Lauderdale (2)     13,230       4,574       8,656       4,433  
4/15/2016   Washington DC     17,269       8,716       8,553       8,756  
4/29/2016   Atlanta 1     10,223       1,196       9,027       1,109  
7/19/2016   Jacksonville     8,127       3,669       4,458       4,257  
7/21/2016   New Jersey     7,828       789       7,039       712  
8/15/2016   Atlanta 2     8,772       3,025       5,747       3,132  
8/25/2016   Denver     11,032       3,557       7,475       3,448  
9/28/2016   Columbia     9,199       3,461       5,738       3,427  
12/22/2016   Raleigh     8,877       1,081       7,796       1,006  
    Total   $ 123,273     $ 42,945     $ 80,328     $ 43,797  

 

  (1) Represents principal balance of loan gross of origination fees.  
  (2) These development property investments (having approximately $8.1 million of outstanding principal balances at contribution) were contributed to the SL1 Venture on March 31, 2016.

 

Business Outlook

 

We continue to experience strong demand for our capital for the development of state-of-the-art Class A self-storage facilities in top U.S. markets. As of May 3, 2017, we had projects that were in various stages of our underwriting process, including several subject to executed term sheets, for prospective investment amounts of approximately $825.0 million. While we typically estimate closing dates for investment transactions subject to executed term sheets, often the closings of such investments are subject to events, such as site plan approval, and other occurrences outside our control, which can result in delays beyond our estimated closing dates. Moreover, we can provide no assurance that any of the existing or future projects subject to term sheets will produce actual investment commitments or if all term sheets will meet all conditions necessary to consummate investment commitments, and we can provide no assurance that we will have adequate capital to close all such prospective commitments in the future.  

 

Throughout the first quarter of 2017, we funded development draws on the 11 development property investments to which we had committed an aggregate of approximately $76.5 million at December 31, 2015. As of March 31, 2017, nine of those development properties had achieved certificates of occupancy, and we have realized a significant portion of the potential profit on these developments through our fair value adjustments. We currently expect certificates of occupancy to be issued on the two remaining projects in 2017. 

 

During the period January 1 through August 31, 2016, we made no development property investments on-balance sheet, with all such investments being made through the SL1 Venture pursuant to the terms of our joint venture agreement executed in March 2016. We have a 10% capital interest in SL1 Venture that entitles us to 10% of operating earnings and profits from sales of properties by the joint venture, as well as potential residual interests upon our SL1 Venture partners achieving certain internal rates of return on their invested capital.

 

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Insofar as we have already realized a substantial percentage of fair value increases on 9 of our 11 development property investments made on-balance sheet in 2015 and have only a 10% interest in SL1 Venture until certain return hurdles are met, our 2017 fair value adjustments could be less than the fair value adjustments we realized in 2016. However, with substantially greater access to capital during the second half of 2016 and into 2017, we resumed investing “on-balance sheet” and closed three development property investments prior to the end of 2016 and thirteen more with an aggregate committed principal of $155.7 million through May 3, 2017, although these development projects are not expected to be completed until late 2017 or the first quarter of 2018. Accordingly, the amount of fair value adjustments for anticipated profits on these projects is expected to be limited in 2017 but should accelerate substantially in 2018.

 

During the three months ended March 31, 2017, the underlying self-storage facility of one of our development property investments with a profits interest received a certificate of occupancy and commenced operations. The following table reflects occupancy data as of May 7, 2017 for these nine facilities:

 

 

Location

Date Opened # Days Open Occupancy
Riverview, Florida (Tampa) April 11, 2016 392 76.9%
Ocoee, Florida (Orlando) May 1, 2016 372 74.2%
Marietta, Georgia (Atlanta) May 24, 2016 349 55.8%
Alpharetta, Georgia (Atlanta) May 25, 2016 348 47.1%
Jacksonville, Florida August 12, 2016 269 70.9%
Charlotte, North Carolina August 18, 2016 263 23.3%
Milwaukee, Wisconsin October 9, 2016 (1) 211 12.1%
New Haven, Connecticut December 16, 2016 143 20.9%
Round Rock, Texas (Austin) March 16, 2017 53 8.1%
Average   267 43.3% (2)

 

(1)Certificate of Occupancy was received in August 2016, prior to the property being ready for opening by the manager of the project. Property opened to partial leasing in October 2016. All floors opened to leasing in February 2017.

 

(2)Represents mean average occupancy. Weighted average occupancy (based on number of days open) is 52.0%.

 

The occupancy rates noted above pertain to the aforementioned nine properties only and are not indicative of future lease-up rates of other facilities that will commence operations.

 

Critical Accounting Policies

 

There have been no significant changes to our critical accounting policies as disclosed in the 2016 Form 10-K.

 

Recent Accounting Pronouncements

 

A discussion of recent accounting pronouncements affecting us is included in Note 2 of the accompanying interim consolidated financial statements.

 

Results of Operations

 

The following discussion of our results of operations should be read in conjunction with the interim consolidated financial statements and the accompanying notes thereto. 

 

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Comparison of the three months ended March 31, 2017 and March 31, 2016:

 

(Dollars in thousands)  Three months ended 
   March 31, 2017   March 31, 2016 
Revenues:        
Interest income from investments  $2,119   $1,143 
Rental  and other property related income from real estate owned   63    - 
Other income   119    - 
Total revenues   2,301    1,143 
           
Costs and expenses:          
General and administrative expenses   1,578    1,304 
Management fees to Manager   630    414 
Property operating expenses of real estate owned   55    - 
Transaction and other expenses   -    1,952 
Restructuring costs   -    7 
Deferred termination fee to Manager   -    157 
Total costs and expenses   2,263    3,834 
           
Operating income (loss)   38    (2,691)
           
Other income (expense):          
Equity in earnings from unconsolidated real estate venture   422    - 
Change in fair value of investments   1,393    3,791 
Interest expense   (204)   - 
Other interest income   134    22 
Total other income   1,745    3,813 
Net income   1,783    1,122 
Net income attributable to preferred stockholders   (546)   - 
Net income attributable to common stockholders  $1,237   $1,122 

 

Revenues

 

Total interest income from investments for the three months ended March 31, 2017 was $2.1 million, an increase of $1.0 million from the three months ended March 31, 2016, and consists of interest earned on the outstanding principal balances on our investment portfolio and other loans and accretion of origination fees. The interest rate on the majority of our investment portfolio and other loans is 6.9% per annum. The increase is primarily attributed to the increase in the outstanding principal balances of our investment portfolio and other loans. We also had rental revenue of $0.1 million from real estate owned during the three months ended March 31, 2017 that is related to our interest in the revenues generated by the self-storage real estate owned that was acquired during the first quarter of 2017. Other income of $0.1 million earned during the three months ended March 31, 2017 is derived from borrower payment of internal costs in connection with closings during the quarter and management fee revenue generated from the SL1 Venture.

 

Expenses

 

The following table provides a detail of total general and administrative expenses (dollars in thousands):

 

   Three months ended 
   March 31, 2017   March 31, 2016 
Compensation and benefits  $920   $766 
Occupancy   89    112 
Business development   74    113 
Professional fees   295    210 
Other   200    103 
Total general and administrative expenses  $1,578   $1,304 
           

 

 

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Total general and administrative expenses

 

Total general and administrative expenses for the three months ended March 31, 2017 were $1.6 million, an increase of $0.3 million from the three months ended March 31, 2016. Compensation and benefits included non-cash expense of stock-based compensation of $292,000 and $175,000 for the three months ended March 31, 2017 and 2016, respectively, which was affected by the increase in the Company’s common stock price during the first quarter of 2017. Other expenses increased primarily due to additional franchise taxes accrued in the first quarter 2017.

 

Transaction and other expenses

 

For the three months ended March 31, 2017, there were no transaction and other expenses. The $2.0 million of transaction and other expenses for the three months ended March 31, 2016 primarily consists of advisory fees and other expenses incurred in connection with our various financing transactions.

 

Other operating expenses

 

The management fees of $0.6 million and $0.4 million in the three months ended March 31, 2017 and 2016, respectively, relate to the fee earned by the Manager pursuant to the management agreement. Management fees increased over the quarter ended March 31, 2017 due to additional equity capital raised in the fourth quarter of 2016. Property operating expenses of real estate owned for the three months ended March 31, 2017 relate to the operating activities of the Company’s self-storage real estate owned and includes $24,000 of depreciation expense. There were no restructuring costs incurred during the three months ended March 31, 2017. The $7,000 of restructuring costs incurred during the three months ended March 31, 2016 related to remaining lease termination costs incurred by closing the Miami, Florida office. The deferred termination fee to our Manager of $0.2 million for the three months ended March 31, 2016 represented the accrual over the term of the management agreement of the deferred termination fee payable by our Operating Company in OC Units pursuant to the management agreement. On May 23, 2016, we amended the management agreement thus resulting in the cessation of this accrual.

 

Other income (expense)

 

For the three months ended March 31, 2017 and 2016, we recorded other income of $1.7 million and $3.8 million, respectively, which primarily relates to the change in fair value of investments. The change in fair value of investments decreased primarily due to a significant portion of the entrepreneurial profit adjustments on our on-balance sheet investments that were closed in 2015 being recognized in 2016. We made no on-balance sheet investments from January through August 31, 2016. The $0.4 million of equity in earnings from unconsolidated real estate venture in the three months ended March 31, 2017 relates to our allocated earnings from the SL1 Venture. Interest expense for the three months ended March 31, 2017 was $0.2 million and relates primarily to interest incurred on our senior A note participations.

  

Adjusted Earnings

 

Adjusted Earnings is a performance measure that is not specifically defined by GAAP and is defined as net income (loss) attributable to common stockholders (computed in accordance with GAAP) plus stock dividends payable to preferred stockholders, stock-based compensation expense, depreciation on real estate assets, transaction and other expenses, deferred termination fee to Manager, and restructuring costs.

 

Adjusted Earnings should not be considered as an alternative to net income or any other GAAP measurement of performance or as an alternative to cash flow from operating, investing, and financing activities as a measure of liquidity. We believe that Adjusted Earnings is helpful to investors as a starting point in measuring our operational performance, because it excludes various equity-based payments (including stock dividends) and other items included in net income that do not relate to or are not indicative of our operating performance, which can make periodic and peer analyses of operating performance more difficult. Our computation of Adjusted Earnings may not be comparable to other key performance indicators reported by other REITs or real estate companies.

 

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The following tables are reconciliations of Adjusted Earnings to net income attributable to common stockholders (dollars in thousands): 

 

   Three months ended 
   March 31,
2017
  

March 31,

2016

 
Net income attributable to common stockholders  $1,237   $1,122 
Plus: stock dividends payable to preferred stockholders   371    - 
Plus: stock-based compensation   292    175 
Plus: depreciation on real estate assets   24    - 
Plus: transaction and other expenses   -    1,952 
Plus: restructuring costs   -    7 
Plus: deferred termination fee to Manager   -    157 
Adjusted Earnings  $1,924   $3,413 

 

Liquidity and Capital Resources

 

Liquidity is a measure of our ability to meet potential cash requirements, including commitments to fund our investment portfolio, repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders and other general business needs. We will use significant cash to originate our target investments, make distributions to our stockholders and fund our operations.

 

Liquidity

 

As of March 31, 2017, we had unrestricted cash of approximately $28.3 million, and we had remaining unfunded commitments of $124.6 million related to our investment portfolio. At March 31, 2017, we had the ability to issue an additional $115.0 million of Series A Preferred Stock pursuant to our Stock Purchase Agreement. Additionally, on April 5, 2017, we entered into the ATM Program whereby we may issue and sell up to $50.0 million of our common stock from time to time. Since the inception of the ATM Program, we have sold 874,402 shares of common stock at a weighted average price of $22.76, receiving net proceeds after commissions of $19.6 million. In addition, we have $11.1 million of available funding from our senior participations at March 31, 2017. Finally, we have current capacity to sell senior participations (A notes) on approximately $32.4 million of investments to raise up to $19.4 million of additional capital, and we expect to create additional debt capacity from senior participations as development property investments are completed and begin to lease-up during 2017. We believe that the foregoing sources of capital will provide us with adequate liquidity to fund our operations and investment activities for at least the next 12 months.

 

Cash Flows

 

The following table sets forth changes in cash and cash equivalents:

 

   Three months ended March 31, 
   2017   2016 
Net income  $1,783   $1,122 
Adjustments to reconcile net income to net cash provided by (used in) operating activities   (1,779)   (2,624)
Net cash provided by (used in) operating activities   4    (1,502)
Net cash used in investing activities   (36,439)   (11,399)
Net cash used in financing activities   (2,686)   (2,157)
Change in cash and cash equivalents  $(39,121)  $(15,058)

 

Cash decreased $39.1 million during the three months ended March 31, 2017 as compared to a decrease in cash of $15.1 million during the three months ended March 31, 2016. Net cash provided by operating activities for the three months ended March 31, 2017 was $4,000 and net cash used in operating activities for the three months ended March 31, 2016 was $1.5 million, reflecting a decrease in cash used of $1.5 million. This decrease in cash used was primarily attributable to $1.1 million of origination fees received in cash during the three months ended March 31, 2017. The primary components of cash provided by operating activities during the three months ended March 31, 2017 were $1.1 million of origination fees received in cash and $0.2 million of return on investment from our unconsolidated joint venture, offset, in part, by net income adjusted for non-cash transactions of $1.3 million.

 

Net cash used in investing activities for the three months ended March 31, 2017 and 2016 was $36.4 million and $11.4 million, respectively. For the three months ended March 31, 2017, the cash used for investing activities consisted primarily of $33.8 million to fund investments, $8.2 million to fund other loans, $1.3 million to purchase an additional interest in one of our development property loans, $1.3 million to fund capital contributions to the SL1 Venture, and a net use of $3.8 million for advancements made on behalf of the SL1 Venture, offset by $11.9 million from repayments of a construction loan and other loan investments.

 

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Net cash used in financing activities for the three months ended March 31, 2017 totaled $2.7 million and primarily related to $3.3 million of dividends paid and $0.1 million of deferred costs, offset by $0.7 million of cash received in connection with the sale of senior loan participations on certain of our investments. For the three months ended March 31, 2016, cash used by financing activities totaled $2.2 million related to dividends paid to our stockholders.

 

Equity Capital Policies

 

Subject to applicable law and NYSE listing standards, our board of directors has the authority, without further stockholder approval, to issue additional authorized common stock and preferred stock or otherwise raise capital, including through the issuance of senior securities, in any manner and on the terms and for the consideration it deems appropriate, including in exchange for property. Stockholders will have no preemptive right to additional shares issued in any offering, and any offering may cause a dilution of your investment.

 

Additionally, the holders of our Series A Preferred Stock have the right to purchase their pro rata share of any qualified offering of common stock, which consists of any offering by the Company of common stock except any shares of common stock issued (i) in connection with a merger, consolidation, acquisition or similar business combination, (ii) in connection with a joint venture, strategic alliance or similar corporate partnering arrangement, (iii) in connection with any acquisition of assets by the Company, (iv) at market prices pursuant to a registered at-the-market program and/or (v) as part of a compensatory or employment arrangement.

 

Leverage Policies

 

To date, we have funded all of our investments with the net proceeds from our IPO and concurrent private placement, which were consummated on April 1, 2015, proceeds from the sale of senior participations in certain investments, proceeds from the issuance of our Series A Preferred Stock, proceeds from our follow-on public offering of common stock, which was consummated on December 13, 2016 and proceeds received from sales of shares from time to time under the ATM Program. In the future, we may utilize equity raised in follow-on offerings, through the ATM Program and/or borrowing against our target investments in accordance with our investment guidelines in order to increase the size of our loan portfolio and potential return to stockholders. Our investment guidelines state that our leverage will generally not exceed 50% of the total value of our loan portfolio. Additionally, as long as shares of Series A Preferred Stock remain outstanding, we are required to maintain a ratio of debt to total tangible assets determined under GAAP of no more than 0.4:1, measured as of the last day of each fiscal quarter. We may borrow up to 100% of the principal value of certain development property loans. Our actual leverage will depend on our mix of loans. Our charter and bylaws do not limit the amount of indebtedness we can incur, and our board of directors has discretion to deviate from or change our investment guidelines at any time. We will use corporate leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates. Our financing strategy focuses on the use of match-funded financing structures. This means that we will seek to match the maturities and/or repricing schedules of our financial obligations with those of our loan portfolio to minimize the risk that we will have to refinance our liabilities prior to the maturities of our loans and to reduce the impact of changing interest rates on earnings. We will disclose any material changes to our leverage policies in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of the quarterly report on Form 10-Q or annual report on Form 10-K for the period in which the change was made, or in a Current Report on Form 8-K if required by the rules of the SEC or the board of directors deems it advisable, in its sole discretion.

  

Future Revisions in Policies and Strategies

 

The board of directors has the power to modify or waive our investment policies and strategies without the consent of our stockholders to the extent that the board of directors (including a majority of our independent directors) determines that a modification or waiver is in the best interest of our stockholders. Among other factors, developments in the market that either affect the policies and strategies mentioned herein or that change our assessment of the market may cause our board of directors to revise our policies and strategies. 

 

Contractual Obligations and Commitments

 

The following table reflects our total contractual cash obligations as of March 31, 2017: 

 

Contractual Obligations  2017   2018   2019   2020   2021   Total 
Long-term debt obligations (1) (2)  $-   $-   $15,397   $-   $3,935   $19,332 
Operating lease obligations   226    209    2    2    -    439 
Total  $226   $209   $15,399   $2   $3,935   $19,771 

 

(1) Represents principal payments gross of discounts and debt issuance costs.

(2) Amounts exclude interest, which is variable based on 30-day LIBOR plus spreads ranging from 3.10% to 3.85%.

 

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At March 31, 2017, we had $124.6 million of unfunded loan commitments related to our investment portfolio. These commitments are funded over the 18-24 months following the investment closing date as construction is completed. At March 31, 2017, we had $1.9 million of unfunded loan commitments related to our other assets.

 

As of March 31, 2017, we had unrestricted cash of approximately $28.3 million.

 

Off-Balance Sheet Arrangements

 

At March 31, 2017, we did not have any relationships, including those with unconsolidated entities or financial partnerships, for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that are material to investors.

 

Our investment in real estate venture is recorded using the equity method as we do not have a controlling interest.

 

Dividends

 

For the quarter ended March 31, 2017, we declared a cash dividend to our stockholders of $0.35 per share, payable on April 14, 2017 to stockholders of record on April 3, 2017. We intend to make regular quarterly distributions to holders of our common stock. U.S. federal income tax law generally requires that a REIT annually distribute at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. We intend to pay regular quarterly dividends to our stockholders in an amount equal to or greater than our net taxable income, if and to the extent authorized by our Board of Directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on any secured funding facilities, other lending facilities, repurchase agreements and other debt payable. If our cash available for distribution is less than our net taxable income, we could be required to reduce our dividends, sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.

 

Additionally, holders of our Series A Preferred Stock are entitled to a cumulative cash distribution (“Cash Distribution”) equal to (A) 7.0% per annum on the liquidation value, or $1,000 per share of Series A Preferred Stock (the “Liquidation Value”) for the period beginning on the respective date of issuance until the sixth anniversary of the Effective Date, payable quarterly in arrears, (B) 8.5% per annum on the Liquidation Value for the period beginning the day after the sixth anniversary of the Effective Date and for each year thereafter so long as the Series A Preferred Stock remains issued and outstanding, payable quarterly in arrears, and (C) an amount in addition to the amounts in (A) and (B) equal to 5.0% per annum on the Liquidation Value upon the occurrence of certain triggering events (a “Cash Premium”). In addition, the holders of the Series A Preferred Stock will be entitled to a cumulative dividend payable in-kind in shares of Common Stock or additional shares of Series A Preferred Stock, at the election of the holders (the “Stock Dividend”), equal in the aggregate to the lesser of (Y) 25% of the incremental increase in the Company’s book value (as adjusted for equity capital issuances, share repurchases and certain non-cash expenses) plus, to the extent the Company owns equity interests in income-producing real property, the incremental increase in net asset value (provided, however, that no interest in the same real estate asset will be double counted) and (Z) an amount that would, together with the Cash Distribution, result in a 14.0% internal rate of return for the holders of the Series A Preferred Stock from the date of issuance of the Series A Preferred Stock, as set forth in the Articles Supplementary classifying the Series A Preferred Stock (the “Articles Supplementary”). Triggering events that will trigger the payment of a Cash Premium with respect to a Cash Distribution include: (i) the occurrence of certain change of control events affecting the Company after the third anniversary of the Effective Date, (ii) the Company’s ceasing to be subject to the reporting requirements of Section 13 or Section 15(d) of the Exchange Act, (iii) the Company’s failure to remain qualified as a real estate investment trust, (iv) an event of default under the Purchase Agreement, (v) the failure by the Company to register for resale shares of Common Stock pursuant to the Registration Rights Agreement (a “Registration Default”), (vi) the Company’s failure to redeem the Series A Preferred Stock as required by the Purchase Agreement, or (vii) the filing of a complaint, a settlement with, or a judgment entered by the Securities and Exchange Commission against the Company or any of its subsidiaries or a director or executive officer of the Company relating to the violation of the securities laws, rules or regulations with respect to the business of the Company. Accrued but unpaid Cash Distributions and Stock Dividends on the Series A Preferred Stock will accumulate and will earn additional Cash Distributions and Stock Dividends as calculated above, compounded quarterly.

 

On March 7, 2017, we declared a (i) cash distribution of $17.50 per share of Series A Preferred stock, payable on April 14, 2017, to holders of Series A Preferred stock of record on the close of business on April 1, 2017, and (ii) distributions payable in kind in a number of shares of common stock as determined in accordance with the terms of the designation of the Series A Preferred stock, payable on April 17, 2017, to holders of Series A Preferred Stock of record on the close of business on April 1, 2017.

 

Inflation

 

Virtually all of our assets and liabilities will be interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions will be determined by our board of directors consistent with our obligation to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.  

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.

 

There have been no material changes in our credit risk, interest rate risk, interest rate mismatch risk, or real estate risks from what was disclosed in the 2016 Form 10-K.

 

Market Risk

 

Our development property investments and operating property loans generally will be reflected at their estimated fair value, with changes in fair market value recorded in our income. The estimated fair value of these investments fluctuates primarily due to changes in interest rates, capitalization rates, and other factors. Generally, in a rising interest rate environment, the estimated fair value of the fixed-rate securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of the fixed-rate securities would be expected to increase. As market volatility increases or liquidity decreases, the fair value of our investments may be adversely impacted. If we are unable to readily obtain independent pricing to validate our estimated fair value of any loan investment in our portfolio, the fair value gains or losses recorded in income may be adversely affected.

 

The following fluctuations in the market yields/discount rates would have had the following impact on the fair value of our investments: 

 

   Increase (decrease) in fair value of investments 
Change in market yields/discount rates (in millions)  March 31, 2017   December 31, 2016 
 Up 25 basis points  $(0.6)  $(0.3)
 Down 25 basis points, subject to a minimum yield/rate of 10 basis points   0.6    0.3 

 

The following fluctuations in the capitalization rates would have had the following impact on the fair value of our investments:

 

   Increase (decrease) in fair value of investments 
Change in capitalization rates (in millions)  March 31, 2017   December 31, 2016 
Up 25 basis points  $(2.2)  $(2.1)
Down 25 basis points   2.4    2.3 
           
Up 50 basis points   (4.2)   (3.8)
Down 50 basis points   5.0    4.6 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q. The controls evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer, President and Chief Operating Officer, and Chief Financial Officer. Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), such as this quarterly report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures are also designed to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Based on the controls evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC, and that material information related to our company and our consolidated subsidiaries is made known to management, including the Chief Executive Officer and Chief Financial Officer.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal controls over financial reporting during the quarter ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.   

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, we may be involved in various claims and legal actions in the ordinary course of business. As of March 31, 2017, we were not involved in any legal proceedings.

 

ITEM 1A. RISK FACTORS

 

The discussion of our business and operations should be read together with the risk factors contained in Part I, Item 1A of our 2016 Form 10-K, which describes various risks and uncertainties to which we are or may be subject. These risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flows and prospects in a material adverse manner.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS FROM REGISTERED SECURITIES

 

Unregistered Sales of Equity Securities

 

On October 4, 2016, we issued an aggregate of 10,000 restricted shares of Series A Preferred Stock to two funds managed by Highland Capital Management, L.P. pursuant to the terms of a Stock Purchase Agreement dated July 27, 2016. The issuance of the Series A Preferred Stock was effected in reliance upon an exemption from registration under the Securities Act of 1933 pursuant to Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D thereunder.

  

Repurchases of Common Stock

 

The following table
provides information
about repurchases of our
common shares during
the three months
ended March 31, 2017:
  Total
Number of
Shares
Purchased
   Average
Price Paid
Per Share
   Total Number of
Shares Purchased
as Part of Publicly Announced Plans or Programs
  

Maximum Dollar Value

that May Yet Be

Purchased Under the

Plans or Programs (1)

(dollars in thousands)

 
                 
January 1- January 31   -   $-    -   $6,848 
February 1- February 28   -    -    -    6,848 
March 1- March 31   -    -    -    6,848 
Total   -   $-    -   $6,848 

 

  (1)  

On May 23, 2016, we announced a program permitting us to repurchase a portion of our outstanding common stock not to exceed a dollar maximum of $10.0 million established by our Board of Directors.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

(a)       Not applicable.

 

(b)       Not applicable.

 

ITEM 6. EXHIBITS

 

The exhibits listed in the accompanying Exhibit Index, which is incorporated herein by reference, are filed or furnished as part of this Quarterly Report on Form 10-Q.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    JERNIGAN CAPITAL, INC.
     
Date: May 9, 2017 By: /s/ Dean Jernigan
    Dean Jernigan
   

Chairman and Chief Executive Officer

(Principal Executive Officer)

     
Date: May 9, 2017 By: /s/ Kelly P. Luttrell
    Kelly P. Luttrell
   

Senior Vice President, Chief Financial Officer, and Treasurer

(Principal Financial and Accounting Officer)

 

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EXHIBIT INDEX

 

*This certification is deemed not filed for purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.

 

       
Exhibit No.   Exhibit Description
       
  10.1*   Second Amended and Restated Management Agreement, dated as of April 1, 2017, by and among Jernigan Capital, Inc., Jernigan Capital Operating Company, LLC and JCap Advisors, LLC
       
  31.1*  

Certification by CEO pursuant to Rule 13(a)-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of Sarbanes-Oxley Act of 2002(1)

       
  31.2*  

Certification by CFO pursuant to Rule 13(a)-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of Sarbanes-Oxley Act of 2002(1)

       
  32.1*  

Certification by CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

       
  101.INS  

XBRL Instance Document*

       
  101.SCH  

XBRL Taxonomy Extension Schema Document*

       
  101.CAL  

XBRL Taxonomy Extension Calculation Linkbase Document*

       
  101.DEF  

XBRL Taxonomy Extension Definition Linkbase Document*

       
  101.LAB  

XBRL Taxonomy Extension Label Linkbase Document*

       
  101.PRE  

XBRL Taxonomy Extension Presentation Linkbase Document*

 

* Filed herewith

  

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