CORNERSTONE CORE PROPERTIES REIT, INC. – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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The following "Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with our financial statements and notes thereto contained elsewhere in this report. This section contains forward-looking statements, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based. These forward-looking statements generally are identified by the words "believes," "project," "expects," "anticipates," "estimates," "intends," "strategy," "plan," "may," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Forward-looking statements that were true at the time made may ultimately prove to be incorrect or false. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. All forward-looking statements should be read in light of the risks identified in Part II, Item 1A herein and Part I, Item 1A of our annual report on Form 10-K for the year endedDecember 31, 2011 filed with theU.S. Securities and Exchange Commission (the "SEC"). Overview
We were incorporated onOctober 22, 2004 for the purpose of engaging in the business of investing in and owning commercial real estate. As ofSeptember 30, 2012 , we had raised$167.1 million of gross proceeds from the sale of 20.9 million shares of our common stock in our initial and follow-on public offerings and had acquired thirteen industrial properties, four of which were sold during 2011. In third quarter of 2012, we acquired four healthcare related properties.
Our revenues, which are comprised largely of rental income, include rents reported on a straight-line basis over the initial term of each lease. Our growth depends, in part, on our ability to increase rental income and other earned income from leases by increasing rental rates and occupancy levels and controlling operating and other expenses. Our operations are impacted by property-specific, market-specific, general economic and other conditions.
OnNovember 23, 2010 , we stopped soliciting and accepting offers to purchase shares of our stock while our board of directors evaluates strategic alternatives to maximize value and we subsequently informed our investors of several decisions made by the board of directors for the health of our REIT.
Suspension of Distribution Reinvestment Plan. We suspended our distribution reinvestment plan effective
Distributions. EffectiveDecember 1, 2010 , our board of directors resolved to reduce distributions on our common stock to an annualized rate of$0.08 per share (1% based on a share price of$8.00 ), from the prior annualized rate of$0.48 per share (6% based on a share price of$8.00 ), in order to preserve capital that may be needed for capital improvements, debt repayment or other corporate purposes. Distributions at this rate were declared for the first and second quarters of 2011. InJune 2011 , the board of directors decided, based on the financial position of the Company, to suspend the declaration of further distributions and to defer the payment of the second quarter 2011 distribution until the financial position improved. In the fourth quarter of 2011, we sold theArizona properties and paid the second quarter distributions. No distributions have been declared for periods afterJune 30, 2011 . The rate and frequency of distributions is subject to the discretion of our board of directors and may change from time to time based on our operating results and cash flow. We can make no assurance when and if distributions will recommence. Stock Repurchase Program. After careful consideration of the proceeds that were available from our distribution reinvestment plan in 2010, and an assessment of our expected capital expenditures, tenant improvement costs and other costs and obligations related to our investments, our board of directors concluded that we did not have sufficient funds available to prudently fund any stock repurchases during 2011. Accordingly, our board of directors approved an amendment to our stock repurchase program to suspend repurchases under the program effectiveDecember 31, 2010 . We can make no assurances as to whether and on what terms repurchases will resume. The share repurchase program may be amended, resumed, suspended again, or terminated at any time. Our board of directors continues to evaluate and implement strategic alternatives to reposition our Company and enhance shareholders' value. Specifically, we sold the Goldenwest property inJune 2011 for gross proceeds of$9.4 million and made a principal payment of$7.8 million on theHSH Nordbank credit facility. Additionally, we sold theMack Deer Valley andPinnacle Park Business Center properties inNovember 2011 for gross proceeds of approximately$23.9 million . The net proceeds were used, in part, to pay down the remaining balance of theHSH Nordbank credit facility. InDecember 2011 , we sold the2111 South Industrial Park property for gross proceeds of$0.9 million . The proceeds were used to pay down the Wells Fargo loan. Furthermore, inFebruary 2012 , we amended our loan agreement with Wells Fargo. The amendment, executed upon our making a$7.5 million principal payment, extended the maturity date of the loan fromFebruary 13, 2012 toFebruary 13, 2014 and reduced the interest rate from 300 basis points over one-month LIBOR to 200 basis points over one-month LIBOR, with the LIBOR floor remaining fixed at 150 basis points. We are continuing to pursue options for repaying our debt, including asset sales. 31
Market Outlook - Real Estate and Real Estate Finance Markets
Beginning in 2010, and continuing through 2011 and into 2012, significant and widespread concerns about credit risk and access to capital experienced during 2009 began to subside. However, uncertainties created by a sluggish U.S. economy and global economic problems have depressed real estate demand. Increased trade volume in 2010 spurred some increase in leasing activity in select west coast industrial markets. However, if economic uncertainty persists, we may continue to experience significant vacancies and expect to be required to reduce rental rates on occupied space. Despite recent positive economic indicators, both the national and most global economies have experienced continued volatility throughout 2011 and 2012. These conditions, combined with stagnant business activity and low consumer confidence, have resulted in a challenging operating environment. As a result of the decline in general economic conditions, the U.S. commercial real estate industry has experienced deteriorating fundamentals across most major property types and most geographic markets. These market conditions have and may continue to have a significant impact on our industrial real estate investments. In addition, these market conditions have impacted our tenants' businesses, which makes it more difficult for them to meet current lease obligations and places pressure on them to negotiate favorable lease terms upon renewal in order for their businesses to remain viable. Increases in rental concessions given to retain tenants and maintain our occupancy level, which are vital to the continued success of our portfolio, have resulted in lower current cash flows from operations. Projected future declines in rental rates, slower or potentially negative net absorption of leased space and expectations of future rental concessions, including free rent to retain tenants who are up for renewal or to sign new tenants, could result in additional decreases in cash flows
from operations. Until market conditions are more stable, we expect to continue to limit capital expenditures, focusing on those capital expenditures that preserve value and/or generate rental revenue. However, if we experience an increase in vacancies, we may have to make capital investments to re-lease properties and pay leasing
commissions. Strategic Repositioning
Commencing in
The initial steps of this "repositioning" strategy involved the sale of certain industrial properties (Goldenwest,Mack Deer Valley ,Pinnacle Park and2111 South Industrial Park ). Proceeds from those sales transactions were used to "de-lever" the Company's balance sheet by paying down certain short term and other higher cost debt, extending maturities and renegotiating lower interest rates on other loan obligations. During the second and third quarters of 2012, the board of directors, in consultation with the Advisor, approved the reinvestment of the remaining proceeds from these 2011 property dispositions into four healthcare real property assets and acquired an option to purchase a fifth health care property. Diversification into healthcare real estate assets is expected to be accretive to the earnings and shareholder value of the combined portfolio. Such healthcare acquisitions were made through a joint venture with an affiliate of the Advisor and involved interim seller and/or third party lender financing. The Company intends to refinance such interim borrowings with long term financing. In the interest of further diversification of risk and to attract new capital partners, the Company may, in the future, reduce its ownership interest in the healthcare joint venture. Healthcare-related properties include a wide variety of properties, including senior housing facilities, medical office buildings ("MOBs"), and skilled nursing facilities ("SNFs"). Senior housing facilities include independent living facilities, assisted living facilities and memory and other continuing care retirement communities. Each of these caters to different segments of the elderly population. Services provided by operators or tenants in these facilities are primarily paid for by the residents directly or through private insurance and are less reliant on government reimbursement programs such asMedicaid andMedicare . MOBs typically contain physicians' offices and examination rooms, and may also include pharmacies, hospital ancillary service space, and outpatient services such as diagnostic centers, rehabilitation clinics and day-surgery operating rooms. While these facilities are similar to commercial office buildings, they require more systems to accommodate special requirements. MOBs are typically multi-tenant properties leased to multiple healthcare providers (hospitals and physician practices) although there is a trend towards net leases to doctors and hospitals. SNFs offer nursing care for people not requiring the more extensive and sophisticated treatment available at hospitals. Sub-acute care services are provided to residents beyond room and board. Certain skilled nursing facilities provide some services on an outpatient basis. Skilled nursing services provided in these facilities are primarily paid for either by private sources or through theMedicare andMedicaid programs. SNFs are typically leased to single-tenant operators under net lease structures. The Advisor has reported to us that it believes the outlook for us raising new property level joint venture equity capital to support our growth and further diversify both operator and healthcare property sector risk may currently be favorable. 32
Based in part on this advice, the board of directors continues to evaluate the repositioning strategy while pursuing other growth initiatives that lower capital costs and enable us to reduce or improve our ability to cover our general and administrative costs over a broader base of assets.
For the remainder of 2012 and in early 2013, the board of directors has requested that the Advisor raise new property level joint venture equity capital while management continues to evaluate opportunities for repositioning and growth and attempts to secure long term debt at favorable rates for recent
and any future acquisitions.
Critical Accounting Policies
There have been no material changes to our critical accounting policies as previously disclosed in our Annual Report on Form 10-K for the year ended
Results of Operations As ofSeptember 30, 2012 , we owned thirteen properties consisting of nine industrial and four healthcare properties which were purchased in the third quarter of 2012. InJanuary 2011 , we owned thirteen industrial properties of which four were subsequently sold. InJune 2011 , we sold the Goldenwest property for gross proceeds of$9.4 million . InNovember 2011 , we sold theMack Deer Valley andPinnacle Park Business Center properties for gross proceeds of$23.9 million . InDecember 2011 , we sold the2111 South Industrial Park property for gross proceeds of$0.9 million .
In
Three months ended
Three Months Ended September 30, % 2012 2011 $ Change Change Rental revenues, tenant reimbursements & other income $ 1,509,000 $ 1,053,000 $ 456,000 43.3 % Property operating and maintenance (380,000 ) (427,000 ) 47,000 (11.0 )% Net operating income (1) 1,129,000 626,000 503,000 80.4 % Interest income from notes receivable 13,000 102,000 (89,000 ) (87.3 )% General and administrative (757,000 ) (713,000 ) (44,000 ) 6.2 % Asset management fees and expenses (240,000 ) (388,000 )
148,000 (38.1 )% Real estate acquisition costs (737,000 ) - (737,000 ) 0.0 % Depreciation and amortization (524,000 ) (384,000 ) (140,000 ) 36.5 % Interest expense (299,000 ) (408,000 ) 109,000 (26.7 )% Impairment of real estate - (425,000 ) 425,000 (100.0 )%
Loss from continuing operations (1,415,000 ) (1,590,000 ) 175,000 (11.0 )% Loss from discontinued operations (156,000 ) 106,000 (262,000 ) (247.2 )% Net loss (1,571,000 ) (1,484,000 ) (87,000 ) 5.9 % Noncontrolling interests' share in losses (258,000 ) (352,000 ) 94,000 (26.7 )% Net loss applicable to common shares $ (1,313,000 ) $ (1,132,000 )
$ (181,000 ) 16.0 %
(1) Net operating income ("NOI") is a non-GAAP supplemental measure used to
evaluate the operating performance of real estate properties. We define NOI
as total rental revenues, tenant reimbursements and other income less
property operating and maintenance expenses. NOI excludes interest income
from notes receivable, general and administrative expense, asset management
fees and expenses, real estate acquisition costs, depreciation and
amortization, impairments, interest income, interest expense, and income from
discontinued operations. We believe NOI provides investors relevant and
useful information because it measures the operating performance of the
REIT's real estate at the property level on an unleveraged basis. We use NOI
to make decisions about resource allocations and to assess and compare
property-level performance. We believe that net income (loss) is the most
directly comparable GAAP measure to NOI. NOI should not be viewed as an
alternative measure of operating performance to net income (loss) as defined
by GAAP since it does not reflect the aforementioned excluded items.
Additionally, NOI as we define it may not be comparable to NOI as defined by
other REITs or companies, as they may use different methodologies for calculating NOI. See Note 18 for a summary table reconciling NOI from net loss. Rental revenues, tenant reimbursements and other income increased to$1.5 million for the three months endedSeptember 30, 2012 from$1.1 million for the three months endedSeptember 30, 2011 . The increase is primarily due to increased overall occupancy rates and approximately$0.3 million related to the acquisition of the new healthcare properties offset by lower average lease rental rates and longer lease-up periods for vacant industrial space as a result of the current economic environment. 33
Property operating and maintenance expense was comparable at
Interest income from notes receivable decreased to$13,000 for the three months endedSeptember 30, 2012 from$0.1 million for the three months endedSeptember 30, 2011 primarily due to the lower outstanding balance for theServant Healthcare Investments, LLC note resulting in less interest income in 2012 compared to approximately$0.1 million in interest income for the three months endedSeptember 30, 2011 .
General and administrative expenses increased to$0.8 million for the three months endedSeptember 30, 2012 from$0.7 million for the three months endedSeptember 30, 2011 . The increase is primarily due to higher professional fees, board meetings, allocations and regulatory filing costs. Asset management fees decreased to$0.2 million for the three months endedSeptember 30, 2012 from$0.4 million for the three months endedSeptember 30, 2011 . The lower asset management fees are primarily due to the sale of four properties in 2011 combined with a reduction in the annual asset management fee basis from 1.0% to 0.75% of the Average Invested Assets (as defined in the Advisory Agreement) partially offset by the fees associated with the four healthcare acquisitions. Real estate acquisition costs consisted primarily of fees paid to our Advisor for the acquisition of the healthcare properties and acquisition costs paid directly to third-parties. Real estate acquisition costs increased to$0.7 million for the three months endedSeptember 30, 2012 compared$0 for the three months endedSeptember 30, 2011 . Depreciation and amortization increased to$0.5 million for the three months endedSeptember 30, 2012 from$0.4 million for the three months endedSeptember 30, 2011 primarily due to the newly acquired healthcare properties and lease commission amortization related to the second and third quarter net leases offset by the property impairments recorded in the second quarter of 2011. Impairment of real estate was$0 for three months endedSeptember 30, 2012 compared to$0.4 million for the three months endedSeptember 30, 2011 . The charge during 2011 was a result of our assumption of shorter hold periods for each property used in our impairment testing brought about by our board of directors' reevaluation of strategic alternatives to maximize shareholder value. These alternatives include potentially selling additional properties to repay debt as it becomes due. Interest expense decreased to$0.3 million for the three months endedSeptember 30, 2012 from$0.4 million for the three months endedSeptember 30, 2011 . The decrease is primarily due to lowering the overall outstanding principal balance of our debt obligations as a result of the$13.1 million pay-off of theHSH Nordbank credit facility in 2011 and principal repayments on the Wells Fargo loan of$1.5 million during 2011 and$7.5 million during the first quarter of 2012, partially offset by the new General Electric ("GE") loans for the healthcare properties andWestern Avenue property refinancing, increasing interest rates during 2011 as a result of theHSH Nordbank andWells Fargo Bank note extensions and the related amortization of deferred financing costs associated with each extension. The loss from discontinued operations represents the results of operations for properties sold and/or classified as held for sale in accordance with Accounting Standards Codification ("ASC") 360, Property, Plant and Equipment. Additionally, all prior periods presented for these properties were reclassified to discontinued operations for presentation purposes. During 2011, we sold our Goldenwest,Mack Deer Valley ,Pinnacle Park Business Center , and2111 South Industrial Park properties to third parties andNantucket Acquisition, LLC , our VIE as held for sale. The loss from discontinued operations was$0.2 million for the three months endedSeptember 30, 2012 compared to income from discontinued operations of$0.1 million for the three months endedSeptember 30, 2011 . 34
Nine months ended
Nine Months Ended September 30, % 2012 2011 $ Change Change Rental revenues, tenant reimbursements & other income $ 3,583,000 $ 3,309,000 $ 274,000 8.3 % Property operating and maintenance (1,173,000 ) (1,246,000 ) 73,000 (5.9 )% Net operating income (1) 2,410,000 2,063,000 347,000 16.8 % Interest income from notes receivable 40,000 366,000 (326,000 ) (89.1 )% General and administrative (2,489,000 ) (2,083,000 ) (406,000 ) 19.5 % Asset management fees and expenses (662,000 ) (1,215,000 ) 553,000 (45.5 )% Real estate acquisition costs (737,000 ) - (737,000 ) 0.0 % Depreciation and amortization (1,294,000 ) (1,457,000 ) 163,000 (11.2 )% Reserve for excess advisor obligation (988,000 ) - (988,000 ) 0.0 % Interest expense (733,000 ) (1,019,000 ) 286,000 (28.1 )% Impairment of notes receivable - (1,650,000 ) 1,650,000 (100.0 )% Impairment of real estate - (23,644,000 ) 23,644,000 (100.0 )% Loss from continuing operations (4,453,000 ) (28,639,000 ) 24,186,000 (84.5 )% Loss from discontinued operations (1,721,000 ) (18,556,000 ) 16,835,000 (90.7 )% Net loss (6,174,000 ) (47,195,000 ) 41,021,000 (86.9 )% Noncontrolling interests' share in losses (787,000 ) (404,000 ) (383,000 ) 94.8 % Net loss applicable to common shares $ (5,387,000 ) $ (46,791,000 )
$ 41,404,000 (88.5 )%
(1) Net operating income ("NOI") is a non-GAAP supplemental measure used to
evaluate the operating performance of real estate properties. We define NOI
as total rental revenues, tenant reimbursements and other income less
property operating and maintenance expenses. NOI excludes interest income
from notes receivable, general and administrative expense, asset management
fees and expenses, real estate acquisition costs, depreciation and
amortization, impairments, interest income, interest expense, and income from
discontinued operations. We believe NOI provides investors relevant and
useful information because it measures the operating performance of the
REIT's real estate at the property level on an unleveraged basis. We use NOI
to make decisions about resource allocations and to assess and compare
property-level performance. We believe that net income (loss) is the most
directly comparable GAAP measure to NOI. NOI should not be viewed as an
alternative measure of operating performance to net income (loss) as defined
by GAAP since it does not reflect the aforementioned excluded items.
Additionally, NOI as we define it may not be comparable to NOI as defined by
other REITs or companies, as they may use different methodologies for calculating NOI. See Note 18 for a summary table reconciling NOI from net loss. Rental revenues, tenant reimbursements and other income increased to$3.6 million for the nine months endedSeptember 30, 2012 from$3.3 million for the nine months endedSeptember 30, 2011 . The increase is primarily due to higher occupancy rates and approximately$0.3 million from the four new healthcare properties offset lower average lease rental rates and longer lease-up periods for vacant industrial space as a result of the current economic environment. Property operating and maintenance expense was comparable at$1.2 million for the nine months endedSeptember 30, 2012 and for the nine months endedSeptember 30, 2011 . Interest income from notes receivable decreased to$40,000 for the nine months endedSeptember 30, 2012 from$0.4 million for the nine months endedSeptember 30, 2011 primarily due to the lower outstanding balance for theServant Healthcare Investments, LLC note (see Note 8) resulting in less interest income and non-payment of interest on theNantucket Acquisition LLC loan in 2012.
General and administrative expenses increased to
Asset management fees decreased to$0.7 million for the nine months endedSeptember 30, 2012 from$1.2 million for the nine months endedSeptember 30, 2011 . The lower asset management fees are attributed to the sale of four properties in 2011 combined with a reduction in the annual asset management fee basis from 1.0% to 0.75% of the Average Invested Assets (as defined in the Advisory Agreement) offset by the four acquisitions in the third quarter of 2012. Real estate acquisition costs consisted primarily of fees paid to our Advisor for the acquisition of the healthcare properties and acquisition costs paid directly to third-parties. Real estate acquisition costs increased to$0.7 million for the nine months endedSeptember 30, 2012 compared$0 for the nine months endedSeptember 30, 2011 . Depreciation and amortization decreased to$1.3 million for the nine months endedSeptember 30, 2012 from$1.5 million for the nine months endedSeptember 30, 2011 largely due to property impairments recorded in the second quarter of 2011 offset by higher lease commission and the new healthcare properties. 35 Reserve for excess advisor obligation represents the organizational and offering costs incurred in excess of 3.5% of the gross proceeds from our and Follow-on Offering. Prior toJune 10, 2012 , approximately$1.0 million was reimbursed to the Advisor in excess of 3.5% of the gross proceeds of our Follow-on Offering. Consistent with the limitations set forth in our charter, the Advisory Agreement provides that the Advisor will repay to the Company the excess (the "Excess Reimbursement"). Consequently, in the second quarter of 2012, we recorded a receivable from the Advisor of$1.0 million reflecting the Excess Reimbursement. As a result of our evaluation of the receivable's collectability, we reserved for the full amount of the receivable as ofJune 30, 2012 . Impairment of note receivable decreased to$0 for nine months endedSeptember 30, 2012 compared to$1.7 million for the nine months endedSeptember 30, 2011 . The decrease relates to theServant Healthcare note receivable which was determined to be impaired due to events arising in the second quarter of 2011 and settled in the forbearance agreement inDecember 22, 2011 . Impairment of real estate decreased to$0 for nine months endedSeptember 30, 2012 compared to$23.6 million for the nine months endedSeptember 30, 2011 . The charge during 2011 was a result of our assumption of shorter hold periods for each property used in our impairment testing brought about by our board of directors' evaluation of strategic alternatives to maximize shareholder value. These alternatives include potentially selling additional properties to repay debt as it becomes due.
Interest expense decreased during the nine months endedSeptember 30, 2012 from$0.7 million compared to$1.0 million for the nine months endedSeptember 30, 2011 . The decrease is primarily due to lowering the overall outstanding principal balance of our debt obligations as a result of the$13.1 million pay-off of theHSH Nordbank credit facility in 2011 and principal repayments on theWells Fargo Bank loan of$1.5 million during 2011 and$7.5 million during the second quarter of 2012, partially offset by GE debt financing of the new acquired healthcare properties, GE refinancing of the Western property, increasing interest rates during 2011 as a result of theHSH Nordbank andWells Fargo Bank note extensions and related amortization of deferred financing costs associated with each extension. The loss from discontinued operations represents the results of operations for properties sold and/or classified as held for sale in accordance with ASC 360, Property, Plant and Equipment. Additionally, operations for all prior periods presented for these properties were reclassified to discontinued operations for presentation purposes. During 2011, we sold our Goldenwest,Mack Deer Valley ,Pinnacle Park Business Center , and2111 South Industrial Park properties to third parties and classified our VIE as held for sale. The loss from discontinued operations was$1.7 million for the nine months endedSeptember 30, 2012 compared to loss from discontinued operations of$18.6 million for the nine months endedSeptember 30, 2011 . The change is primarily due to 2012 losses incurred by our VIE compared to income reported by our soldArizona properties in 2011. Additionally the second quarter of 2011 included$19.3 million of impairments of real estate impairment compared to 2012 where we recorded$1.1 million of impairments of real estate.
Liquidity and Capital Resources
OnNovember 23, 2010 , our board of directors made a decision to stop making or accepting offers to purchase shares of our stock in our Follow-on Offering while evaluating strategic alternatives to maximize value and preserve our capital. OnJune 10, 2012 , our Follow-on Offering was terminated. Going forward, we expect our primary sources of cash to be rental revenues, tenant reimbursements and interest income. In addition, we may increase cash through the sale of additional properties or borrowing against currently-owned properties. We expect our primary uses of cash to be for the repayment of principal on notes payable, funding of future acquisitions, payment of tenant improvements and leasing commissions, operating expenses, interest expense on outstanding indebtedness, advances to our VIE to fund operating shortfalls, and cash distributions. Operating expenses are expected to exceed operating revenues over the next twelve months. We plan to fund this operating shortfall from available cash and the net proceeds from property sales and asset refinancings. As ofSeptember 30, 2012 , we had approximately$4.8 million in cash and cash equivalents on hand. Our liquidity will increase if cash from operations exceeds expenses, additional shares are offered, we receive net proceeds from the sale of a property or if refinancing results in excess loan proceeds and decrease as proceeds are expended in connection with the acquisitions, operation of properties and advances to our VIE. Based on current conditions, we believe that we have sufficient capital resources for the next twelve months.
Credit Facilities and Loan Agreements
As ofSeptember 30, 2012 , we had total debt obligations of$44.3 million that mature in February and November of 2014. Of this amount,$22.3 million was outstanding on a loan agreement withGeneral Electrical Captial Corporation ("GE") for healthcare properties,$8.9 million was outstanding on a separate loan agreement with GE for an industrial property,$6.6 million was outstanding on a loan agreement with Wells Fargo and$6.5 million was outstanding on a loan agreement withTransamerica Life Insurance Company .
On
36
InFebruary 2012 , we amended our loan agreement with Wells Fargo to extend the maturity date toFebruary 13, 2014 . In connection with this amendment, we made a principal payment of$7.5 million , reducing the outstanding principal amount of our obligations under the loan agreement from$14.3 million to $6.8 million as ofFebruary 13, 2012 , and paid fees and expenses totaling approximately$65,000 . The interest rate on the amended loan decreased from 300 basis points over one-month LIBOR to 200 basis points over one-month LIBOR, with the one-month LIBOR floor remaining fixed at 150 basis points. Any amounts repaid under the loan agreement may not be re-borrowed. All other terms of the loan agreement remain in full force and effect.
Short-Term Liquidity Requirements
In addition to the capital requirements for recurring capital expenditures, tenant improvements and leasing commissions, we may incur expenditures for future acquisitions and/or renovations of our existing properties, such as increasing the size of the properties by developing additional rentable square feet and/or making the space more appealing to potential industrial tenants.
We sold three properties in the fourth quarter of 2011 and currently have one property listed for sale to monetize our interest in the VIE, and we amended our loan agreement with Wells Fargo inFebruary 2012 . We continue to pursue options for repaying our debt obligations, including asset sales. We believe that our cash and cash equivalents totaling$4.8 million as ofSeptember 30, 2012 will allow us to meet our obligations during the twelve months endingSeptember 30, 2013 . We expect to fund our short-term liquidity requirements primarily from available cash and future net property sales proceeds. In recent years, financial markets have experienced unusual volatility and uncertainty and liquidity has tightened in all financial markets, including the debt and equity markets. Our ability to repay or refinance debt could be adversely affected by an inability to secure financing at reasonable terms,
if at all. Distributions EffectiveDecember 1, 2010 , our board of directors resolved to reduce distributions on our common stock to an annualized rate of$0.08 per share (1% based on a share price of$8.00 ), from the prior annualized rate of$0.48 per share (6% based on a share price of$8.00 ), in order to preserve capital that may be needed for capital improvements, debt repayment or other corporate purposes. Distributions at this rate were declared for the first and second quarters of 2011. InJune 2011 , the board decided, based on the financial position of the Company, to suspend the declaration of further distributions and to defer the payment of the second quarter 2011 distribution, which was paid inDecember 2011 . No distributions have been declared for periods afterJune 30, 2011 . The rate and frequency of distributions is subject to the discretion of our board of directors and may change from time to time based on our operating results and cash flow. We can make no assurance when and if distributions will recommence.
The following table shows the distributions declared during the nine months ended
Cash Flows Provided by (Used in) Distributions Declared (2) Operating Period Cash Reinvested Total Activities First quarter 2011 (1) $ 454,000 $ - $ 454,000 $ 481,000 Second quarter 2011 (1) $ 468,000 $ - $ 468,000 $ (219,000 ) Third quarter 2011 $ - $ - $ - $ (323,000 ) First quarter 2012 $ - $ - $ - $ (800,000 ) Second quarter 2012 $ - $ - $ - $ (953,000 ) Third quarter 2012 $ - $ - $ - $ (2,400,000 ) 37
(1) 100% of the distributions declared during the nine months ended June 30,
2011 represented a return of capital for federal income tax purposes.
(2) In order to meet the requirements for being treated as a REIT under the
Internal Revenue Code, we must pay distributions to our shareholders each
taxable year equal to at least 90% of our net ordinary taxable income. Some
of our distributions have been paid from sources other than operating cash
flow, such as offering proceeds.
From our inception in
Organization and offering costs
As ofSeptember 30, 2012 , our Advisor and its affiliates had incurred on our behalf organizational and offering costs totaling$5.6 million , including$0.1 million of organizational costs that were expensed and$5.5 million of offering costs which reduced the net proceeds of our combined offerings. Of this amount,$4.4 million reduced the net proceeds of our initial public offering and$1.1 million reduced the net proceeds of our Follow-on Offering. OnJune 10, 2012 , our Follow-on Offering was terminated. Under the Advisory Agreement, within 60 days after the end of the month in which our Follow-on Offering terminated, the Advisor is obligated to reimburse us to the extent that the organization and offering expenses related to our Follow-on Offering borne by us exceeded 3.5% of the gross proceeds of the Follow-on Offering. As ofJune 10, 2012 , we had reimbursed our advisor a total of$1.1 million in organizational and offering costs related to our Follow-on Offering, of which$1.0 million was in excess of the contractual limit. Consequently, in the second quarter of 2012, we recorded a receivable from the Advisor for$1.0 million reflecting the Excess Reimbursement. As a result of our evaluation of various factors related to collectability of this receivable, we recorded a reserve for the full amount of the receivable as ofJune 30, 2012 .
Funds from Operations and Modified Funds from Operations
Funds from operations ("FFO") is a non-GAAP supplemental financial measure that is widely recognized as a measure of REIT operating performance. We compute FFO in accordance with the definition outlined by theNational Association of Real Estate Investment Trusts ("NAREIT"). NAREIT defines FFO as net income (loss), computed in accordance with GAAP, excluding extraordinary items, as defined by the accounting principles generally accepted inthe United States of America ("GAAP"), and gains or losses from sales of property, plus depreciation and amortization on real estate assets, and after adjustments for unconsolidated partnerships, joint ventures, noncontrolling interests and subsidiaries. NAREIT recently issued updated reporting guidance that directs companies, for their computation of NAREIT FFO, to exclude impairments of depreciable real estate when write-downs are driven by measurable decreases in the fair value of real estate holdings. Previously, the Company's calculation of FFO (consistent with NAREIT's previous guidance) did not exclude impairments of, or related to, depreciable real estate. Consistent with this current NAREIT reporting guidance, the Company has restated its 2011 FFO amount. Our FFO may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than we do. We believe that FFO is helpful to investors and our management as a measure of operating performance because it excludes depreciation and amortization, gains and losses from property dispositions, and extraordinary items, and as a result, when compared year to year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, development activities, general and administrative expenses, and interest costs, which is not immediately apparent from net income. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting alone to be insufficient. As a result, our management believes that the use of FFO, together with the required GAAP presentations, provide a more complete understanding of our performance. Factors that impact FFO include start-up costs, fixed costs, delays in buying assets, lower yields on cash held in accounts pending investment, income from portfolio properties and other portfolio assets, interest rates on acquisition financing and operating expenses. FFO should not be considered as an alternative to net income (loss), as an indication of our performance, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions. Changes in the accounting and reporting rules under GAAP have prompted a significant increase in the amount of non-cash and non-operating items included in FFO, as defined. Therefore, we use modified funds from operations ("MFFO"), which excludes from FFO real estate acquisition costs, amortization of above- or below-market rents, and non-cash amounts related to straight-line rents and impairment charges to further evaluate our operating performance. We compute MFFO in accordance with the definition suggested by theInvestment Program Association (the "IPA"), the trade association for direct investment programs (including non-traded REITs). However, certain adjustments included in the IPA's definition are not applicable to us and are therefore not included in the foregoing definition. 38 We believe that MFFO is an important supplemental measure of operating performance because it excludes costs that management considers more reflective of investing activities or non-operating changes. Accordingly, we believe that MFFO can be a useful metric to assist management, investors and analysts in assessing the sustainability of our operating performance. As explained below, management's evaluation of our operating performance excludes these items in the calculation based on the following considerations:
• Real estate acquisition costs. In evaluating investments in real estate,
including both business combinations and investments accounted for under the equity method of accounting, management's investment models and analyses differentiate costs to acquire the investment from the
operations derived from the investment. These acquisition costs have been
funded from the proceeds of our initial public offering and other
financing sources and not from operations. We believe by excluding
expensed acquisition costs, MFFO provides useful supplemental information
that is comparable for each type of our real estate investments and is
consistent with management's analysis of the investing and operating
performance of our properties. Real estate acquisition costs include
those paid to our Advisor and to third parties.
• Adjustments for amortization of above- or below-market rents. Similar to
depreciation and amortization of other real estate-related assets that
are excluded from FFO, GAAP implicitly assumes that the value of lease
assets diminishes predictably over time and that these charges be
recognized currently in revenue. Since real estate values and market
lease rates in the aggregate have historically risen or fallen with
market conditions, management believes that by excluding these charges,
MFFO provides useful supplemental information on the operating performance of our real estate. • Adjustments for straight-line rents. Under GAAP, rental income recognition can be significantly different from underlying contract
terms. By adjusting for these items, MFFO provides useful supplemental
information on the economic impact of our lease terms and presents results in a manner more consistent with management's analysis of our operating performance.
• Impairment charges. Impairment charges relate to a fair value adjustment,
which is based on the impact of current market fluctuations and
underlying assessments of general market conditions and the specific
performance of the holding, which may not be directly attributable to our
current operating performance. As these losses relate to underlying
long-term assets and liabilities, excluding real estate, where we are not
speculating or trading assets, management believes MFFO provides useful
supplemental information by focusing on the changes in our core operating
fundamentals rather than changes that may reflect anticipated losses. In
particular, because GAAP impairment charges are not allowed to be
reversed if the underlying fair values improve or because the timing of
impairment charges may lag the onset of certain operating consequences,
we believe MFFO provides useful supplemental information related to the sustainability of rental rates, occupancy and other core operating fundamentals. 39 FFO and MFFO should not be considered as an alternative to net income (loss) or as an indication of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions. Both FFO and MFFO should be reviewed along with other GAAP measurements. Our FFO and MFFO, as presented, may not be comparable to amounts calculated by other REITs. The following is reconciliation from net loss applicable to common shares, the most direct comparable financial measure calculated and presented with GAAP, to FFO and MFFO for the three and nine months endedSeptember 30, 2012 and 2011: Three months ended Nine months ended September 30, September 30, 2012 2011 2012 2011
Net loss applicable to common shares $ (1,313,000 ) $ (1,132,000 ) $ (5,387,000 ) $ (46,791,000 ) Adjustments: Depreciation and amortization of real estate assets: Continuing operations 524,000 384,000 1,294,000 1,457,000 Discontinued operations - 110,000 - 586,000 Impairment of real estate assets: Continuing operations - 425,000 - 23,644,000 Discontinued operations - 153,000 1,140,000 19,333,000 Noncontrolling interests' share in losses (258,000 ) (352,000 ) (787,000 ) (404,000 ) Noncontrolling interests 'share in FFO 245,000 - 773,000 - FFO applicable to common shares $ (802,000 ) $ (412,000 ) $ (2,967,000 ) $ (2,175,000 ) Adjustments: Amortization of (below-) above-market rents (7,000 ) (6,000 ) (20,000 ) (137,000 ) Straight-line rents (205,000 ) (31,000 ) (244,000 ) (34,000 ) Reserve for excess advisor obligation - - 988,000 - Impairment of note receivable - - - 1,650,000 Amortization of deferred financing costs 27,000 156,000 99,000 357,000 Real estate acquisition costs 737,000 - 737,000 - Modified funds from operations (MMFO) applicable to common shares $ (250,000 ) $ (293,000 ) $ (1,407,000 ) $ (339,000 ) Weighted-average number of common shares Outstanding - basic and diluted 23,028,284 23,028,284 23,028,284 23,032,894 FFO per weighted average common shares $ (0.03 ) $ (0.02 ) $ (0.13 ) $ (0.09 ) MFFO per weighted average common shares $ (0.01 ) $ (0.01 ) $ (0.06 ) $ (0.01 ) 40 Contractual Obligations The following table reflects our contractual obligations as ofSeptember 30, 2012 : Payment due by period Less than More than Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years Notes payable (1) $ 44,290,000 $ 568,000 $ 22,625,000 $ 21,097,000 $ - Interest expense related to long-term debt (2) $ 7,339,000 $ 2,125,000 $ 4,207,000 $ 1,007,000 $ - Below-market ground lease (3)(4) $ 3,609,000 $ - $
5,000 $ 39,000 $ 3,565,000
(1) This represents the sum of loan agreements with
Association,
(2) Interest expense related to the loan agreement with
National Association is calculated based on the loan balance outstanding at
point LIBOR floor, plus a margin of 200 basis points. Interest expense
related to the loan agreement with
based on a fixed rate of 5.89% per annum. Interest expense related to the
loan agreement with General Electric Capital Corporation related to the
acquisition of healthcare properties is based on three-month LIBOR, with a
floor of 50 basis points, a spread or margin of 4.50%. Interest expense
related to the loan agreement with General Electric Capital Corporation
related to the financing of the
three-month LIBOR, with a 25 basis point floor, plus a margin of 430 basis
points.
(3) The below-market ground lease relates to the
VIE for which we were deemed to be the primary beneficiary and began
consolidating as of
Commons property met the requirements for reclassification to real estate
held for sale. Consequently, at
liabilities of the VIE are classified as assets of variable interest entity
held for sale and liabilities of variable interest entity held for sale,
respectively, on our condensed consolidated balance sheets.
(4) The below-market ground lease is a 50-year lease expiring in 2059 relating
to land on which the
The land is leased from the town of
payments totaling
percent of operating revenues, as defined in the ground lease, for years
five through seven, and one percent of operating revenues, as defined in the
ground lease, thereafter. Subsequent Event
See Note 19 of financial statement footnotes.
41
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