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CORNERSTONE CORE PROPERTIES REIT, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

Edgar Online, Inc.
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 ended December 31, 2011
filed with the U.S. Securities and Exchange Commission (the "SEC").



Overview


We were incorporated on October 22, 2004 for the purpose of engaging in the
business of investing in and owning commercial real estate. As of September 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.




On November 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 December 14, 2010. All distributions paid after December 14, 2010 have been and will be made in cash.

Distributions. Effective December 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. In June 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
the Arizona properties and paid the second quarter distributions. No
distributions have been declared for periods after June 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 effective
December 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 in June 2011 for gross proceeds of
$9.4 million and made a principal payment of $7.8 million on the HSH Nordbank
credit facility. Additionally, we sold the Mack Deer Valley and Pinnacle Park
Business Center properties in November 2011 for gross proceeds of approximately
$23.9 million. The net proceeds were used, in part, to pay down the remaining
balance of the HSH Nordbank credit facility. In December 2011, we sold the 2111
South Industrial Park property for gross proceeds of $0.9 million. The proceeds
were used to pay down the Wells Fargo loan. Furthermore, in February 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
from February 13, 2012 to February 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.



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Market Outlook - Real Estate and Real Estate Finance Markets

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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 June 2011, together with our Advisor, we embarked upon an evaluation of options and repositioning that we believed could enhance shareholder value.




The initial steps of this "repositioning" strategy involved the sale of certain
industrial properties (Goldenwest, Mack Deer Valley, Pinnacle Park and 2111
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 as
Medicaid and Medicare. 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 the Medicare and Medicaid 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.



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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.

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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 December 31, 2011, as filed with the SEC.



Results of Operations



As of September 30, 2012, we owned thirteen properties consisting of nine
industrial and four healthcare properties which were purchased in the third
quarter of 2012. In January 2011, we owned thirteen industrial properties of
which four were subsequently sold. In June 2011, we sold the Goldenwest property
for gross proceeds of $9.4 million. In November 2011, we sold the Mack Deer
Valley and Pinnacle Park Business Center properties for gross proceeds of $23.9
million. In December 2011, we sold the 2111 South Industrial Park property for
gross proceeds of $0.9 million.



In October 2011, we reclassified the Sherburne Commons property as held for sale (see Note 11) and the results of its operations have been reported in discontinued operations for all periods presented.

Three months ended September 30, 2012 and 2011



                                                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

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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 ended September 30, 2012 from $1.1 million for the
three months ended September 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.



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Property operating and maintenance expense was comparable at $0.4 million for the three months ended September 30, 2012 and September 30, 2011.




Interest income from notes receivable decreased to $13,000 for the three months
ended September 30, 2012 from $0.1 million for the three months ended September
30, 2011 primarily due to the lower outstanding balance for the Servant
Healthcare Investments, LLC note resulting in less interest income in 2012
compared to approximately $0.1 million in interest income for the three months
ended September 30, 2011.


General and administrative expenses increased to $0.8 million for the three
months ended September 30, 2012 from $0.7 million for the three months ended
September 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 ended
September 30, 2012 from $0.4 million for the three months ended September 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 ended September 30, 2012 compared $0 for the three
months ended September 30, 2011.



Depreciation and amortization increased to $0.5 million for the three months
ended September 30, 2012 from $0.4 million for the three months ended September
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 ended September 30, 2012
compared to $0.4 million for the three months ended September 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 ended September
30, 2012 from $0.4 million for the three months ended September 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 the HSH
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 and Western Avenue property refinancing, increasing
interest rates during 2011 as a result of the HSH Nordbank and Wells 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, and 2111 South
Industrial Park properties to third parties and Nantucket Acquisition, LLC, our
VIE as held for sale. The loss from discontinued operations was $0.2 million for
the three months ended September 30, 2012 compared to income from discontinued
operations of $0.1 million for the three months ended September 30, 2011.



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Nine months ended September 30, 2012 and 2011



                                                 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 ended September 30, 2012 from $3.3 million for the
nine months ended September 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 ended September 30, 2012 and for the nine months ended September
30, 2011.



Interest income from notes receivable decreased to $40,000 for the nine months
ended September 30, 2012 from $0.4 million for the nine months ended September
30, 2011 primarily due to the lower outstanding balance for the Servant
Healthcare Investments, LLC note (see Note 8) resulting in less interest income
and non-payment of interest on the Nantucket Acquisition LLC loan in 2012.

General and administrative expenses increased to $2.5 million for the nine months ended September 30, 2012 from $2.1 million for the nine months ended September 30, 2011. The increase is primarily due to increased legal fees, board expenses, professional fees, allocations, and regulatory filing costs.




Asset management fees decreased to $0.7 million for the nine months ended
September 30, 2012 from $1.2 million for the nine months ended September 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 ended September 30, 2012 compared $0 for the nine
months ended September 30, 2011.



Depreciation and amortization decreased to $1.3 million for the nine months
ended September 30, 2012 from $1.5 million for the nine months ended September
30, 2011 largely due to property impairments recorded in the second quarter of
2011 offset by higher lease commission and the new healthcare properties.



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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 to June 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 of June 30, 2012.



Impairment of note receivable decreased to $0 for nine months ended September
30, 2012 compared to $1.7 million for the nine months ended September 30, 2011.
The decrease relates to the Servant 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 in December 22, 2011.



Impairment of real estate decreased to $0 for nine months ended September 30,
2012 compared to $23.6 million for the nine months ended September 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 ended September 30, 2012 from
$0.7 million compared to $1.0 million for the nine months ended September 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 the HSH Nordbank credit facility in 2011 and principal repayments on
the Wells 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 the HSH Nordbank and Wells
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, and 2111 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 ended
September 30, 2012 compared to loss from discontinued operations of $18.6
million for the nine months ended September 30, 2011. The change is primarily
due to 2012 losses incurred by our VIE compared to income reported by our sold
Arizona 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

On November 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. On
June 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 of September 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 of September 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 with General 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 with Transamerica Life Insurance Company.



On November 28, 2011, the HSH Nordbank credit facility was repaid in its entirety with proceeds from the sale of the Mack Deer Valley and Pinnacle Park Business Center properties (see Notes 15 and 17).



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In February 2012, we amended our loan agreement with Wells Fargo to extend the
maturity date to February 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
of February 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 in February 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 of September 30, 2012 will
allow us to meet our obligations during the twelve months ending September 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



Effective December 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. In June 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 in
December 2011. No distributions have been declared for periods after June 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 September 30, 2012 and 2011:



                                                                               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 October 2004 through September 30, 2012, we declared aggregate distributions of $32.8 million. Our cumulative net loss and cumulative net cash provided by operating activities during the same period were $74.1 million and $0.5 million, respectively.

Organization and offering costs




As of September 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.



On June 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 of June
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 of June 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 the National 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 in the 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 the Investment 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 ended September 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 of September 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 Wells Fargo Bank, National

Association, Transamerica Life Insurance Company and General Electric

Capital Corporation.

(2) Interest expense related to the loan agreement with Wells Fargo Bank,

National Association is calculated based on the loan balance outstanding at

September 30, 2012, one-month LIBOR at September 30, 2012, with a 150 basis

point LIBOR floor, plus a margin of 200 basis points. Interest expense

related to the loan agreement with Transamerica Life Insurance Company is

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 20100 Western Avenue property is based on

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 Sherburne Commons property, a

VIE for which we were deemed to be the primary beneficiary and began

consolidating as of June 30, 2011. As of October 19, 2011, the Sherburne

Commons property met the requirements for reclassification to real estate

held for sale. Consequently, at September 30, 2012, the related assets and

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 Sherburne Commons senior housing facility is located.

The land is leased from the town of Nantucket, Massachusetts with lease

payments totaling $1 per year for years one through four, one-half of one

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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