GRIFFIN CAPITAL ESSENTIAL ASSET 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 the Company's consolidated financial statements and the notes thereto contained in Part I of this Quarterly Report on Form 10-Q, as well as Management's Discussion and Analysis of Financial Condition and Results of Operations, Consolidated Financial Statements, and the notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2012. See also "Cautionary Note Regarding Forward Looking Statements" preceding Part I. As used herein, "we," "us," and "our" refer to Griffin Capital Essential Asset REIT, Inc.

Overview

  We are a public, non-traded REIT that invests primarily in single tenant properties that are business essential to the tenant, diversified by corporate credit, physical geography, product type and lease duration. As described in more detail in Item 1 of this report, we were formed on August 28, 2008 and commenced operations on May 6, 2009. On February 25, 2013, we changed our name from Griffin Capital Net Lease REIT, Inc. to Griffin Capital Essential Asset REIT, Inc. We have no employees and are externally advised and managed by an affiliate, Griffin Capital Essential Asset Advisor, LLC, our Advisor.  Under our initial public offering, we offered a maximum of 82,500,000 shares of common stock to the public, consisting of 75,000,000 shares (the "Primary Public Offering") and 7,500,000 shares for sale pursuant to our distribution reinvestment plan (together with the Primary Public Offering, the "Initial Public Offering"). As of March 31, 2013, we had issued 17,661,832 total shares of our common stock for gross proceeds of approximately $175.8 million in our Initial Public Offering, of which 532,760 shares, or $5.1 million, were issued pursuant to the distribution reinvestment plan ("DRP"). As of March 31, 2013, we redeemed 71,936 shares of common stock for approximately $0.7 million at a weighted average price per share of $9.79.  On April 25, 2013, we terminated our Initial Public Offering and, on April 26, 2013, we began to offer, in a follow-on offering, up to $1.0 billion in shares of common stock, consisting of approximately 97.2 million shares at $10.28 per share (the "Primary Follow-On Offering" and together with the Primary Public Offering, the "Primary Public Offerings") and $100 million in shares of common stock, consisting of approximately 10.2 million shares pursuant to the DRP, at a price equal to 95% of the share price, which is approximately $9.77 per share (together with the Primary Follow-On Offering, the "Follow-On Offering" and, collectively with the Initial Public Offering, the "Public Offerings").  We have made the following acquisitions: (1) two properties in two states (Illinois and South Carolina) for a total purchase price of approximately $54.4 million in the year ended December 31, 2009; (2) four properties in four states (California, Colorado, Illinois and Kansas) for a total purchase price of approximately $54.3 million in the year ended December 31, 2010; (3) one property, located in California, for a purchase price of $56.0 million in the year ended December 31, 2011; (4) seven properties in seven states (Washington, Pennsylvania, New Jersey, Colorado, Illinois, Ohio, and California) for a total purchase price of approximately $160.6 million in the year ended December 31, 2012; and (5) two properties in two states (Colorado and Washington) for a total purchase price of approximately $39.0 million during the three months ended March 31, 2013. The tenants of our properties operate in a diverse range of industries, including consumer products, construction engineering services, education, printing, biotechnology, telecommunications, insurance, energy, and aerospace, as described in more detail in Item 2 of our Annual Report on Form 10-K for the year ended December 31, 2012.                                           29

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As of March 31, 2013, we owned 16 properties, as shown in the table below, encompassing approximately 3.5 million rentable square feet with a current capitalization rate ("cap rate") of 8.3% (1):

                                                                                                                                                                                                                                                                     2013                                                                                                                                                                                                                                                                Annualized                                                                                                                                                                                                                                                                   Net                                                                                                                                                                                                                                                % of            Effective                                                                                                                                                                                                      Initial            Annualized          Annualized          Rent per          Year of                                               Acquisition                                                    Property        Year Built/      Purchase           Square          Approximate           Cap                Gross             Gross Base           Square            Lease Property                                          Date               Tenant              Industry              Type           Renovated         Price             Feet              Acres           Rate  (1)         Base Rent  (2)           Rent             Foot (3)        Expiration Renfro                                                                              Consumer Products     Manufacturing/ Clinton, SC6/18/2009Renfro Corp         (Hosiery)             Distribution          1986        $  21,700,000          566,500               42.2             8.58 %     $      1,898,000               5.8 %     $       3.35             2021 Plainfield                                                      Chicago Bridge &    Construction Plainfield, IL                                                  Iron Company        Engineering           Office/                                                  6/18/2009      (Delaware)          Services              Laboratory          1958-1991        32,660,000          176,000               29.1             7.70 %            2,587,000               7.9 %            14.70             2022 Will Partners                                                                       Consumer Products Monee, IL                                                       World Kitchen,      (Kitchen              Manufacturing/                                                   6/4/2010      LLC                 Accessories)          Distribution          2000           26,305,000          700,200               34.3             8.79 %            2,311,000               7.1 %             3.30             2020 Emporia Partners                                                Hopkins Emporia, KS                                                     Enterprises,        Consumer Products     Manufacturing/                                                  8/27/2010      Inc.                (Automotive Parts)    Distribution        1954/2000         8,360,000          320,800               16.6             9.86 %            1,486,000               4.6 %             2.77             2020 ITT                                                             ITT Educational Los Angeles, CA9/23/2010Services, Inc.      Education             Office              1996/2010         7,800,000           35,800                3.5             9.78 %              762,000               2.3 %            21.28             2016 Quad/Graphics                                                   World Color                               Printing           1986/1996/ Loveland, CO12/30/2010      (USA), LLC          Printing              Facility/Office       2009           11,850,000          169,800               15.0            10.26 %            1,216,000               3.7 %             7.16             2022 LTI                                                             Life Carlsbad, CA                                                    Technologies                              Office/ Flex                                                  5/13/2011      Corporation         Biotechnology         Facility              1999           56,000,000          328,700               17.6             7.21 %            4,206,000              12.9 %            12.80             2022 AT&T                                                            AT&T Services,                            Office/ Data Redmond, WA1/31/2012      Inc.                Telecommunications    Center                1995           40,000,000          155,800                8.4             7.58 %            3,123,000               9.6 %            20.04             2019 Westinghouse                                                    Westinghouse        Energy Cranberry Township, PA                                          Electric            (Nuclear Fuel and     Engineering                                                  3/22/2012Company, LLC        Nuclear Services)     Facility              2010           36,200,000          118,000               25.0             7.97 %            2,887,000               8.8 %            24.47             2025 GE                                                              GE Aviation                               Assembly/ Whippany, NJ5/31/2012      Systems             Aerospace             Manufacturing         1986           13,000,000          114,300               10.8             8.37 %            1,111,000               3.5 %             9.72             2018 Travelers                                                       Travelers Greenwood Village, CO6/29/2012Indemnity           Insurance             Office              1982/2005        16,100,000          131,000                6.4             7.44 %            1,248,000               3.8 %             9.53             2024 Zeller Plastik                                                  Zeller Plastik      Consumer Products Libertyville, IL11/8/2012USA, Inc.           (Plastics)            Manufacturing       1992/2003        15,600,000          193,700               10.2             8.12 %            1,276,000               3.9 %             6.59             2022 Northrop Grumman                                                Northrop Grumman Beavercreek, OH                                 11/13/2012      Systems

Corp.       Aerospace             Office                2012           17,000,000           99,200                9.4             8.88 %            1,510,000               4.6 %            15.22             2019 Health Net                                                      Health Net of Rancho Cordova, CA12/18/2012California, Inc.    Insurance             Office                2002           22,650,000          145,900                8.0             9.08 %            3,331,000              10.2 %            22.83             2022 Comcast                                                         Comcast Greenwood Village, CO1/11/13Holdings, LLC       Telecommunications    Office                1980           27,000,000          157,300                6.2             8.03 %            2,195,000               6.7 %            13.95             2021 Boeing                                                          The Boeing Renton, WA2/15/13      Company             Aerospace             Office                1990           12,000,000           70,100                5.0             7.80 %            1,495,000               4.6 %            21.33             2017                                                                                                                                              $ 364,225,000        3,483,100              247.7             8.15 %     $     32,642,000             100.0 %     $       9.20

(1) The initial cap rate is determined by dividing the projected net rental

payment for the first fiscal year we own the property by the acquisition

price (exclusive of closing and offering costs). Generally, pursuant to each

lease, if the tenant is directly responsible for the payment of all property

operating expenses, insurance and taxes, the net rental payment by the tenant

to the landlord is equivalent to the base rental payment. The projected net

rental payment includes assumptions that may not be indicative of the actual

future performance of a property, including the assumption that the tenant

will perform its obligations under its lease agreement during the next 12

months. The current cap rate is determined by dividing the projected net

rental payment for the twelve-month period subsequent to March 31, 2013 by

the acquisition price. The total amount represents the weighted average

capitalization rate.

(2) The gross base rent is the contractual rental payments for the twelve-month

period subsequent to March 31, 2013, taking into consideration contractual

rent increases for the period presented. The gross base rent for the Health

Net property includes contractual rental payments pursuant to the leases for

the café and fitness center.

(3) The annualized net effective rent per square foot is calculated by dividing

the annualized net effective rent by the square footage for each property

listed in the table above. The annualized net effective rent equals the

annualized gross base rent for all of our properties, except the Emporia

Partners property. The gross base rent for the Emporia Partners property is

reduced by the annualized priority return of $0.6 million due to Hopkins

Enterprises, Inc., to arrive at annualized net effective rent. The total

    represents the average per square foot.                                            30 

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Acquisition Indebtedness

For a discussion of our acquisition indebtedness, see Note 3, Real Estate, and Note 4, Debt, to the consolidated financial statements.

Significant Accounting Policies and Estimates

  We have established accounting policies which conform to generally accepted accounting principles ("GAAP") as contained in the Financial Accounting Standards Board ("FASB") Accounting Standards Codification (the "Codification" or "ASC"). The preparation of our consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. If our judgment or interpretation of the facts and circumstances relating to the various transactions had been different, it is possible that different estimates would have been applied, thus resulting in a different presentation of the financial statements. Additionally, other companies may use different estimates and assumptions that may impact the comparability of our financial condition and results of operations to those companies.  

We believe the accounting policies listed below are the most critical in the preparation of our consolidated financial statements. These policies are described in greater detail in Note 2, Basis of Presentation and Summary of Significant Accounting Policies, to the consolidated financial statements:

     •   Real Estate- Valuation and purchase price allocation, depreciation;    

• Impairment of Real Estate and Related Intangible Assets and Liabilities;

      •   Revenue Recognition;       •   Noncontrolling Interests in Consolidated Subsidiaries;       •   Common Stock and Noncontrolling Interests Subject to Redemption;       •   Fair Value Measurements;    

• Income Taxes- Deferred tax assets and related valuation allowance, REIT

         qualification; and       •   Loss Contingencies.  

Recently Issued Accounting Pronouncements

See Note 2, Basis of Presentation and Summary of Significant Accounting Policies, to the consolidated financial statements.

Results of Operations

  We are not aware of any material trends or uncertainties, other than national economic conditions affecting real estate in general, that may reasonably be expected to have a material impact, favorable or unfavorable, on revenues or income from the acquisition, management and operations of properties other than those listed in Part I, Item 1A. Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2012.  As of March 31, 2012, we owned 9 properties, and, as shown in the table above, as of March 31, 2013 we owned 16 properties. We are a "blind pool" offering and in the early stages of our life cycle, with the objective and concentration of continually growing our portfolio with assets that adhere to our investment criteria. Therefore, our results of operations for the three months ended March 31, 2013 are not directly comparable to those for the same period in the prior year as the variances are substantially the result of portfolio growth, specifically in rental income, operating expenses, acquisition fees and reimbursable expenses and depreciation and amortization expenses. Certain variances on a "same store" basis are not indicative of the actual variance between periods. We expect that rental income, operating expenses, depreciation, and amortization expenses will each increase in future periods as we acquire additional properties.                                           31 

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Comparison of the Three Months Ended March 31, 2013 and 2012

The following table provides summary information about our results of operations for the three months ended March 31, 2013 and 2012:

                                               Three Months Ended                                                  March 31,                  Increase/         Percentage                                           2013              2012            (Decrease)          Change Rental income                          $ 8,179,245$ 4,396,478$  3,782,767                86 % Property expense recoveries            $ 1,667,315$   598,107$  1,069,208               179 % Asset management fees to affiliates                             $   666,500$   367,319$    299,181                81 % Property management fees to affiliates                             $   266,177$   126,862$    139,315               110 % Property operating expense             $   767,207$    25,128$    742,079               N/A Property tax expense                   $   970,055$   562,456$    407,599                72 % Acquisition fees and expenses to non-affiliates                         $   255,779$   681,555$   (425,776 )             (62 %) Acquisition fees and expenses to affiliates                             $ 1,170,000$ 2,286,000$ (1,116,000 )             (49 %) General and administrative expenses                               $   588,968$   494,410$     94,558                19 % Depreciation and amortization          $ 3,546,211$ 1,889,909$  1,656,302                88 % Interest expense                       $ 2,708,794$ 1,607,160$  1,101,634                69 %   Rental Income  Rental income for the three months ended March 31, 2013 is comprised of rental income of $7.7 million and adjustments to straight-line contractual rent and in-place lease valuation amortization with a combined total of $0.5 million. Rental income for the three months ended March 31, 2013 increased by $3.8 million compared to the same period a year ago as a result of (1) $0.3 million in additional rental income as a result of a rent increase which took effect September 2012 and three full months of base rent activity related to the AT&T property; (2) $0.7 million in additional rental income related to the Westinghouse property as a result of three full months of base rent activity; (3) $2.7 million in additional rental income related to the acquisitions made subsequent to March 31, 2012; and (4) $0.1 million in additional straight-line adjustments to contractual rent and in-place lease valuation amortization.  

Property Expense Recoveries

  Also included as a component of revenue is the recovery of property operating expenses, which increased by $1.1 million compared to the same period a year ago as a result of (1) $0.1 million in property tax recoveries related to the GE and Zeller Plastik properties; and (2) $1.0 million increase in property expense recoveries for common area maintenance ("CAM") costs related to the AT&T property which was acquired on January 31, 2012, and the Travelers, Northrop, Health Net, and Comcast properties acquired subsequent to March 31, 2012.  

Property Expenses

  Property expenses for the three months ended March 31, 2013 and 2012 totaled $2.7 million and $1.1 million, respectively, consisting of asset management fees, property management fees, property operating expenses, and property taxes. The total increase of $1.6 million compared to the same period a year ago is a result of (1) $0.3 million in asset management fees, of which $0.2 million relates to acquisitions made subsequent to <chron>March 31, 2012; (2) $0.1 million in property management fees, primarily related to acquisitions made subsequent to March 31, 2012; (3) $0.4 million in property taxes, primarily related to acquisitions made subsequent to March 31, 2012; and (4) $0.7 million in property operating expenses related to certain real estate for which we paid certain operating expenses on behalf of the tenant and recovered through estimated monthly CAM reimbursements. In the prior year, only one of the leases for our properties contained such provisions.  

Acquisition Fees and Expenses

  Real estate acquisition fees and expenses to non-affiliates, which totaled $0.3 million for the three months ended March 31, 2013, decreased by $0.4 million compared to the three months ended March 31, 2012. Real estate acquisition fees and expenses to affiliates of $1.2 million represent the acquisition fees and expense reimbursement due to our Advisor based on the combined acquisition value of $39.0 million for the two properties acquired in the current period, compared to the combined acquisition value of $76.2 million for the acquisitions made in the same period in the prior year.                                           32

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General and Administrative Expenses

  General and administrative expenses for the three months ended March 31, 2013 increased by $0.1 million compared to the same period a year ago due to increased operating activity as discussed below. The $0.1 million increase is primarily due to the following: (1) an increase of $0.06 million in allocated expenses which are related to additional personnel and rent costs incurred by our Advisor; and (2) an increase of $0.04 million in unused commitment fees primarily relating to the KeyBank Credit Facility (as defined herein). As a result of the refinancing and payment that occurred on February 28, 2013, discussed in Note 4, Debt, the outstanding balance on the KeyBank Credit Facility was $48.2 million, resulting in an unused commitment of $126.8 million, compared to the unused commitment during the same period a year ago, which averaged between $20.0 million and $56.0 million.  

Depreciation and Amortization Expense

  Depreciation and amortization expense for the three months ended March 31, 2013 consisted of depreciation of building and building improvements of our properties of $1.5 million and amortization of the contributed and acquired values allocated to tenant origination and absorption costs of $2.0 million. The increase of $1.7 million as compared to the three months ended March 31, 2012 is a result of additional depreciation and amortization of (1) $0.4 million related to the acquisitions made during the three months ended March 31, 2013; and (2) $1.3 million related to the seven acquisitions made during the year ended December 31, 2012, which included three full months of activity compared to the partial months of activity for the two acquisitions during the three months ended March 31, 2012.  

Interest Expense

  Interest expense for the three months ended March 31, 2013 increased by $1.1 million compared to the same period in 2012 due to the following: (1) $0.1 million in additional mortgage interest expense related to the GE mortgage debt for which there were three full months of activity compared to none in the same period of the prior year; (2) $0.3 million related to new mortgage interest expense for the eight properties refinanced during the period which previously served as security for the KeyBank Credit Facility; (3) $0.4 million in additional interest expense related to the KeyBank Credit Facility (discussed below) as a result of the acquisitions made subsequent to March 31, 2012; and (4) $0.4 million in additional amortization of deferred financing costs related to new acquisitions. These increases are offset by a $0.1 million decrease in interest expense as it relates to the Mezzanine and bridge loans. Borrowings during the three months ended March 31, 2013 pursuant to the KeyBank Bridge Loan totaled $10.4 million and were paid in full on January 31, 2013 whereas during the same period in the prior year, a total of $21.4 million was borrowed on the Mezzanine Loan of which $10.9 million remained outstanding as of March 31, 2012.  

Funds from Operations and Modified Funds from Operations

  Our management believes that historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets 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 to be insufficient. Additionally, publicly registered, non-listed REITs typically have a significant amount of acquisition activity and are substantially more dynamic during their initial years of investment and operation. While other start-up entities may also experience significant acquisition activity during their initial years, we believe that non-listed REITs are unique in that they have a limited life with targeted exit strategies within a relatively limited time frame after the acquisition activity ceases.  In order to provide a more complete understanding of the operating performance of a REIT, the National Association of Real Estate Investment Trusts ("NAREIT") promulgated a measure known as funds from operations ("FFO"). FFO is defined as net income or loss computed in accordance with GAAP, excluding extraordinary items, as defined by GAAP, and gains and losses from sales of depreciable operating property, adding back asset impairment write-downs, plus real estate related depreciation and amortization (excluding amortization of deferred financing costs and depreciation of non-real estate assets), and after adjustment for unconsolidated partnerships and joint ventures. Because FFO calculations exclude such items as depreciation and amortization of real estate assets and gains and losses from sales of operating real estate assets (which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates), they facilitate comparisons of operating performance between periods and between other REITs. As a result, we believe that the use of FFO, together with the required GAAP presentations, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities. It should be noted, however, that other REITs may not define FFO in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently than we do, making comparisons less meaningful.  The Investment Program Association ("IPA") issued Practice Guideline 2010-01 (the "IPA MFFO Guideline") on November 2, 2010, which extended financial measures to include modified funds from operations ("MFFO"). In computing MFFO, FFO is adjusted for certain non-operating cash items such as acquisition fees and expenses and certain non-cash items such as straight-line rent, amortization of in-place lease valuations, amortization of discounts and premiums on debt investments, nonrecurring impairments of                                           33

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  real estate-related investments, mark-to-market adjustments included in net income (loss), and nonrecurring gains or losses included in net income (loss) from the extinguishment or sale of debt, hedges, foreign exchange, derivatives or securities holdings where trading of such holdings is not a fundamental attribute of the business plan, unrealized gains or losses resulting from consolidation from, or deconsolidation to, equity accounting, and after adjustments for consolidated and unconsolidated partnerships and joint ventures, with such adjustments calculated to reflect MFFO on the same basis. Management is responsible for managing interest rate, hedge and foreign exchange risk. To achieve our objectives, we may borrow at fixed rates or variable rates. In order to mitigate our interest rate risk on certain financial instruments, if any, we may enter into interest rate cap agreements and in order to mitigate our risk to foreign currency exposure, if any, we may enter into foreign currency hedges. We view fair value adjustments of derivatives, impairment charges and gains and losses from dispositions of assets as non-recurring items or items which are unrealized and may not ultimately be realized, and which are not reflective of on-going operations and are therefore typically adjusted for when assessing operating performance. Additionally, we believe it is appropriate to disregard impairment charges, as this is a fair value adjustment that is largely based on market fluctuations, assessments regarding general market conditions, and the specific performance of properties owned, which can change over time. No less frequently than annually, we evaluate events and changes in circumstances that could indicate that the carrying amounts of real estate and related intangible assets may not be recoverable. When indicators of potential impairment are present, we assess whether the carrying value of the assets will be recovered through the future undiscounted operating cash flows (including net rental and lease revenues, net proceeds on the sale of the property, and any other ancillary cash flows at a property or group level under GAAP) expected from the use of the assets and the eventual disposition. Investors should note, however, that determinations of whether impairment charges have been incurred are based partly on anticipated operating performance, because estimated undiscounted future cash flows from a property, including estimated future net rental and lease revenues, net proceeds on the sale of the property, and certain other ancillary cash flows, are taken into account in determining whether an impairment charge has been incurred. While impairment charges are excluded from the calculation of MFFO as described above, investors are cautioned that due to the fact that impairments are based on estimated future undiscounted cash flows and the relatively limited term of our operations, it could be difficult to recover any impairment charges through operational net revenues or cash flows prior to any liquidity event.  We adopted the IPA MFFO Guideline as management believes that MFFO is a beneficial indicator of our on-going portfolio performance and ability to sustain our current distribution level. More specifically, MFFO isolates the financial results of the REIT's operations. MFFO, however, is not considered an appropriate measure of historical earnings as it excludes certain significant costs that are otherwise included in reported earnings. Further, since the measure is based on historical financial information, MFFO for the period presented may not be indicative of future results or our future ability to pay our dividends. By providing FFO and MFFO, we present information that assists investors in aligning their analysis with management's analysis of long-term operating activities. MFFO also allows for a comparison of the performance of our portfolio with other REITs that are not currently engaging in acquisitions, as well as a comparison of our performance with that of other non-traded REITs, as MFFO, or an equivalent measure, is routinely reported by non-traded REITs, and we believe often used by analysts and investors for comparison purposes. As explained below, management's evaluation of our operating performance excludes items considered in the calculation of MFFO based on the following economic considerations:    

• Straight-line rent. Most of our leases provide for periodic minimum rent

payment increases throughout the term of the lease. In accordance with

GAAP, these periodic minimum rent payment increases during the term of a

lease are recorded to rental revenue on a straight-line basis in order to

reconcile the difference between accrual and cash basis accounting. As

straight-line rent is a GAAP non-cash adjustment and is included in

historical earnings, it is added back to FFO to arrive at MFFO as a means

          of determining operating results of our portfolio.          •   Amortization of in-place lease valuation. As this item is a cash flow

adjustment made to net income in calculating the cash flows provided by

(used in) operating activities, it is added back to FFO to arrive at MFFO

         as a means of determining operating results of our portfolio.    

• Acquisition-related costs. We were organized primarily with the purpose of

acquiring or investing in income-producing real property in order to

generate operational income and cash flow that will allow us to provide

regular cash distributions to our stockholders. In the process, we incur

non-reimbursable affiliated and non-affiliated acquisition-related costs,

which in accordance with GAAP, are expensed as incurred and are included

         in the determination of income (loss) from operations and net income          (loss). These costs have been and will continue to be funded with cash

proceeds from our Primary Public Offerings or included as a component of

the amount borrowed to acquire such real estate. If we acquire a property

after all offering proceeds from our Public Offerings have been invested,

there will not be any offering proceeds to pay the corresponding

acquisition-related costs. Accordingly, unless our Advisor determines to

waive the payment of any then-outstanding acquisition-related costs

otherwise payable to our Advisor, such costs will be paid from additional

debt, operational earnings or cash flow, net proceeds from the sale of

properties, or ancillary cash flows. In evaluating the performance of our

portfolio over time, management employs business models and analyses that

differentiate the costs to acquire investments from the investments'

revenues and expenses. Acquisition-related costs may negatively affect our

operating results, cash flows from operating activities and cash available

         to fund distributions during periods in which                                            34 

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properties are acquired, as the proceeds to fund these costs would

otherwise be invested in other real estate related assets. By excluding

acquisition-related costs, MFFO may not provide an accurate indicator of

our operating performance during periods in which acquisitions are made.

However, it can provide an indication of our on-going ability to generate

       cash flow from operations and continue as a going concern after we cease        to acquire properties on a frequent and regular basis, which can be        compared to the MFFO of other non-listed REITs that have completed their        acquisition activity and have similar operating characteristics to

ours. Management believes that excluding these costs from MFFO provides

investors with supplemental performance information that is consistent

with the performance models and analysis used by management.

   For all of these reasons, we believe the non-GAAP measures of FFO and MFFO, in addition to income (loss) from operations, net income (loss) and cash flows from operating activities, as defined by GAAP, are helpful supplemental performance measures and useful to investors in evaluating the performance of our real estate portfolio. However, a material limitation associated with FFO and MFFO is that they are not indicative of our cash available to fund distributions since other uses of cash, such as capital expenditures at our properties and principal payments of debt, are not deducted when calculating FFO and MFFO. Additionally, MFFO has limitations as a performance measure in an offering such as ours where the price of a share of common stock is a stated value. The use of MFFO as a measure of long-term operating performance on value is also limited if we do not continue to operate under our current business plan as noted above. MFFO is useful in assisting management and investors in assessing our on-going ability to generate cash flow from operations and continue as a going concern in future operating periods, and in particular, after the offering and acquisition stages are complete and NAV is disclosed. However, MFFO is not a useful measure in evaluating NAV because impairments are taken into account in determining NAV but not in determining MFFO. Therefore, FFO and MFFO should not be viewed as more prominent a measure of performance than income (loss) from operations, net income (loss) or to cash flows from operating activities and each should be reviewed in connection with GAAP measurements.  Neither the SEC, NAREIT, nor any other applicable regulatory body has opined on the acceptability of the adjustments contemplated to adjust FFO in order to calculate MFFO and its use as a non-GAAP performance measure. In the future, the SEC or NAREIT may decide to standardize the allowable exclusions across the REIT industry, and we may have to adjust the calculation and characterization of this non-GAAP measure.  

Our calculation of FFO and MFFO is presented in the following table for the three months ended March 31, 2013 and 2012.

                                                                  Three Months Ended                                                                     March 31,                                                             2013                 2012 Net Loss                                                $ (1,092,957 )$ (3,046,017 ) Adjustments: Depreciation of building and improvements                  1,528,347        

946,799

 Amortization of intangible assets                          2,017,864              943,110  FFO/(FFO deficit)                                       $  2,453,254$ (1,156,108 )  Reconciliation of FFO MFFO FFO/(FFO deficit)                                       $  2,453,254$ (1,156,108 ) Adjustments: Acquisition fees and expenses to non-affiliates              255,779        

681,555

 Acquisition fees and expenses to affiliates                1,170,000        

2,286,000

Revenues in excess of cash received (straight-line rents)

                                                      (452,048 )           (271,869 ) Amortization of above/(below) market rent                    (44,334 )           (143,152 )  MFFO                                                    $  3,382,651$  1,396,426

Liquidity and Capital Resources

Long-Term Liquidity and Capital Resources

  On a long-term basis, our principal demands for funds will be for property acquisitions, either directly or through entity interests, for the payment of operating expenses and distributions, and for the payment of debt service on our outstanding indebtedness, including repayment of the KeyBank Credit Facility, KeyBank Bridge Loan, and assumed mortgage loans discussed below, and other investments.                                           35 

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  Generally, cash needs for items, other than property acquisitions, will be met from operations and proceeds received from our Public Offerings. However, there may be a delay between the sale of our shares and our purchase of properties that could result in a delay in the benefits to our stockholders, if any, of returns generated from our investments. Our Advisor will evaluate potential additional property acquisitions and engage in negotiations with sellers on our behalf. After a purchase contract is executed that contains specific terms, the property will not be purchased until the successful completion of due diligence, which includes review of the title insurance commitment, an appraisal and an environmental analysis. In some instances, the proposed acquisition will require the negotiation of final binding agreements, which may include financing documents. During this period, we may decide to temporarily invest any unused proceeds from our Public Offerings in certain investments that could yield lower returns than the properties. These lower returns may affect our ability to make distributions.  KeyBank Credit Facility  On January 11, 2013, in connection with the acquisition of the Comcast property, we, through our Operating Partnership, made a draw of $16.2 million from the $200.0 million credit facility with KeyBank National Association and other syndication partners under which $175.0 million has been committed (the "KeyBank Credit Facility"). On February 15, 2013, in connection with the acquisition of the Boeing property, we made an additional draw of $6.6 million from the KeyBank Credit Facility.  On February 11, 2013, we entered into that certain Third Amendment to the Restated KeyBank Credit Agreement (the "Third Amendment"), pursuant to which the definition of the Pool Loan-To-Value Ratio ("Pool LTV Ratio") was revised to 60% if (i) no single mortgaged property represents greater than 35% of pool value (formerly 30%) and (ii) no mortgaged properties which share the same tenant represent greater than 35% of pool value (formerly 30%) in the aggregate and to 50% if at any time following the six-month anniversary of the date of borrowing, any mortgaged property represents greater than 35% of pool value (formerly 30%).  On February 28, 2013, a principal payment in the amount of $103.6 million was made on the KeyBank Credit Facility in conjunction with a refinancing whereby eight properties, which previously served as security for the KeyBank Credit Facility became collateral for the Midland Mortgage Loan discussed below.  As of March 31, 2013, $48.2 million of the KeyBank Credit Facility was outstanding, which is secured by the Will Partners, Northrop Grumman, Comcast and Boeing properties. Per the terms of the Third Amendment, the maximum loan available is the lesser of the total commitments ($175.0 million) or the aggregate borrowing base availability ($48.2 million), therefore, the KeyBank Credit Facility was fully utilized as of March 31, 2013.  

KeyBank Bridge Loan

  On January 11, 2013, in connection with the acquisition of the Comcast property, we, through our Operating Partnership, made a draw of approximately $10.4 million pursuant to the bridge credit agreement with KeyBank National Association and one other syndication partner under which we may borrow up to $25.0 million (the "KeyBank Bridge Loan"). The balance on the KeyBank Bridge Loan was paid in full on January 31, 2013. As of March 31, 2013, the borrowing availability on the KeyBank Bridge Loan was $25.0 million.  

Midland Mortgage Loan

  On February 28, 2013, certain property-owning special purpose entities ("SPEs") wholly-owned by our Operating Partnership, entered into a fixed-rate mortgage loan agreement with Midland National Life Insurance Company (the "Midland Mortgage Loan"), whereby certain properties, which previously served as security for the KeyBank Credit Facility, were refinanced in the amount of $105.6 million and now serve as collateral for the Midland Mortgage Loan. The Midland Mortgage Loan has a fixed interest rate of 3.94%, a term of 10 years and requires monthly interest-only payments for the first four years of the term, followed by principal and interest payments based on a 30-year amortization schedule with all remaining principal and unpaid interest due on the loan maturity date. The Midland Mortgage Loan is guaranteed by our Operating Partnership and is secured by a first lien on and individual security agreements with the Operating Partnership's underlying interest in the SPEs owning the AT&T, Westinghouse, Renfro, Zeller Plastik, Travelers, Quad/Graphics, ITT, and Health Net properties, along with individual fixture filings, and assignments of leases, rents, income and profits related to each such property.  Other potential future sources of capital include proceeds from our Public Offerings, proceeds from secured or unsecured financings from banks or other lenders, including debt assumed in a real estate acquisition transaction, proceeds from the sale of properties and undistributed funds from operations. If necessary, we may use financings or other sources of capital in the event of unforeseen significant capital expenditures. To the extent we are not able to secure additional financing in the form of a credit facility (other than the current KeyBank Credit Facility) or other third party source of liquidity, we will be heavily dependent upon the proceeds of our Public Offerings and income from operations in order to meet our long-term liquidity requirements and to fund our distributions.                                           36 

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Short-Term Liquidity and Capital Resources

  We expect to meet our short-term operating liquidity requirements with proceeds received in our Public Offerings and operating cash flows generated from our properties and other properties we acquire in the future. All advances from our Advisor will be repaid, without interest, as funds are available after meeting our current liquidity requirements, subject to the limitations on reimbursement set forth in the "Management Compensation" section of our prospectus.  

Our cash and cash equivalent balances increased by $22.4 million during the three months ended March 31, 2013 and were used in or provided by the following:

  Operating Activities. During the three months ended March 31, 2013, we generated $2.1 million of net cash from operating activities, compared to $1.8 million generated during the same period in 2012. The net loss in the current period is offset by (1) non-cash adjustments of $3.6 million (consisting mainly of depreciation and amortization of $4.0 million less deferred rent of $0.4 million), which increased compared to the same period in 2012 in which the same non-cash adjustments totaled $1.6 million, as a result of the increase in depreciation and amortization and deferred rent related to the properties acquired subsequent to March 31, 2012; and (2) cash used for working capital of $0.4 million compared to cash provided by working capital of $3.2 million for the three months ended March 31, 2012. The decrease in working capital is primarily due to the payment of acquisition fees and expenses totaling $2.3 million related to the AT&T and Westinghouse properties and the increase in restricted cash reserves totaling $0.8 million.  Investing Activities. During the three months ended March 31, 2013, we used $39.5 million in cash for investing activities related to (1) $38.6 million for the acquisitions made in the current period; and (2) $0.9 million in real estate acquisition and other deposits. The decrease in cash usage from $75.5 million for the three months ended March 31, 2012 is due to acquisitions made in the same period in the prior year having a combined acquisition value of $76.2 million.  Financing Activities. During the three months ended March 31, 2013, we generated $59.7 million in financing activities, compared to $71.8 million generated during the same period a year ago, a decrease in cash provided by financing activities of $12.1 million. The decrease in cash generated is the net result of a $93.3 million increase in the change in cash provided by financing activities compared to the prior year and a $105.4 million decrease in the change in cash used in financing activities compared to the prior year. The $93.3 million increase is comprised of: (1) an increase of $66.5 million in proceeds from borrowings, primarily related to borrowings on the Midland Mortgage Loan, the KeyBank Credit Facility, and KeyBank Bridge Loan discussed above; and (2) an increase of $26.8 million in the issuance of common stock during the three months ended March 31, 2013, compared to the same period a year ago. The $105.4 million decrease consists of the following: (1) an increase of $103.5 million in loan repayments for the KeyBank Credit Facility and KeyBank Bridge Loan discussed above; (2) a $0.1 million increase in loan amortization compared to the same period a year ago, including the addition of the GE mortgage debt; (3) a $0.7 million increase in distribution payments to common stockholders; (4) a $0.4 million increase in common stock repurchases; and (5) an increase in deferred financing costs of $0.7 million related to the borrowings on the Midland Mortgage Loan, KeyBank Credit Facility and KeyBank Bridge Loan, as a result of the AT&T, Westinghouse, GE, Travelers, Zeller Plastik, Northrop Grumman, Health Net, Comcast, and Boeing property acquisitions and the refinancing of debt that occurred in the current period.  

Distributions and Our Distribution Policy

  Distributions will be paid to our stockholders as of the record date selected by our board of directors. We expect to continue to pay distributions monthly based on daily declaration and record dates so that investors may be entitled to distributions immediately upon purchasing our shares. We expect to pay distributions regularly unless our results of operations, our general financial condition, general economic conditions, or other factors inhibit us from doing so. Distributions will be authorized at the discretion of our board of directors, which will be directed, in substantial part, by its obligation to cause us to comply with the REIT requirements of the Internal Revenue Code of 1986, as amended (the "Code"). The funds we receive from operations that are available for distribution may be affected by a number of factors, including the following:         •   the amount of time required for us to invest the funds received in our          Public Offerings;       •   our operating and interest expenses;          •   the amount of distributions or dividends received by us from our indirect

         real estate investments;       •   our ability to keep our properties occupied;       •   our ability to maintain or increase rental rates;          •   tenant improvements, capital expenditures and reserves for such          expenditures;       •   the issuance of additional shares; and       •   financings and refinancings.                                            37 

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  We have funded distributions with operating cash flow from our properties and offering proceeds raised in our Initial Public Offering. To the extent that we do not have taxable income, distributions paid will be considered a return of capital to stockholders. The following table shows distributions paid during the three months ended March 31, 2013 and the year ended December 31, 2012:                                                  March 31,                       December 31,                                                 2013                              2012 Distributions paid in cash - noncontrolling interests                     $   576,265$    2,334,972 Distributions paid in cash - redeemable noncontrolling interests (1)                      88,709                    

358,617

 Distributions paid in cash - common stockholders                                   1,253,683                    

3,164,685

 Distributions reinvested (shares issued)       1,280,494                          2,732,270  Total distributions                          $ 3,199,151 (2)                 $    8,590,544  Source of distributions: Cash flows provided by (used in) operations (3)                               $ 2,110,917            66 %     $    5,058,053         59 % Proceeds from issuance of common stock (including distributions reinvested pursuant to DRP) (4)                           1,088,234            34 %          3,532,491         41 %  Total sources                                $ 3,199,151           100 %     $    8,590,544        100 %     

(1) Distributions represent the actual payments made to redeemable noncontrolling

interests. These distributions are allocated to common stockholders (see

consolidated statements of operations for the three months ended March 31,

2013) and noncontrolling interests (see consolidated statements of equity for

the three months ended March 31, 2013) based on their respective ownership

percentages as of March 31, 2013.

(2) Total distributions declared but not paid as of March 31, 2013 were $0.5

million and $0.3 million for common stockholders and noncontrolling

interests, respectively.

(3) Percentages were calculated by dividing the respective source amount by the

total sources of distributions.

(4) The terms of the KeyBank Bridge Loan required periodic payments throughout

the month in which a bridge facility draw is outstanding, equal to the net

equity raised in our Public Offerings, as discussed in Note 4, Debt. Proceeds

from the issuance of common stock were used to pay down the principal balance

of the KeyBank Bridge Loan in full on January 31, 2013, totaling $10.4

million.

   For the three months ended March 31, 2013, we paid and declared distributions of approximately $2.7 million to common stockholders including shares issued pursuant to the DRP, and approximately $0.7 million to the limited partners of our Operating Partnership, as compared to FFO and MFFO for the three months ended March 31, 2013 of $2.5 million and $3.4 million, respectively. The payment of distributions from sources other than FFO or MFFO may reduce the amount of proceeds available for investment and operations or cause us to incur additional interest expense as a result of borrowed funds.  

Contractual Commitments and Contingencies

  The following is a summary of our contractual obligations as of March 31, 2013:                                                     Payments Due During the

Years Ending December 31,

                                     Total               2013          2014-2015        2016-2017        Thereafter Outstanding debt obligations (1)                             $ 218,775,180 (2)    $ 1,041,376$ 51,260,243$ 40,564,921$ 125,908,640 Interest on outstanding debt obligations (3)                    58,199,060          6,864,688       17,487,282       12,158,690        21,688,400  Total                           $ 276,974,240$ 7,906,064$ 68,747,525$ 52,723,611$ 147,597,040

(1) Amounts include principal payments only. As of March 31, 2013, the total

KeyBank Credit Facility was $48.2 million and is due on November 18, 2014,

assuming the one-year extension is exercised.

(2) The payments on our mortgage debt do not include the premium of $0.4 million.

(3) Projected interest payments are based on the outstanding principal amounts

    and interest rates in effect at March 31, 2013.                                            38 

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Off-Balance Sheet Arrangements

As of March 31, 2013, we had no off-balance sheet transactions, nor do we currently have any such arrangements or obligations.

Subsequent Events

See Note 9, Subsequent Events, to the consolidated financial statements.

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