GTJ REIT, INC. – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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This report contains statements that we believe to be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give our current expectations or forecasts of future events. Forward-looking statements generally can be identified by the use of forward-looking terminology such as "may," "will," "expect," "intend," "estimate," "anticipate," "believe," "project," or "continue," or similar words or the negative thereof. From time to time, we also may provide oral or written forward-looking statements in other materials we release to the public. Any or all of our forward-looking statements in this report and in any public statements we make could be materially different from actual results. They can be affected by assumptions we might make or by known or unknown risks or uncertainties. Consequently, we cannot guarantee any forward-looking statements. Investors are cautioned not to place undue reliance on any forward-looking statements. Investors should also understand that it is not possible to predict or identify all such factors and should not consider the potential risks and uncertainties set forth herein and in our Report on Form 10-K for the year ended
Executive Summary:
We are a fully integrated, self-administered and self-managed Real Estate Investment Trust ("REIT"), engaged in the acquisition, ownership, and management of real properties. We currently own interests in a total of 32 properties consisting of over 2.4 million square feet of office and industrial properties on 210 acres of land in
We continue to seek opportunities to acquire stabilized properties. To the extent it is in the interests of our stockholders, we will seek to invest in a diversified portfolio of real properties within geographic areas that will satisfy our primary investment objectives of providing our stockholders with stable cash flow, preservation of capital and growth of income and principal without taking undue risk. Because a significant factor in the valuation of income-producing property is the potential for future income, we anticipate that the majority of properties that we will acquire will have both the potential for growth in value and provide for cash distributions to stockholders.
Accounting Pronouncements:
See Note 2, "Recently Issued Accounting Pronouncements," in the Notes to the Condensed Consolidated Financial Statements contained in Part I, Item 1. "Financial Statements" of this Form 10-Q for a detailed discussion regarding recently issued accounting pronouncements.
Critical Accounting Policies:
Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in
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Revenue Recognition-Real Estate Operations:
We recognize revenue in accordance with ASC 840-20-25, which requires that revenue be recognized on a straight-line basis over the term of the lease unless another systematic and rational basis is more representative of the time pattern in which the use benefit is derived from the leased property. In those instances in which we fund tenant improvements and the improvements are deemed to be owned by us, revenue recognition will commence when the improvements are substantially completed and possession or control of the space is turned over to the tenant. When we determine that the tenant allowances are lease incentives, we commence revenue recognition when possession or control of the space is turned over to the tenant for tenant work to begin. Our properties are being leased to tenants under operating leases. Minimum rental income is recognized on a straight-line basis over the term of the lease.
Property operating expense recoveries from tenants of common area maintenance, real estate, and other recoverable costs are recognized in the period the related expenses are incurred.
Revenue Recognition-Electrical Contracting Operations:
We recognize revenues from long-term construction contracts on the percentage-of-completion method in accordance with ASC 605-35. Percentage-of-completion is measured principally by the percentage of costs incurred to date for each contract to the estimated total costs for such contract at completion. Contract costs include all direct costs related to the performance and completion of the contracts. Estimated losses on the long term construction contracts are recognized in the period in which such losses are determined. Revenues from our electrical contracting operations are presented as part of discontinued operations in the condensed consolidated statements of operations (see Note 8 for further discussion regarding discontinued operations).
Accounts Receivable:
Accounts receivable consist of trade receivables recorded at the original invoice amounts, less an estimated allowance for uncollectible accounts. Trade credit is generally extended on a short-term basis; thus trade receivables generally do not bear interest. Trade receivables are periodically evaluated for collectability based on past credit histories with customers and their current financial conditions. Changes in the estimated collectability of trade receivables are recorded in the results of operations for the period in which the estimate is revised. Trade receivables that are deemed uncollectible are offset against the allowance for uncollectible accounts. We generally do not require collateral for trade receivables.
Real Estate Investments:
Real estate assets are stated at cost, less accumulated depreciation and amortization. All costs related to the improvement or replacements of real estate properties are capitalized. Additions, renovations and improvements that enhance and/or extend the useful life of a property are also capitalized. Expenditures for ordinary maintenance, repairs and improvements that do not materially prolong the normal useful life of an asset are charged to operations as incurred.
Upon the acquisition of real estate properties, the fair value of the real estate purchased is allocated to the acquired tangible assets (consisting of land, buildings and building improvements) and identified intangible assets and liabilities (consisting of above-market and below-market leases and in-place leases) in accordance with ASC 805. We utilize methods similar to those used by independent appraisers in estimating the fair value of acquired assets and liabilities. The fair value of the tangible assets of an acquired property considers the value of the property "as-if-vacant." The fair value reflects the depreciated replacement cost of the asset. In allocating purchase price to identified intangible assets and liabilities of an acquired property, the value of above-market and below-market leases is estimated based on the differences between (i) contractual rentals and the estimated market rents over the applicable lease term discounted back to the date of acquisition utilizing a discount rate adjusted for the credit risk associated with the respective tenants and (ii) the estimated cost of acquiring such leases giving effect to our history of providing tenant improvements and paying leasing commissions, offset by a vacancy period during which such space would be leased. The aggregate value of in-place leases is measured by the excess of (i) the purchase price paid for a property after adjusting existing in-place leases to market rental rates over (ii) the estimated fair value of the property "as-if-vacant," determined as set forth above.
Above and below market leases acquired are recorded at their fair value. The capitalized above-market lease values are amortized as a reduction of rental revenue over the remaining term of the respective leases and the capitalized below-market lease values are amortized as an increase to rental revenue over the remaining term of the respective leases. The value of in-place leases is based on our evaluation of the specific characteristics of each tenant's lease. Factors considered include estimates of carrying costs during expected lease-up periods, current market conditions, and costs to execute similar leases. The value of in-place leases are
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amortized over the remaining term of the respective leases. If a tenant vacates its space prior to its contractual expiration date, any unamortized balance of the related intangible asset is expensed.
Asset Impairment:
We apply the guidance in ASC 360-10-05 to recognize and measure impairment of long-lived assets. Management reviews each real estate investment for impairment whenever events or circumstances indicate that the carrying value of a real estate investment may not be recoverable. The review of recoverability is based on an estimate of the undiscounted future cash flows that are expected to result from the real estate investment's use and eventual disposition. Such cash flow analyses consider factors such as expected future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If an impairment event exists due to the projected inability to recover the carrying value of a real estate investment, an impairment loss is recorded to the extent that the carrying value exceeds estimated fair value. Management is required to make subjective assessments as to whether there are impairments in the value of its real estate properties. These assessments could have a direct impact on net income, because an impairment loss is recognized in the period that the assessment is made. Management has determined that there were no indicators of impairment relating to our long lived assets at
When impairment indicators are present, investments in affiliated companies are reviewed for impairment by comparing their fair values to their respective carrying amounts. We make our estimate of fair value by considering certain factors including discounted cash flow analyses. If the fair value of the investment has dropped below the carrying amount, management considers several factors when determining whether an other-than-temporary decline in market value has occurred, including the length of the time and the extent to which the fair value has been below cost, the financial condition and near-term prospects of the affiliated company, and other factors influencing the fair market value, such as general market conditions. Management has determined that there were no indicators of impairment relating to our investments in affiliated companies at
Discontinued Operations:
The condensed consolidated financial statements present the operations of our outdoor maintenance, shelter cleaning, electrical contracting, and parking operations as discontinued operations (Note 8) in accordance with ASC 205-20-55 for the three months ended
Fair Value Measurements:
We determine fair value in accordance with ASC 820-10-05 for financial assets and liabilities. ASC 820-10-05 defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements.
Fair value is defined as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments' complexity.
Assets and liabilities disclosed at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by ASC 820-10-35 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:
† Level 1 - Inputs are unadjusted, quoted prices in active markets for
identical assets or liabilities at the measurement date.
† Level 2 - Inputs (other than quoted prices included in Level 1) are either
directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument's anticipated life. Level 2 inputs include quoted market prices in markets that are not active for an identical or similar asset or liability, and quoted market prices in active markets for a similar asset or liability.
† Level 3 - Inputs reflect management's best estimate of what market
participants would use in pricing the asset or liability at the measurement date. These valuations are based on significant unobservable inputs that require a 34
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considerable amount of judgment and assumptions. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
Determining which category an asset or liability falls within the hierarchy requires significant judgment and we evaluate its hierarchy disclosures each quarter.
Income Taxes:
We are organized and conduct our operations to qualify as a REIT for federal income tax purposes. Accordingly, we will generally not be subject to federal income taxation on that portion of our distributable income that qualifies as REIT taxable income, to the extent that we distribute at least 90% of our taxable income to our stockholders and comply with certain other requirements as defined under Section 856 through 860 of the Code.
We also participate in certain activities conducted by entities which elected to be treated as taxable subsidiaries under the Code. As such we are subject to federal, state and local taxes on the income from these activities.
We account for income taxes under the asset and liability method, as required by the provisions of ASC 740-10-30. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We provide a valuation allowance for deferred tax assets for which we do not consider realization of such assets to be more likely than not.
Investment in Equity Affiliates:
We invested in a joint venture that was formed to perform electrical contracting services. This investment is recorded under the equity method of accounting. We record our share of the net income and losses from the underlying properties and any other-than-temporary impairment on this investment as part of discontinued operations on the condensed consolidated statements of operations.
Variable Interest Entities:
We account for variable interest entities ("VIEs") in accordance with ASC 810-10-50. A VIE is defined as an entity in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, which is defined as the party that (i) has the power to control the activities that impact the VIE's economic performance and (ii) has the right to receive the majority of expected returns or the obligation to absorb the majority of expected losses that could be material to the VIE.
As of
Stock-Based Compensation:
We have a stock-based compensation plan, which is described in Note 11. We account for stock based compensation in accordance with ASC 718-30-30, which establishes accounting for stock-based awards exchanged for employee services. Under the provisions of ASC 718-10-35, share-based compensation cost is measured at the grant date, based on the fair value of the award, and the expense is recognized in earnings at the grant date (for the portion that vests immediately) or ratably over the respective vesting periods.
Real Estate:
On
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lease approximately 107,654 square feet of office space and the adjacent parking structure located at
The United Technologies Lease commenced on
The base annual rent for the Premises will begin 12 months from the lease commencement. The base annual rent for the Premises will range from approximately
On
Acquisition of Wu/Lighthouse Portfolio,
On
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Table of Contents Results of Operations:
Three Months Ended
The following table sets forth our results of operations for the periods indicated (in thousands): Three Months Ended March 31, Increase/(Decrease) 2013 2012 Amount Percent (Unaudited) Revenues: Property rentals$ 6,837 $ 3,448 $ 3,389 98% Tenant reimbursements 1,209 102 1,107 1,085% Other revenue - 10 (10) (100%) Total revenues 8,046 3,560 4,486 126% Operating expenses: General and administrative expenses 2,879 2,658 221 8% Property operating expenses 1,527 226 1,301 576% Depreciation and amortization expense 2,278 338 1,940 574% Total operating expenses 6,684 3,222 3,462 107% Operating income 1,362 338 1,024 303% Other income (expense): Interest income 2 14 (12) 86% Interest expense (1,870) (652) (1,218) 187% Change in insurance reserves (399) 77 (476) (618%) Other (4,444) 5 (4,449) nm Total other income (expense): (6,711) (556) (6,155) 1,107% Loss from continuing operations before income taxes (5,349) (218) (5,131) nm Provision for income taxes - - - nm Loss from continuing operations, net of taxes (5,349) (218) (5,131) nm Discontinued Operations: Loss from discontinued operations, net of taxes (668) (730) 62 (8%) Net loss (6,017) (948) (5,069) 535% Net income attributable to noncontrolling interest 393 - 393 nm Net loss attributable to GTJ REIT, Inc.$ (6,410) $ (948) $ (5,462) 576% nm - not meaningful Property Rental Revenues
Property rental revenue increased
Tenant Reimbursements
Tenant reimbursements increased
Operating Expenses
Operating expenses increased
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Table of Contents Other Income (Expense)
Other income (expense) increased
Provision For Income Taxes
The provision for income taxes represents federal, state, and local taxes primarily based on the taxable income of the taxable REIT subsidiaries. There was no provision for income taxes for the three months ended
Loss from Discontinued Operations, Net of Taxes
Loss from discontinued operations, net of taxes reflects the operating results, accruals, allowances, and asset write offs of our taxable REIT subsidiaries (outdoor maintenance, shelter cleaning, electrical contracting, and parking operations).
Liquidity and Capital Resources
At
Financing Arrangements: Hartford Loan Agreement:
On
The obligations under the Hartford Loan Agreement are secured by, among other things, a first priority mortgage lien and security interest on certain (a) improved real estate commonly known as
Aviva Loan Agreement:
On
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revolving credit facility discussed below. The remaining Proceeds will be used for general working capital and other corporate purposes and partner distributions.
For the purposes of securing the Proceeds, Farm Springs has granted Aviva a security interest in
Genworth Loan Agreement:
On
Pursuant to the New York Note, Fairview and Fieldcrest will make monthly payments of interest only in the amount of approximately
Pursuant to the New Jersey Note, 500 American and 300 American will make monthly payments of interest only in the amount of approximately
The obligations represented by the New York Note are secured by, among other things, a first priority mortgage lien and security interest on certain (a) improved real estate located at
The obligations represented by the New Jersey Note are secured by, among other things, a first priority mortgage lien and security interest on certain (a) improved real estate located at
The proceeds from the Loans were used to satisfy in full the Borrowers' obligations to
As a condition to Lender entering into the Loan Agreements, the Borrowers and the UPREIT agreed to indemnify the Lender against certain claims and guaranty certain obligations of Borrower pursuant to certain Environmental Indemnity Agreements (the "Environmental Indemnities").
The Loan Agreements contain customary representations and warranties, covenants and events of default. Certain obligations under the Loan Agreements are guaranteed by the UPREIT, pursuant to the terms of certain Guaranties entered into by the UPREIT and Lender. As of
Loan Assumptions:
Each of the acquired properties in the Wu/Lighthouse Portfolio was and continues to be encumbered by certain mortgage indebtedness from one of three different lenders in the aggregate amount of approximately
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certain loan assumption and modification documents to facilitate the acquisition of the acquired properties. Below is a summary of the material terms of the arrangement with each lender.
United States Life Insurance Company Loan:
Wu/LH 15
The USLIC Mortgage Loan bears interest at a rate of 5.76% and matures on
John Hancock Loan:
Wu/LH 12
A portion of the John Hancock Loan matured on
People's United Bank Loan:
Wu/LH 15
Secured Revolving Credit Facility:
On
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available to us to be used for Permitted Acquisitions (as defined in the credit agreement) and for general working capital and other corporate purposes. Our obligations under this credit agreement were satisfied in full on
Net Cash Flows:
Three Months Ended
Operating Activities
Net cash (used in) provided by operating activities was approximately
Investing Activities
Net cash (used in) provided by investing activities was approximately
Financing Activities
Net cash provided by (used in) financing activities was approximately
Funds from Operations and Adjusted Funds from Operations
We consider Funds from Operations ("FFO") and Adjusted Funds from Operations ("AFFO"), each of which are non-GAAP measures, to be additional measures of an equity REIT's operating performance. We report FFO in addition to our net (loss) income and net cash provided by operating activities. Management has adopted the definition suggested by the
Management considers FFO a meaningful, additional measure of operating performance because it primarily excludes the assumption that the value of our real estate assets diminishes predictably over time and industry analysts have accepted it as a performance measure. FFO is presented to assist investors in analyzing our performance. It is helpful as it excludes various items included in net income that are not indicative of our operating performance, such as gains or losses from sales of property and depreciation and amortization.
However, FFO:
† does not represent cash flows from operating activities in accordance with GAAP (which, unlike FFO, generally reflects all cash effects of transactions and other events in the determination of net income); and
† should not be considered an alternative to net income as an indication of our performance.
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In determining AFFO we do not consider the operations of our taxable REIT subsidiaries (outside maintenance, shelter cleaning, electrical, and parking operations) as part of our real estate operations and therefore exclude the net income or net loss when arriving at AFFO. This is the one difference between our definition of AFFO and the NAREIT definition of FFO, which includes net income or net loss from taxable REIT subsidiaries.
FFO and AFFO as defined by us may not be comparable to similarly titled items reported by other real estate investment trusts due to possible differences in the application of the NAREIT definition used by such REITs. The following table provides a reconciliation of net (loss) income in accordance with GAAP to FFO and AFFO for the three months ended
Three Months Ended March 31, 2013 2012 Net loss attributable to GTJ REIT, Inc.$ (6,410) $ (948) Plus: Real property depreciation 1,253 285 Amortization of intangible assets 1,326 205 Amortization of deferred leasing commissions 50 32 Funds from operations (FFO)$ 3,781 $ (426) Loss from taxable-REIT Subsidiaries 570 813 Loss from discontinued operations 668 730 Discontinued operations - depreciation 6 8 Adjusted funds from operations (AFFO)$ (2,537) $ 1,125 FFO per common share - basic and diluted$ (0.28) $ (0.03) AFFO per common share - basic and diluted$ (0.19) $ 0.08 Weighted average common shares outstanding - basic and diluted 13,641,693 13,587,051
Acquisitions, Dispositions, and Investments
On
As further described above, on
Cash Payments for Financing
Payment of interest under our Loan Agreements and Loan Assumptions, will consume a portion of our cash flow, reducing net income and the resulting distributions to be made to our stockholders.
Trend in Financial Resources
We expect to receive additional rent payments over time due to scheduled increases in rent set forth in the leases on our real properties. It should be noted, however, that the additional rent payments are expected to result in an approximately equal obligation to make additional distributions to stockholders, and will therefore not result in a material increase in working capital.
Environmental Matters
Except for our Farm Springs Property and the properties acquired as part of the Wu/Lighthouse Portfolio, our properties have had activity regarding removal and replacement of underground storage tanks. Upon removal of the old tanks, any soil found to be unacceptable was thermally treated off site to burn off contaminants. Fresh soil was brought in to replace earth which had been removed. There are still some levels of contamination at the sites, and groundwater monitoring programs have been put into place at certain locations. In
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study (the "Study") for all site locations. We concluded that the estimated cost range to perform full remediation on all site locations would be between approximately
Insurance Regulations
The provisions of the Insurance Law of the
Divestiture
In connection with the completion of the divestiture of our taxable REIT subsidiaries, we may be subject to certain liabilities including union wages, benefits and severance. On
On
Inflation
Low to moderate levels of inflation during the past several years have favorably impacted our operations by stabilizing operating expenses and borrowing costs. At the same time, low inflation has had the indirect effect of reducing our ability to increase tenant rents. However, our properties have tenants whose leases include expense reimbursements and other provisions to minimize the effect of inflation.
Off Balance Sheet Arrangements
As part of our electrical contracting operations, we may put up performance bonds to guarantee completion of services to be performed. As of
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