Report of Independent Registered Public Accounting Firm
1
Consolidated Balance
Sheets
2
Consolidated Statements of Operations and Comprehensive Income
3
Consolidated Statements of Changes in Members’ Equity
4
Consolidated Statements of Cash Flows
5
Notes
to Consolidated Financial Statements
6-16
Report
of Independent Registered Public Accounting Firm
To the Members of FC HCN University Park, LLC:
In our opinion, the accompanying consolidated balance sheets and related consolidated statements of operations and comprehensive income, of changes in members’ equity and of cash flows present fairly, in all material respects, the financial position of FC HCN University Park, LLC and its subsidiaries at December 31, 2013 and January 31, 2013, and the results of their operations and their cash flows for the eleven months
ended December 31, 2013 and the year ended January 31, 2013 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Other Matter
The accompanying balance sheet of FC HCN University Park, LLC and its subsidiaries as of December 31, 2014, and the related statements of operations and comprehensive income, changes in members’ equity and cash flows for the year then ended were not audited, reviewed, or compiled by us and, accordingly, we do not express an opinion or any other form of assurance on them.
NOTE A – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
FC HCN University Park, LLC (the “Company”) was formed on February 22, 2010 for the purpose of acquiring and operating seven life science office buildings located in Cambridge, Massachusetts. The Company
is comprised of two members: Forest City University Park, LLC (“FCUP”) with a 51% ownership interest and HCN FCE Life Sciences, LLC (“HCN”) with a 49% ownership interest.
The Company owns and operates the following life science office buildings, which are located in Cambridge, Massachusetts:
The Company is a 51% owned equity method investment of Forest City Enterprises, Inc. (“FCE”), a publicly traded company, and is a significant subsidiary of FCE for FCE’s transition period from February 1, 2013 to December 31, 2013 and for the fiscal year ended January 31, 2013 but not for the year ended December 31, 2014. The Company met the conditions of a significant subsidiary of FCE in those applicable periods as a result of its allocated income exceeding 20% of FCE’s pre-tax loss from continuing operations, as adjusted for the
Company’s income. As a result, audited consolidated financial statements are required to be filed with the Securities and Exchange Commission in accordance with Rule 3‑09 of Regulation S-X, as of and for the 11 months ended December 31, 2013 and year ended January 31, 2013. The consolidated financial statements and notes thereto as of and for the year ended December 31, 2014 are unaudited and have been presented for comparative purposes in accordance with Regulation S-X. The December 31, 2014 unaudited financial statements include all adjustments of normal recurring nature necessary to present fairly the Company's financial position, results of operations and cash flows for the
year ended December 31, 2014.
Change in Year-End
FCE changed its year-end to December 31 from January 31, effective December 31, 2013. Accordingly, the Company has also changed its year-end to December 31 from January 31, effective December 31, 2013 and presented an 11 month period ending December 31, 2013 as its transition period.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of FC HCN University Park, LLC and its wholly-owned subsidiaries
in accordance with accounting principles generally accepted in the United States of America ("GAAP"). All intercompany balances and transactions have been eliminated in consolidation.
The preparation of consolidated financial statements in conformity
with GAAP requires the Company to make estimates and assumptions that affect amounts reported in the accompanying consolidated financial statements and related notes. Critical estimates include estimates of useful lives for long-lived assets, reserves for collection on accounts receivables, fair value of financial instruments and assessing property and equipment for impairment. As a result of the nature of estimates made by the Company, actual results could differ.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets as follows: land improvements – 20 years, building (including first generation tenant improvements)
– 50 years, building equipment – 10 to 15 years and tenant improvements – 1 to 15 years. Major improvements are capitalized and expensed through depreciation charges. Repairs, maintenance and minor improvements are expensed as incurred. During the year ended December 31, 2014, the Company disposed of $7,113,216 of property and equipment costs, recognizing a loss on disposal of $2,140,072, which is included in depreciation expense for the year ended December 31, 2014. During the 11 months ended December 31, 2013, the Company disposed of $957,084 of property and equipment costs, recognizing a loss on disposal of $196,192, which is included in depreciation expense
for the 11 months ended December 31, 2013.
The Company reviews its property and equipment for impairment whenever events or changes indicate that its carrying value of the long-lived assets may not be recoverable. In cases where the Company does not expect to recover its carrying costs, an impairment charge is recorded to the extent the carrying value exceeds estimated fair value. Significant estimates are made in the determination of future undiscounted cash flows including historical and budgeted net operating income, estimated holding periods, risk of foreclosure and estimated cash proceeds received upon disposition of the asset. Determining fair value of real estate, if required, also involves significant
judgments and estimates including discount and capitalization rates. Changes to these estimates could affect whether or not an impairment charge would be required and/or the amount of impairment charges recognized. The Company did not record any impairments of property and equipment during the year ended December 31, 2014, the 11 months ended December 31, 2013 or the year ended January 31, 2013.
Cash
The Company maintains cash deposits with major financial institutions which, from time to time, may exceed federally insured limits. The
Company periodically assesses the financial condition of the institutions where cash is held and believes that the risk of any loss is minimal.
Restricted Cash
Restricted cash consists of cash held to fund certain capital improvement expenditures, real estate taxes and certain operating expenses, as required by the mortgage notes loan agreements.
Accounts receivable consists of amounts contractually due from tenants plus cumulative revenue recognized in excess of amounts billed (“straight-line rent receivable”). The Company makes estimates of the uncollectability of its accounts receivable related to base rents, expense reimbursements, straight-line rent receivable and other revenues. The Company analyzes accounts receivable and historical bad debt levels, customer credit worthiness and current economic trends when evaluating the adequacy of the allowance for
doubtful accounts. The Company’s reported net income is directly affected by management’s estimate of the collectability of accounts receivable.
Straight-line rent receivable was $10,550,112 and $11,706,930 at December 31 2014 and 2013, respectively, and is included in accounts receivable, net in the Consolidated Balance Sheets.
Deferred Costs
Mortgage procurement costs are amortized over the term of the mortgage note payable. Accumulated amortization of mortgage procurement costs was $1,410,486 and $1,570,191 at December 31, 2014 and 2013, respectively. Fully amortized mortgage procurement costs of $961,853, $528,797 and $1,488,134 were written off during the
year ended December 31, 2014, the 11 months ended December 31, 2013 and the year ended January 31, 2013, respectively. During the year ended December 31, 2014, the Company wrote off unamortized mortgage procurement costs, recognizing a loss on extinguishment of debt of $168,246, which is included in interest expense in the Consolidated Statements of Operations.
Lease procurement costs are amortized on a straight line basis over the term of the related lease and included in depreciation and amortization in the Consolidated Statement of Operations. Accumulated amortization of lease procurement costs was $5,178,025 and $6,142,357 at December 31,
2014 and 2013, respectively. Fully amortized lease procurement costs of $1,766,536, $229,075 and $1,272,805 were written off during the year ended December 31, 2014, the 11 months ended December 31, 2013 and the year ended January 31, 2013, respectively. Unamortized lease procurement costs of $435,825 and $14,441 were written off during the year ended December 31, 2014 and the 11 months ended December 31, 2013, respectively.
Lease inducement costs are amortized on a straight-line basis over the term of the related lease as a component of minimum rents in the Consolidated Statements of Operations. Accumulated amortization of
lease inducement costs was $50,421 and $25,211 at December 31, 2014 and 2013, respectively.
Derivative Instruments and Hedging Activities
The Company maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned impacts on earnings and cash flows that may be caused by interest rate volatility. The principal risk to the Company through its interest rate hedging strategy is the potential inability of the financial institutions from which the interest rate protection was purchased to cover all of its obligations. To mitigate this exposure,
the Company purchased its interest rate protection from the institution that holds the debt. The Company does not enter into derivative financial instrument contracts for trading or speculative purposes.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management strategy for undertaking various hedge transactions. The Company formally assesses (both at the hedge’s inception and on an ongoing basis) whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined a derivative is not (or has ceased to be) highly effective as a hedge, the Company
discontinues hedge accounting prospectively. When hedge accounting is discontinued and the derivative remains outstanding, the Company carries the derivative at fair value in the Consolidated Balance Sheets, recognizing changes in the fair value in current period earnings as interest expense in the Consolidated Statements of Operations.
Deferred Revenues
Deferred revenues consist of prepaid tenant rental income.
Members' Equity
As part of the Company structuring, FCUP was credited with a special capital account balance (“Class B Capital”) of $121,605,600. During the year ended December
31, 2014 and the 11 months ended December 31, 2013, FCUP received priority distributions of $10,689,894 and $2,716,601, respectively, as a result of certain refinancings of the Company's debt. FCUP is entitled to a preferred return equal to 5.25% per annum on its Class B Capital account balance. The total cumulative undistributed preferred return was $1,417,642 and $1,510,731 at December 31, 2014 and 2013, respectively. Distributions to the classes are paid in accordance with the Operating Agreement, which calls for priority distributions to one class or the other depending on the nature of the cash flow source. The Company will continue in perpetuity unless
terminated earlier as provided in the Operating Agreement.
The Company’s net income or loss and cash flows are allocated in accordance with the terms of the Operating Agreement. Income is allocated to Class B Capital to the extent of preferred return distributions.
Lease Revenue
Space in the office buildings is generally leased to tenants for periods ranging from 5 to 17 years. Most of the leases provide for minimum annual rents. Where leases provide for fixed step rent increases, revenue is recognized on a straight-line basis over the related lease terms. Revenue recognized in excess of (less than) amounts billed to tenants was $(1,139,556), $(224,750), and $1,042,140 for the year ended December 31, 2014,
the 11 months ended December 31, 2013 and the year ended January 31, 2013, respectively.
The Company is reimbursed by the tenants for its share of certain operating and real estate tax expenses incurred in connection with operations of the buildings, in accordance with its lease agreements.
Income Taxes
No provision for income taxes is included in the consolidated financial statements. Income taxes, if any, are the responsibility of the individual members.
The Company has evaluated events and transaction that occurred between December 31, 2014 and March 19, 2015, the date the consolidated financial statements were available to be issued. There were no significant subsequent events that require disclosure.
2013
Transition Period Comparative Data
The following table presents certain financial information for the 11 months ended December 31, 2013 and 2012, for comparability purposes.
The Company loaned Forest City Commercial Group, Inc. ("FCCG”), an affiliated entity of FCUP, $135,117,378 under a promissory note dated March 11, 2010. The loan accrues interest at 5% per annum, which is payable in arrears on the first day of each calendar
quarter. On March 10, 2019, the unpaid principal balance, together with all accrued but unpaid interest is due. The outstanding balance at December 31, 2014 and 2013 was $115,422,951 and $126,112,845, respectively. Accrued interest was $1,522,785 and $1,611,442 at December 31, 2014 and 2013, respectively.
The fair value of the Company’s note receivable - affiliate are classified as Level 2 in the fair value hierarchy. The
fair value of the outstanding balance at December 31, 2014 and 2013 was $123,529,407 and $132,536,936, respectively.
Interest rate represents an all-in lender rate (1.39% swap rate plus 2.00% lender spread).
All of the Company’s individual mortgage notes payable are solely collateralized by the respective subsidiary’s individual building and personal property and an assignment of leases and rents. None of these mortgages are cross-collateralized between the affiliated entities.
The following summarizes the mortgage notes payable maturities as of December 31, 2014:
Total
Years Ending December 31,
Maturities
2015
$
4,067,400
2016
85,579,905
2017
63,047,791
2018
30,050,322
2019
64,672,263
Thereafter
110,056,420
Total
$
357,474,101
NOTE D – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In connection with the Company’s 35 Landsdowne Street mortgage note payable, the Company purchased a Treasury option with a notional amount of $52,000,000. The Treasury option matured on August
1, 2002 and was fully amortized during the 11 months ended December 31, 2013.
On December 3, 2012, the Company entered into a new interest rate swap agreement with a notional amount of $66,000,000 that amortizes according to the 35 Landsdowne Street mortgage note payable agreement. Under the swap, the Company pays a fixed rate of 1.39% and receives LIBOR, while the underlying loan pays LIBOR plus the lender spread of 2.00%. The swap effectively fixes the interest rate on the mortgage note payable at 3.39%.
The interest rate swap agreement was designated and qualifies as a cash flow hedge of interest rate risk. The effective portion of changes in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in accumulated OCI and is subsequently reclassified into earnings in the period that the hedged transaction affects earnings. The ineffective portion of the change in fair value of derivatives is recognized directly in earnings. The
Company recorded no ineffectiveness related to the cash flow hedges for the year ended December 31, 2014, the 11 months ended December 31, 2013 and the year ended January 31, 2013. As of December 31, 2014, the Company expects that within the next twelve months it will reclassify approximately $698,476, recorded in accumulated OCI, into earnings as interest expense.
The following table presents the fair values and location in the Consolidated Balance Sheets of all derivative instruments.
Fair
Value of Derivative Instruments
Asset Derivatives (included in Deferred Swap Asset)
Interest rate swaps designated as hedging instruments
$
66,000,000
$
3,580,427
The following table presents the impact of gains and losses related to derivative instruments designated as cash flow hedges included in accumulated OCI in the Consolidated Statements of Changes in Members'
Equity and in interest expense in the Consolidated Statements of Operations.
Gain Reclassified from
Accumulated
OCI
Derivatives Designated as Cash Flow Hedging Instruments
The Company’s financial instruments include accounts receivable, note receivable - affiliate, accounts payable and accrued liabilities, mortgage notes payable and an interest rate swap agreement with a positive fair value included in deferred swap asset at December 31, 2014 and 2013. Considerable judgment is necessary to develop estimated fair values of financial instruments. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize upon disposition of the financial instruments.
The accounting guidance related to estimating fair value specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions that other market participants would use based upon market data obtained from independent sources (also referred to as observable inputs). The following summarizes the fair value hierarchy:
•
Level
1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;
•
Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant observable inputs are available, either directly or indirectly, such as interest rates and yield curves that are observable at commonly quoted intervals; and
•
Level 3 –
Prices or valuations that require inputs that are unobservable.
Inputs used to measure fair value may fall into different levels of the fair value hierarchy. In these cases, the level in the fair value hierarchy is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
Measurement of Fair Value
The Company estimates the fair value of its hedging instruments based on interest rate market pricing models. Although the
Company has determined that the significant inputs used to value its hedging instruments fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with the Company’s counterparties and its own credit risk utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. As of December 31, 2014, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its hedging instrument’s position and has determined that the credit valuation adjustments are not significant to the overall valuation of its hedging instrument. As a result, the
Company has determined that the interest rate swap agreement is classified in Level 2 of the fair value hierarchy.
Items Measured at Fair Value on a Recurring Basis
The following table presents information about the Company’s financial asset measured at fair value on a recurring basis.
The carrying amount of accounts receivable and accounts payable and accrued liabilities approximates fair value based upon the short-term nature of the instruments. The Company estimates the fair value of its note receivable - affiliate and mortgage notes payable by discounting future cash payments at interest rates that the
Company believes approximate the current market. Estimated fair value is based upon market prices of public debt, available industry financing data, current treasury rates and recent financing transactions. The fair value of the Company’s mortgage notes payable are classified as Level 3 in the fair value hierarchy. The following table summarizes the fair value of mortgage notes payable:
The
Company has six tenant leases that accounted for between 11% to 16% of total revenues and totaling approximately 81%, 84% and 80% of total revenues for the year ended December 31, 2014, the 11 months ended December 31, 2013 and the year ended January 31, 2013, respectively.
NOTE G – GROUND LEASES
The Company leases the land on which each of the office buildings are situated from the Massachusetts Institute of Technology (the “Leases”). The Leases are each for a 75-year term, which began on various dates between the years 1986 and 2001. The Lease agreements require the
Company to pay a monthly minimum lease rent payment plus 15% of annual gross revenues in excess of the percentage rent base, as defined. Land rent expense (exclusive of participation payments) amounted to $4,948,998, $4,521,171 and $3,815,613 for the year ended December 31, 2014, the 11 months ended December 31, 2013 and the year ended January 31, 2013, respectively.
The
Leases also require the payment of 15% of gross proceeds less the cost of sale or refinancing, as defined, upon the sale or refinancing of any portion of the office buildings or interests under the Leases. As a result, the Company paid participation payments of $4,468,475, $1,160,653 and $3,364,979, respectively, which are included in land rent in the Consolidated Statements of Operations for the year ended December 31, 2014, the 11 months ended December 31, 2013 and the year ended January 31, 2013, respectively.
NOTE H – TRANSACTIONS WITH AFFILIATES
Forest City Commercial Management Inc, (“FCCMI”), the managing agent and an affiliated entity of
FCUP, provides services under a management agreement. Management fees incurred and paid for the year ended December 31, 2014, the 11 months ended December 31, 2013 and the year ended January 31, 2013 amounted to $1,380,628, $1,253,417 and $1,344,507, respectively, and are included in management fees in the Consolidated Statements of Operations.
The Company incurred and paid financing fees of $395,118 to an affiliated entity of FCCMI to perform services relating to refinancings for the year ended December 31, 2014. These payments are capitalized as mortgage procurement costs in the Consolidated Balance Sheets.
The
Company pays FCCG an asset management fee under a separate management agreement. Management fees incurred and paid for the year ended December 31, 2014, the 11 months ended December 31, 2013 and the year ended January 31, 2013 amounted to $3,564,102, $3,229,800 and $3,459,756, respectively, and are included in management fees in the Consolidated Statements of Operations.
The Company reimburses FCCMI for certain administrative and other expenses incurred on its behalf, which amounted to approximately $1,214,000, $1,041,000 and $1,071,000 for the year ended December 31, 2014, the 11 months ended December
31, 2013 and the year ended January 31, 2013, respectively, and are included in operating expenses in the Consolidated Statements of Operations.
The Company, as ground lessee, is obligated under the Declaration of Covenants Agreement for each building to reimburse FCCMI for the Company’s proportionate share of expenses associated with maintaining certain land known as University Park at MIT. The Company’s portion of the expenses incurred under these agreements for the year ended December 31, 2014, the 11 months ended December 31, 2013
and the year ended January 31, 2013 amounted to $994,383, $899,789 and $1,100,164, respectively, and is included in operating expenses in the Consolidated Statements of Operations.
The transactions with affiliates, as described above, as well as other cash payments
received by FCCMI on behalf of the Company resulted in a net amount due from affiliates of $663,430 and $83,396 at December 31, 2014 and 2013, respectively, which is included in accounts receivable - affiliate in the Consolidated Balance Sheets.
16
Dates Referenced Herein and Documents Incorporated by Reference
