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Talon Real Estate Holding Corp. – ‘10-Q’ for 3/31/17

On:  Friday, 6/7/19, at 12:45pm ET   ·   For:  3/31/17   ·   Accession #:  1520138-19-190   ·   File #:  0-53917

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  As Of               Filer                 Filing    For·On·As Docs:Size             Issuer                      Filing Agent

 6/07/19  Talon Real Estate Holding Corp.   10-Q        3/31/17   54:3.2M                                   West Coast Stock… Inc/FA

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended: March 31, 2017

For the Transition Period from        to        .

Commission file number 000-53917

TALON REAL ESTATE HOLDING CORP.

(Exact Name of Registrant as Specified in its Charter)

100 S. 1^st Street, Minneapolis MN 55458-3357

(Address of Principal Executive Offices, Including Zip Code)

(612) 604-4600

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The number of shares of the registrant’s common stock, par value $0.001 per share, outstanding at June 5, 2019 was 29,102,791 shares.

TALON REAL ESTATE HOLDING CORP.

QUARTERLY REPORT ON FORM 10-Q

INDEX

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

In this Quarterly Report on Form 10-Q, references to “Company,” “we,” “us,” “our” and words of similar import refer to Talon Real Estate Holding Corp. and its subsidiaries, unless the context requires otherwise.

This Quarterly Report on Form 10-Q contains forward-looking statements regarding us, our business prospects and our results of operations that are subject to certain risks and uncertainties posed by many factors and events that could cause our actual business, prospects and results of operations to differ materially from those that may be anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those described under the heading “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2016 as filed with the Securities and Exchange Commission on April 17, 2019. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Commission that advise interested parties of the risks and factors that may affect our business.

PART I. – FINANCIAL INFORMATION

TALON REAL ESTATE HOLDING CORP.

Minneapolis, Minnesota

FINANCIAL STATEMENTS

TABLE OF CONTENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016

TALON REAL ESTATE HOLDING CORP.

CONDENSED CONSOLIDATED BALANCE SHEETS

March 31, 2017 and December 31, 2016

See accompanying notes to condensed consolidated financial statements.

TALON REAL ESTATE HOLDING CORP.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the three months ended March 31, 2017 and 2016

(unaudited)

See accompanying notes to condensed consolidated financial statements.

TALON REAL ESTATE HOLDING CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the three months ended March 31, 2017 and 2016

(unaudited)

See accompanying notes to condensed consolidated financial statements.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION

Organization

Talon Real Estate Holding Corp. (“TREHC”) previously established an Operating Partnership (“Talon OP”) and transferred all of its assets and liabilities to the operating partnership in exchange for general partnership units. As the sole general partner of Talon OP we have the exclusive power to manage and conduct the business and affairs for the operating partnership. TREHC owned approximately 65% of the Operating Partnership as of March 31, 2017 and March 31, 2016, respectively. The Operating Partnership owned 100% of 5130 Industrial Street, LLC, 100% of Talon Bren Road, LLC, 100% of Talon First Trust, LLC, and 100% of Talon RE as of December 31, 2016 and 2015. Talon Bren Road, LLC, and Talon First Trust, LLC, are both limited liability companies organized under the laws of the state of Delaware, and were formed on May 9, 2014 and April 21, 2014, respectively, to purchase real estate. Talon Real Estate, LLC (“Talon RE”) was incorporated in the state of Minnesota on December 20, 2012 and began operations in 2013 for the purpose of acquiring real estate properties. Talon RE merged with Guide Holdings, Inc. in which Guide Holdings, Inc. was the surviving entity and was renamed Talon Real Estate Holding Corp.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with United States Generally Accepted Accounting Principles (“US GAAP”).

The accompanying consolidated financial statements include the accounts of TREHC and its interest in the Operating Partnership. The limited partners in the Operating Partnership have a redemption option that they may exercise. Upon exercise of the redemption option by the limited partners, the Company has the choice of redeeming the limited partners' interests ("Units") for TREHC common shares of stock on a one-for-one basis, or making a cash payment to the unit holder. The redemption generally may be exercised by the limited partners at any time after the first anniversary of the date of the acquisition of the Units subject to volume restrictions.

NOTE 2 – INVESTMENT IN REAL ESTATE PROPERTIES AND ENTITIES

The Company owns, through its subsidiary Talon First Trust, LLC, real estate property located at 180 East 5th Street, St. Paul, MN. The building has 656,875 net rentable square feet and is primarily leased to tenants for commercial and government use. As of March 31, 2017, the Company had tenants occupying approximately 60% of the rentable space. In April 2015, the Company executed a lease for a significant new tenant that would increase the occupancy by over 21% in the St. Paul building upon commencement of the lease. The lease was amended on January 27, 2017 to resolve certain disputes between the Company and the tenant and as amended, the lease is scheduled to commence on January 1, 2018. On March 7, 2017 one tenant that occupies approximately 16% of the net rentable square feet filed for Chapter 11 bankruptcy protection from its creditors. In June of 2018, this asset was sold to First Capital Reit (Note 12).

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 2 – INVESTMENT IN REAL ESTATE PROPERTIES AND ENTITIES (continued)

The Company owns, through its subsidiary Talon Bren Road, LLC, real estate property located on 20 acres of land at 10301 Bren Road West, Minnetonka, MN. This property has 164,472 net rentable square feet and is primarily leased to tenants who are wholesale product sales representatives. These leases are subject to a master lease agreement entered into between Talon Bren Road, LLC and Upper Midwest Allied Gifts Association, Inc. (“UMAGA”), a Minnesota nonprofit corporation. As of March 31, 2017, the Company had 100% of the rentable space leased.

The Company owns and operates the following real estate properties through its subsidiary, 5130 LLC:

5130 Industrial Street, Maple Plain, MN

1350 Budd Ave, Maple Plain, MN

The properties have combined 171,639 net rentable square feet and are primarily leased to tenants for mixed commercial and industrial usage. As of March 31, 2017, the Company had tenants occupying approximately 85% of the rentable space.

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Accounting Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to use estimates and assumptions which affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results could differ from those estimates.

Principles of Consolidation

We evaluate the need to consolidate affiliates based on standards set forth in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation. In determining whether we have a controlling interest in an affiliate and the requirement to consolidate the accounts of that entity, management considers factors such as ownership interest, authority to make decisions, contractual and substantive participating rights of the limited partners and shareholders, as well as whether the entity is a variable interest entity for which we are the primary beneficiary. The accompanying consolidated financial statements include the accounts of Talon Real Estate Holding Corp. (“TREHC”) and Talon OP, our Operating Partnership, and all subsidiaries in which it maintains a controlling interest. Talon OP also consolidates 5130 LLC, an entity in which it has a 49% ownership interest, based on its ability to control the operating and financial decisions of 5130 LLC. All significant intercompany balances have been eliminated in consolidation.

Cash

The Company considers short-term investments with original maturities of 90 days or less to be cash equivalents. The Company believes it is not exposed to any significant credit risk on cash.

Restricted Escrows and Reserves

The Company is required to hold cash in restricted escrow accounts for insurance, real estate taxes and a replacement reserve. The escrows are used to pay periodic charges of real estate taxes and assessments, tenant improvements, and leasing commissions. The balances in the escrow accounts were $13,995,393 and $3,001,232 as of March 31, 2017 and December 31, 2016, respectively.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Rents and Other Receivables

Rents receivable and deferred rent are recorded at their estimated net realizable value. The Company follows a policy of providing an allowance for doubtful accounts, which is based on a review of outstanding receivables, historical collection information, and existing economic conditions. The Company does not require collateral and accounts are considered past due if payment is not made on a timely basis in accordance with our credit terms. Accounts considered uncollectible are written off. Receivables have been reduced by an allowance for doubtful accounts of $129,330 as of both March 31, 2017 and December 31, 2016.

Revenue Recognition

Base rental income is recognized on a straight-line basis over the terms of the related lease agreement, inclusive of leases which provide for scheduled rent increases or rent concessions. Differences between rent income earned and base rent amounts due per the respective lease agreements are credited or charged to deferred rent revenue or deferred rent receivable as applicable. When the Company enters into lease modifications or extensions with current tenants, the deferred rent at the time of the extension is amortized over the remaining term of the lease, and the revised terms are considered a new lease.

Tenant recoveries related to reimbursement of real estate taxes, insurance, repairs and maintenance and other operating expenses are billed monthly based on current year estimated operating costs for applicable expenses. An additional billing or a refund is made to tenants in the following year after actual operating expenses are determined.

Deferred Leasing Costs and Tenant Allowance

Direct and indirect costs, including estimated internal costs and leasing commissions, associated with the leasing of real estate investments owned by the Company are capitalized as deferred leasing costs and amortized on a straight-line basis over the term of the related lease as amortization expense. Unamortized costs are charged to expense upon the early termination of the lease. Costs associated with unsuccessful leasing opportunities are expensed.

In leasing tenant space, the Company may provide funding to the lessee through a tenant allowance. In accounting for a tenant allowance, the Company determines whether the allowance represents funding for the construction of leasehold improvements and evaluates the ownership, for accounting purposes, of such improvements. If the Company is considered the owner of the leasehold improvements for accounting purposes, the Company capitalizes the amount of the tenant allowance as building improvements and depreciates it over the shorter of the useful life of the leasehold improvements or the related lease term. For tenant allowances committed at lease inception and recorded as building improvements but not yet performed or completed, the corresponding liability will be recorded as tenant improvement allowance payables. If the tenant allowance represents a payment for other than funding leasehold improvements, or in the event the Company is not considered the owner of the improvements, for accounting purposes, the tenant allowance is considered to be a lease incentive and is capitalized as a deferred leasing cost and is amortized over the lease term as a reduction of rental revenue on a straight-line basis.

The Company had amortization expense for tenant improvements of $259,782 and $269,475 for the three-months ended March 31, 2017 and 2016, respectively. The Company had amortization expense for leasing costs of $76,926 and $73,622 for the three-months ended March 31, 2017 and 2016, respectively. The Company had accumulated amortization for tenant allowances of $3,140,513 as of March 31, 2017 and $2,880,732 as of December 31, 2016.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Deferred Financing Costs

Costs incurred in connection with obtaining financing are netted against notes payable and are being amortized using the effective interest method over the financing term and are included in interest expense. The Company had amortization expense of $923,463 for the three months ended March 31, 2017, and $204,752 for the three months ended March 31, 2016. Included in amortization expense for the three months ended March 31, 2017 is the write-off of unamortized deferred financing costs of $137,254 due to the refinancing of debt secured by the 180 East 5^th Street property owned by Talon First Trust, LLC.

Real Estate Property and Fixed Assets

Investment in real estate and fixed assets with a useful life of longer than one year are carried at cost less accumulated depreciation and amortization. Property such as land, building and improvements includes cost of acquisitions, development, and construction and tenant allowances and improvements. We allocate the cost of an acquisition, including the assumption of liability, to the acquired tangible assets (including land, buildings and personal property) determined by valuing the property as if it were vacant, and identifiable intangibles based on their relative fair values. Acquisitions of real estate are recorded based upon preliminary allocations of the purchase price to management’s assessment of the fair value of tangible and intangible assets and any assumed liabilities acquired which are subject to adjustment as additional information is obtained up to one year after the date of acquisition. Management’s fair value assessment includes the use of readily accepted fair value techniques such as discounted cash flow analysis and comparable sales analysis including management’s reliance on independent market analysis.

Depreciation is provided using the straight-line method over the estimated useful life of the assets for furniture and equipment, buildings and land improvements, and the term of the lease for tenant improvements. The estimated useful lives being used are as follows:

Repair and maintenance costs are expensed as incurred, whereas expenditures that improve or extend the service lives of assets are capitalized. Disposal and abandonment of improvements are recognized at occurrence as a charge to depreciation.

Intangible Assets and Liabilities

Upon acquisitions of real estate, the Company assesses the fair value of acquired tangible assets and any significant intangible assets and liabilities (such as above- and below-market leases and value of acquired in-place leases), and any assumed liabilities, and allocates the purchase price based on these fair value assessments. The Company records intangible assets and liabilities acquired at their estimated fair value apart from goodwill for acquisitions of real estate. The Company amortizes identified intangible assets and liabilities based on the period over which the assets and liabilities are expected to affect the future cash flows of the real estate property acquired. Lease intangibles (such as in-place or above- and below-market leases) are amortized over the term of the related lease. Above and below-market leases are amortized as a reduction in (addition to) rent revenue. The Company amortized $45,220 as a net reduction in rent revenue for above and below-market leases for the three months ended March 31, 2017, and $48,267 for the three months ended March 31, 2016. Amortization of other intangibles is recorded in depreciation and amortization expense.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Impairment of Long-Lived Assets

Long-lived assets, such as real estate property, and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. An impairment loss would be recognized when the estimated future cash flows from the use and eventual disposition of the asset are less than the carrying amount of that asset. The Company did not recognize any impairment losses for either of the three months ended March 31, 2017 or 2016.

Income Taxes

The Company accounts for income taxes under FASB ASC 740-10-30 which results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities. Deferred income tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when the temporary differences and carry forwards are expected to reverse. Accounting standards require the consideration of a valuation allowance for deferred tax assets if it is “more likely than not” that some component or all of the benefits of deferred tax assets will not be realized.

The Company's policy of accounting for uncertain tax positions is to recognize the tax effects from an uncertain tax position in the financial statements, only if the position is more likely than not to be sustained on audit, based on the technical merits of the position. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized, upon ultimate settlement with the relevant tax authority. The Company has examined the tax positions taken in its tax returns and determined that there are no uncertain tax positions. As a result, the Company has recorded no uncertain tax liabilities in its consolidated balance sheet.

The Company is no longer subject to U.S. federal, state or local income tax examinations by tax authorities for the years before 2013. The Company is not currently under examination by any taxing jurisdiction. In the event of any future tax assessments, the Company has elected to record the income tax penalties as general and administrative expense and any related interest as interest expense in the Company's consolidated statements of operations.

Stock-based Compensation

The Company has granted restricted stock to employees under an approved employee equity incentive plan and to Directors under a director compensation plan. Granted shares are considered issued and outstanding as of the date of the grants. Stock-based compensation is expensed on a straight-line basis over the vesting period and is valued at the fair value on the date of the grant. The Company has recognized $55,740 and $38,285 of compensation expense for the three months ended March 31, 2017 and 2016, respectively.

The Company may also issue common stock in exchange for goods or services of non-employees. These shares are either fully vested at date of grant or vest over a certain period during which services are provided. The Company expenses the fair market value of the services over the period in which they are received.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Non-controlling Interest

Interests in the Operating Partnership held by limited partners are represented by partnership common units of the Operating Partnership. The Company's interest in the Operating Partnership was approximately 67% and 65% of the common units of the Operating Partnership as of March 31, 2017 and December 31, 2016, respectively. The Operating Partnership’s income is allocated to holders of units based upon the ratio of their holdings to the total units outstanding during the period. Capital contributions, distributions, syndication costs, and profits and losses are allocated to non-controlling interests in accordance with the terms of the Operating Partnership agreement.

The portion of membership interests in 5130 LLC not held by Talon OP were reported as non-controlling interest. Capital contributions, distributions, and profits and losses are allocated to the non-controlling interest based on membership percentages and terms of the operating agreement.

Net Income (Loss) or Earnings Per Share

Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average common and potential dilutive common shares outstanding in accordance with the treasury stock method.

Given that the Company has incurred operating losses for all periods presented, diluted earnings per share is not presented. The weighted average outstanding shares used in the basic earnings per share computation is 18,945,481 and 16,788,586 for the three months ended March 31, 2017 and 2016 respectively.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. This new standard will eliminate all industry-specific guidance and replace all current U.S. GAAP guidance on the topic. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. Lease contracts are specifically excluded from the new accounting guidance.  This guidance will be effective for the Company beginning January 1, 2018 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. Adoption had no material impact on the Company’s consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03 Interest—Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs.   The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update.  The Company adopted the amendments in this update effective January 1, 2016. Adoption did not have a material impact on the financial statements.

In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-15—Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 provides guidance for eight specific cash flow issues with respect to how cash receipts and cash payments are classified in the statements of cash flows, with the objective of reducing diversity in practice. The effective date for ASU 2016-15 is for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. Adoption of the ASU had no material impact on the Company’s financial statements.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40).  The amendments in this Update provide guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures.  The amendments require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The Company has adopted this amendment in this update effective for the current fiscal year. (see Note 13).

In March 2016, the FASB issued ASU 2016-09—Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 modifies the accounting for share-

based payment awards, including income tax consequences, classification of awards as equity or liabilities, and classification on the statement of cash flows. The effective date for ASU 2016-09 is for annual periods beginning after December 15, 2016, and interim periods within those fiscal years. The adoption of this standard is not expected to have a material impact on the Company’s business, financial position, results of operations or liquidity.

During February 2016, FASB issued ASU No. 2016-02, “Leases.” ASU No. 2016-02 was issued to increase transparency and comparability among organizations by recognizing all lease transactions (with terms in excess of 12 months) on the balance sheet as a lease liability and a right-of-use asset (as defined). ASU No. 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with earlier application permitted. Upon adoption, the lessee will apply the new standard retrospectively to all periods presented or retrospectively using a cumulative effect adjustment in the year of adoption. The adoption of this Standard did not have a material impact on the Company’s financial statements.

In March 2016, the FASB issued ASU 2016-08 – “Revenue from Contracts with Customers: Principal versus Agent Considerations.” The amendments of this standard are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. The effective date for ASU 2016-08 is the same as the effective date for ASU 2014-09 and ASU 2015-14. Adoption of this Standard did not have a material impact on The Company’s financial statements.

In January 2017, the FASB issued ASU 2017-01 – “Business Combinations (Topic 805): Clarifying the Definition of a Business.” The amendment is intended to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The effective date for ASU 2017-01 is for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. The Company adopted the new guidance effective January 1, 2018 and the guidance resulted in acquisitions of operating properties being accounted for as asset acquisitions instead of business combinations. The adoption of this guidance changed the Company’s accounting for the transaction costs for acquisitions of operating properties such that transaction costs are capitalized as part of the purchase price of the acquisition instead of being expensed as acquisition-related expenses. The ASU is required to be applied prospectively.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 4 – TENANT LEASES

The Company leases various commercial and industrial space to tenants over terms ranging from month-to-month to twelve years. Some of the leases have renewal options for additional terms. The leases expire at various dates from January 2017 to December 2025. Some leases provide for base monthly rentals and reimbursements for real estate taxes and common area maintenance.

The Company has the following future minimum base rentals on non-cancellable leases, including leases entered into subsequent to March 31, 2017:

Included in the above table are base lease payments due beginning January 1, 2018 totaling $15,832,430 for a significant tenant that has not occupied space yet but for which we have an executed lease agreement.

NOTE 5 – NOTES PAYABLE

Note Payable, Related Party

During August 2014, the Company entered a two-year unsecured note payable with Curtis Marks, a former director, which matured on June 30, 2016. The note bore interest at an annual rate of 14% through November 2015, 20% through June 2016 and 26% thereafter under default provisions until the principal is repaid. The note required monthly interest only payments with the outstanding principal due at maturity. The Company defaulted on the note at maturity and in April 2017 the principal was increased by approximately $397,000 as a result of a judgement against the Company described in Note 7. At March 31, 2017, management determined a negative outcome was probable and recorded a $397,695 increase to the principal balance. At March 31, 2017 and December 31, 2016, the unpaid principal on the notes totaled $897,695 and $500,000, respectively.

During June 2014, the Company entered into two two-year unsecured notes payable totaling $370,000 with Bren Road, LLC, a limited partner in Talon OP (Note 11). The notes bore interest at an annual rate of 8% and required monthly principal and interest payments totaling $4,440 with the remaining principal due at maturity. At March 31, 2017 and December 31, 2016, the unpaid principal on the notes totaled $302,293 and $309,472, respectively. In July 2017, the principal and unpaid interest was satisfied by a $594,176 judgement against the lender as described in Note 7.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 5 – NOTES PAYABLE (continued)

Notes Payable

During March 2007, the Company entered into two mortgage notes payable totaling $4,750,000 secured by the Company’s real estate properties operated by 5130 Industrial Street, LLC (Note 2). The first note totaled $4,450,000 and required monthly interest only payments at 6.05% per annum with the outstanding principal due at maturity on April 8, 2017. The second note totaled $300,000 and required monthly interest only payments at 12.75% per annum with the outstanding principal due at maturity on April 8, 2017. At March 31, 2017 and December 31, 2016, the unpaid principal on the first note totaled $3,968,876 and $3,981,740, respectively. At March 31, 2017 and December 31, 2016, the unpaid principal on the second note totaled $292,609 and $292,941, respectively. The Company defaulted on the notes at maturity and in December 2018 the lender foreclosed on the properties as described in Note 12.

During May 2014, the Company entered into a five-year first mortgage note payable totaling $11,500,000 secured by the Company’s real estate property operated by Talon Bren Road, LLC (Note 2). The note bore interest at an annual rate of 4.65% and required monthly principal and interest payments totaling $65,438. At March 31, 2017 and December 31, 2016, the unpaid principal on the note totaled $10,788,414 and $10,858,648, respectively. During April 2017 the Company received a written default notice from the lender and in June 2017 the Company settled this note as described in Note 12.

During February 2015, the Company entered into a two-year second mortgage note payable totaling $2,000,000 secured by the Company’s real estate property operated by Talon Bren Road, LLC (Note 2). The note bore interest at an annual rate of 16% and required monthly interest payments totaling $26,667 with principal due at maturity. At December 31, 2016, the unpaid principal on the note totaled $2,000,000. During January 2017 the Company settled this note as described below.

The May 2014 and February 2015 mortgage notes payable include a restrictive covenant that requires Talon Bren Road, LLC to maintain a minimum debt service coverage ratio (“DSCR”) before distributions of 1.35:1.00 and after distributions of 1:05:1.00 as of the last day of each calendar year. As of December 31, 2015, Talon Bren Road LLC was out of compliance with the DSCR test. An amendment to the note agreements as well as waiver of the DSCR default for the December 31, 2015 test date was executed. The note agreements were amended to include a minimum Senior DSCR (pre-distributions) of not less than 1.50:1.00. It also amended and restated the minimum DSCR before distributions of not less than 1.20:1.00 as of the last day of each calendar year commencing after December 31, 2015. As of March 31, 2017, Talon Bren Road, LLC was not in compliance with the DSCR.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 5 – NOTES PAYABLE (continued)

During July 2014, the Company entered into a three-year first mortgage note payable totaling $32,000,000 secured by the Company’s real estate property operated by Talon First Trust, LLC (Note 2). The note bore interest at an annual rate of 6.04% and required monthly interest only payments totaling $161,067 with the remaining principal due at maturity. At December 31, 2016 the unpaid principal on the note totaled $32,000,000. During the year ended December 31, 2016, mechanics lien statements were filed upon the property for unpaid balances included in accounts payable. In January 2017, the Company settled this note and satisfied all outstanding liens as described in later in this note.

During January and May 2015, respectively, the Company entered into two separate $500,000 unsecured notes payable which matured on June 30, 2016. The notes bore interest at an annual rate of 20% through October 31, 2015, 24% through June 30, 2016 and 26% thereafter until the principal is repaid. The notes required monthly interest only payments totaling approximately $20,000 with the outstanding principal due at maturity. The Company defaulted on the notes at maturity. A judgment was rendered against the Company in May 2017 as described in Note 7. At March 31, 2017, management determined a negative outcome was probable and recorded a $476,498 increase to the principal balance. At March 31, 2017 and December 31, 2016, the unpaid principal on the notes totaled $1,476,498 and $1,000,000, respectively.

During November 2015 the Company entered into a two-month unsecured note payable totaling $481,934. The Company defaulted on the note at maturity in January 2016. During June 2016, the Company refinanced the note with the lender resulting in the issuances of a six-month unsecured note payable totaling $1,008,908, including $481,934 in unpaid principal and $526,974 in accrued interest and penalties. The notes bore interest at an annual rate of 10%. At March 31, 2017 and December 31, 2016, the unpaid principal on the notes totaled $1,330,167 and $1,008,908, respectively. In January 2017, the Company settled the June 2016 note with the lender as described in Note 7.

During May 2016, the Company entered into a $59,489 unsecured note payable to settle accounts payable due to an unrelated party. The note bore interest at an annual rate of 10% and unpaid principal and interest are due upon the sale or refinancing of the property operated by Talon First Trust, LLC. At March 31, 2017 and December 31, 2016, the unpaid principal on the note totaled $59,489. The Company repaid the principal and unpaid interest in July 2017.

During August 2016, the Company entered into a one-year $654,926 unsecured note payable to settle accounts payable due to an unrelated party. The note bears interest at an annual rate of 3% and unpaid principal and interest were due at maturity. At March 31, 2017 and December 31, 2016, the unpaid principal on the note totaled $654,926. The Company defaulted on this note at maturity and the balance remains outstanding.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 5 – NOTES PAYABLE (continued)

During October 2016, the Company entered into a non-interest bearing $181,000 unsecured note payable. At March 31, 2017 and December 31, 2016, the unpaid principal on the note totaled $81,800. The Company defaulted on the note at maturity in October 2016. The Company refinanced the unpaid principal in June 2017 as described in Note 12.

At December 31, 2016, the Company recorded $271,287 unsecured note payable to a former employee to settle a complaint filed by a former employee as described in Note 7. The note bore interest at an annual rate of 15% and matured in January 2018. The unpaid principal balance as of March 31, 2017 was $186,178. The note was repaid during 2017.

During January 2017, the Company entered into two 18-month promissory note agreements with a third-party lender, Quick Liquidity Management, LLC, totaling $2,550,000. The notes had an interest rate of 20% per annum and required monthly interest only payments with the principal due at maturity. The note agreements were guaranteed by First Tracks, LLC, a related party (Note 12). The proceeds from the notes were used to pay off the outstanding principal and interest due under the February 2015 $2,000,000 note payable. During June 2017, the outstanding principal, interest and penalties totaling $3,475,220 under the notes were satisfied through the issuance of the MCREIF and MCC notes described in Note 12.

On January 27, 2017, Talon First Trust, LLC, (the “Talon First Trust”), a Delaware limited liability company that is wholly owned by Talon OP, L.P., (the “Parent”), a Minnesota limited partnership and the entity through which Talon Real Estate Holding Corp. conducts substantially all of its business, entered into a Loan Agreement (the “Gamma Loan”) with Gamma Real Estate Capital LLC (the “Lender”), a Delaware limited liability company, in the principal amount of $51.6 million. The loan bears an interest rate equal to the sum of (i) the greater of (x) the LIBOR Index Rate, and (y) the LIBOR Floor, plus (ii) a margin of 9.00% per annum and has an initial maturity date of January 26, 2018 with two 6-month options for the Company to extend upon satisfaction of certain conditions. Pursuant to the Gamma Loan, approximately $5.3 million has been deposited into an interest reserve account to be applied toward monthly interest payments to the Lender.

The Gamma Loan is secured by (i) a mortgage on the Company’s interest in its building located at 180 East 5th Street, St. Paul, Minnesota, 55101, (ii) an assignment of lease and rents, (iii) 100% of the membership and ownership interests in the Parent, and (iv) other collateral specified in the Gamma Loan documents. The Gamma Loan is guaranteed by First Tracks, LLC, a related party (Note 12). First Tracks received a fee of $750,000 and 2,500,000 shares for the guarantee.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 5 – NOTES PAYABLE (continued)

The following table details the allocation of the proceeds from the January 2017 Gamma Loan:

Under various mortgage notes payable, the Company is required to periodically fund and maintain escrow accounts to make future real estate tax and insurance payments, as well as to fund certain capital expenditures (Note 6).

During 2016, the Company received funds under agreements for the sale of future receivables from four different sources. As of December 31, 2016, the total outstanding balance under the agreements was $430,500 for the sale of future receivables generated by the property located at 180 E. Fifth Street. The agreements required payments totaling $644,039 over 120 days. Per FASB ASC 470-10-25, which provides guidance on funds received from sales of future receivables, these transactions have been classified as debt and included in notes payable. The agreements are guaranteed by the Company’s CEO. The unpaid principal balance as of March 31, 2017 was $215,259. The outstanding balances under the agreements were repaid during 2017.

At March 31, 2017, The Company is required to make the following principal payments on our outstanding notes payable for each of the succeeding fiscal years as follows:

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 6 – RESTRICTED ESCROWS AND RESERVES

According to the terms of the Company's notes payable agreements (Note 5), the Company is required to make monthly and quarterly deposits to various escrow and reserve accounts for the payment of real estate taxes, tenant improvements and leasing commissions. The Company had $13,995,393 and $3,001,232 in restricted escrows and reserve accounts as of March 31, 2017 and December 31, 2016, respectively.

NOTE 7 – COMMITMENTS AND CONTINGENCIES

On June 7, 2013, Talon RE entered into a contribution agreement with the Kaminski Trust, the remaining interest holder of 5130 Industrial Street LLC, pursuant to which the Company will acquire the remaining 51% interest in 5130 Industrial Street LLC in exchange for 2,820,810 shares of the Company’s common stock, subject to receiving consent to the transfer from 5130 Industrial Street LLC’s mortgage holder under the March 2007 notes. During December 2018, the shares were issued to The Kaminski Trust. The Company’s CEO and his wife are the trustees of The Kaminski Trust.

The Company entered into a property lease agreement relating to rental of office space. This non-cancellable lease has been amended to run through May 2024. The Company incurred $22,761 and $26,339 of rent expense for the three-months ended March 31, 2017 and 2016, respectively. On December 15, 2018, the Company entered into a termination agreement with the landlord. In exchange for vacating the premises, the accrued rent was forgiven.

The Company entered into a Contribution Agreement dated May 29, 2014 with Bren Road, LLC, the contributor of the property acquired through our subsidiary, Talon Bren Road, LLC. The agreement provides for any deficit in achieving $1,560,000 of net operating income (“NOI”) per year for the first three years to be funded by Bren Road, LLC. The Company recognized $ 0 and $46,023 of income under this agreement for the three months ended March 31, 2017 and 2016, respectively.

The Company entered into a consulting agreement dated May 29, 2014 with Gerald Trooien (“Consultant”). This agreement provides for consulting services to Talon Bren Road, LLC for $43,750 per month payable beginning August 15, 2014 and continuing for 59 months thereafter. The agreement will terminate upon the occurrence of any of the following:

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 7 – COMMITMENTS AND CONTINGENCIES (continued)

The Company incurred $145,312 and $140,289 of consulting expenses for the three months ended March 31, 2017 and 2016, respectively. The Company had amounts due to the consultant of $771,803 and $627,491 as of March 31, 2017 and December 31, 2016, respectively. The outstanding amount as March 31, 2017 was satisfied on June 23, 2017 (see Note 12) as part of the refinancing of Talon Bren Road, LLC’s outstanding mortgages.

The Company entered into a Property Management Agreement dated July 2, 2014 with Swervo Management Division, LLC (“Property Manager”). This agreement provides for management and other leasing duties for Talon First Trust, LLC for monthly payments of 7.5% of the monthly gross rental receipts at the property beginning July 2, 2014 and continuing for 59 months thereafter. Subsequently, on January 27, 2017, the agreement was terminated.

The Company incurred $-0- and $144,569 of expenses for the three months ended March 31, 2017 and 2016, respectively. On November 16, 2015, the Company entered into a $481,934 unsecured promissory note with the Property Manager related to unpaid fees for the period of March 2015 through December 2015. In June 2016 the Company entered into a $953,908 unsecured promissory note related to the refinance of the previous note plus unpaid fees for the period January 2016 through July 2016 due August 31, 2016 (Note 5). After that date, an additional $55,000 of fees became due and payable.

On April 9, 2015, the Company entered into a significant lease arrangement with a new tenant. On January 27, 2017 the company executed a Second Amendment to the lease with the tenant to resolve issues concerning a notice of default that the Company received from the tenant on April 1, 2016 resulting in the termination of the $7,760,995 improvement allowance. The Second Amendment rescinds the Notice of Default and the Termination Notice that the tenant had delivered, changes to the lease commencement date from January 1, 2016 to January 1, 2018 and placed $5.6 million in escrow to provide evidence of our ability to pay for the remaining tenant improvements. We deposited the required escrow funds on January 27, 2017 (Note 12).

The depositing of the escrowed funds was done for the express purpose of paying for the buildout for the significant tenant. The funds were deployed to pay for the tenant improvements during 2017. All remaining funds were applied to reduce the Gamma Loan (Note 5).

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 7 – COMMITMENTS AND CONTINGENCIES (continued)

Legal Proceedings

The Company filed a complaint in the State of Minnesota on June 10, 2016 to enforce the NOI Payment Agreement and other documents issued in conjunction with the Contribution Agreement entered into on May 29, 2014 with Bren Road, L.L.C, a limited partner in Talon OP, L.P. The defendant has responded and filed a counterclaim and third-party complaint against Talon Bren Road, LLC and Talon OP, LP on July 7, 2016. On November 9, 2016 the matter came before the court on the Defendant’s motion for partial summary judgment. Subsequently, on February 27, 2017 the Hennepin County District Court issued a Findings of Fact and Order for Judgment on the counter claim against the Company in the amount of $719,365, plus post judgment interest which pursuant to our 10301 Bren Road and 180 E 5^th Street loan agreements, constitutes a non-financial event of default. In an attempt to collect on the judgment, the defendant filed a motion for the appointment of the receiver. The outstanding amount of the judgment was satisfied on June 23, 2017 as part of the refinancing of Talon Bren Road, LLC’s outstanding mortgages. On March 27, 2017 our complaint in the amount of $771,408 went to trial in Hennepin County District Court. On July 21, 2017 a judgment was ordered in favor of Talon Bren Road, LLC and Talon O.P LP in the amount of $594,176. The principal and accrued interest under the two June 2014 notes (Note 5) were settled under the July 21, 2017 judgment.

On January 12, 2015 and May 19, 2015, respectively, the Company entered into two separate $500,000 unsecured promissory notes (Note 5) with the same unrelated party. In 2015, the Company extended the maturity dates of both notes to December 31, 2015. Subsequently, the Company extended the maturity dates of both notes to the earlier of, the disposition or refinancing of the property at 180 E 5th Street in St. Paul or June 30, 2016. On September 24, 2016, the unrelated party filed a summons and complaint in the State of Minnesota claiming that the Company breached its obligation under the notes. On May 19, 2017, a judgment was entered against the Company in the amount of $1,476,498. As of the date of this report, the judgment has not been repaid by the Company.

On August 12, 2014, the Company entered into a $500,000 unsecured promissory note with Curtis Marks (Note 5), a former director. The note had an original maturity date of February 8, 2015. Proceeds from this note paid off additional notes entered into on December 30, 2013 and March 7, 2014, respectively, for $100,000 each, with the same party. In 2015, the Company extended the maturity date of the note to December 31, 2015. Subsequently, in 2016 the Company extended the maturity date of the note to the earlier of, the disposition or refinancing of the property at 180 E. Fifth Street in St. Paul or June 30, 2016. On October 18, 2016, the related party filed a summons and complaint in the State of Minnesota claiming that the Company breached its obligation under the notes. In April 2017, this matter went to trial and the plaintiff was awarded $897,695 On May 31, 2017, the Court granted a Charging Order against the Company and Talon OP L.P. where the Company and Talon OP L.P are required to pay all profits and distributions to the plaintiff until the full amount of the judgment is paid and satisfied. Subsequent to the judgment and charging order, in April 2018, the judgment was fully satisfied by the Company, granting a second mortgage in favor of the judgment creditor. As of the date of this filing, the second mortgage amount has not been repaid by the Company.

On October 20, 2016, a former employee filed a summons and complaint in the State of Minnesota claiming that the Company breached its obligation under terms of the former employee’s employment with the Company. In January 2017, the parties reached an agreement to settle all claims. The Company executed a $271,287 promissory note (Note 5) which is fully recorded on the Consolidated Balance Sheet as of December 31, 2016. The promissory note has been satisfied as of December 31, 2017.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 7 – COMMITMENTS AND CONTINGENCIES (continued)

On January 25, 2017, in the matter of Swervo Management Division, LLC, as plaintiff, versus Talon Real Estate Holding Corp, Talon First Trust, LLC and Talon Bren Road, LLC, as defendant, the Company executed a $1,330,167 amended and restated promissory note, plus interest on the unpaid balance at 10%. The entire principal balance shall be due and payable on the earlier of July 24, 2017 or upon a time that the Company refinances or sells its property located at 10301 Bren Road. This note replaces the Amended and Restated promissory note dated June 30, 2016 in the amount of $953,908 ($1,008,908 as of December 31, 2016 – Note 5) given by Talon Real Estate Holding Corp. and Talon First Trust, LLC. On July 24, 2017, the $1,330,167 promissory note was amended and restated, based on the payment of combined principal and interest of $300,000, to a $1,095,764 promissory note, plus interest on the unpaid balance at 10%. The entire principal balance shall be due and payable on the earlier of October 24, 2017 or upon a time that the Company refinances or sells its property located at 10301 Bren Road. On November 6, 2017, the $1,095,764 promissory note was amended and restated to a $927,587 promissory note, plus interest on the unpaid balance at 10%. The entire principal balance shall be due and payable on the earlier of December 31, 2017 or upon a time that the Company refinances or sells its property located at 10301 Bren Road. The Company defaulted on the November 2017 note at December 31, 2017 and accepted a judgment in October 2018 in the amount of $1,010,180. As of the date of this filing, the judgement amount has not been repaid by the Company.

NOTE 8 – RESTRICTED STOCK

The Company has granted restricted stock to employees under an approved employee equity incentive plan and to directors under a director compensation plan. The 2013 Equity Incentive Plan dated June 7, 2013 (the “Plan”) allows up to 1,500,000 shares to be issued and granted to employees, non-employee directors and consultants. Authorized shares automatically increase on January 1 of each year by three percent of the outstanding shares of common stock as of December 31 of the immediately preceding year. Employee awards granted in 2013 vest monthly over 36 months provided the recipient remains an employee or consultant of the Company. Awards granted in 2014 vest either immediately, monthly over a three-year period, or monthly over a five-year period. Awards granted in 2016 vest on a cliff basis one year from the date of issuance, or partially vest immediately and the remaining vest on a cliff basis annually from 2017 to 2019.

The Non-Employee Director Compensation Plan allows shares of restricted common stock to be granted to board members and is included under the Plan. The 2013 board member awards vest one-third of the shares on the date of grant, one-third on January 1 of the year following the date of grant, and one-third on January 1 of the second year following the date of grant, provided the recipient remains a member of the board as of the vesting date. The 2014 awards vested immediately in March of 2014. The 2016 awards vest half on the date of grant and half on April 15, 2017.

As of March 31, 2017, the Company has granted 1,093,759 shares to employees and 480,000 shares to Directors, net of forfeitures, under the Plan. Of the employee shares granted, 360,000 remain unvested as of March 31. 2017.

Total unrecognized compensation expense related to the outstanding restricted stock as of March 31, 2017 was $267,334, which is expected to be recognized over a weighted average period of 32 months.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 9 – INTANGIBLE ASSETS AND LIABILITIES

The Company's identified intangible assets and liabilities at March 31, 2017 and December 31, 2016 were as follows:

The effect of amortization of acquired intangible assets and liabilities was a net charge of $537,372 for the three months ended March 31, 2017 and $544,253 for the three months ended March 31, 2016. Above-market leases, included in intangible assets, are amortized as a reduction of rent revenue and totaled $74,117 for the three months ended March 31, 2017, and $77,167 for the three months ended March 31, 2016. Below-market leases are amortized as an addition to rent revenue and totaled $28,898 for the three months ended March 31, 2017, and $28,898 for the three months ended March 31, 2016. Amortization of in-place leases was $492,152 for the three months ended March 31, 2017, and $495,983 for the three months ended March 31, 2016. In-place leases, and above and below-market leases had a weighted average amortization period of 4.5 years in the year acquired.

The estimated annual amortization of acquired intangible assets and liabilities for each of the five succeeding fiscal years is as follows:

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 10 – MANDATORILY REDEEMABLE PREFERRED OPERATING PARTNERSHIP UNITS

On July 2, 2014, the Company issued 30,000 preferred units, at a price of $100 per unit, totaling $3,000,000. These preferred unit holders are entitled to distributions at a rate of 6% per annum of their liquidation preference amount of $100 per unit which are cumulative from the date of issuance and are payable monthly (to the extent there are sufficient distributable proceeds). The preferred units have been classified as a liability in the consolidated balance sheet as the preferred liquidation preference amount is mandatorily redeemable in specific amounts at specific dates in the future. The preferred units were redeemed on January 27, 2017. (Note 5)

NOTE 11 – RELATED PARTY TRANSACTIONS

In October 2016, the Company entered into a loan guaranty agreement with, First Tracks LLC, an entity wholly owned by the wife of the Company’s Chairman and CEO, to guaranty additional debt financing on behalf of the Company (Note 5). Total fees of approximately $70,000 were paid by the Company to First Tracks during 2016 pursuant to this agreement.

First Tracks, LLC also provided a guarantee on the issuance of debt secured by the property owned by Talon Bren Road, LLC. Fees of $55,000 was paid to First Tracks, LLC on January 5, 2017 for this guarantee.

The Gamma Loan (see Note 5) entered into on January 27, 2017, is guaranteed by First Tracks, LLC. As consideration for the guarantee, Talon Real Estate Holding Company issued First Tracks LLC 2,500,000 shares of its common stock on January 27, 2017 and paid a fee of $750,000.

During 2014, the Company entered into a Contribution Agreement and two note payable agreements (Note 5) with Bren Road, LLC, a limited partner of Talon OP. The Contribution Agreement contained a NOI Payment Agreement under which Bren Road, LLC, owed the Company $287,150 at December 31, 2016 and is included in rents and other receivables on the Company’s consolidated balance sheet. The balances due under the NOI Payment Agreement and note payable agreements were settled during 2017 as detailed in Note 7.

NOTE 12 – SUBSEQUENT EVENTS

In June 2018, the Company entered into a contribution agreement under which the Company sold Talon First Trust, LLC, a subsidiary owned by Talon OP, L.P., the entity through which the Company conducts substantially all of its business, to First Capital Real Estate Operating Partnership, LP (FCROP), a subsidiary of First Capital Real Estate Trust, Inc. (FCREIT). Under the agreement, the Company agreed to sell the Limited Liability Company which contained the ownership of the property located at 180 East 5th Street, St. Paul, MN, for consideration with an estimated value of $98,000,000. Consideration received included 2,495,321 ownership units of FCROP with an estimated valuation of $40,000,000 and the assumption of up to $58,000,000 of principal, interest and penalties due under the January 2017 Gamma loan agreement.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 12 – SUBSEQUENT EVENTS (continued)

Talon First Trust LLC (ft)

Pro Balance Sheet

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 12 – SUBSEQUENT EVENTS (continued)

Talon First Trust LLC (ft)

Pro Balance Sheet (continued)

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 12 – SUBSEQUENT EVENTS (continued)

Talon First Trust LLC (ft)

Pro Forma Statement of Operations

For the Three Months Ending March 31, 2017

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 12 – SUBSEQUENT EVENTS (continued)

Talon First Trust LLC (ft)

Pro Forma Statement of Operations

For the Three Months Ending March 31, 2017 (continued)

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 12 – SUBSEQUENT EVENTS (continued)

Talon First Trust LLC (ft)

Pro Forma Statement of Operations

For the Three Months Ending March 31, 2017 (continued)

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 12 – SUBSEQUENT EVENTS (continued)

In April 2017, the Company defaulted on the March 2007 mortgage notes (Note 5). In December 2018, the lender foreclosed and conducted a sheriff’s sale on properties operated by 5130 Industrial Street, LLC, which secured the mortgage notes. Pursuant to Minnesota law, a property foreclosed upon in this manner is subject to a six (6) month redemption. The Company is currently under contract to sell the property located at 1350 Budd Ave, Maple Plain, MN for $1,400,000. The Company is engaged in refinancing the second property, but as of the date of this report has been unable to do so. Failure to sell the properties or refinance the mortgage notes could result in an acceleration of actions by the lender to foreclose on the properties.

During June 2017, the Company entered into a transaction that included a Promissory Note Secured by a Mortgage and Collateral Security Agreement with MCREIF SubREIT LLC, in the principal amount of $15,127,000. The Note bears interest at a rate equal to 9.5% per annum and had an initial maturity date of June 1, 2018. The Note is subject to a balloon payment upon maturity in the amount of $15,246,755, which is comprised of the unpaid principal balance and unpaid interest of $119,755. The loan is guaranteed personally by the Company’s Chief Executive Officer.

During November 2018, the Company entered into a Forbearance Agreement with MCREIF through February 1, 2019. Under the Forbearance Agreement the interest rate was increased to 16% per annum and the balance due on the note was increased to $16,218,000 for unpaid principal, interest and default penalties.

During January 2019, the Company and MCREIF agreed to extend the maturity of the June 2017 promissory note to July 31, 2019, reduce the interest rate to 9.50% per annum, and increase the balance due under the note to $16,689,000 for unpaid principal, interest and default penalties. As of the date of this filing, the note is in good standing.

During June 2017, the Company entered into a $500,000 secured promissory note payable with MCC, LLC. The note had an interest rate of 4.50% per annum, required monthly principal and interest payments of $10,000 with the unpaid principal and interest balance due at maturity on July 1, 2018.

During September 2018, the unpaid principal and interest under the note was refinanced under a $651,800 secured promissory note with MCC. The note has an interest rate of 10% per annum, requires monthly principal and interest payments of $5,430 with the unpaid principal and interest balance due at maturity on August 1, 2019. As of the date of this filing, the note is in good standing.

The following table details the allocation of proceeds from the June 2017 MCREIF and MCC notes payable:

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 12 – SUBSEQUENT EVENTS (continued)

During October 2017, the Company received funds under agreements for the sale of future receivables from two different sources totaling $500,000. The agreements required payments totaling $720,000 over 120 days and are guaranteed by the Company's CEO. As of the date of this report the agreements are past due and have an outstanding balance of approximately $200,000.

In August 2018, Talon OP, L.P., which is the entity through which the Company conducts substantially all of its business, entered into a Contribution Agreement (the “Antigua Contribution Agreement”) with FCREIT, through FCROP, its operating partnership, for the acquisition of the FCROP’s interests in and to Goat Head Hill and Dutchman’s Bay, Island of Antigua (the “Antigua Project”), including, without limitation, that certain Memorandum of Agreement dated July 28, 2015 between Brown McLennon, the FCROP and the government of Antigua and Barbuda regarding the development of hotels on the properties known as Dutchman’s Bay and Goat Head Hill on Antigua and the FCROP’s 100% ownership interest in Goat Head Hill Resort Development Ltd and Dutchman’s Bay, an Antigua and Barbuda Corporation. Pursuant to the Antigua Contribution Agreement, the FCROP agreed to transfer all of its interests in the Antigua Project to Talon OP, L.P. In consideration for such transfer Talon OP, L.P., will issue to FCROP $30 million in units of its limited partnership interests (“LP Units”), or 12,000,000 LP Units based on a valuation of $2.50 per LP Unit. The LP Units will be payable in three installments over a two-year period with 4,000,000 due at closing and 4,000,000 due one and two years from the closing date. FCROP has agreed to sign such documents at the Closing as are necessary in connection with its admission as a limited partner of Talon OP, L.P. The agreement closed during December 2018.

In August 2018, Talon OP, L.P., which is the entity through which the Company conducts substantially all of its business, entered into a Contribution Agreement (the “Hotels Contribution Agreement”) with FCREIT through FCROP, its operating partnership, for the acquisition of seven entities. In consideration for such transfer Talon OP, L.P. will issue to the FCROP $14,796,765 in units of its limited partnership interests (“LP Units”), or 5,918,706 LP Units based on a valuation of $2.50 per LP Unit. The aggregate value of the Companies/Hotels is $40,790,000 and a credit for existing indebtedness (“Existing Indebtedness”) of $25,993,235. FCROP has agreed to sign such documents at the Closing as are necessary in connection with its admission as a limited partner of Talon OP, L.P. The agreement closed during December 2018. The August 2018 hotel acquisitions require proforma presentation under Regulation S-X. However, as of the date of this filing, records for the three months ended March 31, 2017 provided by FCREIT are incomplete and contain uncorrected material errors. Complete records will be provided by FCREIT when they are available. Accordingly, proforma presentation as of March 31, 2017 and the three months then ended are not included herein.

In November 2018, the Company set up a facility to obtain financing with a private, affiliated limited liability company. The terms of the facility involved draw-downs by various professionals and the selling Two Million (2,000,000) shares. The facility included a Warrant to Purchase Four Hundred Thousand Shares at a floor of One Dollar ($1.00) per share. (the “Warrant”). The facility allows for an amount of Three Hundred Fifty Thousand Dollars ($350,000.00) to be brawn down upon. As of May 2019, approximately One Hundred Fifty Thousand Dollars ($150,000) of the facility are available for use.

During December 2018, the Company issued 675,000 common shares each to Kristian Wyrobek, Marc Agar and First Tracks LLC (on behalf of the Company’s CEO) as director compensation.

TALON REAL ESTATE HOLDING CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of March 31, 2017 and for the three months ended March 31, 2017 and 2016 (unaudited)

NOTE 12 – SUBSEQUENT EVENTS (continued)

During December 2018, the Company issued 3,000,000 common shares to First Tracks LLC (on behalf of the Company’s CEO) and 1,000,000 shares to an employee for compensation under the Company’s employee equity incentive plan (Note 9).

During December 2018, the Company issued 406,000 common shares to vendors.

On April 3rd 2019, Talon entered into two binding contracts  to purchase certain Student Housing assets in Minnesota, Indiana, Illinois, Iowa, Wisconsin, and Kansas. ..  (the “Student Housing Assets”). Talon is purchasing the assets for an aggregate total value of One hundred ninety one million seven hundred forty thousand and seventy nine dollars ($191,740,079). The two  portfolios consist of 2805 beds combined.  The contracts are binding, but include a due diligence contingency and a financing contingency. As of the date of this filing, the Company does not consider closing of the contracts to be probable. Accordingly, proforma presentation as of March 31, 2017 and the three months then ended are not included herein.

On April 29, 2019, Talon reached a settlement with the Upper Midwest Allied Gifts Association “UMAGA” and various tenants at Talon’s Bren Road property.  The settlement includes a new 3.5 year Master Triple Net Lease for the entire property with UMAGA.  Talon through the lease will obtain rights to certain parking areas at the property during the term of the lease.  The settlement also includes the dismissal of all suits, and claims, between Talon, UMAGA and the tenants.  The settlement was read into the court record, and is binding, as the final settlement and lease documents are being drafted.

On April 30, 2019, Talon entered into a Purchase and Sale Agreement to sell the UMAGA property.  Talon has contracted to sell UMAGA for Twenty Six Million Dollars ($26,000,000).  The contract is binding, but the contract includes a due diligence contingency.  The Purchase and Sale Agreement does not contain a financing contingency. As of the date of this filing, the Company does not consider closing of the UMAGA agreement to be probable. Accordingly, proforma presentation as of March 31, 2017 and the three months then ended are not included herein.

NOTE 13 – GOING CONCERN

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, assuming the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. For the three months ended March 31, 2017 and 2016, the Company incurred losses of $2,815,977 and $2,029,639, respectively, and as of March 31, 2017 had a total shareholders’ deficit of $10,855,112. These circumstances raise substantial doubt about the Company's ability to continue as a going concern. The Company's ability to continue as a going concern is dependent on its ability to raise the additional capital to meet short and long-term operating requirements. Management is continuing to pursue external Financing alternatives to improve the Company's working capital position however additional financing may not be available upon acceptable terms, or at all. If the Company is unable to obtain the necessary capital, the Company may have to cease operations.

The following discussion should be read in conjunction with the financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them in light of new information or future events.

Overview

Talon Real Estate Holding Corp is a publicly traded real estate corporation that invests primarily in single and multi-tenant office, industrial, hospitality and retail properties within the Midwest and South Central regions of the United States.  It currently owns eleven properties. Headquartered in Minneapolis, MN and founded in June 2013, Talon’s primary objective is to provide shareholders with attractive returns from investments in real estate through dividend distribution and growth.

On June 7, 2013, we acquired a 49% interest in an entity that owns an industrial complex consisting of two buildings with approximately 171,639 square feet located in the Minneapolis-St. Paul metropolitan area. The buildings currently have a combined occupancy of 85%. We entered into a contribution agreement to acquire the remaining interest in this entity which closed at the end of 2018. In March of 2019 we entered into a purchase and sale agreement to sell this asset.

In 2014, we completed two acquisitions totaling approximately $58 Million and over one million in gross building square feet. On May 29, 2014, we completed the acquisition of a 227,000 square foot building situated on 20 acres of land in Minnetonka, MN that was 100% leased by over 100 tenants who are wholesale distributors.  This property contributes to our core stable income investment strategy. On July 2, 2014, we completed the acquisition of a thirteen-story office tower located in downtown St. Paul, MN totaling 856,223 total building square feet that was 62% occupied by corporate and government tenants at time of acquisition and is currently 60% occupied. Management acquired the St. Paul property for its attractive value-add and growth potential. In April 2015, the Company executed a lease for a significant new tenant that would increase the occupancy by over 21% in the St. Paul building upon commencement of the lease. On January 27, 2017 we executed a second amendment to the lease which amended the original lease to a seven-year term with a commencement date of January 1, 2018. We exchanged this asset for Operating Units of First Capital Reit in June of 2018.

On August 31, 2018, Talon OP, L.P. (Talon-OP), which is the entity through which Talon Real Estate Holding Corp. (“Talon”) conducts substantially all of its business, entered into a Contribution Agreement (the “Antigua Contribution Agreement”) with First Capital Real Estate Trust, Incorporated (“Contributor”), through First Capital Real Estate Operating Partnership, L.P. (the “FC-OP”), its operating partnership, for the acquisition of the FC-OP’s interests in and to Goat Head Hill and Dutchman’s Bay, Island of Antigua (the “Antigua Project”), including, without limitation, that certain Memorandum of Agreement dated July 28, 2015 between Brown McLennon, the FC-OP and the government of Antigua and Barbuda regarding the development of hotels on the properties known as Dutchman’s Bay and Goat Head Hill on Antigua and the FC-OP’s 100% ownership interest in Goat Head Hill Resort Development Ltd and Dutchman’s Bay, an Antigua and Barbuda Corporation.

Pursuant to the Antigua Contribution Agreement, the FC-OP agreed to transfer all of its interests in the Antigua Project to Talon-OP. In consideration for such transfer Talon-OP will issue to the FC-OP $30.0 million in units of its limited partnership interests (“LP Units”), or 12,000,000 LP Units based on a valuation of $2.50 per LP Unit. The LP Units will be payable in three installments over a two year period. The FC-OP has agreed to sign such documents at the Closing as are necessary in connection with its admission as a limited partner of the Company. This transaction closed in November 2018.

On August 31, 2018, Talon OP, L.P. (Talon-OP), which is the entity through which Talon Real Estate Holding Corp. (“Talon”) conducts substantially all of its business, entered into a Contribution Agreement (the “Hotels Contribution Agreement”) with First Capital Real Estate Trust, Incorporated (“Contributor”), through First Capital Real Estate Operating Partnership, L.P. (the “FC-OP”), its operating partnership, for the acquisition of seven entities, as described in the Hotels Contribution Agreement. In consideration for such transfer Talon-OP will issue to the FC-OP $14,796,765.00 in units of its limited partnership interests (“LP Units”), or 5,918,706 LP Units based on a valuation of $2.50 per LP Unit. The aggregate value of the Companies/Hotels is $40,790,000 and a credit for existing indebtedness (“Existing Indebtedness”) of $25,993,235.00. The Existing Indebtedness is set forth on Exhibit B attached hereto. The FC-OP has agreed to sign such documents at the Closing as are necessary in connection with its admission as a limited partner of the Talon-OP.

Pursuant to the terms of the Hotels Contribution Agreement, Talon-OP’s obligation to close upon the acquisition is subject to customary conditions to closing. This series of transactions closed in December 2018.

Our Current Property Interests

We currently own an interest in three properties located in and around the Minneapolis-St. Paul metropolitan area of Minnesota.

We own a 49% interest in an entity that owns an industrial complex consisting of two buildings with approximately 171,639 square feet located in the Minneapolis-St. Paul metropolitan area. We have entered into a contribution agreement to acquire the remaining interest in this entity, subject to receiving consent to the transfer from the entity’s lender.

We also own a 227,000 square foot building situated on 20 acres of land in Minnetonka, Minnesota and an 856,223 square foot thirteen-story office tower located in downtown St. Paul, Minnesota. As of March 31, 2017 the combined occupancy for all of the buildings in our portfolio was 71%. In April 2015, the Company executed a lease in the St. Paul building for a significant new tenant that would increase the occupancy of our portfolio by over 14% upon occupancy. The lease was amended on January 27, 2017 to resolve certain disputes between the Company and the tenant and as amended, the lease is schedule to commence on January 1, 2018.

The following table sets forth information regarding our 5 largest tenants as of March 31, 2017. [To be updated.] this correct for then. Since we don’t own 180 any more it is different today.

The future square feet expiring for all current leases, including leases entered into subsequent to March 31, 2017:

Years ending December 31,

Management may periodically sell certain properties including core income-producing and value-added properties for various reasons based on individual circumstances and opportunities. Proceeds from the sale of such properties may be used to repay related property debt, pay transaction expenses, acquire or invest in other properties and for general corporate purposes including satisfying existing liabilities.

Factors That May Influence Our Operating Results

Acquisition Strategy. We plan to grow our business through the acquisition of new properties, initially targeting properties that meet the criteria described above under “Overview” and elsewhere in this report. We expect the properties we acquire will be subject to mortgage financing and other indebtedness that we will assume or refinance. Debt service on such indebtedness will have a priority over any distributions with respect to our common stock.

Rental Revenue. The amount of net rental revenue generated by our properties depends primarily on our ability to maintain the occupancy rates of currently leased space and to lease space that becomes available. As of March 31, 2017, our properties were 91% leased. We believe that the average rental rates for our properties are generally equal to the current average quoted market rates. Negative trends in one or more of these factors such as a decrease in rental rates or a decrease in demand for our properties could adversely affect our rental revenue in future periods. Future economic downturns affecting the Minneapolis-St. Paul metropolitan area or downturns in our tenants’ businesses that impair our ability to renew leases or re-let space or the ability of our tenants to fulfill their lease commitments could adversely affect our revenues. In addition, growth in rental revenue primarily will depend on our ability to acquire additional properties that meet our investment criteria.

Conditions in Our Markets. Our current properties are located in the Minneapolis-St. Paul metropolitan area. Positive or negative changes in economic or other conditions in this area, or areas in our prospective proprieties, including employment and wage rates, natural disasters and other factors, may impact our overall performance. Our ability to grow in our broader market throughout our region may also be impacted by these factors.

Operating Expenses. Our operating expenses primarily consist of property taxes, management fees, utilities, insurance and site maintenance costs. As of March 31, 2017, some of our leases required tenants to reimburse us for a share of our operating expenses. Increases or decreases in any unreimbursed operating expenses, either due to the nature of the expenses not requiring reimbursement from our tenants or due to a reduction in leased square footage requiring tenant reimbursement of a portion of our operating expenses, will impact our overall performance. Legal fees incurred in 2017 and 2016 were significant due to the Company’s acquisition and refinancing activities, as well as litigation expenses. We expect an increase in legal fees associated with these activities and business matters customary to a public real estate holding company, as well as our ongoing litigation.

Interest Expense. Our interest expense will depend on the amounts we borrow as well as the interest rates charged by our lenders. Our current loan agreements are a mix of both fixed and floating rates, as well as secured and unsecured by our properties. Our aggregate interest expense may increase as we acquire properties and could fluctuate between periods based on the variable rate loan arrangements, if we do not hedge any such interest rate risk.

Critical Accounting Policies and Estimates

Our discussion and analysis of the historical financial condition and results of our operations are based upon our financial statements which have been prepared in accordance with U.S. generally accepted accounting principles, or US GAAP.

The preparation of these condensed consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions in certain circumstances that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses in the reporting period. Actual amounts may differ from these estimates and assumptions. We have provided a summary of our significant accounting policies in the notes to the consolidated financial statements of our company elsewhere in this report. We have summarized below those accounting policies that require material subjective or complex judgments and that have the most significant impact on our financial condition and results of operations. We evaluate these estimates on an ongoing basis, based upon information currently available and on various assumptions that we believe are reasonable as of the date hereof. Other companies in similar businesses may use different estimation policies and methodologies, which may impact the comparability of our results of operations and financial condition to those of other companies. There have been no significant changes to those policies during the three months ended March 31, 2017.

Investment in Real Estate and Fixed Assets

Investment in real estate and fixed assets are carried at cost less accumulated depreciation and amortization. Property such as land, building and improvements includes cost of acquisitions, development, construction, and tenant improvement allowances. Maintenance and repairs are expensed as incurred, and major improvements are capitalized. We allocate the cost of an acquisition, including the assumption of liability, to the acquired tangible asset and identifiable intangibles based on their relative fair values. We assess fair value based on estimated cash flow projections that utilize appropriate discount and/or capitalization rates and available market information. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market economic conditions.

We allocate the cost of an acquisition, including the assumption of liability, to the acquired tangible assets (including land, buildings and personal property) determined by valuing the property as if it were vacant, and identifiable intangibles based on their relative fair values. Acquisitions of real estate are recorded based upon preliminary allocations of the purchase price to management’s assessment of the fair value of tangible and intangible assets and any assumed liabilities acquired which are subject to adjustment as additional information is obtained up to one year after the date of acquisition. Adjustments to preliminary allocations of purchase price are adjusted prospectively when all information necessary to determine the relative fair values has been received.

Depreciation is provided using the straight-line method over the estimated useful life of the assets for building, improvements, and furniture and equipment, and the term of the lease for tenant improvements. The estimated useful lives being used are as follows:

Intangible Assets

Upon acquisitions of real estate, the Company assesses the fair value of acquired tangible assets and any significant intangible assets (such as above- and below-market leases and value of acquired in-place leases), and any assumed liabilities, and allocates the purchase price based on these fair value assessments. The Company amortizes identified intangible assets and liabilities based on the period over which the assets and liabilities are expected to affect the future cash flows of the real estate property acquired. Lease intangibles (such as in-place or above- and below-market leases) are amortized over the term of the related lease. Above and below-market leases are amortized as a reduction in (addition to) rent revenue. Amortization of other intangibles is recorded in depreciation and amortization expense.

Principles of Consolidation

In determining whether we have a controlling interest in an affiliate and the requirement to consolidate the accounts of that entity, management considers factors such as ownership interest, authority to make decisions, contractual and substantive participating rights of the limited partners and shareholders, as well as whether the entity is a variable interest entity for which we are the primary beneficiary. The accompanying consolidated financial statements include the accounts of Talon Real Estate Holding Corp. (“TREHC”) and Talon OP, our Operating Partnership. Talon OP also consolidates 5130 LLC, an entity in which it has a 100% ownership interest as of December 2018, based on its ability to control the operating and financial decisions of 5130 LLC. All significant intercompany balances have been eliminated in consolidation.

Non-controlling Interest

Interests in the Operating Partnership held by limited partners are represented by Operating Partnership units. The Company's interest in the Operating Partnership was approximately 67% and 65% of the common units of the Operating Partnership as of March 31, 2017 and December 31, 2016, respectively. The Operating Partnership’s income is allocated to holders of common units based upon the ratio of their holdings to the total units outstanding during the period. Holders of preferred units receive certain distributions based on a percentage of the liquidation preference. Capital contributions, distributions, syndication costs, and profits and losses are allocated to non-controlling interests in accordance with the terms of the Operating Partnership agreement.

The portion of membership interests in 5130 LLC not held by Talon OP is reported as non-controlling interest. Capital contributions, distributions, and profits and losses are allocated to the non-controlling interest based on membership percentages and terms of the operating agreement. This percentage was be consolidated in December 2018.

Revenue Recognition

Base rental income is recognized on a straight-line basis over the terms of the related leases, inclusive of leases which provide for scheduled rent increases or rent concessions. Differences between rental income earned and amounts due according to the respective lease agreements are credited or charged to deferred rent receivable, as applicable.

Tenant recoveries related to reimbursement of real estate taxes, insurance, repairs and maintenance and other operating expenses are recognized as revenue in the period the applicable expenses are incurred. Recoveries are billed monthly using estimated operating costs and an additional billing or a refund is made to tenants in the following year after actual operating expenses are determined.

Accounting Standards Applicable to Emerging Growth Companies

We qualify as an “emerging growth company” pursuant to the provisions of the JOBS Act. Section 102(b)(1) of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. We have elected to use the extended transition period for complying with these new or revised accounting standards. Since we will not be required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies, our financial statements may not be comparable to the financial statements of companies that comply with public company effective dates. If we were to elect to comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act.

Significant Events and Transactions during the three months ended March 31, 2017

Summarized below are the Company’s significant transactions and events during the three months ended March 31, 2017.

On January 27, 2017, Talon First Trust, LLC entered into a Loan Agreement (the “Gamma Loan”) with Gamma Real Estate Capital LLC (the “Lender”), a Delaware limited liability company, in the principal amount of $51,600,000. The loan bears an interest rate equal to the sum of (i) the greater of (x) the Prime Rate as published in the Wall Street Journal, and (y) the LIBOR Floor, plus (ii) a margin of 9.00% per annum, and has an initial maturity date of January 26, 2018 with two 6-month options for the Company to extend upon satisfaction of certain conditions. Pursuant to the Gamma Loan, approximately $5,298,000 has been deposited into an interest reserve account to be applied toward monthly interest payments to the Lender. The Gamma Loan is secured by (i) a mortgage on the Company’s interest in its building located at 180 East 5^th Street, St. Paul, Minnesota, (ii) an assignment of lease and rents, (iii) 100% of the membership and ownership interests in the Parent, and (iv) other collateral specified in the Gamma Loan documents. The Gamma Loan documents contain events of default that are customary for loans of this type. The loan proceeds were used to pay-off the existing mortgage on the 180 East 5^th Street property, redeem the Talon OP preferred units, and fund various escrows and reserves related to the property.

On April 9, 2015, the Company entered into a significant lease arrangement with a new tenant. On January 27, 2017 the company executed a Second Amendment to the lease with the tenant to resolve issues concerning a notice of default that the Company received from the tenant on April 1, 2016. The Second Amendment rescinds the Notice of Default and the Termination Notice that the tenant had delivered, changes the lease commencement date from January 1, 2016 to January 1, 2018 and required the Company to place approximately $5,640,000 in escrow to provide evidence of our ability to pay for the remaining tenant improvements. We deposited the required escrow funds on January 27, 2017.

On January 25, 2017, in the matter of Swervo Management Division, LLC, as plaintiff, versus Talon Real Estate Holding Corp, Talon First Trust, LLC and Talon Bren Road, LLC, as defendant, the Company executed a $1,330,167 amended and restated promissory note, plus interest on the unpaid balance at 10%. The entire principal balance shall be due and payable on the earlier of July 24, 2017 or upon a time that the Company refinances or sells its property located at 10301 Bren Road. This note replaces the Amended and Restated promissory note dated June 30, 2016 in the amount of $953,908 ($1,008,908 as of December 31, 2016) given by Talon Real Estate Holding Corp. and Talon First Trust, LLC.

The Company filed a complaint in the State of Minnesota in June, 2016 to enforce the NOI Payment Agreement and other documents issued in conjunction with the Contribution Agreement entered into in May, 2014 with Bren Road, L.L.C. The defendant responded and filed a counterclaim and third-party complaint against Talon Bren Road, LLC and Talon OP, LP in July, 2016. In November, 2016 the matter came before the court on the Defendant’s motion for partial summary judgment. Subsequently, in February, 2017 the Hennepin County District Court issued a Findings of Fact and Order for Judgment on the counter claim against the Company in the amount of $719,365, plus post judgment interest which pursuant to our 10301 Bren Road and 180 East 5^th Street loan agreements, constitutes a non-financial event of default. The outstanding amount of the judgment was satisfied on June 23, 2017 as part of the refinancing of Talon Bren Road, LLC’s outstanding mortgages.

In March, 2017, a significant tenant of our 180 East 5^th Street, St Paul property filed for Chapter 11 bankruptcy protection from its creditors. The Company lost a portion of March rent from the period of the initial filing until a Trustee could be appointed. From the date of Trustee appointment through September 30, 2017, full lease payments were received by the Company. Under the terms of the bankruptcy, the tenant’s lease was terminated effective September 30, 2017.

On March 27, 2017, Talon Bren Road, LLC received a notice of default under the terms of our second mortgage agreement, the outstanding balance of which was $2,000,000 as of the date of the receipt of the notice. This mortgage was refinanced on June 23, 2017 which resolved the default.

Market Conditions and Outlook

Our last two acquisitions were accomplished utilizing a 721 Exchange tax deferral methodology similar to that of an “UPREIT” providing several unique advantages over a 1031 exchange or selling to cash buyers. This strategy is advantageous for real estate owners seeking to mitigate and defer their immediate tax obligations, stay invested in real estate, diversify their holdings, and seek potential future growth and liquidity by accepting Talon OP common units which can later be converted 1:1 for Talon common stock, which trade under the ticker “TALR,” and their capital gains tax obligations are deferred until then.

Our strategy is to continue offering these tax-deferred solutions to real estate owners as part of diversifying our shareholder base creating liquidity and shareholder value. We continue to believe office and industrial properties offer the best return on equity metrics as part of our investment strategy. Retail will also be part of our overall portfolio with an average overall target portfolio contribution of nearly 20% over the long-term.

The middle corridor of the United States continues to offer higher cap rates compared to the west and east coasts and we will continue to explore additional investment options within this region to continue our mission to provide return on equity targets of 8-15% per asset or portfolio.

Results of Operations

Our revenues and expenses have changed primarily due to increases in expenses attributable to an increase in legal services related to our legal proceedings in 2017. We expect our revenues, tenant reimbursements and many expenses will continue to increase on an absolute basis in the future as we seek to acquire additional properties, assume or refinance indebtedness in connection with the acquisitions and build the infrastructure necessary to grow our business. In the near term, we expect to continue to incur higher legal and other professional fees in pursuit of potential acquisitions.

Three months ended March 31, 2017 compared to three months ended March 31, 2016

Revenues and Expenses

Rental revenues decreased $104,842, or 5.6%, to $1,771,070 for the three months ended March 31, 2017, compared to $1,875,912 for the same period of the prior year. The modest decrease in rental revenue relates to several smaller adjustments to rented space and certain lease rate adjustments with no significant new leased space across the portfolio.

Tenant reimbursements decreased $36,107, or 4.0%, to $861,384 for the three months ended March 31, 2017 compared to $897,491 for the same period of the prior year. The decrease in tenant reimbursements is consistent with the decrease in rent and stable property operating expenses.

Other income decreased $61,263, or 71.2%, to $24,738 for the three months ended March 31, 2017 compared to $86,001 for the same period of the prior year. The decrease primarily relates to lower recorded amounts related to an income guarantee on one of the properties owned and lower revenue from an event center located in the 180 East 5^th Street property in St. Paul.

General and administrative expenses decreased $295,231, or 85.1%, to $51,722 for the three months ended March 31, 2017 compared to $347,033 for the same period of the prior year. The decrease is primarily due to the expensing of $285,000 of lost deal costs in 2016 with no comparable expense in 2017.

Salary and compensation expenses decreased $42,675 or 19.0%, to $182,022 for the three months ended March 31, 2017 compared to $224,697 for the same period of the prior year. The decrease in salary and compensation expense is primarily related to staff turnover in late 2016 resulting in lower salaries for replacement personnel in 2017.

Professional fees increased $131,295, or 58.1%, to $357,140 for the three months ended March 31, 2017 compared to $225,845 for the same period of the prior year. The increase is primarily due to an increase in legal services related to our legal proceedings and refinancing of debt in the three months ended March 31, 2017.

Property operating expenses decreased $6,391, or 0.5%, to $1,179,187 for the three months ended March 31, 2017 compared to $1,185,578 for the same period of the prior year. Property operating expenses have remained essentially unchanged due to a stable operating environment and the lack of unusual or infrequent expenditures.

Real estate taxes and insurance increased $14,902 or 3.4%, to $460,379 for the three months ended March 31, 2017 compared to $445,477 for the same period of the prior year. The three months ending March 31, 2017 are in line with the annual increase in real estate taxes across the portfolio as the composition of our real estate portfolio remained the same.

Depreciation and amortization expense decreased by $14,163, or 1.2%, to $1,218,242 for the three months ended March 31, 2017 compared to $1,232,405 for the same period of the prior year. The decrease is primarily attributable to certain intangible assets expiring in correlation with the applicable leases.

Interest expense increased by $796,389, or 107.1% to $2,024,427 for the three months ended March 31, 2017 compared to $1,228,038 for the same period of the prior year. The increase is primarily attributable to the refinancing of the 180 East 5^th Street mortgage and other changes in outstanding debt. The weighted average interest rate increased to 11.77% as of March 31, 2017 compared to 6.49% as of March 31, 2016 and outstanding debt increased by $23,105,751. In addition, deferred financing cost amortization was accelerated on the refinanced debt and significant new deferred financing costs were incurred which have predominantly a one-year amortization period.

Funds from Operations and Non-GAAP Reconciliation

The National Association of Real Estate Investment Trusts, or NAREIT, defines funds from operations, or FFO, as net income (loss) available to common shareholders and operating partnership unit holders computed in accordance with GAAP, excluding gains or losses from sales of operating real estate assets and extraordinary items, plus depreciation and amortization of operating properties, and after adjustments for unconsolidated partnerships and joint ventures. We intend to calculate FFO in a manner consistent with the NAREIT definition.

Management intends to use FFO as a supplemental measure to conduct and evaluate our business because there are certain limitations associated with using GAAP net income alone as the primary measure of our operating performance. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Because real estate values instead have historically risen or fallen with market conditions, management believes that the presentation of operating results for real estate companies that use historical cost accounting is insufficient by itself. In addition, securities analysts, investors, and other interested parties use FFO as the primary metric for comparing the relative performance of equity REITs. There can be no assurance that FFO presented by us is comparable to similarly titled measures used by REITs.

FFO should not be considered as an alternative to net income or other measurements under GAAP as an indicator of our operating performance or to cash flows from operating, investing or financing activities as a measure of liquidity. FFO does not reflect working capital changes, cash expenditures for capital improvements or principal payments on indebtedness.

We define adjusted funds from operations, or AFFO, as FFO excluding the non-cash effects of straight-line rent and amortization of lease inducements and deferred financing costs, depreciation of non-real estate, and excluding the effects of non-cash compensation charges. U.S. GAAP requires rental revenues related to non-contingent leases that contain specified rental increases over the life of the lease to be recognized evenly over the life of the lease. This method may result in rental income in the early years of a lease that is higher than actual cash received, creating a deferred rent receivable asset or lower income than actual cash received, creating a deferred rent revenue liability included in our consolidated balance sheet. At some point during the lease, depending on its terms, cash rent payments may exceed or be lower than the straight-line rent which results in the deferred rent receivable asset or liability, respectively, decreasing to zero over the remainder of the lease term. By excluding the non-cash portion of straight-line rental revenue and amortization of lease inducement and deferred financing costs as well as non-cash compensation expense, investors, analysts and our management can compare AFFO between periods.

Below is the calculation of FFO and AFFO and the reconciliation to net income (loss), which we believe is the most comparable GAAP financial measure:

Reconciliation of Net Income Attributable to Talon Real Estate Holding Corp. (“TREHC”) to Funds From Operations

⁽¹⁾ Non-controlling Units of the Operating Partnership are exchangeable for cash, or at the Company's discretion, for common shares of stock on a one-for-one basis.

⁽²⁾ Net income is calculated on a per share basis. FFO and AFFO are calculated on a per share and unit basis.

Liquidity and Capital Resources

Liquidity is a measure of our ability to meet potential cash requirements, including commitments to repay borrowings, fund and maintain our operations and assets, acquire properties, make distributions to our shareholders and other general business needs. We have incurred significant expenses related to operating as a public corporation, building and tenant improvements at our properties, and preparation for and execution of our acquisition strategy creating a cash shortfall from operations through March 31, 2017.

We currently do not have available cash and cash flows from current operations to provide us with adequate liquidity for the foreseeable future. Our current liabilities exceed our unrestricted cash and we have insufficient cash flow from current operations to pursue our strategy without further financing. As of March 31, 2017, we had unrestricted cash of approximately $88,596 and current liabilities including tenant improvement allowances, unsecured debt, accounts payable and accrued expenses substantially in excess of the available cash. We therefore will require additional capital and increased cash flow from future operations to fund our ongoing business. There is no guarantee that we will be able to raise any required additional capital or generate sufficient cash flow from our current and future operations to fund our ongoing business. If the amount of capital we are able to raise together with our income from operations is not sufficient to satisfy our capital needs, we may be required to cease our operations or alter our growth plans. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our consolidated financial statements, and it is likely that investors will lose all or a part of their investment.

Our short-term liquidity requirements consist primarily of funds needed to pay for operating expenses and other expenditures directly associated with our properties, pay off maturing debt, and to pursue our strategy of near-term growth through acquisition of properties as well as general and administrative expenses operating as a public company.

Our long-term liquidity requirements consist primarily of funds to pay for scheduled debt maturities, non-recurring capital expenditures that need to be made periodically and continued expansion of our business through acquisitions. Although we plan to aggressively pursue acquisitions to grow our business, there is no assurance that we will be able to acquire additional properties in the future.

Since our available cash and cash flows from current operations do not provide us with adequate cash to satisfy current liabilities and are not expected to provide us with adequate liquidity for the foreseeable future, we anticipate that we will undertake future debt or equity financings or asset sales during 2017. Additional financing or asset sales are necessary for our company to continue as a going concern.

In the future, we anticipate using a number of different sources to finance our liquidity needs, including cash flows from operations, issuance of debt securities or equity securities (which might be common or preferred stock), private financings (such as additional bank credit facilities or cash advances, which may or may not be secured by our assets), asset sales (including sales of accounts receivable), seller financing, property-level mortgage debt, or any combination of these sources, to the extent available to us, or other sources that may become available from time to time. Any debt that we incur may be recourse or non-recourse and may be secured or unsecured. Although we have successfully raised equity capital in the past, we cannot be assured that we will be able to continue to be successful in raising capital through issuance of securities. Our ability to obtain needed financing may be impaired by such factors as the capital markets, our status as a new enterprise without significant assets or demonstrated operating history, and/or the loss of key management. There is no guarantee that we will be able to raise any required additional capital or generate sufficient cash flow from our current and proposed operations to fund our ongoing business. Ongoing litigation may also impact our liquidity, as cash flow may need to be used on legal and other litigation expenses.

Outstanding Indebtedness

5130 LLC, an entity in which our Operating Partnership owns a 49% interest and that owns an industrial complex located in the Minneapolis-St. Paul metropolitan area, is party to a loan agreement secured by such industrial complex. This percentage was be consolidated in December 2018. The loan agreement provides for two term loans, the A loan and the B loan. The term loans had a balloon payment due on April 8, 2017 and is past due. The Company expects to refinance this loan but as of the filing of this document has been unable to do so.

Talon Bren Road, LLC, an entity through which our Operating Partnership acquired the property located at 10301 Bren Road West, Minnetonka, MN on May 29, 2014, is party to a loan agreement secured by such property. It is also a party to two loans the proceeds of which were used to fund certain capital improvements at the building. This property also secures the Talon Bren Road, LLC Mortgage 2 (as defined in the table below) entered into on July 2, 2014 in connection with the acquisition of the property located at 180 East 5^th Street St. Paul, MN.

Talon First Trust, LLC, an entity through which our Operating Partnership acquired the property located at 180 E. Fifth Street St. Paul, MN on July 2, 2014, is party to a loan agreement secured by such property. The loan has an initial maturity date of January 26, 2018 with two 6-month options for the Company to extend upon satisfaction of certain conditions. If we are unable to satisfy the conditions to extend, we will need to seek alternative financing or possibly sell the property in order to satisfy the obligation.

TREHC has additional indebtedness related to various judgments and obligations arising in the normal course of financing our operations. These notes represent current obligations of the entity and continue to accrue interest while outstanding. We may need to seek alternative financing or sell certain assets in order to generate the necessary funds to satisfy these obligations.

The following table summarizes the Company’s notes payable as of March 31, 2017 and December 31, 2016: